As an investor, you usually look for investments that will withstand the test of time and gain value over the years. Many investment opportunities fail to do this, but real estate is one of the few that can effectively hedge against inflation.
So, what is inflation? The Economic Times defines inflation as the percentage change in the value of the Wholesale Price Index (WPI) on a year-on-year basis. When inflation increases over time, purchasing power diminishes because people have to buy commodities at higher prices without a corresponding increase in their earnings.
For example, in Kenya, the current inflation rate stands at 5.1%, meaning the prices of commodities have generally increased by 5.1% over the past year. In this article, we will explore how real estate serves as a good hedge against inflation.
In instances of inflation in a country, as the value of commodities increases, rental rates will also rise. Landlords will adjust rents to keep their profits in line with prevailing inflation rates. This means that landlords can maintain their profit margins even as inflation increases, making real estate a good hedge compared to investments in government securities.
For example, let’s consider a government bond with a 10-year tenor and a rate of 15.0%. If inflation averages 7.0% during the bond’s tenor, the real return, after accounting for inflation, is 8.0%. In contrast, with a real estate investment operating in the same environment, landlords can continually adjust rental rates upwards to hedge against inflation, potentially providing better returns.
Beyond rental income, the sale value of real estate properties, such as land or buildings, tends to increase over time. The fundamental tenet of natural resources like land is that its supply is fixed. As the population increases, the demand for land will rise, pushing up its value. This means that real estate values are generally expected to increase, except in cases where external factors cause temporary declines.
Real estate stands out as a reliable investment option that can effectively hedge against inflation. Its ability to generate rental income that adjusts with inflation and its potential for value appreciation make it a robust choice for long-term investors. By including real estate in their portfolios, investors can safeguard their purchasing power and achieve sustainable financial growth.
