How Does Inflation Affect Real Estate?
We’re hearing a lot in the news about inflation right now.
The inflation rates have been going up at record-breaking paces. Some of that is to be expected during a period of economic recovery following the COVID-19 pandemic, but there are concerns being echoed by some financial analysts.
Inflation refers to the decline of purchasing power of a currency over time, to put it somewhat technically. Basically, what inflation means is that you have less purchasing power with the same amount of money.
So, how does this affect real estate?
Home Construction Costs
Right now, one of the most obvious and direct effects we see of inflation on the real estate market is in the rising cost of the items used to build a home.
For example, for the past year, lumber prices have been rising. Those prices have added a significant percentage to the cost of new homes. That’s just one example of an item that’s used to build new homes. There are bricks, drywall, concrete and more that go into it. When the required items are more expensive for homebuilders because of inflation, those costs do ultimately get passed onto the buyer.
The fast rises in home prices have actually played a role in inflation being pushed to a 13-year high. Housing costs this year went up by 0.4% between just April and May. The rising home prices accounted for more than ¼ of the overall inflation increase in May.
As was mentioned above, if a home builder is paying more, then the buyer is going to be taking on the consequences of that inflation.
That’s not the only factor that means inflation is going to cause home prices to rise, though.
If the Central Bank increases the money supply in the economy, which is a big cause of inflation, then home prices go up as well.
Sometimes when there’s inflation, then debt is affected. Specifically, if inflation goes up, it’s more expensive to borrow money. With rising interest rates, then people might not borrow money at all. Then, when there are fewer home purchases being financed with a mortgage, economic growth may be affected.
Rent Price Inflation
The price of rent tends to go up with inflation and higher home prices.
Unfortunately, it’s not like rent is a discretionary expense you can cut out if you have to.
More than nine million renters are considered extremely low-income right now and are burdened by their housing costs. That means they spend more than 1/3 of their income on expenses related to shelter. Many of these low-income houses spend more than 50% on housing.
There may be more renters during times of high inflation, despite the increase in rental prices. This is because it can be harder to get a mortgage in high inflationary periods. An expensive mortgage also means less buying power, so it’s more likely that someone might continue to rent.
What about housing inflation's effects on current homeowners?
Well, if you already have a fixed mortgage on your home, your cost of living with regard to your home isn’t going to change much. Your taxes and insurance might a bit, but still, not a huge impact.
You don’t see the change unless you’re moving.
There’s a note of distinction to be made here, though. Inflation is not appreciation, which some homebuyers may confuse.
Appreciation refers to the increase of your property value over time. The value’s not increasing in relation to the currency. It’s increasing because of demand. Your home can appreciate more or less than the rate of inflation at any given time.
Overall, what this means is that, yes, real estate is affected by inflation in both direct and indirect ways.