By: Andrew Syrios, thinkrealty.com, View Original
Unless you have been living under a rock, you know that the Federal Reserve has printed an extraordinary amount of money over the last year. Something like 30 percent of all of the dollars in circulation were put there over the past 12 months. The authorities have clearly lost any inhibitions about quantitative easing and throwing money around. So, there are a lot more dollars around than there used to be.
In addition, the economy is starting to pick up a bit now that the lockdowns are (mostly) ending. Yes, it’s still sluggish, but unemployment has improved from 14.7 percent in April 2020 to 6.1 percent in April 2021.
So, let’s put this all together. If you’re familiar with the Quantity Theory of Money, you know that Money X Velocity = Price X Productivity.
Velocity is how fast money is spent, which increases in a healthy economy (and is thus increasing now). Money is how much money is in circulation (which is up a lot). And productivity, while improved, is still below where it was at for the beginning of 2020.
In other words, every sign points toward prices increasing … a lot.
In fact, we’ve already seen this starting to happen; in stock prices, cryptocurrencies, real estate (we’ll get back to this one), gas prices, lumber (yikes!) and we’re finally starting to see it in commodities as well. Even the CPI or Consumer Price Index (which does not count assets in its calculations) is showing inflation is up to a 4.2 percent annualized rate in April (it was just 1.4 percent in January). And again, because the CPI doesn’t count assets like stocks or real estate, it’s undercounting actual inflation by a substantial amount in my judgement.
First, recognize that the likelihood of hyperinflation is extremely low. The United States is still the richest and most powerful country in the history of the world and its government fully backs the dollar. And while a 30 percent increase in the money supply during the last year is enormous, it’s not enough to cause the dollar to spiral out of control while its value circles the drain. Indeed, if the dollar lost 30 percent of its value, that would be a lot of inflation. But it would be nowhere near hyperinflation.
Therefore, we will almost certainly have very high inflation, but not hyperinflation. So, selling all of your properties and expatriating to some sparsely populated island is not something I would advise.
That being said, the dollar is likely to depreciate, so holding lots of dollars is not a great idea either. You still need to stay liquid and hold good reserves, but just putting large amounts of cash in a savings account won’t be ideal. I wouldn’t put your reserve cash into speculative or risky investments (like say, cryptocurrencies) though. A better bet would be money markets, CDs and index funds. If you want to use some money on more speculative investments (like say, cryptocurrencies), go for it. But make sure your reserves are in low-risk assets.
While it’s common to think that real estate will assuredly go up in a highly inflationary environment, this is not necessarily true. For example, while inflation and home prices both rose about nine percent between 1973 and 1982, they varied greatly year by year.
Between 1976 and 1979, home prices increased over 10 percent each year while inflation was generally around eight percent. Then in 1980, home prices only went up three percent, then six percent in 1981 and one percent in 1982. Inflation, on the other hand, went up 14 percent in 1980, 10 percent in 1981 and six percent in 1982.
In the first three years of the 1980s, inflation beat out home prices by 11, four, and five percent.
The big problem here is that home prices are highly susceptible to interest rate increases. Sooner or later (and likely sooner) the Federal Reserve is going to have to increase rates as they did in the 1980s to stem rising inflation. (Although hopefully not to the point where mortgage rates reach 17 percent, as they did in October 1981!)
But if interest rates go up substantially, home prices will stall even if inflation continues throughout the rest of the economy. Of course, the increase in interest rates will cool off inflation in general, but it will likely take several years to wear off while the real estate market will be hit immediately, just as happened in the 70s and early 80s.
For this reason, I highly recommend getting fixed rate mortgages on any purchases or refinances. Indeed, if you have any properties with adjustable-rate mortgages right now, it may be worth refinancing them just to lock in a fixed rate.
Yes, you’ll pay a bit more for the fixed rate, but I can all but guarantee rates won’t be going any lower in the future. And they are highly likely to increase soon. Furthermore, rates are so low right now even fixed rate loans have fantastic interest rates.
In the same vein, I would recommend against signing longer leases for residential properties. Of course, longer leases are standard in commercial real estate, so I would not aim for short-term leases with commercial. Instead, put a step-up clause in the lease so the rent automatically increases each year. But with residential units, I would not be thrilled to sign a two-year lease when prices (including rents) will likely be substantially higher next year.
Overall, the real estate market is extremely hot right now and inflation could add a substantial amount of volatility to it. For that reason, if you have any underperforming assets, this would be a good time to consider selling them.
And while I would not recommend stop buying, caution is in order. Don’t reach on any deals right now. Good deals are few and far between at this moment and there is no good reason to be a motivated buyer.
High inflation is not the end of the world. The 70s were rough but they were not catastrophic. And we are likely to experience a decade similar to the 70s and early 80s, which will certainly make things more difficult.
That’s especially true when we are likely going to see interest rate increases as a result of this inflation. It’s best to prepare for that as soon as possible, most notably by getting into fixed rate loans.