We’ve seen inflation spike. And the Bank of England is expecting plenty more inflation to come – over 13% this year! And yet, house prices are expected to fall, not rise. That’s not a combination which gels well with conventional wisdom. Isn’t property supposed to benefit from inflation?
Let’s find out what’s going on…
But first, have you seen this latest presentation by Nigel Farage?
If you’re worried about inflation and wondering what you can do about it, Nigel made it for you.
There’s no denying the challenge is extreme. And very few people can recall the 70s, let alone which investments worked.
But Nigel believes he has found the answers you need to survive this inflation spurt with your wealth intact… or even growing.
We all face this challenge together – anyone who uses the pound is having it devalued.
But there are answers. Unfortunately, I’m not convinced one of the most promising ones should be top of the list…
House price inflation has already happened
House prices in this country went bananas over the past two years. The UK’s average house price rose 20% between March 2020 and March 2022. The pandemic, lockdowns and monetary policy created a huge shift in relation to where people want to live and how much they can afford to pay.
Central banks around the world promised to keep interest rates low for a long time to make the recovery from the pandemic easier. But this triggered the inflation spurt that we’re seeing now. The same inflation played out in property as people borrowed to buy houses under the presumption the rates would stay low.
But rates are now going up. So, you could say that the house price boom caused by inflation is already in the past.
But that’s only part of the story.
House prices are part of the inflation we’ve seen
Soaring house prices helped cause the inflation we’re seeing. In fact, they’re part of it.
Soaring property raised the cost of living by increasing rents and mortgage burdens, which are factors in inflation calculations. This adds weight to the idea that property investments are a good inflation hedge given they tend to be part of the inflation calculation.
House building costs spiked in spectacular fashion too, raising the cost of incomplete houses and the viability of planned houses. This is likely to reduce construction and therefore supply in the future.
When property prices rise, this tends to make everything else more expensive, because all of our activities use up space. Whether it’s business or leisure, the cost of acquiring space to conduct it in is factored into the prices we end up paying for those activities.
How are inflation and house prices linked?
The reason property is an excellent inflation hedge is twofold, both factors being about the use of debt.
Inflation reduces the value of debt over time. This makes it cheaper to borrow money during inflation. That is especially true for those borrowers who have fixed-rate mortgages.
Similarly, because people tend to buy property by using a loan, this leverages their capital gains. A homebuyer with a 20% down payment whose house rises in value by 20% actually generates a return of 100% on their investment! That’s a real inflation buster, especially once you consider that capital gains don’t apply in the UK your own home. Other investments are subject to tax, despite a good chunk of the return being due to inflation.
Put these two factors together and inflation is a fantastic tailwind for property investors. And that usually causes property prices to rise when inflation breaks out.
Is there a housing inflation storm coming?
The risk for property investors during an inflationary spurt is simple. Central banks are supposed to raise interest rates to rein in inflation. This makes mortgage payers part of what central bankers call the “policy transmission mechanism”.
Just as mortgage borrowers benefit first from interest rate cuts, they are first to encounter higher costs when central banks raise rates.
That is the environment we are in now. And that is in turn why property prices are falling in many places.
What can you do to combat house price inflation?
Owning your own home is highly likely to be a good financial decision given the tax benefits, inflation protection and equity creation. But borrowers should be very careful not to overextend themselves at a time like this. That is because interest rates are rising.
The chances are that interest rates will not rise as high as inflation, so the tailwind to property remains.
At Fortune & Freedom, we like to shine a light on ideas and opportunities like the connection between house prices and inflation to help readers make better decisions.
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Editor, Fortune & Freedom