Inflation refers to the rise of costs of living (prices of goods and services) which causes a fall in the purchasing power of currency (as the same item can cost more money, over time). Inflation is expressed as a rate – “rate of inflation.”
Generally measured relative to a “consumer price index”, which tracks the prices of core goods and services over time. This will, in turn, track the value of earnings over time.
It is generally considered that inflation is one of the main reasons for making investments – as money itself may decrease in value over time, investing it in other assets that may be less affected by devaluation is a way to try to ensure that the value of earnings endures over time.
It is important to note that a common misconception is that inflation causes all prices to rise uniformly, which is not true. For example, during an increasing inflation rate, the prices of some commodities may rise continuously (such as food stuffs and technology consumer goods) while the prices of other commodities fluctuate (the price of fuel can rise and fall steeply, rather regularly).
Such differences in effects of inflation is why most financial experts recommend that investors do not focus on one specific type of asset, but rather try to invest in diverse assets (“build a diverse investment portfolio”) in order to minimize investment risks.
When inflation decreases purchasing power, this usually affects the cost of credit, in that interest rates tend to go up. As a consequence, buyers may be less inclined to take out a loan for real estate purchases. In turn, the real estate market reacts:
– What may be considered a natural reaction is to lower prices of real estate, so that sales do not lag. This does tend to happen in the case of smaller developers, in smaller markets, as these developers, much like the buyers, are somewhat dependent on loans.
– However, developers who operate larger businesses and have stability in the industry are less dependent on loans and can afford to not lower their prices, instead opt to wait out the “inflation bubble”.
Inflation-affected buyers/renters can also affect the real estate market.
For example, an investor may simply opt for a smaller loan instead of no loan, and therefore invest in lower-priced properties. This context will temporarily lead to more investments in Class B and Class C commercial real estate properties, instead of Class A.
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