How Does Inflation Affect Real Estate?
Time and time again, investing in real estate has been proven to generate income whether be it in the form of passive income through rental properties or increasing property value with appreciation. Aside from that, real estate investment is also used as a ‘shield’ from inflation as this type of investment is more stable compared to stocks and bonds.
If you are in the real estate market eyeing to gain some hefty return of investment, it’s important for you to know how inflation affects your real estate investments so you’ll make smart decisions in purchasing a property, especially during turbulent times of inflation affecting the real estate waters.
What is Inflation?
Before we dive into the correlation between inflation and real estate, let’s do a quick refresher on the definition of inflation.
Inflation, in simple terms, is the gradual increase or decrease of price of goods and services in a specific market. It affects the ‘purchasing power’ of money or currency. For instance, if prices of available goods in the grocery stores or supermarkets surge up, this weakens your money’s purchasing power and therefore causes you to spend more for a gallon of milk or for a full tank of fuel.
Some of the common reasons as to why inflation occurs include supply and demand shock, excess money supply, and the general expectation that prices will soon increase.
In the Philippines, albeit the relaxation of strict COVID-19 guidelines paved way to mobility of goods and services in the market, the soaring inflation hampered the economic growth to only 7.4% in terms of GDP as the country enters the second quarter of 2022.
According to the Philippines Statistics Authority, the main drivers for the slow economic boost are the transportation and storage, manufacturing, human health and social work activities. The agricultural sector remained to be weak due to affecting calamities and rising production and transport costs.
Even though the GDP performance fell below market expectations, Socioeconomic Planning Secretary Arsenio Balisacan still poses a positive outlook for the Philippine economy as it is still the second fastest growing economy in Southeast East, just falling close behind Vietnam’s 7.7% GDP growth.
So how does inflation affect real estate?
Now, that we’ve learned how inflation affects the prices of goods and services in the market, let’s take a closer on how inflation affects investments, particularly real estate.
Inflation has varying effects on different types of investments. According to Ari Rastegar, CEO of Rastegar Property Company in his article How Rising Interest Rates and Inflation Impact Real Estate Investments, “Rising rates erode the principal of bonds, affect the value of stocks and other financial assets and influence interest payments on debt.”
While inflation sends ripples into the global and local economic waters, real estate investment is seen to be performing greatly amidst the volatile, rising environment. First off, real estate prices keep up with the inflation rate unlike other form of investments that’s sitting on top of a swinging pendulum.
“…income-generating real property and multifamily have historically — and as I’ve witnessed from experience as an investor and developer — shown a greater ability to grow net income during expansionary periods than securities and other assets,” Ari added.
Inflation means higher mortgage rates
As a prospective home buyer in an inflationary environment, you need to take note of higher mortgage rates when applying for a mortgage loan. As mentioned earlier, inflation weakens the purchasing power of your money, causing you to spend more. And, as inflation increases, so does prices of goods and services — and that also includes mortgage rates.
Inflation means higher asset prices
While inflation means bad news for consumers, it actually means the opposite for property owners. The most obvious is fact is that the price of your home is relative to inflation. Meaning, as the prices of goods and services surge up, so does the market value of your home. Also, with the limited supply of properties along with the rising demand, you can wage on for a higher asking price — in some cases, buyers would offer higher than that!
Historically, housing prices rise over time, with or without inflation. With that, you should properly time and adjust your investment plans accordingly.
On the flip side, while it is a great time to sell, it is also a difficult time to purchase on the buyers’ part.
Inflation increases rental prices
Probably the main reason why many consider real estate as a hedge against inflation is that rental prices can keep up with inflation. If you are rental property owner, you can pass on the rising costs to your tenants by implementing rental increase. High rental prices means higher passive income on your part.
Also, with the housing developments being slowed by higher material and labor costs, occupancy rates shoots up along with the limited supply of properties, enabling landlords to raise payment prices along with the rising demand.
Inflation means higher constructions costs
Inflation pushes up the price of good and commodities, and that also includes the materials needed for the house building and construction. That also includes the wages you pay to the workers. This in return forces home builder to pass on the expensive costs to home buyers or renters.
Inflation eats up historical debt
If you are an investor, you may find yourself still paying the fixed rate of mortgages while your property’s value rises on a steady pace in an inflationary market. This means that you can expect yielding higher return of investments (ROI) even if inflation arises.
Final takeaway
While real estate investments still poses a positive outlook even in an inflationary environment, it’s important to keep yourself updated on the latest economic trends and risks. It is worth noting whether you want a short term or long term investment.
“If you are in it for the long haul, you should expect the same value increases that existing owners are experiencing. If you are looking at a shorter investment time horizon — perhaps through flipping the property, for example — then we should caution “buyer beware,” reminds David Mount in his The Washington Post article Here’s how inflation could affect your next real estate move.
With careful and smart planning coupled with proper time management and seeking insights from financial advisors, you can keep your finances safe.
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