With unprecedented levels of government spending and huge levels of Federal debt as far as the eye can see material inflation is just a matter of time. How are we likely to be affected as multifamily owners?
When inflation accelerated in the late 70s multifamily rent levels increased materially in many markets throughout the U.S. A number of factors contributed to this event.
Background: The average rate of increase in consumer prices was a low 2.36% in the 1960s, rose to 7.09% in the 1970s, was 5.55% in the 1980s, fell to 3.50% in the 1990s (through 1995) and has remained around 3% over the last decade. Many experts claim the current inflation index used by the government is biased upward; hence actual inflation in the 1980s and 1990s has been even lower.
In 1970, the ratio between income and new home cost was 33%. In other words, a new home cost about 3 times more than the median household income. By 1980, due to the horrific inflation during the 1970s, that ratio dropped to 23%. The new home was now 4 times more than the median household income. By 1990, the ratio had dropped further to 20% and was still at 20% in the year 2000. By 2006, the ratio had dropped to 15.7%. In theory people could no longer afford new houses because their income is not rising nearly as fast as the cost. However, when interest rates fell dramatically starting in 2003 suddenly everyone could buy a house.
Obviously all of this will change if inflation kicks in and rates head north. Some of my personal observations and recollections on the market and inflation back in the late 1970s early 80s are set forth below:
1. Rising interest rates dampened the appeal of single-family home ownership and demand for apartments shot up. Three bedroom units were especially in high demand as were the larger 2BR units which could accommodate two or more children.
2. High interest rates also inhibited new apartment construction for a number of years until rising rents and federal tax policies (accelerated depreciation) again made new construction economic.
3. In order to pay the increasing rents, tenants started spending a larger percentage of their income on housing. They had no choice thus they cut back in other areas and married women entered the workforce in size to bolster household incomes for the first time since World War II.
4. Wage hikes grew steadily reaching 6 to 8% by the early 1980?s again giving the consumer more income to offset declining buying power. One of our projects in Philadelphia unionized and demanded a three year contract with 10% annual increases in wages. They actually went on strike for six weeks before settling for 6% annual hikes each year. Stock prices were pummeled but interest rates on money market accounts, CDs and bonds soared.
5. Baby boomers reached the young adult stage and entered the housing market in mass; much like that which is occurring now with the echo boom generation. Higher demand translated to higher rents.
6. Some markets did not see higher rents even with rampant inflation. The Midwest was shedding manufacturing jobs and losing population to the Sunbelt thus falling housing demand prevented inflationary rent growth. This also occurred in other transitional areas such as the Carolinas, other parts of the south and New England as textile jobs disappeared off-shore. In these markets housing prices and rents were stagnant or actually declined, much like we are seeing in Detroit today!
7. Owners raised rents aggressively as leases expired knowing that tenants would in all likelihood renew and if they moved the apartment would be immediately occupied by someone else. Security deposits, amenity fees, credit checking fees, etc became du jour across the board.
8. New carpet and new appliances were the exception not the rule. Old shag carpeting and gold or avocado appliances were the norm because it was a landlord market. Obviously this helped bolster NOIs along with other reductions that were possible in capital spending.
Many of the conditions that existed in the 1970s and which engendered the inflationary period that occurred also exist once again today and they are primarily the government deficit spending to finance entitlements and the war and the on-going high negative trade balance which ships a significant portion of U.S. wealth abroad. Meanwhile tax receipts haven?t kept up and they are unlikely to keep up over the near future as it appears that the overall population is saying ? No more tax! Thus the Fed?s printing presses will roll and inflation will again take hold.
Steven Macy, CPM? co-founded TGM Associates LP in 1991 and is currently a managing partner of the firm with co-founder Tom Gochberg managing over $1.3 Billion of multifamily assets for a blue-chip roster of institutional clients.