Inflation and Market Cycles

Much attention over the past several years has been given to inflation numbers, and for good reason. According to Peter Linneman, the 10-year treasury generally falls 150 - 200 bps above expected inflation. He also states that the expected cap rate for a “quality apartment property” should be roughly 75 bps above the 10-year treasury yield.

So, if we use the Fed’s stated goal of 2% inflation, which implies a 10-year treasury yield of 3.5% to 4%, the target cap rate for a “quality apartment property” should fall in the 4.25% to 4.75% range.

Obviously, these numbers will fluctuate based on a variety of factors (especially with inflation currently running at 2.85%), but they give us a basis on which to build and adjust as necessary. Also, this is just one view and we know there are others out there.

Speaking of Inflation…

The Wall Street Journal recently published an article explaining the different inflation metrics. Some quick takeaways:

• While the Consumer Price Index (CPI) is widely reported and often moves markets, the Federal Reserve focuses more on the Personal Consumption Expenditures (PCE) index for its 2% inflation target. The PCE index has been running cooler than the CPI, with a significant gap between the two.

• The CPI and PCE indices differ in their composition, with the PCE reflecting actual spending patterns more closely. For example, the weights of items like alcohol differ significantly between the two indices. This difference in composition can lead to diverging inflation rates.

• Housing costs, which have a higher weight in the CPI than in the PCE, have a significant impact on inflation calculations. Changes in housing costs can affect inflation differently in the CPI compared to the PCE, influencing overall inflation rates.

If you’re a WSJ subscriber, click here to access the article. If you’re not and can keep a secret, shoot us an email and we’ll send you a PDF of it. Hopefully this will help us avoid copyright infringement jail.

And Market Cycles…

Another (free) resource we like to review is the Mueller Real Estate Market Cycle Monitor. It’s a market cycle analysis of 5 property types in 54 different MSAs. It has great visuals and gives simple criteria for each stage in a real estate cycle (Recovery, Expansion, Hypersupply, Recession). For Phoenix, the traditional food groups shake out as below (as of Q4 2023):

• Office - 1st half of Recession

• Industrial - 1st half of Hypersupply

• Apartments - Transitioning from Hypersupply to Recession

• Retail - Equilibrium

• Hotel - 1st half of Expansion

It’s important to keep in mind that these stages are reflective of existing properties. We dove into lag time and the challenges it presents from a development perspective in a previous message. The full report can be downloaded here. Past reports can be accessed by heading here and scrolling almost to the bottom of the page where it says ‘Market Reports’.

Thanks for reading and as always, please reach out with any questions or comments!

Thanks,

John and Ramey