There is a thief in your wallet right now. You don't see it, but it's there. By way of multiple stimulus packages, incredible amounts of money printing, and mind-boggling fiscal budget deficits, the consumer price index is steadily rising, and so is that silent burglar know as inflation. Last year was unprecedented, but we have been heading this way really over the past decade or more, as money flooded into the markets as a result of the last recession. Since the great recession, the federal reserve has done its best to hold down interest rates, but at the same time, they have printed unfathomable amounts of money. The inflation rate in the United States was at a whopping 5.39% for the last 12 months ending in June 2021, after most predicted a rise to 3% through the end of 2021. It isn't like a $100 Bill becomes a $97 Bill, so many choose to ignore inflation. But it is times like these where we must put asset types under the microscope and discover their intrinsic value.
WHAT IS INFLATION, AND HOW SHOULD I ADJUST?
As defined, inflation is a general increase in prices and a fall in the purchasing value of money. As inflation rises and erodes our purchasing power, investors need to do much more than evaluate traditional saving vehicles like bank accounts and CDs - they need to weigh asset classes against one another. If you have been banking on earning 10% off your S&P index, that 3% inflation alone brings it down to 7%. The stock market doesn't care for reports of high inflation, leading to an increase in market volatility, which brings average returns down further.
However, multifamily investors appear to be poised to fight off the damaging effects of inflation. Why? Because multifamily properties are physical assets whose value we can control by keeping up their condition through improvements and increasing their rent potential. Multifamily investors can separate themselves from single-family investors, as traditional rental properties rely upon the comps. We appear to be moving towards one of the worst inflationary periods in recent times, so might it be wise to stock up on multifamily assets?
HISTORY SEEMS TO SIDE WITH MULTIFAMILY
In the inflationary periods of the '70s and early '80s, multifamily outperformed single-family and other commercial real estate assets. The American Housing Survey shows that between 1973 and 1983, median rent expanded at an average rate of 8.5% and easily outpaced relative inflation. Rental rates rise with inflation, so this offsets the silent assassin. Have you seen the rise in rents as of late? Anyone who owned a multifamily property felt doomed by the pandemic, with the onset of eviction moratoriums. But as those moratoriums got lifted, rents are now spiking, and so is rental income. This rise in revenue has more than offset high inflation.
I think we have all been surprised how property values have risen coming out of COVID, but not only has the competition to purchase single-family homes and commercial properties increased but so has rental demand.
MULTIFAMILY INVESTMENTS PROVIDE AN INFLATION HEDGE FOR SEVERAL REASONS
Multifamily investments do well in an inflationary environment for several reasons. When inflation rises, interest rates rise along with it, which puts upward pressure on mortgage rates. As home buyers lose their purchasing power, they shift their focus to renting, increasing rental demand for an already minimal supply. As demand outweighs supply, rents steadily rise, outpacing inflation.
Locking in fixed-rate debt can also be a hedge. A fixed interest rate will stabilize your mortgage payment throughout the loan period, even as interest rates rise with inflation.
As I alluded to earlier, multifamily investors have a decisive say in controlling and improving the asset's value. By increasing rents, investors boost the NOI (Net Operating Income) of the property and its cash flow. Now the other part of the NOI equation is expenses, and mitigating rising costs during inflationary periods can challenge. This is why it is necessary to have a property management team and asset manager with years of experience in controlling expenses and looking for operational efficiencies.
The value appreciation of multifamily properties is another way that it hedges against inflation. As the prices of goods and services go up, so do wages, leading to more affordability to rising rents. Additionally, as inflation increases the costs of new construction and materials, new construction costs limit new development and, therefore, competition for existing multifamily property.
The greatest economists have always recommended ridding yourself of a devalued currency and buying hard assets, such as gold or real estate, whether single-family homes or commercial real estate investments. One can make a strong case for real estate investing but a better case for the multifamily asset class. The predictability and higher returns of multifamily properties are a great hedge against annual inflation. If you are a multifamily investor, you then have some news for that invisible thief trying to pick your pocket. You have wisely placed your money into physical assets, and no matter how hard you try thief, you can't catch me. Find another wallet.