Real Estate Isn’t as Safe From Inflation as You Think

25:22They were already super slow in January and February. Mortgage rates have gone up a half point. I think it's probably going to get slower even though we're going into the spring selling season, which is not good news. But basically, much of what's happened, you know, the inflation situation and the real estate situation have been really closely tied together. A lot of the boom that we saw in 2020 to 2023 was because of inflation and money printing. There was a lot of demand pull inflation. We had artificially low money making affordability. Great. That increased demand. Right. That is why we saw this boom during COVID.

25:57And then when the pendulum swung back the other way to fight inflation, we had to reduce demand. That's what raising interest rates does, right? It stops that demand pull inflation cycle because it costs more when people can't afford things that lowers demand. And so we've seen lower demand that has slowed down inflation and it has slowed down the real estate industry with it. So then even though we've come down from 9 % to 3%, even though it's working slower than we all want it, let's be honest. I think we wish inflation went down faster, but it is working, even though it's been required some patience.

26:34Why am I so concerned? Why are we even talking about inflation right now if it's calmed down? Well, I would say that there are three different inflationary pressures that we are seeing in the economy right now. The first is tariffs. We've talked about this before, but tariffs are inflationary. I know a lot of people like to argue that, but it is true. and even though the top line CPI has not gone up that much, it did go up after the tariffs were introduced. And I'll just say this, like people say like, oh, inflation is down, tariffs didn't do anything. If we didn't have tariffs, inflation would be lower right now.

27:07Like look at any reputable study and you'll just see that this is true. Study after study, all across the aisle, different political spectrums, tariffs increase inflation. And so I don't know what it would be if we didn't have tariffs, but that is an inflationary pressure. Like that's just true. Just look at housing in particular, right? Like if you want to look at how tariffs increase the cost of housing, I can tell you we have seen tariffs anywhere from 10 to 45 percent on lumber. We've seen copper up to 50 percent. They've been changing a lot. So I'm just kind of giving ranges. Cabinets and vanities are up 25 percent.

27:41You know, we see drywall. We see steel and aluminum prices are all up. If you look at the National Association of Home Builders, their estimate is that these tariffs have raised the cost to build a new home by$11 ,000. If you look at the Center for American Progress, just different methodology for doing it, they think$17 ,500 per home. If you look at these studies, the Center for American Progress estimated that tariffs will lead to 450 ,000 fewer new homes being built in just the next couple of years by 2030. And so you can't tell me that's not raising prices for homes. Now, if there's no demand, prices could come down in the short run.

28:19But what is happening is replacement costs are going up and that puts the floor for home prices even higher, even if there's a temporary dip in prices in the short run. So that is one inflationary pressure, but that is not the only one. The second one is a labor supply squeeze, right? On one hand, I am worried about unemployment going up. So that could mitigate this issue just to call that out. But particularly in housing, 30 percent of construction workers are immigrants and deportation policies are creating labor pressure, which means that labor costs in construction could go up in addition to what we're seeing from tariffs.

28:54So that is inflationary pressure. The other thing, you know, we obviously got to call out geopolitical risks like we have seen over the last couple of years supply shocks that have come from war. You know, right now we're talking about the oil prices in Iran. But if you looked at wheat prices, right, when Russia invaded Ukraine, like we have a very interconnected global supply chain. And if a war breaks out, a geopolitical situation emerges, whether it's in Iran or Ukraine or in the future in Taiwan, like who knows? But those kinds of things are absolutely supply shock risks for inflation. We're seeing it right now.

29:30Like the price of oil has gone up 50 percent in the last couple of weeks, that is going to ripple through the economy and we're going to see some inflation. Does that mean we're going to get to four percent, five percent? I don't know. Probably not just from oil prices. That's just my understanding of it. But is it going to make inflation a little bit higher? Probably. The last one I want to mention is sort of a long run structural concern, which is our rising national debt. I've done entire episodes on this. It's something I think a lot about. But basically, we have rising debt in this country.

30:02It's making up more and more of the federal budget every single year. No party has been able to even tame it. It's just growing at a faster and faster rate over the last, I think it's like 22 years, right? It just keeps going and getting worse. At some point, the rubber is going to need to meet the road there. And there are different ways you can do that. You can do it through austerity, basically spending less. You can do it through raising taxes, both of which seem politically impossible in the United States right now. I know one party wants to raise taxes. The other one wants to cut spending.

30:32neither of them actually do it right like that's why otherwise you would just see the deficit get under control but both parties have been in power over the last 22 years deficit has been rising under both parties right so what's the third option you print your money you print your way out of it right we have 39 trillion dollars of debt there is no rule that says we can't print 39 trillion dollars and just pay people back now you don't want to do that because that is there is all sorts of negative consequences you will see inflation go through the roof bond rates will go through the roof. Mortgage rates will go through the roof.

