In Dec-2021, inflation, as measured by the consumer price index (CPI), raged ahead at its fastest 12-month pace in nearly 40 years.  According to the Bureau of Labor Statistics, the 12-month change in CPI reached 7% in December, a level not seen since June 1982. To put it into context, that’s roughly 3.7 times higher than the 10-year average of 1.9% and 3.2 times higher than the 20-year average of 2.2%.

As a result, homeowners and investors are now asking the question of how inflation will impact their real estate holdings. For homeowners or investors that currently own real estate, the news is good. Real estate, in general, has traditionally outperformed other asset classes (e.g., stocks, bonds, etc.) during inflationary periods for three basic reasons.

3 Reason Why Real Estate Outperforms Other Asset Classes in an Inflationary Environment

First, property owners, in general, benefit from the ability to charge higher annual rents (income) as most leases are indexed for inflation or a 12-month change in the consumer price index (CPI).

Secondly, inflation increases construction costs (labor and raw materials) which raises the price (value) of new and existing homes. The latter benefits from the step-up effect associated with higher replacement costs and the previously mentioned ability to charge higher rents.

Thirdly, inflation effectively devalues long-term, fixed-rate debt or mortgage loans as it allows borrowers to pay down their fixed-rate debt with inflated (cheaper) dollars.

That’s the good news. The bad news is that inflation typically raises interest rates or borrowing costs which reduces demand for real estate and partially offsets any increase in home prices. Moreover, inflation raises property taxes which partially mitigates the returns received by homeowners and investors.

Bottom line, if you’re a homeowner or an investor who owns property, real estate, in general, has proven to be an effective hedge.