With most consumer products, the price increases as the quality or features improve with each new subsequent model. Any real estate investor can tell you that real estate does not follow this consumer product trend.
Why is that, you may be asking? It’s due to inflation.
Free for All, Or Just for Some?
Real estate is an element of our free market system which is driven almost entirely by supply and demand. When supply, otherwise known as the inventory of units on the market goes up, prices go down. When demand exceeds supply, the price per unit goes up. It’s for this reason that a house can sell for price A one year, and that same house without so much as a lick of paint changed on it 365 days later can sell for a substantially higher price.
From an investor’s perspective, this means that with the right recipe of agility, liquidity, and impeccable timing, the market can provide some low-hanging and highly lucrative fruit. For an investor to gain from this though, someone else must lose, and often, it’s their home that the individual is losing.
Barak Obama‘s Former U.S. Secretary of Housing and Urban Development is quoted as saying the following about the free market system, “We know that in our free market economy that some will prosper more than others. What we don’t accept is that some folks won’t even get a chance.“ That, in a nutshell, is the major criticism of a free market or capitalist system.
What is Inflation?
According to Merriam-Webster dictionary’s definition, the term inflation is “a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services.”
If that left you scratching your head, then you’re not alone. Let’s turn to American Economist and Humourist, Sam Ewing. He famously described inflation as “Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.“
Do We Have a Type?
Although some economists feel that there are more types of inflation, for the most part, all seem to agree on the following three primary classifications: Cost-push inflation, built-in inflation and demand-pull inflation.
Is Inflation a Good Thing or a Bad Thing for Investors?
Many consider real estate to be a shield to investors during inflation. As evidence to support that position, people cite inflation’s typically higher rental prices and increased influx of demand as folks move from being able to afford an entry-level home to having to go back to renting. The reality is it’s not that simple.
While it would be nice if there was a clear-cut answer to the question of whether inflation is a good or bad thing for investors, unfortunately, you‘ll have to settle for the frustratingly tepid answer of “It depends.“
As lukewarm as “it depends“ is as an answer, it does truly depend.
Investor Buying Versus Investor Selling
If you’re an investor who is buying during a time of inflation, the market conditions can be unforgiving. Along with a stark increase in housing prices, the shortage of supply on the market is increasing the competition.
If you’re working with a lender, inflation can make it difficult to project an asset’s profitability. This is because of undetermined variables such as whether the cost of lending will increase in the future, and if so, by how much. Without that information, investors may be challenged when calculating the impact of repayments and cash flow. The last thing you want after spending so much money on a property is to see it lose value because of inflation!
However, inflation is also beneficial to investor-sellers looking to offload a property in the form of increased equity. As inflation drives up prices, the value of the asset increases, as well. This means that savvy investors can sell part or all of their real estate portfolio for more money than was paid for it, resulting in higher equity.
While it may seem very enticing to sell while prices are high, this also means if you don’t have somewhere to move to, you will also have to buy high. For many people who are able to transfer substantial amounts of equity, this can equal out, for some, this does mean significantly increasing costs.
For investors looking for strategies to bolster their portfolio against the ill impacts of inflation, we recommend that you read an earlier publish piece entitled, Recession Proofing Your Real Estate Portfolio:
The upheaval in global financial markets, its boomerang effect on local real estate markets and the profound impact on people in the past year have created palpable stress for Canadians.
Forces such as increased market volatility, supply chain issues resulting in lower inventory, geopolitical discord, higher inflation and tighter monetary policies have struck a negative chord, perhaps even discording markets in 2022 and the first quarter of 2023.
While the root cause may vary, many of these forces are not new. We’ve withstood them before. For example, we‘ve never experienced supply chain issues caused by a global pandemic in our lifetimes before, but our young nation experienced supply chain issues in the form of rationing coming out of World War I and II.
Early predictions showed that Canadian inflation was on the road to recovery and we would soon be back to economic platitudes. It looks like we as Canadians may have to hold our collective breath a little bit longer as the Bank of Canada has most recently expressed some reservations. The only thing that’s certain is that the path forward is clouded in uncertainty. Now is the time to look in the economic history books to leverage lessons learned from the past to prepare for what comes next.