Smoke And Mirrors And DSTs

Smoke & Mirrors & DSTs

According to Meriam-Webster, the meaning of smoke and mirrors is “something intended to disguise or draw attention away from an often embarrassing or unpleasant issue.”

This is exactly what master of the Universe, Jerome Powell and the FOMC’s (Federal Open Market Committee) stated policy of raising rates at each of its remaining six meetings this year is – smoke and mirrors.

It is intended to create the illusion that something is being done about the inflation they said couldn’t occur, while in reality doing nothing.  According to economist Larry Kudlow, the Federal Reserve “hasn’t done one single thing yet to deal with inflation.”

This is because the Fed is still buying bonds and increasing the size of their balance sheet.  This, of course, injects more cash into an economy that doesn’t need anymore cash.  This is analogous to throwing gas on your house when it’s on fire.

To effectively address today’s inflation, they should be withdrawing cash from the economy by selling bonds from their portfolio.  Apparently, this is something anathema to Mr. Powell and his cohorts.

In keeping rates too low for too long and continuing to grow the Fed balance sheet, Powell must be seen as the second coming of Arthur Burns, Fed Chairman between January 31, 1970 and March 8, 1978.

Burns assumed leadership of the Federal Reserve in the middle of what would later become known as the Great Inflation (1965-1982).

In proving too accommodating to then President Richard Nixon, Burns’ easy monetary policy spurred a huge surge in inflation and inflation expectations.  Sound familiar?

His belated response to these pressures, much like Powell’s today, ultimately led to a brutal recession and double digit interest rates.

Spanish writer and philosopher George Santayana famously said, “Those who cannot remember the past are condemned to repeat it.”  In the age of Twitter, who remembers anything beyond their last tweet?

Technically, with first quarter real growth looking to be around 2% and 7-8% inflation, we are already experiencing stagflation.  When inflation is higher than growth, that is the very definition of stagflation.

Please note our blog dated June 2, 2020 “DSTs and the Specter of Stagflation” when we first cautioned investors regarding this.

These conditions of increasing economic uncertainty are now exacerbated by war.  We first brought this to investors attention on August 30, 2021 with our blog entitled, “DSTs and the Risk of War.”

With inflation going higher and lasting longer and more socio-economic upheavals potentially still to come, how should income property investors respond?  We think a thoughtful and thematic approach to portfolio modeling appropriate.  This should be done in light of the recession that may follow in the wake of spiraling inflation and interest rates.

Emphasis should be placed on consideration of asset types such as, medical office buildings, self-storage, multifamily, manufactured housing, etc.  All these assets have a track record of resilience during tough times.

Opportunistically, consideration should also be a given to single property types such as gas stations, doctor’s offices and corner grocery stores.  As individual small businesses, these property types obviously carry greater risk.  However, this may be mitigated to some extent if multiples are included.

The need to buy gas, food and attend to your health is self-evident.  Venturing into more obscure corners of the property market may provide retail investors with better valuations.  Big asset managers typically avoid these property types.

However, smaller tenants such as these may have a place in a portfolio as long as investors do their due diligence in a thorough and comprehensive manner.  Walgreen’s also closes locations so there is risk associated with any real estate investment.

As Milton Friedman suggested in the past, the way to whip inflation is to stop printing money…now.  Unfortunately, Joe Biden having declared on the 2020 campaign trail, “Milton Friedman isn’t running the show anymore” is disinclined to do this.  You, dear investor are paying the price.

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