Navigating Inflation Over the Long Term

2011-2021 Rate of Inflation

Inflation is no longer transitory

Last December, 2021, U.S. officials decided to stop using the term “transitory” (meaning lasting only a short period) to describe the record-breaking inflation rate. Over the last decade, inflation has remained relatively low, except for 2021 where it skyrocketed to 7%—the highest rate since 1982.

There are numerous reasons for this jump in inflation, however, most were triggered by the pandemic. You could say it’s a “perfect storm” of conditions that are impacting how our economy functions such as:

  • Higher demand and more scarcity as consumers flush with cash from savings and government subsidies rush to buy goods

  • Fewer workers who demand more pay and are more selective in the jobs they do

  • Reduced productivity as a result of worker shortage, less goods are output creating more scarcity and demand which over-inflates prices

  • Oil refineries lag due to reduced demand creating higher energy prices (energy has the highest consumer price index increase)

  • Extensive problems with the supply chain and distribution of goods exacerbated by ongoing worker shortages

  • Businesses have reduced storefronts or permanently closed, creating limited supply and choices

We are entering the third year of the pandemic in 2022 and we are only starting to realize the cascading effect of the pandemic and how it’s impacted the economy. These effects are building on and influencing one another, further inflaming the economic downturns that impact consumers and businesses.

What’s important about this compounding effect is that it will likely take longer for the economy and inflation to normalize once we rise above the conditions triggered by the pandemic. There are still many unknowns as the current pandemic is unprecedented—we don’t know when it will end nor when the economy will stabilize.

The good news for investors

There is a silver lining for every downturn. The most important one is for real estate investors who own properties and have multiple types of housing they can offer to the rental market.

The housing market

There continues to be significant drops in new housing construction, making existing properties have higher-than-normal demand. A partial reason for the slowing of construction is the delays and breakdowns in the supply chain—builders cannot get materials. Many are pouring slabs and delaying framing as a result, making development sluggish. Demand still remains high due to low interest rates and a growing population that wants to own property.

Home prices will continue to rise, but not at the rate they have been the last few years. As long as demand is high, inventory will be low. As inflation increases and the economy and job market slows, demand and prices will relax and inventory will grow.

Rents will go up

Rent prices will increase with inflation because there are a larger pool of people who will choose to rent instead of buy. Keep in mind though, expenses will also increase as the cost of goods and services rise. When investors are able to widen the gap between income and expenses, the affects of inflation are normalized. Additionally, tenants will renew or extend their rental commitments which causes more stability and less turnover for an investor’s property.

Debt service is locked

For investors who are newly purchasing a property and leveraging debt, look to obtain a fixed-rate mortgage where the cost of debt remains stable. As cash flow continues to increase through rents, it will be easier to pay off the debt over time. Examine other costs/expenses that remain relatively fixed such as insurance, taxes and such, and include them in property calculations.

Riding the inflation dragon long-term

As the cost of materials, labor and the functions of operating the investment business continue to rise, increasing profit can be difficult. Paying attention to the numbers is critical to see where the money is going and how investors can offset operating expenses with increased rents. Until the supply chain problems end and materials and labor costs stabilize, the cost of improving and maintaining properties will continue to rise.

What investors should be doing right now is planning what improvements they can proactively get done sooner rather than later. If you have been putting off major repairs or work such as replacing a boiler or windows, do those upgrades now because it will cost more later.

 
 
 

Jen’s Investor Tip:

“Be proactive in maintenance and repairs of buildings going into the term of inflation”
— Jennifer de Jesus
 

Summary

Inflation causes uncertainty especially for investors. Knowing what to expect and how to adjust for the long term is critical. Work on widening the gap between income and expenses to remain profitable. When inventory is low, there is less risk of a tenant leaving, therefore, make the necessary adjustments in rent to compensate for the ever-increasing costs of good and services. Don’t wait until something breaks to repair it—be more proactive about maintenance which is key to maintaining your properties for good cash flow and securing longer-term tenants. 🏠

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Terry PappyComment