Real Estate Is Emerging as a Hedge Against Roaring Inflation

Those seeking alternative investments from stocks and bonds may turn to the housing market, but that strategy still presents risks.

Surging markets spurred a buying frenzy for everything from stocks and cryptocurrencies to new homes over the last two years. Now, with inflation at a nearly 40-year high and at least three priced-in rate hikes, the hunt for investing safe havens is on.

Real estate is considered one approach to hedge against inflation, given the asset class usually has little correlation with stocks and bonds. So naturally, investor interest is soaring — even against the backdrop of a super hot real estate market, a low supply of houses and mortgage rates threatening to creep up.

Nikodem Szumilo, economics associate professor at University College London and a specialist in urban economics and finance, said he’s received questions at least twice a week for the last six months about this topic.

“Inflation is pretty high, and increasing rates are not going to help right away,” he said. “So people are evaluating what they want to do with their savings.”

Some experts say buying real estate now — despite a hot and competitive market — is a good bet, given that mortgage rates are still low. Others say that because real estate is so localized, it’s case by case and rural areas might not offer the same prospects as large cities. But really, it comes down to an individual’s circumstances and investment time horizon.

Here’s a look at some questions investors — both professional and amateur — are weighing, and what experts suggest.

Are real estate and inflation correlated?

At first glance, they don’t seem to be. Inflation is based on consumer prices, while housing is based on demographic trends, construction and overall supply.

Yet in the long term, inflation and housing tend to move in the same direction as a result of wages and interest rates. Inflation often pushes up wages, which in turn increases budgets for renting and buying. Inflation also often appears in low interest rate environments — like in the U.S. and parts of Europe now — where the cost of borrowing is cheap. That also increases demand for property.

Swings in prices
U.S. inflation has changed independently of house prices

“To the extent that wages capture inflation, there’s a clear link between house prices and inflation,” said Colin Lizieri, an economist and professor of real estate finance at the University of Cambridge.

On average, housing prices across a longer time span, such as 100 years, have kept up with the rate of inflation — even outstripping it by 2% or 3% in developed economies, he said.

With inflation now reaching levels not seen in years, real estate is an attractive investment option.

“Real estate is an alternative to the stock market,” said Benjamin Miller, chief executive officer of real estate investment platform Fundrise. “People invest in it for the same reason that they invest in cryptocurrencies. They’re worried about the current economic system and they want options.”

How might inflation impact you if you’re looking to sell a house?
At least right now, it’s still a seller’s market. One measure of home prices in 20 U.S. cities jumped 18.4% in October, according to the latest data available — a slight decrease from the prior month, but still elevated. And real estate app Zillow predicts that home values across the U.S. will surge 14% through November 2022.

The number of available homes is shrinking and bidding wars are still raging in some of the hottest markets.

“As the price of everything else goes up, housing’s recent rise in cost doesn’t look so bad by comparison,” said Jeff Tucker, senior economist at Zillow. So in the short term, it’s possible that demand for real estate purchases will remain strong despite inflation.

Increases in the costs of building materials — due to inflation and ongoing supply chain issues — could boost housing prices further this year as homebuilders pass those on to consumers. For instance, lumber prices are at their highest in months. Supply shortages aren’t helping either.

Another risk posed by inflation is that as the prices of other goods rise — like food and gas — potential homebuyers could be left with less to spend on real estate, leaving sellers in the lurch. But Tucker predicts that consumers will trim the fat from more discretionary spending like travel, clothing and entertainment — leaving more room for necessities like housing.

Is now a good time to buy a house?
It all depends on individual circumstances. While owning a home can save you from annual rental increases, property prices have soared. “If it’s not a lifestyle situation where you want more space or want to move to another geographical location, this might be a time to wait it out from buying,” said Liz Young, head of investment strategy at SoFi. “The risk is that the equity in the home doesn’t go up a ton in the next few years because home prices are so high. From an all-time-high price level, there’s downside risk to prices in the near term.”

For those interested in staying in a home for more than five years, buying makes sense, she said. But if you think you might have to sell before then, it might be better to wait.

