APARTMENT INVESTMENTS HEDGE INFLATION CONCERNS 

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The Federal Reserve sees core inflation ending the year at just over 4% after raising the Federal funds rate to 1.9%.  This inflation creates strategic issues from an investment perspective.

For bondholders, inflation erodes principal value. Furthermore, because the coupon on most fixed income securities remains the same until maturity, the purchasing power of the interest payments declines as inflation rises.

For equity investors, the problem relates to stock valuation methods. Market participants frequently discount future cash flows at a higher rate when inflation rises. These higher discount rates reduce the present value of future cash flows. The higher the level of inflation, the greater the discount rate applied to earnings, pushing down the price investors are willing to pay for the stock.

Real estate, on the other hand, and multi-family in particular, provides investors with an inflationary hedge. Leases for multifamily properties usually have terms of just one year, often with monthly lease extensions after the first year. As such, apartment owners can quickly adjust rents to compensate for inflation, unlike most other commercial property owners who typically have longer lease terms with fixed adjustments.  Of course, if a particular multifamily market is oversaturated, or struggling with weak fundamentals like slow job growth and high vacancy rates, then the apartment owners will find it harder to push through rent increases. 

Although some potential challenges loom on the horizon, vacancy rates sit near cyclical lows, tight supply remains, and renters continue to actively seek apartments, allowing operators to implement healthy rent increases. The driving forces for the robust demand include would-be buyers getting priced out of the market for single-family homes, healthy labor dynamics, and a rebound in household formation. In fact, the fundamentals for multifamily may be the best over the last several decades.  Apartment rent growth in 2021 handily outpaced inflation, as the national rate of rent growth topped 10%, with several markets posting gains ranging from 15% to 25%. 

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