What is Inflation and How Does it Affect the Cost of Rent?

What is inflation? 

Inflation reduces the purchasing power of money. At a basic level, when inflation increases, every dollar you earn loses its value. This causes the prices of goods and services to increase, as you need more dollars to account for costs.

Inflation is a macro economic pain, and it impacts everyone's ability to spend money, sometimes resulting in less overall economic growth. Additionally, there is typically a strong correlation between house prices and inflation.

Example of inflation

Consider there is an economy that has a money supply of $10 and has five identical houses in the whole economy. Each house has a price of $2.

Now let's take assume that the central bank in this example economy has decided to increase the money production by physically printing more money to increase spending around the economy. The money supply has increased to $20, and the housing prices inflate to match it, resulting in prices of $4. Now those who could afford $2 homes but not $4 homes are priced out.

This simple example illustrates that the increase in the money supply causes an increase in the price of goods, in this case the cost of real estate.

In the real world there is increased complexity to the problem, with tons of debt instruments, bank lending, and more intertwined in the story. There are also many more factors to be considered which will affect the cost of real estate.

Factors that affect the home price and rent costs 

One of the primary reasons behind the increase in house prices are increasing interest rates. Homes become more affordable to buy when the interest rates are low (not rising) - because it's cheaper to supply debt to homeowners - which historically results in increased demand for home mortgages. When interest rates rise, less homeowners can afford to buy homes.

On the other hand, there are other ways in which real estate prices will rise. If the supply of homes drops or stays the same and the demand for homes keeps increasing, then home prices also rise (classic supply and demand curves from Econ 101).

When referencing large cities, physical real estate is often more limited, which has a more pronounced effect on inflation. 

How does inflation affect rent costs? 

The economy is dynamic and nothing remains the same forever.

When inflation increases, the general prices of goods and services increases with it. This causes taxes, maintenance, and more to go up. Even though mortgages are typically fixed interest, many homeowners decide to increase their rental income to account for those other inflated costs.

When inflation is rampant, rent prices will change more dramatically. Add in the demand for single family homes, and you have what's happening in 2022 - a massive increase in rental prices across the country.

Conclusion 

If you have bought a property on a fixed-rate mortgage, you won't have to worry about increased rental prices. For the 80 million renters in the US though, be ready for your wallet to look a little thinner.

The cost of housing continues to rise and your dollar to square foot ratio will continue to shrink. By participating in shared living, however, your money will go further than a studio or 1 bedroom apartment.

Learn more about how Alcove is making things more economical for renters in our other blogs.