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How Buying a House Can Hedge Against Inflation
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How Buying a House Can Hedge Against Inflation

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The cost of goods across industries is rising, leading to broader concerns about inflation and whether people will struggle to purchase the items they could afford in the past. But there are financial moves consumers can make to hedge against inflation. One of those strategies is to invest in real estate, especially when mortgage rates are low, as they are now.

The latest Consumer Price Index (CPI)—which is the weighted average of the price of goods and services over time—jumped 5% for the 12 months ending in May, the highest annual increase since August 2008. A rise in the CPI is an indicator of inflation.

As inflation rises, the cost of everything goes up, including real estate. However, if you can lock in a low-interest, fixed-rate mortgage, then the cost of your home—an appreciating asset—will stay the same as the value of your property rises.

“We often get hung up on the exact definition of inflation, but one thing we all know is that prices for a lot of items in the economy have gone up,” says Ali Wolf, chief economist at Zonda, a housing data and consulting firm. “If you have cash and are expecting inflation, you want to think through where you can put your money so it does not lose value. Housing is commonly looked at as a good inflation hedge, especially with interest rates so low.”

On the flip side, a bad inflationary hedge would be to leave your cash in a savings account. Even though banks usually pay higher interest rates during inflationary periods, the value likely won’t outperform inflation.

3 Ways a Home Purchase Is a Reliable Hedge Against Inflation

Typically, inflation ushers in higher prices for everything, including mortgage rates, home prices and rental costs. So, if you’re considering buying a home and think we might be heading for rising inflation, here are some ways buying a home now can help you later.

  • Lock in a mortgage with a low, fixed rate. The average rate for a 30-year fixed mortgage is bouncing around the low-3% range, making this a great time to borrow money. As inflation increases, mortgage rates will likely climb, so folks who lock in a low rate now can avoid paying higher interest rates later.
  • You won’t be exposed to rising rent. The rising inflation tide lifts all boats, including rent prices. Homeowners are shielded from mounting rental prices because their cost is fixed, regardless of what’s happening in the market.
  • Property values increase over time. Tangible assets like real estate get more valuable over time, which makes buying a home a good way to spend your money during inflationary times.

Private Investors Are Taking Advantage of Cheap Money

You might have heard lately about private investors scooping up single-family homes, making it even more challenging for first-time homebuyers to enter today’s extremely competitive housing market.

Even though housing prices are surging, most homebuyers are interested now because they want to take advantage of the low interest-rate environment. Likewise, investors are keen on getting cheap money for assets that will go up in value.

In the first quarter of 2021, investors bought one of every seven U.S. homes purchased, which is a significant jump from the previous three quarters, when they were grabbing about one out of every 10 homes. Investors are the largest segment of buyers of multifamily properties, making up 25.8% of all purchases in the first quarter, according to a report by Redfin.

Lennar Homes—one of the largest homebuilders in the United States—recently announced it was purchasing more than $4 billion of new single-family homes and townhomes in high-growth areas in order to rent them out. This is a prime example of investors hedging against inflation while loan rates are low.

“If an investor can lock in a low 30-year, fixed-rate loan, offset that with rising rents due to lack of housing supply and also enjoy the property value appreciation that has been roaring through the U.S., that investor would be well suited against rising inflation,” says John Toohig, a managing director at Raymond James. “Couple this with fintech—like Airbnb, Landing.com or Whyle.com,—making rental access ever easier for consumers and you could see a surge in this product.”

Where Inflation is Headed

For nearly a decade, the Federal Open Market Committee (FOMC), which is in charge of monetary policy for the Federal Reserve, has set the inflation target at around 2%. Inflation has consistently fallen short of that goal, so its new spike—deemed transitory by the Fed—is not as concerning.

Because of scarcity in different parts of the economy, from computer chips to the labor market, the cost of goods and services is rising. This causes inflation to climb. Whether it’s a short-term rise or the beginning of a longer inflationary period is still uncertain.

“The near-term inflation is almost a free lunch and it’s something the Fed wants to encourage,” says Chester Spatt, professor of finance at the Tepper School of Business at Carnegie Mellon University. “Central bankers are more fearful of deflation than inflation. People will delay purchasing goods in deflation which really gets in the way of an effective economy.”

Some economists, like Gus Faucher, chief economist at PNC Financial Services Group, expect inflation to remain at around 4% through the end of the year, followed by some tapering in 2022, with inflation falling to 3%.

“This 4% level is above the recent average, but it’s certainly contained,” Faucher says. “Inflation in 2023 and beyond will be around 2% to 2.5%, right where the Fed wants it.”

Final Thoughts for Homebuyers

Although buying a home can help protect the homeowner’s money against inflation, buyers should still consider how long they plan on staying in the house.

Because closing costs are so expensive, buyers have to factor in those costs before buying a home because it impacts your ability to afford that home in the long run. When you purchase a house you will pay between 2% to 6% of the purchase price in closing costs. And when you sell the home, closing costs can run anywhere from 1% to 3% of the sale price.

If you don’t accrue enough equity in your home to cover those costs, you could end up losing money on the sale. Similarly, some people are purchasing homes above the appraised value, which means they start out in their new home upside down on their mortgage—they owe more than what the property is worth. This is not a good position to be in if you don’t plan on staying in the home long enough for appreciation to catch up.

Often, the only thing that can help you build equity is time. Of course, there are wild card events that cause a housing market boom, and you could see your home appreciate much more rapidly than the average appreciation rate, which is typically 3% to 5%.

Today’s housing market is a great example of rapid price appreciation. Depending on your area, you could be paying top dollar for a house. This isn’t necessarily a bad thing if you plan on staying in the house long-term, says Steve Schnall, CEO of Quontic Bank.

“Even homes that were bought at the peak of the housing market, prior to the Great Recession of 2008, are worth much more now than they were then. Time smoothes out the dips and proves equity growth,” Schnall says. “If, on the other hand, you’re buying with an eye on flipping or simply as a speculative move, buyer beware.”

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