“Modern Monetary Theory” is a new trope or illusion popular with the political left that most income property investors have likely never heard of. Even if they have, it is sufficiently arcane (mysterious, secret) they are likely to ignore it. You do this at your own peril from an equity and income standpoint.
Modern Monetary Theory posits that the Fed can provide virtually unlimited funding (money) with little or no downside from an inflationary standpoint. This is the takeaway from the Fed purchasing $3.7 trillion of government and private debt from 2008 – 2014 and defying conventional economic wisdom, not causing any inflation other than financial asset price inflation.
With the economy in a deep contraction from the coronavirus shutdown, this becomes the predicate for a new round of unlimited spending and additional debt. However, this time around things are very different. Instead of paying banks interest on their excess reserves which inhibits lending and expansion of the money supply, the Fed has reversed course by lowering this rate along with the reserve capital requirements mandated under the Dodd-Frank Act.
According to the WSJ, to shore up a capital depleted economy “in the past two months, the money supply has risen at an annualized rate of 102%.” Therefore, during the recovery that is coming, banks will have both the monetary capacity and the incentive to “expand loans, ballooning the money supply and creating inflationary pressures.”
This is of particular significance for income property investors. If, contrary to political class expectations, inflation does again raise its ugly head it spells death for long term, flat triple net leases. This is because commercial, income producing properties behave in a very similar way to bonds in an inflationary/rising interest rate environment.
If the income stream from your property remains relatively flat while rates of return are going up elsewhere due to rising interest rates, the value of your property will likely go down.
An inflationary/rising interest rate environment can be particularly hard on long term triple net leases. This is because triple net leases are most often used for freestanding commercial buildings, with a single tenant. These leases typically have an initial term of 10 years or more and often have rent increase built in.
However, these rent increases tend to be incremental (small). This is the trade-off for the greater security offered by a long term tenant; the longer the lease, the flatter the rent. This lease structure works well when interest rates are flat or declining. When interest rates rise they are more liability than asset.
If you are unable to raise rents in a commensurate manner with interest rates, there is a strong likelihood your property value will go down. This is because buyers newly come to the market can generally discover lower prices and higher yields than were available to you.
The historical method to hedge against this risk, is to focus on operating assets such as; self-storage, apartment buildings, senior living, hospitality, anything with a short lease interval. These property types and their short lease duration (anything from a day to a year) have the potential to provide you with the flexibility to increase rents in a commensurate manner with interest rates. This, of course, assumes full occupancy.
There will be lasting economic changes wrought by Covid-19 and government’s unprecedented spending response. For income property investors to assume we will get off lightly from an inflationary standpoint is dangerous. The ‘experts’ have been wrong at every turn regarding this. To assume their Modern Monetary Theory of unlimited money creation with no downside is correct may be a very costly mistake.