How Inflation Impacts the Real Estate Market: What Investors Need to Know

Inflation affects every aspect of the economy, from property prices to grocery costs, driving costs upward.The real estate market faces a unique challenge during times of inflation, especially if there’s a housing shortage. If you’re an investor, you need to understand the direct and indirect impact of inflation on the real estate market to find the right strategies to navigate these challenges. 

The Consumer Price Index has shown that rent generally matches inflation, however, property prices have historically risen faster than inflation. If you’re looking for an investment property, you can expect to pay more during inflationary periods. 

If inflationary trends are emerging, securing an investment property sooner rather than later may help you lock in lower costs before values rise further. During inflationary periods, rental prices typically rise, offering investors the opportunity to increase revenue—provided tenant affordability remains stable

This article explores the impact of inflation on the real estate market, including how it influences cash flow, financing, and property values. 

Understanding Inflation and Its Economic Effects

Inflation is the term used to describe economic situations where the cost of goods and services has increased over a specific period. As goods and services become more expensive, there’s a decrease in cash purchasing power. 

The Consumer Price Index (CPI) is used to track inflation in the United States, comparing the price consumers pay for particular goods. It’s worth noting that not all these goods will have the same percentage change. 

Inflation isn’t the only factor that can cause housing prices to rise. Supply and demand have a major influence on property costs as population growth continues to follow an upward trend. Zoning regulations and high-density developments can make it hard to access accessible housing. 

While inflation can cause concern, it doesn’t always result in economic turmoil. If consumer income keeps pace with inflation, then consumer purchasing power will remain largely unaffected. Housing prices will still rise, but they won’t reduce the competition or demand for properties as consumers are still able to afford them. 

Historical Context of Real Estate and Inflation 

The economy follows cyclical patterns of expansion and contraction. Savvy investors analyze trends to anticipate inflationary periods and adjust their strategies accordingly It’s an important caveat to remember that while inflation is measured on a national level, housing should always be considered on a regional and local level.

Specific markets may experience a more drastic price increase than others. Even when incomes rise in line with inflation, home prices typically increase at a faster rate. 

Historically, housing prices have always outpaced inflation with property values continuing to increase, even after being adjusted to account for inflation. Many investors deliberately choose real estate to protect the value of their capital, offsetting inflation. 

The Direct Impact of Inflation on Real Estate Investors

Inflation impacts your bottom line, whether it’s the value of your money at the grocery store or the cost of filling up your car. If you’re a property investor, you can expect to feel the direct impact of inflation in both positive and negative ways. Identifying warning signs for inflation can help you prepare to counteract these additional costs. 

Here are 4 ways inflation directly impacts real estate investors:

1. Property Values

Inflation contributes to rising property values due to increasing labor, material, and borrowing costs.Whether you have a mortgage or invested with up-front capital, inflation will improve the value of your investment. 

If you have a fixed-rate mortgage, you won’t pay more on your mortgage with the outstanding amount being worth less than it was previously. While there can be short-term price volatility with properties being sold at a higher price, all properties will see long-term value increases.

2. Increased Renovation and Construction Costs

The cost of everything goes up during inflation. As a real estate investor, you’ll feel the pinch if you’re refurbishing, renovating, or repairing your property. It’s important to balance the need for renovation and development with increased costs within an inflationary economy. 

Supply chain issues, labor shortages, and rising material costs may make it necessary to postpone renovation work or consider adapting your plans to make them more affordable. Research from the University of South Alabama found that the median home renovation cost $24,000 in 2023— a 60% increase from 2020, largely driven by pandemic-induced inflation.

Construction inflation is typically higher than in other sectors as it’s influenced by wage pressures, labor shortages, regulatory changes, economic conditions, and supply chain disruptions.

3. Higher Interest Rates and Financing Costs

Inflation heavily influences Federal Reserve policies, including interest rate adjustments aimed at stabilizing the economy. The Federal Reserve will usually raise interest rates in response to high inflation to encourage consumers to save and reduce their borrowing, effectively slowing down the economy to reduce the rate of inflation. It has been increasing rates since 2022 with the Federal Funds Rate increasing to 5%, causing other loan products, such as mortgages, to also increase. 

Most homeowners finance their property with a mortgage, meaning that rising interest rates can make monthly payments more expensive for variable-rate mortgage holders. It may lead to an increase in properties entering pre-foreclosure, presenting potential opportunities for wholesalers and off-market investors. 

4. Rent Increases

If you’re an investor with rental properties, inflation isn’t always a negative. Typically, inflation causes rental prices to increase, improving profits and revenue for landlords. However, it’s important to determine if your property is subjected to rent control laws or other regulations that may impact your ability to increase rental rates, including for current tenants. 

