inflation

Editorial

Editorial: Inflation is Coming, Inflation is Coming!

It is my opinion that we are going to have some inflation in the United States shortly, and that this will be a good thing for the economy — and especially good for real estate.

I believe inflation is the inevitable result of the monetary and fiscal policies of the past year and those projected for 2011. Budget deficits have been growing dramatically, in absolute terms and as a percentage of GDP, and for the most part up to now they have not been financed with newly printed money. Instead, the deficit has been financed primarily with Treasury Bonds sold to foreign investors (China being by far the largest).

By announcing its plan to inject $ 600 billion into the economy by buying up Treasury Bonds to support the recovery and boost prices, the Federal Reserve Bank has unleashed a near-certain inflation. Fed Chairman Ben Bernanke has reiterated that the Fed is prepared to buy even more Treasury bonds over the next eight months, to continue the "economic easing" he began last month.

The simple fact is that this amounts to the Fed printing $600 billion dollars of paper money. Anyone who has taken an economics course knows that printing paper money causes inflation. That said, a modest inflation should be welcomed by those in the real estate industry.

“...a modest inflation should be welcomed
by those in the real estate industry."



A reasonable rate of inflation is good for real estate. The magic of real estate has historically been that you could invest in real estate (a home or investment property) with a small down payment, and borrow the balance with a long-term mortgage. Wise investors know that the mortgage must be at a fixed interest rate. Then, if inflation occurs (as it has for many decades), the investment appreciates in value.

Here is an example of how the magic of real estate investments works when there is a reasonable amount of inflation. Say the purchase price of a property is $300,000. The buyer puts down 10% of the purchase price, or $30,000. They get a mortgage on the remaining $270,000. In this example, the cash investment was $30,000. If there is an inflation of 3% a year, in just 5 years the property will be worth $345,000 ($300,000 x 115%) and the investor will have made $45,000 -- a 150% return on their initial $30,000 investment.

Of course this example is an over simplification, as it does not consider many other factors that may affect the value of the property, but it does explain why real estate has been a great investment when a small but reliable rate of inflation is operating in the economy.

Psychologically, moderate inflation stimulates spending, and lowers the real cost of paying off long term debt (you can pay off your mortgage using inflated dollars which are of lower value).

A nicely timed moderate inflation is, in my opinion, what will get us out of this slump! Hats off to Ben. I think he's made the right decision at the right time.