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Looming Inflation

Looming Inflation How you can protect your family's wealth

Controlling inflation is going to be a nightmare for governments and central banks over the next 5 years, especially if it happens when interest rates are still low.

Inflation can be a bit like a drunken visitor - once you let them into your house it´s very hard to get rid of them. If you´ll forgive the extension of a crude pun, the drunks will be banging on a lot of doors soon.

China, India and Brazil are already battling with inflation as is Britain. The jury is still out on the USA in the short term, but I think higher inflation is inevitable. You´ll find all manner of predictions on the internet (from wildly optimistic to doomsday) regarding the course of US inflation once the Fed Reserve starts to unwind it´s gargantuan quantitative easing program

Inflation: Winners and losers
On the one hand, high inflation can cause a lot of damage to people holding (non commodity) stocks, government bonds, variable rate mortgages, bank deposits and unprotected pensions. A huge amount of people fall into this category.

On the other hand, you don´t need to be Paul Volcker (famous US central banker who tamed inflation in the 80s) to know that the higher the rate of inflation, the more expensive everything will become. That includes property prices and rental rates.

To clarify - if inflation is high, the value of your property will increase and the rent tenants pay to their landlords will increase. Looking at figures for the US market over the last 40 years (i.e. not just the recent boom), property prices have consistently outpaced the rate of inflation.

Property - there´s more to it than supply and demand
Property is unique in many respects, and the fact that people gossip about it more than any other investment is just one of them. It is also unusual in that prices are set by local transactions - one absurd bid on a house can push up the value of every other property on the same street.

Culture also has a major influence (Germans like renting, Americans like owning), as do property taxes (very high in Spain, reasonably low in Britain). The lax property laws and politics of Ireland´s outgoing government made a hefty contribution to the recent boom (and was a major reason the incumbent Fianna Fail party were hammered in recent elections).

Less obvious factors like demography (a steadily increasing population has always underpinned US housing investment from institutional buyers) and geography (limited space in Hong Kong, lots of space in Phoenix) can also have dramatic impacts over time.

Efforts to control the property market can often have unintended side effects. Spanish first time buyers have always had to deal with very strict mortgage lending laws, and yet the same banks that were required to ask for 25% deposits were given free rein to finance rampant speculation on behalf of developers. On the other hand, German banks who couldn´t lend to local developers invested in subprime mortgage bonds in America instead. Go figure.

What can we predict about property?
Nowadays, most people would agree that property investment can be very unpredictable and making a profit is far from guaranteed. However, there is quite a lot you can predict about how a market will move, especially if prices are bottoming out.

A high net rental yield, free of gimmicks, is one of the simplest and easiest ways to establish if a property is over or underpriced.

During equilibrium, you can expect a 3-5% yield, depending on the area. During a bubble, yields tend to be very low (1-3%) mostly because speculation causes prices rise faster than rents. When a market bottoms out and rent rates increase before house prices do, you can get 7% and above.

The ratio of house prices to rents is another indicator of a balanced market. Over the long term the average should be 100 and if a market is oversupplied, the ratio will be very high.

For example, the two biggest property bubbles, in Spain & Ireland, had ratios of 160-180 in 2006-2007, which was ludicrously high. Of the four best known property crashes (US, Spain, Ireland and Britain) only the USA is back to its long term average of 100.

Cash is still king
The great benefit of buying a cash positive property with your own money is that you will be insulated against rising mortgage interest rates as well as inflation. There are many cities in the US and elsewhere that have seen prices of quality properties fall way below construction cost. If you can identify which of these cities have stable rental returns, you may have a unique opportunity to hedge against inflation and protect your family’s wealth for years to come.

Colin Murphy

Colin Murphy is Director of Torcana.com, a Dublin & Florida based investment specialist which promotes a variety of real estate investments in the USA (primarily Florida) and solar energy investments in Italy, Germany and the United Kingdom.

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