" Successful investing is about managing risk - not avoiding it"
- Benjamin Graham
I’ve been thinking recently about the ways that inflation affects companies, consumers, countries and lastly investors. Despite the ubiquity of recent mentions of inflation in the press our generation has relatively little experience with it. I’m in my mid-50’s and have a dim recollection of inflation as a young child. Our current public policy makers who are mostly in their 50’s and 60’s were teenagers at the oldest when the last serious bouts of inflation were dealt with in the early 80’s have no personal experience dealing with inflation as policy makers.
This just in: Inflation is not good for investors – but investing (as opposed to sitting on cash) has historically done better during these times. Consider that cash and cash equivalents are currently paying anywhere from nothing to perhaps a little less than 1% when inflation as measured by CPI is now 8.3% year over year. That means that sitting on cash is guaranteeing a REAL (after inflation) loss of around 7-8 percent! Brutal…
So instead of taking that loss you choose to invest in a wide variety of assets including stocks, bonds and for the purposes of this letter real estate as an investment (as opposed to real estate as an alternative to renting).
Mortgage rates have come up a lot in the last year – from below 3% to around 5.5% now. But rates of 5.5% are STILL incredibly cheap when you consider that inflation is running 8.3%. In past inflationary environments mortgage rates generally go higher than inflation (which makes sense). Can you imagine if that happened now? How much home could you afford with mortgages at 10%? Answer: a lot less than you could at 3 percent! (it's a little more than double the cost)
Real estate as an investment has two components: Cash flow and price appreciation. Cash flow is the reliable driver of producing economics – whereas price appreciation is the speculative piece. IF (and it’s a big “IF”) you can find and buy real estate with attractive cash flow currently than it will probably be worth consideration as an investment but relying upon price appreciation is pure speculation.
I am not suggesting real estate as an investment is in for a precipitous fall – but I am suggesting that BECAUSE of higher interest rates the economics of buying real estate and expecting it to produce prodigious returns by way of price appreciation is likely to change in coming years. So, “Buyer Beware”!