What is inflation and how does it affect real estate investments?

What is inflation and how does it affect real estate investments?

If you are a regular reader of our blog, you will have noticed that we constantly mention that  Blue World City is one of the best investment options to protect your capital from inflation.

Given the circumstances of the current economy – after the months of crisis due to the COVID 19 pandemic – many investors have focused most of their efforts on diversifying their capital in real estate, as many financial markets were affected by the global crisis.

Unlike other assets that depreciate and suffer the consequences of rising inflation in the country, the real estate sector is one of the assets that performs best with the increase in prices.

In this article we will talk about what inflation is, its characteristics, causes and why protecting your capital by acquiring real estate is the best option to safeguard your future.

What is inflation?

The word inflation comes from the Latin ¨inflation¨ which translates as inflate, taking this as a basis we can define inflation as the generalized and sustained increase in the prices of products and services in a given period of time.

This increase in prices causes the value of money to decrease, so that compared to what could be bought in the past with a certain amount of money, this is insufficient for a later period.

It is common to hear from our grandparents that with a certain amount of money they could buy a large amount of goods, which today is not enough for almost anything. For this reason, we are known as the generation that could not acquire cheap land, however, all is not lost.

Although land prices are not the same as in the past, they are still an accessible form of investment that offers many advantages, including preserving the value of the money invested without being affected by inflation in the economy.

How is inflation measured?

Inflation is measured by the Consumer Price Index (CPI), which has an impact on all the concepts that are measured based on this indicator, for example: wages, pensions, lease contracts, among others.

Like the CPI, other indicators are used, such as the Wholesale Price Index (WPI) and the Implicit Deflator of GDP (DIPIB), however, the CPI is the most used because it uses variations taken from essential products.

So, what is the CPI? It could be defined as the index that measures the variation in the basic products and services of a family during a certain period of time, as is the case of the basic food basket.

Its formula is:

Inflation Rate CPI = (current CPI – historical CPI) / current CPI * 100

It should be taken into account that it is the most used indicator in the world, because it is carried out on a monthly basis and excludes volatile price variables, therefore, it does not include perishable food or energy products.

The IPM, as its acronym indicates, measures the variation in wholesale prices. It is mostly used to measure the productivity and competitiveness of countries in fiscal matters.

Its formula is:

Inflation rate MPI = (current MPI – historical MPI) / current MPI * 100

The DIPIB refers to the market price value of the products generated by a country, this includes the increases and decreases that occurred in a set period of time.

Its formula is:

DIPIB inflation rate = nominal DIPIB / real GDP * 100

To make accurate investments that protect your money from inflation, you must know in detail how it works and what its causes are. In the same way, you might be interested in reading more about financial topics such as: What is the financial bubble and how does it affect investments?

Inflation characteristics

Knowing well the characteristics of inflation will allow you to identify it and create financial strategies to make movements that protect your money from rising prices.

Some of the most important features are:

  • It must be a sustained increase in prices, that is, if prices rise only once, it is not considered as inflation.
  • In the same way, it must be a generalized increase in prices in goods and services for it to be considered as such.
  • Another characteristic is the demand for products and services for the amount of money that is in circulation.
  • The rise in production costs, as a consequence of the increase in the price of raw materials.
  • The increase in taxes, which denotes problems in the economy.

Types of inflation

Now, inflation can be divided into several types that we can include in:

  • Consumer inflation: This occurs when demand grows faster than supply, which causes the productive sector to be unable to adapt, and consequently prices rise.
  • Cost inflation: This is caused by the increase in the price of raw materials, which causes it to be necessary to raise the price of products if you want to maintain a profit margin.

Another way to classify the types of inflation is:

According to the behavior of the price increase

Among the many factors that can cause an increase in prices are the fall of the GDP (Gross Domestic Product) or the intervention of the state.

What does this mean? Because GDP is the income that the country receives from the products it produces, if this decrease, the state is forced to intervene and among the measures they take to solve the problem is the printing of more money.

As a result, three types of inflation can be generated:

  • Stagflation: The term stagflation results from the combination of stagflation (stagnation) and inflation (inflation). It consists of the increase in prices together with the decrease in GDP during a period of 6 uninterrupted months.
  • Reflation: It is generated by the state in order to stimulate the economy and avoid stagflation. It is carried out through monetary policy stimuli to inject liquidity into the financial market. An example of this is the decrease in interest rates.
  • Core inflation: It is a tool that uses the CPI as a base and allows to know an approximate of inflation in the medium term, in order to implement measures to control inflation more quickly.

