Many believe they need a hedge against inflation. TIAA-CREF points out reasons for these fears: “Rising food and energy prices, coupled with federal debt levels and low interest rates, have recently fueled new inflationary fears. These concerns are understandable given the Federal Reserve’s determination to keep interest rates at exceptionally low levels. As a result, some investors may be looking for ways to protect their portfolios from the ravages of inflation.
Is real estate a hedge against inflation? The Daily Reckoning writes:
“First, what is an inflation hedge? An inflation hedge is an asset that loses little value in periods of rising prices. Thus, it holds its value and purchasing power during inflation. This also applies to hyperinflation. An investor expecting inflation will buy this asset to hedge against inflation.
Second, what makes a good inflation hedge? The answer to the second question requires understanding of the two basic types of assets: real assets and financial assets.
Real assets have intrinsic value. They have value of their own. People value them for their direct or indirect usefulness. Examples include books, TVs, cars, wheat, gold, real estate, land, etc.
Financial assets, on the other hand, are a claim on the income or wealth of a firm, family or the government. Their typical form is a certificate or a receipt. Examples include paper money, stocks, bonds, mortgages and exchange traded funds. All money market and capital market instruments serve as examples.
In general, real assets hedge better than paper assets. By definition, real assets have a value of their own. Inflation does not erode their value. Thus, any real asset can be an inflation hedge. It follows that real estate is also a hedge, but it’s not the best.
Good hedges have a few key properties.
- One key property of a hedge is that it holds its value. It should lose little value over time. Cars and eggs lose value over time. Land, silver and wine do not.
- Another key property is marketability. This means that it is easy to sell. Other people will easily take it for payment. Hence, it is good for barter. Chairs and clothes do not sell. Corn and gold do. Real estate can fluctuate from a buyer’s market to a seller’s market.
- A third key property is divisibility. This means that the asset splits into smaller parts without a loss of value. Houses, cars and cows are not divisible. Rice, wine, gas and gold are. Land is divisible in most cases.
- The last key property is financing. It is vital. Experts prefer to fully ignore it. Investors buy assets with either cash or credit. Cash-based hedges are good. Credit-based hedges are bad. History repeatedly shows that assets bought on credit are prone to speculation and bubbles. The hedge might be already overvalued. In this case, investors should avoid it. Credit clearly drives real estate.
Bottom Line: Real estate can be a great hedge against inflation over time. However, short term real estate is subject to the laws of supply and demand and credit availability.