Published in Real Estate
August 25, 2023
Published in Real Estate
August 25, 2023
Published in Real Estate
August 25, 2023
Navigating High-Interest Rates: Should You Buy or Sell Real Estate? Lessons from the 1970s Stagflation
Navigating High-Interest Rates: Should You Buy or Sell Real Estate? Lessons from the 1970s Stagflation
Navigating High-Interest Rates: Should You Buy or Sell Real Estate? Lessons from the 1970s Stagflation
Many homeowners in the US and Europe are struggling to navigate the new high interest rate environment we are in since 2022. After record-low mortgage rates following decade-long financial stimulus, homeowners are now suddenly facing mortgage rates which are twice or thrice as high as their initial rates. Home prices in several US states and European countries are under pressure, with home prices in Sweden decreasing by 13.5% off their all-time highs.
Swedish central bank policy rate and house price index
Source: Sveriges Riksbank, House prices and interest rate expectations, 20 september 2022
Although the current high interest rate environment is a rude awakening for many, this is not quite uncharted territory. The current economic environment has many parallels with the turbulent stagflation era of the 1970s. Studying this period can provide us with valuable insights on how to navigate the current environment.
Understanding the 1970s Stagflation
The 1970s were marked by stagflation, characterized by stagnation of economic growth, high inflation, and relatively high unemployment across the US and Europe. This period posed unique challenges to investors and homeowners alike, as high-interest rates became a central tool for the Federal Reserve, Bank of England and European central banks to combat inflation.
Current inflation rates and interest rates are still well below the levels of the 1970s, as shown in the charts below. The US CPI inflation index increased by 159% between 1970 and 1982. In an attempt to stem inflation, the Fed funds rate increased to 12.92% in 1974 and to 19.10% in 1981. The current FED funds rate of 5.12%, a 15-year high after almost a decade of near-zero rates, is still well below these levels.
Although proving a causal effect in these matters is typically difficult, it is generally accepted that the high inflation of the 70s was caused by high government spending (Vietnam war, social programs) in the preceding decade, as well as a supply shock (1973 oil crisis). This is not unlike our current situation in 2023, after 15 years of high government spending (in the US and Europe) in a near-zero interest rate environment, and a supply shock following the 2021 covid-19 crisis.
Inflation, consumer prices in the US
Source: St. Louis Federal Reserve, https://fred.stlouisfed.org/series/FPCPITOTLZGUSA
FED federal funds effective rate
Source: St. Louis Federal Reserve, https://fred.stlouisfed.org/series/FEDFUNDS
The Case for Buying During High-Interest Rates
Surprisingly, historical data from the 1970s suggests that buying real estate during periods of high-interest rates can be a good strategic move. Residential real estate prices dipped in the early 70s when inflation and interest rates increased. However, after the inflation shock, real estate prices recovered, eventually outpacing inflation, despite persistent high mortgage rates.
UK real estate total returns averaged 16.3% per year. Real estate returns exceeded the returns of both UK equities and bonds with total returns of 14.2% p.a. and 10.2% p.a., respectively. US real estate prices increased by 159% between 1970 and 1982, outperforming equities during this period, despite high mortgage rates. This highlights that, despite an initial pullback, real estate can serve as a solid hedge against inflation over the long term.
Cause and effect
The causal factors behind the real estate price boom during the 1970s is less easy to establish. In economics, it is much easier to establish correlation than to establish a causal relationship. However, in general, real estate is considered a solid hedge against inflation. Usually, including in the 1970s and the current decade, high interest rates are used as a tool by central banks to combat high inflation. Hence, both will usually coincide. Whereas high mortgage rates would normally have a negative effect on real estate valuations, high inflation rates would normally have a positive effect on real estate valuations.
Here are a few reasons why high inflation, all else being equal, is generally beneficial for real estate valuations:
1. Rent increases: Rent can typically be increased at around the inflation rate, regulation permitting. Consequently, the gross income of real estate usually keeps pace with inflation.
2. Leverage: as inflation increases, the nominal rent amount typically increases, and the nominal value of the property can increase as well, but the nominal value of the outstanding mortgage debt does not. Given higher inflation rates, the present value of the outstanding mortgage debt decreases. To offset this, mortgage rates will increase. However, if you have a fixed rate mortgage, you are in a great position to benefit from higher inflation, as your outstanding mortgage debt will be worth significantly less, while the value of your property increases.
