With the news cycles dominated by headlines regarding the economy and particularly inflation, seeing the numbers the highest in four decades, many investors are seeking strategies and investment opportunities that will buck the bear market and still yield high returns.
First, let's take a step back and actually understand the meaning of inflation. Inflation is defined as the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Inflation can have a number of different effects on an economy, but for the purposes of this article, we'll focus on investments, and more specifically, real estate investing.
Of all the different types of investment products, it is generally understood that real estate, and specifically real estate debt as a form of investing, is a strong hedge against inflationary market conditions.
In order to understand how real estate functions as a hedge against inflation, it is important to first understand how inflation affects investments. Generally speaking, investments can be divided into two categories: real assets and paper assets. Real assets are physical items that maintain their value or appreciate over time, while paper assets are financial instruments whose value is based on faith and credit.
During periods of inflation, paper assets tend to lose value because the amount of currency available in circulation increases, therefore each unit is worth less. On the other hand, real assets such as commodities and real estate usually increase in price along with the general level of prices, so they maintain their value or go up in value relative to paper assets. When inflation is high, each dollar you have in the bank loses value. Over time, this can eat away at your purchasing power and leave you worse off than if you had just kept your money under your mattress.
While there are risks associated with any type of investment, including real estate, diversifying your portfolio with investments in both real and paper assets can help protect you from inflationary pressures.
Keep Pace with Inflation
Inflation is a broad measure of the average price level of goods and services in an economy. It's important to understand how inflation can impact investments, as even a small change in the inflation rate can have a significant effect on the purchasing power of your investment portfolio.
For example, say you have a portfolio valued at $100,000. If inflation is running at 6%, then your portfolio will only be able to purchase $94,000 worth of goods and services in the following year. In order to keep pace with inflation, your portfolio would need to grow by at least 6% over the course of the year.
Inflation and Your Portfolio
As an investor, it's important to be aware of how inflation can affect your portfolio. Here are a few ways that inflation can hurt your finances:
The Stock Market May Stagnate
Inflation can also lead to stagnation in the stock market. That's because as companies' costs increase due to inflation, their profits may not keep pace. As a result, their stock prices may not increase as much as investors would like. In fact, if profits don't keep up with inflation at all, then stock prices may actually fall.
You'll Need to Save More for Retirement
If you're already retired or close to retirement, rising prices due to inflation can eat into your nest egg faster than anticipated. That's why it's important to have a retirement plan that accounts for the possibility of higher inflation. Working with a financial advisor can help you create a retirement strategy that takes inflationary pressures into account.
Safeguard your investments with Groundfloor. Learn how we do this.
Demand for Real Estate During Inflation Periods
When inflation rates rise, so does the demand for certain types of investments. One of these is real estate since it is seen as a stable way to preserve the value of your money. However, before making any decisions, it is important to understand how inflation affects different sectors of the real estate market.
In order to make sound investment decisions, it is crucial to have a firm understanding of how inflation affects the demand for different types of real estate. One way to hedge against inflation is to invest in assets that are not as affected by inflationary pressures. Real estate can be a good hedge against inflation for a number of reasons.
The first reason why real estate can be a good hedge against inflation is that real estate values generally increase along with inflation. This means that although each dollar buys you less than it did in the past, your real estate assets are likely to be worth more in nominal terms. That increased value can offset some of the loss in purchasing power caused by inflation.
Another reason why real estate can be a good hedge against inflation is that real estate owners have the ability to raise rents in order to keep up with increases in the cost of living. This means that owners' incomes are less likely to be eroded by inflationary pressures than those of people who solely rely on wages or fixed investments.
Finally, real estate has what is known as intrinsic value. This means that even if there were no such thing as cash flow or rental income, an investor could still sell the property and recoup some of their investment. This makes real estate one of the more secure investments out there and helps protect investors from losses should there be a sudden drop in asset prices.
Different Real Estate Sectors = Different Impacts
It’s no secret that inflation can have a major impact on real estate prices and demand—but not all sectors are created equal. Here’s a look at how some of the most common types of property are influenced by inflationary periods.
Residential Property
In areas with high inflation, there is often an increase in demand for a residential property close to urban centers. This is because people want to be able to commute to work easily and don’t want their purchasing power to be diminished by rising prices. Families may also choose to move closer together in order to pool resources and save money.
On the other hand, in low-inflation environments, as we saw in 2021, people are more likely to trade up to larger homes since they can afford them and feel confident that their home’s value will continue to appreciate. Since demand has a direct impact on prices, this sector is particularly sensitive to changes in the rate of inflation.
Commercial Property
The impact of inflation on the commercial property varies depending on the type of business being conducted. For example, businesses that require a lot of inventory or those that sell products that are price-sensitive may suffer during periods of high inflation because consumers will start cutting back on spending. On the other hand, businesses that provide services that people need regardless of the economic conditions will be less affected by changes in inflation rates—but they will still be impacted since their customers will have less disposable income.
In general, businesses located in areas with high foot traffic tend to weather economic downturns better than those located in out-of-the-way places since people are more likely to keep going to these locations even when they’re cutting back on spending elsewhere. As with residential property, changes in commercial rental rates lag behind changes in the overall rate of inflation—so if you’re thinking about investing in this sector, it’s important to be patient and wait for prices to catch up before buying anything.
Industrial Property
Just like commercial property, industrial property is impacted by changes in consumer spending habits—but there are some additional factors at play as well. For instance, manufacturers tend to do very well during periods of high inflation because they can pass along their higher costs to customers without fear of losing market share (since people still need their products). Additionally, many companies choose to lease industrial space rather than buy it outright—so if you own industrial property, you may find yourself with tenants who are locked into long-term leases even when conditions start to deteriorate.
That said, there’s always a risk that companies will go bankrupt or decide to move operations abroad during periods of high unemployment and/or low economic growth—so if you do invest in this sector, make sure you diversify your holdings in across different industries and geographical regions.
Growth in rent has moved in Line with Inflation
Despite an unpredictable economy, real estate has been a dependable way for investors to safeguard against inflation. Thanks to landlords' ability to raise rents in markets with low vacancy rates, returns are often able to pass the test of time – making investments more profitable even as prices rise and living costs increase.
Despite the shock of global inflation increases over the last year, real estate investment remains an attractive asset for protecting investors from these market risks. Historically, rising prices have not had a negative effect on property performance due to its reliable income generation amid economic uncertainty - such as was seen during 2020's COVID-19 pandemic. Data suggest that investing in real estate may be one of the safest options when faced with high levels of inflation and volatility elsewhere in markets.
Groundfloor Investments That Can Help You Keep Pace With Inflation
There are a number of investment options that can help you keep pace with inflation.
Groundfloor Real Estate Investments: In a first-lien position, Groundfloor’s investments are secured by real assets. You can choose individual renovation projects to invest in, or use our automatic investing tools to continuously invest in projects that meet your criteria.
Investments repay every 4-12 months on average, so if you make investments each month, after four months, you’ll always have investments repaying each month. That’s pretty good liquidity for a secured investment backed by real assets! Groundfloor is a safe way to earn great results.
