The Benefit of Owning Real Estate when Inflation Rises
Inflation is at its highest point in over 40 years. Even though it’s not expected to stay this high, many economists are saying that for at least the next couple of years it should stay higher than it has been for most of the past decade.
What does that mean for real estate?
Real Estate is one of the best hedges against inflation for several reasons.
1) It’s a fixed cost asset. Once a home is purchased (fixed rate loan) the payment will stay the same regardless of inflation. Taxes will rise but that affects both renters and owners. I purchased a couple of homes in Austin almost a decade ago and the house payments (less taxes) remain around $700/month. Not bad considering the average rent on a studio apartment in Austin is now $1235/month and 3 bedroom apartments are renting for almost $2400/month.
2) Real Estate is a leveraged asset. A simple example is if you put a $100,000 down payment on a $500K house (20% down) and that house value increases 10% in a year, you just increased your equity by $50,000, a 50% annual return on investment. If you bought $100,000 of stock or crypto and its value increased 10% in a year, you increased your equity by $10,000, a 10% annual return on your investment.
3) You won’t be exposed to rising rent costs. Real Estate home prices and rents tend to rise in tandem. The previous chart is a perfect example of how the recent jump in home prices in Austin is now being matched by a similar jump in rents. If you would like some historical perspective on the impact inflation has on rents, here is look at the last almost 50 years of rent vs. inflation. It’s fair to say both rent and home prices will keep up if not surpass any increase we see in inflation.
Could we be in a real estate bubble?
The biggest threat to real estate from inflation comes from rising mortgage rates. If you look at the chart below there are two key takeaways. First, the average mortgage rate very closely mirrors the inflation rate in the previous chart. If inflation keeps increasing in the next few years, expect mortgage rates to closely follow. The second key takeaway is just how low rates still are historically. Even though we’ve come off our sub 3% rates of a year ago, we’re still lower than we’ve been at almost any time in the past 50 years.
I can never predict the future but feel confident that as long as Austin keeps attracting jobs and being a popular place to live, house prices will continue to rise. With mortgage rates still low, it seems like a good time to lock into a fixed cost asset. Similar to the houses I purchased 10 years ago, a home purchased today for $2500-3000/month (including taxes) will look like a great investment 10 years from now if the average Austin studio is renting for $3000/month. Kind of like the old proverb, the best time to plant a tree was 20 years ago. The second best time is today.