Inflation Analogy

How does inflation affect real estate values? Now, you may be thinking, "What exactly is inflation?"

What Is Inflation

Inflation is a general increase in prices and a fall in the purchasing value of money. Now, this can occur for a variety of reasons, but primarily it's related to the increase in production cost, meaning raw materials or wages, or an increase in demand for a fixed basket of goods and services. Now on average, historically, the average inflation rate has been roughly 2% to 3%.

One of the best ways to track this average inflation rate is by being able to track the consumer price index. The consumer price index is an index that follows a basket of goods. Essentially it looks at a basket of goods that are purchased commonly in the economy, and then tracks the average prices of those goods across the United States, over a period of time.

So, as an example, let's say that a gallon of milk last year cost $2, and this year it costs $2.20. You can reasonably say that the inflation rate from the prior year is roughly 10%. Now, this is not an exact science, so I don't want people to harp on me on whether or not this is something that indicates exactly that we experienced a 10% inflation rate, but it is a pretty good indicator of what inflation rate you have experienced.

Why is Inflation Important in Real Estate?

Why is this so important when it comes to real estate? Over the last decade, or really a little bit more than the last decade, the US government and the Fed have been pumping money into the economy, thus increasing the supply of money in the economy. Now, what happens? When there's an increase in the supply of money in the economy and a fixed number of goods, in particular, let's pertain this to real estate, there's a fixed basket of goods.

There's not an unlimited supply of real estate. There's a lot more money competing for those fixed basket of goods. So what happens? The price of those fixed basket of goods or those hard assets begin to increase over time. Over the last year, we have pumped trillions and trillions of dollars in the economy as a result of the Corona Virus pandemic. Real estate prices will increase as a result of the decisions we've made over the last few years.