• Inflationary risks are rising in a post-pandemic world, and public awareness is at an unrivaled high.
• Inflation is known to hurt many investments (especially fixed-income securities) that are subject to daily market fluctuations, but it can actually strengthen real estate performance
• Diversifying your portfolio with real estate investments provides a significant hedge against inflation
According to Google Trends, “inflation” was searched 50% more between May 9–15, 2021 than it has been in the past five years.
Why the sudden interest in inflation?
On May 12, the government announced that the consumer price index (CPI) was 4.2 percent higher in April 2021 than the year prior, the fastest growth spurt we have seen since the Great Recession in 2008. (Inflation in the United States peaked at 13.5 percent in 1980.) And it’s not slowing down—June 2021 saw a 5.4% increase compared to June 2020. After a rough 18 months, these announcements are sending some into a tailspin. For others, the news stories came as no surprise.
In response to the COVID-19 pandemic and subsequent lockdowns, policymakers and central banks have introduced stimulus packages worth trillions of dollars, “printing money” to thwart a global economic crisis. Historically, these emergency fiscal policies have set a precedent for a rapidly increasing inflation that reflects an equal increase in the velocity of money. Evidence of increased velocity has not yet come to fruition, but the money supply (as measured by M2) has increased by more than 20% in the U.S. since the recession started in February 2020.
Inflation is inevitable, and the Fed expects a 2% average increase year over year. But beyond that percentage, economic risks swell—including runway inflation that is known to result in a recession. No one has officially sounded the emergency alarm just yet, but economists, government officials, and Wall Street are on high alert.
(M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money; it is a widely used indicator of money supply and future inflation as well as a target of central banking’s fiscal policy.)
So should private real estate investors be this weary of inflation too?
Let’s release the pressure value: inflation does NOT erode the value of real estate. In fact, real estate is a hedge AGAINST inflation; beyond that, it generally performs well during periods of high interest rates. (Read our full guide to inflation and interest rates here.)
For any investor, inflation is an important factor in considering returns. Most investors primarily seek to grow their long-term purchasing power; many do so through fixed-income securities. However, that puts this primary goal at risk.
- First and foremost, those returns must keep up with the inflation rate.
- When adjusted for inflation, an investment that returns 2% in an environment of 3% inflation will produce a negative return (−1%).
Since real estate is backed by a “hard” asset that generates cash flow, it is generally viewed as frontline portfolio protection against inflationary risks. Here’s why:
It would not come as a shock if inflation held steady at 3–4% in 2021 before it slopes off in the coming years as the effect of pandemic-related government spending fades. On the other hand, rent growth will likely continue to outpace inflation due to the vast housing shortages in nearly every market.
Note: Past performance is not indicative of future results.