Faced with an inflation that looks more intransigent each day, everyone is on the hunt for places to protect wealth. Bonds look like a poor prospect. As the Federal Reserve (Fed) raises interest rates bonds will lose value simply as a matter or arithmetic. Even if the Fed were to cease its counter-inflationary efforts, a persistent inflation would drive up bond yields (and depress bond prices) as lenders increasingly insist on returns that compensate them for the declining value of the monies repaid them. As rates and yields rise, stock prices will decline, because interest rates factor into calculations of value and because rising rates, as well as the inflation itself, will raise uncertainties about future profits. Only real assets — commodities and especially real estate — have a chance of keeping up with inflation, and if history is any guide, outpacing it.
The argument for real estate rests on at least three lines of reasoning. First and most obvious is that the same forces raising the cost of living generally will naturally do so to the price of land and structures. A second attraction of real estate, especially residential real estate, is how home ownership can fix the cost of at least one part of a household budget, and an important part at that. While inflation is playing hob with all other costs in life, from filling one’s gas tank to buying groceries or a new suit of clothes, homeownership assures people that their basic cost of shelter will remain more or less constant, locked in so to speak whether the house is owned outright or supported by fixed-rate mortgage.
These two natural attractions create a third reason why residential real estate tends to protect wealth against the ravages of inflation. By driving people into this area, home prices tend historically to outpace inflation, usually by a wide margin, even as mortgage rates rise. Of course, price and rate increases go hard with late buyers, but this reality makes real estate especially attractive for those who are already in place or can get into place quickly. The last great inflation of the 1970s and 1980s offers ample evidence. Between 1970 and 1990, the consumer price index in this country rose 6.2 percent a year on average. During that same time the median price of a house sold in the United States rose from $23,900 to $125,000 an increase of 8.6 percent a year and a return-on-investment 2.4 percent a year better than inflation and better than most any other option open to investors.
Remarkably, increases and decreases in mortgage rates, though they had effect, failed to alter this fundamental pattern and likely will not this time either. To be sure, rising mortgage rates discourages buying, but rather than halt the pace of buying and so braking the rate of real estate appreciation, it prompts buyers, eager to get into the real estate haven, to buy smaller less well-appointed properties rather than give up the effort altogether. Again, the experience of the last great inflation illustrates. Fixed mortgage rates rose from about 7.3 percent in 1970 to over 13 percent by 1985. For those who owned their houses outright or had their mortgage rates locked in, this meant nothing, but it mattered a lot to prospective buyers. After all, the cost of supporting a mortgage had risen almost 80 percent. Yet, as indicated earlier, home price appreciation continued, perhaps at a slower rate than it would have otherwise but continued and continued to outpace the overall rate of inflation.
The same thing seems to be happening again. Mortgage rates have risen from 2.7 percent early in 2021 to 3.6 percent early this year to about 5.4 percent at last measure. That is about doubling, albeit from an inordinately low level. Yet the median sales price of a home during this time has risen almost 16 percent. And as in the past, the steep rise in the cost of supporting a mortgage has prompted buyers to shift down along the price distribution. Last December, when mortgage rates were still low and inflation concerns were just budding, a disproportionate number of sales occurred at the extremes in the price distribution. While the median home price tracked by the National Association of Realtors stood at some $360,000, fully one-third of home purchases nationwide occurred at over $500,000. Only 29 percent of national purchases occurred at prices near the median. But with the rise in mortgage rates, the picture as of June showed some 63 percent of the purchases occurring at prices closely clustered around the median price. The change was from the high extremes down and not from the low extremes upwards.
No sane person would look for a precise replay of history. But the reasoning that prevailed in the last inflation experience remains valid and there is nothing in the present that would impede it from having effects similar to the past, if not exactly the same. Real estate, residential real estate in particular, remains an inflation haven for those who are in or can get in. It may not be the only one, but the others – such as commodities futures or put options on stocks — impose more burdens and risks on the investor and demand more investment sophistication than is common.
