What happens to real estate during inflation_

What Happens to Real Estate During Inflation?

March 22, 2022

Produced by:
Richard Stevens

Richard Stevens is an active real estate investor with over 8 years of industry experience. He specializes in researching topics that appeal to real estate investors and building calculators that can help property investors understand the expected costs and returns when executing real estate deals.

Inflation is a major topic of discussion at the moment. Many investors are looking for ways to store their money, so it doesn’t lose value while sitting in the bank. Real estate is often touted as one of the best ways to hedge against inflation. Here is a look at what happens to real estate during inflation.

How are Inflation and Housing Prices Connected?

There are several factors impacted by inflation that impact the overall real estate market. Inflation leads to an increase in the price of goods, including the material used to build homes. If the cost of lumber and other materials goes up, the overall cost of building a home goes up as well.

Plus, inflation can also lead to an increase in the cost of labor, which must also be factored into the final price of a home. So, inflation will lead to the cost of new construction and renovations increasing, which will be passed along to the buyer or tenant.

Inflation is also often accompanied by a rise in interest rates. Raising the federal funds rate is a common tactic to curb inflation because it tends to decrease consumer spending. This makes it more expensive for banks and lending institutions to borrow money from each other, which typically leads to higher mortgage rates. While higher mortgage rates don’t necessarily impact housing prices, it does have an impact on the broader real estate market.

What Happens to House Prices During Inflation?

What Happens to House Prices During Inflation_

It’s typical for house prices to rise during times of inflation. For instance, housing prices increased by 16.9% in 2021, while the consumer price index – the metric used to judge inflation – also increased by about 7%.

But even before the current inflation brought on by the economic fallout of the pandemic, housing prices and inflation tend to be in sync. Over the past 10 years, housing prices in the US have increased by 48.55%, while inflation has gone up by about 32%. So, while the two are not directly correlated, they tend to steadily rise at the same rate.

Inflation has a direct impact on any good with a limited supply. When inflation is high, it isn’t necessarily wise to keep your money sitting in the bank, because most savings accounts earn less than 1% interest. This means that at the current rate of inflation, your money is actually losing 6% of its value while it’s sitting in the bank.

So, investors typically look for a way to store their money that will provide a consistent return to keep up with inflation – for instance, real estate. So, if the supply remains the same but there is a sudden spike in demand from investors, housing prices are bound to go up.

Why is Real Estate a Hedge Against Inflation?

Real estate is often seen as a good hedge against inflation because it’s an asset that will likely increase in value along with inflation. Landlords can also pass the costs of inflation onto their tenants by increasing rent prices. During times of inflation, landlords are often able to increase rent prices without restructuring their mortgages, allowing them to pocket the extra cash flow.

Inflation also has a favorable impact on debt. As home values increase, the loan to value ratio for your mortgage naturally decreases. If you paid $200,000 for your home but over time it increases to $240,000, you’ve suddenly gained $40,000 in equity without putting any money into renovations. If you have a fixed-rate mortgage, your monthly payments will remain the same, but the property is suddenly more valuable.

Plus, it’s a good way to store your cash until the dust settles. If you have excess money sitting in the bank, you’ll want to find a place to invest to prevent it from losing its value.

While stocks and bonds can be another good vehicle for hedging inflation, you may take a temporary hit due to shifts in the market. Gold is another common hedge against inflation but can be risky to hold and store it yourself and doesn’t provide as high a rate of return.

Real estate, on the other hand, can be leveraged in a variety of different ways to create cashflow. Plus, it can be sold or mortgaged at any time if you need the cash and barring a market crash, it will always increase in value over time.

Does Inflation Affect Rent Prices?

Yes, inflation can often cause rent prices to increase as well. Inflation makes the cost of everything increase. So, investors will often increase rents in order to neutralize any additional expenses. For instance, if it costs more to renovate an apartment or fix broken features and appliances, the landlord will likely have to increase the rent to make up the difference.

Or if interest rates go up, the owner will likely have to increase rent in order to pay the mortgage. This is more likely to affect newer buildings or those that have recently been refinanced. But it can often lead to a ripple effect. If one building raises rents to make up for the effects of inflation, it’s only a matter of time before other landlords do the same to keep up with the market.

But, there is also a limit to how much rents can increase If tenants do not have enough money to afford the rent increase because they are already paying more for groceries and household goods, there is only so much they can raise prices. But in general, inflation causes the cost of everything to increase, and rent prices are not immune.

Final Thoughts

Ultimately if you are looking for a good way to invest your money because you are concerned about the current state of fiat currency, real estate is always a smart investment. You’ll still have to do your due diligence and make sure it’s a wise investment – owning a property is a major responsibility and you certainly still lose money if you’re not careful. But as long as you make an informed decision based on market data, real estate is a great way to protect your money against the effects of inflation.

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