Are you in real estate and wondering how inflation affects the real estate market? This blog discusses the historical look at inflation and real estate, impact of inflation on the real estate, how inflation affects homeowners and investors.
The first three months of 2022 saw an increase in the prices of goods and services. That was inflation in action. Inflation became an issue of concern in many areas of the economy, and real estate was not left behind. It made many real-estate investors get worried about their businesses and assets. Some ways in which inflation affects the real estate market include: higher mortgage rates, expensive construction rates, an increase in asset prices, and devaluation of long-term debts, to mention a few. Read along to learn more about how inflation affects real estate.
Understanding Inflation
Inflation is a decrease in the value of money in terms of its purchasing power. Inflation leads to an increase in the value of goods and services available in the economy. Inflation rise leads to loss in the value of dollar, affecting how you spend. Even though the housing supply was seeing low and high demand before 2020, the coronavirus (COVID-19) arrival made things even worse. Most renters went in search for their homes; these made plenty of homeowners increase their space since they sought opportunities to resist. It led to a low supply of properties since homeowners stayed put. The housing market inflation is a good example of how supply and demand are always at work.
A Historical Look at Inflation and Real Estate
Real estate has always been considered a potent inflation hedge from long ago. According to researchers, the consumer price index (CPI) in 1979 in the US reached 13.5 percent. It was the highest CPI ever seen since 1947. In the same year, the average dividend income in stock trading was 21.2 percent which was contributed by REITs trading. In the first eight months of 2011 the consumer price inflation was at 5.1 percent. It made the REITs returns safeguard its buying power again, with its total annual returns averaging 8.4 percent. Between 1978 and 2011, there was an increase in REIT dividends, which averaged 7.71 percent per year. At the same time, the consumer price inflation averaged 3.92 percent. Exact outcomes were also noted in private real estate. According to the NCREIF Property Index review, private real estate returns are robust during inflation. A good example was noted in the last three months of 2021, whereby the annual GDP growth and inflation rates stood at 4.9 percent and 54 percent, respectively. However, the NCREIF Property Index posted an annual rate of 12.1 percent.
Impact of Inflation on the Real Estate
Real estate investors should never be worried about the rising inflations since they benefit when inflation rises. However, individuals on the lower economic spectrum (those who do not have money in the game and with debts) suffer. Property owners are different from real estate investors. Property owners do not have to be real estate investors.
Below are ways in which inflation is affecting Real estate:
Increase in Rent
Since real estate has cash flow (through rent), it is an asset. According to Boesel et al, (2021) when there is inflation in the economy, it helps investors since inflation increases rent prices. Studies have also proven that high inflation increases rent hence increasing cash flow. It might even lead to the cost of rent being higher than the cost of other commodities like energy. Inflation increases rental rates since there is an increase in the demand for rental properties since there is a higher borrowing cost used for funding properties. In turn, rental rates increase due to a higher demand for these properties. Due to this, most tenants prefer paying higher rents other than taking on mortgages at unmanageable rates.
With the ongoing economic situation and the pressure put on the economy because of COVID -19, the return of inflation looks impossible. In February 2002, the reserve bank of India (RBI) set the inflation rate at 5.3{10869d906370ac92246a45117153392add26ddaaa5395511b5ae6e0b554d28dd}, which is expected to increase in the short term.
A Rise in Interest Rates
An inflationary economy has a higher borrowing cost, making it unconducive if a buyer needs favorable loan rates. It can result from the decreasing currency value when there is inflation. Eldomiaty et al, (2019) commented that it makes lenders increase interest rates to help them cover their losses due to the devaluation of the currency. When the financial regulator raises the reverse repo rate to help curb inflation, it affects the home loan floating interest rates. It leads to a rise in EMI outgo of the home purchasers whose loans are linked to the floating rates. A higher borrowing cost affects the buyer and construction developers since they depend on housing loans to finish their house projects. When the interest rates increase, it leads to higher property prices.
A Rise in Property Prices
Inflation leads to increased property prices since the construction materials raise too, making developers spend highly on developing properties. It then affects new real estate property prices directly. Since the supply of new construction decreases too, it leads to an increase in the current property value. There are however exceptions to that rule, as was explained by Premier Real Estate which has noticed a major increase in construction due to the area surrounding the Research Triangle area of Raleigh, Durham, and Chapel Hill being highly favorable for people transplanting from the northeastern seaboard seeking a lower cost of living.
Effect of Inflation on Homeowners
For property owners, inflation is not that bad. The reason is inflation increases the value of their homes. Since the supply is low and demand is high, asking prices increase. Sometimes sellers even get a higher asking price than what they offer. During inflation, selling becomes easier while buying gets more and more difficult.
Effects of Inflation on Investors
If you are an investor of a certain property, when the financial rates are low, you tend to pay the exact fixed rate even if your property’s value increases. With the current inflationary market, the financing rates are not increasing alongside inflation, making the return on investment (ROI) soar soon.
Conclusion
Most individuals underrate inflation. For investors, you should get your money to do the job for you and consider cash flow locations. Even though property cost is expensive, you should not doubt investing in real estate since it is good leverage against inflation. For real estate investors, inflation can be good if you diligently assess your property. If you are planning to invest, it is not yet too late. Never let inflation intimidate you! However, you should be aware of your target property market and confident with your numbers to make things go right.
References
Boesel, M., Chen, S., & Nothaft, F. E. (2021). Housing preferences during the pandemic: effect on home price, rent, and inflation measurement. Business Economics, 56(4), 200-211.
Eldomiaty, T., Saeed, Y., Hammam, R., & AboulSoud, S. (2019). The associations between stock prices, inflation rates, interest rates are still persistent: Empirical evidence from stock duration model. Journal of Economics, Finance and Administrative Science.
Hansen, B. (2016). A Study in the Theory of Inflation. Routledge.
Inoue, T., Shimizu, C., Nishimura, K. G., & Deng, Y. (2017). Aging, inflation and property prices. University of Tokyo.