At the end of the day, all economics and its subset of business, of which real estate is but one segment, are about supply and demand.
The greater the supply, the weaker prices tend to be; the greater the demand, the stronger prices usually are. One output of this simple equation is price moves, whereby rises are inflationary and net reductions deflationary.
When it comes to money, the theory also applies. Since the global financial crisis (GFC), central banks have pumped enormous sums of money into economies, normally through the filter of the banking and financial system, which means the public do not tend to see much clear evidence of it, whereas well-connected investment banks and those with credit worthiness (family offices, private equity and sovereign wealth fund) do.
The GFC funding tap was sustained by the pandemic, with the UK’s exit from the EU also encouraging the Bank of England (BoE) to sustain quantitative easing (QE), as printing money has become known.
The pandemic is bringing forward new economic issues, most notably supply pressures
The masses of liquidity pumped into markets have had a profound effect on the prices of financial assets, driving up the value of businesses, listed and private, as manifested in take-out multiples, and most other asset classes too, including much real estate. If financial assets were included in inflation calculations, the aggregate figure would have been way above the paltry figures manifested in the Consumer Price Index (CPI) in recent years.
The pandemic is bringing forward new economic issues, most notably supply pressures as demand recovers, something that has not been evident on a widespread level since the 1970s.
Some of those pressures are politically influenced, such as Russia and gas; some are down to circumstance, such as freight; and others are down to the forces of nature, such as wheat prices.
However, the big talking point on supply in the old world is labour and ‘the great retirement’. Millions of folks have hung up their boots since Covid arrived on the scene in spring 2020, leading to a shortage of the labour factor of production – and so materially rising wages.
Inflation, therefore, is rising as businesses seek to recover costs – so much so that UK CPI increases of 4% to 6%-plus by the end of the year are now openly discussed by the BoE’s Monetary Policy Committee members (well above the targeted 2%); and inflation is already above 5% in the US.
The problem is that traditional policy steps to control inflation – particularly increasing the price of money through interest rates – may be inappropriate as demand may ease in the face of steep price adjustments.
More to the point, the alternative approach of letting inflation run its course to control demand through higher prices risks behaviour that could propel prices even higher, as workers seek to protect real incomes through wage awards.
Tightening monetary policy and/or sustained inflation feel like they are ahead, so something is going wrong and policymakers may already be in the lesser of two evils territory: shake financial markets with base rate rises – policymakers have been far too deferential to markets for too long and are now paying the price with an empty toolkit – or accept the inevitability of falling real living standards, economic slowdown and possibly rising unemployment.
For real estate players, where there is a close connection to the price of money and prevailing economic conditions, policy is entering a new phase, just as it did with QE.
Some rule books may need to be ripped up again and policy agility and innovation are required to prevent turbulence and possibly collateral financial and economic damage. It feels like choppier waters are ahead.
Dr Clive Black is head of research at Shore Capital Markets