Historically, real rents, for the last fifty years at least, have been stable. They have risen almost point by point with inflation. If you consider the nature of inflation and borrowing-- as, inflation is good for the borrower and poor for the lender. Then, considering our current climate of high inflation and low mortgage rates, would you consider real estate a possible top investment opportunity? I say this because of rental incomes ability to move with inflation. A borrower’s gains from high inflation and low borrowing rates depends on the borrowers income. If income moves proportionally, the borrow gains. If income lags behind inflation, the borrow is not gaining (proportionally). So, Ddoes rental income rise with inflation? Yes it does. Thusly, giving a landlord/borrower more dollars to pay back a fixed payment. In today’s borrower/landlord case, considering that rents move with inflation, real estate investment and management seems a good play.
agree? disagree?
pitfalls of my analysis?
Comments (or compliments)?
p.s. Just read page 1 of book 1 of lvl 1 curriculum…
Your OP post is why I applied and bought a place 2 months after getting my job out of college. Not only does rent respond postively to inflation, but the real estate values itself do as well (since the rental income able to be generated affects some appraisal methods). I did some cash flow analysis and found with the current interest rates, buying a 3BR worked out well – I travel a lot for work, so I rent 2 bed rooms out and spend mostly weekends in the third. And due to it being a mixed used residential, I get the tax benefits on 2/3 of the property. It takes 2 years for rental income to be counted as income from what I’ve read. If interest rates are still low when I reach 2 years (I’m at 1 year right now), I may buy another place.
But, that being said. I live in the South in a largely unregulated state in terms of rentals. I’ve become really familiar with rental law in my free time and I looked into some other areas of the country. Not sure if I’d want to be in the game in the Northeast, for example. Some crazy regulations.
I’m young and still learning, but I think there are two approaches to investments. You have cash flow guys and then networth guys. Investment properties are networth, but not necessarily great for cash flow unless its a slum lord kind of deal (especially initially). I’m still deciding if cash flow or networth is the better goal to pursue at this point in my life. The investment properties seem to work as a store of value as you slowly build equity, but most types of properties don’t seem to generate a ton of extra cash relative to the cost initially – pretty slim margin, since the price you pay is usaully related to the rent one can charge.
But I still have a lot to learn and may be thinking about it wrongly.
yes, sorry sorry. I realize that Bernake is targeting this 2.5% area and has been successful in this, as others have been, since the 80s.
I should have been more accurate. I’m reffering to the “unofficial” measures of inflation that have it being higher. Also, some believe higher inflation is down the road.
Now I’m not glenn beck, ron paul, or someone trying to huck gold, but I do think there could be a. more inflation in the future, or b. inflation may be slightly higher than what is captured by the current CPI
even if you consider the 2.5% inflation rate, rentals still seem like a buy.
I would be targeting REOs and HUDs and other properties from persons in distressed circumstances. Thusly, initial costs MAY be lower (if repairs and such don’t add up too high).
I plan to use very current RE market analysis to one by one target investment properties to rent out.
I feel this model, coupled with the above points that I mentioned, could be very succesful
Most smart money investors I listen to believe we are in a world of deleveraging and deflation is more likely than inflation. There’s a reason the 10 year bond is at 1.5%. Austerity measures is coming to a town near you.
The 'pitfall" of your analysis is that we are not going to have high inflation for a while. Check out Reinhart’s paper on “panoramic views of credit bubbles”.
Some do about “high inflation” etc etc but that particular inflation is very ephemeral and linked to high petro prices (which can drop as quickly) but overall, inflation has been very low.
However, let’s assume that inflation does become a reality, I don’t think you made your case clearly, at least to me. You are right that inflation is good for borrowers and bad for lenders, but I think that gap really becomes dramatic only when inflation itself is really high AND fluctuates. Otherwise loans will reflect expected inflation and you will not earn a greater rate of return.
But why specifically rentals as a play on inflation? Why not other assets…? I do think rentals and real estate could be really good investments in of themselves, but as a bet on inflation, I’m not clear.
