Thursday, March 26, 2009

Inflation = Buy a house now?

Dear Freakwenter

1: It was recently suggested to me that "purchasing a house is a good hedge against inflation." Does this claim hold any truth?
2: What is The Freakwenter's inflation forecast for the next 10 years?

Sincerely,
A Freakwenter frequenter
As a general rule, holding durable assets instead of cash protects you from inflation. As "durable" suggests, the value of durable assets does not fall quickly over time, unlike cash during high inflation.

So question 1 boils down to "how durable is the value of a house?" Houses lose value over time due to aging and wear, and property taxes eat away at your original investment. Suppose these factors cause the "real" value of an investment in housing to fall at 2% annually. In order for this investment to be serving as a protection against inflation (compared to simply holding cash), inflation rates would have to exceed 2%.

Therefore, as long as inflation rates are moderate, I think that the hedging-value of a house is negligible, especially in comparison to the broader trends which cause house prices to rise and fall relative to other assets.

My inflation forecast for the next 10 years is an average annual inflation rate of 2.4 percent. The Federal Reserve learned its lesson not to let inflation get out of control back in the 70's and 80's, and it is unlikely to happen again.

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