A Watched Pot Does Boil

Recently, we wrote a post on the potential impact of inflation on the local and national economy. After years of easy monetary policy aimed at an inflation rate of 2%, the Fed was caught flatfooted when both their measures of inflation spiked to more than double their target.

Claims that the increase is transitory were immediately made, but more of the experts are coming out with predictions of a prolonged inflationary cycle. It’s no easy task to stop inflation and the process is painful. Just look back to the Volcker days of 1981 for proof. Mortgage rates for industrial properties were over 15%.

The post-pandemic recovery has been full of surprises. The flood of cash distributed by the federal government sparked demand for goods and services beyond expectations. But the supply chain, scrambling to recover from the pandemic shutdown, is falling woefully short of meeting surging demand. Product shortages are running across multiple sectors and that has been exacerbated by a labor shortage. There are now more jobs to fill than there are people to fill them. Many of those openings are in the transportation sector, which has further slowed the flow of goods to their destinations. Container ships are lined up outside the harbors, sometimes waiting weeks to unload.

While all this is happening, the commercial real estate market in Southern California is on a tear. Lease rates are rising faster than ever and every sale sets a new record price. It’s hard to believe that we just went through the worst health crisis in a hundred years. Demand for quality industrial real estate has never been higher despite the fact that a huge tax hike proposal is being debated in Congress. If passed, it could really throw a broomstick into the spokes in terms of real estate property values.

How long can this current course continue? That’s what is starting to bother us right now. Things just don’t seem to add up and we grow increasingly concerned about another bubble forming. It’s kind of like those little air bubbles that come off the bottom before your pot of water breaks into a full boil. Eventually, the watched pot really does boil and we are watching very closely.

The current economic recovery is being fueled by loose monetary policy and government giveaways, both of which, we believe, are manufacturing demand that would not otherwise exist. Mortgage rates, benchmarked against low US Treasury yields, are in the low 3% range. That and 90% loan-to-value mortgages make it easier for buyers to pay today’s prices. The savings rate has skyrocketed during the pandemic due to enhanced unemployment benefits and forgivable loans to millions of businesses. With rates on savings also low, that money is being spent on goods that are in short supply, driving up prices in the process. 

To us, this all points to a longer term inflationary cycle over a transitory one. We just don’t think that a hamburger that now costs $17 at a restaurant will cost $15 again a year from now. We also don’t think that those now working for $17 per hour will stay in their jobs after a pay cut to $15 when things get back to so-called normal. We look around and see the price of everything going up, not just the price of a car, a gallon of gas or a dozen eggs. If our central bankers take a closer look and see what we see, the era of cheap money will have to stop. Raising rates is the Fed’s primary braking mechanism for runaway inflation. When the rate bumps begin, the party will wind down. 

While we don’t pretend to know exactly what will happen in the future, we have been through boom-bust cycles before. The bust part can be very painful, and lately we have been having a lot more conversations with owners like you who also remember that pain. Some are deciding to take at least some of their cards off the table to hedge against a painful downturn. We think that’s a good idea for anyone who already has near-term plans to liquidate some or all of their real estate for estate planning reasons. If you are one of those owners, perhaps we can help you sort things out. Just give us a call.