31:05You know, it's just not good. You know, the value of our dollar will plummet. All of the people who lend money to the United States at good rates will no longer do that because you're basically screwing them over. There are all sorts of reasons not to do this. But will they do it? Honestly, I don't know. But there are a lot of people, if you listen to Ray Dalio, a lot of people think that this is a very likely scenario and it doesn't need to be complete. Like they don't have to print 39 trillion, But could they print a little bit more money every year? Could the Fed decide, you know what, rather than a 2 % target, we're going to do a 4 % target so we can print some money and get rid of our debt.

31:39That to me seems like a possible outcome. And if that happens, there is going to be long run inflation. Mortgage rates are going to be higher than they are today. We are going to see bond rates higher than they are today. And so there are all sorts of implications here. My point is that right now we have these four different inflationary pressures. We have tariffs, a labor supply squeeze. We have geopolitical risks and we have this long term monetization of our debt. All of these things could be happening, but they are not demand poll sides. This is cost push inflation risk. And I want to call out that I am not saying that inflation is going to go to four percent or five percent or eight percent.

32:16Actually, I'm going to talk through the scenarios in which I think are more or more probable. But the reason I am telling you this is that there is inflation risk. Again, I try and make this very clear in every episode. When I say that there is risk of something, that does not mean I'm saying it is going to happen. I'm just saying that there are some variables at play here that mean that inflation reigniting is possible. And if it does happen, it's going to be on the cost push side, which is not as good as for real estate investors. So that's the main point here, right? If we see inflation start to rise, it is not necessarily the type that is super great for real estate investors.

32:52Real estate might still be a better way to hedge than other asset classes, but this is not one of those times where real estate investors say, I don't care about inflation because I'm benefiting in all these ways. You probably get debt devaluation. That's true. You probably get some tax benefits. But will rents and prices rise in an inflationary environment in the next couple of years? I don't know. I honestly don't think so. If I had to bet, I would say no. And so I think you need to plan your portfolio accordingly. If my house had a resume, it would probably say, great at structure and not much else.

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36:42relatively low, like it might be fine. Right. And in that case, I think what happens is we stay in the great stall. It's the stuff that we've been talking about for years now. Rates hopefully start to come back down. We get a gradual restoration of affordability. These are things that we were talking about for years. And it's the situation I felt we were in pre Iran situation. It's still a likely outcome if the conflict is resolved quickly, in my opinion, and inflation doesn't reignite. Like if if the war ends and oil prices go back down, this is probably what's going to happen. Right. But we have absolutely no idea what's going to happen in Iran.

37:16It does seem like the White House is, you know, signaling conflicting ideas probably as a negotiating tactic, but like we don't know what's going to go on. So although this could happen, it is only one of several likely scenarios. The second scenario is what I would call like a moderate reinflation. We get CPI from three to four percent, maybe three to five percent. You know, that's not good. You don't want to be there, but it's not runaway inflation, right? This is kind of like just the we're just going to muck through it kind of case, right? How does this happen? Well, tariffs become embedded, right?

37:46We have seen and I've read a lot of studies that show that although some of the costs have been passed along to consumers from tariffs, not all of them have yet. And that's going to continue to drip through the economy. So we'll probably see. I don't think that takes us to four or five percent. But, you know, maybe that keeps us at three or the low threes for a little while. I think the real way we get to this where we're, you know, in a higher inflationary environment is oil, right? If oil prices stay high, if they stay in the 80s or 90s or 100, they were$65 a barrel, by the way, before the Iran crisis.

38:17They're about 98 as of this recording. So up 50 percent. But even if they stay, if they don't go up more or even if they come down just a little bit, I do think that we are going to see I think the chance of a recession goes up. I think we're going to see wage growth sort of moderate. it. And I think rates are going to stay high, right? The Fed is not going to be able to lower rates as quickly as they want. And so what happens here is I think we're going to see downward pressure on pricing, right? This would raise mortgage rates. Even if inflation doesn't get terrible, we'll probably see mortgage rates in the six and a half to seven and a half percent range.

38:50Remember, I said earlier this year, I thought it'd be five and a half to six and a half. Just that one point jump, I think psychologically on top of financially, but psychologically is going to be demoralizing to home buyers and investors alike. I think we're going to we're going to see prices go down, right? We're going to probably see five, six, seven percent price declines. I was, you know, just as a reminder this year, I predicted between negative four and two percent price appreciation. Right now we're about flat. I think if we see inflation reignite that, you know, we're going to lose a couple more points in terms of home prices.

