Abhi Golhar – Chief Investment Officer of Summit and Crowne
Whether it’s stocks, commodities or real estate, all markets move in cycles. Markets can generally be classified as rising, falling or stable/stagnant. Many investments suffer in one or two of these cycles, while they prosper in another. Or, they can do well in one cycle and hold steady or suffer in one of the other two. The point is that many investments in stocks and commodities are dependent on market cycles for profit.
Inflation Influences Markets Differently
When prices for goods and services are rising at faster-than-normal rates, some stock prices can suffer due to the products or services of the corporations. When goods and services cost more, companies usually need to raise their prices to meet profit projections and please shareholders. If there is too much competition to raise prices as needed, higher prices to deliver the company’s products or services will bring down profits, and the stock prices will suffer. A down market for stocks as a whole can result from inflationary trends.
Real estate, particularly rental real estate, responds quite differently to inflationary trends, as a rule. There are few more labor- and material-intensive products than a new home. Building a home when labor and materials prices are rising becomes more expensive, so the prices of new homes rise. This usually drives many buyers out of the market, but they still need a place to live. They will rent, so rents can rise from higher demand.
Another effect of higher new home prices is the pushing of buyers toward existing homes. Higher demand for existing homes will create upward pressure on prices, and more buyers will leave the market and rent. The values of the rental homes rise, so the investor-owners enjoy higher equity. They also can often raise rents to increase their cash flow.
Rising Interest Rates Influence Markets Differently
When interest rates are rising, many corporations that borrow to fund their operations will find their costs rising for the money they borrow. They will be in the same situation as the corporations that suffer from inflation. They will find that raising prices is necessary. If they can, they will often see lower demand, and their stock prices may suffer. If they pay dividends, they may reduce their dividend payments as well, usually a negative hit on their stock prices.
Rental real estate responds differently to rising interest rates, too. When rates rise, it does put a bit of a damper on buying more rental homes, as it becomes more difficult to realize adequate cash flow when mortgage payments rise. However, the homes already owned by rental investors will be financed by long-term fixed-rate mortgages, so they will see no difference in their mortgage payment or cash flow. Rental investors just sit back and collect their rent checks and deposit their profits.
These two major influencers of market cycles have very different effects on real estate than on stocks in most cases. For this reason, owning rental homes is and always has been a steady source of profits and cash flow. Consider reallocation of some of your investment assets into rental real estate to weather the ebb and flow of the markets.