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Rick Tobin's Blog

By Rick Tobin | Broker in Los Angeles, CA

Low Rates, High Inflation, and Real Estate's Benefits

Question: Historically, which asset class of investments has benefited the most over the past century as related to a combination of low interest rates and increasing inflation? Answer: Real Estate.

In recent years, interest rates have fallen to near record low levels while inflation continues to rapidly increase. Typically, rates and inflation are inverse to one another, and are akin to being on a “see saw”. The lower interest rates tend to fall, then the higher inflation rises (and vice versa).

It is usually the availability of mortgage capital that is the most important factor in determining the “boom and bust cycles” of the U.S. housing market. People need money to get into, and to get out of most real estate transactions since most real estate buyers need 3rd party loans to acquire real estate. During tight lending cycles like these past few years, both home sales and prices usually decline. When access to money eases up, home sales and prices can increase dramatically.

In recent years, the underwriting requirements to qualify for mortgage loans have tightened significantly. Most residential mortgages (97%+) are now either backed or insured by some form of a governmental agency (i.e., FHA, VA, Fannie Mae, Freddie Mac, USDA Rural, etc.). As a result, the qualifying requirements are much more challenging for borrowers today so our financial leaders have tried to make mortgage loans much more affordable in recent years.

   Cut Short Term Rates To Near Zero

Back in the mid ‘70s through the early ‘80s, the Federal Reserve was allegedly so concerned about inflation that they helped support a “Whip Inflation Now” (WIN) campaign, which even included buttons and bumper stickers. In order to try to quash inflation back in the early ‘80s, then Fed Chairman Paul Volker encouraged the raising of rates to as high as 21.5% for the U.S. Prime Rate back in January of 1981.

The higher interest rates then slowed down consumer spending and real estate purchases since the cost of mortgage loans had increased significantly as well. Interestingly, seller financed home sales options such as Contracts for Deed (or Land Contracts) and All Inclusive Deeds of Trust (AITDs) “wraparound” sales methods began to increase in popularity back in the early ‘80s primarily because many home buyers could not qualify for 14% to 16% mortgage loans amortized for over thirty (30) years. As a result, seller financed wraparound loans, or new 1st deeds of trust created for “free and clear” properties at 10% to 12% seemed relatively “cheap” as a comparison.

Let’s compare today’s Prime Rate of 3.25%, the Federal Discount Rate of 0.75%, the Fed Funds Rate of 0.25%, and the 11th District Cost of Funds (Western U.S. region) rate at 0.962% with January 1981’s 21.5% Prime Rate levels. Isn’t this then relatively cheap money today?

In theory, the U.S. housing market should be selling at record levels with this cheap money out there today. However, the stagnant U.S. job market, rampant inflation as partly noted by gasoline and food prices, and the more challenging lending underwriting guidelines have held back the next potential housing boom. If lending does ease up and the U.S. employment figures improve, then we may all see much higher home sales and prices.

    Operation Twist

As Chubby Checker once sang, “Let’s do the Twist….” Operation Twist is an investment strategy created by the Federal Reserve back in late 2011 and 2012 to allegedly help stimulate the U.S. economy. This program’s “Twist” nickname was coined to describe the Federal Reserve’s desire to purchase longer term U.S. Treasury Bonds while simultaneously selling a portion of the existing shorter term Treasuries at the same time.

The Fed’s theory was that by buying larger amounts of longer term Treasuries, then they may help drive Bond prices up which, in turn, would then drive downward the 10 year Treasury yields. Since thirty (30) year fixed mortgage rates are tied to the directions of the 10 Year Treasury Yields, then lower 10 Year Treasuries leads to much lower fixed mortgage rates for us all.

   Quantitative Easing & Hyperinflation

What in the world is “Quantitative Easing” (QE), and why were there three rounds so far (QE1, QE2, and QE3 / Infinity)? In a nutshell, it is the attempts by the Fed to create more money out of thin air in order to invest in Treasuries, Stocks, and Mortgages in order to try to better stimulate the economy. Each month, the Fed buys upwards of $85 billion dollars worth of Treasury Bonds and Mortgage Securities thanks to their QE policies.

How does anyone believe that the Dow’s 14,000+ levels in recent times confirm an economic boom time period now when so many other segments of the U.S. economy are still stagnant? Most U.S. citizens do not own any stocks today so they are not experiencing any of the financial benefits associated with the stock boom time period, unfortunately. 

As a comparison, the Dow Jones index was near a low of just 940 in January 1981 back when the Prime Rate was at 21.5%. Why risk money in the stock market back in the early ‘80s when the bank savings rates were so high?

Today, the opposite is much truer. Why keep our money in banks to earn negative net returns after factoring in taxes and inflation when we may invest in stocks, real estate, or other assets that may be a better potential hedge against inflation? As such, the Fed is trying to encourage more investors into both the stock and real estate markets in order to better stimulate the economy.

When inflation begins to accelerate, then the buying power of the U.S. dollar falls. A weaker dollar then leads to much higher prices for everyday items such as food, gas, utilities, clothing, and so on.

How can anyone today say that our inflation levels are relatively modest or low? Specifically, the cost of gasoline has absolutely skyrocketed in recent years due to the world’s “Petrodollar System” (“Oil for Dollars”). The U.S. Dollar is not entirely a “Fiat Currency” which is created out of thin air, and backed by the full faith of our Central Bank and government. Our Dollar is also backed by the value of oil too as opposed to gold back when we had a “Gold Standard” which ended in 1971.

It is not increased demand and lack of oil supply worldwide which is the primary reason for the rapid increase of gasoline here in America. Rather, it is a combination of a weaker Dollar partly related to QE policies, and increased government taxes and fees that have led to $4 to $6+ per gallon nationwide in recent times.

Does Real Estate have a higher potential upside than stocks today?

The Fed is trying to inflate our way out of this almost six (6) years of an economic slowdown with their “inflate or die” mindset by making mortgage loans so cheap that home prices then eventually began appreciating significantly after borrowers could qualify for larger loan amounts and higher prices.

Just since last year, the median price of homes in regions like Las Vegas, Phoenix, and Los Angeles have increased between 5% and 20%+ so this financial strategy is beginning to work. The low rates, coupled with the declining home listing inventory, are making real estate a much more attractive real estate investment option today.

The most assertive and knowledgeable real estate investors today are trying to pick up the best discounted home deals for a fraction of their true market value today, and locking into near record low rates in order to better guarantee exceptional monthly cash flow for many years to come.

With real estate investment options, location, timing, and access to cheap money are all very important factors in determining one’s future net worth and monthly cash flow upsides. The keys are to know how to find the best deals, and how to lock into the cheapest rates possible.

After the end of “The Great Depression”  (1929 – 1939), many investors created the bulk of their family’s future generations of high net worth by picking up assets for a fraction of their values. Will history repeat itself in the hopefully near term if real estate values continue to increase partly related to all of the cheap money out there today? 

*** To read the original version of my same article, please visit Creative Real Estate Online (#1 real estate investing site in the USA since 1995): http://www.creonline.com/blog/are-low-interest-rates-high-inflation-good-for-real-estate-investing/


By Jamie Tian,  Thu Mar 28 2013, 08:28
Thanks for sharing!

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