Effect of rising inflation on Real Estate

My own recipe for world peace is a bit of land for everyone - Gladys Taber

Inflation is the prime concern of one-and-all right now, the sky touching prices of onion on one hand and future of property prices on the other. 

People feel that during any inflation, there is a price increase for all real assets such as commodities, plants and machinery as well as real estate. Whereas the opposite holds true for financial assets such as stocks and bonds. Even the explanation on correlation between inflation and real estate prices in http://www.investopedia.com/ask/answers/correlation-inflation-houses.asp states that inflation causes real estate prices to increase. Well the above statement is false as far as effect of inflation on real estate prices is concerned.

The reasoning that goes behind saying that real estate prices should rise during inflation is simple: the cost of construction material rises leading to rise in construction cost and increased money supply (cause for inflation) leading to rise in demands for house in the market.

Let us look at the reasoning for falsifying the above statement and claiming that real estate prices fall during inflation. The immediate effect of inflation in the market is on credits. Due to inflation, interest rates rise. And how do increased interest rates affect the house prices?

Housing is almost entirely driven by credits. Imagine what the situation would be when credit is completely eliminated from the market and people have to pay through cash for their house purchase. Housing prices would drop drastically. Banks that lends money, on seeing the inflation rate rise, will naturally react by increasing the interest rate on the credit outflows. Due to this increased interest rates, buyers will have to shell out more in form of EMIs. Whereas their salaries do not rise by the same amount. As a result, they tend to curtail borrowing. Real estate companies want banks to lend money at cheaper rates to be able to sell their properties. When this does not happen, real estate companies are forced to lower their prices. They cannot increase the prices of their properties at the same pace as inflation, because if they do, there won’t be buyers for their properties.

And you know who is the king at these times of high inflation, a person who has cash. This is the time of distressed sale when sellers want to sell their property due to personal needs and banks are not ready to provide easy mortgage. Then someone who has cash available with him tends to benefit the most. So, as inflation rises and property prices fall the next time, ensure that you sell the commodities that you own and buy real estate at reduced prices. Happy Investing!