The present generation living in the developed world has no idea about inflation and hyperinflation affects daily living simply because they have not lived through it; they were too young when it happened in Europe and USA. The reality is that inflation has a rippling effect on the economy leaving no area untouched.
In economics, inflation refers to a sustained trend of a general and progressive increase in prices over a period of time. The rate at which prices increase is known as the inflation rate and is important because it represents loss in spending power and reduction in the real value of your investments. The inflation rate also tells you as to what rate of return on investment you should aim at so as to maintain your existing lifestyle. Rampant inflation would eventually have you wondering how will inflation affect my real estate.
Inflation and its effect can be explained easily through an example. Suppose you can buy a loaf of bread for $1 today and the rate at which prices are increasing per year is 10%. This means that the same loaf of bread will cost $1.10 next year. This means that if your income does not increase by at least 10%, you will not be able to buy as many loaves next year. Another way of looking at it is that if an investment gives 8% percent return and the inflation rate is 10%, you are in fact getting a negative return because the real return in this case is minus 2% (10%-8%).
However, the question that we are asking here is how inflation will affect my real estate and whether it is a matter of concern. Inflation means that everything, food, clothing, utility bills and petrol, becomes costlier; the cost of living per se is higher. It is like a rising tide and affects all goods and services. It also affects assets across all classes.
Just because people believe that inflation has an economic-wide rippling effect, many people believe that prices of real assets such as commodities, land, buildings and machinery will rise and that of bonds and stocks fall. This is actually wrong and if you believe this you are actually committing a big mistake. The facts of the case are slightly different.
The immediate effect of inflation is seen only in daily necessities; things like food and fuel. The other thing to be affected immediately is credit. The effect on daily necessities is obvious but the effect on credit is slightly difficult to understand.
Interest rates are an important tool of monetary policy that governments and central banks employ to deal with variables like unemployment, investment and inflation. Inflation is usually the result of increased money supply and to control it central banks hike interest rates in an effort to motivate people to invest rather than spend. It is the increase in interest rates that has an effect on real estate prices.
Real estate prices actually go down in an inflationary economy, at least in the short term. Real estate sellers depend upon loan providers to offer credit to buyers in order to sell their properties. However, when interest rates rise, borrowers are less inclined to borrow. The forces of demand and supply take over and real estate sellers are compelled to reduce prices because if they do not, they will not find any buyers.
However, that still is not the full answer to the question how will inflation affect my real estate. The reason is that the relation between the two is much more complex. Modern economies are cyclical in nature and typically, investment in real estate does not do well at the start of an inflationary cycle. One of the reasons for this is that property related income (rent) does not increase until the inflationary cycle has firmly established itself, which may take several months; sometimes years.
The bottom line is that prices of food, clothing and fuel etc increase early in the inflationary cycle but it takes time for the rippling effect of inflation to reflect in property values. At the same time, hyperinflation (very rapid inflation) and too much inflation is not good for real estate values. Rapid inflation that continues for long can wreck the economy leading to currency devaluation and recession, which will eventually have a negative effect on real estate values.