Opinion: The Impact of Inflation on Savings – what can we do to maintain the value of capital

March 24, 2022

Olga Rudzika, Managing Director of Pro Kapital Latvia

In the spring of 2022, it seems inappropriate to talk about preserving capital. There is a feeling that at a time when Ukraine is selflessly fighting Russian aggression, there is no point in talking about money. It is understandable that many everyday issues have remained in the shadows today, but they have not lost their relevance. They happen whether we think about them or not. For example, the fact that Latvia is rapidly approaching double-digit inflation means that we need to take care of our deposits and investments. And it should not be done “after a while”, but right now.

The rise in inflation began because of the pandemic. First, world prices fell due to falling demand. On the other hand, as soon as the first signs of overcoming emerged, prices began to rise rapidly. There were several reasons for this, but three main ones were: rising energy prices, which are always “catching up” with all other sectors; significant disruptions in supply chains due to huge demand; additional stocks created by companies to prevent material shortages (read more about the causes of inflation in the article by LB President Mārtiņš Kazakas here – the article is in Latvian).

Russia’s extremely aggressive invasion of Ukraine has exacerbated energy prices and caused uncertainty, for example, over grain exports and prices. Most Europeans realize that they have to adapt to a new lifestyle because they are aware of the reasons for what is happening and understand that more expensive fuel or food is the inevitable result of war. Given that there are still too many uncertainties at the moment, even bank analysts have remained reluctant to make specific predictions about economic development. One can be predicted with some certainty: the rise in prices will not be an “inconvenience” of one or two months, but a much longer period. Therefore, it would be worth considering possible ways to maintain your savings, the price increase of which, if deposited in a bank, would likely gradually fade away.

Quality real estate has always been one of the most popular types of investment. In recent years, there have been many projects in the Baltic States that have been sold out long before the buildings were built. The Baltics themselves invest in real estate, as well as Nordic pension funds and other investors. A well-built house in a good location is a safe and stable investment that does not lose its value (even increases in the conditions of inflation increases). Moreover, by offering it on the rental market. there is the opportunity to recoup this investment.  As for the profitability of such an investment, if the apartment bought in the center of Riga about eight years ago were now offered to the market, its price would have almost doubled, ensuring an increase in the capital investment of about 10-12% per year. If this property had been rented out all this time, it would be possible to take into account the income that would allow covering the purchase price of a one-room apartment in the new project in full.

Unlike other types of investments (shares, bonds, other financial instruments), the biggest advantage of real estate is the constantly growing, stable demand. Indeed, there have been declines and problems in this sector as well, which in the case of Latvia resulted from a disproportionate lending policy. However, it has never been the case that people do not want to improve their living conditions and quality of life. This is a kind of “eternal engine” that is forcing real estate developers to look for new ways to meet this demand. And that’s why real estate is a sought-after way to invest money, especially in times of uncertainty and crisis.

What should be the real estate project that would be worth investing in?  First, you need to understand the purpose for which the property is purchased – for your own use or for rent. The next steps will depend on it. If the apartment is intended for your family, in addition to the necessary space, layout, and quality of the building, an important issue is the infrastructure around the property – transport, educational institutions, opportunities for daily sports activities. Given the rise in energy prices, the proximity of housing to workplaces (children’s schools) as well as its energy efficiency are particularly important factors.

If this is planned as an investment, it is necessary to understand what type of tenants the landlord will focus on. At present, a large part of the demand in the rental market is made up of young families, while during the pre-pandemic the number of foreign students who did not want to live in a dormitory but rented small apartments with their fellow students grew rapidly. It can be expected that as the economic situation takes the form of a “new normal”, students will return to the rental market.

In the case of exclusive properties, a good option is to use the services of a real estate broker, who takes responsibility for finding tenants in the long run. Namely, the owner himself does not have to deal with this issue at all. When evaluating the purchase of an apartment as an investment object, demand trends should be assessed very carefully. For example, if you look at ads in publicly available databases, you can immediately see which areas are most in demand. Currently, in Riga, those areas are for example Āgenskalns and the surrounding areas and remote center. After a while, however, the range of attractive areas is expected to be wider, thus when investing money in property, one should think about the reasons people want to rent apartments in these places and keep track of where and what real estate developers are currently building or planning to build. Taking all these aspects into account, the understanding of where and in which developments to invest to maximize the return on investment becomes much clearer.

And just like buying an apartment for your family, the quality of the building and apartments, energy-saving  (the importance of this factor is growing rapidly) and location will always be important when renting.