How Does Inflation Affect RAL Deals?

May 11, 2023

Inflation is the gradual increase in the prices of goods and services over time.

The government has set the target of 2% inflation per year in order to maintain a stable economy. However, recent data from the US Bureau of Labor Statistics has shown that actual inflation has surpassed the target rate, with an 8.3% increase in prices over the last 12 months. This means that goods and services are getting more expensive faster than what the government deems comfortable. One goal of investors is to match or beat inflation so that their money's worth remains the same in terms of purchasing power as it was worth 12 months ago. 

One way to achieve this is by investing in commercial real estate properties or US Treasuries. Commercial real estate properties have a capitalization rate (cap rate) which is a measure of the worth of a property's prospective cash flows combined with the level of risk involved. An investor can buy a cash-flowing property that is earning 4% per year based on its net operating income and market value. However, rising inflation makes it harder to buy commercial real estate assets from a cash flow perspective. 

Another option is US Treasuries, which are bonds issued by the federal government and considered to be one of the safest assets that investors can buy. These Treasuries have different maturity dates and interest rates. An investor can choose to buy a Treasury that matures in one year and pays 4.42%, or they can opt for a Treasury that matures in 10 years and pays 3.88% per year over the 10-year period. 

When inflation is running high, it can have harmful effects on the economy. Prices rise too fast for wages and investments to keep up, and the public becomes poorer and unable to afford what they could last year. The Federal Reserve tries to combat inflation by increasing rates, which makes borrowing more expensive and slows down the economy. This makes companies turn their focus on cost-cutting measures instead of growth. 

In conclusion, while inflation can lead to harmful effects, there are always options available for investors. Sellers will need to be willing to accept lower offers or hold their property until the next cycle, and investors will have to update their business plan to seek more value-add strategies with more conservative underwriting. Investing in commercial real estate properties or US Treasuries can be a way to match or beat inflation, but investors need to weigh the risks involved and adapt to changing market environments. 

With RAL homes we have definitely seen a reduction in prices on what sellers have asked in terms of business side valuations. Now is the time to negotiate heavily! 

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