is inflation good for property?

[Andrew_A]

Is inflation good for property and who benefits the most?

Warren Buffet said it well: Absolute wealth creation is all about the number of hamburgers (and cherry cokes) you can buy with your paper money.

If you (a) forego ten hamburgers to purchase an investment; (b) receive dividends which, after tax, buy two hamburgers; and (c) receive, upon sale of your holdings, after-tax proceeds that will buy eight hamburgers, then (d) you have had no real income from your investment, no matter how much it appreciated in dollars. You may feel richer, but you won't eat richer..... Buffet 1980 letter to shareholders.

My current level of knowledge has me believing this:

* Inflation is great for debtors.
* Property is a tax advantaged way of inflation proofing your hamburgers.
* Inflation will push prices up more in absolute terms than in real terms with regards to property (Exactly the same argument applies to equities incidentally for anyone using that particular argument about why it might be better to stay away from property presently.)
* Property is more likely to follow the post ww2 model of inflation plus 1-2% than it is to revert to just tracking inflation.
* Inflation is primarily a monetary phenomenon. A video from 1980 I found recently describes the causes of inflation much better than I can. Milton Friedman on how to cure inflation. (Google video)
* House price rises are a symptom of inflation (and speculation) and not a cause of inflation.

I'm raising this issue because of views expressed recently by Michael Yardney in his latest newsletter. It's my opinion that Michael has a fundamental misunderstanding of inflation and it's causes vs it's effects. I'm interested in learning more about the subject and being corrected where required.

From Michael Yardney's website.

....

If you look at the historical rise in property values more carefully, you will find that inflation hasn't had a really big impact in the past. In fact instead of being the precursor to increasing property values, typically it has been the opposite. Inflation has increased after a property boom.

There are a number of reasons for this.

The main one being that building costs are a major factor in the basket of items that the government looks at when it calculates inflation. So increased housing prices leads to inflation.

Another reason is the wealth effect. After a property boom many investors feel wealthier, in fact they are, because their properties have gone up in value and they spend more money. This translates to increased inflationary pressure.

....

 

[alexlee]

In general, is inflation good for property investors? Yes, if you have a mortgage on the property.

e.g. $100k property, $100k loan. 7.2% inflation. in 10 years, the loan is still $100k and presumably your property goes up. That's $100k in extra purchasing power that inflation has 'created' for you.

In general property appreciates faster than inflation, but the fact is if you borrow you still win if the property only appreciates at the rate of inflation.

The difficulty is that property (or shares, for that matter) isn't affected directly by inflation. If inflation was 10%, you don't naturally assume your house will go up by 10%: the RBA's inflation figures includes housing but is based on current housing prices, rents, etc. In fact it might be the opposite: high inflation usually leads to higher interest rates that hurts property values. Property values rise the fastest in times of low interest rates (which usualy implies low inflation). As Michael says, it's more secondary effects; increased housing prices increases building costs, economic activity, wages, etc LEADING to inflation.

So IMHO, inflation directly decreases the real value of your mortgage (good) but will probably cause high interest rates and decrease the value of your property (bad). However, long term property trends up (independently of inflation, see my argument below) while your mortgage keeps going down in real terms. Inflation only decreases the real value of your mortgage. It doesn't necessarily have a direct effect on your property value (which is driven by supply and demand of property).
Alex

 

[alexlee]

Specifically re Andrew’s points, my own take:

* Property is a tax advantaged way of inflation proofing your hamburgers.
I’ve always wondered whether this is a tail wagging the dog. Property has long term increased above the level of inflation. However, that doesn’t mean property is pegged to inflation. If anything, high inflation should hurt property prices. So it might be just looking at two separate things (house price growth and inflation), seeing a trend (housing growth > interest) and inferring a relationship where one doesn’t necessarily exist.

e.g. commemorative elvis plates have increased 10% a year while inflation has been 5% a year. Elvis plates would seem to be inflation proof but there may not be a relationship at all.


* Inflation will push prices up more in absolute terms than in real terms with regards to property (Exactly the same argument applies to equities incidentally for anyone using that particular argument about why it might be better to stay away from property presently.)
High inflation probably means high interest rates, which pushes property prices down. Low inflation means low interest rates and probably property appreciation. Housing / rent aren’t directly affected by inflation (which is based on wages as well as other factors like oil) because it’s more about supply and demand of housing, which can isn’t related to much of components of inflation. e.g. what relationship does housing supply and demand have to oil or banana prices?


