Will it? Or wont it? I am talking about the persistence of the current rise in inflation. It's hit 5% already in many parts of the world.
The problem for most people who own real estate is that they need to borrow money to pay for it, and unlike past times, the last thirty years has been one of declining interest rates, making the cost of buying a house cheaper and cheaper as the years have passed by.
This should have made life easier for people to start saving and putting the money saved out to work for them. I wonder how many people have taken advantage of the good times to increase those savings and put them to work. Probably very few.
If inflation is coming back, it may well be a good time to sit down and think what that might do to house prices. We could be in the midst of a Portugal property bubble.
Those of you who have been following me over the years will know that I have several little maxims that help me navigate my way through the financial maze that we live in. This next maxim is very appropriate at the moment.
The most advantageous way to buy real estate is to buy when interest rates are high, but are declining. By contrast, the worst time to buy is when interest rates are low because the asymmetry is against you.
Let me explain.
The last time when it was great to buy real estate was during the nineties. By the time we had got to 2004 things were starting to look difficult, and I advised my clients to stop buying, and maybe consider taking some profits. Maybe I was a couple of years early, but I dont regret following my own advice.
In 1991 interest rates were high but falling. There had just been a house-price crash. No-one wanted to buy real estate, so prices were on the floor. Low prices, and reducing interest rates meant it was the ideal time to buy. You can afford to buy because prices are low. You can assume prices will therefore rise, or at least not fall much further; and you can assume that as interest rates are high but falling, that they are likely to continue to fall. You get the best of both worlds. The asymmetry is in your favour.
If we look at the opposite situation, existing high prices, and interest rates on the floor, we have a situation where the only change possible is for house prices to fall if inflation continues to rise, and the only way interest rates can move is up.
In short, the likelihood of prices rising is low, and the likelihood of interest rates rising is high. That means the asymmetry is against you.
I maintain that now is possibly the very worst time to buy. Obviously I may be wrong as I dont have that essential crystal ball, but the odds are against you at the moment. If you dont know the future, dont expect to win by betting against the odds.
Now let's set that against the situation in which the economies of the world find themselves.
Government bonds are yielding pitiful returns even for a low inflationary environment. However, in an environment where inflation is rising above 5%, the return on those bonds is seriously negative. You are guaranteed to lose approximately 5% of your invested wealth every year. That's insane.
If you add to that absurdity by buying at the top of the market, future prices will almost guarantee you losing even more money. And when interest rates rise you will start losing even more.
Dont say I didn't warn you.
Now let's look at some distinct possibilities.
When inflation goes from 1.5% to 4.5% as it has this year, that loss in purchasing power has tripled. That's not funny. If the rate goes from 5% to 6% it only increases by a fifth, but if it goes from 1% to 5% it has increased by 500%. That's a nasty hit to the average household. What does that tell you? Obviously, the average household is going to find the going tough. That means you won't get people chasing house prices higher, because they won't have the money to do so.
And that will certainly impact on the second-home market.
Now add to that the possibility of interest rates increasing by a similar amount. That takes the average household into ruin. It's interesting to note how this is set out in the media down under.
"Between 1990 and 2020, the Reserve Bank of Australia slashed interest rates time and time again, with rates falling from 17.5 per cent in January 1990 to sit at just 0.1 per cent today."
What would a reversal of interest rate policy do to household finances if the current rates simply rose back to 5%? The average household would be facing bankruptcy. And what will that do to house prices? Those who can't pay the increased interest charges will be forced to sell. Those who cant pay the increased interest charges won't be able to pay the higher costs associated with the loans needed to buy, so they will back off. House prices will fall. That will put more people under water, and you can work out the rest for yourself.
So, there are the possibilities. We are just left with that original question: will that little problem of increasing inflation stay with us and maybe increase? Or will it fade back to insignificance?
Perhaps keeping an eye on the level of inflation is something we should start to take seriously.
