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justdoitstewart
16 years ago

Rich,
Great article and you

Rich,

Great article and you taught me a few things for sure! I think a better title would have been, “Real Estate as an Inflation Hedge, or More to the Point, Not (in bubble markets)”

Anonymous
Anonymous
16 years ago

Well, real estate IS a hedge
Well, real estate IS a hedge against inflation, even as an overpaid asset.

If you buy a house to actually live in and use a fixed-rate mortgage rather than an ARM, it means you no longer really have to worry about inflation in housing costs like you do as a renter.

Of course, with an overvalued market, you have to assume 3%/year inflation for 5-10+ years before it makes sense, but inflation-hedge really is one of the few things which does work, even IN an overvalued market, if your time horizon is long enough.

bsrsharma
16 years ago

Rich, I think you may like
Rich, I think you may like to put an exception clause to your generally sensible advice. For those with a lot of cash (I am thinking of at least a Million $), prime real estate in international gateway cities may be a good investment. This is not as a hedge against your everyday inflation as much as a conservative hedge against “Wile E. Coyote” drop of US $. There is now a general acceptance that US $ has to undergo significant devaluation over long term (50% in 10 years, may be even 75% in 20 years). Not just due to real estate crisis but due to baby boom retirement crisis. If $ loses 75% of international exchange rate value, prime real estate in gateway cities will hold its value due to demand by foreigners.

Anonymous
Anonymous
16 years ago
Reply to  Rich Toscano

What I’ve always done is
What I’ve always done is just “make a spreadsheet”. (mine is at http://www.icsi.berkeley.edu/~nweaver/buy_v_rent.xls ). The true inflation hedge aspect (and it is a true hedge) was the most compelling reason to even consider buying.

As I said, however, its a pretty long time horizon. EG, on the condo-conversion on my apt complex, I needed to assume >7+ years before just the “lost money” cost/month of buying exceeded the lost-money cost of renting, assuming 3% annual inflation.

But if you KNEW you were going to be in the same place for >10 years, and you had a strong belief that prices were going to increase at just inflation or higher, you could make a case as a hedge.

Not a very strong case, however, as the other (un)stated assumption in the inflation-hedge model is that the price of buying has to continue to go up faster than you can earn interest by not buying.

Also, the CPI’s housing deliberately went with rent rather than purchase, because rental prices are not subject to speculative bubbles. I argue that this is the correct decision when constructing an inflation index.

brian_in_la
16 years ago
Reply to  Rich Toscano

nweaver, cool spreadsheet.
nweaver, cool spreadsheet.

Another benefit to owning is the forced savings. most people have a hard time not spending ready cash and paying down a mortgage is, for many people, just about their only form of savings.

Of course, with the heloc’s and refinancing equity-extraction, that benefit has also been screwed in the boom. Sadly, many people have burned their fake bubble equity.

Anonymous
Anonymous
16 years ago
Reply to  brian_in_la

The “forced savings” aspect
The “forced savings” aspect is why what I care about is ‘tax-netural nonsavings’: payment to principle isn’t an expense in the long term.

Whenever I looked at sane markets, it was always “raw cost/month exceeds rent. tax adjusted cost/month exceeds rent. But tax-neutral nonsavings is equal or less than rent”.

Eugene
16 years ago
Reply to  Anonymous

One major exception.
Real

One major exception.

Real estate is a good hedge against inflation, even at today’s prices, if you expect 5-10 year inflation to be way above the interest rate of your fixed interest loan.

You get a tangible asset today but you’ll have to pay for it with tomorrow’s depreciated money.

Imagine that you buy a 500k house zero down and finance it at 7% fixed. After high inflation for 5 years, your house is still worth 500k, except it’s no longer overvalued. In addition, you’re locked into nice and low 7% rate when everyone around you is forced to pay 10% or 11%.

In a sense, overpricedness of the house is compensated by stupidity of the lender willing to lend you money at the interest that’s way below probable inflation rate.

Another way to hedge against inflation is to buy a good car with 0% APR. One of Peter Schiff’s predictions is that used cars will keep a lot of value in hyperinflation because America will be selling used consumer goods (e.g. cars) to foreigners.

brian_in_la
16 years ago
Reply to  Eugene

Hi esmith…this also
Hi esmith…this also implictly assumes that you keep your job and that you get big inflation adjustments…not a sure thing. If you get the kind of hyper-inflation that you are talking about, there is also likely to be other nasty economic effects and social disruption.

If you really think that we are in for that kind of economic armagedon, do you really want to leverage-up and buy a physically-immovable asset?

Eugene
16 years ago
Reply to  brian_in_la

Well – real estate is really
Well – real estate is really a hedge against inflation as measured by wage growth. If wages grow 3% a year and “real inflation” is 10%, houses won’t grow 10%.

There are two kinds of inflation.

Inflation because of the Fed printing money results in rising prices and rising wages. Real estate protects us against this kind.

Inflation because of rising oil and depreciating dollar, including “Wile E. Coyote moment” ((c) Paul Krugman), does not result in higher wages, real estate won’t help with this one.

Also, you need one heck of a lot of inflation for this argument to work, given San Diego prices. 500k house with 3000/month payment starts making sense when 3000 is 28% of median gross income in the area. I.e. when your median household in the area is making 130k/year.

underdose
16 years ago
Reply to  Eugene

esmith refers to two kinds
esmith refers to two kinds of inflation. Economics 101 tells us (and many PhD’s in economics have mysteriously forgotten this!) that there is only one kind of inflation: devaluation of the currency caused by the central bank making it more abundant. Both of esmith’s flavors of inflation are essentially the same thing. The expansion of the money supply started by Greenspan and continued by Bernanke will result in all of the above, rising consumer prices, rising commodity prices (oil, etc.), declining dollar. The “Wile E. Coyote” moment is occurring precisely because Bernanke is, as promised, throwing money out of helicopters, thus effectively defaulting on the US’s debts abroad. When holders of dollar denominated debt realize it is worthless because of the expansion of “liquidity”, they look to dump their dollars. It all comes from the same root cause though, the printing press.

