With Rising Inflation, How Can You Capitalize Through Real Estate?

Last week, the Federal Reserve poured another bucket of cold water on the U.S. economy after raising benchmark interest rates by three-quarters of a percentage point, shaking up consumer nerves in fear of entering another recession.

With inflation at the highest point since 1982, many federal officials have also expressed their nerves that mirror many of the economical traumatic memories from the 1970s — soaring gasoline prices and oil shocks, meat price increases, and temporary shortages in the supply chain.

According to the Bureau of Labor Statistics, inflation rose more than expected in August, as rising shelter and food costs offset a drop in gas prices.

Speaking to this “runaway inflation,” Mike Loweengart, head of model portfolio construction for Morgan Stanley’s Global Investment Office said that the most recent CPI reading “is a stark reminder of the long road we have until inflation is back down to earth.” He followed up with his belief of the “wishful expectations that we are on a downward trajectory and the Fed will lay off the gas may have been a bit premature.”

Chicago Federal Reserve President Charles Evans recently shared his apprehension to CNBC about the U.S. central bank raising interest rates too quickly and going too far — before anything can be fixed in the near future. However, Evans also stated that he’s “cautiously optimistic” that the U.S. economy can avoid another recession — provided that there are no more additional external shocks like we’ve just witnessed (again).

So, how does the recent interest hike by the Fed affect overly saturated markets like real estate?

In most cases, real estate has traditionally served as a hedge against inflation for investors — but why?

Property values almost always skyrocket with inflation, followed by a spike in rental income. Yet, mortgage rates somehow remain fixed and stagnant.

COVID-19 Aftermath and the Supply Chain

Over the past two years, the aftermath of the COVID-19 pandemic certainly did its damage to the supply chain, causing a global supply/demand crisis, which also acted as a major driver of inflation rates. During this time, home inventory was also at its lowest, with the housing and real estate industry experiencing an inventory of short supplies, with rising prices in construction materials.

Prior to 2020, home inventory took an average 4.4 months — fast forward to June 2021, the time increased to approximately 5.5 months. This window is worth noting as building materials typically impact 35% – 60% of overall costs. Consequently, material cost increases were further exacerbated by legislative policy decisions including tariffs, quotas on steel and aluminum, and the overall failure to renew the softwood lumber agreement with Canada.

At the end of the day, real estate took a massive hit, and the shortage of skilled workers led to a further increase in labor costs.

We’re All In a Seller’s Market

For prospective homeowners, the negative impacts of inflation is quite clear. Every major region is currently facing an underbuilding gap, keeping in mind the 5.5 million housing unit gap from the last 20 years.

However, this number increased by over 1 million to 6.8 million, when considering losses of current units.  As we are currently living in a seller’s market, 2020 and 2021 served as the highest levels of homes sold since 2006, with nearly 6.5 million homes sold in November 2021.

Comparing the Case Shiller U.S. Home Price Index as between September 2020 and 2021, there was a rise of 18.6 percentage points.

All this to say, COVID-19 changed everything, and future trends are heavily dependent upon the changes that went into effect these past two years. Most importantly, current inflation trends are no longer considered transitory — meaning, this year is likely to exhibit similar inflation trends that we experienced in 2021. 

And the Federal Reserve isn’t helping. Given last week’s interest rate hikes, it’s not out of the question for the central bank to raise rates again in 2023 — despite warnings from several federal officials.

The good news, however, is that as the effects felt from COVID-19 continue to decline, the increasing demand for goods/services will balance, easing pressure on supply chains — allowing for production to make its slow recovery. 

Measuring Future Inflation Against Housing Inflation

While lumber prices have fallen since May 2021, these prices are steadily rising, but may still be impacted by certain policy decisions that could decrease overall material costs.

With steel and aluminum tariffs on the European Union recently lifted, we can expect to see similar changes in ongoing negotiations with Japan. The reality, unfortunately, according to experts, is that demand and building costs will remain high. 

Looking at the 2022 housing market, these remaining months are still uncertain when considering whether certain real estate investments (commercial real estate and real estate investment trusts) are right for you due to this expected continuation of this seller’s market we are in. 

As we prepare to close out 2022, there is an expectation that there will be a 6.6% increase in home sales and a 2.9% increase in appreciation — but with the growing popularity of emerging tech, including NFTs and the metaverse, real estate as we know it is about to change in ways we cannot yet fully comprehend — so, who knows?

Perhaps considering what real estate investment options are available could be the next move, despite economic uncertainty.

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