What if Inflation Goes Crazy?Apr 21, 2021
Right now, interest rates – and inflation – have been tame for so long that I wonder if we are not really considering a possible imminent outcome, which is that due to all the government spending, inflation goes kind of crazy to the upside. If so, have you considered what would happen to your investments in real estate?
Would it hurt your existing deals by reducing the value of what you own? Would it cause defaults on indebtedness? Would your borrowers not be able to make their payments? Would your tenants not be able to pay their rent? Are there CPI hurdles in the documentation that would harm your investments? Would other negative outcomes ensue?
To be clear, I am NOT predicting that that will happen. Trying to think ahead, I know I don’t know whether there will be inflation coming, but I am wondering if maybe we are just too used to ridiculously low-interest rates. I mean, the ten-year T-Bill getting near 2% “feels” kind of high, doesn’t it?
But it isn’t at all.
In this vein, I looked at the 54-year chart just now, and the ten-year T-Bill started at 4% in about 1960. That is 250% higher than it is today. And then, of course, most of us recall that the rate went crazy up to almost 16% in 1981, and then there has been a long slow ride to almost zero just a year ago.
And there is a wee bit of government spending going on—both last year and this year, and every indication that this will continue forward. And, the excesses of all of this spending shows up in all sorts of places. Speculative excess is at such a fever pitch it compares with the tech boom that ended rather quickly with the 2001 crash.
This time around, it may become evident in just a few months that we are in a mega-economic boom, and fighting inflation may become the Fed’s new mission.
Also – to make things of even more concern – these kinds of things tend to happen quickly, if at all. We saw this only a year ago with the impact of COVID, did we not? One minute there was infinite cash around. Then the next minute, there was none. And then there was a lot. And, thus far, interest rates have swung in reverse tandem.
You know the rest here, so I won’t belabor it.
My point is that it is certainly not implausible that what is going on today will lead to a good amount of inflation with concomitant higher interest rates.
Perhaps it is worthy of some thought as to what would happen if inflation suddenly reared its head.
You don’t need me to tell you what options you would have to hedge, i.e., interest rate swaps and collars, buying short positions on treasuries, building inflation protection into your transactions, etc.
My point here is to think ahead about a possible inflation jolt and perhaps make that jolt your friend rather than a concern.
Bruce Stachenfeld aka The Real Estate Philosopher™