Rising Inflation and Interest Rates - Any Real Estate Consequences?

There sure seems to be a lot of talk about the danger of runaway inflation and subsequent rising interest rates. Will it happen? What effect will this have on commercial real estate?

Well, first things first. Will we see runaway inflation and rising interest rates? Now I am not an economist and I certainly do not pretend to be one. Fortunately that doesn't bother me because there is an old saying that goes, "If you placed all the economists in the world end to end, they wouldn't reach a conclusion". In otherwords, economics is so complicated, making projections is risky at best. So, what the hey, I may as well jump into the fray, couldn't hurt. And remember, I am speaking from a Canadian perspective.

Up until recently, I have been quite concerned about runaway inflation and interest rates but my concerns have recently abated....somewhat. Okay, first, a primer on inflation and interest rates. Theoretically there is no such thing as inflation. The theory goes that prices don't rise; rather, printing more money makes the dollar worth less (and eventually worthless). To illustrate, imagine that there was $100 billion in the whole world and suddenly our governments printed another $100 billion overnight. Would we all get rich? No, prices would just double because there is twice as much money chasing the same amount of goods and services.

Governments raise and lower the amount of money available (money supply) to increase or decrease economic activity. They also use interest rates for a similar purpose. If you want consumers to spend more, lower interest rates so that debt is cheaper. If you want consumers to spend less, raise interest rates so that debt is too expensive and less people borrow money.

Sometimes governments get a little out of whack and need to print money for their own purposes, like for example, to finance foreign wars in, oh I don't know, Afghanistan and Iraq for example (in actuality, throughout history Kings have used debt, printed money, taxed citizens, etc., etc., to pay for their wars). Word on the street is that the US has printed wheelbarrow loads of money to finance their foreign wars. This money found it's way into the hands of investors who decided real estate was the place to be. They (US Gov't) also lowered interest rates at the same time, spurring a double whammy - loads of money and cheap interest rates - spurring untold investment in real estate and subsequent home price inflation.

Oh, one more important point. When we say governments "print" money, I'm not so sure they actually print most of it. You see, banks are allowed to create money. For every dollar people put into their bank accounts, the banks are allowed to loan out much larger sums, say $100. Where does the $100 come from? Thin air, it is simply, well, created. It probably doesn't exist other than as a number in a deposit record.

Finally, the bubble burst and now debt is hard to get, and billions and billions of dollars simply disappeared when home prices dropped. AND THAT is why I am becoming a little skeptical about the runaway inflation and interest rates. You see, inflation is a by-product of the "printed" money getting into circulation. Well, it's been in circulation for a few years now, why no inflation? Well, I believe we saw the inflation already, but it was mostly focused on real estate (and wages). BUT before it could spread throughout the economy in a more lasting manner, the bubble burst. Home prices fell dramatically, and a huge chunk of the inflation-causing money simply vanished, taking much of the inflationary pressure with it.

And subsequently, I don't expect huge interest rate increases, but we will probably experience some movement off the historical lows. Now, after that great big long story on money, what to do with our real estate? My best guess is that you keep your properties at a safe level of leverage (not too much debt). Things are still very unsettled and you don't want to lose it all; don't play it risky right now.

Remember money is more of a concept than an actual "thing". I mean, really, money is just paper with numbers on it. It is nothing more than a way to count the real value that rests in assets, goods and services. So, I am beginning to wonder if the whole inflation thing is well...overinflated.

Aaah but then there's Greece. Stay tuned.