Inflation affects different prices of goods and services differently. But while this may be true for many goods, real estate behaves rather differently when there is an inflationary environment. One may have noticed that during a period of inflation most of the time real estate prices tend to be static and in a few cases they have also been known to drop. This happens because inflation is driven by cost of credit. During a high inflation period people stop taking loans as their ability to pay back decrease thus directly affecting the home loan market as well which results in discounts and price reductions. If this affect prevails for longer then we see that prices stop dipping and remain static.
There are several factors which will affect the builders’ decisions to reduce prices or keep them static such as – size of builder, investment, health of capitalization , stage of the project, location of project and cost of credit. Inflation does increase the price of goods needed for construction thus increasing the cost of construction. Material and labour costs rise and new construction slows down. This reduces the supply of new homes and existing home may have the added advantage of seeing an increase in price on the condition that the interest rates stay the same. There is a difference in the way smaller and larger builders react to the inflationary environment. Small players are also dependent on borrowings from banks and lenders and hence in order to service their own borrowings they need an inflow of money. This pushes them to lower prices fast in order to ensure that they keep selling. Larger players who are primarily focussed in big cities and have more experience in real estate business cannot react as quickly on prices as their investments are higher. If they have a healthier capitalization they can weather the storm hence they may not reduce prices. But these builders will also be forced to keep prices static and won’t be able to increase them.
Even existing home owners are affected by this because their personal wealth valuations will come down once inflation is factored into their property prices. If in a 5 year period there has been a 11% increase in house prices in your area and there has been a 17% in your inflation rate then actual average current price of the house has reduced. This doesn’t allow for redevelopment options or refinancing options thus reducing the chances of positive activity in the real estate market
The combination of falling or static prices and rising inflation is toxic for economic growth in the sector. If the trend continues over the long term then real estate market will erode and so will wealth determined from property investments.