October 25, 2020

Real Estate:  A True Inflation Hedge

Inflation can devastate your buying power. Smart investing, particularly in real estate, can offer plenty of protection.

Special to California Business Journal. 

Not to sound like our dads and grand dads, but does it ever seem like your dollar doesn’t go as far as it used to? That’s because it doesn’t. The reason is inflation — the economic term that refers to the decline in value of your hard-earned money.

It’s a term you’re no doubt familiar with. Nonetheless it can be difficult to grasp inflation’s long-term effect on finances. Inflation rates have been extremely low for years now, making individuals, personal finance experts, advisors and even economists complacent.

The reality is, no matter how low the inflation rate is, it has an ongoing corrosive effect on the value of money. Just consider that four pounds of sirloin steak in 1913 or an ounce of silver in 1960, was about the same price as a cup of coffee at Starbucks today in inflation adjusted dollars. Math like this makes us wonder, just how pricey things will continue to get, especially for retirees on fixed incomes.  At PCMA we’re convinced ignoring the effects of inflation on long-term savings is one of the biggest mistakes investors can make.

But there are sophisticated ways to hedge against inflation that can alleviate that anxiety and help individuals prepare for the financial future.

Hedging against inflation

Just as inflation refers to a decline in your buying power, a hedge means investing in an asset that will protect you from feeling the full force of that decline.  An inflation hedge usually means investing in an asset that is expected to increase in value beyond the rate of inflation.

Enter real estate. Anyone who has tried to recapture the equity in their home to move to a new one, knows just how fast home-price appreciation outpaces the rise in inflation. Last year in California alone, housing prices rose an average of 4.5%, compared to a 2.5% rise in the inflation rate for the year ended January 2020.

End-of-the year predictions from realtors and economists anticipated a nationwide slowdown in price appreciation for 2020. But that outlook has changed dramatically in recent weeks as rising demand and a deepening inventory shortage are set to push real estate prices up at the fastest rate in years, according to a new report from Redfin.

The Real Estate Hedge is not Without Challenges

While we believe real estate is one of the best inflation hedges, it can be a difficult one to implement for many high net worth and mass affluent individuals.  High capacity individuals with unconventional income streams such as business owners, investors, asset rich retirees and the like; may find they are caught in a credit gap due to well-intentioned legislation that may make it difficult to qualify for traditional financing.

What’s more, the squeeze in inventory is fostering a heated sellers’ market and an onslaught of all-cash offers. In California, from 2010 through August 2019 there have been roughly 103,000 all cash transactions with no mortgage present at the time of closing. More than a third of total U.S. property sales were all-cash arrangements in recent years, according to RealtyTrac data.

Due to the restrictions imposed on residential financing by Dodd Frank Legislation, many private client individuals are leveraging investable assets or all cash to make real estate purchases. This used to be a very rare event prior to the credit crisis but today it has become the norm in the buying and selling of luxury real estate, but this is often not a sound financial strategy.

All cash ties up a disproportionate amount of assets into real estate, sacrificing diversification and forfeiting higher returns garnered through other inflation protected investments. 100% basis invested at time of settlement also erodes the inflation hedging benefits of real estate. Inflation has a positive impact on leverage used against real property. The “real value” of the dollar at the time of borrowing is much higher than its “real value” when the loan is repaid. If the loan amount is not adjusted over time due to inflation, the borrower is the beneficiary.

Although most of us are in a hurry to pay off debt, leverage in real estate can actually be one area where maintaining some debt has an upside. Because your mortgage payment is locked in at a fixed debt service level, every year that inflation grows the impact of that monthly payment is diminished by equal amount.

Private Client Lending Can Help

Sophisticated firms specializing in private client lending can help high net worth and mass affluent individuals bridge the credit gap and the financing they need to take full advantage of the diversification and inflation hedging that leveraged real estate purchases provide.

At PCMA we’re committed to providing efficient liquidity to high capacity households for new home purchases or to help recapture basis invested in prior all-cash purchases. “Inflation is a slow, silent killer, which gradually erodes the value of money and wealth over the years,” warns PCMA CEO John Lynch. “It shouldn’t be ignored.”

Written by

Rick Weinberg is Editor-in-Chief at California Business Journal. He is a well-known journalist, writer, reporter and on-air talent who has worked for the New York Times, FOX and ESPN. He launched California Business Journal to focus on California businesses and business professionals as well as California business news and information. Contact: Rick@CalBizJournal.com / 949-648-3815