[00:00] What is Inflation?
[00:25] How Inflation Affects the Real Estate Market
[01:42] How to Hedge Against Inflation with Real Estate
[02:41] How to Hedge Against Inflation Using Mortgage Loans
[03:43] Advice for Prospective Real Estate Investors
[04:22] Shameless Plug

Inflation refers to the increase in the average price of a basket of goods or the cost of living. When those prices increase purchasing power decreases. So for example, if inflation is 8% per year, when a basket of goods that costs $100 is repriced a year later after 8% inflation, that same basket of goods would cost $108.

Inflation affects the market in a variety of ways.

In the U S the federal Reserve’s primary task is to keep inflation at a steady and manageable rate, in order to avoid, big runs in the economy, followed by severe recessions. The way that the fed tackles inflation is by raising interest rates.

And the purpose of that is to increase the cost of borrowing, which makes expansion of the economy more expensive and tends to slow down the development of housing, the production of goods, and a variety of other things in the economy.

Consequently, mortgage rates also rise during periods of inflation whenever either lenders anticipate that the fed or the market average interest rate will go up or when they are following increases in the federal reserve rate.

For example, In real estate development, the cost of construction materials, the cost of machinery, and by extension, the cost of labor, all increase. So developing a piece of real estate in an 8% inflationary environment, typically becomes about 8% more expensive to build.
So consequently, a real estate development project during a period of inflation will be more expensive to build after inflation than it would have been before.

I just got a call from a client who is worried about inflation, particularly with recent news coming out that inflation is on the rise. And he asked me, “Is there a way that I can take advantage of this in order to capitalize on the rising inflation and what is certain to be the impending rise of interest rates?” And I told him ” Absolutely, yes.”

In real estate investments, rents typically rise during inflationary periods. And that’s just because the cost of ownership of the building becomes more expensive and landlords typically pass that higher expense onto their tenants.

Consequently, the increase in income in investment real estate also causes the value of the real estate to up.

And this is why real estate is a great hedge against inflation. Because rents and income will typically rise with inflation, and therefore the real estate investor will not lose as much purchasing power from their cashflow as they would have if they weren’t invested in real estate.

And strengthening that increase in value is the cost of debt. During an inflationary period, when interest rates go up, new debt becomes more expensive. So existing debt becomes relatively cheaper. For instance, if you have a 4% mortgage on a piece of real estate, and then after inflation, interest rates rise to 6%, then the real estate owner who has a 4% mortgage is effectively getting below market financing and therefore earning greater returns than they would if they had 6% financing on the property.

Savvy real estate investors that understand this will use this to their advantage by taking a look forward at when their existing loans are coming due, and will often choose to refinance early in order to lock in the current interest rate and hedge against future inflation.

If you have a loan coming due in the next couple years, it’s highly likely that your interest rate then will be much higher than it would be today, if you locked in a fixed rate loan right now.

Prospective real estate investors, or those who are not yet invested, but thinking about getting into investing, they need to be careful. Real estate can be a great hedge, but there are certain risks associated with investing in real estate in an inflationary period, especially if you’re holding period is projected to be very short.

The Fed’s reaction of raising interest rates in order to curb inflation is an attempt to slow down the economy and that puts the real estate market at risk of a correction or a bubble.

It’s probably a good idea to have a longer projected hold time and to lock in as long of a fixed rate loan period as possible.

Understanding inflation is just one small part of a vast array of knowledge that is necessary to be successful in real estate investing. So you haven’t already, check out my online real estate courses for training and coaching and real estate investing at TrevorCalton.com.

#realestateinvesting #realestatefinance #TrevorCalton #EvergreenLLC
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