Inflation and Choosing Real Estate for Your Portfolio

April 7, 2018 by Allen Shayanfekr
inflation and real estate investing

Numerous investment options are available to the modern accredited investor. What is the best vehicle for your long-term investments? Why is marketplace real estate lending an excellent choice compared to the alternatives such as stocks, bonds, and other fixed assets? The many benefits of investing in real estate include tax advantages, passive income, asset growth, and satisfaction. How does inflation fit into these benefits?

Constant Appreciation

First of all, what is inflation? Inflation is the economic force that drives prices continually upward. Inflation has several causes, but the primary reason is excess capital in an economy. When this happens, the value of each unit of currency declines, pushing prices up to maintain the same value and balance between supply and demand. This is great for real estate and generally means that property prices are increasing.

For real estate investors this is important as it relates to purchasing power. Inflation tends to erode purchasing power and has the potential to hamper portfolio growth. To achieve optimum growth, especially during inflationary periods, it’s critical to select properties in expanding markets that will experience strong demand. With these factors in mind, it’s very possible to secure and operate properties that will experience growth in value that exceeds the rate of inflation, enabling expansion with incrementally increasing purchasing power.

This further exemplifies the uniqueness and potential that real investment represents: income properties present some of the greatest opportunities to optimize cash flow and investment returns. Whereas other fixed assets and conventional securities tend to lag, active engagement in the management of real estate can increase NOI regardless of economic environment, inflationary or recessive.

Inflation and Increasing Rental Income

When prices increase, rents generally increase in tandem; however, when prices decline, rental rates can continue to rise. A notable example was during the recent recession when the default rate outpaced the availability of rental housing in markets such as Southern California. The increasing demand pushed up the rental rate while inventories of single family residences grew, closings fell, and prices dropped. This phenomenon is an additional indicator of the suitability of real estate as an income generating investment during any economic cycle, inflationary or otherwise. A real estate portfolio diversified in both class and geography, centered on growth markets and professionally managed, provides the greatest opportunities for lease rate growth and overall appreciation.

Compared to other asset types that tend to under-perform in an inflationary market, real estate maintains and increases its value at rates that exceed historical averages. Fortunately, increasing prices typically mean the overall demand for housing and commercial space is increasing. In expanding markets lease rates tend to rise at a rate that exceeds the rate of inflation. This is important to consider in inflationary periods when drafting commercial leases for terms that exceed 5-10 years. To protect from economic losses due to fixed rent leases, include rental rate increases tied to an index to ensure that your lease rate follows the market.

Tax Advantages and Alternative Investments

Investment in real estate offers many tax advantages, that when considered a savings on the expenses associated with holding an investment, further offsets the effects of inflation compared to fixed-income and securities investments. Depreciation provides increasing deductions from the revenue generated by the property. Additionally, depreciation increases at a fixed rate every year, improving its ongoing benefit in terms of reduced income tax liability. With the increase in rents, rising value due to active management, and upward price pressure, real estate has a distinct advantage.

Fixed-income investments, or those that pay a fixed rate until maturity, are a very safe choice in terms of a minimal risk profile; however, they tend to lose actual value and purchasing power over time. Stocks are an attractive option for investors seeking faster growth, but who are also very risk tolerant or only willing to invest in the most stable, slowest growth firms. Over the long term, stocks can increase in value at a rate that exceeds inflation, but over shorter periods, the market can be extremely dynamic and result in a dramatic decrease in growth and short-term losses. While there are other investments options, real estate offers the lowest risk profile and greatest purchasing power increases over time.

Participating in marketplace lending is another alternative that allows accredited investors to take advantage of the benefit of investment in real estate without the due-diligence and management responsibilities. Like other shared-risk investments such as mutual funds or REIT, working with a marketplace lending platform provides minimal risk, but provides even more financial benefits in terms of tax benefits, revenue generation, appreciation, and strong returns. Partnering with other investors in a real estate development funding platform offers the best combination of benefits from real estate and shared investment models.

New Opportunities

It’s clear that real estate is by far the best investment available by many different measures. Whether it be appreciation, tax benefits, or passive income, real estate shines in every category. Even in times of recession and inflation, smart investors can continue to profit. Working with a team of real estate investment and finance professionals can help expand your access to new opportunities and provide a lower risk, less time-intensive investment model that may be the perfect fit for your lifestyle and investment objectives.

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