3. Replacement cost: as inflation increases, the cost of building a home from scratch (labour and materials) will typically increase as well. The cost of rebuilding a home is called its replacement cost. When construction labor and construction materials increase in price, so does the replacement cost of the existing home inventory. In normal market circumstances, the price of a home is significantly higher than its replacement cost, given buyers are willing to pay a premium of not going through the time-consuming process of building a home from scratch. The replacement cost acts as a floor below the market value of real estate. Hence, an increase in the replacement cost of real estate is positive for market prices, all else being equal.
These factors are balanced against the negative effect of higher mortgage rates, which negatively impact an investor’s net cash flow, and typically depresses the valuation multiples paid for real estate as well.
Consider Your Financial Goals and Diversification
Ultimately, the decision to buy or sell real estate during high-interest rate periods should align with your broader financial objectives. Investors with multiple properties or extensive real estate holdings should evaluate how these assets fit into their overall strategy. Additionally, local real estate market conditions will also play a role in determining whether buying or selling is the right choice for you.
Conclusion
The 1970s stagflation era in the US and UK provide valuable lessons for making real estate decisions in times of high interest rates. Contrary to what some might expect, significantly higher mortgage rates did not depress real estate prices for multiple years. After an initial pullback, US and UK residential real estate markets rallied, outperforming equities. In the 70s, selling out of fear for lower returns due to higher interest rates would have proven to be a mistake.
Past returns do not guarantee future returns. Despite several similarities between the current economic environment and the 1970s, there is no guarantee that the current economic environment will develop in a similar way. As always, it is important to make informed decisions that align with your financial goals and the specific conditions of your local real estate market.
Sources
https://datatrekresearch.com/us-stock-and-real-estate-values-during-stagflation/
St. Louis Federal Reserve, https://fred.stlouisfed.org/series/FPCPITOTLZGUSA
St. Louis Federal Reserve, https://fred.stlouisfed.org/series/FEDFUNDS
Many homeowners in the US and Europe are struggling to navigate the new high interest rate environment we are in since 2022. After record-low mortgage rates following decade-long financial stimulus, homeowners are now suddenly facing mortgage rates which are twice or thrice as high as their initial rates. Home prices in several US states and European countries are under pressure, with home prices in Sweden decreasing by 13.5% off their all-time highs.
Swedish central bank policy rate and house price index
Source: Sveriges Riksbank, House prices and interest rate expectations, 20 september 2022
Although the current high interest rate environment is a rude awakening for many, this is not quite uncharted territory. The current economic environment has many parallels with the turbulent stagflation era of the 1970s. Studying this period can provide us with valuable insights on how to navigate the current environment.
Understanding the 1970s Stagflation
The 1970s were marked by stagflation, characterized by stagnation of economic growth, high inflation, and relatively high unemployment across the US and Europe. This period posed unique challenges to investors and homeowners alike, as high-interest rates became a central tool for the Federal Reserve, Bank of England and European central banks to combat inflation.
Current inflation rates and interest rates are still well below the levels of the 1970s, as shown in the charts below. The US CPI inflation index increased by 159% between 1970 and 1982. In an attempt to stem inflation, the Fed funds rate increased to 12.92% in 1974 and to 19.10% in 1981. The current FED funds rate of 5.12%, a 15-year high after almost a decade of near-zero rates, is still well below these levels.
Although proving a causal effect in these matters is typically difficult, it is generally accepted that the high inflation of the 70s was caused by high government spending (Vietnam war, social programs) in the preceding decade, as well as a supply shock (1973 oil crisis). This is not unlike our current situation in 2023, after 15 years of high government spending (in the US and Europe) in a near-zero interest rate environment, and a supply shock following the 2021 covid-19 crisis.
Inflation, consumer prices in the US
Source: St. Louis Federal Reserve, https://fred.stlouisfed.org/series/FPCPITOTLZGUSA
FED federal funds effective rate
Source: St. Louis Federal Reserve, https://fred.stlouisfed.org/series/FEDFUNDS
The Case for Buying During High-Interest Rates
Surprisingly, historical data from the 1970s suggests that buying real estate during periods of high-interest rates can be a good strategic move. Residential real estate prices dipped in the early 70s when inflation and interest rates increased. However, after the inflation shock, real estate prices recovered, eventually outpacing inflation, despite persistent high mortgage rates.
UK real estate total returns averaged 16.3% per year. Real estate returns exceeded the returns of both UK equities and bonds with total returns of 14.2% p.a. and 10.2% p.a., respectively. US real estate prices increased by 159% between 1970 and 1982, outperforming equities during this period, despite high mortgage rates. This highlights that, despite an initial pullback, real estate can serve as a solid hedge against inflation over the long term.
