On today’s show we’re taking a look at a front page article in the Wall Street Journal. I’m not one to rant very often about articles in the mainstream media. You could build a career out that endeavor. But this prominent article in such a widely read newspaper was particularly offensive. The article was entitled:
“Investors Buying Real Estate to Beat Inflation May Find Tactic Backfires”
I was a more offended by the slant of the article than by any of the detailed points in the article itself. The article seemed to imply that real estate is a bad investment in the current inflationary market environment.
I quote directly from the article.
There is no question that there are risks in any asset. But the article seems to criticize investors for piling into real estate and completely neglects the pricing of certain tech stocks and the stock market indices.
Of course any investor needs to properly analyze any investment opportunity and recognize where there are risks. Rent controlled properties can face situations where expenses rise faster than rents in an inflationary environment. This can be death to an investor. Real Estate isn’t the problem. Buying property in a rent controlled environment can be a bad idea.
For example, I’ve been a landlord in NY state in the past. I learned my lesson and I won’t do it again.
There is no question that some assets in some locations may experience a rise in vacancy. Yes, it’s more difficult to raise prices to match inflation in an oversupplied market condition.
The author of the article seemed to dance around one central issue without coming out and stating it.
Real Estate values follow the laws of supply and demand. News flash, you have to pay attention to the law of supply and demand. Since when did ignoring the law of supply and demand result in a good investment, of any description. Show me any investment asset that operates completely independently of the law of supply and demand.
All the author needed to say is that any investor needs to pay attention to the law of supply and demand when making investment decisions. Instead, he tried to paint the possibility of oversupply as a problem which in some markets makes real estate a bad investment. He also tried to paint longer term leases as a reason not to invest in real estate in an inflationary environment.
There are so many things wrong with this article that I almost don’t know where to begin.
The fact is, we have experienced rapid devaluation of the currency steadily for the past 50 years, dating back to the early 1970’s. Yes, we are in a period of heightened inflation. Who knows for how long. But a broad retrospective look at real estate over the past 50 years shows that almost all asset classes have experienced dramatic resilience against inflation.
Three things get wiped out in inflation.
- purchasing power for those on fixed income
- Savings gets wiped out
- Debt gets wiped out
Since real estate investors tend to use a high proportion of debt in their investments, they almost always end up being the beneficiary of inflation because those long term loans get devalued disproportionately compared with all the other elements associated with real estate. Rents go up in price. Operating expenses go up in price. New Construction goes up in price. It’s the last item that causes existing real estate to rise in price. Since the loan on a property doesn’t go up due to inflation, the increase in price is always to the benefit of the equity holder. Therein lies the inflation hedge.