In my blogs I have talked about how typically when we have large inflation this will drastically slow the real estate market as interest rates rise. With all the craziness from the Covid bump occurring could just the opposite occur? Will inflation actually increase real estate prices? Will this recovery cycle be different?
What happens to real estate historically when inflation rises?
Remember the federal reserve does not “set” mortgage rates. As inflation fears rise the bond market will rise and in turn interest rates. Furthermore, the federal reserve likely will raise rates sooner than they are saying if inflation comes in higher. Here is a more in-depth article on inflation and where we are heading with rates.
If you look in the last 50 years or so, as interest rates rise housing slows. The reason is that most housing purchases are bought using a loan. As interest rates rise, even a small amount, the payments quickly change. Below is an example of the change in payments assuming a median priced home with a 30-year fixed mortgage. As rates move from 2.75% to the more historic range between 4-5% payments increased almost 30 percent. There is no way salaries are increasing 30% even with inflation. As payments increase, the number of available buyers decreases as they can no longer afford the payments. This trend is further fueled by huge jumps in housing prices. Higher prices and higher interest rates ultimately lead to a slowdown in the real estate market.
| Loan Amount | Interest rate | Payment |
| $ 500,000.00 | 2.75% | $2,041.21 |
| $ 500,000.00 | 3.25% | $2,176.03 |
| $ 500,000.00 | 3.75% | $2,315.58 |
| $ 500,000.00 | 4.25% | $2,459.70 |
| $ 500,000.00 | 4.75% | $2,608.24 |
What is happening now in real estate that could change historical models on inflation?
Residential and Commercial real estate is drastically different than in prior cycles. For example, Blackstone (Invitation homes) owns close to 100,000 single family homes and over 1 billion square feet of commercial real estate.
- Commercial: Commercial real estate kicked off the consolidation trend years ago with Blackstone now holding the crown of the largest real estate owner in the world with 100 billion under management. They are the Amazon of commercial real estate. Simon property group leads the way in retail and Prologis specializes in light industrial. Commercial real estate has quickly consolidated with large players gobbling up assets throughout the country.
- Residential: Until the 2008 crisis, residential real estate was composed of smaller mom and pop and regional players. After the 2008 meltdown multiple companies were formed to gobble up foreclosed houses on the cheap. Companies like Blackstone, American Homes for rent, and others now buying one in ten residential properties in the United States. Wall street backed firms own 40 billion in residential real estate and they will continue to get bigger. Investors have bought nearly $900 million of new shares sold by the two largest rental companies since the pandemic began. Other home-rental operations have also sold nearly $6 billion of rent-backed bonds in an effort to raise cash in order to capitalize on the market uncertainty to purchase more properties.
Will real estate follow historical patterns on inflation?
I think the trend of higher prices could last a year or so more than one would typically expect in a rising rate environment. With the corporate buyers in commercial and now residential real estate they can raise prices. For example, assume one of the big property owners like Invitation homes owns an entire subdivision of single-family homes. If you want to stay in the subdivision you have to pay the higher rental prices like everyone else. Furthermore, as salaries rise due to inflationary pressures the property owners can demand higher rents due to their pricing power. We are already seeing this as residential rents continue to soar.
Fortunately, this cycle cannot go on into perpetuity. At some point salaries will begin rising at a slower pace than inflation which will eliminate further rent increases. In other words, at some point there will be a tipping point for real estate where rents will not keep up with rising costs. This will occur faster in the commercial sector as companies will be less likely to absorb big increases in real estate costs than consumers on the residential side.
Summary
Covid has thrown historical models for a loop and upended assumptions that have been formed over the last 100 years. The relationship between inflation and real estate values is no different. Typically rising rates would stop real estate on a dime. Today with all the corporate buyers of real estate looking for a location to chase higher yields and the sheer quantity of rental properties they now own; historical models have been upended. On the commercial side, the slowdown from inflation will follow historical trends much closer, but on the residential side all bets are off.
In the short term as inflation rises, residential real estate might hold up better than anticipated as large corporate owners can raise prices to sustain their returns. This is a drastic departure from historical norms. Over time though, history will repeat. The Covid bump will follow traditional trends. Residential real estate will slow/possibly fall as inflation raises rates and salaries cannot keep pace with the rising rents.
Additional reading/resources
- https://www.fairviewlending.com/wall-street-new-residential-landlord/
- https://www.fairviewlending.com/is-inflation-transitory-the-answer-to-this-question-will-predict-real-estates-future/
- https://nypost.com/2020/07/18/corporations-are-buying-houses-robbing-families-of-american-dream/
- https://www.wsj.com/articles/millions-are-house-rich-but-cash-poor-wall-street-landlords-are-ready-11600421401?mod=hp_lead_pos5
- https://www.wsj.com/articles/meet-your-new-landlord-wall-street-1500647417
- https://economictimes.indiatimes.com/industry/services/property-/-cstruction/consolidation-in-real-estate-may-speed-up-amid-covid-19/articleshow/76477074.cms?from=mdr
- https://blog.realestate.cornell.edu/2018/10/23/reit-sector-likely-to-see-more-consolidation/
- https://seekingalpha.com/amp/article/4121471-outlook-reit-sector-2018
- https://www.businessinsider.com/blackstone-is-largest-owner-of-real-estate-2015-11
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
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