Inflation has become an increasingly hotter topic over the last couple of years and seems to be peaking in our current economic environment. Talks of another recession have been looming for months, and there’s no industry that’s not on high alert because of it.
Certain industries feel the effects much stronger than others, but what about the real estate sector? How does inflation directly affect the housing market, and what does this mean for your strategy?
In this article, we’ll answer those questions and more. Continue reading to understand how inflation could affect your next real estate move.
Rising Rates
Last October, inflation rates rose to 6.2%, which is the highest they’ve been since November of 1990. This is a drastic increase from the 2% that we’ve become accustomed to over the last five years.
When you think about this in terms of your everyday life, it means that you’re spending more money on just about everything imaginable. When you’re at the gas station, paying utility bills, and buying your food, the drain on your wallet seems like it becomes worse with each trip.
The bottom line is our money isn’t going nearly as far as it used to. So how does this specifically affect the housing industry?
It shouldn’t surprise you that inflation is hitting the real estate market hard, as well.
According to most investors, residential real estate has always been a safe investment during heavy inflation. During the 1970s (another period of heavy inflation), prices of homes increased relative to the size of our economy. This was a good thing for homeowners because it meant that rising values in homes worked to offset increases everywhere else.
However, if you were looking for a new home, this presented major challenges, which is true of today’s market.
What causes Inflation, and How Does It Happen?
Inflation is when the prices of goods and services rise, which decreases the purchasing power of the money you hold in your wallet. Currently, several things are influencing inflation, specifically the government aid during the COVID pandemic.
When the government helped American homeowners and extended financial assistance, this gave consumers more purchasing power. However, the intention of the assistance was to put money back into the economy and various work-related businesses, and this didn’t happen as planned.
These companies had to charge more for goods and services because people were working remotely and didn’t need to spend on things like takeout lunches, commuting, dry cleaning, and other work-related expenses. Sometimes having fewer customers leaves you no other choice.
When the number of transactions drops, business owners are forced to increase prices to stay in the black.
Another large factor contributing to inflation is the supply chain issues occurring in multiple countries. Manufacturing and other services became disrupted because of restrictions, and sickness and lockdowns drastically slowed business. This creates significant problems with the needed goods making it into ports.
When the items did finally arrive, trucking them across the United States became challenging because there were lower numbers of people with CDLs available to drive the big rigs to haul these goods. During times of worker shortage, companies raise wages to fix that, but it also brings subsequent price increases.
When you have a kitchen table that might normally sell for $200, but you have to pay workers and drivers more, the price might rise to $250 or $300 to soften the blow for a company.
How does inflation data specifically affect the real estate industry?
Inflation and Real Estate
There’s no question that strong inflation periods affect the budgets of homebuyers. The great majority of consumers will finance a home they purchase, meaning there’s a need for a down payment, then the application for a mortgage.
Let’s assume they have money for the down payment. In this case, the price of the mortgage payment will be the main influence in determining what they can and can’t afford. Unfortunately, mortgage rates seem to move in tandem with inflation rates, which causes the former to increase.
Back in November, Freddie Mac rates went up to 3.10%, which means that average buyers of a median-priced home will spend an additional $160 more on their mortgage payment. This is far from a slight increase and has a noticeable impact on your budget.
When you’re talking home sellers, the tight market can be the perfect time to net a large profit. However, this is assuming that post-sale, they’re able to find an affordable place to move if they don’t already have one in mind. When the house you bought for $150,000 is now worth $225,000, that’s great.
But if you want to sell and remain in the same area, what has inflation done for your spending power? Did you really get ahead at all in this scenario?
These are important questions you need to ask yourself.
How Long Will Inflation Last?
While inflation steadily eats away at the spending power of homebuyers, many are left wondering: Is there any end in sight?
Most areas will probably continue to see higher prices for housing until the supply chain issues are resolved. Trends in consumption are being untangled from up to 50 years in the past.
Individuals were shifting from spending on goods to instead spending on experiences. They want to go to the gym, eat out, go on a vacation. COVID-19 totally decimated those plans. Who wants to be around a lot of people during a pandemic crisis?
Mortgage rates will play a role as well. 30-year rates could rise as high as 3.7% by the end of this year. Many buyers would no longer be able to qualify for mortgages because of this. They’ll either have to take their spending down a bit or sit on the sidelines for a while until the housing market becomes less expensive.
If things shift and we begin spending more on services, that will help correct supply chain challenges. The demand for goods will be less at the current bottlenecked ports that exist, and things will have an opportunity to level out and return to some form of normalcy.
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