What is inflation and how to protect against it?

Date
10.02.2022
Read time

6 min

Author

Editorial Invest in Slovakia

Investopedia explains inflation as a decline in the purchasing power of a given currency over time. It manifests itself in an increase in the average price of an imaginary "shopping basket" filled with food and services selected by economists. The speed of this decline varies under different market conditions. Over the last period, inflation has been rising significantly, i.e. the strength of the currency has been declining. And while our basket is imaginary, the impact of inflation on citizens is real. In human terms, in a few years' time, I will no longer be buying milk for one euro, but for two.

Inflation in Slovakia

It should be noted that inflation is a normal and justified phenomenon in the economic system. However, its rate and growth matter. In the euro area, it has climbed to record values, despite the ECB's objectives to keep it at 2%.

Unlike, for example, the Czech Republic, interest on bank accounts is virtually non-existent. So money in the bank is losing value by the day. What are the real values?

"Slovaks have 47 billion euros in current accounts, of which 5 per cent (2.3 billion euros) is cut annually. This is the highest inflation in 17 years, which we could not have predicted." Pavol Kožík

How to protect against inflation?

Here again Investopedia advise - hedging inflation. That is, an investment that, by increasing its value above the rate of inflation, protects the owner from its impact. A simple example (with illustrative values): the value of gold in my vault rises by 10% in two years, the annual inflation rate over this period was 4% per year, so 8% over the whole period. So if I sold it at this point, my investment would have made me a profit of 2% over the period.

The investor has several options to choose from. The aforementioned gold is also worth considering, while young investors may be particularly interested in various cryptocurrencies and NFTs. However, more on this elsewhere.

An investor may stick to a sector that he likes or in which he is oriented and keep diversification across sectors to a minimum, but with a one-off or narrow profile investment, the investor is taking a risk, betting on one card. Or even playing directly with speculation.

Again, regular investing and diversification significantly reduce the level of risk. If our primary objective is asset protection, we want to avoid risk. The asset we have chosen today is therefore tangible and historically proven.

As with any investment, there is a return and risk associated with it. And also a degree of liquidity. Unlike stocks or bonds, however, it requires care and costs are also associated with the actual purchase. The investor capitalizes one-time on its sale, or on the cash flow (cash-flow) that its rental generates from time to time. The latter, however, is associated with additional risks and expenses (renovation, administration, maintenance and others).

Real estate as an investment

According to experts, currently the yield on renting flats in Slovakia ranges from 3 - 4.5%. In the long-term market average, the increase in the value of real estate is on average 6% per year. Thus, an investor could value his investment in this way with a return of 10% per annum. However, taxes still need to be taken into account here. And it should be noted that the proceeds from the sale are from them after 5 years freed!

What mistakes to avoid when buying an apartment?

"The desirability of buying an apartment for rent depends primarily on its location, price and the regular expenses associated with owning it. Advice such as familiarise yourself with the zoning plan, take an interest in the neighbours, confront the neighbourhood of the flat with the possible requirements of subtenants or test your way to it in rush hour traffic and evening parking are nice and useful, but very time-consuming. By the time you test and find out, the apartment will sell. Look for a specific location first and then look for an apartment in that location." - Pavel Škriniar

"It's important to remember that being in the position of a landlord can be time-consuming, and it's certainly important to be lucky to have a good tenant. Investors look at buying an investment property through the lens of the continuous increase in the price of the property in question, and in particular as a safe preservation of the value of their money, as a conservative estimate puts the annual increase in property prices at around 5 %." - Viktor Obtulovic

In the pandemic period, prices of holiday properties have also skyrocketed. The main reason for this is the need for people to find an escape to the countryside and spend their leisure time there. Renting them out offers even higher appreciation, in exchange for a higher level of risk and management worries. Buyers also face the risk that the property is irrationally overpriced. This is because both the seller and competing buyers set the price based on "intellectual" value and not on return on investment.

"Someone has to take care of the clients, take over the property after each tour, change the laundry, clean and so on. From that point of view, it's a more demanding property to look after. Of course, today there are agencies that handle all the care for the client. However, it is not free and it reduces the overall profitability. We also need to be wary of the location in which we are buying a holiday property, whether there are enough attractions and what the environment offers. Properties in locations with established infrastructure are more commercially successful." - Mario Glos

But what about the investor who does not have sufficient funds?

Mortgage as one of the options to protect against inflation

During the rise in inflation, the borrowers' advantage increases. This is because the bank's money loses value when it is borrowed. A suitable defence against inflation may therefore be to buy an investment property 'on mortgage'. This is because its value will rise while the value of the debt will fall.

Don't forget to take stock of the crisis scenario.

  • Spending is rising, goods and services are becoming more expensive.
  • People are moving out, rents are falling.
  • Things depreciate - not every tenant is responsible, so be careful when choosing.

Another factor is the rise in interest rates. These are currently at a minimum, which means that they will rise in the future. We do not know exactly when and to what extent, but with a time horizon of 12-30 years, we do not need to know. Interest rates below one per cent will become two, three, five... Which, with a mortgage, can amount to hundreds of euros extra. So don't forget this either, and if you decide to take out a mortgage, lock in your interest rate for as long a period as possible.

"In my opinion, it is now also advantageous to buy cottages and holiday properties in interesting locations, because they are still at good prices, and when you look at the development of these prices, it is worth it. I also think that with the situation we have been experiencing for the last two years, it is a good buy just because one can go to the cottage every weekend to air one's head out, recharge one's batteries and possibly offer it for short-term rent when one is not there. Of course, it's still worth buying apartments to rent out, but you have to do very good maths before you buy." - Tomas Kuba

Real estate crowdfunding

The biggest advantages of this method include:

  • Low minimum amount.
  • Due diligence of investment opportunities.
  • Interesting investment opportunities.
  • Easy diversification.
  • A passive form of investment.

You can also learn more about it here.

About the author
Editorial Invest in Slovakia
The Invest in Slovakia crowdfunding platform facilitates investments in Slovak real estate projects to investors from all over Europe. It focuses on innovative solutions with benefits for the surrounding area. The long-term effort of the team of specialists is the development of financial literacy. It provides clients with access to thoroughly vetted assets with different appreciation strategies.

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