Inflation’s Impact In The 1970’sWINNERSBORROWERSINVESTORS IN REAL

ESTATEINDIVIDUALS WITH

HIGH SKILLS AND/OR JOB MOBILITY

INDIVIDUALS EMPLOYED IN GROWTH AND HIGH-TECHNOLOGY INDUSTRIES

MOST GOVERNMENT TAX COLLECTORS

LOSERSLENDERSINVESTORS IN

FINANCIAL ASSETSINDIVIDUALS WITH

FIXED INCOME AND/OR NO JOB MOBILITY

INDIVIDUALS IN MATURE AND/OR ENERGY-INEFFICIENT INDUSTRIES

MOST TAXPAYERS AND SAVERS

The Wealth Transfer Effects Of Inflation MR. CONSERVATIVE MR. AGGRESSIVE

INITIAL POSITION INITIAL POSITION

ASSETS LIABILITIES ASSETS LIABILITIES

50,000 CASH 25,000 MORTGAGE 10,000 CASH 75,000 MORTGAGE

50,000 REAL

ESTATE

75,000 NET WORTH 90,000 REAL

ESTATE

25,000 NET WORTH

AFTER INFLATION AFTER INFLATION

ASSETS LIABILITIES ASSETS LIABILITIES

50,000 CASH 25,000 MORTGAGE 10,000 CASH 75,000 MORTGAGE

100,000 REAL

ESTATE

125,000 NET WORTH 180,000 REAL

ESTATE

115,000 NET WORTH

Effects Of Inflation On Existing-property Economics

ECONOMIC VARIABLE

INITIAL PERIOD

CASE A

CASE B

GROSS POSSIBLE RENTAL INCOME $100,000 $121,000 $125,440

EXPECTED VACANCY ADJUSTMENT -5,000 -6,050 -3,763

EXPECTED OPERATING EXPENSES -40,000 -48,400 -48,400

NOI $55,000 $66,550 $73,277

CAP RATE 10% 10% 9%

MARKET VALUE OF PROPERTY $550,000 $665,500 $814,187

ASSUMPTIONS: (1) General inflation of 10%, and initial market equilibrium. (2) Case A: Balanced supply and demand. Vacancy rate = 5%; Rental income growth = 10%; Expense growth =

10%; CAP rate = 10% (i.e., constant). (3) Case B: Excess demand, caused by unexpected inflation growth. Vacancy = 3%; Rental income growth = 12%;

Expense growth = 10%; CAP rate = 9% (i.e., declining with new inflation).

Inflation Affects Existing And New Real Estate Developments Differently?

SHORT-RUN IMPACTHIGHER COSTS OF FINANCINGHIGHER COSTS OF GOODS AND SERVICES

INTERMEDIATE IMPACTVACANCY RATES FALLRENTS INCREASE

LONGER RUN IMPACTEXCESS DEMANDNEW INCENTIVES TO DEVELOPCYCLICAL SWING BACK (MAY OCCUR)

Three Elements To Protect Real Estate Parcels From Cyclical Factors:

STRENGTH OF REAL ESTATE MARKETNATURE OF LEASE CONTRACTSFINANCING RATES AND TERMS

Impact Of Inflation, By Land Use

URBAN LANDAGRICULTURAL AND FOREST LANDRESIDENTIAL PARCELS

- OWNER-OCCUPIED UNITS- MULTI-FAMILY PARCELS

COMMERCIAL SPACE

Unanticipated Inflation Is the Greatest Economic Risk

But because the effect tends to be small (

Nominal interest rate = Real interest rate + inflation

Important Inflation Related ConceptsANTICIPATED VS. UNANTICIPATED

INFLATIONRELATIVE REAL RATE OF RETURN AMONG

VARIOUS ASSETS- REAL ECONOMICS- TAX EFFECTS

Expected Inflation, Real And Nominal Interest Rates, And Capital Market EquilibriumA CHANGE IN THE EXPECTED RATE OF

INFLATION MAY CHANGE THE REAL RATE OF INTEREST

CHANNELS FOR THE CHANGE IN THE REAL RATE OF INTEREST ARE:- INCOME SAVINGS EFFECTS- WEALTH EFFECTS

Inflation and the After Tax Real Rate Of Interest

INFLATION OFRATE EXPECTED

INTEREST OFRATE NOMINAL RATE TAX-1

TAXES AFTER INTEREST

OF RATE REAL EXPECTED

Note ThatInflation has no impact in principle.Tax bracket creep changes above conclusion.Depreciation effects also alter investment

criterion.Lower required real rate of return.