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Renting in Mass · Posted: Wed Dec 16, 2009 8:30 pm GMT Post subject: Building an inflation hedge

http://www.reuters.com/article/idUSTRE5B844G20091209

balor123 · Joined: 08 Mar 2008 Posts: 1204

The problem with inflation is that not all things inflate equally. It's looking like the flood of dollars is causing two things to happen: home prices are relatively rising (that is not falling as much) and the dollar to drop. The dollar drop means that foreign goods like cars, appliances, some food, electronics, oil, etc are costing a lot more. Income, however, is not going up and that's why houses represent a poor hedge against inflation because they are a measure of income. I'm guessing that it won't start acting that way again until unemployment drops and income can start rising again, which by most estimates will be about 5-7 years at the minimum to be back where we were. It may be worse, though, especially if the H1B visas are a increased as they are currently discussing (increasing labor pool and decreasing need for employers to raise wages to hire talented Americans). For houses that bankers can afford, this is a fantastic time to buy as their incomes are rising. Probably also doctors and lawyers with health care "reform".

CL · Guest

Real estate is an inflation hedge, but with significant flaws if the sole purpose is to hedge against inflation. Any real asset is inflation hedge when financed with a fixed nominal amount of liability. When price is inflated, your debt stay the same and your asset rise with inflation, which is how the hedge works.

The issue is, of course, many factors other than inflation drives real estate price. I disagree that real estate is a measure of income unless it's very long term (30+ years). If real estate is a function of income, and wages being a big part of inflation calculation, it follows real estate should track inflation stably and thus real estate should be a good inflation hedge. But the last housing boom and subsequent bust tells us that house price can deviate quite substantially from the norm of price to income ratio. Demographics, credit availability, rate expectation, government incentives/subsidy, general demand and supply in the specific area, all have significant influence in house prices.

Long story short, I think real estate (finance with mortgage) can help hedging inflation, but too many other factors moving the price make it a flawed hedge. If your sole purpose is to hedge inflation (and afraid that Gold is in bubble), buy TIPS and short same dated treasury.

admin · Posted: Thu Dec 17, 2009 4:10 pm GMT Post subject:

First, I'd like to take issue with this point from the article:

Renting in Mass · Posted: Thu Dec 17, 2009 6:30 pm GMT Post subject:

Thanks admin!

Renting in Mass · Posted: Thu Dec 17, 2009 6:32 pm GMT Post subject:

balor123 · Joined: 08 Mar 2008 Posts: 1204

I'd be afraid of buying because I'm not confident that my income will rise much over the next 5 years. Generally when you buy you get as much as you (and because anything less than that stinks around here), toughing it out for the first few years while your income catches up. Except if your income isn't rising then you'll just be toughing it out. Suppose 5 years is correct, then you'll be looking at living paycheck to paycheck for maybe 10 years. I think the time to buy is when incomes start rising again, if not for the future value of the home then for yourself. You're right that there's only correlation over the long term with incomes because of other factors but I think other factors are also pointing in the same direction (interest rates will go up starting in 2010, mortgages will be harder to get, incomes will stagnate, unemployment will remain high, taxes will rise, etc).

GenXer · Joined: 20 Feb 2009 Posts: 703

'house', 'hedge','inflation' shouldn't be used in one sentence. Doing so shows that the person who's writing this has no idea about house prices, and worst of all, saying this assumes that house prices for any time period will always grow long term! This is nonsense.

Whether something is a hedge against inflation is understood after the fact. We can look back 20 years and see that on average owning a house (if you bought and held on for 20 years) may net you about inflation. Does this mean that a house is a hedge against inflation? Hell no. An average of all those who bought in 2005 will have a completely different result in 20 years, having overpaid by an order of magnitude, and they'll be lucky if they break even. And of course, even saying that in the past 20 years a house 'yielded' inflation actually assumes many other things, such as
1) That somebody actually sold the house in exactly 20 years (and not in 5-7, which is the average)
2) A VERY specific 20 year period. Unless you analyze every overlapping 20 year period in one year increments...
3) That this will necessarily be the case in the future, which it will not.

This is like saying that stocks are a hedge against inflation. Again, complete nonsense. If you happen to know what you are doing, maybe you can do well, and maybe not. Same goes for real estate, commodities, etc. Nothing is a hedge. A properly managed portfolio may provide a hedge against inflation, and STILL you may be able to find a period when this portfolio underperforms (or possibly yields less than inflation). The whole point of investing is the ability to take risks such that on average, the result will beat inflation, but there are no guarantees. Real estate is not such an asset, and neither are stocks. In fact, very few assets beat inflation, unless you are one of those people who bought IBM 30 years ago and held on. For every one of these people, there are thousands who bought Qualcom in 2000 (for $1000 a share). Investor returns are usually much worse than a hypothetical average, simply (and I want to say this as clear as I can) BECAUSE AN AVERAGE INVESTOR ALWAYS UNDERPERFORMS THE AVERAGE.

This is a fact, not a hypothesis. Very few investors actually make what the market makes (or what the Case-Schiller index returns, if you had the ability to invest in it). And of course, how many investors HONESTLY calculate their total ROI? Again, very few. Stick to the basics. Interest on the house <= rent paid. Keep a slush fund for expenses. A house is a big money drain, period. The only reason to upgrade is for a supposedly better lifestyle (if you can afford it). That is, new furniture, new kitchen, new basement, house cleaning, lots of repairs, landscaping, and many other things such as taxes, water bill, heat and electricity. And of course, the time you spend doing all of the repairs/chores yourself is the time you don't spend with your kids (or giving yourself a break from work).

balor123 · Joined: 08 Mar 2008 Posts: 1204

Actually, I think the average return for a house is slightly above inflation so the average investor has kept up. The typical investor, however, is not average. We know that the coasts had significantly higher appreciation than the rest of the country so other parts of the country must have had significantly less. My parent's house is one of those for example. Not that they live in a bad idea (actually, it has grown a lot) but rather in San Antonio you are largely paying for the building and their building has become older, even if the land has appreciated (it's not just a deduction against your taxes!). It is unfortunately very hard to reduce risk when it comes to purchasing a house. You can't buy little pieces of lots of houses and you can't dollar cost average. For an investment, it kind of stinks because the risk is high and there is little or no growth. There is, however, high risk which means that, like the lottery, you can hit it big (or lose big as many people have learned over the last 2 years).