With inflation, prices of goods and services increase, making it difficult for consumers to purchase what they need. However, consumers are not the only ones impacted by this. Investors and landlords are also affected by the rates of inflation. Some effects of inflation in real estate include the following:
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Increased mortgage rates
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More expensive construction costs
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Devaluation of long-term debts
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Increase in asset prices
Inflation is the rate at which the prices of goods and services increase over time, and it’s calculated by year. The primary cause of inflation is an increase in money in circulation, with the Federal Reserve primarily in charge of this.
This article looks at everything you need to know about inflation in real estate and how landlords, investors and homeowners can navigate it.
Effects of Inflation in Real Estate
Here are some of the effects of inflation in real estate
1. Increased Mortgage Rates
As inflation grows, interest rates on houses and properties also rise. Mortgage lenders and central banks increase short-term rates in response to inflation to reduce the inflationary environment. When interest rates are low, more customers are likely to borrow, which results in higher disposable income. This results in an increased level of inflation.
More people will save due to rising interest rates when central banks raise bank rates to combat inflation. It is hoped that less consumption will lessen inflation.
What does this mean for investors? In times of high inflation, it may not be easy to get a mortgage because of high mortgage rates, which indicates that users have less purchasing power. So, they’d continue to rent. An increase in demand for housing will lead to increased rent which is great for landlords.
2. Increase in Construction Costs
The inflation in real estate will also cause an increase in the cost of building materials. Other things in real estate development will also be affected, as inflation will increase wages and machinery costs. This makes development activity not feasible financially. Also, this puts developers and investors in a situation where costs overrun.
3. Devaluation of History Debt
In times of inflation, the currency’s purchasing power decreases. Consequently, as inflation rises, your present debt becomes more affordable. For instance, if you purchased a property five years ago for $125,000 with a $25,000 down payment, you’re left with a 25-year $100,000 mortgage at a 3% fixed interest rate. If inflation rates increase by 3% every year, you end up paying $475 each year, but the value of the money would have increased by 3% every year.
In essence, your debt devalues each time inflation rates increases.
4. Increase in Real Estate Value
As prices of services and goods increase, so does real estate increase. Housing and all real estate asset prices increase with the rise in inflation. If you have an investment in genuine real estate property (your asset is working for you), you can expect to receive cash flow and appreciation in the property.
Can Real Estate Be a Hedge Against Inflation?
In some ways, real estate can be used as a hedge against inflation. Because of the inflationary environment, it’s common for landlords to increase rents and for asset prices to increase. While charging more for their properties during inflation, landlords can still be paying the same mortgage payment. This allows landlords to profit more while others deal with higher housing costs. Because of this phenomenon, real estate can be seen as an excellent hedge against inflation.
Below are some of the ways inflation acts as a hedge in times of inflation in real estate:
Rents rise with inflation:
investors with severally owned rental properties can take advantage of short-term lease agreements by raising rents while maintaining the same mortgage payment.
Property values increase with inflation:
Typically, properties appreciate with time. Now you can be sure that your property will increase in value in the future regardless of the inflation.
The debts on your assets devalue:
When the prices of houses increases, this lowers the loan-to-value of property mortgage debt. That is, the equity of your rental property or house goes up while the mortgage payment remains the same.
Note that there is a difference between real estate investors and property owners or landlords. Not all property owners or landlords are real estate investors. For instance, if you own a residential property that doesn’t generate cash flow, your property is a lazy equity property. However, if your property is generating cash flow, the property is an asset. You, as the owner, can now be referred to as a real estate investor.
Last Thoughts on Inflation in Real Estate
Inflation can be a trying time for consumers. However, inflation in real estate can be advantageous to investors and landlords. The best way to benefit in inflation seasons is to get your property to work for you; turn your lazy equity into an asset that generates cash flow. Investors should consider locations with cash flow, like rental properties, including residential, commercial, and single-family homes, as these will have higher than regular demand and returns.
If you want to invest in real estate, don’t let inflation scare you. As long as you know your numbers and have your target property market marked, then you’re on the right path.
Disclaimer
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