Inflation is one of those words that gets tossed around a lot, but many do not really understand what it means or how it can impact our day-to-day lives and long-term wealth.
In short, inflation is the rate at which prices for goods and services increase. It is measured by looking at the change in price levels over time. The US economy is almost always in a state of inflation - the Federal Reserve targets an inflation rate of around 2% (although it is not always successful). Instead, we have averaged 3.8% for the past 60 years. It is the Federal Reserve’s job to monitor the economy and make adjustments to keep inflation at acceptable levels.
Recently, the US inflation rate has been over 8%, which is considered out of control, and the Federal Reserve was forced to take action by yanking up interest rates.
When inflation is high, what does that mean for your investment portfolio?
Different asset classes respond to inflation in their own ways. For example, when inflation begins, many investors get excited as they watch their stock values increase. This is known as asset price inflation. Asset price inflation is when stocks, bonds, and real estate rise at a faster rate than the overall inflation rate. It can be a good thing for investors but can make it increasingly challenging to enter the market as an investor.
Unfortunately for stock investors, the stock market was the first to feel the impact once the Federal Reserve stepped in with interest rate hikes. Because of its volatility, the stock market is usually the first to react to uncertain economic climates, and that has undoubtedly been the case in 2022. So, how can you protect yourself, your assets, and your net worth from inflation?
Hedge against inflation through investment.
When inflation is high, it erodes the purchasing power of people’s salaries and savings, making it harder to afford everyday items. It also can worry investors because it can eat into the value of their investments. As a result, investors and savers are now wondering how to protect their capital in such an inflationary economy. Common investment tools to hedge against inflation are:
- Gold
- Reducing bonds and buying stable stocks - however, this can be challenging in a volatile stock market.
- Treasury inflation-protected securities (TIPS)
No strategy is perfect; what’s important is for you to weigh your risk tolerance with the potential gain and make decisions based on data and market knowledge. But one of the best investment classes to hedge against inflation is multifamily because it is an essential need.
Hedge against inflation with multifamily investing.
A consistent trend during inflationary times is that housing costs also tend to go up. For example, the single-family housing market has seen record-breaking growth over the past two years, with most rental markets not far behind. Historically, unit rents tend to outpace inflation, market-depending. As market rent increases, multifamily investors benefit because (depending on state and local housing regulations) when leases are renewed, their rate is either increased by a set amount or brought to market rent. When market rents have been rising (in some areas) as much as 10% year-over-year, that means substantial yield increases for multifamily investors.
Furthermore, multifamily usually has lower vacancy rates than other real estate investment classes. Therefore, during times of inflation, if a unit becomes vacant, it can actually benefit the investor because the unit can then be tenanted at the new market premium.
If a multifamily asset is selected well at the time of purchase and then managed carefully, the rents can mitigate inflation.
Difficulties that come hand-in-hand with inflation.
Inflation does not remain high for long before the Federal Reserve takes action, which is exactly what we are seeing now with rapid interest rate hikes. To rein in inflation to a tolerable level, the Fed implements a series of interest hikes, often leading to a forced recession. In addition, high interest rates can make purchasing multifamily properties difficult.
But while interest rates for investors go up, so do interest rates for homebuyers, which we are seeing today. Unfortunately for many buyers, high interest rates mean that they see their purchasing capacity plummet. For example, a homebuyer who qualified for a $500,000 mortgage at the start of the year may qualify for $250,000 today, which may likely isn’t enough to get them a desirable property in their area. As a result, many aspiring homebuyers choose to remain renters, contributing to increased tenant demand for multifamily and single-family rentals.
A key takeaway should be that while multifamily properties can be an excellent way to hedge against inflation, the asset selection strategy can make or break your investment. Therefore, choosing properties with strong demographic metrics, including population, job, and income growth, should all be factored into the asset acquisition strategy and an investment’s underwriting process.
Working with an experienced multifamily investment company like Crown Capital Management allows investors to put the stress of finding deals and managing properties in the hands of professionals. Each property undergoes an intensive due diligence process to preserve investor capital and deliver predictable returns. For more information on how to hedge against inflation with passive multifamily investing, contact
Kevin Greer, Managing Director
Crown Capital Management LLC.
312-525-1131