5 Reasons Apartment Investments Hedge Against Inflation
There’s no doubt that we are seeing historically high levels of inflation. We see it in housing, materials, energy, and general consumer products. While politicians and economists can argue over the reasons for these price increases, it’s abundantly obvious that the buying power of a dollar is not what it used to be. For investors, it also means the real world value of your returns on investment are under pressure. However, one particular asset class–large multifamily or apartments–can act as a hedge against the impact of inflation on your investment capital and returns.
Higher Home Prices Provide Upward Pressure on Rent Prices
One of the most obvious signs of inflation are higher home prices. While the general trendline of home values has an upward slope over time, it’s in times of high inflation that values increase in a much more dramatic fashion. That can have an impact on rent prices. When home prices increase beyond people’s ability to afford them, it tends to drive them towards rental housing. When that increased demand meets limited supply of rental housing, rent prices increase. Apartment owners can typically charge higher rents when there are 10 applicants than they could when there are one or two applicants for a unit. Certainly, home prices are not the only upward pressure factor in rent prices, but this dynamic does play a meaningful role.
The Effect of Inflation on Debt-to-Value Ratio
Not only does inflation raise the value of single family homes, but it also increases the value of apartment properties. As the value of the asset rises, it actually lowers the loan-to-value of the mortgage debt. Let’s say an apartment property has a $20 million mortgage when it was bought for $25 million. If the value of that property rises to $35 million due to inflationary market dynamics, that increases the owners’ equity in the property. The ratio of the loan to the value of the property has decreased, meaning the owners have accrued more wealth–albeit unrealized until the property is sold.
Inflationary Material Costs Limit Supply of New Rental Properties
When inflation is running hot, perhaps no other area is more affected than the cost of materials and goods needed in the construction of buildings and rental housing. Lumber, wiring, concrete, paint, etc all run well higher than recent norms. Those costs don’t take long to add up when considering the construction of large multifamily assets with 100+ units. Developers of apartment complexes must factor in these costs and whether or not they will be able to build and still generate a profit upon exit after completion. In many markets, it becomes cost prohibitive to build new apartments. The end result is very few new properties coming online, which creates a very constrained supply of rental housing. Low supply combined with high demand in most markets creates the opportunity for landlords to charge ever increasing rents.
Short-term Leases Allow for Inflationary-Adaptive Pricing of Rents
While commercial retail leases can range in duration from 5 to 10 years or more, apartment rental leases are almost always one year or less. This allows for a more frequent “reset” of rent pricing. This is key because it allows the apartment ownership to raise prices inline with inflationary pressure–as well as supply and demand dynamics within the market. The frequency of this repricing also allows the landlords the opportunity to pass along increased expenses to renters–either directly in the form of charge backs or indirectly in the form of general rent increases.
Investment Hold Periods Allow for Market Timing
Effective apartment properties run cashflow positive. Actually, apartment assets should produce health cashflow if they are managed properly and reside in the right market. Their cashflow nature allows apartments to be held through the ups and downs of market trends. If valuations do not behave in line with expectations, apartment owners can rely on the positive cashflow to weather the storm until valuations improve and exit return targets can be achieved.
In short, while inflation can eat away at the buying power of your dollar, investments in apartment assets can not only hedge against inflation but can thrive in an inflationary environment. But, how does the average investor take on apartment ownership? The answer: apartment syndications. Quite simply, apartment syndications are the pooling of investment capital among small investors to acquire large multifamily assets that are typically reserved to institutional investors. At New Sight Capital, our apartment syndications allow busy professionals to obtain this equity and achieve passive cash flow and capital growth.
To learn more, please register and we’ll send you introductory information on syndications, as well as insights on our current investment opportunities.
by
Walt Whitley, O.D. and Russ Beach, O.D.
