Inflation and its Effect on Real Estate
While inflation causes the prices of goods to go up, your salary usually doesn’t. Therefore inflation, in effect, makes each of us poorer. After all, if you must pay more for essential goods and services, you’ll have less money for leisure, savings and investments, including savings for retirement.
However, your real estate investments (including your home) will rise commensurate with inflation, if not more so. So, owning real estate according to all historical data is a great hedge against inflation. While you are losing in an inflationary cycle because prices are rising, you are gaining all of it back because your real estate investments are rising sharply. Renters unfortunately are on the losing end, as they have no hedge against inflation.
A final point in terms of explanation of the above: One of the many reasons that real estate prices rise during inflationary cycles is that the cost of construction materials rise (as costs for everything does). This makes every new home built more expensive. During inflationary periods there is less construction of residences as builders are concerned that the prospective buyers will be priced out of the market. Therefore, buyers will have a lower supply of newly constructed homes to buy and will therefore heavily depend on existing homes for sale. This leads to an inevitable rise in existing home prices due to the reduced supply of newly constructed homes. Bottom line: When many buyers are seeking any commodity (homes in this case) where there is a reduction in availability, prices always rise.
Another aspect to consider is during inflationary periods, interest rates go up. Since most home construction companies rely on loans to build their projects, any rise in interest rates will inevitably result in higher home purchase costs.
Real estate investors who own rental properties (whether its many homes or just a single condo unit) will enjoy soaring rental prices during inflationary cycles. Since mortgage rates will go up, more people will choose to rent rather than buy. Again, when there is an increase in demand for any item, prices will rise. Bottom line: Owning a rental property in this inflationary economy puts a rental property owner in a great position as tenants are willing to pay higher rents rather than assume a mortgage which will be heavily burdensome – even unaffordable. A secondary bonus will be very low vacancy rates – a great thing for landlords.
An important factor to know is that the appreciation of real estate over the decades has consistently outperformed inflation. This fact is vital to know for investors: Real estate ownership will protect your net worth from the devaluing effects of inflation.
Yet another factor important to real estate investors is the fixed mortgage (15 or 30 years). If an investor is paying off a fixed mortgage at a rate well below those rates during inflationary cycles (because he purchased the home when rates were lower – before inflation started), that investor is well ahead of the game. In plain terms: The investors costs are fixed at a lower mortgage rate, but the renters are not. The renter will therefore pay more in an environment of rising prices.