Cause and effect
The causal factors behind the real estate price boom during the 1970s is less easy to establish. In economics, it is much easier to establish correlation than to establish a causal relationship. However, in general, real estate is considered a solid hedge against inflation. Usually, including in the 1970s and the current decade, high interest rates are used as a tool by central banks to combat high inflation. Hence, both will usually coincide. Whereas high mortgage rates would normally have a negative effect on real estate valuations, high inflation rates would normally have a positive effect on real estate valuations.
Here are a few reasons why high inflation, all else being equal, is generally beneficial for real estate valuations:
1. Rent increases: Rent can typically be increased at around the inflation rate, regulation permitting. Consequently, the gross income of real estate usually keeps pace with inflation.
2. Leverage: as inflation increases, the nominal rent amount typically increases, and the nominal value of the property can increase as well, but the nominal value of the outstanding mortgage debt does not. Given higher inflation rates, the present value of the outstanding mortgage debt decreases. To offset this, mortgage rates will increase. However, if you have a fixed rate mortgage, you are in a great position to benefit from higher inflation, as your outstanding mortgage debt will be worth significantly less, while the value of your property increases.
3. Replacement cost: as inflation increases, the cost of building a home from scratch (labour and materials) will typically increase as well. The cost of rebuilding a home is called its replacement cost. When construction labor and construction materials increase in price, so does the replacement cost of the existing home inventory. In normal market circumstances, the price of a home is significantly higher than its replacement cost, given buyers are willing to pay a premium of not going through the time-consuming process of building a home from scratch. The replacement cost acts as a floor below the market value of real estate. Hence, an increase in the replacement cost of real estate is positive for market prices, all else being equal.
These factors are balanced against the negative effect of higher mortgage rates, which negatively impact an investor’s net cash flow, and typically depresses the valuation multiples paid for real estate as well.
Consider Your Financial Goals and Diversification
Ultimately, the decision to buy or sell real estate during high-interest rate periods should align with your broader financial objectives. Investors with multiple properties or extensive real estate holdings should evaluate how these assets fit into their overall strategy. Additionally, local real estate market conditions will also play a role in determining whether buying or selling is the right choice for you.
Conclusion
The 1970s stagflation era in the US and UK provide valuable lessons for making real estate decisions in times of high interest rates. Contrary to what some might expect, significantly higher mortgage rates did not depress real estate prices for multiple years. After an initial pullback, US and UK residential real estate markets rallied, outperforming equities. In the 70s, selling out of fear for lower returns due to higher interest rates would have proven to be a mistake.
Past returns do not guarantee future returns. Despite several similarities between the current economic environment and the 1970s, there is no guarantee that the current economic environment will develop in a similar way. As always, it is important to make informed decisions that align with your financial goals and the specific conditions of your local real estate market.
Sources
https://datatrekresearch.com/us-stock-and-real-estate-values-during-stagflation/
St. Louis Federal Reserve, https://fred.stlouisfed.org/series/FPCPITOTLZGUSA
St. Louis Federal Reserve, https://fred.stlouisfed.org/series/FEDFUNDS
Many homeowners in the US and Europe are struggling to navigate the new high interest rate environment we are in since 2022. After record-low mortgage rates following decade-long financial stimulus, homeowners are now suddenly facing mortgage rates which are twice or thrice as high as their initial rates. Home prices in several US states and European countries are under pressure, with home prices in Sweden decreasing by 13.5% off their all-time highs.
Swedish central bank policy rate and house price index
Source: Sveriges Riksbank, House prices and interest rate expectations, 20 september 2022
Although the current high interest rate environment is a rude awakening for many, this is not quite uncharted territory. The current economic environment has many parallels with the turbulent stagflation era of the 1970s. Studying this period can provide us with valuable insights on how to navigate the current environment.
Understanding the 1970s Stagflation
The 1970s were marked by stagflation, characterized by stagnation of economic growth, high inflation, and relatively high unemployment across the US and Europe. This period posed unique challenges to investors and homeowners alike, as high-interest rates became a central tool for the Federal Reserve, Bank of England and European central banks to combat inflation.
Current inflation rates and interest rates are still well below the levels of the 1970s, as shown in the charts below. The US CPI inflation index increased by 159% between 1970 and 1982. In an attempt to stem inflation, the Fed funds rate increased to 12.92% in 1974 and to 19.10% in 1981. The current FED funds rate of 5.12%, a 15-year high after almost a decade of near-zero rates, is still well below these levels.
