- Real Estate
The Truth About Home Value vs. Inflation
Inflation can happen when the economy is experiencing a boom, with an influx of more money creating higher consumer demands that drive prices up. An inflationary environment has positive and negative effects, including an influence on the value of homes. Current homeowners and prospective homebuyers will gain from understanding how inflation affects them and their home investment.
What is Inflation?
Inflation is an increase in the average cost of the goods and services people purchase over a certain a length of time. It is measured by taking the difference between the Consumer Price Index (CPI) at the beginning and end of a year. The CPI shows how much prices have changed over the course of the year. Generally, inflation is the result of an over-abundant supply of money in the economy, or an increase in expenses, such as wages, taxes or foreign imports, that cause businesses to increase prices.
Effects on Home Values
Home values are the result of various market forces, including buyer demand. When inflation is high, the housing market does well due to increased money in the pockets of buyers. When inflation is at its lowest, the housing market also does well, since home prices are usually lower due to less demand. History shows that real estate prices have risen over the past few decades faster than inflation.
Residential Real Estate as Inflation Hedge
Buying a home protects against inflation regardless of the home's current market value. Owning allows people to avoid the need to pay rents that may be driven up by inflation. Additionally, tax benefits reduce the overall cost of the down payment plus monthly mortgage payments. A fixed-rate mortgage prevents inflation from having any effect on what is the largest part of most peoples’ investment portfolio – the investment in their home. If a person continues to live in the same house and does not refinance, his home will be paid off after 30 years and the ability to live rent-free will mean a substantial drop in his personal inflation rate.
Real Estate Investing in Inflationary Times
When inflation is unexpected, investors become wary and hesitant to part with their money. However, when inflation is expected, an environment of modest inflation levels, less than 6 percent, works well in the real estate market. Individuals who have adequate cash reserves can purchase better properties for a long term investment, or to resell. Additionally, properties that produce rents that rise with inflation can serve as inflation hedges.