Low CPI Inflation Keeps Pressure Off Real Estate Buyers

posted on May 31st, 2010 filed under: Financial Responsibility, Real Estate Market Data, Real Estate News

The Wall Street Journal recently reported that inflation in the United States has declined to its lowest level in 44 years, as measured by the core consumer price index (i.e., excluding food and energy).  A prior post here at The REF made a similar observation several months ago.

Why does it matter?  CPI data provide a backdrop for making informed decisions about whether to buy or sell real estate.  In times of inflation, people flee their devaluing cash for hard assets like real estate and commodities.  There are other ways for real estate prices to rise — like when interest rates are slashed and lending standards are abandoned.  (Sound familiar?)  But we will not return to the days of NINJA (no income, job or assets) loans again.  So the next real estate boom is far more likely to be fueled by inflation than easy credit.

The 1970s are a classic example of inflation-based gains in home prices.  Throughout that inflationary decade, real estate values rose in tandem with wages and general CPI inflation.

U.S. CPI -- 1960 to Apr. 2010

But this is not the 1970s, and the current lack of general CPI and wage inflation takes the pressure off your decision whether to buy a home.

Recognize, however, that inflation is not gone.  Rather, inflation in some items is being offset by deflation in other items — principally shelter.  In fact, the shelter component has gone negative for the first time in the history of the data series.

U.S. CPI -- Shelter Component -- 1950 to Apr. 2010

The declining shelter component is keeping the overall CPI much lower than it otherwise would be.

U.S. CPI -- All Items Less Shelter -- 1960 to Apr. 2010

The shelter component is based on the cost of renting, not buying.  But you won’t have sustainable gains in real estate prices as long as rents are falling.  As noted here time and again, one of the pathologies of real estate values in Miami and Coral Gables is that the cost of owning far exceeds the cost of renting — well beyond historical norms.

Articles like the one in the Wall Street Journal indicate that the fear of deflation has not disappeared, and that the risk of inflation is thought to be muted.  As long as that remains true, there will be little pressure to buy real estate.

Recognize, however, that others believe the government deliberately understates inflation, and that easy money and government spending will cause inflation to surge in the not-too-distant future.  (See., e.g., www.shadowstats.com).

See both sides.  When the shelter component flips positive, the evidence of deflation could vanish and lead quickly to general inflation.  So it will be wise to keep an eye on this canary in the coal mine.

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posted by // This entry was posted on Monday, May 31st, 2010 at 11:30 am and is filed under Financial Responsibility, Real Estate Market Data, Real Estate News. You can follow any responses to this entry through the RSS 2.0 feed.

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