Is real estate a good inflation hedge?

UK inflation as measured by the Consumer Prices Index has hit 3.2% this year, the highest since March 2012. What's more, it's forecast to reach as much as 5% in the next 18 months.

In this article, we’ll explore the effects on inflation on the UK property market, and whether UK residential property is a good investment in a high-inflation environment.

Real estate inflation 2021: what you need to know

Like practically every other aspect of our lives since March 2020, the economy has been anything but normal of late. At present, we’re witnessing an inflation spike that can be attributed to the impact of Covid-19 on the economy - or more specifically, our lightning-fast return to normality following eighteen months of lockdowns and uncertainty.

Many of us are back in the office. Travel is beginning to open up at levels unseen since before the first lockdown, and the hospitality sector is in full swing once again. However, quantitative easing measures to counteract debts incurred during the shutdown of the economy mean that inflation - an increase in the cost of goods and services - is causing the prices of everything from our weekly grocery shop to concert tickets to increase.

But is there a way to beat inflation or perhaps even benefit from it? Over the years, investors have considered certain assets as some of the best investments for inflation. These include premium bonds, precious metals and - yes, you guessed it - real estate.

Does real estate do well in inflation?

Property investment is a good hedge against inflation for a variety of reasons. Firstly, inflation has a positive effect on debt. House prices generally rise over time, and inflation causes them to leap more quickly than usual. This ultimately lowers the loan-to-value of any outstanding mortgage debts and acts as a natural discount of sorts. While fixed-rate mortgage payments remain the same, the equity on the property actually increases. In real terms, this means your property is worth significantly more than what you originally agreed to pay for it by the time your mortgage is repaid.

What happens to property during inflation?

If you’re a buy-to-let investor, inflation can help improve your rental income. As a general rule, rental yields generally rise in tandem with property prices. If you’re in a position to increase rental charges while keeping your fixed-rate mortgage the same, this creates an opportunity for higher rental yields.

Real estate is a good hedge against the effects of inflation because property values tend to appreciate over time. In times of economic uncertainty, property values are generally resilient, too. Take the 2008 global financial crisis as an example: while the property bubble may have burst, prices returned to pre-recession levels in less than a decade. As a source of recurring rental income, and as a means of keeping pace with or even exceeding inflation, property investment is easily one of the best ways to hedge.

What does inflation do to property prices?

Property prices generally increase during periods of inflation, often eclipsing the overall rate of inflation. For example, house prices increased by 11 percent between August 2020 and August 2021, while the actual consumer price inflation rate currently sits at 4 percent. Real estate has traditionally been considered as an inflation hedge by investors, both directly (outright purchase) or indirectly (as part of a hedge fund). If you’re purchasing a property with financing, the best way to benefit from real estate inflation in 2021 is to lock in a fixed-rate, low-interest mortgage to allow you to witness the appreciation of your assets as much as possible.

Real estate inflation 2021: will my ability to sell a property be impacted?

Because inflation affects the price of all goods and services, many would-be first-time buyers can find it difficult to save enough for a deposit during these periods. With many potential buyers being priced out of the market, it can be difficult to sell property during times of inflation.

On average, first-time buyers are expected to raise a deposit of 20 percent of a property’s value before lenders will consider financing a mortgage. However, the impact of inflation over the past year means that a 20 percent deposit equates to 113 percent of the average homebuyers’ typical wage. In real terms, this means that almost £23,000 has been added to the cost of the average home in just twelve months, with average house prices now sitting at almost £248,750.

However, an inability for many would-be homeowners to raise capital to fund property purchases means that the rental market remains healthy. At the same time, inflation generally drives up the cost of rent. The trade-off here is that while you might find it more difficult to sell tangible assets, you’ll be able to enjoy an improvement rental yield.

Conclusion

Tangible assets like property are some of the best investments for inflation, particularly if your portfolio is put to use in the rental sector. Whether you’re experienced in property investment or considering becoming a buy-to-let landlord for the first time, real estate inflation in 2021 could provide you with an opportunity to enjoy a rapid increase in property prices while you concurrently benefit from higher rental yields.

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