CHAPTER ONE
1.0 INTRODUCTION
The impact of inflation on the value of assets is considered one of the primary financial concerns of long term investors. While actual and expected inflation have slowed considerably since the early 1980’s, concern over future increases is still a consideration for long term investors. Ibbotson and Siegael (1995) conclude that real estate compensates the investor for inflation risk. When real estate is added to a mixed-asset portfolio, the inflation risk of the expanded portfolio is substantially below that the original portfolio (expanded real estate). In recent years, during which we have inflation seen the incidence of inflation falling to low levels and fairly static property markets, the conventional wisdom has means low, or no growth in property values. There are many benefits from investing in property in a low inflation environment and particular risks in investing in a high inflation environment.
The key to understand the impact inflation on property values is found in two factors in particular. Firstly, the benefit from real estate is maintaining a hedge against inflation and over
and above that, increasing the purchasing power of capital by having it increase in value ahead of the rate of inflation, any change in value for a given period above or below the rate of inflation is called the “real” growth rate. Parkin, J. Micjeal (1975) Historically Kwara houses prices have increased over the long term at around 10% per annum compound. Inflation during the same period has averaged around 7% per annum growth, that is, the growth above the inflation rate which is increasing the purchasing power of our capital and therefore our “real “ wealth, has averaged around 3% per annum. If in every year inflation was 12% and prices increased by 15% giving us a 3% real increase, this will be telling us that the property market is booming. Chris and Ola (2001) Why then, when inflation is saying 2% and values increases 5%, again giving us a 3% real increases do they adopt a negative view? The result is virtually the same.
The second key to understand the impact of inflation on property values is on the aspect of homeowners’wealth in housing is currently the largest part of Nigeria households’ investment portfolios. After stock prices collapsed in 2009 and mortgage rates hit historically low levels,
investment in residential housing picked up. This increase, coupled with higher home prices, boosted household wealth in real estate from $6.6 trillion in 2000 to $10.5 trillion in the second quarter of 2005 and an increase of more than 58 percent. Over the same period, household
wealth in corporate equities lost a fourth of its value, falling from $8 trillion to $6 trillion.
Housing price bubbles occur when home prices grow at a rate exceeding the inflation rate in an area, especially the inflation rate for construction materials and labor. In such situations, higher home prices generally reflect increased demand.Chris and Ola (2001)
For world economic markets, Inflation is a fairly new experience as for much of the pre-twentieth century there had been little upward pressure on prices. These limit governments’ abilities. Inflation reflects a situation where the demand for goods and services exceeds their supply in the economy (Hall, 1982). It causes could be triggered by the private sector and the government spending more than their revenues, or by shortfalls in output. Price increases could also be triggered by increases in costs of production. For instance increases in prices of imported raw materials will cause inflation if not managed. Whatever the initial cause, inflation will not persist unless accomplished by sustained increase in money supply. In this case, inflation is monetary phenomenon. But what effect does inflation have on property values. Inflation causes many distortions in the real estate market. It hurts people who are retired and living on a fixed income. When prices rise these consumers cannot buy as much as they could previously. This discourages saving due to the fact that the money is worth more presently than in the future. This expectation reduces economy needs a certain level of savings to finance investments which boosts economic growth.
1.1 STATEMENT OF PROBLEM
Inflation is one of the challenges facing property values any urban areas in the World. The first is through increased costs: higher wages for construction labor, higher construction material costs and higher land prices. When the prices of new houses and old houses are compared, new houses are more expensive on average than old houses, and the price difference to a great extent reflects higher construction labor and material costs.
Inflation as affected property values in terms of rent. Irving Fisher (1998), a noted American economist, put forth a theory about the relationship between interest rates and inflation rates that can be applied to housing market rents.
According to Fisher, when lenders loan money, they consider the expected inflation over the term of the loan and add that expected inflation rate to the interest rate they charge. If lenders want to charge 2 percent interest and expect a 3 percent rate of inflation, they charge 5 percent interest on the loan.
A similar process takes place in housing markets. When landlords rent housing units, they consider recent inflation rates as well as expected inflation rates over the terms of rental contracts. They increase rents to meet their inflation expectations. Higher rents translate into higher home prices because the price of a home is equal to the present value of future streams of actual or imputed rents (gross rentsminus maintenance costs, taxes, depreciation and so forth). Thus, inflation impacts house prices through increased rents.
1.2 RESEARCH QUESTION
In other to have a deep insight about the impact of inflation on the property values in the study area. The following issues must be properly addressed;
1.What type of properties are in the study area?
2.What are the types and causes of inflation?
2. How does inflation affect property values?
1.3 AIM AND OBJECTIVES
The aim of this study is to examine the impact of inflation on property values in Ilorin, Kwara State. To this end, the study shall focus on the following specific objectives;
1. To identify the different types of properties in the study area
2.To identify the types and causes of inflation
3. To examine the effects of the inflation on property values.
4. To recommend probable solutions to the problem.
1.4 JUSTIFICATION OF THE STUDY
Glenn R. Mueller (1993) examines real estate performance during and low inflation periods in U.S. The results show that real estate does provide an inflationhedge. Second, real estate returns are broken down by major property type categories (office and industrial) to determine if any property type differences exist. A major difference is found between the inflation hedging
effectiveness of office and industrial properties. Third, the industrial are further analyzed in relation to vacancy rates in the two property types. A structural imbalance in the office market is evidenced by high vacancy rates. Therefore, the relative impact of vacancy rates upon office and industrial property performance is examined and found to be a significant factor in explaining
returns, thus affecting inflation hedging characteristics.
Anari and Kolari (2002), they examined the long-run impact of inflation on homeowner equity in South Africa by analyzing the relationship between house prices and the prices of non-housing goods and services. There are two reasons for this methodological departure:
(i) The total return on housing is fully reflected in house prices even when it
cannot be measured accurately, and (ii) Valuable long-run information can be captured by using prices rather than using returns, since differencing house prices and non-housing CPI lead to a loss of long-run information contained in the series, Moreover, unlike previous studies, to avoid potential bias in estimating how inflation affects housing prices, we exclude housing costs from our measure of the consumer price index of goods and services.
Irving Fisher (1998), a noted American economist, put forth a theory about the relationship between interest rates and inflation rates that can be applied to housing market rents. The inflation hedging characteristics of property prices have been examined in both developed and developing countries: Australia (Brown, 1990), Canada (Newell, 1995), New Zealand
(Newell& Boyd, 1995) and Switzerland (Hoesli, 1994). The purpose of this study is to examine the impact of inflation on property values. Unlike previous studies, such an analysis has never been attempted in Kwara State and this is where the uniqueness of this study lies.
1.5 SCOPE OF THE STUDY
A study of an impact of inflation on rental values which will covers all issues relating to the effect, solution and methods adopted in reducing it impact on the populace in the study area. It
will cover a wide range of residential, industrial and commercial properties.
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