39:21And I think home sales are going to slow. No one's going to be buying. So this is not a good scenario for real estate. And this is kind of one of the things I want to call out. I think anyone who owns real estate currently, if you go into this kind of situation, real estate, it will be a good hedge, right? Because you've already built some equity. You're already, you know, you're getting that debt devalued, probably bought at a good price. You've probably locked in a good interest rate. But if we're in this scenario, buying and acquiring new real estate is going to be tough, right? Buying in a inflationary environment where prices aren't going up, but your mortgage rate is six and a half and seven and a half percent.

39:56I wouldn't do it. Right. Like I that doesn't excite me. So like I think that, you know, prices would have to really come down. Right. You need to buy eight, 10, 12, 15 percent below current comps to make something work, which will still happen. Right. It's definitely still going to happen, but it's going to be a slower market. Let's talk about scenario number three, which is this stagflationary shock. And I got to admit, maybe this is just paranoia, but I worry about this. Right. Because I actually see scenario two as less likely than this? Because scenario two, we're saying the CPI goes up to three to 5%, but the economy is still going strong.

40:31I have a hard time envisioning that. I think that a stagflationary shock is maybe more likely because regardless of tariffs, regardless of inflation, I am worried about rising unemployment. It's been going up. We all have fears about AI. A lot of parts and segments of the economy are starting to slow down. And so if you get the inflation from scenario two, with the three to 5 % inflation rate, I think it's probably more likely than not that we're gonna see that with unemployment at the same time. And that is not happening yet. But I'm just saying, if inflation goes up, I think we're probably gonna see some degree of stagflation.

41:06Now, people throw that word out a lot and panic about it. If we have three to 5 % inflation and unemployment stays in the five to 6 % range, that stinks, it's not good, but it's not like a disaster. If we see inflation go up to five to 8%, unemployment goes to five to eight percent. That's a big problem. That is where the economy really starts to suffer. And the Fed really has its hands time. Stagflation is just brutal. It ties their hands. There are few ways to get around the pain. Right. And if that happens, this is where I see, you know, transaction volume really low. Like, I think it could go down to like three million.

41:43Right. We're at four million now. Like it could possibly go that low. Again, this is sort of the worst case stagflation scenario. Again, I'm not saying that this is going to happen, but if this scenario unfolds, we're going to see transactions drop. We're going to see home prices drop, right? Inflation is going to erode people's purchasing power faster than inflation. We're going to see prices go down. We're going to see rental vacancies go up because unemployed tenants can't pay, right? Like this is going to be a big issue. We might even see another eviction moratorium, like we saw during COVID, like all of those things are going to be on the table if we see real stagflation.

42:18So let's just all hope that this doesn't happen. If it does, though, what I would recommend is really just trying to keep liquidity, right? Just have cash reserves to cover six to 12 months, a vacancy debt service. Ideally, do not take on any floating rate debt. Please do not do that. And then be opportunistic, right? Like that is the thing, You know, even in these scenarios, I, you know, I'm saying transaction volume is down, prices are going to fall, rents are going to fall. That could be true. It also means that, you know, that's kind of what happened in 2008, right? 2009, 2010, where everyone's like, I should have bought back then.

42:52So opportunities will emerge if this happens, right? Especially people who got cash, there's going to be distressed sellers. You're going to have a lot of people who want to sell and there's going to be very few buyers. So buyers are going to have a lot of leverage. So that's what I would focus on. I wouldn't use fixed, you know, adjustable rate debt. But if you have cash or fixed rate debt, you can qualify and buy in that kind of environment. It's a good time to reload. But I'm saying to buy that not just as an inflation edge. I just think that's probably a good time to buy. But we'll see if that actually happens.

43:23The last scenario is sort of out in the future, but I did mention this sort of long run monetization of our debt monetary inflation. Like I just kind of want to mention that even though it's not an immediate term threat, I worry down and down the line. So I want to just explain this. How does this happen again? You know, U.S. debt continues to grow faster than GDP. Interest expenses become maybe the largest budget item that we have in our federal budget is depressing, but it might be true. Political pressure is going to increase to monetize the debt. Right. Like, maybe I'm wrong. Maybe I'm being so pessimistic.

43:55But when I look at our Congress right now, this is both parties. I don't see either of them meaningfully chipping away at our debt. None of them have done it for two decades. Right. So maybe I'll be wrong. But I think the more likely scenarios, the Fed says, hey, we're going to change our inflation target to 4%. We're going to print more money. Right. That means the dollar is going to lose purchasing power relative to hard assets. Right. The bond market is going to go up. We're going to need higher yields. that's going to mean mortgage rates go up. And although it's a slow moving scenario, this is one of the scenarios where I do think it makes sense to own real estate, right?

