Risk of Inflation to Property Investments

What is inflation?
Inflation is the average increase in price for a particular set of goods or services in a particular economy over a defined period of time, usually a year. More importantly, it's the decrease in the purchasing power of a currency over time. Taking the historical average rate of 2.48% inflation in the UK, the £30,000 car you bought last year would likely cost an additional £744 today. If you add this to all purchases over the course of a year the decrease in your purchasing power will become quite clear. For example, Greece had inflation nearing 5% over the past decade, meaning that same £30,000 car would cost an additional £1,500 today. If you require financing to purchase the car the overall cost of the vehicle increases significantly.

We should not confuse inflation with appreciation.
An appreciation rate in relation to real estate is the increase of a property’s value over time. Appreciation value does not increase in relation to currency, but increases according to demand, which means real estate could appreciate above the inflation rate over the same period.

How does Inflation affect real estate?
Positives
One of the positives of inflation is the increase in both rental values and property values. Inflation can make it difficult to obtain a mortgage as the rates are likely to be higher and the overall cost of borrowing may push the purchase of a property beyond the means of many.
Many people continue to rent, which creates a spike in demand and as a result, rental prices increase.

Negatives
Of the potential negatives of inflation in relation to real estate, perhaps the most significant is the increased cost of borrowing. Banks are likely to offer fewer loans, and of the loans which are offered interest rates are likely to be higher to offset the risk of bad debt.
Another potential negative is the increased cost of building materials. A good example of the impact this had on the market was during the COVID pandemic, where the cost of natural wood increased significantly. This increase can be seen in the price of new homes. The high cost of borrowing and the increased cost of construction can make new builds a tricky investment during inflation.
Another consideration is in relation to vacation rentals. If purchasing power is reduced, vacation rentals may suffer.

Considerations for an inflationary economy
Real estate investment can be dependent on several factors, including market conditions and location of the property.
But it could be argued that rental properties perform better than others during an inflationary market due to an increase in demand. This could include residential, commercial, multi-unit and single-family homes. Real estate investment trusts (REIT) could follow market demand and appreciation which may be a useful vehicle to distribute your investment across a greater number of assets.
Inflation has both positive and negative effects on real estate investing, which in the final analysis depends on the property, the market and having the means available to conclude the purchase. Ultimately, your real estate agent is best placed to provide this advice to you.

Paul Hogarty, Solicitor
Shallon CSP