House prices tend to rise with inflation, so with the UK annual inflation hitting 4.2% last week, that’s good news, isn’t it? Yes and no – let me explain what it means for Heatons homeowners.
The year-on-year cost of living rose by 4.2% in October, its highest rate in almost a decade. The jump in prices (inflation), pushed mainly by increasing fuel and energy costs, places further pressure on Heatons household budgets.
So, what will this rise in inflation mean to Heatons house prices?
Let me look at the downsides first. The first is the effect inflation has on the true spending power or value of your hard-earned money.
The mid-1970s to mid-1980s was a time of high inflation in the UK, so I think that is an excellent place to start.
The average house in the Heatons in 1974 was worth £15,126, and by 1984 it had risen to £44,651
So, Heatons property prices had risen by 195.2% in the decade 1974 to 1984.
Good news for everyone, then? Well, as always, the devil is in the detail.
Inflation over the same decade rose by 224.2%, meaning your Heatons house was worthless in real terms (i.e. spending power terms).
If that same Heatons home had gone up by the inflation rate seen between 1974 and 1984, the house would have been worth £49,043 in 1984
That doesn’t sound a lot (the difference between £44,651 and £49,043), until you apply that difference to today’s prices; that’s a loss of £33,231 in today’s money.
The second is the effect of interest rates.
When inflation rises, the usual weapon of choice to reduce inflation is to increase interest rates. Homebuyers tend not to borrow as much on their mortgage when borrowing money becomes more expensive due to higher interest rates.
When interest rates get high (they were over 15% in 1992) Heatons homebuyers may not even want to borrow any money at all (staying put in their existing home). This would mean fewer home buyers wanting to buy (decreased demand). However, at the same time, more Heatons houses would be coming onto the market (because existing Heatons homeowners would want to sell and downsize because they have high mortgage payments), meaning higher supply … low demand and high supply does drive house prices in a downward direction.
So, does that mean you should hold off buying a Heatons home?
Although Heatons house prices did not keep up fully with inflation in the late 1970s and early 1980s, they did a pretty good job (and much better than keeping money in a savings account). You must remember your house is not a pure investment, it’s a place you and your family live in. It’s a place you call home. So don’t worry if it doesn’t keep up with inflation in the medium term as your four walls offer a lot more than just a simple investment.
Ok, so let’s look at what does happen when inflation effects property.
When your Heatons house price rises because of inflation, it increases the value of your house, not by the cost/value of your deposit. So, if inflation increases the value of your Heatons home by, say half (50%), it may triple, quadruple, or even quintuple the value of your deposit/equity.
For example, if you buy a Heatons property for £500,000 with a £50,000 deposit and inflation increases the price/value by 50% to £750,000, that means your equity in the property quintuples from £50,000 to £300,000. It also means you go from (in this scenario) owning 10% equity (£50k of £500k) in your home to 40% after inflation (£300k of £750k).
Even better if you take out a fixed-rate mortgage because you would be making a fixed monthly mortgage payment that dropped in real spending power ‘inflation adjusted’ pounds over the time of the fixed rate. You might ask why? Well, you are paying less for the mortgage than you did when you took it out (i.e. inflation erodes the actual value of money, meaning your mortgage debt diminishes in real value terms in line with inflation).
So, holding off moving home could cost you a lot of money.
What does this all mean for existing Heatons homeowners?
It’s challenging to forecast with any certainty what will happen with UK inflation and interest rates. I believe we will see inflation hover between 3% and 5% in 2022, with it returning to more normal levels of around 2% in 2023 (although I am no economist!).
We know the Bank of England base rate is just 0.1%, meaning it’s unlikely to get any lower. I have spoken about this in previous articles on the Heatons property market and said the money markets have already priced in an interest rate rise to 0.75% to 1% by the summer of 2022.
So, if you haven’t already, you need to seriously consider taking advantage of these low mortgage rates (can you believe 21% of Heatons homeowners aren’t on a fixed-rate mortgage). The bottom line is, irrespective of what is happening to inflation and local house prices, being able to afford the monthly payments on your Heatons home is what counts for everyone.
Next, if you are worried about the spending power of the equity tied up in your Heatons home, you will have built up a decent buffer if you have been in your house, for example…
The average value of a Heatons house has risen by 22.8% in the last five years, yet inflation has only been 11.3%
This means the equity in ‘real spending power terms’ has increased by 11.5% in the last five years.
One final thought for any Heatons homeowners thinking of selling and not buying another home, inflation could eat into the real spending power terms of your equity in your Heatons home – so now might be the best time to sell your home to get maximum bang for your bucks. Then invest the money in other pure investments that consistently tend to beat inflation, such as gold, commodities, or Real Estate Investment Trusts? Again, I am giving you my opinion here, not financial advice. You must take independent advice from someone qualified in these matters and make your own decisions.