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"The $5 Store", formerly known as "The Dollar Store"…

Updated: Jan 12, 2022

These are really unprecedented times. Even though there are many historical inflationary references to pull experience from, there are none that example this unique point in history and the magnitude of effects Covid has imposed on the world. The first thing that needs to be clear, is every country in the world responded in very similar manners, shutting down their non-essential economies and stopping and/or limiting the movement and interaction of people. All governments and central banks introduced and supported monetary support, injecting more money into circulation while at the same time reducing lending rates. Also of importance, the world today is a much different place than it was 100, 50, 20, or even 10 years ago, so it’s very hard to rationalize today’s events against previous periods in time. For example, technology has changed the world dramatically. We can now purchase whatever we want or need online, have it delivered straight to our doorsteps, and can do these financial transactions online in seconds. There are new places to park cash in non-fiat currencies e.g. crypto-currencies. Today, online brokerages have become very popular, allowing everyone to easily participate in the stock market, and we can all move in and out of markets and sectors with a password, an account, and a few simple key-strokes. The economy has become much more accessible and real-time, is forming new areas of resiliency, and this shift will only continue. These are just a few changes in the last 10-20 years.

So, what is inflation? In it’s simplest definition, inflation is a rise in the price of goods and services, and/or a decrease in the value of your dollar. Both lead to an erosion of consumer buying power, and result in inflated (more costly) prices. Inflation is commonly initiated by a significant increase of soveriegn money in circulation. In Covid's example this was brought on by the vast monetary interventions by governments printing and circulating new money to support struggling citizens and businesses. The more dollars in circulation, the more diluted the value of the dollar, though inflation can manifest and grow in other ways. Inflation in Canada has been floating around 2% or lower for the last 10 years, and has been relatively flat and below 3% for the last 20 years. The last time inflation was above 4% was about 20 years ago, and last time it was above 6% was in the early 80’s. Governments have inherently tried to maintain a 2% per year inflation rate. This maintains a level of predictability and stability for economies, and prevents runaway economic scenarios associated with too much inflation (or deflation).

There are 3 general classifications used to explain inflationary effects; demand-pull inflation, cost-push inflation, and built-in inflation. Demand-pull is when there is not enough supply to meet growing demand, leading to a rise in the price. Cost-push is caused when prices are increased as a result of rising production costs. And, with built-in inflation, the drag effect of rising prices causes employee wages to increase and follow suit, resulting in more costs being added to the consumer.

Inflation is commonly measured using the CPI (Consumer Price Index). CPI takes a broad basket of human goods and services that are required for every day life, and calculates the price rise as a weighted average to establish the index. The products include things like groceries, clothing, utilities, fuel, transportation, insurance, medical, etc.

Considering the simple definition of inflation, “more money in circulation”, and the 3 classifications under which inflation occurs (demand-pull, cost-push, and built-in), it is most certain that the world will experience a period of increased inflation. The perfect environment for inflation exists due to the huge monetary support during Covid, and the reality that many businesses have had to turn down their output (supply) to manage costs in the last two years of Covid lockdowns. Consumerism is ramping back up and driving demand while supply shortages still exist. All this plus the odd geopolitical curveballs like the recent China anti-sentiment, fuel crisis in Euro-zones, and there is a recipe for much higher prices all around, until the world scales are rebalanced. We have already seen the effects of inflation in Canada in real estate, and at gas pumps, grocery stores, restaurants, and car lots, to name a few. Last week tire companies were in the news announcing people better get their winter tires early as they were expecting supply shortages. With Christmas on the near horizon, retailors are already announcing that their inventories are down as much as 35-40% due to world supply chain constraints.

