Table of Contents
- 1 What is Inflation?
- 2 How Inflation is Affecting Real Estate
- 3 Income Generating Asset
- 4 Inflation Leads to High Mortgage Rates
- 5 Inflation Leads to High Asset Price
- 6 Limited Real Estate Properties Available
- 7 Rise In Construction costs due to inflation
- 8 How is Real Estate Considered an Inflation Hedge?
Real estate is usually called a hedge against inflation. With inflation being high, many investors second-guess their opinion about investing in real estate. Consumer prices have also tended to increase due to the rise in inflation, but how is it affecting Estate agents in Sittingbourne?
There are various real-estate side effects of an increase in inflation like high mortgage rates, long term debt being devalued, an increase in asset price, construction being more expensive, and many more.
What is Inflation?
Inflation is an increase in the prices of particular goods or services over a certain period. As per the US Bureau of Labour Statistics, the one year change in the selected categories for consumer prices is increased by 6.2% as of October 2021, and it is more than the Fed’s publicised inflation target of 2 per cent. In other words, inflation is a reduction in purchasing power of consumers for each dollar because of a rise in prices.
How Inflation is Affecting Real Estate
As per research, the value of the typical middle price tier for a single-family home in the US has increased by 90 per cent. There are various reasons why real estate prices increase with inflation:
Income Generating Asset
The primary reason for the increase in real estate prices is investors searching for assets that produce yields above inflation. The rented income being collected from the tenant pays for operating expenses, mortgage and property taxes. After the end of each period, the remaining money has termed a return on investment that is expressed as a capitalisation rate.
The capitalisation rate is calculated by dividing the property’s net operating income by the property’s purchase price. For instance, single-family rentals have an average cap rate of 5.8 per cent. Thus, when you compare cap rates on multi-family properties, it is 5 percent, while the ten-year treasury yield is around 1.5 per cent.
Inflation Leads to High Mortgage Rates
As inflation increases, the interest rate increases too. With high inflation, the bank tends to raise the short term rate to put downward pressure on the inflationary environment. With a low-interest rate, more consumers tend to borrow, which means they have a surplus amount of money to spend.
This makes inflation high. Thus central banks raise the interest rates to fight inflation. This leads consumers to start saving because returns from higher interest rates are appealing. This gives hope that inflation eases with less consumer consumption.
Inflation Leads to High Asset Price
As price increases with inflation, so does real estate. Generally speaking, with the rise in inflation, housing and other real estate asset prices also increase. This leads to a rise in mortgage rates and puts downward pressure on the demand for real estate because the debt becomes more expensive. This leads to downward pressure on the asset price because the demand tends to decrease.
Limited Real Estate Properties Available
You might have wondered why real estate prices rise with inflation? The reason is the limited amount of property available compared to fiat currency. The money supply increases with printing a greater amount of money than the prices of real estate rise. For instance, an economy has a dollar 1 million of total money available and has approximately 100 houses without any availability of goods or services.
The value of each house would be 10,000 dollars, assuming that each property is identical. Imagine that the central bank thinks of printing an additional dollar 1 million overnight. This means the whole economy has a dollar of 2 million, and each home would cost a dollar of 20,000. Understandably, money printing leads to inflation, leading to a rise in real estate prices.
Rise In Construction costs due to inflation
As things become expensive in inflation, the cost of materials used in construction also rises. There is a lot of development needed in real estate, and with high prices, inflation comes in. It is commonly understood that machinery costs, wages, and building materials increase with inflation.
It puts developers in a scenario where cost overruns are most likely. So, if you plan to build something several years ago in an inflammatory environment, then the costing accounts for inflation of building material and labour. The national association of home builders recently reported the prices for overall building materials have increased by 19 per cent in the past 12 months. The home building material includes gypsum board for finishing walls and ceilings, ready to mix concrete and lumber.
How is Real Estate Considered an Inflation Hedge?
During inflationary periods, the price of everything rises, including rent prices, housing costs, and sometimes mortgage interest rates. The below ways might help investors hedge against inflation and rising prices:
- Capitalise on Cheap Money: Low mortgage interest rates offer investors the advantage of cheap money today, and they can avoid paying high rates in the future. When the mortgage rates are low, investors could think of investing in the real estate business.
- Export Inflation: Investors have the opportunity to pass the rising costs to tenants leading to high monthly rents in single-family rental properties.
- Benefits from Asset Value: When the asset value rises, the investors can avail of various benefits. Housing prices fluctuate with time, and when they increase with time, investors use real estate as a hedge against inflation.
In most circumstances, with an increase in inflation, the rents become higher, and so does the asset price. The real estate industry is the greatest hedge against inflation.
This could be – a rise in rent with inflation, property value rises with inflation, and debt on assets is devalued because the value of debt decreases with inflation. With the increase in inflation, investors should be wary about making real estate development. A high inflation environment leads to an increase in the cost of borrowing, putting downward pressure on the cash flow. Thus, making property investments during high inflation may not be a good thought. It could be a costly affair because of high prices and excess money supply.
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