Inflation, banking and real estate

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SmallCityDave
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Inflation, banking and real estate

Post by SmallCityDave »

Just a theoretical question if we experience high inflation such as 20% per year does it make sense to be highly leveraged in real estate?

I think we will see high inflation perhaps hyperinflation soon and I'm not a fan of debt or leverage but in this scenario does it make sense to be highly leveraged in real estate? Do the banks have any protections if we experience inflation like Venezuela?
Beehave
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Re: Inflation, banking and real estate

Post by Beehave »

Full disclosure before I respond: My idea of leveraging is sacrificing some current income for a healthy future pension.

That said, I've fairly recently scoured the internet for insight into the potential for steep, future inflation. Many of those offering their opinion suggest that a significant spike in inflation would likely be preceded by a sharp economic downturn. So the concern I have with your high-leverage real-estate defense against hyperinflation is the possibility of your leveraged position being wiped out by a sharp deflation just before that big inflation hits. That would be not the proverbial Mike Tyson punch in the face. It would be a Mike Tyson two punch knockout where first the leveraged holdings evaporate in the downturn and then you face the inflation in a depleted condition.

I'd suggest a employing a strategy with more diversification and learning to love it for its probabilistic robustness. Strategies based on belief we can predict the future with certainty are way too easy to fall in love with and way too risky in my opinion.

Best wishes.
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Re: Inflation, banking and real estate

Post by WS1 »

Are you also thinking about something historically moderate...like double our current inflation?

Lots of possible futures between current inflation and peak 70s inflation. Nobody ever wants to talk about a boring, but still consequential 5%
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SmallCityDave
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Re: Inflation, banking and real estate

Post by SmallCityDave »

Beehave wrote: Thu Jan 14, 2021 12:50 pm Full disclosure before I respond: My idea of leveraging is sacrificing some current income for a healthy future pension.

That said, I've fairly recently scoured the internet for insight into the potential for steep, future inflation. Many of those offering their opinion suggest that a significant spike in inflation would likely be preceded by a sharp economic downturn. So the concern I have with your high-leverage real-estate defense against hyperinflation is the possibility of your leveraged position being wiped out by a sharp deflation just before that big inflation hits. That would be not the proverbial Mike Tyson punch in the face. It would be a Mike Tyson two punch knockout where first the leveraged holdings evaporate in the downturn and then you face the inflation in a depleted condition.

I'd suggest a employing a strategy with more diversification and learning to love it for its probabilistic robustness. Strategies based on belief we can predict the future with certainty are way too easy to fall in love with and way too risky in my opinion.

Best wishes.
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SmallCityDave
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Re: Inflation, banking and real estate

Post by SmallCityDave »

WS1 wrote: Thu Jan 14, 2021 1:01 pm Are you also thinking about something historically moderate...like double our current inflation?

Lots of possible futures between current inflation and peak 70s inflation. Nobody ever wants to talk about a boring, but still consequential 5%
Certainly, but that's boring ;)

I'm not well educated about the 70's but it looks like the stock market tumbled but real estate rose a substantial amount. It appears that the rise in real estate is reminiscent of the 70's.
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Re: Inflation, banking and real estate

Post by Scooter57 »

The inflation of the 1970s was driven largely by the sudden dramatic spike in the price of oil, which affected both raw materials (plastics), manufacturing costs (heating, etc), and transportation. You also had the baby boom reaching the age where they wanted to start having families and thus were motivated to buy homes. There weren't enough homes because the previous generation had been so much smaller. Hence real estate shot up.

We have some short term inflationary pressures right now mostly because of the Pandemic disrupting supply chains and wealthy people fleeing cities for places they probably won't enjoy living in once they discover how different the lifestyle is in their havens. But unless you believe the pandemic will last forever, it is hard to see where your inflation will be coming from long-term.
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Re: Inflation, banking and real estate

Post by alex_686 »

SmallCityDave wrote: Thu Jan 14, 2021 12:05 pm Just a theoretical question if we experience high inflation such as 20% per year does it make sense to be highly leveraged in real estate?

I think we will see high inflation perhaps hyperinflation soon and I'm not a fan of debt or leverage but in this scenario does it make sense to be highly leveraged in real estate? Do the banks have any protections if we experience inflation like Venezuela?
A qualified yes.

