The news cycle has fixated on inflation in recent months, causing concern that we are on the brink of 1970s-style stagflation. Gas prices are up, no one can seem to find a rental car, and we see this on our newsfeed:
“Prices keep soaring: Inflation rockets to a 13-year high” – CNN Business
“Watch out: High inflation plus very low-interest rates are a deadly combination for stocks” – Fortune
“How Inflation Is Killing Social Security Quicker”– The Motley Fool
Despite the splashy headlines, the Fed and many economists believe that this is a temporary blip with high inflation rates caused by supply chain bottlenecks and the lower base prices we saw during the depths of the pandemic shutdowns a year ago. (PS: We agree.) They are qualifying anything above the standard 2% increase as “purely transitional” as we return to normalcy.
But other economists and investors argue that inflation could become a larger, lasting issue. There are suspicions that inflation expectations could hold steady at elevated levels, eroding the dollar’s purchasing power for the foreseeable future. In the past, the Fed has stepped in and increased interest rates to tamper inflation, which is also raising red flags for some. These fears are now trickling down to the average consumer.
Inflation: A Self-Fulfilling Prophecy?
Oscar Wilde once wrote, “Life imitates art far more than art imitates life.” These sensational (often distorted) stories are driving spending behavior, and a large swath of the consumer base is rushing to spend now and spend more in response to inflation fears, driving up demand and prices as they go. Inflation essentially is feeding itself, creating a pattern that can be hard to break.
How to Outsmart Inflation …
As an investor, you have the power to protect your investment dollars by taking pragmatic, preemptive steps—no matter what the future holds. These are several approaches that have historically provided inflation protection and maintained future spending power:
1) Buy more stocks, where gains typically outperform inflation
2) Purchase international stocks to diversify from local inflation
3) Invest in real estate assets that see rents and property values increase during inflationary periods while debt is paid back with inflated dollars. (For more, click here.)
4) Buy treasury inflation-protected securities, as coupon payments rise with inflation
5) Purchase precious metals and commodities that see prices rise with inflation
6) Invest in floating-rate loans or bonds—as inflation and eventually interest rates rise, the interest payments will too.
… With Real Estate Investments
Of course, we are here to talk about why real estate is the best hedge against inflation.
During times of inflation, it’s actually beneficial to be a debtor. If you borrow $500,000 today and plan to pay it back in 10 years during a period when there is a 2.5% annual inflation rate, you will still have to pay back $500,000. However, the sum you pay back in a decade will be worth 28% less due to inflation, meaning you will be paying back the equivalent of a $390,000 loan today.
In short, inflation “deflates” the value of the loan in comparison to the dollars you use to pay it back. Not only does the loan get cheaper, but rents typically rise to keep up with inflation. If rent increases keep up with or outpace expense growth, net income and the value of the property will increase as well. Having less debt relative to income is great for your real estate investments.
For more on real estate as an inflation hedge, click here.
If inflation and interest rates have you on edge, think calmly and logically about your portfolio construction and allocation strategy. Rather than panic-buying or selling at a loss, rebalance your portfolio to restore your target allocations. By doing so, you will naturally buy when the market is low and sell when the market is high.
Our best advice is to prepare your portfolio allocations now, include real estate as an inflation hedge, and rebalance as necessary when the market gets spooked.
For our full guide to inflation and interest rates—and how they apply to real estate investing—click here.