The Effect of Inflation & Deflation on Real Estate

The Real Estate Market and the Stock Market are behaving irrationally – with frenzied multiple offers on properties, crazy market highs on stocks and lots of talk about bitcoin!  Isn’t it crazy that the tweets of Elon Musk are controlling market actions – what a crazy time we are living in.

With all the media information out there, you really have to pick and choose what to read and what to believe.  A few days ago I read “Over 40% of the Money US has EVER printed in its history was printed in 2020.  More and more signs of a bubble being in the works.”

A similar kind of money printing has been going on in Canada.  See article below:

Canada unveils largest economic relief package since WW2

https://www.bbc.com/news/world-us-canada-55139229

This is what leads me to my discussion below:

The biggest reason I started investing in Real Estate was due to my negative experiences with the stock market crash in 2007/08.  Although I have only been doing this for a little over a decade, I feel confident that we can survive the challenges of any economic change.

As a conservative investor, I am fairly risk averse.  I am always doing my best to evaluate the downside and look at all potential risk factors when doing deals.  I look at worse case scenarios and proceed based on my findings.  I feel great responsibility in protecting my capital and the money partners I work with.  

During this pandemic, a time like no other in history, the economy is currently going through tremendous challenges.  Some of the headlines coming up read “The Global Economy seems to be in the worst position since  the 1930s.”  In terms of real estate investing, the thing that most concerns me at this time is inflation and possibly deflation.

Inflation and deflation are both are complex to fully understand; especially in today’s world where there is money being printed to support the various government interventions.  This in addition to huge government debts being mounted along with bank interest rates being dropped to nearly zero lead to a volatile economic situation..

So let’s look at each separately. First, what happens during periods of high inflation? The purchasing power of the dollar declines. As a result, creditors are getting paid back in dollars that are worth less than they lent out and as a result, they raise interest rates to accommodate. 

Every country is printing trillions of dollars to help their citizens.  I won’t get political, I am merely trying to access the impact on my portfolio and future investments. Most suggest this will lead at some point to massive inflation. Supply and demand suggest the more currency available in the marketplace the less that currency is worth.

This will result in fewer people being able to qualify for a home mortgage, rental demand will increase and rents will go up over the long term. Rental property owners with fixed rate mortgages would receive higher income while their mortgage expenses (the largest expense of rental property) would remain constant. Assuming that expenses of operation don’t get out of control and the loan is fixed, the cash flow of the property should improve.

Let’s take the other scenario; deflation, which I believe we are more likely headed for than inflation in the short term. In times of deflation, there is simply a lack of money to conduct business. The general level of prices in any economy comes down to lack of activity. More people will hoard their cash due to the uncertainty we are faced with today.  This is already happening for many months now, see this recent article below:

U.S. consumer spending decreases further; inflation creeping up

https://ca.finance.yahoo.com/news/u-consumer-spending-falls-again-150149716.html

I have been trying to figure out why we continue to deflate after this massive printing of currency. I think it is because the cash is in the hands of a few and the rest of the first world is living on credit, which by the way is the new currency. When they finally shut off the credit supply you will continue to get deflation. That is merely my theory and interpretation.

If you are a real estate investor or landlord, you shouldn’t care too much about the home prices in the short term.  You are in the rental business or “rental housing provider” business for the long term.  People have to live somewhere and you should see stability in the rental market.  There maybe some short term ups and downs due to job losses that people are being faced with, however currently in the GTA due to lack of supply and low interest rates, the prices have been continuing to go up.

During periods of deflation, income-property has one huge advantage over other assets; the cash-flow continues. Assuming the property was not over-leveraged, you should be able to continue to operate the property while paying down debt.  

I am generally a conservative investor, most of our holdings are in B class properties in B+ neighbourhoods attracting B+ rents.  I avoid buying rental properties that cater to the high-end renter paying over $2000 per month. 

In summary, rental properties, do very well in times of inflation and they have advantages over other investments in times of deflation. Of course, you still have to buy the property right, finance it right and manage it right. 

Currently, our main focus is doing a few second suite conversions and buying multi-family apartments.  We continue to do re-development projects being extra cautious with the short term sale price risk by monitoring the market very closely.  There isn’t an investment opportunity at this time however we are acquiring additional assets in the next 1-2 months and if you would like to find out how to become a passive investor alongside with us, please get in touch and we can keep you informed.

So until next time, happy Ontario Real Estate Investing.

Jose Jafferji, REIA