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Real Inflation Likely To Undermine A Housing Recovery

By Donna S. Robinson | October 19, 2012

The idea that home prices benefit from inflation is a long held tenet of real estate investing. This belief originated in the 1980's during the first era of creative finance. Most investing "gurus" of that period taught seminars in which they said that home prices were rising because of the inflation which occurred in the early 1980's. A time when Fed Chairman Paul Volcker hiked interest rates all the way to a record high of 21.5% in an attempt to battle runaway inflation.

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Today, some 30 years later, current Federal Reserve Chairman Ben Bernanke, is telling us that inflation is not the problem, that "deflation" is instead the real problem, and as a result, Bernanke has been making aggressive attempts to force interest rates down by injecting trillions of dollars into the U.S. economy, in hopes that those low interest rates would spur the housing market into recovery. But so far, most agree, this has not worked, as home prices are essentially flat, and home sales have yet to improve to any degree that could be called a legitimate recovery.

But it is having a very real impact in another area that has been conveniently omitted from the Consumer Price Index - food and fuel. In Bernanke's world, these items can be removed from the data set, so that the inflation numbers can be held to whatever level is desired to achieve political or economic ends.

But in the real world, the one that 99% of regular Americans live and work in, the inflation problem is getting worse, reducing the amount of funds consumers have to spend on housing. Prices for food and gasoline have reached levels never before seen in the U.S. Rising food prices are fast becoming a problem for average consumers - you know, the same folks who buy or rent houses. These people have to live with reality, they can't remove food and fuel from their data set.

Recently, California made news as gas prices hit $5.00 a gallon for the first time ever. Thanks to a record drought in the farm belt, corn prices are up 60% just since June of this year. All food commodities are up significantly. And the only real "tool" the Fed can utilize to stop prices from rising too much would be to raise interest rates. And this means mortgage costs would also rise, making homes less affordable.

According to a detailed regression analysis of the history of inflation correlated to interest rates and housing prices, published on the blog in 2010, inflation simply does not generate significant increases in housing prices.

This data shows that there is a strong correlation between rising interest rates, and reductions in home prices. It's not obvious to the casual observer or the typical buy and hold investor, because the analysis discovered that there is a 6 month or longer lag time. It takes about 6 months for an increase in mortgage interest rates to begin to translate into a reduction in home prices. Conversely, in the historical past, falling interest rates stimulated home sales, and the resulting increase in demand led to rising home prices when interest rates were falling. But not this time. The near-zero interest rates have done nothing to stimulate home sales.

But the money pumping is beginning to have a significant impact on consumer prices. Grocery stores are now filled with packaged items in which significant reductions of the net contents have been used to mask commodity prices that are rising rapidly. Fuel prices have doubled in just the past three and one-half years. When you combine those facts into the equation, Bernanke is clearly caught between a "rock" of deflated mortgage backed securities, (which he is trying desperately to re-inflate), and a "hard place" of food and fuel prices that have begun a run-away inflationary spiral.

Also lurking in the shadows for housing is the continuation of high unemployment, still officially near 8%, while non-government analysts at Shadow Government Statistics place the real unemployment rate well above 20%.

I believe that the lack of real demand, from real-end-user buyers is being masked in the housing sales data, because sales data does not differentiate between end-user buyers and investors. Yes sales are up, and demand is up slightly, relative to the bottom, but it's not the general public doing much of this buying. Instead, big investment companies are making an unprecedented push into the housing market, in anticipation of rising rental rates that may not materialize in many markets.

In short, we've been lying to ourselves for so long about economic data that the government and the housing industry don't seem to realize the economic headwinds that consumers are facing.

This being said, I believe the best approach is a conservative one. All home buyers as well as real estate investors should continue to buy at the lowest possible prices, and not project any benefits from property appreciation or significant rental increases for at least the next 5 years.

An old time rental property owner, now in his 80's told me the other day that "the rental property business just isn't what it used to be when I was your age." He still has rental properties that have been paid off for many years, but their tenants are struggling more than ever to pay a rent rate that has not risen in 5 or more years, while taxes and insurance costs continue to escalate.

It's important to be realistic about the fact that rent rates can't rise much in the markets that are not supported by strong job growth sectors. If you are in metro Washington DC, demand will remain strong because the government complex grows ever larger by the day, and is a major job growth leader nationally. (at least until Uncle Sam runs out of money) But if your properties are in metro Atlanta, GA, Phoenix, AZ, Las Vegas, NV, central Florida, Riverside California, or the "rust belt", you should be very realistic about flat rent rates, systemic unemployment and rising consumer prices.

Personally, as a real estate investor, I'd love to see a big housing recovery, complete with rising property prices, rising employment, rising incomes and a new housing boom, but unfortunately this is 2012, not 1993. The only thing rising right now is the cost of living. As investors, it's in our best interest to be realistic about the financial challenges that are still ahead for would-be home buyers and rent paying tenants.
Donna S. Robinson is an investor, author and residential market analyst located in Atlanta, GA. Follow her on twitter at donnaconsults and read her blog on her website at

Donna S. Robinson has been involved in the real estate industry since 1996. A licensed agent and real estate investor, she is a recognized expert on residential real estate investing. Her course, "Fundamentals & Strategies For Real Estate Investing" is approved for CE credit by the GA Real Estate Commission. She has authored several books on real estate investing, and consults with residential investment companies. She also offers coaching services to real estate investors.

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