The Ultimate Inflation Hedge
Inflation is the enemy of an investment portfolio – a stock portfolio. At least that’s what investors have been programmed to think.
There’s a theoretical explanation for why stock prices drop as inflation rises, but I doubt that’s what goes through most investors’ heads. Theoretically, the price of a company’s stock is based on the present value of the stock’s expected future income stream from dividends.
As a company’s demand for its goods or services shrinks due to rising prices from inflation, this reduces its income stream – thereby devaluing its stock.
I doubt investors are thinking about the present value of future income streams from dividends when inflation hits. Most are indoctrinated with the “inflation bad” narrative and simply react to news of inflationary fears by unloading their stocks and driving prices down – self-fulfilling the prophecy in a way.
Lately, inflationary fears have started creeping in as economic stimulus in response to the COVID-19 pandemic has pumped trillions of new money into the economy. And we’re not done as another round of stimulus is on the horizon.
So far, inflation has held steady but elite investors aren’t waiting around for the shoe to drop. Over the summer and recently as retail investors have driven the Dow to record highs, the ultra-rich were zigging while everyone else was zagging. The wealthy were unloading stocks and hoarding cash. And if history is any indication, they will likely start buying up hard assets to hedge against inflation.
While Wall Street investors fear inflation, the wealthy take advantage of it by buying up tangible assets – especially ones that cash flow like commercial real estate.
That’s because rising prices not only increase the underlying value of cash flowing property but also increase the income generated by the real estate as rents rise. Just as the underlying value of the property rises with inflation, so too does the amount of rent tenants are required to pay.
This strategy is particularly prudent with real estate asset classes that are demand inelastic because of short supply such as multifamily housing where price increases don’t affect occupancy.
You want to avoid assets that have a negative correlation to inflation and run to the assets with a positive correlation. In other words, avoid assets that fall with inflation and invest in assets that rise with it.
Some investors have the misconception that putting money under the mattress or into savings accounts and CD’s are innocuous moves in an inflationary environment, but they’re wrong.
With savings and CD rates well below 1%, inflation will only erode the value of those funds just as it erodes money under a mattress that earns nothing but loses buying power the longer it lies dormant.
Time is inflation’s fuel. The longer inflation goes on, the more its destructive power over many assets like stocks, bonds, and consumer bank offerings. However, with the right assets, time, and inflation works in the investor’s favor as the asset increasingly generates wealth from accelerating appreciation and rents.
Real estate’s hedging value is backed up by private data as well as government data. A recent Wall Street Journal article singled out real estate as one of the top two assets with the highest correlation to inflation of any investment class – based on 50 years of data. This means real estate prices moved in the same direction as inflations.
It should be noted, however, that the study’s conclusions on real estate were based purely on the price of real estate without taking into consideration the cash flow factor. When factoring in cash flow, commercial real estate is far and away from the best hedge against inflation.
In a recent government report, the Bureau of Labor Statistics identified the increase in housing and rents as one of the biggest factors for the biggest jump in CPI since 2012.
Cash flowing real estate is not only a strong hedge against inflation, it’s a strong investment in any economic environment. This is especially true with real asset classes that are recession-resistant such as multifamily.
Real estate has historically been one of the best ways to invest your money and to hedge against inflation. With real estate, you can build and grow your money in any economy, rather than watching it lose value.
This is all due to real estate being a truly essential product. People will always need shelter. The prices of goods such as shelter, health care, and fuel have historically risen with inflation because they’re essential. People will always need them.
That’s why elite investors stock up on tangible assets like commercial real estate when inflation rears its ugly head and it’s why you should also consider it for your portfolio.