The economy of a country to a large extent determines many things including the profitability of investments. With people constantly sourcing ways to invest in real estate, there’s still the silent question of how much changes in the economy can affect their investment. One of the major strongholds of the economy in every country, including Nigeria is devaluation. In this article, we examine what devaluations are and how they affect real estate investments.
What is Devaluation?
It is important to know that the value of the currency that devaluation affects is the value of that currency against other currencies. It is essentially a downward adjustment to a country’s currency value in relation to the value or standard of a foreign currency. Devaluations happen for different reasons, while the government may evaluate the currency themselves, sometimes, the country may be forced to devalue the currency when it can no longer defend it’s exchange rates.
Why Does Devaluation Occur?
Devaluation occurs because the current fixed exchange rate set by the government has become unsustainable and needs to be changed. This change in the exchange rate is what causes the devaluation of the currency. The government prints more money which of course increases the supply and consequently lowers demand and causes a drop in the value of the currency which in this case is the naira.
Asides this, comparing imports against exports, if a country begins to import more than it exports then there’s going to be a need to alter the value of the currency to reflect the losses. In the same vein, if the supply of a country’s currency exceeds the demand for the currency, the currency must decline in value and this is when devaluation becomes a reality.
Looking at this may make devaluation seem harmless, however, in the case that a country has borrowed heavily from other countries, transactions particularly made in dollars, the devaluation causes the debt to increase substantially, causing the economy to go into recession. Recession then goes on to affect firms and then stock prices are also affected.
What Are Some Good Sides to Devaluation?
- Devaluation makes exports cheaper. This causes a rise in demand for locally made products, this can greatly boost local businesses and open up these businesses to a larger market and consequently more opportunities. This can be harnessed by the government to increase the country’s competitiveness in the global market.
- The devaluation can allow the government to roll over debt which may have been immediately due, and can force governments to make structural adjustments in their economies, often under guidance of the International Monetary Fund, which would have otherwise been politically difficult.
- A fall in importation and a rise in exportation can cause a better balance of payments because the trade deficit shrinks. In short, a country that devalues its currency can reduce its deficit because there is greater demand for cheaper exports.
How Devaluations Affect Real Estate
An increased supply of currency causes a decrease in demand and this is the reason why the devaluation of the currency (Naira) takes place, however real estate is not bound by the same rules that bind the currency.
For example, a house that was selling at ₦2,000,000 ($5,248.93)will not be affected by a devaluation as long as it is already listed at this price. Asides this, the value of real estate properties increase regardless of devaluation, this means a property sold at ₦2,000,000 ($5,248.93)increases in value regardless of devaluations. In some other cases of real estate investments, this may not necessarily apply. In house flipping for example, a period of devaluation may be a wrong time to sell off a property that was worked on sourcing materials that were not obtained during the period of devaluation. On the other hand, the period of devaluation makes it more economical to purchase materials for a house flipping, this is if the materials to be used are locally made. materials to be imported are usually more expensive at that period. on the good side, flipped houses retain their value even in the face of devaluation.
Devaluation and Real Estate Investment Trusts
Real estate investments are similar to stocks and operate in similar ways. In cases of devaluations, there are a lot of buying opportunities. This is however not always a positive change, devaluation may cause the reits to be oversold, this causes a general drop in prices and the prices of stocks decline to very low levels. Asides this, the devaluation opens a buying opportunity that also enables many potential investors to buy, this eventually leads to an increase in prices.
Effects of devaluation
1. Inflation. Devaluation is likely to cause inflation because:
Imports will be more expensive (any imported good or raw material will increase in price)
Aggregate Demand (AD) increases – causing demand-pull inflation.
Firms/exporters have less incentive to cut costs because they can rely on the devaluation to improve competitiveness. The concern is that long-term devaluation may lead to lower productivity because of the decline in incentives.
2. Reduced real wages.
Real wages have a lesser value in the face of devaluation. This is because buying power is greatly reduced and the wages can only be applied to only a few things.
3. A large and rapid devaluation may scare off international investors. It makes investors less willing to hold government debt because the devaluation is effectively reducing the real value of their holdings. In some cases, rapid devaluation can trigger capital flight.
4. Debts in foreign currency become very difficult to pay back. The devaluation causes the value of the currency to fall against the value of the foreighn currency as a result it takes a lot more to meet up with the consumers have debts, e.g. mortgages in foreign currency – after a devaluation, they will see a sharp rise in the cost of their debt repayments.