Real assets, like real estate, should rise in value in tandem with inflation. This would be both for the property and rental income. Maybe not lease income - some of those have fixed terms for years.

Banks are a trickery question, but yes. Now, I am going to step away from inflation and talk about interest rates. Interest rates = expected inflation + real interest rates. A big driver of interest rates is inflation and I think this is where you primary concern is.

If you are familiar with bond duration, then know that banks are very aware of duration risk. Any bank of any size is going to have a team working on this who report directly - and often - to the CFO, CEO, board, investors, and the Federal Reserve. Lots of lessons were learned from The Great Stagflation periods (70s), Saturday Night Massacre (1979), S&L Savings Crisis (80s), and the Great Financial Crisis

Let us say that a bank has a 30 year mortgage which has a duration of about 10 years. This is a asset. As such, banks should fund it with a liability of 10 years.

Here are the basic options.

1. Sell the mortgage on to a Mortgage Backed Security (MBS). That removes it from your portfolio. You can let somebody else worry about the risk.

2. Sell a 10 year fixed bond.

3. Enter into a 10 year fix-to-float swap. Bank pays a fixed, receives a floating rate. You have now transformed a fixed rate asset into a floating rate asset. You can fund this from deposits on demand accounts (savings & checking accounts)

4. Bear the risk. The Fed looks at this number closely.

There are more advance options, but they build off of this.

Not saying that banks would not have issues - they would.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
alex_686
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Re: Inflation, banking and real estate

Post by alex_686 »

WS1 wrote: Thu Jan 14, 2021 1:01 pm Lots of possible futures between current inflation and peak 70s inflation. Nobody ever wants to talk about a boring, but still consequential 5%
I will differ. Society and the economy can handle inflation of up to 10%. It has got be constant. No big jumping around because of oil embargos. Lots of examples in the past 100 years across multiple countries.

That being said, I would be shocked if the US CPI breached 5% over the next 10 years.
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Re: Inflation, banking and real estate

Post by gwe67 »

SmallCityDave wrote: Thu Jan 14, 2021 1:50 pm
WS1 wrote: Thu Jan 14, 2021 1:01 pm Are you also thinking about something historically moderate...like double our current inflation?

Lots of possible futures between current inflation and peak 70s inflation. Nobody ever wants to talk about a boring, but still consequential 5%
Certainly, but that's boring ;)

I'm not well educated about the 70's but it looks like the stock market tumbled but real estate rose a substantial amount. It appears that the rise in real estate is reminiscent of the 70's.
There is no rise in real estate. Dead last for the year.
viewtopic.php?t=335582
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alex_686
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Re: Inflation, banking and real estate

Post by alex_686 »

gwe67 wrote: Thu Jan 14, 2021 2:31 pm There is no rise in real estate. Dead last for the year.
viewtopic.php?t=335582
This may well be off. True, real estate lagged, but what about highly leveraged real estate like the OP asked? Lots of people had mortgages that effectively negative real rates, with their fixed mortgage rate below inflation.
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Ramjet
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Re: Inflation, banking and real estate

Post by Ramjet »

SmallCityDave wrote: Thu Jan 14, 2021 12:05 pm I think we will see high inflation perhaps hyperinflation soon...
You are likely looking at the possibility of hyperinflation from a narrow lens. Think of inflationary versus deflationary forces as a tug of war of sorts. Globalization, U.S. demographics, and technology advances are all deflationary forces. Is printing money inflationary? Sure, but how much of that is actually getting into consumers hands? Stimulus checks have accounted for something like 20% of the QE so far. The other 80% goes to public health, schools, transportation, unemployment insurance, rental assistance, etc. Think back to 2008, how much stimulus got into consumers hands versus the banks? How much inflation was there? All I'm trying to get at is that the odds of hyperinflation seem miniscule and inflation may not be as much as a concern as you think, at least right now. To answer your question though, yes, real estate should be a good investment if meaningful inflation occurred
Last edited by Ramjet on Thu Jan 14, 2021 3:27 pm, edited 1 time in total.
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Re: Inflation, banking and real estate

Post by kosomoto »

gwe67 wrote: Thu Jan 14, 2021 2:31 pm
SmallCityDave wrote: Thu Jan 14, 2021 1:50 pm
WS1 wrote: Thu Jan 14, 2021 1:01 pm Are you also thinking about something historically moderate...like double our current inflation?

