Increasing inflation is in the news and on the mind of US investors. Significant inflation has not been experienced in the US since the late 1970’s and early 1980’s. Since that time, interest rates have been on a steady and relentless decline. While there have been occasional upticks in inflation over the last few decades, these have been short-lived.
However, many investment experts are starting to wonder out loud if this time is different. In the second quarter of 2021, recently released inflation numbers are the highest recorded in over a decade. As recently reported in the Wall Street Journal, “Consumer prices rose 5% in May from a year earlier, according to the U.S. Labor Department, the biggest surge in inflation in nearly 13 years. Federal Reserve officials signaled Wednesday that they expect to raise interest rates by late 2023 as inflation picks up.”
Here at Aloha Capital, we have always advocated that real estate should be a vital component of an investment portfolio. However, we have also emphasized that diversification is a key ingredient to generational wealth creation. If inflation continues to increase, diversification both within and across investment sectors will be more important than ever.
In the past, investors have often looked to real estate as a valuable hedge against inflationary pressure. As signs of inflation picking up begin to appear, this is happening once again. As detailed in the article, “Investors looking to cushion their portfolios against inflation helped real-estate stocks lead the S&P 500 in recent weeks. Money managers often turn to real-estate stocks when they anticipate higher inflation because of the segment’s pricing power. Some leases are tied to inflation and many tenants bear a rent increase to avoid the cost of moving. But overall, equity investors see the sector as an attractive corner of the market when prices are rising.”
Although our Aloha LTD Income Fund focuses on lending in residential real estate markets, we keep tabs on commercial real estate as well. We also own some commercial real estate in our personal investment portfolios. Diversification amongst real estate sectors can be a helpful tool when economic conditions change, just as diversification is recommended within other asset classes. As mentioned in the article, investors must understand how inflation can be expected to affect different categories of real estate. Not every real estate sector makes for a good inflation hedge. From the article: “Investors need to sweat the details of their real-estate bets: Some properties, like offices and retail, can have very long leases. If those agreements don’t adjust rent to account for inflation, landlords could see their real incomes shrink.”
No one knows for sure if the inflation we are experiencing right now will persist. The Federal Reserve is on record saying that they believe the recent uptick in inflation is transitory, most likely linked to shortages and supply bottlenecks due to the pandemic. They believe the inflation rate will tick back down once businesses successfully work through the pandemic disruptions. However, many Wall Street investment firms believe higher inflation will persist and that investors need to adjust their portfolios accordingly. Jonathan Woloshin, head of US Real Estate at UBS Global Wealth Management is quoted in the article as saying, “The real question is does inflation become a bigger worry or a smaller worry. If inflation continues to be a worry, I think people will look to real estate as an inflation hedge.” As with many of the economic concepts we write about – only time will tell how things play out.
In the meantime, the underlying fundamentals for residential real estate are as strong as we have seen in our careers. The market continues to experience shortages in both homes to rent and homes for sale. Prices in some markets have moderated somewhat as buyers have stepped back from the market. However, it will take time for the housing industry to work through the supply shortage. It appears that ample demand may continue for the foreseeable future.
Steve Sapourn is an active real estate investor, Aloha Capital’s co-founder, and portfolio manager. At Aloha, Steve has overseen more than 1300 real estate investor loans in 35 states. He has managed alternative investments in a variety of asset classes for over 25 years. He has deep experience in designing low-risk portfolios that reliably outperform benchmarks. Over his career, Steve has served as portfolio manager for a Fund of Funds, where he analyzed hundreds of alternative investment strategies. In addition, he has developed and implemented quantitative trading strategies in the futures, stock, and volatility markets. Steve’s long and diverse career benefits Aloha’s investors.