The Effect of Inflation on Real Estate

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Buying a townhouse or condominium unit in the Philippines suddenly boosted by double digits as real estate prices soared for the second consecutive quarter in the fourth quarter of 2021. Following years of relatively stable economic status, structural and cyclical factors suggest that inherent rates of inflation are expected to soar in the coming years. This article will discuss the effect of inflation rates on real estate assets and mortgages. Furthermore, this will be a simple guide for investors so that they can position themselves in an inflationary environment.

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Soaring Inflation Rates

This is seen as a response to the pandemic which continues to inflict damage on our global market. Regardless of the rising GDP growth, the Philippines’ annual rate of headline inflation was at 3 percent in January 2022, continuing a downward trend that began in December 2021 (3.6 percent) and ended in November 2021 (3.6 percent) (4.2 percent). Incisive investors understand that the real indicator of growth must be undervalued against inflation, and this is where the Philippines’ actual worth comes to the fore. In addition, inflation rates have risen to 4.5 percent in 2021 which shows a significant increase from the 2.1 percent inflation rate in 2020.

At present, the Philippines’ annual inflation rate increased to 4.9 percent in April 2022, up from 4.0 percent in March, the highest level since last December. A lot of data and studies have shown that inflation prices and real estate rates have a correlation. In fact, there are correlations between inflation and any good that are scarce or limited. Inflation prices, hence, are considered a major concern for all markets in 2022.

What is Inflation?

Before anything else, let us first define inflation. Inflation is the rate at which prices rise over a given time period. Inflation is typically defined as a broad measure, such as the cumulative rise in the prices of goods and services purchased or the cost of living in a country. Furthermore, inflation is a sustained increase in the overall price level of goods and services in an economic system. It is equivalent to a decrease in purchasing power for a currency used in the market. As a consequence, it takes more currency units to buy the same amount of goods and services.

With inflation on the frontier in the Philippines, many real estate investors are concerned about its impact on their assets and businesses. Consumer prices rise as inflation rises. Inflation has several impacts on real estates, such as higher mortgage rates, rising asset prices, depreciation of long-term debt, increased construction costs, and more.

The Effect of Inflation on Real Estate

Real estate has long been regarded as a strong inflation hedge, as it protects an investment from losing value despite the existence of a decline in purchasing power. This can be explained by these circumstances alongside inflation:

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1. Existing debts can be consumed by inflation rates

Salaries and wages rise in line with inflation. When this happens, inflation gives an advantage to the borrower. This is due to the fact that the debtor is still indebted with the same amount of money, but they are now equipped with more money from their salary to clear the debt.

Inflation, by definition, causes the value of a currency to fall over time. Hence, when a loan is made, the money it receives now is repaid with money it earns later. In a nutshell, the value of cash at this moment is far more profitable than the value of the cash later. This makes borrowers repay lenders with money that is worth less than it was when they loaned it.

2. Mortgage rates will soar as a result of inflation

Inflation prices in 2022 raise the cost of just about everything, such as mortgage rates. This is one effect of inflation rates on real estate. The basic idea is that mortgages behave similarly to bonds in such a way that when inflation and purchasing power decline, interest rates must grow and soar to keep investors engaged. Inflation has a substantial impact on mortgage rates. This is attributable to the fact that mortgage rates are established by the bond market. Since investors are repeatedly buying and selling mortgages, inflation also diminishes investor demand for mortgage-backed securities. Mortgage-backed bond prices fall as demand falls. As a result, all mortgage types have higher interest rates.

3. Costs of construction tools increase massively due to inflation

Another effect inflation rates have on real estate is on construction. The construction sector and its operational processes are significant contributors to the development of the Philippines’ economy. Inflation plays a critical part in the price increases of construction equipment, workforce, and machinery, causing the original budget and final expenses to diverge. Inflation is also affected by labor and material costs, but there is a significant difference due to the margins of the contractor and the supplier. Construction costs are dynamic, and the prices of construction tools and other costs are constantly rapidly changing, causing economic growth to be risky.

4. Increased rates in assets are associated with inflation

Real estate prices rise in synch with the cost of living. In general, as inflation rises, so do the prices of housing and other real estate assets. Nevertheless, depreciation in real estate demands follows an increase in mortgages. This is due to fact that debt becomes more costly. Thus, demand falls alongside a downward pressure on rates of assets.

5. During inflation, residential properties transcend

Condominiums and single or multifamily properties perform better in inflationary environments. This is a real kicker for investors who own these assets. Economists claim that during periods of rapid inflation, owners of residential and commercial real estate are often more prosperous than holders of stocks or bonds. Rents for offices, retail, and apartments are typically linked to consumer prices and rise with inflation which in turn increases property income. We have also discussed that inflation raises the cost of construction equipment and machinery, which benefits property owners by reducing competition from new buildings and constructions.

6. In line with inflation is the increase in rent prices

According to research, rapidly increasing periods of inflation resulted in a significant rise in rent prices. Housing costs account for a large portion of the overall inflation index, so they retain inflationary pressure even as interest rates cool inflation. Indeed, there may be a period when higher mortgage rates prevent renters from becoming homeowners, thereby keeping the rental market strained.

In conclusion, an inflationary environment can offer huge benefits to real estate investors if they make smart acquisitions and evaluate their portfolios against inflationary pressures such as increasing interest rates. Since none of us can foretell the future, properly informed real estate investors should fully comprehend how real estate inflation works, how a rising inflation market affects your assets or debt, and the best way to manage risks associated with inflation.

Written by MC Sanchez