In this series of posts, our goal is to explain economic concepts so you can better understand the risks to your assets, whether you hold them in cash, stocks, mutual funds, real estate, or gold.
In a previous post, we discussed how the trillions of dollars in new money being injected into the U.S. economy by the Federal Reserve have sparked fears of an inflationary disaster. But while inflation could become a problem in the not-so-distant future, economic history suggests there is a more pressing—and perhaps more dangerous—concern: Deflation.
In simple terms, deflation is a drop in the prices—as opposed to inflation, where prices rise. The economic phenomenon can be caused by an increase in goods and services, a decrease in the supply of money and credit, or—as is the case during this pandemic—a decrease in demand.
If falling prices sound like an attractive scenario, think again. While a moderate drop in prices can promote consumption and encourage saving, an extended run of deflation can wreak considerable havoc.
More than just a symptom of economic dysfunction, deflation can be its own destructive force by reducing the spending power of consumers and businesses. Once deflation takes hold, falling prices can discourage spending as consumers delay big-ticket purchases likely to fall in price in the future. Even if this occurs only at the margin of every household budget, the accumulated impact can do significant harm to an already faltering economy.
The last time the U.S. dealt with a deep and extended period of deflation was 1930-33 during the Great Depression, when prices tumbled almost 25% over four years.
And with demand for many goods and services wiped out by the efforts to contain the deadly outbreak through economic shutdown, 2nd quarter GDP plunged by 32.9%, the worst statistic for the US ever. Remember, by definition, deflation is caused by a fall in aggregate demand and output, mainly during a recession.
Should investors be worried about US deflation? As the COVID-19 pandemic has instilled uncertainty into nearly every aspect of society, economic forecasting is virtually impossible. But—if we had to wager a guess—our expectation is that the U.S. will skirt deflation. We predict that low saving rates in the U.S., coupled with quick and decisive Federal Reserve moves to continue to expand the money supply, will help us sidestep the deflation trap. We have the tools that Japan and many other countries no longer have which allows us to go through this economic downturn and recover again. But nobody can be really sure, especially given we can't predict the timing of the end of the pandemic and once you couple that with US Election uncertainty...perfect storm anyone?
While severe economic deflation is not a certainty, it’s nevertheless important for investors to be prepared. In these uncertain times, the smartest thing investors can do is hope for the best but plan for the worst-case scenario. At Global Investor Alliance, we’ve invested in assets that will be well-positioned in the event of both inflationary or deflationary disasters: Multifamily real estate.
Since we dove into inflation in our last post, let’s go over how this type of asset provides protection in the event of deflation.
In times of deflation, a lack of money forces prices down—including real estate prices. In the recession of 2007, real estate went through a major deflationary period due mostly to over-leveraging, bank foreclosures, and a lack of credit. However, the real estate sector that was least affected by deflation during the recession was apartment buildings. Without enough wealth to afford their homes, many people continued or transitioned into renting during this time. So, even as values plummeted across all other types of real estate due to foreclosures, rents on apartments stayed stable.
During periods of deflation, income-generating properties like multifamily apartments have one huge advantage over other assets: A continuing cash-flow. Assuming the property is not over-leveraged (what we teach!), the net rental incomes allow investors to continue to operate the property while building wealth and paying down debt during deflationary periods.
Are you interested in learning more about investing in multifamily apartment buildings to protect your wealth during inflationary and deflationary environments? Just schedule a chat with us—we’d love to discuss multifamily real estate investments with you.