We're Turning Japanese!

There has been an ongoing debate for the last two years about which direction our nation is headed economically. Some have speculated about hyperinflation as the government prints its way to oblivion. Even I have talked about future inflation, its causes, and the effect it would have on real estate. The other camp has talked about deflation. Particularly a Japanese style recession.

After learning a few things from those I trust on this issue, I am finding myself more in the deflation camp.

I don't think that deflation will go on forever, but for the foreseeable future (say 7 years or so), I believe it will have an impact on our national economy.

Real Estate is always a good bet in the long term. So how do you make money in a deflationary market?

The answer is "Buy Right". Or, in other words "Buy below current market pricing."



Lets take a look at an example and see how things play out. In this first chart, you bought a home worth $100,000 and paid full price and financed the entire purchase. Lets say the market has deflationary pressure from economic contraction, population shrinkage, war, or some other factor. If the rate of contraction is 1% per year for 30 years (highly unlikely in real life), you still experience an equity position (albeit small at first) the entire life of the loan. This is because, due to the time value of money, the amoritization pays off faster than the property declines in value.

If the deflation rate is 2% annually, then you pretty much maintain zero or slightly negetive equity until about year 10. At that point, you pay your loan down faster than your propety depreciates.

Finally, at a 4% deflation rate, you would be underwater for 23 years with the final seven years being in an equity position. No fun.

This example above is for those folks, mostly first time home buyers, who are getting into property with no equity position and little down payment..

Here is the chart for investors and those with downpayments:


This chart shows you what would happen if you bought a $115,000 home but only financed $100,000 for it. The scenarios are much more encouraging. In this case, you have equity in all the scenarios except the 4% deflation scenario. Hence, the importance of buying below market value or with significant down payments.

Of course, this is just a theoretical model. Unlike this model, Utah does not have a shrinking population. In fact, it is growing quickly from reproductively ambitious souls like myself (I have four daughters already) and immigration. Also, economically speaking, Utah is more balanced and has a friendlier business environment than most of the nation. For these reasons, we may experience the macro effects the national-deflation phenomonea (low interest rates, consumer product price decreases, declining wages) and yet have real estate not as affected by the problem due to our demographics and economic environment. Time will tell.

I expect that Utah will follow its usual stair-step-up price pattern with the runner on this cycle being extra long. Look for flat pricing for the foreseeable future in Utah.