But what does all this mean for inflation? The Feds have hit the news lately to curb fears, announcing tapering plans over the next 1-2 years and predicting that inflation will rise to 4% by the end of 2021. Tapering is essentially a slow unwinding of the monetary supports that were put in place (for Covid) in a predictable manner. This allows people to manage to future expectations and businesses to replace resources and supplies without huge financial uncertainties. But will inflation manifest in the way the Feds expect? It’s really anybody’s guess. A couple things seem obvious? All the inflationary forces by definition are in play today, and all the governments and central banks have a vested interest in managing inflation to the targets they have announced. They have ways and means to pivot some key factors that influence inflation like monetary support, tapering, and interest rates. But a lot of the inflationary triggers still rely on basic human behavior and past experience admist all of this. People could still quit spending and investing and hoard their money, and businesses could stay shuttered and at reduced capacity much longer than expected. For example, if jobs don't come back, where will the replacement spending come from? However, as has been repeated over and over in history, the market always recovers and comes back stronger, finding a way back to true north, .. eventually.

Inflation has good and bad outcomes. For spenders or people living pay to pay it’s usually a very scary situation, because spenders use today’s money with a lower value to buy products of a higher price. Many retirees are in this position, and inflations’ broad effects coupled with retirees' usually tight budgets and no jobs makes for a lot of budget uncertainties.

People with physical assets based in currency, like real estate or stocked commodities will enjoy some inflation, as they will see a corresponding increase in the value of these holdings over time. Therefore they can get more for these assets if sold into an inflationary environment. People with assets held in cash-equivalent products like treasury notes or bonds will not like inflation, as the value of these products erodes with inflation. People who want to protect their investments from inflation will generally move into more stable investments like gold, silver, other commodities or Real Estate Investment Trusts. People who want inflation-resistant investments like to buy into the stock market index, because good companies expect and plan to do better than inflation on their returns, and share holders will benefit from this over time.

Someone in the rental housing market recently asked me if he should be worried about future inflationary pressures. In BC, you can legally hike your rent only by 1.5% for 2022, yet inflation is projected to increase +2% this year and the same or more next year. Therefore, the drag on your overall rental costs (e.g. interest, utilities, maintenance costs) will follow, and may go even higher. In this scenario, the maximum allowable rent hikes over the next 2 years seem inevitable for renters in BC. If you are a landlord and are in a variable mortgage with your rental, you might want to consider breaking it and locking in a fixed mortage rate for the next 5 years while rates are still low? The savings might be significant, if not just for peace of mind.

The rental housing market is usually a long-term play for people who invest in it. Usually, the main objective is to leverage your money to get rental financing, then rent out your property and get someone else to pay the principle portion of your loan plus expenses. The loan interest and other qualifying expenses can be written off against the rental income on your taxes. Eventually, your equity in the property becomes whole, along with any value increases you may have enjoyed over time, and you can enjoy the full rental income and any capital gains if you decide to sell. Though increased value is possible, and a lot of people have been very successful owning rentals in the past, this should not necessarily be expected as it is very dependent on housing demands in your area, plus the condition and timing of the sale of your property. Having one property is kind of like owning one decent stock in the market. It can go up and down over time, and enjoys the benefits of inflation which usually translates into increased value. But like any single skew in the market, rental properties stand alone in terms of risk. The sales values are affected by how many people want it (demand) and what they can afford to pay for it. If nobody wants your rental when you are ready to sell or renew the lease, similar to a struggling stock paying dividends, you can lose value in both future equity and income.

Taking good care of your property is something you will need to account for in your long term rental planning. Unexpected costs like replacing the shingles, flooring, or a roof for that matter can cause setbacks if you don’t have a maintenance reserve fund established or are unable to pay for it yourself. If you let your property deteriorate over time, it will inevitably result in higher future costs and lost value.

All this babble probably doesn’t answer the question of “should I worry about my rental given the inflationary pressure?”, but it is all food for thought. Investment and risk is a very personal thing, and we all have to make our own decisions on when and where we’ll put our money to work. Rentals have proven out to be decent investments, especially in areas where the demand remains high and is continually growing.

Inflation is necessary in a healthy economy. But too much, too little, or too much variability can spell trouble for an economy. Knowing a little bit about inflation and building your assets and portfolio with the diversification to have resiliency against inflation can help you sleep better at night.

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