By Ozzie Jurock
"Inflation is primarily a monetary phenomenon." - Milton Friedman
Real estate is a hard asset and hard assets do well in inflationary periods. And we have been in highly inflationary periods for decades. We may not report it, we may understate it, but it is as real as paying the $1.45 a litre for gas.
In a previous life - in 1968 - when I was the Maitre'd' Hotel at the Devonshire Hotel, we imported the first live lobsters from the East coast to Vancouver. It was a major event... it was so major that we displayed the lobster tank in the lobby so all and sundry could ogle and be astounded. Well, you dear reader maybe astounded by what we charged for these Lobster dinners. Are you sitting down? Soup, salad and coffee included in the two pound feast set you back $3.95 - and no taxes. Today that dinner would run you $60. That's inflation. I bought my first apartment building - an 8 unit building on the beach in White Rock in 1970. The ground floor was a Fish n' Chips restaurant which my wife and I ran and operated. Apart from the fact that we served the best fresh Fish n' Chips ever (ahem!) we also sold them at only .35 cts. Last week I had lunch at 'Bridges' and the Fish n' chips clocked in at $22. That's inflation. Not to talk of my first house on Williams Street on the East Side which I - without haggling - paid $13,400 for. Had someone told me it could rise in value to $26,000 I would have thought him a fool. I certainly would not have believed a price of 10 times that or $134,000. Today that house is 40 years older, still there and worth $800,000. That is inflation. Nothing of real value has been added, no newfangled gadgets created that price. It is simply price inflation created through an excess increase in the money supply by weak governments (worldwide) anxious to appease an ever more demanding and unreasonable public. It is insidious, invisible, under-reported, understated but it is real. And, dear reader, as you instinctively know inflation is certainly more real than the 1.7 per cent official rate you are being quoted.
I wrote in my newsletter and have said so at every Land Rush and Outlook conference since 1998: If we compared what was in the 'Ronald Reagan basket' in 1980 to what we have left in it today the total rate of inflation quoted would be a lot higher. In fact I used it as my main argument that eventually that extra cash in circulation would drive up all hard assets. Boy has it ever. But you do not see it in the monthly numbers ... yet compare all prices from 1980 to now and you see that prices have risen 10 times faster than one per cent or so a year. In fact, if we were to compare the 'apples to apples' we would run closer to 1980's 12 per cent rate. Of course that would not sit well with governments' desire to keep the pension increases and entitlements (in the US) at below two per cent (that is the real reason). It also keeps us from striking for more money. It allows the mad creation of money, without it being visible by having you use this nonsensical official inflation rate explained to us by very reasonable sounding academics.
Of course, every month I get challenged by a 'real' economist (I am not one) who tells me: "Ozzie you just do not understand. When you take food, house prices, oil and a host of other things out of the basket and put in woman's clothes it evens out and the real inflation rate is only 1.7 per cent - TVs and computers are deflating after all".
Well, I don't buy it. You can't take out what we use the most every day. And the newest and best TV sets and the best computers still are very expensive - in fact, in the 80s we never had a $10,000 TV ... the top of the line laptop is still more than $3,000. Just the cycles come faster. You know it as well instinctively. Everything that you and I buy is up higher than 1.7 per cent. A lot higher.
Perhaps my view is simplistic ... so be it. Ozzie's easy 'inflation definition': Excessive money creation (i.e., inflation) today will subsequently lead to rising prices tomorrow. In our view, the correct definition of inflation leads people naturally from the cause (injection of newly created money) to the result (a subsequent rise in price levels) not the incorrect definition of inflation (a rise in the general price level).
We respect other arguments, but we do not agree. I mean, how can rising prices, commodities, oil, real estate, gold (a result) be the cause of rising prices? The plain answer is that rising prices cannot cause a general rise in the price level unless they are accompanied by further injections of new money and credit into the economy.
The money that central banks 'create' and that money then competes with the money you and I earn and that new competing cash drives up hard assets eventually for all of us ... period!
In our Jurock Real Estate Insider we have debated argued and stated for years that the cheap, easy cash lent at low rates to people whether they could afford it or not - created out of thin air - and swirling around in the world creates the bubbles. It certainly has created the high tech bubble, over-exaggerated the real estate values worldwide ... and now is likely driving the commodity market looking for returns that beat the official inflation rate.
Of course, there it is in a nutshell. Do we really think that food prices, oil prices and all commodities totally out of the blue - all at the very same time, more or less shot up 40 per cent (food) to 100 per cent (oil) in one year? Or is it more likely that the cash in the world is looking for better returns than lending money at a third of the real inflation rate.
So, more money in circulation increases purchasing power, cheap money increases purchasing power, low interest rates increase purchasing power, debtor nations (North America is indebted more than anyone else) pay back debt with cheaper (inflated) cash. Easily accessible cheap money chases hard assets ... ergo more inflation in hard assets.
Ask any pensioner whether they believe that their pension money (indexed to the 'official' rate of inflation) buys them the same thing it did five years ago.
Fixed income retirement money is worth far less. Ok, then, is there more money in circulation? In our view since 9/11 we've had an unprecedented creation of cash. The US Fed is doing all it can. US dollar inflation, as measured by M3, is currently more than 16.8 per cent per year, the highest level of inflation since M3 was created in 1959.
Ok, Ozzie, what does it have to do with real estate? Everything! We may make poor local decisions - pay too much for land (usually at the end of a cycle as now) overbuild - as in San Diego, Miami (dare I say Vancouver?), we may have foolish laws limiting rental construction. And we may go through a period of readjustment but with our massive inflation built into the system ... hard asset prices will eventually always be higher.
No question these are tough times. The likely outcome of the U.S. downturn will be similar to the Savings and Loan crisis in the late eighties (that cost $400 billion) or other previous mutual fund and REIT collapses - we will muddle through. But it is getting more serious and difficult every troubled time. You cannot debase your currency without impunity forever.
In any case, you have to answer these questions if you wish to invest in real estate:
Do I believe governments can stop inflating? If you do, get into cash.
If governments cannot stop inflating what will be the outcome? See above ... more inflation of hard assets.
In order to stave off further crazy price rises, governments must sooner or later increase interest rates? Then go long on your mortgage now.
Does the real estate I own cash flow? Then continue to have your tenant pay off your mortgage.
Every prolonged rise in values was followed by an equally prolonged downturn. Every downturn was followed by an even larger upturn - because of inflation.
Published in the Vancouver Sun, June 5, 2008
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