Power Point Inflation With Real Property

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Inflation With Real PropertyInflation With Real Property

Ahmed SalemAhmed SalemDan SmythDan Smyth

TrenceTrence SmithSmith



What is inflation?What is inflation?³³The general increase in the price level´́

An inflationary shock is anything that tends to increasethe price level.A deflationary shock is anything that tends to decreasethe price level.

In economics, inflation is a rise in the general level of prices of goods and services in an economy over aperiod of time.



What is inflation?What is inflation?When the price level rises, each unit of currency buysfewer goods and services; consequently, inflation is alsoan erosion in the purchasing power of money a loss of real value in the internal medium of exchange and unit of account in the economy.A chief measure of price inflation is the inflation rate, theannualized percentage change in a general price index

(normally the Consumer Price Index) over time.



What is inflation?What is inflation?It is important to clarify the meaning of price index andthe CPI (Consumer Price Index).

price index ( PI ) : a measurement that shows how theaverage price of a standard group of goods changes overtime.Consumer Price Index ( CPI ) : a price index determinedby measuring the price of a standard group of goodsmeant to represent the market basket of a typicalurban consumer.



What is inflation?What is inflation?Inflation can have positive and negative effects on aneconomy.

Negative effects of inflation include;1. Decrease in the real value of money and other

monetary items over time;2. Uncertainty about future inflation may discourage

investment and saving;3. High inflation may lead to shortages of goods if

consumers begin hoarding out of concern that priceswill increase in the future.



What is inflation?What is inflation?Positive effects of inflation include a mitigation of economic recessions, and debt relief by reducing the real

level of debt.



M easure of inflation:M easure of inflation:Inflation rate =

PI for a certain year - PI for a comparative year

X 100PI for a comparative year

PI= Price Index



M easure of inflation:M easure of inflation:Example :

1) Inflation rate (1995-97)= (120 - 100) X 100 = 20 %

100y 2) Inflation rate (1997-2000)y = (123 - 120) X 100 = 2.5 %y 120

Year Price index

1995 100

1996 110

1997 120

2000 123



Degrees of inflationDegrees of inflationThere are different degrees of inflation. It includes mild inflation, strato-inflation and hyper-inflation.

M ild inflation is a slow rise in price level of no more than 5 percent per annum.It is associated with a low level of unemployment and is during the upswingphase of a trade cycle.

Strato-inflation, the inflation rate ranges from about 10 percent to severalhundred per cent. M any developing countries particularly those in LatinAmerica experienced this.

Hyper-inflation is a very rapidly accelerating inflation which is also know as

runaway inflation or galloping inflation. This usually leads to the breakdown of the country's monetary system as the existing currency may have to bewithdrawn and a new one introduced ( Zimbabwe).



C ase for inflationC ase for inflationZ imbabwe is one of the richest countries in Africa.

in 1980, one Z imbabwe dollar was worth more than US$1.Now, Z imbabwe inflation at 231,000,000%.(http://news.bbc.co.uk/1/hi/8258723.stm )

(16 September 2009)This inflation is hyperinflation which is out of control.Just an example showing how inflation affecting on thevalue of money.



C urrency trading nowC urrency trading now



Prices for some goodsPrices for some goods



B urning money for heating will beB urning money for heating will becheaper than buying coalcheaper than buying coal



How inflation occursy Inflation can be caused in two ways;y Cost Push Inflation:y This occurs when business respond to rising

production costs by increasing their prices so as tocontinue to have a large profit margin. Happensdue to

y Rising imported raw materials costsy Rising labour costsy Higher indirect taxes imposed by the government



How Inflation Occursy D emand Pull Inflation:y This is type of cause of inflation is more likely to

happen when there is a full employment of resourcesany increase in aggregate demand will lead to higherprices.

y A depreciation of the exchange rate,y A reduction in direct or indirect taxationy

The rapid growth of the money supply y Rising consumer confidence and an increase in therate of growth of house prices

y Faster economic growth in other countries



C auses of inflationC auses of inflationGrowth of money supply too much money in theeconomy causes inflation.

C hanges in aggregate demand inflation can occurwhen demand for goods and services exceedsexisting supplies.C hanges in aggregate supply inflation can occur

when producers raise prices in order to meetincreased costs.Wage increases are the largest single production costfor most companies.



WageWage--Price SpiralPrice SpiralIncreasing wages can lead to a spiral of ever-higher pricebecause one increase in costs leads to an increase in

prices, which leads to another increase in costs, and onand on.



