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IS REAL ESTATE SAFE FROM INFLATION?

The fear of a sharp rise in inflation is particularly pronounced in Germany. Above all, this has a historical background. Almost 100 years ago there was an inflation that included inflation rates of 50 and more percent per week. The desire for an inflation-proof investment is therefore latent. In this context, the home, land or real estate are repeatedly brought into play as inflation-proof investments.

WHAT IS INFLATION AND DEFLATION?

In economics, a distinction is made between the terms inflation and deflation. They denote the opposite of each other. The term inflation is the more common or more commonly used of the two.

The word inflation comes from Latin. It literally means “bloating” or “puffing up” or “swelling”. In economics, it denotes the increase in the amount of money in circulation. More precisely defined: Inflation always occurs when the amount of money increases faster than the sum of all services and goods produced. This is accompanied by an increase in prices. In other words, money is losing value, while products and services become more expensive.

Correspondingly, deflation denotes a phase in which the amount of money is reduced. The services and products are becoming cheaper. Accordingly, one speaks of a drop in prices. However, debts still exist at their (face) value. This makes them more expensive in comparison.

Created with Highcharts 9.0.1Change compared to the previous year in percentChart context menuINFLATION RATE IN GERMANY FROM 2005 TO 2016Source: Federal Statistical Office (2017)Inflationsrate2005200620072008200920102011201220132014201520160123Highcharts.com2015 Inflationsrate: 0.3

HOW DOES INFLATION OR DEFLATION AFFECT TANGIBLE ASSETS SUCH AS REAL ESTATE?

In order to be able to assess whether real estate or homes are suitable for protecting against inflation, one needs to know how inflation and deflation affect real estate. With inflation, real estate, like other products, rises in price while money loses its value. It is also said that real estate compensates for currency depreciation, as it increases in price. This difference becomes even more striking when you have financed real estate. As the face value of the debt remains the same and the real value of the debt decreases due to the inflation, the value of the property increases. In this respect, there is initially a double positive effect.

In the case of deflation, the opposite is true. While money gains in value, products and services, and with them real estate as a product, lose value. Deflation is having an even more serious impact on financed real estate. Here not only does the value of the property decrease, but the loan, which can be measured in money, becomes more expensive.

HOW INFLATION-PROOF IS REAL ESTATE?

When assessing how inflation-proof real estate or homes are, a distinction must first be made between owner-occupied homes and real estate as an investment, i.e. real estate rented out to third parties , since the effects are also of different nature.

In the case of owner-occupied property, there seems to be a certain degree of security against the effects of inflation. Since the owner on the one hand hardly has any costs that rise in the course of inflation (ancillary and operating costs, if necessary), there is an increase in the value of his property on the other. If the property is financed, there could be a double positive effect (see above). However, these conclusions are theoretical. It is very likely that there will be intervention by the state in the event of (extreme) inflation. It is conceivable that there will be a kind of compulsory mortgage or special tax on property so that property owners will be the winners of inflation. This “gain” contrasts with the state's interest in social equality.

The situation is far different for properties that are not used themselves but are rented out. In the event of inflation, the value of the property increases but so does the costs. These are much larger and less manageable for rented properties than for owner-occupied properties. On the other hand, the value of the money that the landlord receives in compensation and as “profit” from the rent and operating cost payments made by the tenants decreases. This means that there is a gap between the expenses and the income of the property rented out by someone else in the event of inflation. The landlord can only try to close this hole by paying the rent, the ancillary and operating costselevated. Rent increases are not possible at all locations or are limited in amount. The landlord also runs the risk of losing tenants due to the increase. In addition, the above also applies here to the possible regulatory measures by the state for building owners in the event of (high) inflation.

However, the individual case must always be taken into account when evaluating . Newer properties are better at protecting against inflation than those in need of renovation. There are also regional differences. If a property is about to be renovated, its inflation security is reversed. Renovation has become significantly more expensive as a service with inflation. Older properties are therefore not considered inflation-proof without restriction. There can also be significant regional differences in this regard.

Created with Highcharts 9.0.1In ProzentChart context menuINFLATION RATE IN SELECTED WORLD REGIONS IN 2016 (COMPARED TO THE PREVIOUS YEAR)Source: IMF - International Monetary Fund, Oktober 2017Inflation rate compared to previous yearIndustriestaatenEuro-ZoneEUSchwellen- undEntwicklungsländerSchwellen- undEntwicklungsländerAsienLateinamerika /KaribikMittlerer Osten undNordafrikaAfrika Sub-Sahara010515Highcharts.com

DOES IT MAKE SENSE TO INVEST IN YOUR OWN HOME?

There can be no clear answer to this question. First of all, investing in a home to protect against inflation makes sense, especially if it is used by yourself and is in good condition. Then, in the event of inflation, the costs remain relatively low while the value of the property increases. The situation is different if the property is rented and / or in need of renovation. In this case, inflation increases the costs, while compensation through external income such as rent is difficult to achieve. In both cases, the behavior of the state is questionable.

WHY DOESN'T INVESTING IN A HOME NECESSARILY OFFER INFLATION PROTECTION?

Especially because you cannot make this statement across the board. First of all, a differentiation must always be made according to the use and condition of the property and sometimes also according to the location.

For a property, especially a rented one, inflation also increases the costs and these are difficult to compensate with income. This differentiation is particularly noticeable when the building has to be renovated. The high costs are no longer offset by the increase in value.

Conclusion:

The blanket statement that real estate is an inflation-proof investment is incorrect. When evaluating this question, one always has to distinguish between owner-occupied and rented property as well as the location and condition of the property. Basically, the value of a property increases with inflation. But so are the maintenance costs. Especially with rented properties, it is difficult to compensate for this with rents or ancillary and operating cost payments from tenants. Older properties usually cause more costs than newer ones.

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