Over the last two years, inflation rates have increased significantly in America. In fact, over just the last 12 months, inflation is up 8.3 % according to the consumer price index. For the housing market, Zillow is estimating that year-over-year inflation will come in at around 17.8 percent for 2022. This means that America is still in the middle of a red-hot housing market and that housing prices are still inflating steadily.
The inflation that we are seeing in America is largely due to the fact that the U.S. government printed trillions of dollars in various COVID relief packages. It is also due to supply chain problems, inventory shortages, labor shortages, and other problems that occurred as a result of the pandemic.
Because inflation is so high right now and because it is having a tremendous impact on the housing sector, it is crucial for real estate investors to understand how it is going to impact real estate investments and what steps they can take to use it to their advantage. In this blog, we are going to break down the key things that real estate investors need to know to thrive during this inflationary period.
The Positive and Negative Aspects of Inflation for Real Estate Investors
On one hand, inflation has positive aspects because rents are on the rise. In fact, here at Blue Lake, we have risen rents by almost 60 percent in some circumstances. Rising rents are a good thing for real estate investors because it means that properties produce more income. When properties produce more income, it means that real estate investors can enjoy higher profits as long as they can keep their expenses down.
However, it is true that the expenses associated with real estate investment also tend to increase when inflation goes up. For example, payroll can increase dramatically in inflationary environments. Payroll is one of the single most expensive line items in the real estate investing industry. Part of the reason why this is the case is because we are still in the middle of the “great resignation.”
The great resignation is a phenomenon in which tens of millions of Americans have been quitting their jobs every year and when a large percentage of the workforce is currently “seeking a new job.” Roughly 41 million people quit their jobs in 2021 and currently, about 44 percent of the workforce is “seeking a new job” with higher pay as the chief motivating factor.
So, in other words, payroll expenses are rising because tens of millions of Americans are quitting their jobs each year looking for jobs with higher pay. Additionally, another inflation-related problem is that if you took a loan with a variable interest rate, it is on the rise, which puts more pressure on the cash flow.
So… What Can You Do About It? 1. Get a fixed-rate loan.
One thing that you can do to deal with inflation is to get a fixed-rate loan, if you can find one that suits your needs. However, if you are going to take this approach, then you need to be aware that it will normally be higher than current adjustable rates. That is just the way it usually works. But, that is okay because fixed-rates can be much more stable and predictable compared to adjustable rates, which is ideal in a high-inflationary period. Adjustable rates, on the other hand, can be dangerous in inflationary periods. This is because when the rate changes, you could find yourself ending up owing too much money every month. Considering that your other expenses are likely to keep increasing due to inflation, you really don’t want your mortgage rates to go significantly higher than what you are comfortable paying. 2. Enjoy the increase in rents, but don't bank on it for the long term, because some markets are already softening.
Rising rents can be a huge win for real estate investors during periods of high inflation. This is because rising rents equal greater cash flow, and usually end up improving ROI. But, rents cannot just rise infinitely forever without any market downturns. So, don’t just assume that rents will increase steadily month after month and year after year. Some real estate markets in America are already starting to soften. When your market softens, there is a very good chance that you will start to see rents plateau or even start slipping downward.
3. Understand that inflation may equal higher prices, but actually, some real estate assets (specifically multifamily) prices are softening.
When inflation occurs, it’s true that it can cause real estate prices to increase dramatically. However, the federal reserve has started to raise interest rates. Also, there is significantly less financial stimulus happening now compared to the past few years. This is causing prices to start softening in some areas, particularly in multifamily real estate. So, make sure that you understand that the market might be starting to shift. You can adapt to this changing real estate landscape by taking a cautious approach. For example, it is now critical that you don’t overbid. This was not as much of a concern when interest rates were at historic lows. But now that they are starting to rise, you have to be more careful to avoid overpaying. If you do overbid, then it could eat too much into your profits, which is not ideal.
4. Always underwrite conservatively.
You should expect inflation to significantly increase your expenses. You need to factor this into your underwriting to make sure that you do not accidentally expose yourself to unnecessary risk. So, make sure that you do not only anticipate rising rent and property values, but also rising expenses. Expect repairs, appliances, renovations, legal fees, property management fees, etc. to all increase along with everything else. You should do your best to try to anticipate how much your expenses will increase each year and make sure that you budget for this increase.
Inflation in the housing market is unlikely to go away any time soon. It might slow down because of factors such as rising interest rates, but it is still likely that both property values and rental values are going to keep increasing, perhaps just not quite as fast. In order to thrive as a real estate investor during this period, there are a number of things that you need to do.
First, you should prioritize fixed-rate loans, which provide greater stability and are safer. Second, you should enjoy rental increases, but not bet too heavily on them, because the market is softening a little bit in some places. Third, you should be aware that rising interest rates are also causing property prices to soften in certain areas, so you have to be careful not to overbid. Finally, fourth, you need to always underwrite conservatively. This is especially important considering that payroll expenses are also inflating along with property and rental prices.
Currently, the federal reserve is trying to combat inflation with rising interest rates. So, it is possible that inflation will not be quite as high in the future. However, it appears that high inflation will still be here for the foreseeable future. So, take steps now to best anticipate it and act accordingly.
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About the Author
Ellie is the founder of Blue Lake Capital, a commercial real estate investment firm specializing in multifamily investing throughout the United States. At Blue Lake Capital, Ellie partners with both institutional and individual investors to grow their wealth by achieving double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.
A defining factor of Blue Lake Capital’s strategy is founded in utilizing machine learning/artificial intelligence throughout the course of all acquisitions and asset management. This advanced technology enables the company to produce accurate and data-driven forecasting for all assets on a market, property, and even tenant basis. In doing so, Blue Lake is able to lead commercial investments with the full capabilities of today’s technology.
Ellie is the host of REady2Scale, a podcast that highlights the assets, processes, and strategies for the multiple approaches to successful real estate investing.
She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations.
Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management.
You can read more about Blue Lake Capital and Ellie Perlman at www.bluelake-capital.com.