Investing in real-estate is often seen as a natural protection against inflation. This is important as inflation can eat away at an investor’s return, especially when thinking about long-term investments. Why is this important, how does this work, and why should this factor into your investment decision-making?
The UK economy is undergoing intense changes, and particularly as it relates to inflation. Let’s first go over what inflation actually means. Put simply, inflation is the rise in general prices over time which reduces your purchasing power (your ability to buy things at the same price). In other words, £100 today will buy you less things than £100 ten years ago. Inflation can affect many things, including consumer goods or business services.
So when looking at an investment, investors should look at assets that can offer them higher returns over inflation. That way, you are beating the corroding effects of inflation.
The Bank of England Chief Economist Andy Haldane argues that inflation could be heading towards 4% this year. His fears are not unfounded. Consumer price inflation hit a 2 year record with a high of 2.1% in the year to May 2021, exceeding the bank’s target. Historically, according to Statista, the UK has seen an inflation rate of near 0% in 2016 (post-Brexit) and 1.9% in 2019.
So how should inflation affect your decision-making process, and if buy-to-let investing is right for you? There are three key reasons.
1) House value appreciates above inflation:
Depending on where your property is purchased, a house in the UK will typically appreciate in value between 3-5% each year, per our analysis of ONS Housing Data. This compares with an average inflation rate of 1-2% over the past few decades.
So each year, you are gaining 1-2% more return on your money over inflation. Put simply, you are “beating” the corroding effects of inflation as your house is appreciating in value.
For buy-to-let property owners, this does not yet include the benefits of constantly receiving rental income, which is the next topic.
2) Rental income tends to increase with inflation:
A landlord with short term leases can slowly increase their rent over time to keep up with inflation. An analysis by Ezytrac confirms that rental prices have increased by 2.3% across the UK against an inflation rate of 2.1% the previous year. In London in particular, rental rates have instead increased by 3.1%.
However, some expenses like management and insurance fees can also move up with inflation. But your ability to increase rental prices allows you more flexibility to better cover your costs without being negatively impacted by the effects of inflation.
3) Your mortgage depreciates in value over time:
Assuming you have a fixed rate payment, the monthly payments you will make to your mortgage provider depreciates over time. How does this work?
Let’s assume you have a mortgage that requires you to make a £500 payment each month. As we discussed earlier on the concept of inflation, £500 today is worth less than £500 in the past. Extending this reasoning further, £500 in the future must also then be worth less than £500 today. So an investor with a long-term fixed rate mortgage will benefit from their debt depreciating over time as inflation increases.
So, is buy-to-let a safeguard against inflation?
As shown, buy-to-let properties can offer great benefits against inflation when an investor considers the impacts on housing prices, rising rental yield, and the depreciation of an investor’s mortgage. This is especially important under our current environment when forward inflation is expected to increase over time, and investors need to look for asset classes that offer them protection against the corroding effects of inflation.
Although buy-to-let properties may offer benefits against inflation, make sure to consider other variables such as property location, rental yield, management fees, among others before making the decision whether buy-to-let investing is right for you.