The last year has been rough. Safeguards to limit exposure to COVID-19 reduced or eliminated millions of jobs. The Federal Reserve acted quickly and aggressively to push money out to those who desperately needed it, and even some that didn’t. There’s a ton of newly minted money, a total of $4.1 trillion dollars from the Coronavirus Aid, Relief, and Economic Security (CARES) Act and the American Rescue Plan. This translates into inflationary risk.
While $4.1 trillion of new currency is startling, it is not the only inflation risk we are facing. Interest rates are near zero, the government is purchasing bonds from banks to help with liquidity, and what about the massive state and federal budget deficits that were ever-increasing even without COVID-19 relief funds?
We all want the economy to heal, but what happens when that healing starts moving the dial on inflation? What hedges do you have in play against this risk? Can the multifamily asset class be that hedge for you?
For the majority of Americans, shelter is their biggest expense. When inflation rises, it hits renters harder than most homeowners. Often, the cost of renters’ housing increases even faster than the rate reflected in their wages. However, there’s an inverse effect for the multifamily investor. Assuming a somewhat stable financial sunk cost, your largest asset holding cost is fixed while your rent revenue stream increases.
Multifamily is a superior inflation hedge compared to other commercial real estate assets. This is because of the short duration of housing leases, which are often a year. Other commercial real estates could have lease terms of seven or more years with minimal annual rent increases. Multifamily leases can reset to current market rates at renewal, a fraction of the time of other real estate classes.
Seasonal staggering of leases is almost automatic with multifamily and creates further inflationary hedges. Most multifamily properties are going to have turnover and lease expirations throughout the year. Think of this as your own personal income indexing. It’s like a mutual fund, or dollar-cost averaging, with financial smoothing and risk reduction. Sometimes, though, you want to strike when the market is best, and that is typically in the spring and summer when more households tend to move. This unique fluctuation should maximize your rental rates which contractually lock-in, even through the slower months.
Multifamily real estate is a necessity for our communities. Homeownership is something most Americans aspire to, but it is getting further out of reach. Inflation exacerbates this problem with personal savings losing value while housing costs go the other direction. As a generation, Millennials are forming households far later and are still scarred from the Great Recession. Generation Z has recently entered the workforce and their savings rate is at historic lows. Both of these groups will struggle to save the down payment needed for purchasing a home.
Inflation will again rear its ugly head, maybe even sooner than we expect. Investments in multifamily real estate can be your inflation hedge, certainly more than most imaginable investments, even those in other real estate classes. With multifamily as a protective investment, your exposure to inflationary risk can be somewhat mitigated. Don’t fear a small spike in inflation. It may even be a positive for your multifamily portfolio.
Written by:
Agnes Wong
-San Francisco Chapter Leader
