Does Investing In Real Estate Give You Protection From Inflation?
Real estate has long been regarded as a highly effective inflation hedge because it protects investments from depreciation owing to a fall in buying power.
Real estate prices have been able to keep pace with inflation and preserve their value over time due to increased construction costs and other costs.
If we examine the residential real estate price index from 2016 to 2021, we will find that property prices have increased by an annual average of 4.2%, which is faster than the annual average increase of 3.5% for the consumer price index.
Based on this data, we will also see that investing in townhouses and condominiums looks to be a better plan than investing in single-family detached homes, as the average price growth over the past five years has exceeded inflation.
For example, townhouse prices have increased by an average of 11,4 percent per year, while condo prices have increased by 6.2 percent per year.
If inflation causes property prices to rise, then it must also be beneficial for property developers, as this will boost their possibilities for total revenue and earnings growth.
However, market history indicates that property stocks tend to decline as inflation rises, particularly when combined with other macroeconomic threats.
For instance, combining inflation and unemployment rate reveals that the property index negatively correlates with the "misery index" 51% of the time over the past 22 years.
Inflation and unemployment tend to go in opposite directions historically.
Inflation rises as unemployment falls because a higher labor force participation rate increases the demand for labor, which can exert upward pressure on wages.
In contrast, when unemployment rises, a decline in employment translates to a decrease in future income, which can lead to a reduction in aggregate expenditure and a consequent decrease in inflation.
Due to inflation targeting by the central bank, which has helped to anchor market expectations, the relationship between inflation and unemployment has significantly diminished over time.
In reality, inflation and unemployment are positively associated during the previous two decades, which indicates that unemployment tends to rise in the same direction as inflation.
Although inflation can increase property prices, a rise in unemployment might lead to a decrease in property demand.
A rise in both inflation and unemployment will increase the "misery index," which could exert downward pressure on the values of property stocks.
As mentioned in this column, the other result of rising inflation is a rise in interest rates.
Higher interest rates increase the cost of borrowing, which may reduce the demand for house loan financing and result in fewer property sales.
If we examine the relationship between property stocks and interest rates, we discover that the property index has been considerably adversely linked with the 10-year Philippine bond yield 63 percent of the time since 2000.
During this period of uncertainty, it is possible that inflation and interest rates may continue to rise, as these are intrinsic market risks.
Identifying the historical volatility of a stock, often known as the beta, which indicates how sensitive stock is to the movement of an index, is one technique to mitigate such risks.
Among the sector's property equities, Ayala Land has the highest beta of 1.16, indicating the company is 16 percent more volatile than the property index.
A 1 percent loss in the property index due to an increase in interest rates or inflation can result in a 1.16 percent decline in the stock price and vice versa.
If we choose a more reliable real estate investment, we can select SM Prime Holdings, which has the same beta as the market at 1.0.
Alternately, we may select property stocks with betas below 1.0, such as Robinsons Land (0.89 beta) and Megaworld (0.78 beta).
Investing in hard assets such as real estate can provide inflation protection, but investing in property equities may not necessarily provide the same level of protection due to variances in risk and volatility.