If you’re interested in profiting from real estate, it is important to understand the relationship between real estate prices and inflation. While the correlation between inflation and property returns isn’t perfect, it’s still remarkably high and inflation affects both rental income and changes in capital value of assets, two factors that must be considered in total returns.
What is inflation?
When you ask, “What is inflation?” you’re probably thinking about price inflation, the general increase in the cost of goods and services. Prices rise gradually when the economy is experiencing normal growth but can spike out of control during periods of heavy inflation.
Inflation is measured by comparing the change in prices of certain goods and services over time. This is called the Consumer Price Index, or CPI. In India for example, the CPI is based on a basket of 299 different consumer goods and services, which is then weighted. A lower CPI means that inflation is decreasing, and a higher one means that inflation is increasing.
Inflation rates in India can fluctuate wildly throughout the year, ranging from 5% to nearly 10% in a few months. The current inflation rate in India is measured at 6.95 percent as of March 2022. As the rate of inflation continues to rise, it is important to remember that the official inflation rate does not measure all aspects of price increases. The rise in prices has a double-edged effect on the non-rich and income business owners, with the loss of income due to curtailed demand and layoffs making inflation a double-edged sword.
There are three main causes of the current post COVID inflation we are seeing in the world today, Governments having printed a large amount of money during the pandemic, the reopening of the economy increasing the demand for energy and commodities, and finally problems with supply chains being enhanced due to the conflict in the Ukraine.
Recent data show that the RBI’s latest estimates of India’s inflation rate are higher than the previous ones. The RBI has been focusing on inflation only since February 2022, after putting growth at the top of its priority list.
Rising inflation in India is a result of a combination of demand and supply side factors. High input costs are a contributing factor, as are energy concerns. A supply-driven factor may be used as a fiscal tool to moderate inflation, but the global level impact of a price rise can be profound. The price rises in many countries have affected both supply and demand-side inflation in different ways. The impact of inflation on India’s GDP growth will likely be larger than the economic impact on the individual economy.
What happens to real estate prices during periods of inflation?
Since construction costs play a big part in determining the price of real estate, rising inflation can result in higher property prices. As the cost of developing new projects increases, less real estate is also developed, causing real estate inventories to slump and prices to rise. With less real estate being built, occupancy rates also rise, and landlords can raise rents to increase their revenues. Inflation overall pushes all prices upwards.
In India as well as many developing countries, inflation has been a problem for many years and is one of the reasons why the cost of living keeps going up. However, inflation can also be a good thing for investors and asset holders, including real estate investors. This is why real estate has traditionally been looked at as a hedge against inflation. Here are some ways inflation can help your real estate returns:
- Inflation increases the value of your investment. Over time, the price of real estate will go up along with the rest of the prices in the economy. This means that if you invest in real estate today, your investment will likely be worth more in the future as a result of inflation.
- Inflation makes rental income more valuable. If you’re a landlord, inflation is good news for you. That’s because when prices go up, so does rent. This means that your rental income will be higher in the future.
- Inflation can help improve your cash flow if you have a fixed mortgage on your property. This is because your rental yield will increase with time while your mortgage payment on the property will stay the same with a fixed interest rate mortgage. This will give you additional cashflow to put towards other investments.
- When the price of a property rises with inflation, the loan-to-value of mortgage debt goes down, meaning the investor’s equity increases. Investors can take advantage of this to borrow additional funds on the property that can then be used as a down payment to purchase additional assets.
- Inflation can create distress buying opportunities in periods of inflation. Those without a good source of income may be forced to sell assets at a discounted price for quick access to capital. This creates opportunities for savvy investors to buy properties at a discount.
In conclusion, investing in real estate can be a great way to protect yourself against inflation and grow your wealth. Your ability to increase the income received from your property will play a key factor in how it performs as an inflation hedge.