June 24, 2006
Why inflation is great for property owners
Filip Vercauteren | Fincalena
You can’t open a financial paper these last weeks without being confronted with the word ‘Inflation’; it is the talk of the day and it is responsible for rising interest rates which make our mortgages more expensive. Now, there is a big difference between the causes and the consequences of inflation, something that confuses a lot of people. Rising prices for goods and services are the consequences of inflation not the cause. The cause of inflation is monetary easing mainly in the form of credit expansion.
The money supply statistics which can be found in the Economist, show us that e.g. Denmark now has 12,8% more money in circulation than the year before. Since all this money needs to go somewhere it is no surprise that the Danish economy is growing strong and that Denmark was on top of the house price index. So clearly, there is a big correlation between the money supply and economic growth and real estate prices. The problem is that governments want to avoid that inflation filters through to our wages, since that would make us even more vulnerable to the stiff competition from the East. Hence they raise interest rates and this is when it starts hurting you and me and all consumers out there.
Even though interest rates are still at a very low level historically, this actually means nothing since that has caused us to borrow a lot more than we would have with higher interest rates. What also needs to be considered is that an interest rate rise from 3% to 4% is actually an increase of 33%, so it has quite a spectacular effect on our mortgage repayments. Furthermore, fewer people will qualify for a new mortgage and some people will actually fall behind with their repayments to the bank. So, how can all this bad news actually be good for property owners? Here’s why:
Initially it will put extra pressure on the real estate market since people cannot borrow as much anymore given that their wage has stayed the same, furthermore this can lead to a small chain reaction: as real estate activity slows down, fewer new projects will be started leading to job losses and it will negatively impact consumption since there are many people out there who took a mortgage on their existing home simply for consumption purposes. In my opinion this will mostly affect the ‘marginal’ buyer whose bank repayments are a monthly struggle. For most people this will mean that they will become a little bit more cautious, perhaps try to save a little bit more and it will stop them from speculating with off-plan properties, but that’s it.
Now comes the good part: as fewer people will be able to buy and given the fact that everybody needs a home, rents will go up and so will rental yields. Where many markets are now facing oversupply (Costa del Sol being one of them), this will gradually start to diminish as inflation will make new built or drastic reforms too expensive. In times of inflation people are looking for defensive means to invest in, which will at least secure their purchase power; historically real estate has proven to be the best investment in the beginning of an inflationary period. Eventually, this new demand will start pushing prices further up. So do I suggest buying tomorrow? Yes, as long as you stay away from ‘generic’ properties such as two bedrooms, two bathrooms apartments: there is an oversupply in those and most of them lack every minimum of both creativity and quality. Much more promising are e.g. townhouses, since a lot of people who now live in apartments will want to upgrade to a better, more ample property. On the property section we focus on those unique properties that will definitely better preserve and increase in value, some of them can now be bought 30% cheaper than a year ago (check out this one in La Quinta). So inflation is nothing to worry about if you are a home-owner, it’s actually great news as long as you make sure that your properties are well managed and well financed.
So to recapitulate, here are three super reasons why inflation is good for property owners:
1. As fewer people are able to qualify for a mortgage because of the higher interest rates, rental demand and rental yields will dramatically improve.
2. As inflation filters through in wages and material cost, new built is becoming too expensive to be economically viable which in turn will divert home purchasers to existing homes.
3. In times of insecurity, such as inflation, people tend to look for defensive investments that will preserve the purchasing value of their money. Historically real estate is second to none as a defensive investment.
Category: The Great Housing Debate