Inflation is one of the biggest concerns for investors. This is because an increase or decrease in the inflation rates can affect different assets in different ways. As a prudent investor, it is important to understand inflation and the effects it can have on various assets. Today, we will explore inflation and talk about its effects on real estate.
What is Inflation?
Inflation is a continuous increase in the prices of services and products in an economy over a period of time. In other words, inflation is an increase in the prices of all products and services – not just a few. This increase in prices implies that for every unit of currency spent, fewer goods and/or services can be purchased. Hence, inflation leads to lowering the purchasing power of money invariably impacting the demand and supply of such goods/services. Usually, with the growth of an economy, consumers and organizations spend more money on buying goods/services. In a typical growing economy, the demand is usually more than the supply of goods. Therefore, sellers raise the prices leading to an increase in the rate of inflation.
Inflation is measured by tracking the speed with which the prices of a basket of products increase in a given period of time. In the UAE, the Federal Competitiveness and Statistics Authority (FCSA) collects around 334 different categories of services and goods, and calculates the cost of this bucket to arrive at the Consumer Price Index (CPI), also called headline inflation.
Impact of Inflation on Real Estate
In the UAE, housing and utilities have the highest weight of around 34%. In addition to it, the impact of inflation is on the purchasing power of people and also there are many ways in which inflation impacts real estate.
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Cost of Materials
Construction of a building involves a wide range of materials like steel, wood, copper, glass, concrete, etc. In an economy, if the rate of inflation is increasing, then the prices of all these materials would increase too. Further, labour will also be available at higher rates. This means that the construction company would spend more to build an apartment complex. In order to offset the additional costs, the developer increases the sale price of the house. Therefore, inflation makes new houses more expensive reducing the supply of new constructions. This invariably leads to an increase in the price of existing houses.