People tend to overpay for property in a hot market for emotional reasons. Although it is sometimes worthwhile, it is now more vital than ever to avoid overpaying for real estate. Inflation is a threat in the aftermath of the COVID-19 pandemic. Costs are rising across many sectors as economies recover from a severe economic disruption. Because real estate is rarely a short-term investment, understanding the cash flow and subsequent rate of return is crucial to attaining the goal of making profitable investments.
What Is An Inflation Hedge?
An inflation hedge involves investing in an asset that is predicted to sustain or increase in value during an inflationary period. Rent and property values tend to rise with inflation, hence real estate has long been thought to be a good inflation hedge. Real estate and farms have been shown to be excellent inflation hedges in the past.
Cumulative change in inflation and the new housing price index. (Statista, Statistics Canada)
This chart compares inflation to the new housing price index from 2000 to 2020. The change in cumulative inflation was 39 percent, compared to a change and increase in the new house price index of 51.8 percent. According to the data, the new price housing index outperformed inflation, demonstrating that real estate can be used as an inflation hedge.
As your home price increases over time, it lowers the loan-to-value of any mortgage debt, acting as a discount. Therefore, the equity on your property increases, but your fixed-rate mortgage payments remain the same.
Why You Shouldn’t Overpay
As Will Rogers once said, “Don’t wait to buy real estate. Buy real estate and wait.” It is important to define and stick to a timeline when purchasing real estate to determine if it is worth it to overpay. Overtime, inflation will correct any mistakes made. Easily substituted suburban properties are likely to depreciate in value when held onto for a short period of time. New properties have initial depreciation where the value of the building decreases further than the value of the land increases. The property value will decline until there is more establishment in the area and inflation occurs. So, if you overpay for a property today and you hold onto it for 25 years, you are likely to get a great return on investment.
Overpaying is a broad term and could have different meanings to different people. The most important thing is that you know what is worth overpaying for. If you’re holding onto a property for a short period of time but you know you will highly enjoy it’s assets, it might be worth it to overpay.
A good real estate agent will more often than not tell you to not buy a property. Good real estate agents are most concerned with completing a successful transaction where the client makes the right move for them.