Although proving a causal effect in these matters is typically difficult, it is generally accepted that the high inflation of the 70s was caused by high government spending (Vietnam war, social programs) in the preceding decade, as well as a supply shock (1973 oil crisis). This is not unlike our current situation in 2023, after 15 years of high government spending (in the US and Europe) in a near-zero interest rate environment, and a supply shock following the 2021 covid-19 crisis.
Inflation, consumer prices in the US
Source: St. Louis Federal Reserve, https://fred.stlouisfed.org/series/FPCPITOTLZGUSA
FED federal funds effective rate
Source: St. Louis Federal Reserve, https://fred.stlouisfed.org/series/FEDFUNDS
The Case for Buying During High-Interest Rates
Surprisingly, historical data from the 1970s suggests that buying real estate during periods of high-interest rates can be a good strategic move. Residential real estate prices dipped in the early 70s when inflation and interest rates increased. However, after the inflation shock, real estate prices recovered, eventually outpacing inflation, despite persistent high mortgage rates.
UK real estate total returns averaged 16.3% per year. Real estate returns exceeded the returns of both UK equities and bonds with total returns of 14.2% p.a. and 10.2% p.a., respectively. US real estate prices increased by 159% between 1970 and 1982, outperforming equities during this period, despite high mortgage rates. This highlights that, despite an initial pullback, real estate can serve as a solid hedge against inflation over the long term.
Cause and effect
The causal factors behind the real estate price boom during the 1970s is less easy to establish. In economics, it is much easier to establish correlation than to establish a causal relationship. However, in general, real estate is considered a solid hedge against inflation. Usually, including in the 1970s and the current decade, high interest rates are used as a tool by central banks to combat high inflation. Hence, both will usually coincide. Whereas high mortgage rates would normally have a negative effect on real estate valuations, high inflation rates would normally have a positive effect on real estate valuations.
Here are a few reasons why high inflation, all else being equal, is generally beneficial for real estate valuations:
1. Rent increases: Rent can typically be increased at around the inflation rate, regulation permitting. Consequently, the gross income of real estate usually keeps pace with inflation.
2. Leverage: as inflation increases, the nominal rent amount typically increases, and the nominal value of the property can increase as well, but the nominal value of the outstanding mortgage debt does not. Given higher inflation rates, the present value of the outstanding mortgage debt decreases. To offset this, mortgage rates will increase. However, if you have a fixed rate mortgage, you are in a great position to benefit from higher inflation, as your outstanding mortgage debt will be worth significantly less, while the value of your property increases.
3. Replacement cost: as inflation increases, the cost of building a home from scratch (labour and materials) will typically increase as well. The cost of rebuilding a home is called its replacement cost. When construction labor and construction materials increase in price, so does the replacement cost of the existing home inventory. In normal market circumstances, the price of a home is significantly higher than its replacement cost, given buyers are willing to pay a premium of not going through the time-consuming process of building a home from scratch. The replacement cost acts as a floor below the market value of real estate. Hence, an increase in the replacement cost of real estate is positive for market prices, all else being equal.
These factors are balanced against the negative effect of higher mortgage rates, which negatively impact an investor’s net cash flow, and typically depresses the valuation multiples paid for real estate as well.
Consider Your Financial Goals and Diversification
Ultimately, the decision to buy or sell real estate during high-interest rate periods should align with your broader financial objectives. Investors with multiple properties or extensive real estate holdings should evaluate how these assets fit into their overall strategy. Additionally, local real estate market conditions will also play a role in determining whether buying or selling is the right choice for you.
Conclusion
The 1970s stagflation era in the US and UK provide valuable lessons for making real estate decisions in times of high interest rates. Contrary to what some might expect, significantly higher mortgage rates did not depress real estate prices for multiple years. After an initial pullback, US and UK residential real estate markets rallied, outperforming equities. In the 70s, selling out of fear for lower returns due to higher interest rates would have proven to be a mistake.
Past returns do not guarantee future returns. Despite several similarities between the current economic environment and the 1970s, there is no guarantee that the current economic environment will develop in a similar way. As always, it is important to make informed decisions that align with your financial goals and the specific conditions of your local real estate market.
Sources
https://datatrekresearch.com/us-stock-and-real-estate-values-during-stagflation/
St. Louis Federal Reserve, https://fred.stlouisfed.org/series/FPCPITOTLZGUSA
St. Louis Federal Reserve, https://fred.stlouisfed.org/series/FEDFUNDS