A. If inflation is high, as you hypothetically granted, then it must be higher than 2.5%, if you can get mortgages at a fixed rate over the next year, generally as low as 3.8% then… The fluctuations are not necessary… I understand that lenders figure inflation into their rates, what I’m saying I guess, is that curently rates are positioned incorrectly to future inflation expectations. B. Not so much saying other assets won’t be good… But unless your lt bonds income adjusts with inflation, or the companys you invest ins product or service income moves with inflation, then rentals over assets. You do bring up valid problems, thanks for your insights
This is a subject of interest to me, and thank you for bringing up that point. My take is:
we are indeed in a deflationary environment, caused by deleveraging. But we are witnessing no deflation, rather controlled inflation under 3%. So what is happening is that the massive post-08/09 deflationary forces have been balanced by massive (this “massiveness” is not debatable) printing of money. This, in my mind, is the only explanation as for why we are not suffering hyperinflation already, given the scale of liquidity injection in the system.
so far so good, many would argue, a depression has been avoided and inflation is controlled. But wouldn’t you agree that this is all a very delicate balance ? What happens in the future when deflationary forces decrease further, past a point where inflation starts to increase at a dangerous pace ? Do you think that at that point you can just decide to raise interest rate and everything is fine again, given the scale of the inflationary forces ? Also, raising rates could be “pulling the plug”, and you fall into a recession. My point is that this has been an experiment so far, and nobody knows how it will play out. I fail to see, however, how the current monetary mass can *not* throw inflation at us at some point. There is also the whole US treasury monetising its debt thing, but this is another issue.
About the 10Y treasuries @ 1,5% indicating there will be no inflation, the same yield decreased by 1% in the 3 months following the downgrade in summer 2011. IMO the only thing that 10Y treasuries indicate is that US treasuries are still perceived as a safe haven.
I don’t understand that sentence. If there is inflation of say, 5% in 3 years, and you get a 15 year fixed rate reflecting an expected inflation of 3% today, your bank will see its real returns decrease. As an investor, if the rent you receive is indexed, your real rate of return will increase.
Wikipedia has this to say: I_nflation hedge_ is an investment with intrinsic value such as oil, natural gas, gold, farmland, and to a lesser degree commercial real estate
I listened to a Planet Money Podcast recently where investors are buying farmland in Africa. I bet there is a fund to get into that somewhere.
He is talking about nominal interest rates vs. real interest rates. Theoretically, the nominal interest rate that you get from the bank/creditcard/ whoever is suppose to have “expected inflation” worked into it.
nominal rate - inflation = real rate
so, if the inflation number used is correct, then the real rate will be what the lender hoped it would be. If inflation fluctuates FROM THE EXPECTED INFLATION RATE THAT WAS USED IN THE LENDERS CALCULATIONS then the borrower will realize the gains you mention (assuming his income is indexed/ing)
I believe the low rates from the fed’s bond buying have brought rates so low that any upward fluctuation in the current 2.5% puts lenders almost at a loss… also, many prices are inflating faster than the CPI says for their “general average” of rates… real interest rates are about 1% from 30 yr Tbills to mortgage lenders… doesn’t seem like the same game I learned in my finance classes
Just remember, CPI has roughly 50% of its measurement based on home values. So if CPI is how you are measuring inflation, it’s going to be greatly affected by a recovering housing sector. I think last I read Case-Shiller just turned upward.
Again, for your scenario to work, there has to be a “change” in expected inflation rates. There’s a difference between high inflation rates and “rising” inflation rates.
As for hedges against inflation, many exist, I wouldn’t say gold, but equities in general should do well, in addition things that own real assets like oil and commodities…
Are equities actually a good inflation hedge? I was under the impression they may outperform certain assets during extreme inflationary periods, but their performance is still negative.
The rental market is about as good as it’s ever been. Getting in now risks calling the top of a market. With 9 million homes in inventory, there’s a huge substitute market out there. Not sure when the secular shift back into home ownership will occur, but when it does the rental market will suffer.
Depending on where you think we are in the inflationary cycle you have a few options that can hedge away the risk. Some equities hold up well. Any business that can pass along the higher input costs to its consumers - P&G is always a good example. Of course oil companies would work too. And REITs.
Or you could look at TIPS, FX, floating rate, commodities, and gold.