Inflation is currently high in the United States, and it is one of the major problems for the country. With the rise of inflation, the prices of many goods and services increase, and the real estate market is no different.
Higher mortgage rates, devaluation of long-term debts, and increasing asset prices are some effects of inflation on the real estate sector. We’ve explained the impact of inflation on real estate in greater detail below.
What Causes Inflation?
The pace at which the price of a product or service rises over time is known as inflation. Prices might vary depending on the circumstances, but inflation commonly increases the money supply. Despite this, the Federal Reserve's policies also play a major role in inflation.
There are a few instances in which the growth in the money supply might impact consumers, even though it ultimately leads to inflation. For instance, in a demand-pull effect, a rise in the money supply increases the general demand for products and services. In simpler terms, increased spending and greater product demand result from having more money accessible.
The expensive manufacturing of products and services can also contribute to inflation. When manufacturing a product becomes more expensive, the cost of the product rises. The real estate market is also affected in this way, but a major influence involves demand and supply, too.
How Does Inflation Affect the Real Estate Market?
Higher Mortgage Rates
Higher mortgage rates is one of the major side effects of inflation that the real estate market has to bear. It becomes more difficult to take out a loan from the bank when inflation goes up along with interest rates. The common procedure for central banks is to increase short-term rates to reduce the inflationary environment. This may lead to a decline in the number of investors who finance or buy homes.
When interest rates are low, more people borrow, which increases their rate of spending money. As a result, inflation increases. Consumers are likely to save more money than they spend as central banks increase interest rates to combat inflation because the gains from rising interest rates are more tempting.
Rise of Construction Costs
The cost of building materials will increase as a result of inflation in prices for goods and services. There are several costs involved in real estate development, and they will all typically rise when inflation starts to spread. New buildings can be a highly challenging investment during an inflationary period due to the high cost of borrowing and the increased expenditure of construction.
Additionally, when money is tight, travel expenses are reduced. Retirement communities, commercial tourist areas, and vacation rentals will not perform as effectively as other real estate investments. Additionally, if a builder had planned to construct a recreational building in an inflationary setting a few years prior, the budgeting will now have to take into account the escalation of prices in the labor and construction equipment.
Increase in Rental Rates
Inflation also affects rental rates. Obtaining a mortgage during periods of high inflation can be quite challenging. Since buyers' purchasing power is reduced by high mortgage rates, several of them continue to rent. Rents rise as a result of the increase in demand, which is favorable for landlords.
Studies show that during high periods of inflation, a similar increase in rent prices is seen. A study found that the median rent climbed at an average yearly rate of 8.5% during the high period of inflation between 1973 and 1983, which is higher than all measures of inflation.
Higher Asset Prices
Inflation causes prices of goods to increase. As such, when inflation rises, then the prices of housing and other real estate assets also increase. However, since mortgage rates rise with inflation, it could reduce the demand for real estate assets because people hesitate getting a loan with higher interest rates. This can put a downward pressure on the prices of assets due to reduced demand.
Real estate is seen as a fantastic hedge against inflation since it typically results in increased rents and greater asset values. Inflation can be good for real estate investors provided they do their due diligence when assessing the property. It is important to consider locations with cash flow and avoid lazy equity.
Our team at Bondon Insurance Services can help you if you're an investor looking to buy more properties by offering you reasonable insurance and top-notch customer service. Visit us here to get a quote today!