- August 2, 2006 at 3:21 pm #52074
I do not know whether this article interests somebody, but it is about inflation and the effect that it has on the value of all our property investments:
Why inflation is a good defensive investment for property owners: with particular reference to the Costa del Sol.
You can’t open a financial newspaper without being confronted with the word ‘Inflation’; it is the talk of the day and it is responsible for rising interest rates which make our mortgages more expensive to repay.
There is an important distinction between the causes and the consequences of inflation. Rising prices for goods and services are the consequences of inflation not the cause. The cause of inflation is monetary policy mainly in the form of credit expansion. The money supply statistics can be found in the Economist (May 2006 issue) and show that for example Denmark now has 12.8% more money in circulation than in 2005. Since all this money needs to go somewhere it is no surprise that the Danish economy is booming and Denmark tops of the European house price index. There is a direct correlation between a country’s money supply, its economic growth and its real estate prices. Governments want to avoid inflation as it has a direct impact on wages, which in turn impacts on the export industry of a country making it more vulnerable to the stiff price competition from the Eastern European countries, the Far East and Latin America. Hence raising interest rates are one of the common strategies of controlling this problem, but this action invariably hurts the consumer.
Presently interest rates are low throughout Europe, but this situation actually represents a double edged sword for the consumer as there is an increasing tendency to borrow more than perhaps would have happened if interest rates were higher. Importantly for home owners with mortgages linked to the Euribor, a repayment rate rise from 3% to 4% is actually an increase of 33% in the amount repaid monthly.
In periods of rising interest rates the large money lenders become more defensive in their lending policy, therefore, fewer people qualify for a new mortgage and some people will fall behind with their repayments to the bank. Potential home owners are put under extra pressure because they can not qualify as easily for finance and if they do they face an increasing proportion of their wage going towards their monthly mortgage repayment (if they choose to have a variable rate or interest only mortgage) .
This scenario can lead to a small chain reaction: as less people buy, prices stagnate, the real estate industry slows, fewer new projects are started (leading to job losses within that industry sector), increasing numbers of marginal buyers find it harder and harder to make their mortgage payments, increasing numbers of people default on payment and eventually have their houses repossessed. This exacerbates the negative trend on consumer spending levels that rising interest rates have, lower spending levels also denotes reduced confidence as people become more conservative in their spending habits and try and save a little more. In the worst case this can lead to a full blown recession in the economy, at best it slows any form of high risk speculative investment (i.e. new build off plan property investment).
There are some benefits for the homeowner or landlord during periods of rising inflation and interest rates: as fewer people will be able to buy (given the fact that everybody needs a home) the number of people renting will increase and so will rental yields. Rising inflation will eventually make new build property prohibitively expensive. This will affect the supply of additional housing which in turn will eventually lead to a further increase in the price of property. This is good news for markets that are currently facing oversupply (Costa del Sol being one of them), as availability should start to decrease by the end of 2007.
Historically real estate has proven to be the best investment in the beginning of an inflationary period. If you are a home-owner and you can afford your repayments your property will remain a sound long term investment and a good defensive investment strategy for protecting the purchasing power of your capital, as house prices tend to rise in accordance with inflation.
What is the impact of rising inflation and interest rates on the Costa del Sol and is it still a good investment?
We feel that the demand for property investment and holiday homes along the Costa del Sol will continue for the long term as the area has sound infrastructure, interesting culture, good weather and is in close proximity to and easily accessible from northern Europe.
We also feel that many people will be lured back to the Costa del Sol because of this.
So is it a good idea to buy a property on the Costa del Sol? Yes, as long as you stay away from ‘generic’ properties such as two bedrooms, two bathrooms apartments: this market sector is most affected by oversupply and most of these properties lack every minimum of both creativity and quality. A much safer long term investment is townhouses, since a lot of people who now live in apartments will want to upgrade. We feel there will be a growing opportunity along the Costa del Sol and we are starting to see re-sale at prices that are 20% cheaper than they were two years ago, good rates for holiday rentals are still easily achievable.
This is the focus of our own property section on our site, as we feel it is the market segment that will increase in value the most over the mid to long term.
In summary here are three reasons why inflation is good for property owners on the Costa del Sol:
As fewer people are able to qualify for a mortgage because of the higher interest rates, rental demand and rental yields will dramatically improve.
As inflation filters through in wages and material cost, new build property will become too expensive to be economically viable which in turn will divert home purchasers to existing homes.
In times of insecurity and rising inflation, people tend to look for defensive investments that will preserve the purchasing value of their money. Historically real estate is a sound defensive investment as house prices tend to rise in line with inflation
- August 2, 2006 at 3:54 pm #64333
As inflation rises interest rates generally rise, cancelling out any nominal gain in price. You should distinguish between wage inflation and inflation in the price of goods, because rents are based on incomes inflation (wage growth) not general inflation. Many economists argue that we will face a prolonged period of deflation in the coming decades due to the impact of cheap globalised labour (the average industrial wage in China is 0.75c an hour). If I was thinking of investing in foreign property I’d be looking at markets that will see real incomes growth (India, China etc.) By the way
Equities (shares) have always outperformed property as an investment and are good hedge against inflation.
I think keeping your powder dry in the present uncertain economic and political environment would be worth considering. 😕
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