Still, if the move is brought about by necessity, not to fret. Mortgage rates, though creeping up slowly, are still historically low: The average for a 30-year loan is currently 3.56%, up from 2.65% a year ago. That’s an advantage for those buying a home now, said Randy Frederick, vice president of trading and derivatives at Charles Schwab.

“If you can lock in a low rate, it can certainly be beneficial if it’s your view that inflation is going to move higher or stay elevated,” he said.

With the Federal Reserve’s planned interest rate hikes, the sooner the better. The same goes for any current homeowners looking to refinance.

“The best time may have passed but certainly rates are still very low relative to inflation,” said Aneta Markowska, chief financial economist at Jefferies. “Anybody who refinances now is going to lock in a still incredibly attractive rate.”

Fiona Cincotta, senior financial market analyst at City Index, recommends that those with adjustable-rate mortgages — which have interest rates that can fluctuate — look to a fixed-rate mortgage now to take advantage of the current environment.

“If you’re going to look at your mortgage, now is the time,” she said. “You don’t want to leave it until the third quarter of the year.”

Are the trends the same in the U.S. as in Europe?
So far, both the U.S. Federal Reserve and the European Central Bank are planning interest rate hikes to curb inflated prices. Last month, the Bank of England increased its base rate to 0.25% from 0.1% and the country’s inflation rate reached a 30-year high at 5.4%.

Still, inflation growth is slower in Europe, where GDP dropped around 8% in France compared to a 3% decrease in the U.S. in 2020. Average prices as a result increased at a slower pace in Europe, with inflation in France at 3.4% over the past year compared to 7% in the U.S.

That means finding ways to hedge against inflation may not feel as urgent in Europe as it does in the U.S.

According to William C. Wheaton, economist at the Massachusetts Institute of Technology and professor at the MIT Center for Real Estate, the issue lies in large cities. In big metropolises, house prices outpace inflation due to the concentration of work opportunities, whereas in more rural areas, home prices barely keep pace with inflation.

This means that cities with strong demand like London, Paris, San Francisco and New York could see their prices boosted and enter bubble territory, whereas rural areas, such as the Midwest in the U.S. or certain areas of southern Europe, could experience a drop in house prices.

People wanting to take advantage of inflation have looked to invest in regions of the U.S. where inflation rates are highest and unemployment is low, said Fundrise’s Miller.

“People will look to buy in parts of the country that have the highest inflation rate, like the Sun Belt region or the mountain states rather than the Northeast or Ohio,” he said.

Should you invest in commercial real estate?
Appreciation in commercial real estate has been more timid than housing overall, according to economists, at times even falling short of matching long-term inflation rates.

Leases in office buildings tend to be longer than in housing, meaning rents take longer to adjust to inflation, which can be a disadvantage to a real estate investor. And during the pandemic, the rise of remote work and online shopping have made retail and office spaces less in demand.

“In the past, people have invested in real assets because they couldn’t find value in financial assets,” Lizieri said. “There was a sense that equities were so expensive relative to historic values that they looked for other sources of income and shifted to real assets.

Multifamily housing is a different story. Since leases are typically up for renewal every 12 months, landlords have more opportunities to bake factors like utility cost increases into rent.

What about REITs?
Real-estate investment trusts are companies that own or manage real estate operations such as office buildings, apartments, hotels or shopping malls. Like with a mutual fund, one share of a REIT offers partial ownership of the assets held by the fund. One advantage is that they are required by law to dispense 90% of taxable income to shareholders.

REIT exchange-traded funds, meanwhile, contain multiple REITs, and the indices behind them can be adjusted periodically to replace bad performers with good ones. In the past year alone, such products took in more than $13 billion from both professional and retail investors, a 10% increase from the prior year, according to data compiled by Bloomberg. One of the largest — the Vanguard Real Estate ETF — rose 37% in 2021 compared with 27% for the S&P 500.

“A REIT or a REIT ETF is a pretty good way to get diversified exposure to the real estate asset class,” said Ross Mayfield, an investment strategy analyst at Robert W. Baird & Co. “They usually have a pretty nice income associated with them, and they performed really strongly last year in an inflationary environment.”

By Claire Ballentine and Alice Kantor (see Bloomberg article here)
January 24, 2022, 6:00 AM PST