That’s not to say that people don’t understand the basic concept of what it is, but more that they often discount its effect in the wider world and how it can dictate their investments both negatively and positively.
In its most basic form, the Oxford Dictionary defines it as “a general increase in prices and fall in the purchasing value of money”. The first part is broadly understood, but the second is not.
It’s something that bafflingly isn’t covered in most mainstream education curriculums, and finance and basic economics is rarely touched upon until university level.
In investment terms, it leaves people thinking that if they sit with £20 in their wallet for 1 year, that bank note is still worth exactly the same amount. However, if inflation (the goods that £20 buys) rises by 2% then their £20 is actually only worth £19.60 compared to when they acquired it, and they’ve lost money.
This basic principle applies across many factors of our daily lives, but can be specifically applied into property and investment strategy to ensure that our money is working for us in the best possible way.
The most basic expression of inflation in property is a rise in prices, and UK property prices have grown for 21 years of the last 25, starting in 1995.
In the 1990’s if you’d have tried to spend the same £10 you’d acquired at the beginning of the decade, you’d have lost 3% of your money by the end. If you’d have invested the same £10 in UK property, it would have been worth 21% more. The same exercise in the following decade, between 2000 and 2010, would have meant your cash would have been worth 2.8% less if you’d have kept it. If you had put your money in to property in the 2000’s it would be worth 117% more. If you kept a £10 note from 2010, it would be worth 2.9% less today, whereas your property investment would have increased by 33%.
The base line summary is that UK residential property, as an investment, has grown at least 7 times quicker than inflation in every year for the past 30. That doesn’t quite tell the whole picture, as of course we have to consider other costs of being a landlord or investor such as solicitors fees, maintenance, agent fees and so on, but it does allow us to get a clearer one.
Inflation is neither good nor bad in itself, but depends on the context. If, for example inflation increases and takes property prices and earnings with it that’s a positive, because chances are it will also bring with it higher yields and rental increases. If inflation increases but doesn’t take average wages with it, then this can cause a lag in rental demand and suppress yields.
It’s been a weird year to say the least, with Covid-19 dominating the headlines, the news cycle and our collective consciousness for what feels like an eternity now.
Not just that though, it’s also temporarily paused the economy whilst the government defines its strategy for the coming weeks and months to lift us out of these measures.
That means that we’re in uncharted waters when it comes to trying to monitor, predict and analyse not just economic activity but also inflation too.
Probably a best of both worlds scenario in that, thanks to the chancellor’s furlough measures, much of the UK isn’t expected to suddenly fall into economic hardship through unemployment, and so real earnings are expected to stay steady.
Meanwhile the demand for goods and services, and especially property, are set to increase at a time when supply can’t be expected to keep
up. That will more than likely translate into a drive in rental prices and growth whilst property price remains fairly stable. That in turn will mean that property yields, the measure of income per year, will increase quickly.
Understanding the relationship between property and inflation is important, making it easier to see where profit and growth will come from in this coming year.