Lots of possible futures between current inflation and peak 70s inflation. Nobody ever wants to talk about a boring, but still consequential 5%
Certainly, but that's boring ;)

I'm not well educated about the 70's but it looks like the stock market tumbled but real estate rose a substantial amount. It appears that the rise in real estate is reminiscent of the 70's.
There is no rise in real estate. Dead last for the year.
viewtopic.php?t=335582
You're thinking commercial. Home prices are up over 10% year over year. I think the OP was talking about residential real estate since most individuals invest in rental properties in residential.

http://www.mortgagenewsdaily.com/12232020_fhfa_hpi.asp
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SmallCityDave
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Re: Inflation, banking and real estate

Post by SmallCityDave »

Great information guys, it's a lot to take in.
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SmallCityDave
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Re: Inflation, banking and real estate

Post by SmallCityDave »

Inflation is starting to seem more real now.
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Schlabba
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Re: Inflation, banking and real estate

Post by Schlabba »

SmallCityDave wrote: Wed May 12, 2021 7:48 pm Inflation is starting to seem more real now.
If you mean year-on-year inflation, you should think back to what happened this month last year. This 4+% was actually to be expected.
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Re: Inflation, banking and real estate

Post by Blue456 »

Scooter57 wrote: Thu Jan 14, 2021 1:52 pm We have some short term inflationary pressures right now mostly because of the Pandemic disrupting supply chains and wealthy people fleeing cities for places they probably won't enjoy living in once they discover how different the lifestyle is in their havens. But unless you believe the pandemic will last forever, it is hard to see where your inflation will be coming from long-term.
Maybe, maybe not. There is large exit of people from both California and NYC who are upper middle class and and can afford much bigger house, more privacy and more land.
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Re: Inflation, banking and real estate

Post by NiceUnparticularMan »

My understanding is usually diversified investments in real estate perform reasonably well with expected high inflation, particularly in the long run.

My understanding is also that real estate can be very volatile in the short term with unexpected high inflation, including having negative correlations at times.

I think people above have already hit on some of the reasons. Longer-term leases and such may fail to keep up in periods of unexpected high inflation. Unexpected high inflation may be correlated with other economically disruptive factors that interfere with income, cause relative depreciation of real estate in certain markets, and so on.

So I'd be a little cautious about highly-leveraged real estate investments, because real estate may only converge on reasonable real returns in unexpectedly high inflation scenarios in the long run.

Now of course in theory, if you are borrowing capital at nominal market rates, then those debts will also automatically be devalued in an unexpectedly high inflation scenario. But still, banks want to be paid each month, they don't want to hear your excuses about having trouble finding new tenants to replace tenants lost to economic disruption, and foreclosures can really ruin a real estate venture.

And then what happens if you are wrong, and inflation isn't unexpectedly high or is actually unexpectedly low? Now those nominal borrowing rates may not look so good.

Point being leverage is risky, and in that context it is important to distinguish between the expected long term performance of real estate with respect to inflation, and what can happen in the short term when inflation does unexpected things.
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Re: Inflation, banking and real estate

Post by Scooter57 »

Blue456 wrote: Thu May 13, 2021 5:45 am
Scooter57 wrote: Thu Jan 14, 2021 1:52 pm We have some short term inflationary pressures right now mostly because of the Pandemic disrupting supply chains and wealthy people fleeing cities for places they probably won't enjoy living in once they discover how different the lifestyle is in their havens. But unless you believe the pandemic will last forever, it is hard to see where your inflation will be coming from long-term.
Maybe, maybe not. There is large exit of people from both California and NYC who are upper middle class and and can afford much bigger house, more privacy and more land.
A bigger house and more land are nice. When you have to drive 30 minutes to the supermarket and drugstore, and that market is not at all like Zabar's, the thrill wears off. When you realize that the much-touted local "culture" is, well, provincial, one step up from High School musicals and largely made up of touring performers who were really hot 30 years ago, and when you discover that there are only a few local restaurants that are serving more than Pizza and burgers reality sets in.