Effects of InflationEffects of InflationHigh inflation is a major economic problem, effectingpurchasing power, income, and interest rates.

Inflation can erode purchasing power. If the inflationrate is 10 percent, 1.00 will buy the equivalent of only .90 world of goods today.purchasing power = real value of one unit of money

( 1) = ( 1 / price index ) X 100



Effects on IncomeInflation sometimes, erodes income.If workers wages do not increase as much as

inflation does, they are in a worse economic positionthan before.People living on a fixed income, like retired people,are especially hard hit by inflation because theirmoney does not increase, even when prices go up.Real income = (nominal income / PI) X 100



Affects on interest rateAffects on interest ratePeople receive a given amount of interest on money intheir savings accounts, but their true return depends onthe rate of inflation.If the inflation rate is higher than the bank sinterest rates, savers lose money.Real interest rate =nominal interest rate - inflation rate.



Headline and core inflationHeadline and core inflationTh ere are two types for inflation :Headline inflation: a measure of t h e totalinflation wit h in an economy and is affected by areas of t h e market w h ich may experience suddeninflationary spikes suc h as food or energy. As aresult, h eadline inflation may not present anaccurate picture of t h e current state of t h e

economy.Core inflation: a measure of inflation w h ich

excludes certain items t h at face volatile pricemovements, notably food and energy .



Global InflationGlobal Inflation



Why investing in property combats

inflationy Property and shares are expected to be hedges against

inflation because the expected real returns should be

independent of the rate of inflation, and shouldinstead be determined by the real factors affectingsupply and demand in the relevant markets. (Tarbert,1996)



Why inflation causes investors to

add property to their portfolio.y W hile it may depend on the period or type of inflation

it has been found that by investors incorporating real

estate in portfolios of assets, the risk per unit return was lowered and inflation hedging was improved.(Rubens, Bond and W ebb, 1989)

y By investing in property it gives the portfolio another

outlet to diversity so as to combat inflation. thatcommercial property has relatively superior hedgingqualities and inclusion in a portfolio would reduceoverall inflation risk. (Tarbert, 1996)



Expected and unexpectedy Inflation is decomposed into two components, expected

inflation and unexpected inflation. (Matysiak and Hoesli et la,1996)

y

Expected inflation is usually calculated using yield on 3 monthtreasury bills. It can be planned against were as, Unexpectedinflation is calculated by deducting the forecast expected ratefrom the actual rate when this occurs it leaves investors with alevel of uncertainty.

y The many investors that make purchases in property do so asthey believe it is the best way in which to hedge against inflation.However this method of hedging is different at times of expected, unexpected and actual inflation. The chart belowshows just how difficult it is to predict inflation.



Outcome of inflation



Hedging against inflationy Previous research believed that property was a

complete hedge against inflation, but newer research

has shown that it is deemed to only be a particle hedgeagainst inflation. The correlations are considerably lower than one, which indicates that property is only apartial hedge. Tarbert, (1996)

y

Clearly, if property is an inflation hedge, it does notoffer full hedging. (Barber, et la, 1997).



Hedging against inflationy Many researchers are in agreement that while property is a

partial hedge against inf lation, It is however a stronger hedge attimes of unexpected inflation. These results suggest that

property does play a role as an inf lation hedge but only tounexpected inflation shocks, not anticipated inflation trends.(Barber, et la 1997).

y It was also reported that property was a better hedge againstunexpected rather than expected inf lation. (Barber and W hite,1995)

y In order to see tthe full benefit of property investing as a hedgeagainst inflation, property should be broken into sectors.



Property Sectorsy Through the research most authors tend to side with the

industrial sector being the best investment at times of unexpected inflation. So at times when inflation ispredicted incorrectly you may see a rise in investment inthe industrial sector.

y The analysis was also undertaken at a sector level, and it was found that the industrial sector exhibited the best

hedging attributes. (Barber and W hite, 1995)y The same conculsion is found by Limmack and W ard

(1988) and Barkham and W ard and Henry (1996)



Property sectorsy W hile industrial sector seems the best to invest in to hedge

against inflation. Other types of property can also do this job, with some property investment out performing others.

y that property shares may not be as effective a long-term inflation hedge as directcommercial property (Matysiak and Hoesli et la, 1996)

y This shows that inflation affects investment in property by sector and that if an investor were likely to invest inproperty when there is an expected high inflation rate, they would most likely put their money into commercialproperty.

y



Timing and C ausesy There is also the view which suggests that one sector of

property may perform better than another againstinflation at different time periods or against differentfactors that cause inflation e.g. D emand Pull or Costpush. commercial property has not been a very effective inflation hedge also reveals that over someperiods the real performance of commercial property has been very impressive, whereas in other periods ithas been disastrous. Instead the chart suggests thatproperty offers a hedge against only particular periodsor types of inflation. (Barber, et la, 1997).



