When Is a Good Time To Buy Real Estate? Answer: Yes

I have been thinking a lot about inflation, purchasing power, interest rates, and when my father purchased real estate when interest rates were 18%. Hard assets like Silver, Gold, Land, and Real Estate are a hedge against inflation. Real Estate and Land are one of the few areas where you can make a return in excess of the cost of the asset (taxes for both and maintenance and repairs for the property). Silver and Gold cannot make you a return and has a cost for the storage of the asset. Real Estate is the only place where you can also leverage the asset by getting a loan.

During any period of inflation, the purchasing power of the dollar decreases. For this reason, when you pay your first month's principal and interest payment and the 360th month's principal and interest payment, the amount of money paid is the same but the purchasing power of that same amount of money is very different.

I had heard about countries with hyper inflation in the soviet era ripping up the loan as the debt amount was not worth servicing anymore.

This led me to the thought of "In light of inflation, what is the effective interest rate of a loan when you back out some inflation scenarios?" Here's the conclusion I came up with. You should always buy real estate.

I looked at the last ten year of inflation data. Over these ten years, the average inflation per month was 0.24%, the standard deviation was 0.36%, the maximum inflation was 1.37%, the minimum inflation was -0.67%, and the median inflation was 0.23%.

Over the worst period of inflation in this ten year data set (a period of 17 months from February 2021 through June 2022), the average inflation per month was 0.74%, the standard deviation was 0.34%, the maximum inflation was 1.37%, the minimum inflation was 0.21% and the median inflation was 0.80%.

I then generated a standard amortization schedule for 30 year and 15 year mortgages. I added columns that reduced the effective payment by the 0.24% per month. I used the results I saw from today's 30 year interest rate (7.09%) and 15 year interest rate (6.56%). The results indicate that the effective interest rate (when correcting for the reduction in the purchasing power) is 1.84% per year for the 15 year loan and 2.05% per year for the 30 year loan.

When I did the same analysis but reduced the first 17 payments based on 0.74% (instead of 0.24%), the effective interest rate reduced to 1.63% for 30 year loan, and 1.18% for 15 year loan.

I also redid the analysis with a 4% interest rate as we saw for much of the past 10 years or so. In this situation, the effective interest rate is 0.50% to 0.19% for 30 years (when using 0.24% the whole period and 0.74% for first 17 payments and then 0.24% for the remaining periods), and 0.53% to -0.03% for 15 years.

What does this all mean?

This is the reverse of considering how much a house will be worth 30 years in the future. Much of that increase in home value is because the purchasing power has decreased over the 30 years.

Mortgage companies way underestimated the expected inflation of our country when offering mortgage vehicles over the last 15 years as it relates to pricing mortgages. This was probably mostly caused by quantitative easing and the government buying mortgages with Fannie/Freddie. To get the housing market going, the government was causing the market to be mispriced, thus subsidizing many of us who bought with artificially low mortgage rates.

My buddy says it best, the asset is not the property but the loan itself. If you have a property with a 2.5% loan, the bank is essentially subsidizing your loan when you consider the impact of inflation and the reduction of purchasing power.

When inflation is high, buying hard assets like real estate is a good idea as your purchasing power is getting crushed. The interest rate will be higher to make up for the expected reduction in the purchasing power. This is why the mortgage rates do not follow the prime rate but do the 10 year treasury (which tracks an amount of money slightly higher than the expected inflation rate only and is not a direct lever controlled by the FED). In this scenario, over long enough periods of time, your investment returns will be heavily based on appreciation, instead of cash flow. This is why everyone is screaming that they cannot afford a house.

When inflation is low, buying real estate is good since you can get a lower interest rate, and if you are running your numbers correctly, can make a return on the payment from the residents renting the space. In this scenario, over long enough periods of time, your investment returns will be heavily based on cash flow, instead of appreciation.

Sam Eddinger