Tuesday, October 14, 2014

How Inflation Affects the Real Estate Sector

Inflation has always been the tricky devil that haunts all business and commodity sectors of the world. Economists have studied this phenomenon for years and theorized in abundance to explain its effect on our lives.

When you reach that stage in life when you're ready to invest in real estate, keep in mind that inflation cannot be overlooked. Any realty investment should be made cautiously. Let's look at how inflation affects the real estate sector.

Understanding Inflation

There are umpteen explanations for inflation, ranging from the concise dictionary definition to more complex explanations in economic textbooks. Put simply, inflation dictates how the buying power of your currency decreases with changes in demand or supply of basic serviceable goods. So, when you hear about a price rise in any commodity, it is considered to be because of inflation.

More specifically, price rise can be attributed to two things: increased demand or reduced supply. But how does inflation play into your equation with real estate? Let's look at it from three different perspectives:

Buyer's Inflation

When a buyer decides to purchase a house, he or she looks to strike a favorable chord between the money at hand and the price put up for the property. Typically, if there is a rise in property prices, you as a buyer will be unwilling to invest in one. What you need to understand here is that during inflation, not just the price of the property, but also your wages are rising. The only difference is that the wages are rising at an undetermined rate.

Buyers generally don't face the repercussions of inflation by themselves. They go through a lender, a bank, or a financial agent. The lender's terms and conditions would affect your buying decision more than the inflation itself.

Lender's Inflation

A lender, in this case, is the middleman in real estate business. A bank is an example of a lender. During inflation, lenders increase the one factor they have complete control over - interest rates. For instance, if the lender knows that the inflation is going to be 10% next year (based on the current market trend), they would hike up the interest rate in order to reap profits. This leads to a dilemma for the buyer. Invariably the buyer ends up not taking the loan, and thus creating a loss for the lender. But where does the real estate agent fit in all this?

Seller's Inflation

Sellers have a hard time during inflation because of the rising prices. Naturally the buyers will back out. If a seller wants to run a profitable business, they will have to reduce the prices. That explains how real estate prices stay stagnant or fall, but never rise during an inflation.

Thus, you can see that inflation has a cyclical effect on the real estate market. Are you still planning on buying that house? Be smart. Assess how the banks will play you, and make the right buying moves.

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