Inflation and real estate: should you buy a home?

Is it a good idea to buy a property to defend yourself against inflation? In this article, I will talk to you about inflation and investment in real estate. We know that buying a real asset class is the most commonly used method against rising prices.

Property is undoubtedly the “real asset” par excellence, or it has been until now. And it is also true that inflation and real estate cycles are always correlated.

Today, many investors fear the rising prices of goods and services. We receive advice to buy physical assets to defend themselves from money devaluing.

Perhaps you have to consider many viewpoints because the rise in house prices is not as automatic as expected.

We can use many financial indicators to analyze price trends. A widely used indicator is the S&P Case-Shiller. The S&P Case-Shiller U.S. National Home Price Index is based on the value of single-family homes in the United States.

S&p Case Shiller U.S. national home price index
S&p Case Shiller U.S. national home price index

Remember that if the price of apples and bread increases, the cost of houses does not necessarily rise over the same period. In fact, many other factors influence inflation and property prices.

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When inflation rises, there will be properties that increase in value and others that decrease. Only knowing how to choose the right investment property will make the difference.

Inflation and real estate

One of the most commonly used arguments for linking rising house prices to inflation is the higher cost of commodities. Inflation would drive up the prices of raw materials to build new homes, and prices could rise. 

In fact, if raw materials increase, fewer new homes will be available. As a result, existing ones are becoming more expensive, but we must also consider that fewer people will buy properties. It’s two sides to the same coin; for this reason, it is difficult to link inflation to the increase in property prices reliably.

As inflation increases, fewer people will be able to afford a mortgage to buy their homes. Moreover, the generalized rise in prices will lead to a generalized impoverished middle class.

What if mortgages increase

Mortgages will become more expensive when inflation increases, interest rates rise, and the cost of borrowing increases. The more mortgages increase, the fewer people will buy homes.

Inflation and real estate Historical Mortgage Rate Averages From the Past 23 Months
Historical Mortgage Rate Averages From the Past 23 Months

The real estate market moves according to supply and demand rules; no other causes influence this simple rule. When the demand decreases, the supply increases, and the prices drop, nothing can change this rule.

Wages lose the purchasing power

People with a fixed salary will have less money because living costs will be higher. The increase in raw material costs will lead to an increase in consumer prices.

For fixed-income families, it will be difficult to pay their bills, and they will surely postpone purchasing a new home.

Moreover, fewer people can afford higher rents. Rental rates must rise to make the business economically profitable, which leads to a contraction in the market.

As prices rise, the economy is under a downturn, reducing demand in many sectors.

Effect of inflation on the housing market

The question many are asking is whether the purchase of a home protects against rising prices. Nevertheless, the question is wrong and cannot be answered correctly. As I said, inflation and real estate correlation are challenging.

The right question is how to choose the right home that will be worth it when inflation hits. If you ask yourself this question, everything becomes more simple and predictable. As I told you, the real estate market moves according to the classic rules of supply and demand.

If you buy a random property, you will not be a smart investor. You will certainly not be fighting an increase in prices.

The house to be bought must have two fundamental characteristics. It must be quickly resealable, and you can rent it to create a cash flow. Houses with these characteristics are usually small to medium-sized and located in strategic areas of the city.

Condo and middle class difficulties

During a high inflation long period, the gap between rich people and poor people increases. Many fixed salary families can’t afford to rent a home in a central area and prefer a suburb low-priced home.

Home Price to Median Household Income Ratio (US)
Home Price to Median Household Income Ratio (US)

Middle-class wealth tends to disappear in times of crisis. Much of the real estate market comprises medium-sized condominiums or terraced houses explicitly designed for the middle class.

In times of crisis, a costly condo in the city center could quickly be empty.

Evaluate a holiday home

Less risky than an apartment in an apartment building, it could be a vacation home. It might be more expensive but hold the price better in case of inflation.

If you buy a holiday home in a tourist area, you will always have some wealthy family who wants to spend their holidays there. If you can find the right price for a holiday home, you can easily rent it.

Buying a holiday apartment to rent on Airbnb could be safer than renting a one-bedroom apartment in the city center. You can also easily resell this property as demand increases, and you get a capital gain.

Why not a financial instrument?

Buying a financial instrument could be an intelligent way to invest in the real estate market with experts who should do the work for you. There are also many ETFs that invest in real estate with low management costs.

This doesn’t always happen because low fees and performance make many ETFs and investment funds less profitable. But if your idea was to buy a random house, you are undoubtedly riskless with a financial instrument.

Many investors use regularly listed equity securities called REITs. It is also possible to purchase houses with small investments through investment groups online.

Conclusions

It’s very challenging to predict an inflation rise. It doesn’t matter what the analysts write, Wall Street, or what your financial advisor says. There are too many factors to consider, both political and economic.

Covid is among the main factors of uncertainty.  Future scenarios in the fight against Covid will change inflation expectations.

A quick resolution could lead to a recovery of the economy and tapering by central banks. On the contrary, protracted lockdowns will lead to financial crises in all sectors but continuous liquidity injections.

So if you decide to buy a home, do it regardless of the catastrophic forecasts and choose based only on real estate supply and demand.

In the future, how many people will want to buy or rent the house you are considering as an investment? At what prices will you be able to rent? What could go wrong in the event of an economic crisis or an increase in interest rates? 

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