Inflation is here to stay and so is Real Estate Investment

[AJ Wong]

I started writing this post last week, but the banking errr.. financial 'crisis' of 2023 (and make no doubt about it, that's what this is) has been 'evolving' so rapidly I had to delete what I was going to post to stay relevant. Describe it however you would like but there is a large debt and small dollar problem. 

QE5 or whatever we're on is now, the FED is expanding its balance sheet, calling emergency meetings and the financial analysts and experts of the world have no clue what's going to 'break' next. 

Well surprise, they've had no clue all along! The net effect of monetary policy is to kick the proverbial can down the road. We never solved the issues of 2008 and in fact created a much larger everything debt and everything asset bubble. The asterisk this go around is that there (or should I say their) is 'stubborn,' 'sticky' or 'persistent,' inflation. Not of the transitory type, but of the self induced, savings and wealth destruction kind. 

Self induced - because it was artificially suppressed interest rates of 2005ish that created the housing bubble and the past decade that created the current one. Banks invested in low yield assets, as rates have risen, those same assets are worthless...errr..worth less. Considerably less. What are we to expect? Consumers don't care what banks do with their deposits so why should they? Even the industry 'leaders' at SVB with often tens of millions in deposits didn't do their homework...but who cares. They were paid in full. 

Call monetary policy or programs by any name you would like but the net effect is inflationary spending. Every bailout, every depositor insurance policy, every natural disaster aid, infrastructure project and bullet or navy boat is paid for, usually with debt. Which BTW has been historically cheap debt, BUT the interest costs just went up, a lot. 

It was actually the cheapness of the debt itself that helped contain inflation inspire of record monetary supply. Businesses and investors borrowed at historically low rates, keeping the costs of doing business low and prices in check.

Let's also be clear. Resources are finite. Commodity prices will rise with demand, consumption and time. 

My ignorant perspective is the planet/market isn't producing these limited supplies in increasing quantity without a corresponding increase in input of energy and expense.  The costs of living are going to increase. Doesn't it have to from 0%? Unless the demand destruction is significant enough to offset the rising costs of commodity prices. Which is a pleasant explanation of a recession. 

More importantly I think the growth of the US money supply is all but a foregone conclusion. In a nutshell, the more dollars in the system, the less our savings are worth. According to the Congressional Budget Office: "Changes in CBO’s Budget Projections. CBO’s projection of the deficit for 2023 is now $0.4 trillion more than it was in May 2022; the projection of the cumulative deficit over the 2023–2032 period is now $3.1 trillion (or about 20 percent) more, largely because of newly enacted legislation and changes in CBO’s economic forecast, including higher projected inflation and interest rates."

Time will tell.. 

 '6%' inflation means your $100k cash reserve is $94k next year and $88,360 in March 2025. Equity investor? Well last year your $100k equity position is on average $80k+/- and not looking like a great return year or even super safe at the moment..Oh and the banks themselves don't seem all that stable but that won't really matter if the money on deposit isn't worth anything. lol 

Sooo where do investors go for security and safety? 

Historically? Hard, tangible assets: Land. Gold. Commodities. Real Estate. 

I'm under 40 but I've lived 40 financial lives. I, like many of my clients are concerned to say the least. Do I think the 'world' is going to end? No. Do I think the financial landscape as we know it is going through monumental, necessary and painful evolution? Yes. Unfortunately for most of us, we need to adapt or risk losing most of what we worked for if current trends continue. 

I'm forever bullish real assets. Will asset prices fluctuate? Yes. But those same commodities and services that are inflating will make developing or creating US real estate more expensive. I've held the perspective for sometime that US real estate was somewhat undervalued considering the amount of required resources and skills to build to modern standard and the safety and accessibility in comparison to other countries. 

That's not to imply it's not an uncertain time to invest, but most residential real estate investment in the US is leveraged. If the property cash flows and the capital invested isn't losing purchasing power, that seems like a double win? Perhaps the paper value or Zillow Zestimate drops, but isn't that what all these bank assets (the same mortgage backed securities underlying the market) are doing? I'm certain to get some push back here, but at least you know where your 'money' is. It isn't where you think it is at Wells Fargo and at this point should it be? 

I could be well off base, and things go back to 'normal' but when is the last time US economic conditions were normal? 2003-2007 was an artificial boom. 2008 the world stood still. 2009-2019 0% rate artificial boom. 2020 end of the world. 2021-2022 Covid stimulus. Whatever this is? 2023 Financial Crisis..

What is certain is that people will rent, eat, buy, sell, get married, have children and pass their assets on to their children. What's not clear is the quality of those experiences without some observant, prudent and calculated investment of time, capital and credit. 

Off record, I think all good times come with a cost. A cost the USD and policy has enabled and is clearly on the down slope. In the near term there will likely be opportunity as housing rates drop and programs are enacted that ultimately support lower residential housing costs. In the medium to long term the cost of a high standard of living is going to increase, as is the quality of investment required to meet that standard.

Conversely credit conditions for businesses and borrowers are likely to tighten, in fact my local credit union reached out to me weeks ago to let me know that they would be focusing on existing members and that indeed underwriting guidelines would be more cumbersome for clients. As the lifeblood of businesses, housing and the economy many experienced investors or businesses owners are already planning for a more restrictive lending environment. 

This past treasury auction was weak, as I finish this there is discussion of Schwab coming under investor focus as the majority of their income is based of interest rate related returns and many of their assets have an average yield of 2%ish..this is profitable in an ultra low interest environment where depositors are paid relatively nothing but if they flee to more secure assets..such as..real estate..their $7 Trillion empire could begin to wobble. That would be bad. 

I doubt we'll all agree but the risks of investment INACTIVITY or complacency is also increasing. 

"There is more lost by indecision than bad decision," is an old adage that might be more relevant to prudent real estate investment than at any time in recent memory. 

Fearless forecast:  healthy investment portfolios of the future MUST include high quality real estate.