Is real estate a good hedge against inflation?
Newspapers are awash with headlines about inflation that is hitting the world economies hard. The situation, experts claim, is precarious and doesn’t bode well for the foreseeable future. So, what led to the inflation and how to safeguard from its ill effects?
The current rise in inflation can be pinned on COVID-19, or, more particularly, the mismatch in demand and supply following the post-pandemic reopening. The recovery in supply chains was further impeded by the Russia-Ukraine crisis, with prices of global commodities like oil skyrocketing. The accompanying increase in freight rates, too, has contributed to inflation in the UAE and across the world. While economists are wary of inflation, they are equally concerned about the concurrent recessionary pressures, including unemployment rates.
How did this inflation rise?
It’s a natural economic incidence that prices rise at a moderate rate, steadily. However, when met with unprecedented circumstances like the COVID-19 pandemic, economic activities are disrupted to a point where even the revival causes problems. In a globalized world, such disruptions will not be without widespread consequences.
Due to a reduction in both transportation and restaurant/hotel prices, annual inflation in the UAE dropped to 2.50% in December 2021(1) from 2.58% the previous month, which was the highest level in 36 months, a report by the National Bureau of Statistics, UAE(2), indicates. Meanwhile, food and beverage prices have continued to grow(3) (3.71% vs 3.65%). But how long will this inflation persist? One way to brace for the adverse effects of inflation is to hedge your portfolio. Simply put, a hedge is something that moves in the opposite direction of the market or isn’t vulnerable to dramatic volatility.
Real estate as a hedge
Real estate can be effectively used as a hedge due to the impact of debt on inflation. As the value of a home rises over time, the loan-to-value ratio of any mortgage debt dives, creating a natural discount. As a result, a property’s equity grows, but its fixed-rate mortgage payments stay the same. Inflation favours property owners who benefit from their rental incomes, especially those with short-term lease contracts, such as huge condominiums. A potential increase in rental income will bring more money to the owner’s pocket. The capacity of real estate to defend against inflation can be explored by owners who are willing to ride through the vicissitudes of multi-year economic and real estate cycles.
However, from higher pricing on consumer items to increased interest rates, some aspects of inflation are simply unavoidable. By and large, investors should always focus on what have always been the fundamentals of the sector during inflation. The good news is that retaining real estate assets for the long haul and picking property segments and locations that benefit from structural trends can help investors maintain and grow their wealth.
Is real estate a hedge against inflation in UAE?
Investors in the UAE are seeking hedge instruments to safeguard their financial portfolios from inflation. And many are looking at real estate and ESG investments. A UBS survey(4) suggests that 35% of UAE investors are interested in real estate to combat inflation, while 34% are contemplating sustainable investments. The survey reveals that 83% of UAE investors have expressed confidence in the stock market, with 47% intending to raise their stock allocation in the next few months.
Despite concerns about inflation, a majority of investors in the UAE are positive about the nation’s economic prospects over the next few months, believing that real estate and specific stocks put together can serve as a hedge against the inflationary pressures.