How Inflation Affects Real Estate
Inflation has been a hot topic lately and knowing how inflation affects real estate helps to forecast things into the future. This article is about how inflation affects real estate and how to deal with it as a real estate investor.
Many individuals have speculated that with passage of government stimulus programs sending money directly to the general public and pandemic related assistance programs, that all this money flowing into the economy will cause inflation to increase. This was mentioned in the media with the dramatic increase in lumber prices, which have recently receded.
It’s important to be conscious that some price increases were due to adjustments in distribution channels of goods and commodities that were in low demand or affected by work force reductions during the pandemic. Despite this it’s reasonable to be attentive as any intelligent real estate investor should be aware of how inflation affects real estate.
What is Inflation?
The fundamental premise with inflation is that as more dollars are introduced into the economy, prices increase. Because more money is now available to buy goods and services, the purchasing power of a dollar is diminished. It becomes easier and necessary for companies to charge more for goods and services. It’s easier because more people with more dollars in their hands are less likely to reject price increases and pay a higher cost for necessities. It’s necessary because as prices for raw materials and employees go up, company’s need to charge more for their products and services to stay in business.
How Inflation Affects Real Estate Values
With more money in the economy chasing the same real estate assets, it’s generally expected that prices to purchase real estate will go up. Inflation affects real estate by increasing values. This has certainly played out during the pandemic; however, it’s not exactly related to inflation and more having to do with the lack of supply. It’s my belief that the pandemic caused some people to reconsider or delay selling their real estate; therefore decreasing the supply. Real estate prices continue to increase and with lenders willing to lend, I think it’s reasonable to believe that values will continue to increase until demand slows or the supply dramatically increases.
Inflation When Selling and Buying Real Estate
When inflation causes real estate values to increase, it’s good for sellers because they get a higher price for their property. It’s bad for buyers because they will have to pay more for the real estate. Buyers will also experience higher costs to borrow money. Generally interest rates rise with inflation. Higher interest rates increase the monthly mortgage payment for the borrower.
How Inflation Affects Rents on Real Estate
If inflation causes values to increase, the ability for people to buy homes will diminish. If people cannot afford to buy a home, they will seek rental housing. Inflation will cause rents on real estate to increase because of increased rental demand. Our company has experienced this first hand through our asset management and property management operations. We’ve seen a dramatic increase in the amount of responses from prospective tenants whenever rentals are advertised.
As rents across similar properties increase, the ability for property managers and landlords to increase their rents to market rates becomes less challenging. If a landlord sees that a neighboring property rents for a higher amount, they may believe that they can receive the same amount and bump up their rents.
If a tenant receives a rent increase notice and they see similar rents in their area at the same level, they will decide to stay and pay the increase. Even with a slight cost savings at another location, it may not be enough to motivate a tenant to move. The time and costs associated with relocating are major considerations. All the planning and preparation to adapt to a new location and rearrange lifestyles, driving patterns and community connections, may not make personal or economic sense overall.
For investors that already own commercial multifamily rentals, inflation is beneficial in a couple of ways. The increase in rental income will cause the net-operating-income to increase and cash flow of the operations will go up. With the increase to net-operating-income the cap rate valuation of the property will also go up making it more valuable.
How Inflation Affects Real Estate Developers
For builders and developers, inflation’s effects on real estate can be negative or positive depending on the building phase of their projects. Inflation affects real estate developments by causing materials and labor to increase. Because the planning process to create a building or major project can happen years in advance, changes in material costs may not be factored in at the planning and estimating stages. This can cause cost overruns on building projects to go over budget. If the developer can’t sell their building at an increased price, they may not be able to recoup their costs and wind up losing money.
Conversely if the developer has finished the build-out phase of their project and inflation has started affecting prices of assets, the developer may find that they can get a higher price for their building. This is dependent on market forces – mainly if buyers are willing to bid up and offer more for the building.
New Housing Development and the Job Multiplier Effect
Watch this Short Video about a Housing Development Near Our Recent Apartment Purchase
How Inflation Affects Real Estate Depends on Where You Stand
This article shows the different ways inflation affects real estate depending on what position you hold. Real Estate is generally considered a good hedge against inflation due to its positive effects on valuations. It’s especially true with income generating real estate. Rising values and rents are generally counter balancing forces that mitigate price increases caused by inflation.