AP, if you attribute so much of an IP's net profit to inflation, then you are saying property growth at the rate of inflation is a sound investment. And remember, the RBA aims to keep inflation between 2 and 3% via rates.
In focusing on inflation, you are erring in believing cash flows and growth have a linear positive correlation with it. This isn't so. When inflation is up, rates go up, and growth is restricted.
Are you mistaking property growth to be solely an effect of inflation?
It is true, inflation fuels a portion of growth, but remember higher rates try to offset that......
The growth that makes an investment a good one, is the portion of growth
above the inflation rate.....and that is provided by
Loose Credit
...and loose credit tends to occur moreso in low inflationary environments....though credit has been loose for the last 12 years, which I'll address below.
Where you are right in your thinking, is in the effect of inflation on cash flows:
- Holding costs normally escalate at the rate of inflation.
- Rents escalate at a rate somewhere between inflation and property growth, as rent has to strike a balance between maintaining yield on current value, and inflation's effect on wages.
- Interest is a function of inflation.
If inflation goes up, interest goes up.
BUT, importantly, and in support of your views, when inflation goes down, interest goes down.
These effects are better appreciated when cash flows and net worth are charted. When you do so, sensitivity analysis shows net returns are most influenced by that portion of property growth
above the inflation rate. And growth above the inflation rate is possible how?????
BY LOOSE CREDIT
Admittedly, over the last 10 years, growth has been strong. IMO, that is very much due to loose credit via looser DSRs and LVRs. One has to ask whether these can be loosened further in the future.
The argument that undersupply and population growth are the prime drivers of property growth, is shot down when credit it tightened. No matter how many people want houses, if they can't pay cash, the houses don't get built.
Below is property performance over 2 economic cycles.
Average cpi, property and rent growth are 4%.
Rental yield begins as 5%, and retains that on average.
Interest rate averages 3% above cpi.
Hopefully it is evident this investment has weak returns, and most likely underperforms cash in (term deposits or bonds)
To summarize and simplify,
property performance is dependent on the degree combined cash flow and growth outperform inflation.
In the real world, this reduces to how much the combination of rent (and initial rent yield) and growth outperforms cpi.