In inflation, your money loses its previous purchasing power and loses value. This happens when money is put into circulation in increased quantities, as was the case, for example, during the 2008 financial crisis and is now being repeated during the Corona crisis. The central banks print new money, which ultimately results in the previously existing money having less value, regardless of its form (cash or bank deposits).
Inflation therefore mainly affects monetary assets. But what about tangible assets?
First of all, we have to state that not all tangible assets are the same. In our article Shares vs. real estatewe have already dealt with the topic of asset inflation in real estate. Both shares and real estate represent tangible assets. In principle, shares offer protection against inflation, but since the stock market is subject to very strong fluctuations, investing in securities is a more speculative matter.
A property can compensate for a rising inflation rate by increasing rental income in parallel, so that security-loving capital investors could rather concentrate on yield properties. This is how you make yourself independent of inflation.
In the long run, real estate investors enjoy a significant increase in value. But how can it be that some assets increase in value and others lose?
The secret is not in the seasoning, but in the scarcity of a good. Scarce goods are goods whose resources are limited. These include gold, oil, real estate, etc.
Scarce goods become more expensive with inflation
Resources cannot be exhausted and multiplied indefinitely, so that a higher price can be obtained as a result than for free goods, which are available indefinitely. An increasing amount of money is distributed over the same amount of goods as before the increase in the money supply. The consequence: rising values of goods such as real estate and shares .
Coronavirus and real estate
The corona virus has plunged the whole world into a crisis at the beginning of 2020. Those who have invested in monetary assets must now tremble or may already have suffered a major loss.
For real estate owners, the situation looks much more relaxed. Certainly, individual emergency sales have caused the price level to drop in the short term. But only a few months after the outbreak of the pandemic, there was again a very high demand for investment properties on the real estate market; the price level in A-locations has remained completely unchanged or has even risen compared to the pre-crisis level. Although the following presentation ends in December 2020, the trend has continued unabated with prices rising further since then:
Real estate and inflation: purchase prices and rents increasingly decoupling, change in percent. (Status: August 2021).
And in the medium to long term, a recovery of the real estate market and thus an increase in the price level can be expected.
Real estate debt and inflation
Debt is bad. Many of us have grown up with this "knowledge". However, one has to distinguish between good and bad debt here, especially when it comes to real estate.
Buying an income property, for example, only makes sense if you use leverage. In practice, this means that you take out a bank loan in order to finance your Acquire a property. However, the monthly loan instalments are not paid by you, but (indirectly) by your tenants.
Now the question is how real estate loans behave during inflation. Basically, during inflation, prices rise and so does the interest on your loan. If you have concluded a good financing contract, a long fixed interest rate applies and you initially have nothing to worry about (e.g. 10, 15 or even 30 years). But when this fixed interest rate expires, the interest rates could rise sharply and your loan will become more expensive.
However, as already mentioned, prices are also rising. This means that you can also charge a higher rent for your property. So in this scenario, the tenant would cover the additional costs of your loan through the increased rent.
Moreover - and therein lies the great advantage of leveraged real estate during inflation - you can now pay off the loan much more easily, because the loan amount does not change, while the achievable rent is now significantly higher. This means that the loan can be repaid in a much shorter period of time, e.g. with unscheduled repayments.
Investment recommendation for real estate to protect against inflation
Whether real estate offers protection against inflation depends very much on how you use the property.
Many Germans want to fulfil their dream of owning their own home. They buy a property, live in it and eventually bequeath the house or flat to their children. During inflation, however, this scenario develops negatively, because both the interest on the loan and the maintenance costs rise. So the owner has to pay more.
When you Real estate as an investment the whole situation is different. As described above, rents also increase, so you don't have to fear inflation.
Only income property offers you this security. No other investment option is likely to protect you so well against inflation and at the same time build up wealth - Cash flow real estate thanks to. The cash in your safe is losing more and more of its purchasing power, stock markets are crashing or moving sideways and speculative objects such as art or cars represent a high risk even without inflation.
Deflation Effects Real Estate
Supply and demand determine the price of a good (the principle of the free market economy). If supply is greater than demand, prices fall. This is called deflation. Deflation therefore also affects real estate, as its value decreases. If many properties are offered but only a few are in demand, prices fall. In addition, the price level for rents, salaries and goods falls.
However, the loan taken out must be paid off at the old conditions, which can be a particular challenge for homeowners and is not always possible. Thus, not a favourable scenario for income-producing real estate.
However, states and central banks want to avoid a deflationary situation. Avoid at all costs. Japan can be cited as an example: In order to fight deflation since 1990 (triggered by the bursting of a financial bubble), the Japanese central bank is countering with massive money printing orgies. The goal is an inflation rate of 2%.
Should a similar crisis affect Germany, the measures would look very similar. As the owner of a Investment property a good starting position. More on this in the next paragraph.
Test now: Does real estate as an investment suit you?
Japan Deflation Real Estate
How far do prices fall in deflation? We can answer this question using Japan as an example.
Japan has been struggling with deflation since the 1990s. When the financial bubble burst, prices plummeted. The Japanese stock index Nikkei collapsed, the real estate loans could no longer be repaid and many banks had to file for insolvency. The labour market was also affected and unemployment rose enormously.
The Japanese government has tried to revive the economy by taking on new government debt - but without success.
The stock index fell from around 40,000 to 16,000 points and many properties were suddenly only worth half their original purchase price. Thanks to the measures taken by the central bank, however, the deflationary tendencies were kept in check - real estate is currently rising significantly in value again and is no longer so far away from the values of 1990.
Inflation money: When today's money is worth nothing tomorrow.
Inflation 1923 Real estate
Germany experienced exactly the opposite in 1923 - namely hyperinflation. In hyperinflation, the price level rises extremely quickly, by at least 50% per month (that would be a whole 13,000% per year!). At that time, people transported their money in wheelbarrows or travelling bags and tried to exchange it for goods as quickly as possible, because money was losing value day by day.
While an egg still cost 7 pfennigs in 1912, the value of an egg rose to 2.1 million paper marks in September 1923, to 227 million in October and finally to 320 billion in November. As a result, the government decided on a currency reform in the same month, whereby all assets, but also debts, became worthless from one day to the next.
Anyone who owns an investment property at such a moment is completely protected from the devastating effects of hyperinflation.
Hyperinflation in Germany: hundreds became trillions.
Conclusion and outlook
The Corona crisis is currently raising the question of whether we can now expect renewed inflation. Or do we have to fear deflation?
Experts expect the inflation rate to continue to fall in the second half of 2020. In the long term, however, the effects of the crisis cannot be determined. However, it is assumed that the global economy will recover and the inflation rate will settle back at a normal level. But the danger of stronger inflation due to the global money-printing orgies of the central banks is also a not unlikely possibility. Especially since the measures have to be stepped up more and more in order to be able to service the debts of indebted states, companies and households. Stronger inflation of several percentage points would therefore not be an improbable scenario - against which investors in investment properties are protected.