As an investor, your goal should always be to balance rent increases with what tenants can actually afford to maintain occupancy rates. HUD projects median rents to increase nearly 5% from 2024 to 2025, with low inventory in high-demand areas further driving rent growth.

The Indirect Impact of Inflation on the Real Estate Market

It’s natural to focus on the direct impact of inflation on the real estate market, but it’s also important to consider the indirect impact. While these may not actively impact your bottom line or investment value, they can negatively impact your investment strategy. It’s important to consider these as an investor during a time of inflation regardless of your property focus. 

Here are 3 ways that inflation indirectly impacts the real estate market:

1. Market Liquidity

Inflation has an indirect impact on the real estate market’s liquidity, causing an imbalance between the number of sellers and buyers. Although there are typically fewer buyers due to rising mortgage costs and interest rates, sellers can be just as cautious and may prefer a more competitive market to sell their property in.

High inflation typically results in lower consumer confidence with fewer traditional homeowners entering the market. Investor sentiment may shift, depending on asset class and regional market conditions.  Multi-family properties continue to maintain high demand, even during high inflation, but commercial properties may have lower demand when inflation is high. 

2. Changing Affordability and Tenant Behavior 

One of the most overlooked consequences of inflation on the real estate market is how it impacts tenant behavior and affordability. While you may want to raise rent in line with inflation, it’s important to consider whether it’s affordable for tenants. If income has not risen in line with inflation, increasing your rent might make it unaffordable for your current tenants and result in long-term vacancy. 

As rental prices increase, we see ‘doubling up’ within properties, resulting in multi-family and multi-generational living situations. It’s not uncommon for unmarried children to live with their parents, even when they’re employed, or for older people to live with their children. 

3. Regional Variations with Local Economies

While you might see a headline rate for inflation, it impacts every local economy differently. Real estate will always vary depending on local factors and its location. Cities are typically more resilient during times of inflation, particularly in neighborhoods that attract high earners, while rural areas can face increased pressures during inflationary periods. 

5 Strategies for Real Estate Investors During Inflationary Periods

As an investor, you’re guaranteed to see the impact of inflation at some stage in your portfolio. Stay ahead and do your research, understanding how the decisions you take today may negatively impact your portfolio during inflationary periods. There are ways to adjust and prepare your portfolio for inflationary periods. 

On a basic level, inflation is one of the reasons why diversifying your portfolio is so important as a real estate investor. Here are 5 strategies you can adopt during inflationary periods to protect your investments:

1. Investing in Real Estate for Inflation Protection

As we touched on earlier, real estate is often chosen as an inflation hedge as property values increase with inflation, along with rental costs. While a stock portfolio can rise and fall, real estate provides more stability during inflationary periods. Prioritizing real estate investment can enable you to preserve the purchasing power of your capital and build wealth.

2. Fixed-Rate Mortgages vs. Adjustable-Rate Mortgages (ARMs)

When you’re getting a mortgage for a property, you’ll usually be offered a fixed-rate or an adjustable-rate. Even if you’re choosing these outside of an inflationary period, it’s important to consider the impact of inflation on these. A fixed-rate mortgage will not change during the loan’s duration, whereas an adjustable-rate mortgage increases and decreases in line with interest rates. 

An adjustable-rate mortgage will usually start with a rate below the comparable fixed-rate mortgage to make it appear more attractive, however, the rate will rise during inflationary periods. Depending on how much interest rates rise, your mortgage payments may become unaffordable, leading to potential foreclosure. 

3. Focus on Income-Producing Properties

During inflationary periods, you want to focus on cash flow properties that generate revenue. Rental homes, multi-family units, and short-term lets, such as Airbnb, will continue to generate income. If you were considering selling a property, it may be a better solution to convert it into a rental property for the duration of the inflationary period to maintain its long-term value.

4. Diversifying Investment Portfolio

The best way to prepare for inflationary periods is to diversify your investment portfolio by investing in residential, commercial, and industrial properties. Diversification will minimize your risk during inflationary periods and give you the flexibility to adjust your strategy accordingly. 

Geographical diversification is just as important as you want to spread your portfolio across different areas to protect against localized economic challenges and downturns. Seasoned investors will typically choose to have both rural and urban properties in their portfolio to balance these risks.

5. Adjusting Capital Expenditures Planning

Planning for capital expenditure is crucial as a real estate investor, whether it’s upgrading components like your HVAC system or conducting major repairs. If inflation looks likely, investors should be ready to increase their budget to account for higher renovation and maintenance costs. 

Working with a reliable contractor long-term can help you access more competitive pricing options, giving you an affordable way to continue to maintain your property’s value, while improving tenant satisfaction.