I live near an area that traditionally attracts NYC refugees. They do buy those very large houses, but several that we have known over the years end up selling out and moving back to cities. They get too bored. Though realtors promote the area it is a "short drive" to the major coastal cities, that short drive is 3 or 4 hours (depending on the city and the traffic) which is too far to go for taking in dinner and a show when the urge strikes you.
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Re: Inflation, banking and real estate

Post by x3sphere »

Real estate should do well in period of high inflation. Hyper inflation though? I honestly don't know, seeing as the dollar is considered the reserve currency hyperinflation of it could have some serious geopolitical ramifications. The dollar hyper inflating compared to Venezuela's currency hyper inflating is a much bigger deal. You would be talking about goods/services going up 1000%. This would certainly have a destablizing effect and I'm not sure I'd want to be leveraged to the max in such a scenario.

I think it's unlikely I see hyperinflation of the dollar in my lifetime and I'm 32 atm. The Fed will do everything they can to prevent that from happening even if it means crashing the markets.
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Re: Inflation, banking and real estate

Post by DB2 »

Scooter57 wrote: Thu Jan 14, 2021 1:52 pm The inflation of the 1970s was driven largely by the sudden dramatic spike in the price of oil, which affected both raw materials (plastics), manufacturing costs (heating, etc), and transportation. You also had the baby boom reaching the age where they wanted to start having families and thus were motivated to buy homes. There weren't enough homes because the previous generation had been so much smaller. Hence real estate shot up.

We have some short term inflationary pressures right now mostly because of the Pandemic disrupting supply chains and wealthy people fleeing cities for places they probably won't enjoy living in once they discover how different the lifestyle is in their havens. But unless you believe the pandemic will last forever, it is hard to see where your inflation will be coming from long-term.
I agree, the 70s were a different dynamic. I think some of this inflation is transitory, however, I think it depends on what happens to the dollar with this amount of unprecedented debt level which will exceed WWII - only there is no war.
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Re: Inflation, banking and real estate

Post by Jebediah »

I would think rents would more or less keep up with high inflation but home prices would not because with inflation you assume rising mortgages rates which should depress prices.
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Re: Inflation, banking and real estate

Post by Tommy »

Jebediah wrote: Fri May 14, 2021 5:58 pm I would think rents would more or less keep up with high inflation but home prices would not because with inflation you assume rising mortgages rates which should depress prices.
Except places where rent control exists. And assuming that in places where not exists people will be able to pay..
Home prices big unknown. In countries experienced big inflation in the past houses stopped to sell in local currency. What will happens in US I don't know.
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Re: Inflation, banking and real estate

Post by Blue456 »

Scooter57 wrote: Fri May 14, 2021 3:59 pm
Blue456 wrote: Thu May 13, 2021 5:45 am
Scooter57 wrote: Thu Jan 14, 2021 1:52 pm We have some short term inflationary pressures right now mostly because of the Pandemic disrupting supply chains and wealthy people fleeing cities for places they probably won't enjoy living in once they discover how different the lifestyle is in their havens. But unless you believe the pandemic will last forever, it is hard to see where your inflation will be coming from long-term.
Maybe, maybe not. There is large exit of people from both California and NYC who are upper middle class and and can afford much bigger house, more privacy and more land.
A bigger house and more land are nice. When you have to drive 30 minutes to the supermarket and drugstore, and that market is not at all like Zabar's, the thrill wears off. When you realize that the much-touted local "culture" is, well, provincial, one step up from High School musicals and largely made up of touring performers who were really hot 30 years ago, and when you discover that there are only a few local restaurants that are serving more than Pizza and burgers reality sets in.

I live near an area that traditionally attracts NYC refugees. They do buy those very large houses, but several that we have known over the years end up selling out and moving back to cities. They get too bored. Though realtors promote the area it is a "short drive" to the major coastal cities, that short drive is 3 or 4 hours (depending on the city and the traffic) which is too far to go for taking in dinner and a show when the urge strikes you.
I live 3-4 hours from NYC but thanks to that I have every weekend off, I never work evenings and my job never calls me home. I no longer get silly 1am or 3am calls. Thanks to that I get to spend every weekend with my children and I can dedicate them 100% of my attention in the afternoons. Additionally I get paid 50% more than what I would get in a big city. For us this is worth commuting 3-4 hours once a month to NYC. But we are also about 1-2 hours away to other big cities which often have fun things to do for kids as well. I completely disagree with you on shopping. Our Wegmans, Walmart, Aldi and Target are all 5 minutes drive and not 40 minutes in traffic like in NJ or NYC. Of course there are places in NY state where you can live completely off the grid with your nearest neighbor 1 hour away but that wasn't our goal and I agree that going from NYC into complete farmland set up would be a mistake for most people who lived all their life in a big city. Finally on the culture perspective I found a small town with neighborhood of mostly like minded highly educated people.
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Re: Inflation, banking and real estate

Post by Goldwater85 »

To OP’s original point, real assets levered by fixed rate debt are good long-term inflation hedges. Asset prices will ultimately adjust to reflect currency devaluation (maybe not immediately—recession and higher interest rates may hold values in check) while the debt becomes cheaper to repay.

