In this article were going to take a look at how real estate performs in various macroeconomic climates.

If youre following the news and the actions of not only the US government but most of the major governments in the world, then it is very reasonable, maybe even a foregone conclusion, that we are headed for massive inflation in the not too distant future.  If things get even more out of control we could even experience hyperinflation.  On the other hand, a case can be made that were heading for massive deflation, just like in the Great Depression.

It is out of the scope of this article to go into details on the factors leading to these 2 scenarios. However, if you are a real estate investor, or are considering investing in real estate, then it is important to understand how real estate investments perform in each of these 2 scenarios.

What happens in periods of high inflation? The purchasing power of the dollar declines.  As a result, creditors are getting paid back in dollars that are worth less then they lent out and as a result they raise interest rates. Creditors like interest rates to be a few percentage points above inflation.

So lets use some numbers as examples. If inflation hits 12%, then interest rates could easily go up to 15-20% so creditors can make money. But at 15% the cost of a mortgage skyrockets and most people cant afford to buy a home. This happened in the 70s and many other times in history.

As fewer people qualify for mortgages, rental demand increases and rents go up. Rental property owners, especially those with fixed interest rate mortgages, receive higher rental income while their biggest expense stays fixed. Thus their cash flow increases.

One important note here. In times of high inflation, properties with shorter rental periods generally perform better so residential rental property with 6-12 month leases is a good bet. Commercial rental properties such as office complexes and shopping centers, which often have 5-10 year leases can actually see cash flow go down as expenses such as utilities, insurance, maintenance, etc increase while rents are flat.

How is appreciation affected by periods of  inflation? During times of high inflation, the cost of the raw materials needed for new construction increases which also directly affects overall property prices. As the costs of materials, labor, and legal rise, prices of existing properties are positively impacted.

But what if were headed for another Great Depression? We certainly hope that is not the case but lets take a look at how real estate performs in deflationary times. If residential real estate performs well in inflationary times then you might expect that it would not perform well as an investment in times of deflation but as well see that is not the case.

In times of deflation, there isnt much money available to buy anything.  This lack of money creates a lack of demand and the lack of demand forces prices down and that includes real estate prices. However, real estate has just gone through a major deflationary period while other commodities such as gold, silver, and oil have had major upswings. So real estate has less room to fall and less risk than other commodities.

But heres the kicker, cash-flow real estate has a huge advantage over other assets during deflation: the cash-flow!

Even if the value of a rental property drops during a period of deflation, the rent checks still give you a return on investment each month.  Other investments do not. Plus it’s easy to find renters during deflation because banks don’t have the money to lend for mortgages.  People can’t buy homes, so they have to rent. If you expect a period of deflation, your real estate investment will perform best with longer lease periods so increase your lease durations as much as possible.

In summary, you can see that residential rental properties do very well in times of inflation and they have advantages over other investments in times of deflation.

Lori Greymont

PS Our team of experienced real estate professionals can help you create a customized investment plan and find properties in the best rental markets the country that fit your plan. Contact Dan  today for a free consultation at 408-268-9777.