What Multifamily Investors Need to Know About Inflation
Inflation is already here for multifamily property developers - the amount they have to spend for lumber and steel has risen and risen again over the last few months.
As the global economy emerges from the coronavirus pandemic, some economists worry spiking prices for things like lumber might be just the beginning. The consumers who kept their jobs and built up savings during the crisis could rapidly spend their money in a recovery, bidding up prices, potentially creating an upward spiral of price hikes throughout the economy. In this scenario, officials at the Federal Reserve would step in to stop this inflation using the most powerful tool they have: higher interest rates.
That would have a huge effect on commercial real estate – adding to the cost of financing and potentially strangling the recovery in the U.S. economy.
Inflation Trends During the Pandemic
The consumer price index (CPI) rose 0.9 percent between May and June, with inflation the highest it’s been in more than a decade. Over the last 12 months ending May 2021, prices for consumers rose more quickly (5.0 percent) than any time since before the Global Financial Crisis, according to the Consumer Price Index for All Urban Consumers, kept by the U.S. Bureau of Labor Statistics. But that is measuring from a low point in May 2020, in the worst days of the crisis. The index is also distorted by prices of items like car and truck rentals that have spiked upwards while other prices, like the cost of food consumed at home, have barely moved and some prices, like the cost of hotel rooms, are still far below their levels before the pandemic.
Economists and pundits have started a debate about these price hikes that may continue for years.
Inflation has hurt the U.S. economy in the past. In the late 1970s, prices rose quickly despite a weak economy, peaking at 13.5 percent in 1980. The Federal Reserve fought back, raising interest rates again and again, pushing their benchmark rate to a peak of 19.1 percent in 1981. In comparison, the Fed Funds rate is now at zero. High interest rates eventually broke inflation and drove the U.S. economy into a deep recession.
The debate over the likelihood of serious inflation today is likely to intensify as Congress considers bold spending plans that would add trillions more dollars to the U.S. economy.
Multifamily investors are keeping their eyes on the Federal Reserve, which decides how quickly to raise their benchmark interest rates up from zero – just as they had begun to do in the years before the pandemic. Wall Street’s guesses are already affecting long-term interest rates like the yield on 10-year Treasury bonds, which rose from a low below 0.5 percent to back up to 1.5 percent as the number of new coronavirus infections dropped.
In the meantime, the apartment business is certainly facing price inflation in the cost of construction. Lumber and plywood prices rose 86 percent over the 12 months that ended in April 2021 – and the price of wood seemed high even before that price hike, according to data from the Bureau of Labor. Like the cost of rental cars, these cost increases are amplified by particular forces caused by the pandemic. Homeowners with time on their hands invested in renovations during the crisis, while rock-bottom low interest rates attracted home buyers, all of which pushed up the demand at the same time as the COVID-19 crisis disrupted the supply chain for lumber.
Inflation is a normal occurrence, but the rate of inflation is what multifamily investors should watch, and for developers, lumber is seeing the greatest impact today. As the economy recovers from the pandemic, it will be clearer to see if these spiking prices will be sustained, or will level off. Only time will tell if price hikes like these remain outliers or spread throughout the economy.
Most recently, Bloomberg reports that the Federal Reserve said “the widening Covid-19 vaccination program has helped the U.S. economy stage a robust rebound, pledging that monetary policy will continue to provide ‘powerful support.’”
In its most recent Monetary Policy Report, the Fed held interest rates near zero with the expectation they expect to keep them there until 2023.
In the meantime, the multifamily sector may face sustained, high lumber prices as the pandemic recovery continues, and warned that CRE prices are higher than normal, “Asset prices may be vulnerable to significant declines should investor risk appetite fall, interest rates rise unexpectedly, or the recovery stall,” the Fed said.