How inflation affects Real estate investment

Inflation is a powerful economic force with the potential to cause serious harm if left unchecked. But, how does it affect you as a property investor? We’ll explore that in this post.

What is inflation?

Is an aggregate increase in the prices of goods and services in a specific economy over a particular period.

While it can occur in just about any product or service, like demand-driven expenses like food, medical care, and utilities, it is important to think of it in a broader sense. Proper inflation is an overall increase in prices across an industry or sector which ultimately affects an entire economy.

A key indicator of inflation in the UK is the Consumer Prices Index (CPI).

Note: While the RPI is a long-running and well-known inflation measure, its calculation does not meet international standards. For this reason, the UK government does not consider it a national statistic.

What drives inflation?

Inflation may emerge from several factors. But, usually, it results from increasing production costs or increasing demand for products and services. We’ll categorize the reasons by inflation-type.

Demand-pull inflation

Demand-pull inflation happens whenever there is strong consumer demand for services or products.  Prices will increase whenever there is a sudden increase in demand for various goods across the economy. although this is usually short-lived when there are short-term supply and demand imbalances, constant demand may have a long term effect that raises costs for other goods

Cost-push inflation

Cost-push inflation cot push happens when prices rise due to increased production costs like wages and raw materials. The demand for the goods remains steady while supply declines due to increased production costs. What usually happens, as a result, is that the costs of production are passed on to buyers in the form of higher prices.

A tell-tale sign of potential cost-push inflation is rising commodity prices for goods like metals and oil. Both are vital production imputes, so a price increase would have economy-wide ramifications. A good example here would be OPEC’s (Organization of Petroleum Exporting Countries) decision to restrict its oil production in 1973.

The move caused oil prices to increase by 400%. All industries that relied on oil and gas saw a remarkable increase in production expenses, and they were forced to raise prices to survive.

Wages affect the cost of production, too, as they are the most significant expense for businesses.  Companies increase salaries to attract qualified workers whenever labor shortages occur (usually due to low unemployment rates and optimal economic performance). This approach increases production costs, leading to cost-push inflation.

Expansionary fiscal policy

If a government cuts taxes, businesses will likely spend their surpluses on employee compensation, capital improvements, or new staff. Consumers may spend more too. These trends will increase demand for goods and services, leading to a general increase in prices.

Inflation may also arise when governments attempt to stimulate spending through quantitative easing.

How inflation affects the property market?

Although average consumers won’t gain much from inflation, investors will enjoy significant returns if they hold assets that positively benefit from inflation, like real estate.

Here’s why

Increased value

Real estate gains value during inflation so much that it is considered an inflation hedge investment. There are many reasons for this, but let’s look at the two most prominent

First, real estate prices will rise along with prices of other goods during inflation. This means putting your money into a property will keep it safe – it won’t lose value.

The second reason is appreciation.

A property’s value will increase by between 3 and 5% each year without inflation. This phenomenon, known as real estate appreciation, is caused by several factors like population growth and infrastructure development. Interestingly, it works even during inflation.  Investing in a property will allow you to preserve and even grow your money.

Increasing income

If you manage your properties wisely, the rise in real estate prices that comes during inflation will allow you to increase your rental returns. 

The high cost of mortgages will force most people to rent rather than buy. This will increase demand for rental properties, prompting a general increase in rental rates. Owning a rental property in such a situation puts you in an ideal position to make more money.

Although some expenses like insurance and taxes may increase, your increased earnings will help you settle those fees and provide additional cash flow. Increased rental fees will help you counter the effect of inflation on your taxes and maintenance fees.

Reduced debt burden

Inflation causes a currency to lose value over time. In simpler words, cash before inflation is worth more than the same amount after inflation has occurred. If you borrowed money (at a fixed rate) before inflation, you’d pay back with cash that’s worth less than when you originally borrowed it. So, your monthly payments will remain the same, but the value of that payment will decline as time passes.

Will there be inflation in the UK economy?

Inflation was at about 2% in the UK before the pandemic, which the Bank of England prefers. However, it quickly rose to 2.5% in the first half of 2021 and is forecast to increase to about 3% before the year ends. 

The question right now is not whether inflation will occur (because it already has) but if it will continue.

The Bank of England believes that this trend is temporary – that it’s a natural response to increased consumer demand as the UK opens up its economy. However, the reality isn’t so straightforward. 

On the one hand, the government has created jobs and revised policies that encouraged consumer spending, like the stamp duty holiday. This could curb inflation.

On the other hand, The Bank of England is printing more money to limit the effects of the second lockdown, and manufacturing businesses are yet to recover from the impacts of the pandemic. All these factors could sustain and perhaps increase inflation.

So, it’s hard to say for sure what will happen, but there’s a more detailed explanation in the video below

How property investors should prepare

The key to success in property investing (or any other investment strategy) is to prepare for all possible outcomes. This way, you won’t miss valuable opportunities whether or not inflation occurs.

Momentum property investing has several effective training programs that will equip you with the skills and knowledge to thrive in any economic situation.