How is real wealth created in real estate?
In real estate, and with other investments, it is not enough for values to increase over time.
The reason is that we measure the value of goods in cash. The catch is that when inflation strikes, individual dollars buy less. Seen another way, it takes more dollars to buy a given item, thus prices appear to “rise.”
To see inflation at work imagine that you could have bought a loaf of bread for $1 last year. This year the loaf “costs” $1.25. If you think about it you can see that the loaf is unchanged, it has just as many slices. What’s changed is the buying power of the dollar — it buys less and so goods seem to have a “higher” price.
If we say that we want “real wealth” after inflation, what we actually mean is increased buying power. We’re looking for a property that appreciates faster than the rate of inflation.
We also want financing which can be re-paid over time and with cheaper dollars. If we have a fixed-rate loan, and if inflation erodes buying power, then such financing favors borrowers. Adjustable rate mortgages (ARMs) provide less protection against inflation for borrowers since rates can rise to reflect current borrowing costs.
In all cases, of course, it should be recognized that real estate, like other investments, is subject to both price increases — and price decreases. All investments represent some level of risk to the investor, a good reason to study the market with care before buying.
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