Investing During Inflation: Real Estate
More and more pundits and observers looking for a secular increase in inflation. Now Jim Rogers, who has a good track record on calling big turns, is talking about the potential risks of hyperinflation. The big question for most people is no longer “will we have inflation” but rather, “how to invest during inflationary time periods?” The asset class that I am asked about most is real estate. After all, real estate has many of the characteristics that you would look for in historical inflation periods and real estate, particularly residential real estate in the United States, performed well during a notable recent period of inflation, the 1970′s and early 1980′s.
I am not so bullish on real estate as an investment, although I think the evaluation is very specific to the local area conditions. My primary reason is that real estate has benefited from the bubble of easy credit and has mostly decoupled from wage growth. In addition, for many areas, the real estate boom led to over building and rampant speculation, I think that will have a few years to work itself out. Here are the following reasons, I am wary on real estate as an investment:
–Lack of liquidity- unlike stocks and bonds, real estate tends to be illiquid. With inventory levels high, and new homes competing with bank foreclosure sales, the amount of time needed to sell a house is substantially longer than 2 years ago. In case of an emergency or a desire to re-allocate investments, the lack of liquidity is a huge barrier.
–High transaction costs - Although most real estate transactions today do not hit the maximum 6% fee that brokers can assess, I have been surprised at how real estate fees have not moved downward. Compared to mutual funds and stocks, the transaction costs are still comparatively high.
–Lack of transparent pricing – one of the good things about holding marketable securities (stocks, bonds, mutual funds, most options and other exchange traded products), is the availability of knowing what a mark-to-market price is. I have many neighbors who are confident that their homes are worth about 20% more than what I think they would receive if they were to try to sell the place today. This lack of accurate pricing information has been a major cause of overspending across households. Hopefully, new sites and tools such as Zillow may improve this situation.
–Inability to diversify – One of the challenges of having a large percentage of assets tied up in one investment is the inability to diversify risk, including diversity of currency and geographical exposure. Since I am more bullish on growth in emerging markets, and bearish on the future value of the US dollar, I have a lot of investments outside the US.
See more inflation musings in previous posts:
Investing for Inflation
The Money Illusion
Will Historic Patterns Hold
The Shrinking Dollar
see other posts at this week’s Carnival of Personal Finance
These are some great points and they are all definitely valid.
But, there are also many positive points of invsting in real estate that have been overlooked in this post. Avantages such as leverage, preferred tax treatment and the practical value of a real asset help to counter some of the negatives listed above.
Bret, yes, the points you raise have underpinned the desirability of real estate. In my opinion (which is simply my opinion), many of the advantages such as leverage, lower capital gains taxes compared to stocks, are only advantageous if prices are going up and if property is actually transacted. The situation is very local, and while I believe many localities may present real estate investment opportunities, I am skeptical that we will have a quick return to a booming market.
From the lens of current inflation rates, real estate does look bad. Historically, real estate does well during inflationary periods. I expect that this will be true in the coming years as well. Inflation is really the only way out of the real estate bubble for many.
However, in the areas that aren’t way out of line with historical pricing, real esate will be a great inflation hedge
Paul, good points.
I’m buying Reo homes that need little repair at discount prices in the nicer neighborhood areas and renting them out. Although I am financing them they are cash flowing or near to cash flow. The market seems strong for these homes and I am getting nice tax breaks. My plan is to wait for inflation (which is certainly on the way) and at the right time sell the homes. Other than paying taxes on the profits whats wrong with my plan ?
Del, sounds like a good plan. Just be sure to sell when necessary.