I have read many posts here and elsewhere stating that real estate is a good hedge against inflation. A look at inflation adjusted SF home prices since 1890 does validate that view. (Sorry, don't know how to insert an image here to show the graph.)

My problem is that I am thinking of buying an apartment complex and am not sure whether it will be a good hedge against inflation. I understand that rents will hopefully go up with inflation. But what about the resale value? It seems to me that the resale value will only match the rent increase if we were to assume that interest rates will remain unchanged. But the reality is that interest rates track inflation. (That is, the "real" interest rate does not change much and it is the nominal rate that changes.)

Here is a set of hypothetical numbers to demonstrate my point.

Let's say the NOI is $100K today and the interest rate (cost of capital) is 10%. We can say the property is worth $1,000,000 ballpark.

Suppose prices rise by 50% over the next 10 years, thanks to money being printed, etc. If we were to assume that our rents and expenses would also go up correspondingly, then our NOI should be $150,000. That, of course, means that the rents are a good hedge against inflation because $150K in 10 years will be worth the same as $100K today.

But what happens if we try to sell the property at that point because we need the cash? If inflation is higher in 10 years by 5% compared to today, it means interest rates will also be higher by that much. Thus, a potential buyer will be capitalizing the $150K NOI at 15% instead of today's 10%, resulting in the resale value of the property remaining $1 million.

The problem, of course, is that $1 million then would be equal to $666K today, which would mean that we would have taken a 1/3 loss on our asset in spite of rents going up.

Am I right to worry about this when considering an investment in an apartment complex?

Vikram

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Real estate as an inflation hedge

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