There is much conversation in the financial sector that inflation may be brewing. I’m concerned about it myself. In a world where every asset seems to be in a bubble, I’m looking to find a store of value for my wealth and reduce risk. If significant inflation is on the horizon, cash is not what you want, as your principal’s purchasing power will erode over time. So where does an investor put their money to earn a modest return and protect their principal from inflation?
Gold is often looked to as the ultimate store of value, as it tends to sync up with inflation over longer periods. However, it’s subject to long cycles of decline and pays no income. Okay, how about bonds? After a 40 year bull market and interest rates at all-time lows, bonds are likely to depreciate, as their prices fall when interest rates rise. Bitcoin has been marketed as the new digital store of value. But you have to have nerves of steel to invest in crypto, with tolerance for wild swings in prices that make it hard to believe its nothing more than a gambling tool. A store of value by definition should not be so volatile.
With these points in mind, I’ve turned to real estate as the solution - an income paying hard assets, that offers the opportunity to appreciate, and combats inflation in multiple ways.
Price Appreciation
Let’s say you’re an investor in a multifamily syndication that owns a 100 unit apartment building that’s worth $10M. In five years, assets and the price of goods have increased by 10%. The syndication’s apartment has also gone up by 10% and is now worth $11M, a $1M increase in equity. The price appreciation of the apartment has offset the price of goods, and you’ve successfully protected your principal. Real estate has provided a store of value for its investors.
But there’s better news. The apartment was purchased with a bank loan with a 70% LTV ratio. The syndication used only $3M in equity for the purchase. Through the power of leverage the equity in the deal has risen 33.3% ($1M/3M), far more than the 10% increase in prices caused by inflation.
This simple math shines a light on how real estate can not only be used as a store of value during inflationary times, but can also produce outsized gains with the use of positive leverage.
Debt Becomes Cheaper to Pay Back
Another way real estate performs in times of inflation is by reducing the burden of debt. In the prior example, the apartment syndication’s lender brought 70% of the capital to the deal, or $7M, at a fixed rate. Five years later, there's been 10% price inflation, but the payment to service that debt remains the same as when the loan was originated. At the same time, wages/income/rents, which historically have risen faster than inflation, are putting at least 10% more dollars in your pocket. Thereby, in today’s dollars, the five year old debt is now 10% easier to pay.
Understanding this principal is what’s leading many to think inflation is inevitable in our current environment, as without it the country’s debt burden would be crushing. The Federal Reserve has committed to keeping rates lower for longer to keep the economy from stumbling. This makes credit easier to obtain. At the same time, The Fed is increasing the money supply through the purchase of government issued securities (i.e. “printing money”). By doing this they are trying to stoke inflation to make the national debt easier to repay, by inflating tomorrows dollars to pay back today’s fixed debt.
The same advantage The Fed is creating to help pay down debt in the future by forcing inflation can be used to a real estate investor’s benefit. By borrowing at historically low rates today, its likely inflation will make that debt easier to pay back in five years, when prices and wages have increased. Inflation reduces the debt burden and benefits those that invest in real estate for a store of value and more. Don’t fight The Fed.
Rents Increase
Inflation causes prices of goods and services to rise. Food, services, entertainment, cars, utilities…..most things that affect our everyday lives become more expensive in nominal dollars. Rent is no different. In real dollars, a measure of purchasing power accounting for inflation, rents keep pace. In most of the county, rents have not only kept up with inflation, but far outpaced it.
This is the easiest concept to grasp in understanding how income generating real estate can protect against inflation. If the price of goods and services has increased by 10%, the rental income from your asset has also increased by 10% or more, providing you a store of value for your investment dollars.
Conclusion
If you are concerned about protecting your purchasing power and finding a store of value for your money, keep it simple. Diversification into real, tangible assets like commodities, gold, even Bitcoin, can be ways to counter inflationary forces.
But real estate gives you multiple outlets to profit off of inflation, and even welcome it - price appreciation, a reduced debt burden, and rising rents. Additionally you own an asset that pays income like a bond.
For these reasons, look no further than real estate as the ultimate store of value.