The idea of this post is to follow upon my recent post regarding inflation and why I think it is likely in at least the relatively near future. Real estate is commonly regarded as being a hedge against inflation since it is a hard asset, similar to gold, silver, corn, fine art, etc. I believe there are strong reasons to prefer real estate to those other investment alternatives, especially at this point in time.
All of the above mentioned alternatives, plus many others would serve to hedge inflation risk. However, in picking between them we need to analyze what value are we paying now to hedge that future risk, what kind of income can the hedge generate for you and what happens to the value of the asset if inflation doesn’t occur?
On each of these questions real estate fares better than the other alternatives.
What price are you paying? Gold, silver and commodities such as coffee and cocoa beans are hitting record highs. On the other hand, real estate has been mired in a multi-year decline in prices. As far as buying low, its a much more difficult argument to make that gold and silver are cheaper than real estate.
What kind of income will this asset produce? Gold, silver, corn, wheat are to be bought and sold. At the end of the day, either you have made money in commodities or you have lost money. If you buy too high and can’t sell for a profit – you lose money! Real estate is unique in that even if you were to buy for a price that was too high and that would prevent you from turning around and selling at some point in the future there is always the possibility to lease out the property! As long as you are buying real estate that, when purchased, provides a positive cash flow, then you can’t lose. If financed, worst case scenario is you rent the property out and have a tenant pay off your mortgage for you. If purchased with cash, worst case scenario is you receive a monthly payment – which can be adjusted for inflation or market conditions as needed.
What happens to asset if inflation doesn’t occur? If the expected amount of inflation doesn’t occur, or at worst if there is deflation, history has shown that commodity prices get crushed – in most circumstances. In the last recession we saw oil drop from a high of $147 a barrel in 2008 to a low of under $40 a barrel by 2009. Other factors played a role in the price of gold which actually increased, however, corn, wheat and other consumables crashed in late 2008 as well. Real estate which was in many ways the instigation behind the crash also did very poorly. However, again, the difference between those other asset classes is that real estate can generate income, which will mitigate price declines. Of course, the majority of people investing in real estate during the last boom weren’t focused on cash flow – if you were then you are still doing just fine.