INFLATION

1
INFLATIONS IMPACT IN THE 1970S

• WINNERS
• BORROWERS
• INVESTORS IN REAL ESTATE
• INDIVIDUALS WITH HIGH SKILLS AND/OR JOB MOBILITY
• INDIVIDUALS EMPLOYED IN GROWTH AND
  HIGH-TECHNOLOGY INDUSTRIES
• MOST GOVERNMENT TAX COLLECTORS

• LOSERS
• LENDERS
• INVESTORS IN FINANCIAL ASSETS
• INDIVIDUALS WITH FIXED INCOME AND/OR NO JOB
  MOBILITY
• INDIVIDUALS IN MATURE AND/OR ENERGY-INEFFICIENT
  INDUSTRIES
• MOST TAXPAYERS AND SAVERS

2
THE WEALTH TRANSFER EFFECTS OF INFLATION
3
EFFECTS OF INFLATION ON EXISTING-PROPERTY
ECONOMICS
4
WHY MAY INFLATION AFFECT EXISTING AND
NEW-DEVELOPMENT REAL ESTATE DIFFERENTLY?

• SHORT-RUN IMPACT
• COSTS OF FINANCING
• COSTS OF GOODS AND SERVICES
• INTERMEDIATE IMPACT
• VACANCY RATES FALL
• RENTS INCREASE
• LONGER RUN IMPACT
• EXCESS DEMAND
• NEW INCENTIVES TO DEVELOP
• CYCLICAL SWING BACK (MAY OCCUR)

5

• THREE ELEMENTS TO PROTECT REAL ESTATE PARCELS
  FROM CYCLICAL VAGARIES
• STRENGTH OF REAL ESTATE MARKET
• NATURE OF LEASE CONTRACTS
• FINANCING RATES AND TERMS

6
GRAPH FROM III-56
7
IMPACT OF INFLATION, BY LAND USE

• URBAN LAND
• AGRICULTURAL AND FOREST LAND
• RESIDENTIAL PARCELS
• - OWNER - OCCUPANT UNITS
• - MULTI-FAMILY PARCELS
• COMMERCIAL SPACE

8
INFLATION AND MACRO-CYCLES AND REAL ESTATE
INVESTMENT STRATEGIES

• LONG CYCLES
• WENZLICK
• CASE
• SHORT CYCLES
• CONSTRUCTION CYCLES
• MORTGAGE AVAILABILITY CYCLES
• OTHER CYCLES
• URBAN AREA / CITY CYCLES
• NEIGHBORHOOD CYCLES
• PROPERTY-SPECIFIC CYCLES
• NEW CONCEPT / OVERKILL
• HOT MARKET / OVERKILL

9
EXHIBIT 7-10
10
ECONOMIC RISKS RELATE TO THE EXTENT INFLATION IS
PROPERLY ANTICIPATED VERSUS UNANTICIPATED
11
IMPORTANT INFLATION RELATED CONCEPTS

• ANTICIPATED VS. UNANTICIPATED INFLATION
• RELATIVE REAL RATE OF RETURN AMONG VARIOUS ASSETS
• - REAL ECONOMICS
• - TAX EFFECTS

12
EXCEL CHARTS

13
EXPECTED INFLATION, REAL AND NOMINAL INTEREST
RATES, AND CAPITAL MARKET EQUILIBRIUM

• A 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
• NOTE THERE MAY BE DIFFERENCES IN SHORT RUN
  VERSUS LONG RUN IMPACTS OF CHANGES IN INFLATION.

14
INFLATION AND THE AFTER TAX REAL RATE OF INTEREST
15
LENDER RETURN UNDER INFLATION EXAMPLE

• ASSUME
• DESIRE 2 REAL RETURN AFTER TAXES
• IF NOMINAL RATE IS 12 AND THE EXPECTED INFLATION
  RATE IS 10, WHAT IS THE REAL RETURN FOR THE
  LENDER?
• LENDER IS IN 50 TAX BRACKET

16
INFLATION AND DEPRECIATION THE FIRM

• NET AFTER TAX REAL REVENUE FROM INVESTMENT
  PROJECT
• (1 - TAX RATE) X (SALES REVENUE -
  PRODUCTION COSTS)
• NOTE
• GENERAL INFLATION HAS NO REAL IMPACT IN
  PRINCIPLE!
• BRACKET CREEP CHANGES CONCLUSION
• DEPRECIATION EFFECT ALTERS INCENTIVE TO INVEST
• In sum, the firm will require a lower real rate
  of return (i.e., and cost of financing) if high
  inflation persists. Hence, as inflation
  increases, nominal interest rates must rise less
  than the change in the inflation rate.

17
INFLATION AND THE AFTER-TAX REAL RATE OF INTEREST

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18
INFLATION AND DEPRECIATION

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