Without a doubt, inflation is a growing concern.
Since the beginning of the COVID-19 pandemic, the Federal Reserve has been adopting an ultra-easy monetary policy stance, which took form in a massive quantitative easing exercise. This resulted in excessive consumer demand, which, coupled with a supply chain disruption, has sent U.S. consumer prices soaring to 7.9% in February 2022 — the highest level in 40 years, since January 1982.
Singapore is not spared by the impact of rising inflation either, as the economy progressively recovers from COVID-19 shocks. In January 2022, core inflation in the island-state surged to 2.4% on a year-on-year basis — the highest level in more than nine years — before slightly easing to 2.2% in February. Additionally, an impending hike of the Goods & Services Tax (GST) starting from January 2023 from 7% to 8% (and a further hike to 9% from January 2024), is likely to mount greater pressure on consumer prices, going forward.
To add to the consumer price woes, the impact of the current Russia-Ukraine armed conflict is just not helping the situation.
Inflation would decrease the value of your money over time, diminishing your purchasing power and setting you back further from your retirement goals consequently. What this implies is that you will need to make your money (or yourself) work harder in order to get closer to your intended retirement objectives.
And, we are not just talking about the current inflationary environment, but the rise in consumer prices over the long term.
Would you have imagined that food prices in Singapore had risen some 49% over a 20-year period? That is according to the Singapore Department of Statistics’ Consumer Price Index (CPI) data for food, which include the years 2001 to 2020. That explains why a bowl of noodles at a food centre would cost SGD4.50 these days, when it only used to be SGD3.00, twenty years back.
In the same period, public transport became pricier by more than 30%; healthcare costs rose by about 53%; while the cost of education increased by close to 74%.
The impact of inflation on your wealth is evident.
To illustrate this, if you were to consistently save SGD40,000 a year from 2001 to 2020, at an annual inflation rate of 1.5%, including the compounding effect, your savings of SGD800,000 at the end of the 20-year period would only be worth SGD602,805 in terms of purchasing power back in 2001. So, essentially, the purchasing power of your savings in 2020 would be SGD197,195 less than it was in 2001, when inflation throughout the two decades is taken into consideration.Sign Up at RealVantage
Your savings will still lose value in a bank
If you believe in putting all your money in a bank account to grow your savings to beat inflation, think again. The truth is, history has proven that doing so would not achieve that, and may still shrink the purchasing power of your savings.
Based on the average interest rates of banks and finance companies listed on the Monetary Authority of Singapore’s website, your original savings of SGD800,000 in the earlier illustration would only be worth SGD611,381 in terms of purchasing power, at an annual inflation rate of 1.5%, if you were to put all your money in a bank account throughout those 20 years. That is assuming that there is no change to your income, no bank charges, and that compounded interest has been factored in.
You could, of course, choose to make your money work harder through a higher-risk approach by investing in equities. But despite the more impressive returns, not everyone may have a high risk appetite or could stomach the market volatility in extreme market conditions that could occur from time to time over such a long period of time.
Real estate has been an effective hedge against inflation at a lower risk
Research has shown that real estate investments typically have a low correlation with equities and bonds, and could provide diversification benefits. This is evidenced by many studies, including a 2020 study by Stanford University’s Department of Economics as well as a 2019 report from the Bank of Singapore, among others. What this implies is that investment returns from real estate investments are less likely to be influenced by the vagaries of the equity and bond markets, hence more stable and predictable.
Studies have also found that real estate has been an effective hedge against inflation.
"Property values tend to stay on a steady upward curve over time. Real estate investments can also offer investors potential recurring income and keep pace with or exceed inflation when they appreciate in value."
A recent report by Franklin Templeton, for example, asserts that real estate has performed well during periods of elevated inflation. According to the report, the NCREIF Property Index, which includes apartment, hotel, industrial, office and retail properties, and the sub-types within each of these property types, suggests that the total returns from private real estate were strong during the years where there were varying levels of inflation.
A latest example was the 12-month period through Q3 2021, when the annual real GDP growth rate and inflation rate were 4.9% and 5.4%, respectively, while the Index returned an impressive annual rate of 12.1%.
In the world of real estate investing, residential properties have always been a popular hedge against inflation, owing to several reasons:
- As the price of a home rises over time, it lowers the loan-to-value ratio of any mortgage debt. This increases the equity on the property, while the fixed-rate mortgage payments remain the same.
- Inflation also increases rental income, especially for property sectors with short-term lease structures, as higher home prices usually lead to higher rent. If the mortgage remains unchanged as rent increases, investors will see their wealth grow in this aspect despite inflation.
- Property values also tend to stay on a steady upward curve over time. Real estate investments can also offer investors potential recurring income and keep pace with or exceed inflation when they appreciate in value.
Commercial real estate too has been observed to perform well in an inflationary environment.
According to a 2011 report by the Counselors of Real Estate, commercial real estate in the U.S. had “handily” beaten inflation, except when there were severe supply gluts from excessive construction or a fall in demand for such properties, which have been infrequent.
When it comes to commercial real estate, ‘lease escalation clauses’, which allow landlords to keep up with inflation and other increasing expenses over the course of a multi-year lease, are very common. These clauses allow landlords to either:
- Synchronise rent with the pace of inflation;
- Increase a fixed amount of rent every year (stepped increases); or
- Increase rent at a predetermined percentage each year.
These essentially provide commercial real estate investors with a hedge against inflation.Sign Up at RealVantage
"... like the other common asset classes, you can also invest in real estate with an investment portfolio approach to benefit from diversification across various geographies, property types, as well as investment strategies, time horizons and amounts, to enhance your risk-adjusted returns."
It is also worth mentioning that in a recent LinkedIn poll RealVantage conducted, an overwhelming majority of respondents (73%) have expressed that real estate is their preferred investment for hedging against inflation. This implies that the notion of investing in real estate to hedge against inflation is not unfamiliar to investors.
Investing in a portfolio of fractionally owned properties is a smart way to beat inflation
You may think that investing in physical real estate is only for the well-heeled. But the fact is, investors can now have access to co-invest in and fractionally own investment-grade physical properties through the route of a real estate private equity investment platform, as a possible means to protect their money against inflation.
And like the other common asset classes, you can also invest in real estate with an investment portfolio approach to benefit from diversification across various geographies, property types, as well as investment strategies, time horizons and amounts, to enhance your risk-adjusted returns.
One obvious advantage of co-investing in physical real estate through this approach is that the barriers to entry are much lower than if you were to purchase one yourself, as you could start with a relatively lower capital outlay.
In addition, you could ride on the different favourable macroeconomic and market conditions of different countries by investing in properties worldwide to further mitigate your investment risks in an investment portfolio.
And here’s the best part: you would never have to worry about the upkeep and complicated investment processes of your invested properties throughout the investment period, as professional investment and asset managers will be doing all the heavy lifting.
Don’t let inflation devour your money before you start to act
It is clear that inflation will only diminish the purchasing power of your savings over time and set you further apart from your retirement goals if you do nothing to safeguard your money.
While you could invest in a myriad of assets to grow your nest egg, it is definitely worth considering co-investing in physical real estate through the fractional ownership route, as the benefits are evident.
Importantly, always remember that it is never too early, or too late, to start securing your wealth and the future of your retirement.
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Disclaimer: The information and/or documents contained in this article does not constitute financial advice and is meant for educational purposes. Please consult your financial advisor, accountant, and/or attorney before proceeding with any financial/real estate investments.