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Inflation: Curves Ahead For The Real Estate Industry

March 30, 2021

2021 will be a year of transition but at this point the scope of the transition and its impact on real estate values is unclear. There are those who suggest that everything will return to the patterns of the past and those who assert that nothing will ever be the same. The reality lies somewhere in between. As people and businesses adjust to the new realities in the world, patterns have obviously shifted. Along with new challenges and threats have come some old familiar issues that are especially significant for those in the real estate investment business.

The issue of inflation

The most threatening and perhaps the most immediate issue is the renewed threat of inflation. It has quite literally been over twenty years since this has figured prominently in any kind of business conversation. It was the early 1990s when the Fed saw the core rate above 2.0% for more than a few weeks and it is the core rate that matters as far as setting interest rate policy. The Fed (and other central banks) prefer a rate around 2.0% and strive to keep inflation in that range. Two percent is not high enough to create issues, but it is enough to allow some producer flexibility on prices.

So, why is inflation an issue now after two decades? It is not entirely clear that it is – at least not yet. The problem is that it could be setting up to be an issue, which may be enough to trigger the Fed to take action as their moves do not have an instant impact on the economy. It takes anywhere from 12 to 18 months for a rate hike to slow the economy which forces the Fed to take preemptive action long before inflation has become a notable issue. The possibility of inflation has already had an impact on the bond market. Yields are going up and are expected to continue on that path. The logic is that the Fed will push rates up at some point and that will make investing in the US that much more lucrative – it becomes something of a self-fulfilling prophecy.

The impact on the real estate sector

The real estate investor sees these bond yields rising and realizes that interest rates are likely to follow suit and therefore mortgage rates rise and so on. Commercial development usually slows with rising interest rates as it becomes more expensive to finance new projects.

The real estate sector is in a quandary when it comes to the future of the office building and other forms of commercial construction. If people continue to work from home will that kill demand for the traditional office building? The enthusiasm for working from home has faded to some degree but is still considered a viable option by many employers and employees. What is the future of the shopping mall and the Big Box store? Have people embraced the online option to the exclusion of brick and mortar? What will retail have to do to bring consumers back? What happens with lodging and hospitality? It was an assumption by economic developers for years that hotel space was necessary to attract conferences and meetings. Will this resume or will the virtual meeting take over? Will people vacation at resorts again? Attend concerts and events again? There are no simple answers to these questions. It is obvious that many people will indeed return to their old habits, but will it be enough for the businesses that were low margin to begin with?

The one thing that has been sustaining the growth in the residential real estate market has been mortgage rates as there have been price hikes that should have been enough to slow down demand. Now the sector suddenly appears beset with problems. If everything breaks in a negative direction, the housing sector is looking at higher mortgage rates, more expensive homes (existing and new), housing shortages, labor shortages, and more expensive commodities (lumber is just the most obvious).

This all assumes an inflation surge that goes unaddressed. Triggering the downsides of higher mortgages and higher bond yields will require the Fed to reverse course and engage in the rate hike that people seem to expect. At this point the Fed governors and regional Fed Presidents are saying nothing of the kind. Not even the hawks have weighed in with suggestions that rates need to go up. They do acknowledge there is growth in the economy visible but they also hasten to add the caveat that growth will have to be impressive to undo the extreme damage from last year. They still assert the economy needs all the help it can get. There have been some voices of concern regarding the connection between the stimulus and inflation, but at the moment the Fed and the Treasury are on the same page and assert that the stimulus is a good thing.

The flip side of the risk is that old consumer behaviors resume with gusto. There is an enormous pile of cash on the sidelines currently. It is held by the business community, investors, and consumers. It is estimated that consumers have trillions in savings to release once the pandemic is over. Due to the nearly $2 trillion stimulus/rescue plan, the US now has roughly 10% of its GDP in excess consumer savings. That money is waiting for an opportunity to come into the economy. So, we are back to the discussion of inflation which started this article. If all or most of that money comes cascading out there will be far more demand than there is ability to meet that demand. Prices will rise as a means to control demand and in an environment like this there will be far more tolerance for higher prices – at least from those who have the ability to keep up with the hikes. This sets up another issue for real estate – too many people chasing too few opportunities and driving prices higher in a market that could be considered hot (or even warm).  

The real estate industry is a major focus for MarksNelson. Our team of experts can help support your development project starting with the vision, concluding with the completion and beyond. We help with location strategies, incentives, tax planning and more. If we can be of assistance to you or your business, give us a call today.

David Belpedio leads the firm’s Commercial Real Estate industry specialty group. He is responsible for positioning MarksNelson as the premier partner dedicated to maintaining and growing commercial property needs. In this capacity he works directly with clients to offer real estate solutions, which include identifying... >>> READ MORE

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