Examining Real Estate and Inflation on a Global Perspective

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To truly undesrtand the relationship between real estate and inflation we can start by examining how US monetary policies have created an inflationary environment elsewhere in the world and what effects it have on real estate in those regions. More specifically, in this article we will be looking at what is happening in Hong Kong and China.

Effects of Monetary Policies on the Global Economy

World trade has dominated the global economy ever since the end of World War I. The Bretton Woods system, the dollar as the reserve currency, and foreign exchange epicenter in London all play different roles in greasing the wheels of commerce globally. While most countries typically have their own competitive advantage in certain industries, export oriented countries often see a cheaper currency as a way to gain a price advantage over other and to obtain strong currencies for other trades.

China and Hong Kong both have utilized a similar strategy over the past couple of decades to promote the growth of their industries. Hong Kong has actually pegged its currency to the US dollar, while China uses a small band of changes to tie itself to the US dollar. In effect these two countries sacrificed their own monetary policy in order to ensure that they can maintain a consistent value in relation to the dollar.

With that being said, it is quite silly for US policymakers to cry currency manipulation on China. The US economy has become reliant on imports, especially in consumer goods. Asking China to strengthen its currency would mean that everything US imports will become more expensive. It is extremely shortsighted to boost America’s few export industries’ profits at the expense of all Americans’ ability to purchase. But that’s a subject for another day.

In any case, it is precisely because China and Hong Kong peg their own currency values directly to the US that US actually has the ability to manipulate both the Yuan and the Hong Kong dollar. In recent years, the Federal Reserve Chairman Ben Bernanke had embarked on a path of throwing money out of the helicopter in hopes of improving the liquidity position in the US. As soon as Bernanke whipped out the magical printing press, Hong Kong and China had to print money as well in order to maintain the exchange rate. While Hong Kong had no choice, China had to begrudgingly do it while slowly strengthening its currency (what makes it even harder in China is that it has capital control so money just cannot flow freely like the dollar). Thus, hoards of cash flushed across the region like a typhoon in the summer months.

How Does the Inflationary Environment Affect Real Estate?

While some people (including me) are worried about the eventual effects of inflation in the US, Bernanke has already sparked an extreme inflationary environment in China and Hong Kong. The effects of the inflation in China and Hong Kong may one day serve as a warning to what could happen in the United States.

Although Hong Kong has a relatively strong stock market exchange, China’s relatively young stock market has not been established enough to attract large investments from mom and pop investors. Instead, what most Chinese people invest in is in real estate (the same applies to Hong Kong). As a result, the typhoon of cash toppled over people’s common sense. Real estate values quickly rose up all across the board, with most of its meteoric rise in metropolitan cities such as Shen Zhen, Shanghai, Beijing, and Hong Kong.

The sudden meteoric rise has generated a tremendous amount of paper wealth for those who own the assets. The rise has also attracted many speculators to the game. Investors are starting funds together to get into the game before it gets out of hand. Once the ball started rolling it was not to be stopped.

Unfortunately, not everyone could afford to play this game. Housing prices had risen at a much faster pace than wages did. Increasingly workers were being pushed out of the market and now they demanded to be paid higher. Additionally, because of the higher real estate values, rents rose as well, especially for commercial properties. As rents for stores and shops rose, shopkeepers had no choice but to either raise their prices or move out. Inflation for goods jumped along with real estate prices.

Ultimately the grim effect is that the poor are getting poorer and the rich are getting richer. In the current environment, real estate investors stand to benefit from inflating real estate values, especially those who uses real estate debt to leverage and control real estate with little money.

Meanwhile, a factory worker who works 12 hour shifts and saves every penny watches helplessly as the house he dreams of getting go up by 20-30% every several months. What hurts more is that while it used to cost him $0.25 to eat breakfast it now costs him $1.00 (side note, back in 2007 I got a haircut, wash, and half an hour head massage for a grand total of $1.75. Nowadays it would probably cost me at least $6 to $7 – as an American does it mean I’ve gotten a lot poorer?).

What Benefits One Group May Hurt Another

The effects of inflation can be quite insidious for the common man but can be quite profitable for investors. Unsurprisingly, as the effects become more pronounced people are starting to lash out and protest. Both governments are trying to respond and placate the people’s anger. Even a closed communist government like China has to get its act together when people’s money is involved.

With recent policies such as instituting foreign sales taxes, flipper taxes, property taxes, and raising interest rates, both real estate markets in China and Hong Kong are getting slowed down. Yet both governments are highly motivated to not see the market collapse either. I cannot imagine the effects on the world economy if either market experiences a sudden collapse, which will ultimately lead to steep drops in consumption and construction and investment. Yet I also do not see these high real estate prices being sustainable in the long term. One or the other has to give. If I were a real estate investor in China or Hong Kong, I would start considering my exit strategy, especially if I came into the market early. I would not invest in either region now. I would, however, keep my eyes on it in the event that there is a collapse.

Lessons Learned

If China and Hong Kong have taught me anything, it is that inflation will separate the rich from the poor, the smart from the not so smart, the haves from the have nots. It might not happen today or tomorrow. But if you are not prepared then there is a chance that it is going to hurt. As of right now, the real estate prices in major metropolitan cities are unimaginably expensive. To put it in a perspective, think about some of the most expensive real estate markets you know about, and then triple it. Unlike what Ben Bernanke likes to sell, there is no wealth effect in those regions. People just do not have enough money to buy houses and those who already own real estate are glad they do. Thus, I will keep shouting at you to buy some real estate now.

Photo: Ding Yuin Shan

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.