The Consumer Price Index (CPI) measures the year-over-year percentage change in the average retail price of products and services that are typically purchased by households. The Bureau of Labor Services collects about 94,000 prices from 23,000 establishments monthly to calculate CPI. CPI is one of the main measures of inflation. A survey on the rental prices for 43,000 units also occurs, making up a third of the overall CPI, which is then used to calculate the increases in rental prices.

Because there is a correlation between inflation and goods with a limited supply, CPI also impacts real estate investments and housing costs. Here’s how rising costs affect real estate investments and why making smart real estate purchases can benefit you in periods of high inflation:

Rising construction costs

Inflation leads to the increase in prices of many aspects of the construction process, including building materials, machinery hiring rates, and consultant fees. With the costs of labor and construction materials increasing, real estate developers aren’t too keen to invest in any new developments. They will likely wait for inflation to ease and for prices to go down. Projects that are under development may also be delayed as construction costs become too expensive and investors worry about their profit margins.

Higher mortgage rates

In high-inflation environments, interest rates increase, and consequently, so do mortgage rates. When interest rates are low, more people are likely to borrow money. But as inflation moves higher, banks and other financial institutions raise interest rates to make borrowing less appealing. The goal is to lessen consumer consumption, which will help ease inflation. Overall this should slow transactional volume for real estate purchases, as many may people may be priced out of purchasing due to higher mortgage payments. Typically, as demand wanes, sellers will adjust pricing downwards to compensate.

Rising asset prices

When inflation rises, so does the cost of living and with it comes increasing real estate prices. Rising construction costs lead to fewer new developments, which leads to limited supply. Higher interest and mortgage rates also mean fewer people borrowing money to invest in real estate. All these factors lead to low supply, resulting in increased demand for an existing property. And with amplified demand in those properties comes an increase in their asset value.

Better performance for residential properties

During inflationary periods, residential properties such as condominiums, single-family, and multi-family properties tend to perform better. With higher building costs and more difficulty borrowing money, people will turn to renting more than buying. Commercial real estate also tends to perform better during periods of high inflation, especially those properties that have long-term leases in place, with set rental increases, allowing for the investor to “park” their money and still receive their anticipated returns until the economy improves.

Increase in rent prices

Historically, high periods of inflation have resulted in increases in rent prices. Investors use real estate to hedge inflation by taking advantage of the limited supply and leases that include annual rental increase clauses. Low inventory makes existing properties more in demand. Property owners can also justify the rental increase due to higher maintenance costs as a result of inflation and increased prices on consumer goods and services. Therefore, people with existing residential and commercial real estate tend to reap significant benefits during inflationary environments.