Investment professionals often mention three investments that provide a positive hedge against inflation: Multi-family, gold and Treasure Inflation Protected Securities (TIPS). Today we are going to examine how investing in multi-family can provide an inflation hedge.
First of all, a few basics. Inflation devalues the purchasing power of a dollar, so finding a safe haven for your cash is critical during inflationary periods. The International Monetary Fund has studied the impact of interest rates on inflation and concluded that, “Cross-correlations show that higher inflation leads to higher interest rates and higher interest rates result in a reduction in inflation.”
Historically in the US, rents have increased every year except 10 years prior to 1935. Forbes reported that inflation has averaged 3.8% per year from 1960 to 2021. Since 2000, the average apartment rental cost has increased 73% versus 46% for general inflation. From this data we can assume that rents will most likely continue to rise and probably outpace general inflation.
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Higher inflation leads to higher interest rates and makes renting cheaper than owning- increases demand
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Inflation boosts rents at a higher rate than underlying expenses- increases NOI
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Higher interest rates will reduce new supply which also boosts rents- reduces supply
Mathematically, inflation is good for multi-family. Prudent multi-family investors utilize fixed-rate financing, so inflation reduces the value of the cost of financing over time. Rent inflation has outpaced overall inflation by 1.27% per year since 1980. With operating expenses on a typical multi-family averaging 50% of rental income, investors will see the top-line grow much faster than expenses on a dollar basis. This translates into higher NOI and higher property valuations.
Clearly, using broad stroke statements can be proven wrong depending on a number of factors but overall, there is a tailwind for multi-family investors during inflationary periods. The flood of cash injected into the system during Covid clearly led to overbuilding in some markets. Projections show that in the next couple of years, supply will moderate and favor property owners. The FED is poised to begin cutting rates which, according to history, could lead to higher inflation and boost NOI for apartment owners and strengthen property valuations.