inflation

DSTs Peak Inflation and Deja VU

Now that inflation is here and the Federal Reserve has pledged to keep the pedal to the metal and let it rise, income property owners must ask themselves what this means to their future and survival of their wealth.

Few, if any of our investors would disagree that our nation is at an economic turning point.  The problem is in deciding how to respond to it from an investment standpoint.  We feel those who judge it correctly may keep their wealth.  While those who get it wrong may be devastated, with some seeing a lifetime of work washed away.

Covid-19 hit the U.S. and world economies hard.  Taking the low road in appealing to instant gratification and venality, Biden has unleashed unprecedented spending, estimated at $6 trillion and counting.  However, with very little true investment taking place as a result of this, we feel this will likely act as a massive boost to inflation, which is already running beyond the official 1.4%.

Adding to this are Biden’s massive, proposed tax increases on corporations.  This, of course, could be passed along to consumers in the form of higher prices, further stoking the fires of inflation.

Inflation, already in double digits if timber, copper, gas, food, education and healthcare are included may force the Fed to raise interest rates far sooner than most expect.  This is because with consumers paying more every time they open their wallet for food, fuel and other staples higher inflation expectations may become embedded in business and consumer decisions.  This would be like throwing gasoline on a fire.  If this occurs the Fed will have no choice but to end the party, perhaps more abruptly than most people, including Powel and Yellen, think. 

It’s important to understand that the Fed is never right for very long.  Since its creation in 1913, it has presided over a 98% devaluation in dollar.  This means that what cost you 2 cents in 1913 now costs you a dollar.  This is because successive Fed chairs starting with William McChesney Martin then following through with Arthur Burns, presided over a monstrous increase in the money supply to artificially stimulate growth and curry favor with sitting presidents.

Alan Greenspan, Ben Bernanke and Janet Yellen then picked up the torch driving the Federal – funds rate down to 1% in 2003, contributing significantly to the housing bubble and leading to the Great Recession.

Chairman Jerome Powell is continuing this easy monetary policy in the face of rising inflation and exploding government deficits.  In so doing, it is clear the Fed “has engineered another housing boom in the past year and continues to stimulate this form of economic consumption via $40 billion of mortgage-backed securities purchase each month.” (WSJ 6/15/21)

The housing market did not need this additional stimulus to begin with.  Demand was already strong pre-pandemic.  All this is doing now is skewing incentive to over invest in housing.  Sound familiar?  Think 2007 – 2008.  Don’t these people ever learn anything?

Other asset prices are soaring as well; SPACS, which raise capital via IPOs for unknown acquisitions, non-fungible tokens and junk bonds.

Human behavior seldom changes at speculative market tops like this.  All and sundry rush to impute value to essentially valueless things.  What does change is the locus of this behavior.  Therefore, it is imperative for income property investors to determine the place or site that this activity is focused upon and stay as far away from it as possible.

If the Fed continues to not take current inflation issues seriously and allows real short term treasury yields to remain negative, cap rates may continue to compress.  If this proves to be the case cash-on-cash returns may shrink as well.

This may result in more non-core asset types coming to market as investors chase yield.  This is what happened in 2007-2008 with catastrophic results as soon as the Fed did begin to tighten. 

Investors overreacted, sending the real economy into a tailspin.  Non-core property types went dark and much money was lost.

With interest rates still near historic lows, we believe the Fed has ample room to infuse some reality into markets without running things off the rails.  However, it must act soon.  Wise real property investors will consider hedging against another too-little-too-late response by the Fed in not straying too far from investment grade commercial property types.

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