Tue 31 May 2011
Inflation, the double-edged sword
Posted by Marc Kushner under Economy, The Informed Appraiser
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by Marc Kushner, The Informed Appraiser
With the economy still reeling from the recent recession, there’s been lots of talk about the risk of significant inflation. Meanwhile, others are concerned about the possibility of deflation. The reality is that in this unstable economic climate, anything is possible. The cataclysmic economic events of the past few years have spooked us to the point that we’ve grown fearful of our own shadows.
Let’s focus on inflation for the moment. There is little question that the U.S. economy has experienced inflation over the past year - the overall seasonally adjusted CPI rose 3.2% between April 2010 and April 2011. Now, by historical standards this figure is not remarkable, and is considered to be a fairly “healthy” rate of inflation. However, given that the relatively stable macroeconomic circumstances we are experiencing at the moment can be at least partially attributed to some rather drastic actions taken by the Fed (zero interest rates, QE, QE2, etc.), there’s no guarantee as to what could happen next. What might be the implications for real estate values if inflation goes up substantially?
On the one hand, real estate has historically been regarded as a good inflationary hedge. This is quite a simple notion to comprehend and reflects the observation that if prices rise in general, real estate prices should also rise along with them. Furthermore, the fixed-rate mortgages so often used for real estate purchases can become very favorable in long run, as the monthly payments stay level and therefore effectively become less expensive as a result of the declining purchasing power of the dollar (i.e., inflation). In addition, inflation often implies rent growth, which is good for income property.
On the other hand, increased inflation tends to (at least eventually) translate to higher mortgage interest rates, and consequently higher mortgage payments for a given loan amount. Because most real estate is purchased using mortgage financing, the increased cost of borrowing money has the effect of decreasing affordability, and this may place downward pressure on prices.
Only time will tell whether inflation becomes a drag on the economy, and how that might play out in the real estate market. What’s somewhat disconcerting is that the housing market remains in shambles, with falling prices, weak sales volume, and a glut of foreclosures still working through the pipeline. Yet, this is all taking place despite record-low interest rates (i.e., cheap financing). If interest rates eventually rise, as some say is inevitable, that may spell yet more bad news for the housing market.
