But in all, inflation isn’t going to be high for awhile for two main reasons. One, the whole recession brought everyone back down to reality; the “real” value of items are starting to be actualized (and in some cases the cost of good is lower than its actual value due to people being conservative in pricing). Kind of like houses, right? The peoples’ purchasing power hasn’t eroded over the past one or two years, prices of common goods has stayed the same. Second, we haven’t really seen the market being flooded with cash or capital. Banks are still cautious to lend our money to the middle class and people who pinching their pennies and dimes. Sure, the government has loaned and given out a lot of money, but where is it? Most of it was to take care of state and local budgets so that they can continue with their day to day operations and move on with planned projects. Some of it was spent to bail our companies who really aren’t putting it out in the market, they just used it to offset their “toxic investments”. We might see how inflation in the coming years, however, I don’t know if anyone can say it is totally attributed to the bailout.

I thought the huge concern about the Federal government pumping so much money into the economy was that it would most likely lead to high inflation. You seem extremely knowledgeable on the subject, could you explain why this won’t be the case?

Also, please note above that with respect to inflation I wrote that “With real estate, the value of your money is “preserved” but with cash the value of your money is lost.” I am sure that there can be exceptions to this but I did not mean to lead people to believe that real estate offers a net gain, but rather keeps one at par.

I look forward to reading your response. Will Daly

Also, the correlation between national inflation and home prices is a little weak. First, all economic indicators show that inflation is to remain extremely low. I have yet to find a reliable source that shows inflation will be that high. An inflation of 10% would almost be catastrophic, as that is an inflation rate often seen in third world/developing countries in Africa – Ethiopia just recently had a tuff battle with high inflation rates and I believe they just decreased their inflation rate to about 7.5% recently. The last time the US had an inflation rate that high was back in 1981. Second, inflation doesn’t increase the value of the house. The figure you used of jumping from $250K to $275K is just simply a correlation of comparing today’s cost with previous year’s cost, not necessarily equitable or tangible value. Often, if we were to show the actual increased value of the house, it would simply be a function of increase in market value rate minus that of the inflation median rate over the period of time, ie, for the example, you provide, the house did not increase in value, since the increase of the house cost is equal to the inflation rate. Typically, the inflation rate of the US for the last 10 years is roughly 2.5 to 3.5%, so if the average cost of home increases each year at 5% and the average inflation rate is 3%, the home really increased in value by 2%. Third, if the national inflation rate is 10% higher (and you hope/fingers cross that means your home values is 10% higher), that means all the other stuff you buy, as in gas, food, and other essentials will most likely be 10% higher. Employeers will try to compensate employees fairly but more often than not, increase in wages to compensate for inflation are often months or a year behind the actual increase costs of living. Basically, you effective buying power is less than the previous year’s and you are trying to play catch up. Forth, traditionally when inflation rates are high, the Federal Reserve (aka the “Fed”) will increase the interest rate, which means higher mortgage rates. The Fed wants to decrease the supply of money in the market during times of high inflation.

Finally, your analysis of saying ‘$50k garners in 50% return in a year’ is slightly misleading. A simple time value of money engineering diagram shows that the initial investment of $50K and a uniform distributed load of additional costs (assuming a fixed rate mortgage) through at the rest of the year, then maybe an increase of $25K at the end. Your analysis does not include the monthly payments, let alone the interest included in the monthly payments. So let’s say you have a $200k loan at a 6.5% interest for 30 years. That is about . . .lets use easy numbers here, $1600 a month. That equates to $19,200 a year in payments, or a total of about $69K spent in 12 months when including the down payment. So, in all actuality, the increase of 2% in your example, or $5000, took $69,000. That is a yearly return of 7%, which is still a great return in all actuality in this market. However, it is no where near the 25%. But the real calculation of return should be looked at a longer time frame since they simple ratio of return you provided does not consider your total overall contractual debts – maybe more importantly than anything else, the home value is always, always, always equal to what you paid for it. Any price is just purely speculation and just a fancy/legal form of gambling. A home value is only defined at the time cash or checks exchange hands, not what anyone speculates what it may be.

However, my quick analysis is not to detract from the spirit of this blog. Basically, inflation is great for borrowers, like home buyers, and real estate is still a viable investment for smart investors. But the emphasis shouldn’t be placed on the quick return or immediate satisfaction, as this is what got the US housing market in trouble. Be more concerned about the long term, 10/15/20/40 years from now. Besides, do you want the place you lay your head down at night to be a home or to be an investment? That is the biggest question you have to ask yourself.

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