Inflation can have a negative impact on normal household spending, from gas to groceries and beyond. This is why many people seek opportunities to hedge their wallets and portfolios against rising inflation as it starts to negatively impact the money. Real estate has long been considered one of the best hedges against inflation because you can pay less for your home over time compared to what you may pay in rising rent. This can help your wallet as you pay more for everyday items. To help you determine if it’s the right time to invest in real estate, consider working with a financial advisor.
How Inflation Can Hurt Your Finances
Inflation is the rise of prices for things purchased within an economy that leads to a decline in purchasing power over time. Inflation is inherently considered a bad thing because it means that a unit of currency effectively buys less than it used to. This can put a strain on individuals and families as they strive to keep up with the same amount of things to buy but effectively with less money to spend.
A steady climb in inflation is considered acceptable as the economy has time to keep up with higher wages or more financial opportunities. Where inflation really hurts your finances is when it rises quickly over the period of a year or less, driving the costs of normal spending up without any extra income in the economy.
An example of this is thinking about what a cup of coffee used to cost in 1990 compared to what it costs today. That is normal inflation. However, costs for many goods, like gasoline, increased quite dramatically throughout 2021 and 2022. This has caused significant struggle in the economy as individuals and families try to keep up by spending the same amount of money on less than before.
Why Real Estate Can Be a Good Hedge Against Inflation
The cost of real estate tends to rise along with inflation, which can price many people out of the market. So the question is, then, why can real estate make for a hedge against inflation? Owning real estate can be a strong hedge because it can increase your value while keeping your housing costs, a major expense for anyone, the same over time. This makes it especially valuable if you own real estate before inflation really takes hold of the economy.
Here are three main benefits of using real estate as a hedge against inflation:
- Increased Property Values: If you own real estate during a dramatic inflation climb then the value of the property you own is likely to increase. You can sell the property and get some extra cash or you can see where the market ends up, likely giving you a permanent increase in value.
- Favorable Housing Costs: As inflation continues to worsen, housing costs become more expensive for those who are renting. As rental agreements end the total cost of renting each month is likely to go up quite substantially. If you own your home then those costs are going to stay the same for you unless you have an adjustable-rate mortgage.
- Increased Profit on Rentals: If you own a second home, vacation home or other rental property then you likely are going to be able to receive an increased profit each month. As you raise the rent for those staying at your house you’ll be able to pocket more if you have a typical mortgage on the property.
If you’re looking to buy real estate as a hedge, then you’ll want to think about doing so before interest rates rise. During inflation, the government typically chooses to raise interest rates quite substantially to get inflation to decrease. You don’t want to pay, for instance, 6% or more on a home loan when you could have paid 3% if you did it at the right time. That can add up to quite a lot of extra money over the course of a 30-year mortgage.
When Real Estate Might Not Work as an Inflation Hedge
Real estate isn’t always a perfect hedge to fight off the rising inflation that is hurting your wallet. When inflation is rising, this could mean that the prices of homes are also rising. Paying more for your home, over the long run, could end up hurting your finances more than helping them. You would need to do the calculations on the extra rent you’re paying due to inflation against the extra money you would end up spending on your new property.
Another reason that real estate isn’t always the perfect hedge is that the Fed typically responds to rising inflation by increasing interest rates. This can make borrowing money extremely expensive. If you wait too long during the inflation cycle, you could end up paying significantly more in interest over the course of your mortgage. In this case, you’d be in the red with the increased inflation.
Waiting for home prices or mortgage rates to come down might be the better strategy for some. You really need to look at your individual financial situation along with the potential future market of the location where you’re looking to purchase your property to come up with an answer for you.
Other Ways to Hedge Against Rising Inflation
Real estate might be the most popular way to hedge against inflation but it’s far from the only way you can attempt to do it. The key to hedging comes in some diversification across asset classes that are less affected, or that actually benefit from rising costs. If you missed the opportunity to buy real estate or don’t want to invest in an additional property, then here are three additional options that could work as an inflation hedge:
- Purchase Treasury Inflation-Protected Securities (TIPS): TIPS are a kind of treasury bonds that helps fight inflation over time. The principal of a TIPS investment increases and decreases as inflation rises and falls. As a treasury investment, it is also government-backed so it is an investment that’s on the safer side.
- Invest in Gold: Gold is a tangible asset that has been considered a good hedge against inflation because it holds its value pretty consistently over time. The value of gold can fluctuate over time but that price isn’t directly tied to inflation so it isn’t a perfect hedge even if many use it successfully. Other commodities might also work as a hedge.
- Buy More Equities: Stocks can be a good bet to spend more of your investment dollars, especially if you’re buying before the worst part of inflation flares up. When inflation happens it can be a shot in the arm to stocks. However, as the Fed responds and raises interest rates, and consumer spending declines, then you could take a hit on the back end of the inflation period.
The best investments during inflation tend to be ones that won’t be negatively impacted by a lack of consumer spending or increased interest rates. This makes real estate a good hedge for the first part of a rise in inflation but could make it more difficult the longer the inflation period occurs. You can work with a financial advisor to help you better understand how you can prepare your personal finances during inflation.
Tips for Real Estate Investing
- Buying real estate, regardless of the reason, is a huge investment. You’re committing a lot of capital, often over a long period of time, and you want to make sure it’s a smart choice. You can consult with a financial advisor before making such a hefty choice. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Inflation can be difficult to predict. Use SmartAsset’s free inflation calculator to see how it might impact you and your finances.
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