Should you invest in real estate during inflation?

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Updated
Apr 2023

When inflation is high, the value of your money can erode fast, and you will likely be looking for "hard" assets to invest in that can preserve their value well. Real estate is definitely a long-lasting hard asset, but is it really a good inflation hedge? We'll break it down for you in this article, including tips on how to invest in real estate.

THE ESSENCE

  • Property prices and rental income tend to outpace inflation over the long term...
  • ...but property prices and the wider real estate sector often don't do well in stagflation
  • Having a fixed-rate mortgage is beneficial when inflation hits
  • REITs and real estate-focused ETFs are the easiest way to invest in real estate

How does inflation affect real estate?

When you look at the value of real estate and how it can change over time, there are two main aspects: the actual value of real estate (such as the price of a house you own), and the level of rental income that can be derived from a piece of real estate.

Owning your own real estate

Data show that over the long term - meaning several decades - home prices in the US have increased at a significantly faster rate than consumer prices.

Orange line: US single family home prices; Blue line: US CPI (Source: TradingView)

However, the short-term relationship between real estate prices and inflation is more complicated. It is true that rising raw material prices and labor costs in times of inflation will raise the price of new homes. However, high inflation often prompts central banks to raise interest rates. This dampens demand for mortgage loans and therefore new homes, slowing or even reversing the rising trend in home prices.

Meanwhile, low inflation is usually accompanied by low interest rates, which means cheap mortgage loans. This, in turn, usually brings an upturn in demand for new and used homes, lifting their prices.

Still, it's not a bad thing to be a homeowner during times of high inflation. This is especially true if you are paying a fixed-rate mortgage. That's because when prices - and, ideally, your income - rise, your fixed monthly payments will amount to a smaller share of your income and overall expenses.

By contrast, housing rent in the US has usually increased slightly faster than consumer prices in the past decades.

Collecting rental income

You can also profit from real estate by collecting rental income. You can do this by renting out an apartment you own; or more likely, investing in a company or fund that makes money by renting out real estate such as apartments, office space, retail stores or warehouses (more on these below).

How does inflation affect rent? Generally, rent also rises in times of inflation. This is mainly because landlords will try to pass on rising costs (such as that of personnel, maintenance or utilities) to tenants. Lease contracts often explicitly include "mark-to-market" clauses that allow landlords to periodically raise rent. Other than that, how successfully they can do this - and therefore the rate at which rental income increases - often depends on the type of inflation.

  • When inflation coincides with strong economic growth, rent tends to rise faster, as demand for space such as offices or warehouses often outstrips supply, and tenants are able and willing to pay more.

  • In times of stagflation - that is, when inflation is mainly driven by rising costs and the economy is otherwise stagnating - it is usually more difficult to raise rent (or simply to keep tenants), which therefore may not keep pace with inflation.

How to invest in real estate?

If you’re not up to buying a(nother) house for investment purposes, the best way to invest in real estate or the wider property market is via real estate-focused exchange-traded funds (ETFs) or real estate investment trusts (REITS).

  • REITs are publicly-traded companies that own, operate or finance income-generating real estate such as hotels, offices, shopping malls, warehouses or residential properties.

  • Real-estate ETFs are funds whose portfolio covers the broader real estate sector, such as developers, retail and hotel operators, or companies providing real estate-related services.

REITs are strictly regulated: they must derive at least 75% of their gross income from property rent, property sales or mortgage interest, and must pay out 90% of profit each year in the form of dividend.

As an investor, you can benefit from the rising price of REIT shares (which mostly reflects the combined value of the underlying property portfolio); and also from annual dividend payments, which reflects rental income earned by the REIT. The two don't always go hand in hand; in fact, in times of high inflation, REIT dividend often rises, even as REIT share prices stagnate or fall. When combined, though, returns on REIT investments compare favorably to those on stocks during high or even moderate inflation.

Source: National Association of Real Estate Investment Trusts

You can buy REIT stocks at any of the best stock brokers available in your country. For more information, see our guide on how to invest in REITs.

Real estate ETFs, traded on many of the world's biggest exchanges, are perhaps the easiest way to tap into the wider real estate market. Think of them as a stock that moves up and down with the fortunes of the real estate sector. Many real estate-focused ETFs invest heavily in REITs, so they can be a good choice if you don't want to pick individual REITs to invest in.

Real estate ETFs are a good bet to outpace inflation over the long term. However, their price is often affected by broader stock-market sentiment, and they often tend to underperform major stock indices such as the S&P500.

Orange line: Vanguard S&P500 ETF; Blue line: Vanguard Real Estate Index Fund ETF (Source: TradingView)

To invest in ETFs, check out our list of the best brokers for ETFs. You can start investing into ETFs with as little as $1 at brokers that offer fractional shares.

Is real estate a good inflation hedge?

To sum up, is it a good idea to invest in real estate during high inflation? Like with so many other asset types, real estate and its derivatives are good to already hold when inflation hits, but may not be the most obvious choice to invest in when inflation is already high.

  • Owning your own home (fully or on a fixed mortgage) is a better situation to be in times of high inflation than to be paying rent

  • If you’re looking for passive income, REITs can help you outpace inflation with a steady dividend stream

  • Real estate-focused ETFs are an easy option if you want to beat inflation in the long term, though stocks may be a better alternative

  • Growth in rental income tends to track broad economic growth rather than inflation; so it can offer only limited protection in times of stagflation

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Further reading

Author of this article

Balázs Szládek

Financial Story Weaver | Stock • CFD • Financial Journalism

I have 20+ years of hands-on experience as a business journalist, researcher, copy editor and translator covering topics including general news, economic policy, politics and energy markets. I enjoy the challenge of explaining difficult subjects in plain English, helping would-be investors navigate the field of financial markets. I hold a master's degree in American Studies and Political Science.

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