Preamble: What follows is simply how I think with regards to my own investing and I am not an economist or financial advisor. Please seek your own advice from suitably qualified professionals.
Inflation is when the purchasing value of a dollar (owned or borrowed) devalues.
The value of your dollar declining is bad news for consumers, however the corresponding drop in the value of debt can be a significant win for borrowers. It eventually will lead to capital growth for the associated asset, assuming you navigate the risks that lie ahead.
Buy and hold property investment is all about the long term, so when the news in the market and on the TV is grim, it is important to understand as much as possible what is going on, work out your risks, and plan a course through it.
Inflation didn't take long to move from economists politely publishing "is it temporary or real this time" articles in the back of the business section, to "The Great Cost Of Living Crisis of 2022" becoming the political battleground playing out on the front pages.
Seen any headlines like these recently?
A quantitative estimate of inflation is usually reported as the increase of an average price level of a basket of select goods and services in an economy over some period of time.
The rise in the general level of prices, often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.
While asset owners like to see some inflation, as it raises the value of their assets and erodes debt, high inflation is generally viewed as damaging because it is so disruptive to all areas in society. Businesses can't predict their medium- and long-term costs, consumers can't predict their cost of living, and since central banks usually combat inflation with interest rate rises, life can get tough.
Several things are happening at the same time:
Popular opinion among economists in New Zealand has shifted in recent months, from "it will all blow through once shipping sorts itself" to "at least some of these cost increases are here to stay... and we likely aren't done yet".
Increases in wages, benefits, and allowances are virtually never wound back and an increase in the minimum wage, in particular, serves as an anchor for wage increases right "up the chain" of employees.
As for housing construction costs... this armchair critic feels it will be a cold day in hell before our cosy building material duopoly unwinds what they can charge for materials unless they are forced to.
So yes, some of this will be the new normal.
Offsetting this are long term trends in technology, productivity, changes in consumer behavior, and the ongoing trend of globalization.
For example, oil prices are increasing and electric vehicle sales are at an all-time high. EVs result in other cost and infrastructure pressures of course, however, they lower the impact of petrol prices on the owner.
Inflation is usually a result of an "overheated" economy, to which banks respond by increasing interest rates to "dampen" demand and avoid an inflation spiral.
Side note: Looking at the "why are we in an inflationary cycle" section above, only half of the items listed can be targeted by lifting interest rates. There is a lot of debate on what central banks and governments can do, and should do. Increasing the OCR won't make ships unload any faster, for example.
When interest rates increase the price people can pay for assets bought with borrowed money usually goes down. This is visible in property and also the share market (companies also face an increase in debt costs).
Ironically, for those borrowing the money a drop in price doesn't make home ownership much cheaper, if at all, due to the higher servicing costs.
These changes can take a while to play out in the property market because:
Not all properties are affected in the same way. I can't repeat this enough... you are not buying a share in the local property market. A single property or area can perform differently from the rest of the market, and you can buy very well or very badly at any time.
Everybody, and I mean this literally, every adult person that you know, will focus on house values.
Fear and greed are funny things and we humans tend to have a recency bias when predicting what will happen. If house values go up or down 5% there will invariably be a vocal group who are certain they will go up or down 50%. This is emotional stuff because we remember when houses were 50% the price they were now. News outlets gleefully produce articles about movements in house values on a daily, weekly, monthly, and quarterly basis.
I encourage you to try and think objectively about this stuff because when we search for evidence of what we want to happen, we tend to ignore or discount any contrary ideas.
Pushing against downward pressure, albeit not in a headline-grabbing way, are:
During the last 2 years, the cost of construction has skyrocketed. You may have seen headlines like the below...
There is only so much that the cost of building a house can go up before the existing houses start to appear cheap by comparison.
Side note: Replacement cost (including demolition, designs, and council) is what you should have your property insured for by the way, so if you take nothing else away from this article, jump on a calculator and prepare yourself for a surprise.
In Part 2 I write about the long term benefits and immediate risks to property investors from inflation, with some ideas on how to stay safe now and prosper in the long term.
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