Real Estate in an Inflationary Market
Inflation means that your dollar can buy less this year than it could last year, i.e. there is more money in circulation in the economy than before; all else being equal, a loaf of bread costs the same one year to another, save for inflationary effects.
Tangible assets with a finite supply, such as real estate, gold, and commodities, have all been used to hedge against and profit from inflation.
To illustrate: consider an economy that has total money available of $10 and there are 5 identical houses in the whole economy. Each house would be priced at $2 (assuming no other goods available to purchase). Now, suppose the central bank puts in an additional $10, expanding the supply to $20; each house would eventually reach $4. In this simplistic example, increasing the money supply causes house prices to increase.
OK, so why does real estate appreciate (increase) with inflation?
There are a few reasons:
- There is a finite amount of real estate. Yes, we can build higher, but land is never increasing. So, when the money supply grows, real estate should appreciate with inflation.
- A property is an asset and its rent can increase. When there is inflation, money decreases in value and landlords will increase their rents. The increase in rents provide for higher “cap rates” (return on investments) or, most likely, an increase in the value of the real estate.
*Even if your property is not a rental, the benefits of rental properties increasing in value will also affect yours and those surrounding them.
- Fixed mortgage rates… In an inflationary market, the dollar in interest you’re being charged is actually worth less this year than it did the last. This can put upward pressure on the value of your home.
By far, supply and demand is the most important factor in real estate’s values keeping with inflation due to real estate being a finite resource. If supply and demand stays the same, and the money supply increases, the price of goods will increase.
Is Inflation Going to Happen?
This is a great question (thanks for asking, Eitan). To make things simple, inflation happens when:
- Wages grow: During economic booms – Demand-side inflation
- Rising input prices: such as oil, timber, etc. – Cost-side inflation
- Currency depreciation vs others: rising import costs – Pass-through inflation
- Low unemployment: Strong economy and wage negotiation – Wage-push inflation
- Rapid expansion of money and credit: Gov’t programs – like now – Demand-side inflation
Over the past few years, Canada and the USA had pretty stable inflation. Believe it or not, governments want inflation and we’ve been right on target. You’d assume that since unemployment has been low, we would have large wage push inflation but apparently wage growth did not happen with low unemployment.
Now, we have two competing forces.
Experts are saying that since we have a rapid expansion of money and credit due to government programs such as the CERB, CEWS, BCAP, CEBA, and more, we should see inflation down the road. The money supply is increasing quite dramatically.
However, just because we have stimulus, doesn’t mean we’re going to have inflation…
What’s yet to be determined is what will be the long-term impacts of COVID-19 on employment and wages. Should companies be able to reopen and bring back “business as usual” quickly, we will probably see inflation.
However, if it takes many more months or even years to get the economy back on track, the monetary stimulus we’ve been seeing would not have been enough to create inflation, but just a stopgap to prop up and stave off economic collapse.
Furthermore, just because the money supply has increased now, doesn’t mean we’ll see the spending of that money. From the example above with the central bank putting in an additional $10 into the money supply, what would happen if, after a year or two, the government decides to raise taxes in order to recoup some of the money they have put into the economy? It’s entirely possible that that $10 given today would be taxed tomorrow. Or, more simply, if the $10 is put into people’s savings account instead of being spent? That money would no longer be available in the market and not part of the money supply.
More on the “velocity” of money and how it affects inflation here.
So, Inflation?! Real Estate?!
Even if Canada does not have inflation, we’re still down to the supply and demand side issues of Vancouver real estate. There is just far too much demand for the supply in Vancouver.
Prices will continue to increase. Period.
*There’s the obvious factor of COVID-19 negatively impacting the economy and people’s ability to purchase in the short term, but based on what I’m seeing, it’s not going to decrease values by much.
Just a quick fact: Vancouver itself has 115 sq. k.m., whereas Toronto is 630 sq. k.m. Greater Toronto is 7,124 sq. k.m., and Metro Vancouver is 2,700 sq. k.m. (half of which livable and half is mountainous above North Vancouver and Coquitlam)…