The Rent Review C lause, Inflation andProperty Investment



The Nature and Purpose of Rent Reviews

y

Commercial property leases grant tenants a significantperiod of occupation.y Prior to 1960s rents often fixed for the entire term on the

lease.y Rent reviews came into being in response to two

economic factors:1.Inflation2.Fluctuating value of property in real terms.



Rent Review: C orrective M echanism

y

The rent review clause is design to allow periodicadjustments to rents taking into account the impact of inflation and changes in real rental values.

y Corrective mechanism and commercial properties ability

to hedge against inflation.



Rent Review: Hedging Against Inflation?

rent reviews have not been used as an opportunity to gaincompensation in the form of cost pass-throughs for previous one-off shocks to prices. In

contrast, rents do respond to persistent inf lation changes. Because inflation changes have along-lasting and permanent effect, rental and capital growth in part change in the face of inflation changes ( BARBER)



Rent Review: The Real World

y Historically numerous types of rent review have been written into commercial leases.

y In practice, the vast majority of rent reviews in

commercial leases are upwards only i.e. At review the rentcan only go up and can never fall.



Rent Review: Upward Only?y

D ecember 2009 upward only rent reviews are bannedin the Republic of Ireland.y Property consultants CB Richard Ellis have

denounced the decision by The Minister for Justice,Equality and Law Reform, Mr D ermot Ahern, T D , tosign legislation banning upwardly only rent reviewclauses in business leases. The Minister signed abanning order on upwardly only rent review clausesunder section 132 of the Land and Conveyancing LawReform Act. The section will come into operation on28 February 2010.



Rent Review: Upward Only?y The UK government has been

considering legislating againstupward only rent reviews.

y

May 2004 the Office of theD eputy Prime Minister (nowCommunities and LocalGovernment) published aconsultation paper, Comm ercial pr o perty leases: o ptions f or deterri ng o r ou tlawi ng the use o f u pward on ly rent review cla uses

y The consultation paper sfindings reported on a numberof key areas:

1. Lending2. Investment3. D evelopment4. Regeneration



Referencesy Alexander, J (2001) Rent Review Blackstone Press Limited, Londony Barkham, R, J., W ard, C, W , R., Henry, O, T. (1996) The inflation-hedging characteristic of UK

property Journal of property finance, 1:7, pp. 62-76, Economics Help (2010) Helping to simplify economics [online] available athttp://www.economicshelp.org/macroeconomics/inflation/definition.html [accessed on 17/02/10]

y Barber, C. and W hite, M. (1995) Property and Inflation , Barber W hite Property Economics, London.y Barber, C., Robinson, D ., Scott, A. (1997) Property and inf lation: The hedging characteristics of U.K.

commercial property, 1967-1994 Journal of real estate finance and economics, 15:1, pp.59-76y Brett, M (1997) Property and money 2 nd Ed EG Booksy Brueggeman, W and Fisher, J (2002) Real Estate Finance and Investments McGraw-Hill Irwin,

Bostony Hill and Redman (2001) Guide to rent review Butterworthsy Isaac, D (1998) Property Investment Macmillany Matysiak, G., Hoesli, M., Mcgregor, B., Nanthakumaran, N. (1996) The long-term inf lation hedging

characteristics of UK commercial property Journal of property finance, 7:1, pp, 50-61y Limmick, R, J., W ard, C, W , R. (1988), Property returns and inflation , L and Devel o pmen t St udies, V ol.5, pp. 47-55.



Referencesy Rubens, J., H., Bond, M., T., W ebb., JR. (1989) The Inflation-Hedging

Effectiveness of Real Estate Journal of Real Estate Research 41, pp. 45-56.

y

Tarbert, H. (1996) Is commercial property a hedge against inflation, A co integration approach , Journal of property finance, 7:1, pp.77-98y Bank of England www.bankofengland.gov.uky Office of National Statistics www.statistics.gov.uk

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