Deflation and the real estate market

As the UK consumer price index (CPI) dips to -0.1% for the month of April there are concerns about the potential impact upon the UK real estate market in the short to medium term. This move to a negative inflation figure (deflation) is the first since the 1960s which saw an estimated fall of 0.6%. The good news is that the Bank of England is adamant that this fall in the CPI figure is a one-off caused by the falling oil price although there are obvious concerns that the UK economic recovery may not be as strong as some believe.

Deflation and real estate prices

One of the very basic barometers dictating the price of real estate is rental yields which tend to move ahead year-on-year in traditional economic environments. If we were to see a prolonged period of deflation in the UK then this would at best limit rent income growth in the short to medium term and, depending upon the terms of some leases, could potentially see rents decrease. It is highly unlikely that this one-off dip by 0.1% will have any real impact upon the UK real estate market but it does open investor eyes to potential issues they had never thought of.

While a period of deflation will be seen as potentially positive by many families across the UK it could have a significantly detrimental impact upon businesses. If this was to occur for a prolonged period then this would limit potential price rises, squeeze margins and likely result in job losses. Significant job losses would obviously impact demand for real estate with fewer people able to afford mortgages with such a grey cloud over the economy.

UK base rates

Even though inflation is set to recover strongly towards the end of 2015 there is a growing belief that the Bank of England is unlikely to raise UK base rates until well into 2016. This comes despite the fact that Mark Carney, Governor of the Bank of England, has on occasion indicated a potential rate rise if the economic recovery was to continue. It is extremely difficult to see as and when both UK base rates and worldwide base rates in general will rise significantly to more “traditional” levels.

Planning for the future

While the Bank of England is adamant that the dip in inflation is only temporary it does put another spanner in the works in the short term for those looking to invest in their business. Even the slightest degree of risk will increase the relative cost of investment and indeed negative inflation actually increases the real value of existing debt. The Trade Union Congress (TUC) has been very vocal on this particular issue today, suggesting that there may be “something awry” with the on-going economic recovery.

Whether this is but a political spat after the general election is debatable with trade unions already lining up to challenge the authority of the incumbent Tory government.

Conclusion

There is no doubt that since the worldwide crash of 2008 we have seen some very irregular movements in economies around the world. While this dip into negative inflation in the UK will likely be a short-term situation, the on-going economic troubles around the world have certainly thrown up some interesting scenarios.