After decades of little or no inflation there is mounting evidence that the Federal Reserve’s Quantatitive Easing program is beginning to take its toll on the value of the dollar.  Shown below are some of these indicators:
  • The Producer Price Index (PPI), which measures average changes in prices received by domestic producers for their output, is up 5.6% for the twelve months ending February 2011.
  • Commodity prices are rising in relation to the dollar.  The price of gold hit an all time high earlier this week before settling down a bit.  Silver prices continue to soar hitting a 31 year high.  So far this year silver has gained 33% in value.
  • A recent Deloitte Consulting poll indicated that 74% of those polled believe their spending will slow due to rising prices they are currently experiencing.

So what impact will inflation have on commercial real estate?  In the short-term the real question is what impact will the threat of inflation have on the Federal Reserve raising interest rates?  An increase in the federal funds rate would ease the concerns of those who fear inflation but it would likely have a detrimental impact on the fragile U.S. economy which is just beginning to show signs of recovery.  It’s a delicate balance between these two policy positions.

In the long run, modest inflation would be a great benefit to commercial real estate, as long as it happens gradually so that the market can make the necessary adjustments along the way.  Real estate over the long run has been an excellent inflation hedge and it should be the same this time around too.  Over time, with modest inflation those commercial real estate investors who are currently upside down on their investment portfolio could gradually become whole again. 

My greatest fear is what happens in June when the Federal Reserve ends its own bond purchase program known as quantitative easing.  Who will fill the gap in buying U.S. Treasuries?  If no one steps in to the fill the void what will happen to interest rates?  Doesn’t the law of supply and demand require that interest rates have to increase?  And more importantly how quickly will they rise and how dramatically?

Those are the questions that are currently being debated.  Surprisingly there is no clear consensus among the pundits.  We’ll have to watch and see.  Stay tuned.  It’s going to be fascinating to watch! 

Sources: PIMCO bets against U.S. government debt, Reuters, April 11, 2011; Don’t Believe the Inflation Fear-Mongers, The Mark, April 12, 2011; Inflation Not a Threat? Most Consumers Aren’t So Sure;, April 12, 2011; Gold Price Sinks After Hitting Ne High at $1,478, Gold Alert, April 11, 2011; Producer Price Indexes – February 2011, Bureau of Labor Statistics, March 16, 2011.