* Property is more likely to follow the post ww2 model of inflation plus 1-2% than it is to revert to just tracking inflation.
If you assume wages increase with inflation, technically housing should track inflation. (I don’t necessarily agree with that: see above). However, post ww2 housing increases have also been driven by population / household increases. If the population didn’t increase, I don’t believe property would go up no matter what the inflation rate is, in part because current prices already factor in expected appreciation. Or to put it another way, if people only expected housing to go up by the rate of inflation, prices would be a lot lower than they are.

Whether housing keeps beating inflation in the future is a function of supply and demand of housing, not inflation itself.


* Inflation is primarily a monetary phenomenon. A recent video I found describes the causes of inflation much better than I can. Milton Friedman on how to cure inflation. (Google video)
The monetary view states that inflation occurs when more money chases the same amount of goods. That’s why you can have money supply increasing and NOT cause inflation IF productivity (amount of goods produced by the same inputs) also increases. i.e. if you have $100 chasing 100 units of goods, the price is $1. If you increase money supply and now $105 is chasing 100 units, you have inflation of 5%. However, if you also increase productivity by 5%, you now have $105 chasing 105 units of goods, so no inflation. That’s why MacFarlane is so concerned that the economy is at capacity. Any increase in money supply (credit, printing it, etc) will go directly into inflation.


* House price rises are a symptom of inflation (and speculation) and not a cause of inflation.
I don’t agree with that. I think house prices can fluctuate independently from inflation. e.g. we had a crazy boom in the last 10 years without inflation going up much. If anything a housing boom shouldn’t happen in times of high inflation because in such times interest rates are usually high. The relationship is indirect: housing / interest rates and interest rates / inflation.

Part of the reason why the US got out of its 2001 recession was from property appreciation: people refinanced mortgages to consume, and generally felt richer so they were willing to take on more debt to fund consumption. Same with Australia. Whether using a debt binge to save the economy is good or not, instead of taking some pain is another issue.
Alex

 

[Aceyducey]

What's good for property is more buyers than sellers.

Limited supply and growing demand.

Interestingly enough this form of scarcity can also be a cause of inflation....as can the mere expectation that prices will rise.

As inflation is a human-created definition of the devaluation of money over time based on a consistent basket of goods, if you consider it more closely you could say that one cause of inflation is increases in property prices - rather than the other way around.

I've always found it amusing that when we measure inflation based on a basket of goods, there's an economic implication that the goods of X years ago were of equivalent value to the goods today. Of course economists try to account for this in the calculations, however on average the goods and services (and homes) we use today have materially increased in quality and quantity (if not longevity) than those of, say, 50 years ago.

So adjusting the fudge factor designed to make a home of today equivalent to a home of 50 years ago, or the same for a car, vacuum cleaner or other product, can significantly tip the set of scales from an impact on inflation rate to price changes due to the premium for higher quality goods - while having no actual impact on the prices.

Cheers,

Aceyducey

 

[thefirstbruce]

* Inflation is great for debtors.
* Property is a tax advantaged way of inflation proofing your hamburgers.

....

I agree with MY's last point about ppl spending more when their equity goes up. At least that's been the case in this last property boom. I am ignorant about previous booms though.

I think in Oz, inflation is good for property prices, well more specifically, those already holding property. But on the proviso that you lock in rates before core inflation threatens 3%pa...

Since 2004, I haven't seen a lot of price movement in many locales. Hence the real price of property there has been backwards, at the rate of inflation.

The other angle where inflation can push prices is in the effect of inflation on rent. If inflation goes up, interest rates generally follow, in addition to maintenance costs, council rates, insurance, and finally rents.

As rents go up, I think that is a big sentiment driven incentive for ppl to start looking for the security of buying, and ignoring an objective differential analysis of owning versus renting. However, I have no idea how powerful this effect is in relation to other market forces.

 

[Beach Bum]

I think in Oz, inflation is good for property prices, well more specifically, those already holding property. But on the proviso that you lock in rates before core inflation threatens 3%pa...

My recollections are that inflation brings higher interest rates, which brings more inflation, which then brings higher interest rates which eventually leads to a recession and or market crash.
Sorry to bring such good news