Concrete Thoughts: Inflation Valuation

As we emerge from the present credit crisis, we anticipate another period of positive leverage, which means that if interest rates increase from their present levels substantially, due to Fed policy changes to combat inflation, we could see mortgage rates hit 7 to 9 percent. If this is the case, double-digit capitalization rates would likely follow.

 

INFLATION MAY NOT BE a given. According to Goldman Sachs research released last week, there is a growing school of thought that we may not be looking at a pending inflationary environment because of the change in savings-rate patterns among U.S. residents.

In 2006, we had a negative 4 percent savings rate in this country. You might ask how the savings rate could be negative; the answer is that Americans were spending more than the amount of their disposable income by virtue of credit-card expenditures and massive home-equity withdrawal. Today, the savings rate is approximately 6 percent. If we consider that the U.S. has about a $13 trillion economy and that 70 percent of our GDP is due to consumer spending, this 10 percent swing in the savings rate has extracted $1 trillion from our annual GDP.

A large percentage of these trillion dollars has flowed into Treasury bonds. As the demand for Treasuries increases, the price goes up, and as the price of a bond goes up, the yield goes down, exerting downward pressure on interest rates. This will create a flattening of the yield curve (two-year T bill rate vs. 10-year T bill rate); and this will cause market dynamics that lead to a non-inflationary or modestly inflationary period.

For those real estate investors who believe inflation is headed toward us, the way to take advantage of it would be to acquire assets during a non-inflationary period, locking in today’s low interest rates on a long-term basis to ride out the inflation. No one knows whether we will be hit with above-trend inflation, but whether it occurs and the extent to which it occurs could have a profound effect on the future of our commercial real estate market.

editorial@observer.com

Robert Knakal is the chairman and founding partner of Massey Knakal Realty Services and has brokered the sale of more than 1,000 properties in his career.

Concrete Thoughts: Inflation Valuation