Deflation is an economic trend that occurs whenever consumer and asset prices fall over time while the value of money increases. In essence, the same amount of money will allow you to buy an increasing quantity of goods and services as time goes on.
While deflation may seem beneficial (especially for customers), it often indicates recession and tough economic times.
When consumers realize that prices are going down, they delay spending decisions in the hope that they can purchase commodities for even less at a later date. Lower spending reduces producers’ profit margins, which leads to unemployment and higher interest rates.
This starts a feedback loop that leads to higher unemployment, even lower prices, and less spending. Simply put, deflation leads to more deflation, and it affects everyone negatively.
The UK economy might be on the verge of a deflationary trend, as we explain in the video below
How deflation affects the property market.
Deflation encourages consumers to postpone buying decisions, which has a detrimental impact on the velocity of money and negatively affects commodity prices (including real estate). This means it will diminish the value of your properties.
How to survive a deflation
Do not overleverage
leveraging occurs whenever you use borrowed capital as your funding source in an investment.
It allows you to acquire large assets and increase potential investment returns even when you can’t pay the full purchase price upfront. In simpler terms.
You get overleveraged whenever you take on excessive debt in contrast to your operating cash flows and equity. This situation makes it difficult to pay interests, principle payments, and even operating expenses due to your debt burden.
Deflation would make all this worse for two reasons.
First, monetary supply is tightened during this period, thereby increasing the value of money. This increases the real value of debt. You’ll still owe the same amount of dollars (if you’re on a fixed-rate mortgage) but their value will have increased. This will make it harder to pay what you owe.
Second, taking on large amounts of debt strains your finances, so you can’t cope with the declining revenue that would follow a deflationary spiral. A less leveraged investor would find it easier to survive a decline in revenue because they won’t have to deal with an expensive debt burden.
How to avoid getting overleveraged
Before you acquire an investment property, you should consider one or more of the following strategies to avoid being overleveraged.
Make larger down payments.
Increasing you deposit gives you more equity from the start and helps you minimize debt. Larger down payments may also be more appealing to sellers.
Build equity instead of cash flow
It is tempting to devote the income from your properties to personal affairs. However, your primary goal should be on building equity, not excess cash flow. The more equity you have, the less you’ll owe others. You should use your excess cash to pay off or pay down your debts.
Keep cash on hand
You may have shunned the money market in the past because it had low interest rates. Deflation calls for a different approach. Even a no interest checking account is better than losing your money.
Furthermore, a deflationary spiral may bring frozen wages and layouts. It helps to have cash on hand in such times.
Limit your loan-to-value ratio (ltv)
Ltv is a lending risk assessment that financial institutions and other lending often consider before approving mortgages. Loans assessments with high ltv ratios are considered high risk. So, if your creditor approves the mortgage, the loan will have a higher interest rate. Furthermore, loans with high ltv might force you to purchase mortgage insurance to offset the increased risk to the lender.
Note
Purchasing a property will involve several upfront fees and costs. They could cut back on your deposit if you haven’t taken them into account, and you may end up with less money as a result.
How to lower your lTV?
The measures required to lower LTV are more or less the same as what you’d do to avoid overleveraging. You need to make a large own payment. You may also focus on purchasing more affordable properties, as this would allow you to cover a large portion of the purchase price upfront.
Moving forward
Deflation has a negative impact on all assets besides money. However, income properties have a significant advantage over everything else. You’ll keep getting cash flow. Assuming that you did not over-leverage your property, you should remain capable of maintaining it while paying down any money you still owe.
The property’s value may decline during this period, but the net rental income should enable you to remain operational while achieving positive cash flow. Most investments cannot match this kind of performance.
Furthermore, deflation deprives banks of the money they would lend for mortgages so there will be fewer tenants moving out to purchase new homes. So, you’ll still earn money while managing the property and paying down your debt.
The good news is that if you can retain your assets during this period, you stand to make significant profits when the prices go back up
