Everything you need to know about buying property to hedge against inflation

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

Property 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, says he’s received questions at least twice a week for the past six months about this topic.

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

Some experts say buying property 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 localised, 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 that 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 – such as in the US and other parts of the world, including Dubai, now – where the cost of borrowing is cheap. That also increases demand for property.

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

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 per cent or 3 per cent in developed economies, he says.

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

“Real estate is an alternative to the stock market,” says Benjamin Miller, chief executive of Washington-based property 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 affect you if you’re hoping to sell a house?

At least right now, it’s still a seller’s market. One measure of home prices in 20 US cities rose 18.4 per cent 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 prices across the US will surge 14 per cent until November this year.

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,” says Jeff Tucker, a senior economist at Zillow. So in the short term, it’s possible that demand for real estate purchases will remain strong despite inflation.

As the price of everything else goes up, housing’s recent rise in cost doesn’t look so bad by comparison

Jeff Tucker, senior economist at Zillow

Increases in the costs of building materials – due to inflation and continuing supply chain problems – could boost housing prices further this year as home builders 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 – such as food and petrol – rise, potential homebuyers could be left with less to spend on property, leaving sellers in the lurch. But Mr Tucker predicts that consumers will trim the fat from more discretionary spending such as travel, clothing and entertainment, leaving more room for necessities.

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,” says Liz Young, head of investment strategy at SoFi. “The risk is that the equity in the home doesn’t go up a tonne 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 says. 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. That’s an advantage for those buying a home now, says 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 says.

With the US 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,” says 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 says. “You don’t want to leave it until the third quarter of the year.”

Are the trends the same around the world?

So far, both the US Federal Reserve and the European Central Bank plan sharp interest rate rises to curb inflated prices. Last month, the Bank of England increased its base rate to 0.25 per cent from 0.1 per cent and the country’s inflation rate reached a 30-year high at 5.4 per cent.

Interest rate hikes in America this year will result in an increase in lending rates in the UAE because the dirham is pegged to the US dollar.

Still, inflation growth is slower in Europe, where gross domestic product dropped about 8 per cent in France compared with a 3 per cent decrease in the US in 2020. Average prices as a result increased at a slower pace in Europe, with inflation in France at 3.4 per cent over the past year compared with 7 per cent in the US.

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

According to William C Wheaton, an economist at Massachusetts Institute of Technology and professor at the MIT Centre 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, they barely keep pace with inflation.

The Manhattan skyline. Cities with strong demand, such as New York, could have their property prices boosted and enter bubble territory. Reuters

This means that in cities with strong demand, such as London, Paris, New York and San Francisco, prices could be boosted into bubble territory, whereas in rural areas, such as the Midwest in the US or certain parts of southern Europe, they could fall.

Dubai’s luxury property market recorded the third-highest price growth among global cities last year, consultancy Savills said on January 20. It said prime residential centres were set to be a safe haven for investment in 2022.

The city’s real estate market is expected to achieve capital growth of 4 per cent to 5.9 per cent this year after growing 17.4 per cent in 2021, according to Savills World Cities Prime Residential Index, as the economy recovers from the Covid-19 pandemic and demand outstrips supply.

Should you invest in commercial property?

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.

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

Colin Lizieri, economist and professor of real estate finance at the University of Cambridge

“In the past, people have invested in real assets because they couldn’t find value in financial assets,” Prof Lizieri says. “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. That might not be the case right now.”

Multi-family housing is a different story. Since leases are typically up for renewal every 12 months, landlords have more opportunities to bake in factors such as 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 malls. Similar to a mutual fund, one share of a Reit offers partial ownership of the assets held by the fund.

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 per cent increase from the prior year, according to data compiled by Bloomberg. One of the largest – the Vanguard Real Estate ETF – rose 37 per cent in 2021 compared with 27 per cent 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,” says Ross Mayfield, an investment strategy analyst at Robert W. Baird. “They usually have a pretty nice income associated with them and they performed really strongly last year in an inflationary environment.”

Updated: January 28th 2022, 6:06 PM

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