Incidentally, I agree with the UT and Voice of San Diego articles that CPI is a poor measure of inflation. Since growth of the money supply is the only true measure of inflation, the best gauge of inflation would be the M3 money supply figure. Oops! Bernanke has been hiding that data for quite some time now. I guess he wants us to look at the birdie (CPI) while he slight-of-hands the fact that he is willfully causing massive inflation. It really is criminal, but it is almost more criminal that virtually nobody is crying foul….

Anonymous
Anonymous
16 years ago
Reply to  underdose

ok, so finally the owner of
ok, so finally the owner of this web site posts something really stupid

the fact is housing is an EXCELLENT inflation hedge.

please look at what happened to housing prices during the periods of very high inflation in the late 70’s and early 80s

enough said

Anonymous
Anonymous
16 years ago
Reply to  Rich Toscano

Ok here are the stats for
Ok here are the stats for california, median house value

1950 $9,564
1960 $15,100
1970 $23,100
1980 $84,500
1990 $195,500

so, during the period of super high inflation in the 1970s, the median house value QUADRUPLED – every other decade was double or less.

And the stats country wide are in similar proportions.

so perhaps it is you who needs to re-evaluate since I have now provided hard evidence for my point.

JWM in SD
16 years ago
Reply to  Rich Toscano

My first argument against
My first argument against housing as an inflation hedge(in bubble markets) is the opportunity cost aspect. At absurd asset prices, one is tying up large amount of capital or worse still…future income (debt service). Second depends on the definition of inflation and the state of the economy at the point of purchase. If you believe the Austrian definition then inflation is not rising prices but rather loose monetary policy. This can be achieved by printing presses or with… credit standards. I sometimes argue that hyperinflation already happened in the form of easy credit and a bubble in RE. Whan that happens, you get rising commodity prices and deflating assets as a result credit contraction…like RE right now. If you believe this, then RE as a hedge right now in SD is a laughable consideration.

bubble_contagion
16 years ago
Reply to  Anonymous

Pretty impressive Buy vs.
Pretty impressive Buy vs. Rent Excel calculator. Here is a screenshot of my Buy vs. Rent Excel calculator. It seems I have some work to do. In addition to graphs, maybe I’ll write some code to automatically download the latest interest and tax rates. No doubt this website is full of geeks.

http://home.san.rr.com/bstruck/EXCAL.jpg

NotCranky
16 years ago

I have participated in some
I have participated in some of the posts your are referring to Rich,no doubt. My consideration is how cheap mortgage money is currently and how that affects costs of borrowing, which affects the overall cost of my intended use for the money(which is in theory productive). I think mortage money from my house at conservative LTV’s might be a worthwhile consideration. Inflation possibilities could weigh in positively. Certainly one would not recommend buying an over priced house speculating on inflation trends alone.

Maybe I need to hire a “geek” to make me a spreadsheet. I mean that in the friendly, kind of envious way.

AKguy
16 years ago

The house we are living in
The house we are living in we own free and clear–benefit of buying before the bubble. RE has obviously been a good inflation hedge for us, but I’m dubious about buying now, especially as an investment:

1. You may need to move sooner than you expect, even if you don’t think you will now–life happens, plans change. I never thought we’d sell our little house in the East Bay hills with its view through the Golden Gate. But in 2005 after 14 years, it was time to move on (schools, job, health care issue). So we sold for 3x what I originally paid, moved out of state and bought a much nicer house for 2/3 the price. We were lucky–our need to sell coincided with the peak of the bubble. I don’t expect to repeat that trick.

2. RE carrying cost is significant, even if you pay cash. Taxes, maintenance, landscaping, HOA fees for some, etc.

3. Leverage looks very dangerous right now. It’s cold comfort paying depreciated dollars for a asset that’s worth less than you owe.

I love owning my own house, but the benefits are about lifestyle (picking school districts, control over our living environment), not about investment returns. I’ll be happy to break even on the new place if/when we decide to sell.

Anonymous
Anonymous
15 years ago

My wife and I are considering
My wife and I are considering removing cash from a bank account that is earning 2% ish and invest in a rental property. We’re worried about inflation kicking in and the interest rates that banks pay not keeping up. While I think I have understood your comments about overpaying for an asset not being a good hedge against inflation, I suspect that your banished poster may also be correct that in periods of high inflation property values go up overall. The key question is: how does one tell the difference between the overpriced properties that will stagnate and the rest of them that will increase along with inflation.

Do you know of any rules of thumb to differentiate between the overpriced properties and the “normal” properties? I notice in looking at the NAR statistics on single family home prices, that the big losers in the last year have been the big, hot markets of the last 5 years (Boston, LA, San Francisco, etc) and the few gainers in the last year have been places like De Moines, Decatur, Binghampton, etc.

Are there rules of thumb as to what multiple of rent a home price should be? Or what multiple of incomes? How about Farmland?

xiv014
13 years ago

Hi Rich,
A whimsical google

Hi Rich,

A whimsical google search for “what happens to housing prices during inflation” brought up this page.

I would be really interested to know if your thoughts have changed since 2007 (especially given the “housing prices are now reasonable” post a while back).

Personally, I’m not in any hurry to buy.