Monday, September 05, 2011

Rent Control Likely To Survive Hyperinflation

Real estate is arguably an inflation hedge, but it is crucial to identify what kind of real estate - residential, commercial, undeveloped land, etc. - is likely to perform well in a hyperinflationary scenario.  Hyperinflation often brings unpredictable political changes that can affect the attractiveness of real estate. 

One early casualty of hyperinflation is the control landlords can exert over rental property.  Local governments often implement rent control laws to ameliorate public outcries over the rising cost of living.  This is good news for renters who live in rent-controlled apartments and bad news for multi-unit landlords who can't raise rents to match their increasing costs for utilities and maintenance. 

Commercial property may or may not be subject to rent control depending on how it is zoned.  Rent controls are designed to protect live human beings who vote in elections and support political campaigns.  Commercial tenants may not be a protected class during hyperinflationary politics, so their rents may not be protected.  That's potentially good news for commercial landlords.  Property that has no live tenants - warehouses, mini-storage units, etc. -  may be able to maintain cash flow that keeps up with inflation.  The valuation of the property is another story.  Rising interest rates in an inflationary economy will depress the value of real estate. 

Undeveloped land is another story.  Raw land with rights of way, minerals, farm/ranch potential, and other goodies will not be subject to rent control.  The unpredictability of development costs and the general lack of credit available during hyperinflation may prohibit all but the most rudimentary development of raw land.  Developers with deep pockets and cash flows that keep place with inflation will not suffer.  Investors buying raw land as an inflation hedge should see it as a store of value that will not be available for cash flow until after hyperinflation ends.  The remainder of their portfolios should be in assets that will generate inflation-indexed cash flows. 

Consider hyperinflation under Germany's Weimar government as a possible template.  Germany printed its Papiermark into oblivion to alleviate its war reparations burden.  The introduction of the Rentenmark ended the hyperinflation by reorienting Germany's currency toward hard, productive assets.  Gold bugs will be dismayed that the new currency was not directly redeemable in gold, but was subject to a complex valuation involving gold bonds, agricultural land, and industrial assets.  Any similar innovation to halt hyperinflation in the U.S. has the advantage of an immediate supply of assets with which to back the new currency.  The problem is that these assets - mortgage backed securities held by the Federal Reserve and bank stocks/warrants held by the U.S. Treasury under TARP - may have very questionable valuations themselves.  The U.S. government will need additional stores of assets - perhaps stocks and bonds confiscated from investors' retirement accounts - to back a new currency.

We will keep wargaming hyperinflationary endgames here at Alfidi Capital.  Meanwhile, we can seek out investments that will offer some hope of retaining value during hyperinflation.  Rent-controlled residential properties probably are not among the safest choices for investors.