Rising inflation is a growing concern, but real estate investors can rest assured that their investments are, at least for the time being, inflation-proof.
“Real estate has been protected from inflation since the 1970s but it won’t work if there’s anything extreme, if we go back to a 15% benchmark interest rate,” said Patrice Groleau, owner of McGill Real Estate and of Engel & Völkers’ rights to the Quebec market.
However, even if rates somehow surged into the double digits, the value of real estate is mostly tied to the value of land and the cost of construction, namely materials and labour, which rise commensurately with inflation.
After the subprime mortgage fiasco that led to the Great Recession, real estate in major cities like Miami and New York quickly returned to their base values, which Groleau noted is why investors always pounce on properties in the immediate aftermath of economic downturns. Nevertheless, under normal economic conditions, inflation increases slowly and is always matched by rents, offering property investors a measure of protection.
“Rents adjust to inflation. In Quebec, every time you have a rental increase, the government looks at inflation to justify that increase, and if the price of rent goes up, the value of the building obviously goes up too,” said Groleau. “The problem with monetary policy in Canada is most decisions are all based on inflation—the biggest concern for the government is always inflation, inflation, inflation, so as soon as inflation rises, you see a direct link to real estate. It’s not perfect but if you look at all other options, there’s almost nothing better than that. Stocks don’t even match inflation the way real estate does, unless they’re blue chips.”
Groleau added that two-thirds of a downtown property’s value is tied up in the land, with the remainder determined by material costs, while it’s the opposite in suburban markets.
It is highly unlikely that interest rates reach the double digits, at least any time soon. In Japan, for example, interest rates have been near the basement since the aughties and Groleau suggests that, with Canada following suit—many advanced economies have had declining interest rates for over two decades—real estate is one of the safest investments today.
“As Andrew Carnegie said, ‘90% of all millionaires became so through owning real estate,’” said Groleau. “It has a stable core value over time because everybody needs somewhere to live, and every study and financial professional I’ve spoken to says we will follow the Japanese model. People don’t think rates can stay low forever, but in Japan they’ve been low since the early 2000s and inflation is under control.”