Inflation occurs when there is an increase in price levels over a
sustained period, and in terms of economics is measured as an annual
When there is inflation, the value of the dollar continually
decreases, along with its purchasing power. Purchasing power refers to
what one can buy with one unit of currency. When there is inflation,
something that costs $1.00 in one year may cost $1.02 the next.
What this means in terms of real estate is that inflation decreases
the purchasing power of the dollar in relation to the cost of buying a
house or paying to lease a property.
The inflation-adjusted price of a property refers to the value of a
property when it has been adjusted to account for inflation and reflects
a present-day value. For example, if the price to purchase a piece of
property a decade ago was $100,000, one must adjust for inflation to
come up with the inflation-adjusted price of $109,000 in terms of modern
day purchasing power.
Investors must take into account the inflation-adjusted prices of
properties and leases to assess their investment prospects. If a
property were to lease for $650 10 years ago and now leases for $700, it
may seem that there has been a value increase.
However, when inflation adjusted prices are taken into account, one
can see that the actual value of that property as a buy-to-let
investment has decreased.
On the other hand, if it let for $650 a decade ago and now leases
for $800 a month, the inflation adjusted price of $710 a decade ago
shows that the value of the property has increased.
The disparity between real values as exemplified above, illustrates
why it is so important that you take inflation-adjusted prices into
account as an investor.