312: Should Real Estate Investors Be Worried About Inflation?

The most common question I get from investors these days is how increasing interest rates will affect the performance of our real estate holdings. There is often concern, for good reason, that as rates go up our net operating income will go down. The good news is that things aren't that simple. Rate increases don't happen in a vacuum. Remember that the reason the Fed is increasing interest rates in the first place is because of inflation. We are in 1980s territory with 8.5 year over year inflation. The Federal Reserve has to raise rates to keep it under control. But drilling down on inflation reveals an important reality in multifamily real estate. In our high growth markets, we are increasing rents at a pace that often significantly out-paces inflation right now. In other words, what we are finding is that we are driving net operating income up at our properties far in excess to what the inflation numbers show—as scary as they may sound. This is why we always talk about real estate as a hedge to inflation. You are seeing this reality in real time. Not only are we hedging inflation. In reality, as the second largest landlord in Phoenix, our rent increases are probably making a significant impact on the inflationary data in that market. The specific kind of real estate that we focus on is also helpful. Our leases are year-to-year so we can raise rents appropriately with the economic realities on the ground. Many commercial leases are multi-year fixed contracts that can not be altered to reflect inflation. Finally, you should know that cap rates do not correlate with interest rates in a linear fashion. Cap rates rise slower than interest rates. We also mitigate that risk by buying rate caps on all of our properties. Bottom line is that, in my opinion, high quality multifamily real estate in high growth markets is a great place to be in inflationary environments like we are now. I understand the anxiety people have about deploying capital but remember, not investing when there is 8.5 percent inflation year over year essentially guarantees you lose money in form of buying power. So fear is not going to save you money. But I know it's a complicated topic and to drill down on it further I talk with serial real estate entrepreneur, Christopher Volk, on this week's episode of Wealth Formula Podcast. Having taken multiple companies public including a REIT, he knows a thing or two about the real estate market!