I is for Inflation

Written by Tyler Kastelberg

January 16, 2022

Happy Sunday! 

My son has a book called “The ABCs of Economics,” and in the book, “i” stands for inflation. Given the numerous conversations I’ve had this week about inflation, I couldn’t help but make this the subject line of this week’s letter. 

If you’re new here, be sure to subscribe to get this in your inbox every Sunday.  We have an archive, but it’s more fun to get these in real-time. 

Before we get started, thanks to Max from our team who contributed to this week’s letter.

Inflation hasn’t been this bad since the 80s 

Last week’s CPI index report showed 7.0% … again. 

The current inflation environment, coupled with the Federal Reserve’s recent hawkish tone, has sent shockwaves through the US equity markets in the last couple of weeks. 

As a point of reference, the last time inflation was at 7% (1982), the 10-year treasury was 13%, and mortgage rates reached 16%+. Also … Physical (you’re welcome for not linking the music video) and Eye of the Tiger were the top two songs of the Billboard 100.  

Although we’re now facing 3-4 possible rate hikes in 2022, rates are still historically low, and the United States has a long road back to rate normalization. 

On a global level, there are still 349 banks in Germany charging negative interest rates to customers! 

Adding fuel to the fire, 2022 is an election year for the US House of Representatives. It’s still TBD if policy-makers will be willing to jeopardize their House seats for the sake of monetary policy. Will they opt to “kick the can” once again for another election cycle before making the hard decisions required to combat inflation? 

Time will tell – but one thing is for certain, the United States’ economy is on a completely different planet from just a few months ago. 

What does this all mean for property owners? 

While speaking with a broker friend this week, we realized that properties in his market that trade at a 3% cap rate would lose 33% of their market values if cap rates snapped to 4%. With the 10-year treasury moving 20 bps higher last week, rising cap rates are looking more and more possible.  

Isn’t real estate an inflation hedge? 

Under normal market conditions, it most definitely can be. Rents and expenses typically slowly increase together over time. However, hyper-inflationary periods behave differently. If expenses inflate more quickly than rents (which is more likely than the inverse), then NOI will get squeezed. Properties with long-term, fixed-rate debt should be fine. If you’re buying on bridge debt … bon voyage. 

That’s all for this week! Keep it classy.

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