It’s a little OT for this site, but I put up a voiceofsandiego.org piece linking to and expounding on a Union Tribune article about how the CPI understates inflation. Check it out, if you can brave the slight offness of topic.
To bring this here post on topic while sticking with the inflation motif, I’d like to quickly address an argument that I hear a lot. The argument purports that inflation has been and will continue to be worse than is widely acknowledged (so far I’m in agreement), so real estate — being a tangible asset — is actually a good investment to hedge inflation risk (oops, you lost me).
There are two problems with this argument. One is that buying tangible assets to protect oneself from inflation is just great as long as one doesn’t ridiculously overpay for said tangible assets. What with home prices’ continued disparity with rents, incomes, and the like, buying a San Diego home right now would be doing just that.
The bigger problem is that real estate is financed, not purchased outright. People have been leveraging 10 or 20 to 1 (or more) on their real estate purchases. So while it’s a tangible asset, it’s actually bought with intangible paper. Further, the cost of financing tends to rise in inflationary times, so if anything the resulting higher rates could put downward pressure on prices even as inflation slowly rendered those prices more reasonable.
As a kind-of-related aside, can you imagine if everyone had to pay all cash for houses? What do you think the median San Diego home price would be in this case? Quite a bit lower, we can safely say, as prices would actually be tied to how much people earn rather than how much they can borrow via layer upon layer of securitization from some chump at a German pension fund.
In any case, due to elevated real estate valuations and the fact that homes are typically bought using extensive leverage, the "housing as an inflation hedge" argument doesn’t hold much water.
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)”
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.
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.
bsr: I was really talking
bsr: I was really talking about real estate in overpriced US bubble markets. In my opinion, if you think the $ is dropping there are much better ways to hedge against that than to buy real estate that is already extremely overpriced.
nweaver (and jdis I guess): Perhaps I wasn’t specific enough in the title, but I only have so many characters to work with. The point is that I don’t agree that SD real estate is a good inflation hedge at this time, given the fundamentals at this time.
You are fixing your costs, yes, but you are fixing them at an absurdly high level. Just because inflation will eventually cause the fundamentals to catch up with the price you’ve fixed at an artificially high level doesn’t mean that it is a good inflation hedge.
I suppose it can start being a good inflation hedge AFTER inflation has pushed the fundamentals up enough that your fixed cost makes sense. That’s years away, however, and the timeframe I intended to address in this article was the next several years, not decades down the road.
Thanks for the comments; I agree with them but they don’t really address the point I was trying to get across, which is my fault for not being clear enough.
rich
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.
nweaver — Agreed on all
nweaver — Agreed on all counts — well stated.
Rich
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.
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”.
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.
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?
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.
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….
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
Perhaps you are the one who
Perhaps you are the one who should go look at what happened in the 70s and 80s.
Housing was a horrible inflation hedge here in the early 80s. Home prices in SD had gotten too high by 1980 and were practically flat for 6 years or so while the price of everything else went up.
Housing was a better inflation hedge in the 70s, because prices were actually reasonable earlier in the 70s.
Fix your costs at a low or reasonable level == good inflation hedge.
Fix your costs at a high level == bad inflation hedge.
It’s all very simple, jasonjm, and is spelled out in the post and comments above. Also this link, if you can be bothered to click it, graphically depicts the extent to which you do not have your basic facts straight.
http://piggington.com/historical_home_prices_payments_rents_rates
Maybe you can try to understand the post or to do a little rudimentary research next time you decide to come to this site and insult me.
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.
Did you even read or try to
Did you even read or try to understand my reply? Did you even read the original post? Did you even look at the data in the charts I linked to? None of the above, obviously.
I don’t have time to debate with people who are just looking for a fight and who won’t even address the substance of my arguments. Take it somewhere else.
As everyone who’s been
As everyone who’s been around for a while knows by now, I welcome debate and I’d much prefer the forum to be a place where differing viewpoints can be (civilly) discussed, instead of just being a bearish echo chamber. Many bulls have posted on this forum but banning has been an extremely rare event.
However, I have no tolerance for someone who comes to to my own website and calls me names. Period. The insult is only compounded when that person is clearly unwilling or unable to comprehend the argument he purports to address.
User jasonjm fits this bill perfectly. He has thus been banned and his further attempt to post with a different login has been deleted (as will all future attempts). This, for the record, is only the second time I’ve banned a commenter in the history of the site.
rich
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.
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
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.
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.
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?
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.