44:29If you are slowly devaluing the dollar, that means that that debt devaluation, that third mechanism we talked about before is gonna be in full swing, right? The people who get killed in this debt, the monetization scenario are not borrowers, it's lenders. This is a scenario a lender would hate. They would get crushed by this because I am paying you for 30 years with increasingly less valuable dollars. They can, you know, I'm paying them that$2 ,000 a month, but what they can go and turn around and use that$2 ,000 for is much less than when it started. In this scenario, you will probably also have nominal home prices rising, right, because there will be more demand.

45:08If they're printing more money, that's more money circulating around the economy and will increase demand. Now, I should mention that some of that might be offset because mortgage rates will go up. They will absolutely go up in this scenario. But even with that replacement costs going up, the debt devaluation, I do think property values do rise in this scenario. So if this thing unfolds again, it's a long time in the future. But if we see this debt monetization thing unfold, I think it's a good time to hold real estate. Maybe the best of these scenarios do hold real estate. So those are our four scenarios.

45:40Remember, number one is nothing happens. We stay in the great stall. I still think this is a highly probable outcome. You know, there is no knowing, but there is a chance that inflation doesn't really go up. And let's all hope, right, that that's the best outcome. Scenario two is we don't see stagflation, but we just see inflation go up. I think that could happen. But I think scenario three is more likely where inflation goes up and we see a recession. That would probably be because we have a geopolitical situation pushing up prices outside of our control. At the same time, We have AI, we have a slower economy, higher input costs.

46:12We might see stagflation for a period. That's not a great time for anyone. Real estate can help, especially for people who bought and have fixed rate debt. But buying new assets in that environment to hedge inflation may not make so much sense. So I wouldn't just jump into that scenario. In that scenario, I think it's highly unlikely we see appreciation for the next couple of years. So don't buy it just assuming that properties are going to go up because everything else is going up. That is maybe the main thing I wanted to convey in this episode. In scenario number four, which is that long-term debt monetization, that's a great time to buy real estate, in my opinion, especially if you can time that right when that's just starting and it happens for 10, 15 years while the value of your mortgage payments that you're paying out are going down.

46:54That is a great way to hedge inflation. It's also a great way to earn a return in an inflationary period. So that's it. I know it's a long episode. There's a lot to talk about. I really wanted to make sure everyone understands this because I hear I see these people, right, like on social media right now, like the war in Iran is gonna increase inflation. You should buy real estate. Maybe, but like there is more nuance to it. It is not that simple, right? And so I hopefully you can all understand it. Just a couple of takeaways. Real estate is a proven long run inflation hedge. Absolutely huge correlation between home prices and the CPI over the last 45 years, but it works really differently.

47:30The hedge works differently depending on the type of inflation. Demand pull is good, right? Cost push is mixed. stagflation is bad, right? That's the takeaway. Demand pull inflation, that's like what we would see with the debt monetization. It's going to be good for real estate. Cost push, you'll have a mixed bag. Stagflation is bad. And the current environment, what we're risking right now is cost push. And that means that we could also have cost push plus rising unemployment, which is stagflation. So that's my fear. That is the thing I want you all to remember is that if we see inflation in the near term, it's probably not the good time.

48:06If we see it in five years or 10 years because we're monetizing our debt, it's bad for our society. I'm not happy about that. But if you want to hedge against that, real estate is an excellent way to hedge against that. Just some parting thoughts, though, like no matter what happens, like I think the things that work regardless are number one, fixed rate debt, right? I kept saying this again, but fixed rate debt is an excellent inflation hedge in all environments. So I really like it. There are times that I've used adjustable rate, but for most things, fixed rate debt. Invest in supply-constrained markets, right?

48:37That protects values no matter what is going on with inflation. And keep high liquidity reserves. It's the number one thing. It determines who survives during a stagflationary event, who survives during bad times, and gets to see the good type of inflation, right? That's what we're talking about. How do you survive the bad inflation to get the good inflation? Again, not saying we're necessarily going to have it, but I want you guys to start thinking about this as you build your portfolio strategy. If we start to see inflation, diagnose it. Is it the kind that real estate can help you hedge or not?

49:08And you need to make your portfolio decisions based on that analysis. Of course, I will be letting you know if you listen to this podcast, I will update you if inflation goes up, what kind it is and how it will likely impact real estate. But hopefully this episode will help you make some of this analysis for yourself and protect yourself against any potential inflation in the future. That's it for today's episode of On the Market. I'm Dave Meyer. Thank you so much for listening. We'll see you next time.