Very long term, demographic shifts in the U.S. are likely to be a major source of deflationary pressure. A country with fewer, older people simply tends to consume less of most things than a country with more, younger people. Europe is well ahead of us on this. Japan illustrates that no matter how inflated your money supply or low your interest rates, it is difficult to have any endemic inflation while your population is significantly shrinking and aging.
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Re: Inflation, banking and real estate

Post by Scooter57 »

Blue456 wrote: Sat May 15, 2021 6:16 am
I live 3-4 hours from NYC but thanks to that I have every weekend off, I never work evenings and my job never calls me home. I no longer get silly 1am or 3am calls. Thanks to that I get to spend every weekend with my children and I can dedicate them 100% of my attention in the afternoons. Additionally I get paid 50% more than what I would get in a big city. For us this is worth commuting 3-4 hours once a month to NYC. But we are also about 1-2 hours away to other big cities which often have fun things to do for kids as well. I completely disagree with you on shopping. Our Wegmans, Walmart, Aldi and Target are all 5 minutes drive and not 40 minutes in traffic like in NJ or NYC. Of course there are places in NY state where you can live completely off the grid with your nearest neighbor 1 hour away but that wasn't our goal and I agree that going from NYC into complete farmland set up would be a mistake for most people who lived all their life in a big city. Finally on the culture perspective I found a small town with neighborhood of mostly like minded highly educated people.
Your last sentence is telling. I suspect that the reason that your town is full of "like minded highly educated people" is that its real estate prices have been inflated to a level where no one who grew up in that region and didn't go to a top 10 university can afford to buy property there, nor can young people who aren't dedicating their lives to making money in conventional careers live there and create together.

I have seen several communities that were vibrant, exciting places filled with young, creative people in the 1970s, 1980s, and 1990s turn into just that kind of community since 9/11 sent the first wave of New Yorkers out of the city. The housing stock gets fancier and fancier, the neighborhoods more suburban, and the creative young people and locals are priced out, at which point the chain stores move in--just as you describe. I bet you have quite a few restaurants where dinner will cost you well over $100, too, several with "Bistro" in their names.

This is pleasant for the big city people. But this suburbification has destroyed the unique character of some of my favorite small towns. The uniformity that comes when urbanites move in, with the strip malls and the traffic and the developments full of mini-mansions is destroying something valuable and irreplaceable.
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Re: Inflation, banking and real estate

Post by Blue456 »

Scooter57 wrote: Sun May 16, 2021 7:32 am
Blue456 wrote: Sat May 15, 2021 6:16 am Finally on the culture perspective I found a small town with neighborhood of mostly like minded highly educated people.
Your last sentence is telling. I suspect that the reason that your town is full of "like minded highly educated people" is that its real estate prices have been inflated to a level where no one who grew up in that region and didn't go to a top 10 university can afford to buy property there, nor can young people who aren't dedicating their lives to making money in conventional careers live there and create together.

I have seen several communities that were vibrant, exciting places filled with young, creative people in the 1970s, 1980s, and 1990s turn into just that kind of community since 9/11 sent the first wave of New Yorkers out of the city. The housing stock gets fancier and fancier, the neighborhoods more suburban, and the creative young people and locals are priced out, at which point the chain stores move in--just as you describe. I bet you have quite a few restaurants where dinner will cost you well over $100, too, several with "Bistro" in their names.

This is pleasant for the big city people. But this suburbification has destroyed the unique character of some of my favorite small towns. The uniformity that comes when urbanites move in, with the strip malls and the traffic and the developments full of mini-mansions is destroying something valuable and irreplaceable.
I don't understand your point. I still get to live in a nice area, for less than NYC, with like minded people and for higher pay and better life style than what NYC could offer for me. As for being poor and young, I grew up as a poor kid in a small-medium size town in Europe. I came here and made my American dream come true. Nothing wrong with now enjoying the fruits of my hard work.
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