When a recession hits, and interest rates rise, the cost of goods and services go up, and over time, this reduces the value of money. So you can buy less for the same money.
Real estate is often considered one smart way to offset the effects of inflation.
Here are a few reasons why:
1. Rental Income Growth:
Inflation is often accompanied by rising rent growth, which works in favor of multi-family investors and owners. As the general price level increases, property owners can adjust their rental prices accordingly, boosting their cash flow and overall returns for investors.
2. Fixed-Rate Debt Advantage:
One of the most compelling aspects of investing in multi-family real estate during inflationary periods is the availability of long-term, fixed-rate debt financing. As inflation rises, the cost of borrowing increases, but investors who have secured fixed-rate financing beforehand can benefit from lower interest payments, enhancing their cash-on-cash returns.
3. Tangible Asset:
Unlike financial instruments that can be highly susceptible to inflationary pressures, multi-family properties are tangible assets with intrinsic value. Real Estate, by nature, is a hard asset that tends to retain its value during inflationary periods, providing a crucial safeguard against economic volatility.
4. Limited Supply:
The supply-demand dynamics in the multi-family real estate market often favor investors and property owners during inflation. As the cost of construction materials and labor rises, the development of new multi-family projects becomes costlier, limiting the supply of new rental units. This can contribute to increased demand for existing properties and further drive rental income growth.
5. Diversification:
Including multi-family real estate in an investment portfolio can offer diversification benefits, reducing overall risk exposure. Investors can achieve a more balanced and resilient investment strategy by having a mix of assets that respond differently to inflationary pressures.
The Value Add LifeCycle
So, when investing in real estate, it’s vital to ensure your money doesn’t depreciate further. This is why we focus on the ‘value add.’ Simply, we look for assets with a potential upside in the business plan.
It could be as simple as changing out the management, making repairs, or facilitating long-term renovations. When these are completed, rents can be brought up to market rates because the tenants will pay it.
Tenants always drive the market because if you are overcharging, they will leave, and as an asset owner, you want to avoid that at all costs.
That is also why we focus on the B & C class of assets. Real estate is generally placed in one of three buckets: A, B, and C.
Each of our investments have some sort of value add component to them. Anything from changing out the management, clean up and reorganizing to full on renovations. We are always looking for ways to increase the value, occupancy and cash-flow. – Parker Smith COO.
Class A is the top. An example would be a new apartment building in downtown San Diego overlooking the bay with all the bells and whistles, such as a state-of-the-art gym, spa, pool, and much more. The rents are high, and the expectation from tenets matches this.
Class B tends to be built within the last 20 years or has just been renovated. A class B asset is in general good order but might require some upgrades and ongoing maintenance.
Class C are older, at least 30 years old, and often do not have amenities such as the other classes. They can also be in economic areas that are lower on the scale than where Class A and B would be.
Class B and C have potential upside value-add opportunities, whereas Class A tends not to. Class A buildings are already at their best when you invest in them, so there is no real way to add value other than hoping the market increases and your rents can increase. While this isn’t a bad business plan per se, you are out of options if the market turns.
If you look at the CalTier portfolio, you will see the properties have some value add to them. We increase the value of the assets by adding value to the tenants and, therefore, increase rents and cash flow.
If you have yet to invest in Real Estate, consider the CalTier Fund.