According to the percentage of price increase

  • Creeping inflation: This type of inflation is common in developed or developing countries, since it is the one whose fluctuation does not exceed 10%.
  • Moderate inflation: In this case inflation exceeds 10%, however, it is considered within the standards whose price variation is still manageable.
  • High or galloping inflation: This type is characterized by having a very high interest rate, however it can be controlled by means of economic policies, although there is a risk that if not implemented in time it will become hyperinflation.
  • Hyperinflation: It is the uncontrolled increase in prices, even in serious cases there may be variations in these within the same day. When the currency loses all its value, the purchasing power of the population is practically nil.

At present, the INEGI (National Institute of Geography and Statistics) is in charge of investigating month by month the movement of approximately 235 thousand product prices, which are grouped into 283 generic concepts.

What are the main causes of inflation?

Like knowing the types of inflation that the economy can face, being aware of the causes can help you prevent and implement strategies that allow you to take actions in order to invest at the right time and where to do it.

Here are the main causes:

1. Imbalance between supply and demand

This imbalance originates when a large number of consumers are interested in acquiring a certain good or service, but companies do not have enough production to solve it, that is, there is not enough supply to satisfy demand.

The consequences of this is that since there is little supply, consumers are willing to pay more for said good, inflating prices and causing variations in the market. An example of this is the shortage of products in the basic basket, which can lead to speculation or the appearance of black or parallel markets.

2. Increase in production costs

Naturally, if the prices of raw materials increase, the cost of production will increase and, therefore, entrepreneurs will be forced to raise the price of the final product to maintain production and their profit margin. This can be a trigger for inflation if it occurs in a specific item.

3. Price adjustments

Although these are carried out gradually, the purchasing power of consumers will be affected, which results in a decrease in the consumption of said product. Although the intention is to avoid the abrupt change in prices, in the end it can result in an inflationary crisis.

This is summarized as: a lot of supply and little demand. The greatest risk of this is that – if not corrected in time – negative inflation or deflation may occur.

4. Increase in the amount of money in circulation

As we mentioned, the fall in GDP can activate financial strategies such as the printing of more money, giving rise to an imbalance, which occurs due to the increase in the money supply but the demand for money remains the same or decreases.

The risk of this is to lead to an inflationary crisis that results in the devaluation of the currency, affecting the purchasing power of the population.

5. Lack of economic prevention policies

Inflation becomes inevitable when a country does not implement monetary policies on time, especially if there has been an increase in prices or there is a large amount of money in circulation that is not balanced with demand.

Real estate investments to cope with inflation

Now, how does everything inside affect the real estate sector? Of course, properties are also affected by inflation, from houses and apartments to investors and renters.

For what reason? With the rise in prices of construction materials, production costs as well as the final product increase, in this case houses, offices, apartments, condominiums, commercial premises, among others.

One way used by owners of rental properties is to include clauses in the contract that establish the possibility of adjusting the amount of rent according to inflation.

In mortgage matters, some central banks have to adjust to the financial policies of the state, which can make it more difficult to access credit for people who depend on this form of financing to get a property.

However, as we have commented in other articles, Mexico is a country with broad policies to support entrepreneurship and access to housing and real estate, so these resources are intended to facilitate access to credit, which is an advantage both for users such as developers and construction companies.

Investing in real estate even in times of crisis, for example buying land for industry or investing in commercial land, will always be the right decision.

The reason is very simple, because even if prices rise at the same time, the value of the properties you own will also do so. It is an infallible formula to protect your money from inflation.

The land does not depreciate, over the years it will increase its value according to inflation rates, so your money will always be worth more, in addition to keeping properties in your portfolio as assets for your family and ensuring a relaxed retirement.

Without a doubt, investing your retirement savings on land is the best way to ensure your retirement and that your money does not lose its value.

If you want to know more about this topic, we invite you to read on our blog the tips to invest and make better decisions, which will help you acquire assets that will grow your capital considerably.

Commercial land, the best option to protect your capital

As we’ve seen throughout this article, investing in real estate not only protects your money, it makes it grow. Commercial lands, as well as industrial lands, even in times of a pandemic, are your best option to diversify your investments and minimize the risk of losses.

At BMF Inversions we are committed to helping you find the commercial land that best suits the needs of your industry or business. We have trained personnel to provide you with information about the developments we have in the main cities of the southeast of the country.