What can we expect? Thoughts about Inflation and Interest Rates with Steve Raub
March 29, 2021
Inflation is once again in the headlines. Is it here yet? Just around the corner? Those questions come from investors who remember the 10% inflation of the 1970’s, with gas lines, and mortgage rates peaking at 16% in 1981 in order to squash inflation and the economy along with it. Now, if you are asking “what is inflation” then you probably graduated from college more recently. For reference, over the past 20 years inflation has averaged 2%, and over the past 100 years, 3.1%. Sounds tame, but at 3% inflation over 20 years, prices double; or to say it more accurately, the buying power of your dollar is cut in half.
Why does this matter to me, a commercial real estate investor? Because it is generally accepted that real estate is one of the best hedges against inflation. Prices of “hard” assets are supposed to go up at or above the rate of inflation, so your buying power stays intact. Of course, things aren’t that simple — ever.
A year ago, we all were sweating the calamity of the Pandemic. Thanks to Operation Warp Speed, the amazing ingenuity of modern science and big pharma, the end is insight. Thank God.
The Consumer Price Index, CPI for short, was 1.7% over the past twelve months. That’s pretty tame. Now for some reason, the Bureau of Labor Statistics has chosen not to include Food and Energy costs because they are too volatile. Sure, but they are kind of essential.
Let’s focus on inflation and its effects on investment assets like real estate. Have real estate prices gone up in the past 12 months? Emphatically yes. In fact, residential real estate is in such short supply that sales volume will decline this year, because there are not enough homes for sale to buy! This is unlike the bubble in 1985 and 2007 when there was massive overbuilding. Now we have under building. Days on the market in Austin are essentially negative, that is, people no longer price homes, they just put it up for sale with the expectation of multiple offers from which to choose. Some builders are no longer taking contracts on homes before they are built. Prices of lumber and other materials are going up so fast, they can’t lock in the cost of the home. So then they can raise their price in the six months it takes to build the home because they believe they will make a better profit margin and not leave money on the table. One builder told me he projected 136 sales in Austin in 2021, but had sold 100 by the end of February. The prices of cars and trucks will go up, because there is a microchip shortage that will persist through the year. So, new cars and trucks will be in short supply, driving prices up across the board. Oh, and the stock market keeps hitting record highs, Bitcoin has soared to over $60,000 from under $10,000 last year. Gold, pretty flat, actually. Gasoline, not too bad, yet. Oh, the biggest asset inflation yet – the supply of U.S. Treasuries. The Federal Reserve had a balance sheet of under $800-billion in 2008, and it now approaches $8-trillion
So based on those factoids, do you take a 1.7% rate of inflation with a little grain of salt? It’s like me taking my temperature on February 15th – it was 98.6 inside me, but it was a whole lot colder outside! So, inflation is really how you measure it. The federal government has created their definition of inflation and they have a bias to keep it low, so they don’t scare people, but inflation is all around us.
Yet, in the end, owning commercial real estate allows you to benefit from inflation as rents increase, which increases the value of your property. Right now, toward the end of the Days of Covid, rents are fairly steady, believe it or not. There is a lot of leasing activity and development plans and projects are plentiful. Once confidence is restored, rent increases and the build out of our fair city will continue.