If you have bought, sold, invested or otherwise participated in the economy lately, you have likely seen the forces of inflation in action.
What is inflation?
Inflation refers to a decrease in the purchasing power of money, reflected in an increase of the price of goods and services in the economy. So, as inflation ticks up, every dollar you earn loses value and therefore impacts your ability to spend.
While the housing market was already seeing short supply and high demand before 2020, it is safe to say that the pandemic’s arrival exacerbated these trends. Many renters entered the housing market in search of a home of their own, while plenty of homeowners sought opportunities to trade up and increase their space. As this increasing demand took shape, we saw many existing homeowners staying put, therefore limiting the supply of available properties.
The resulting housing market inflation amounts to a basic case of supply and demand at work, adding fuel to an already raging fire.
How does inflation impact the market?
For several reasons, inflation is actually a good development for property owners. The most obvious benefit is the fact that the value of your home rises with the inflation rate. With supply low and demand high, sellers can shoot for the moon with their asking prices, and in many cases, receive offers for or even above that asking price. This makes it a great time to sell, but a much more difficult time to buy.
If you are invested in a property as a leveraged asset, especially with financing rates as low as they currently are, you will find yourself paying the same fixed rate even as your property’s value steadily rises. In this current inflationary market, we are not yet seeing financing rates rise alongside inflation, and as a result, your return on investment (ROI) can be expected to soar.
For prospective investors:
Not surprisingly, the circumstances for prospective investors in an inflationary market are very different from those for existing owners. With that reality in mind, the most important factor this group must consider is timing.
How long do you plan to own the prospective property? If you are in it for the long haul, you should expect the same value increases that existing owners are experiencing. If you are looking at a shorter investment time horizon — perhaps through flipping the property, for example — then we should caution “buyer beware.”
One of the dangers of short-term investing in an inflationary real estate market is the risk of getting caught in a real estate bubble. New home buyers should expect closing costs to run as high as 6 percent of the home price, and if you do not possess enough equity to absorb those costs, then you may find yourself at risk of losing money when the bubble bursts.
Housing prices have seen historic rises over such a short period of time. And while that may not be inherently concerning, it underscores the importance of understanding your expected investment time horizon and adjusting your plans accordingly.
So what’s next?
As we map out the market’s near- and long-term future, it is certainly understandable for the ghosts of 2008’s housing bubble to haunt buyers, sellers and investors alike. Yet while a market decline is difficult to predict, it’s worth noting that there isn’t much data suggesting one is imminent.
For starters, the current asset market is vastly different from what we saw in 2008, right before the Great Recession. Although labor is in short supply, the economy is growing, unemployment remains low and optimism remains high as reopening efforts continue and better opportunities emerge.
As with any big financial decision, it’s important to keep your guard up for economic risks. However, smart planning, time management and seeking advice from a financial adviser can help keep you and your money safe.
David Mount is a director with the Wise Investor Group at Robert W. Baird & Co. in Reston, Va. Baird does not provide tax, legal or real estate advice, and does not provide or service mortgages.
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