During periods of inflation and interest rates variability, many clients ask if this will impact their appraisals. This article attempts to shed some light on these issues.
A little background first
Inflation rates and interest rates are correlated. Rising inflation is typically caused by imbalances in supply and demand. Simply put, when demand of a good or service exceeds supply, prices go up. Central banks then increase interest rates to cool demand, which in time will cool inflation. Price increases slow, and then interest rates fall.
During 2021 and into 2022, inflation has been increasing significantly, mainly due to supply chain constrains causing supply of many good and services to fall significantly below demand levels. In response, in early 2022 central banks began increasing interest rates. Inflation will eventually begin to slow, but at time of writing (August 2022) it is unknown when and at what level these cycles will peak and reverse.
Do changing inflation rates and changing interest rates affect appraisals of tangible assets?
Generally speaking, yes, but in different ways depending on the type of appraisal (cost estimate or value estimate). Note: For more insight on the difference between cost and value, please see Suncorp Valuations recent blog on that topic.
The Impact on Insurance Appraisals
A “Cost Estimate Report” (eg. an “insurance appraisal”) is an estimate of the cost to replace a particular asset to ensure adequate insurance coverage is in place. Changing interest rates have little effect on these types of appraisals, however inflation has a significant impact. During times of rapidly changing material and/or labour costs the appraiser must pay close attention to cost trends in a myriad of categories, sub-markets, and regions. Often these trends show significant volatility and little correlation. Expert data acquisition and analysis is essential. It is important for users of Insurance Appraisal services to communicate frequently with their Suncorp Valuations consultant to ensure costs are updated on a regular basis to reduce the risk of an insurance coverage shortfall in the event of a loss.
The Impact on Value Appraisals
A “Value Appraisal” is an estimate of what a particular asset may sell or rent for. These types of appraisals are used for many purposes such as secured lending, buyer/seller due diligence, property division, etc. Inflation and cost has some impact, however interest rates have a significant impact on value estimates, for two main reasons.
Firstly, most tangible assets require some type of financing, such as a mortgage or secured loan, to facilitate the purchase. When interest rates increase, this decreases the relative purchasing power thereby reducing demand, and value. When interest rates go down, the reverse happens and values of tangible assets often increase.
And secondly, when interest rates increase the return on low risk investments (such as GIC’s, t-bills, bonds, etc.), also increase. These low risk investments compete with higher risk investments (such as income producing tangible assets and real property) for investor’s funds. Investors (buyers) then require a higher return on the purchase of tangible assets, and as a result values tend to fall. When interest rates fall, the reverse happens and values often go up.
There are many factors (such as tight supply) that impact the value of a tangible asset, and some of these factors change quite frequently. It is important for users of valuation services to communicate frequently with their Suncorp Valuations consultant to ensure their tangible asset value estimates are updated on a regular basis. In this way, our clients have the most up to date and accurate information with which to make informed decisions.