Inflation and the Great Hedge
Updated: Sep 12
What is inflation?
The accepted definition according to Wikipedia is:
“a general increase in the prices of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduction in the purchasing power of money.”
In simple laymen terms, Inflation is actually the devaluation of the dollar. The reason for inflation is the over printing and circulation of cash in the economy. Our wants desires and needs are never satisfied. Too much cash in circulation creates to much access to the ability to feed the insatiable demands brought on by human wants and desires. This puts pressure on the product or service producers to attempt to keep up with this overabundance of access to cash. In an effort to get this disparity under control the producers will increase pricing in the attempt to slow demand. Governments will raise taxes to decrease the amount of cash in circulation or increase interest rates in an attempt to reduce demand. This is a simplification of a much more complicated economic theory but some of the most complicated theories can be expressed in simple terms.
Have home values really increased?
Let’s see. Five years ago, our friend John purchased a home for, $150,000. Today however he can sell that house for $325,000. Wow! the value of his home really went up. Or did it? Let’s see, did he do any major improvements? No? Did all the other houses in his neighborhood burn down or move away making the demand for his home more valuable due to scarcity? No? Did the increase in population and demand in his area suddenly grow in the past 5 years, at a rate that exceeded the ability for builders and suppliers to support the demand? Maybe, but highly unlikely, at least not to the point to cause values to appreciate at a rate greater than 20% per year. So, if the factors that would typically cause value to increase are not present, then what happened to cause the VALUE of John’s home to increase so significantly? The simple answer is it didn’t. The real value of John’s home likely didn’t increase much at all. So, what happened? What happened, was the Dollar (cash) that John used to purchase his home, the same dollar that the rest of use to purchase our homes and other goods and services, lost its value. Why? because there’s a lot more of it available in circulation to spend today then there was five years ago. There you have it. More money supply, without the ability to satisfy the natural human desire for more that creates demand (example: lack of housing inventory, labor and supply chain issues) has caused an increase in pricing. That’s the simple explanation of inflation.
So now you may be asking the question, if there’s so much new money circulating in the economy, then where’s mine? Why are things more expensive than they were before? why do I have to work harder for what I want? Why do I have less to spend and save then I did before? Well, I did say that there is more money available and circulating in the economy, but that doesn’t mean it circulates evenly or to everybody. Statistically real estate has increased in cost in some markets as much as 200% since 2008 but salaries may have increased, if you’re lucky, at the rate of only 30%. So, without all of that increased circulation not flowing through you, what are you left with? Higher prices and not enough cash to afford those higher prices. This phenomenon is the negative result of Inflation and what we should attempt to hedge against.
Does real estate provide a hedge against inflation?
The answer to this question is? Yes and no. The value of real-estate, like the value of any other product or service, is driven by supply and demand. For John’s home to have increased 116% in the five years that he owned it, would mean that a significant amount of inflation occurred but also that the demand for his home stayed constant or increased. Not all real estate types have this characteristic of demand. For example, retail, office and much of the hotel industry’s real estate values were decimated due in strong part to the pandemic, but also due to the availability of new technology and services that allow for people to work and shop from home in significant enough numbers to effect demand for those types of real estate. At the same time the demand for certain types of Industrial real estate has increased for the same reasons.
As an asset class, investment groups like the Arela Partners who are real estate advisors and investment fund sponsors, choose to specialize in residential and multifamily rental and for sale real estate. Their reasoning is pretty basic. “No matter what’s going on in the world, people will always need a place to live”. Residential real estate is a class or type of real estate that even though demand may shift, demand will always exist. Since the pandemic and the work from home boom occurred, demand for homes and other types of residential real estate in parts of the country once considered rural and suburban have exploded. Areas like the Sunbelt states, where values were depressed relative to the values in the larger metropolitan cities are growing rapidly due to rates of demand that supply can’t support. This demand has occurred because the Sunbelt areas presented more value for the dollar and for many, a better way to live. Since we are no longer limited to where we can live because of where we can work or what we can access by way of products or services, this shift has made the residential real estate in these areas a great value-add and a significant hedge against inflation.
The Arela Partners, who are real estate advisors and investment fund sponsors, chose to specialize in residential and multifamily rental and for sale real estate. Their reasoning is pretty basic. “No matter what’s going on in the world, people will always need a place to live”. Residential real estate is a class or type of real estate that even though demand may shift, demand will always exist. Since the pandemic and the work from home boom occurred, demand for homes and other types of residential real estate in parts of the country once considered rural and suburban have exploded. Areas like the Sunbelt states, where values were depressed relative to the values in the larger metropolitan cities are growing rapidly due rates of demand that supply can’t support. This demand has occurred because the Sunbelt areas presented more value for the dollar and for many a better way to live. Since we are no longer limited to where we can live because of where we can work or what we can access by way of products or services, this shift has made the residential real estate in these areas a great value-add and a significant hedge against inflation.
This is evident in the previous example. Within the last 14 years, (if John and his home are comparable to US statistical data) the cost of John’s home rose approximately 200%, while in the same time frame, John’s salary or wages rose 30%. What this proposes, is that as it relates to John's demand in the marketplace, for the service, labor, or products, that John can offer and produce, John’s home, is more valuable than he is. Housing cost and demand has significantly increased with the hyper rates of inflation that has occurred and is indisputable proof that residential real estate is and will likely continue to be a definite hedge against inflation and a preservative of cash values in the US.
When is the best time to buy?
The short answer is, there is never a bad time to buy. The more important question to ask, is what, where and how you should buy?
The uninformed and inexperienced buyers in the market lack this understanding. Well! what to buy has been discussed. Unless you happen to be in an area that has been declared contaminated and not likely to recover for years or some other strange phenomenon has made the property uninhabitable, there will always be a demand for residential real-estate. There are times when certain markets may become more desirable or less desirable than others, and supply vs demand may shift, like during the occurrence of a worldwide pandemic or financial collapse in the market. When market shifts occur, you may find yourself in a likely though brief, period of deflationary pricing. These times can be the best times to buy and to earn great returns on your investment.
If your interest is to buy real estate for any other reason than your personal residence, it is always a good idea to consult with a professional real estate investment advisor. Advisors like Arela Partners will have specialized knowledge to answer the questions like, the what, the where and the how. They can provide in-depth knowledge of the location, type of real estate and access to the analysis of the market to assist you in making the best investment decisions. An advisor may also offer alternative investment vehicle options such as, investment funds, joint venture and partner introductions as well as access to financing, education and support. This relationship can be invaluable to your success and the reduction of your investment risk.
To the question, “Is real estate a good hedge against inflation?”
The facts are undeniable. Yes, it is, you must be aware however of the nuances that lead to making the best choice about the what, the where and the how.
Hopefully this article has been informative and helpful toward your financial well-being.