Real Estate As A Hedge
America’s Struggle Against Inflation
The average American has little or no defense against inflation. For most of us, our home is the ONLY asset we have that may keep up with inflation and thus gives us some protection. Although there has not been much in the news about inflation, prices have started to creep upward over the last year.
As examples, here are a few categories that increased from November 2010 to November 2011:
Food at home – up 6.2%
Housing fuels and utilities – up 3.5%
Transportation – up 9.2%
Moody’s Economy.com predicts that the headline Consumer Price Index, which counts food and energy prices, will rise at a relatively modest rate of approximately 2% per year in 2011 and 2012, up from 1.6% in 2010. With inflation the value of consumables and commodities are depreciating, but the value of real estate keeps pace with inflation. In a purchase of a real estate asset, we are essentially buying today’s property with tomorrow’s dollars.
Real Estate As A Hedge
About 63% of Americans own their own home, but less than 5% of Americans have investment property. While owning a own home is a good first step, having one property does not begin to yield wealth. On the other hand, you don’t need 1,000 properties or even 100 properties in order to build true wealth through real estate. In fact, you don’t even need to own any real estate to build wealth with it— you just need to know where to find real estate-based investments that provide consistently great returns.
Real estate has always been a constantly appreciating asset in our economy. Everyone needs a place to live, land to produce food and buildings to run a business.
According the National Census Bureau, median home values adjusted for inflation nearly quadrupled over the 60-year period since the first housing census in 1940. The median value of single-family homes in the United States rose from $30,600 in 1940 to $119,600 in 2000, after adjusting for inflation.
When the returns from investing in an asset exceed the rate of inflation, it is considered to be a good hedge. Indeed, The National Council of Real Estate Investment Fiduciaries’ total return index, which attempts to capture the gain from both net operating income as well as increases in asset value, generally posted higher returns than inflation in most of the 1980s. The index tracks a large pool of institutional quality commercial real estate held mostly by pension funds.
Trophy properties in gateway cities trade at cap rates under 5%, while distressed deals transact at cap rates of 8% or above. (The cap rate is the initial return to the investor based on the purchase price and the annual net operating income the property generates.) But paying a higher price for trophy properties translates to a lower rate of income return. Distressed deals offer value-added investors potentially higher rates of both income and capital returns. These are opportunistic ventures best handled by those who know how to navigate the distressed market like Resolution Capital Management.
“The consensus is that total annual returns from commercial real estate over the next two years will be fairly robust, in the 10 to 11 percent range,” says Reis senior economist Ryan Severino, who serves on the National Council of Real Estate Investment Fiduciaries’ research committee. “More than half of that [return] will come from income returns as vacancies tighten and rent growth accelerates, but don’t expect big jumps in commercial real estate values,” adds Severino.
An asset that returns 10% to 11% certainly implies a good hedge against rising prices, even if consensus inflation expectations from professional business forecasters double from its current 2% +.
However, with many real estate property types still in flux, it is easy to make a mistake. By investing with a knowledgeable company like Resolution Capital Management, you can have a great hedge against inflation without having to do the research required to gauge market trends and find assets that offer a good rate of income and capital return.