Yesterday we talked about the Fat Bear strategy #1, the multiple streams of income that make up a Real Estate meal. This post is about Real Estate as a Hedge against inflation, Fat Bear strategy #2. Let me divert away from real estate for a moment, because the following systems directly affects real estate prices.
I love living in Canada, and I believe in democracy and in capitalism. I am not the only person who feels this way, and it appears these forms of government and economics are here to stay.
Since democratic governments will be around for the foreseeable future, and since they must satisfy interest groups and voters or risk losing a re-election, there is constant pressure to spend money on social programs and infrastructure such as roads, hospitals and schools. Governments frequently go over budget and spend more than they collect through taxes.
Since governments cannot get all the money needed through taxes, or achieve a balanced budget through cuts, they must find a way to pay the bills. Governments are more fortunate than you or I, because when they run out of money, they simply print more!
What does this have to do with real estate?
If you are familiar with the law of supply and demand(pictured), you know that an increase in the money supply causes existing money to be worth less. This is called inflation.
The Bank of Canada(BoC), Canada’s central bank, is responsible for monetary policy and taking measures to influence the Canadian economy. The Bank of Canada’s policy is to keep inflation between 1-3% per year, with the target at the 2% midpoint. This target for inflation is the sweet spot where there can be healthy economic growth.
Since the system we live in, and most of us enjoy, has been around awhile and shows no signs of changing soon, it is safe to assume there will always be inflation.
That means, at 2% inflation(the BoC’s target) if you leave $100 under your mattress for:
- 1 year it will be worth $98
- 5 years it will be worth $90
- 10 years = $80
- 20 years = $60
- 30 years = $40
It will not be very nice if in today’s dollars you can dine out once or twice with your spouse, but years later when you have less energy to work and are living off your savings, you could not afford it at all!
Real estate, like many hard assets such as gold, tends to rise in value, at least at the pace of inflation. Real estate has the added bonus of increasing rental income. As inflation rises, income gradually follows, and people can afford more rent. In fact in British Columbia, the amount that rent can be increased each year is determined by law, and for 2013 the allowable increase is 3.8%.
That basically sums up Fat Bear strategy #2, the hedge against inflation.
Until next time,