Grant Alexander Wilson, Ph.D., Assistant Professor, Faculty of Business Administration, University of Regina
Jason Jogia, MBA, M.Fin., Chief Investment Officer, Avenue Living
Dr. Wilson is an Assistant Professor at the Hill and Levene School of Business, University of Regina. His research focuses on marketing, strategy, and innovation. He has published over 20 peer-reviewed articles in top management journals including Journal of Small Business Management, Research-Technology Management, and Journal of Business Strategy. His research has been featured in the National Post and by the World Economic Forum. Dr. Wilson is also a research consultant and contributor to Avenue Living Asset Management.
Mr. Jogia is the Chief Investment Officer at Avenue Living and has over 15 years of experience in real estate capital markets, originating over $10 billion in real estate loans and $1 billion in equity. He has extensive experience in real estate investment analysis and capital structure across various real estate classes. In addition to holding 2 Masters’ degrees in Finance, Mr. Jogia is pursuing his Doctorate of Business Administration and currently serves as an instructor at the University of Calgary, specializing in real estate finance.
One hundred years ago, a gallon of milk was $0.40. Today, that same gallon of milk is close to $4.00 (MasterClass, 2020). This economic phenomenon is called inflation. “Inflation is an economics statistic that tracks the increase in prices of goods and services over a period of time” (Pride et al., 2020). The primary explanations of inflation include demand-pull or cost-push (Lumsden, 2011). Demand-pull inflation occurs when there is an increased need for goods and services creating supply pressures that elicit positive price changes (Lumsden, 2011). In essence, too many dollars are chasing too few goods. Cost-push inflation occurs when wages and cost of raw materials increase, putting upward pressure on prices. Essentially, rising production costs push up prices.
In the past five decades, all of the industrialized economies of the Western world have experienced inflation (Lumsden, 2011). A typical rate of inflation is 2% per annum and an indication of a stable economy (Pride et al., 2020). Over the last 30 years, Canada’s inflation rate has ranged from 0.01% to 5.63%, averaging 2.07% (Statista, 2021) (Figure 1).
COVID-19 & INFLATION
Although inflation in Canada has been historically stable, as Lumsden (2011) aptly acknowledges, it can never be fully anticipated. The COVID-19 pandemic of 2020 has created unprecedented market uncertainty and forced economic anomalies. According to the latest Statistics Canada (2021a) data, the year-over-year inflation rate was 0.7%.
The relationship between inflation and unemployment is fixed and inverse (Phillips, 1958). According to the Phillips Curve (Figure 2), when the natural rate of unemployment is 4.5%, inflation will be stable at 2%. If unemployment is 8%, inflation will approach zero (Phillips, 1958). With Statistics Canada (2020) reporting a current unemployment rate of 8.5%, inflation should theoretically track near-zero in the short-run (Phillips, 1958).
However, some experts are suggesting that inflation is currently underestimated (Carmichael, 2021). Demand for essential goods and services are high, as their prices are tracking above average. Yet, the current “basket of goods” in the consumer price index (CPI), used to assess inflation, includes many non-essential categories as well as those that were reduced as a direct result of COVID-19 (Statistics Canada, 2021a). Accordingly, current measures of assessment may need to be reconsidered to accurately reflect Canada’s inflation.
The much-anticipated end to COIVD-19 and Canada’s stimulus package further point to long-term inflation. As economies emerge from recessions and gross domestic product (GDP) rises, inflation occurs. Historically, Canada’s inflation has followed, but lagged, its GDP increases (Figure 3). Accordingly, post-COVID-19 GDP gains are likely to be an antecedent to inflationary trends.
The unparalleled COVID-19 stimulus package, intended to encourage economic activity, is also likely to create inflationary trends (Janson, 2021). The stimulus package injected, and will continue to inject, cash into the households of Canadians, maintaining degrees of demand and consumer spending normality. As compared to Canada’s 2008 financial stimulus package, its COVID-19 stimulus package was over 420% larger. Measured as a percentage of Canada’s GDP, the 2008 financial crisis stimulus package was 2.8% as compared to the COVID-19 stimulus package of 11.2% (McKinsey, 2020).
Similar to Canada, stimulus packages from governments across the world have exceeded 300% (McKinsey, 2020). The global stimulus packages have increased government debt and may lead to fiscal dominance. According to Ersel and Özatay (2008), fiscal dominance is by definition the dominance of a country’s fiscal policy over its monetary policy. It is caused by a country’s high debt ratio that severely constrains the effectiveness of its monetary policy (Ersel & Özatay, 2008). In such scenarios, more government spending is required to combat an inflationary shock.
Collectively, the extraordinary stimulus package as well as the expected GDP gains and unemployment reductions following COVID-19 are likely to produce inflation in Canada.
Although “the natural tendency of the state is inflation” (Rothbard, 1962), it has its drawbacks. “If prices increase too fast – as they did a few decades ago when inflation jumped to more than 10% a year – your dollars lose purchasing power” (Pride et al., 2020). To this end, Milton Friedman observed that inflation is taxation without legislation.
Lumsden (2011) describes five negative effects of inflation. First, it “impairs the efficiency of the price mechanism and raises costs of buying and selling because money becomes less reliable as a standard of value.” Second, inflation disadvantages individuals on fixed incomes, as it does not adjust in a timely manner. Third, inflation penalizes lenders and favors borrowers. Fourth, “given a system of unindexed taxes, namely one where tax thresholds are specified in money terms rather than real terms, inflation will redistribute resources from the private to public sector.” Finally, a high domestic inflation rate increases imports and decreases exports. To individuals, losing purchasing power as a result of inflation is perhaps the most salient. Anticipating increasing prices, prudent investors explore ways to hedge against inflation.
HEDGE AGAINST INFLATION
An inflation hedge involves investment in an asset that is expected to maintain or appreciate in an inflationary period. Hopefully, its appreciation exceeds, or is at least comparable to, inflation. Real estate has long been considered a hedge against inflation, as rent and property values tend to increase with inflation. Historical empirical evidence supports real estate and farmland as effective inflation hedges (Hartzell, Hekman, & Miles, 1987; Hoesli, 1994; Lee & Lee, 2014; Rubens, Bond, & Webb, 1989).
In order to explore the historical effectiveness of Canada’s real estate and farmland as an investment hedge, inflation was compared to the new housing price index and farmland values from 2000 to 2020. The new house pricing index was selected as a proxy for property appreciation, as it is the most timely indicator of changes to residential real estate values. Farmland values obtained from Farm Credit Canada (2019; 2020) were used to determine its appreciation.
From 2000 to 2020, the cumulative inflation change was 39.0% as compared to a change of 51.8% to the new price housing index (Figure 5). The data showed that the new price housing index significantly outpaced inflation.
From 2000 to 2020, the cumulative farmland value appreciation was 168.4% (Figure 6). The data showed that Canadian farmland outpaced inflation by 129.4%.
In this 20-year period, it is evident that residential real estate and farmland values appreciated faster than inflation, suggesting both were effective hedges against inflation.
To further examine the appreciation after high inflationary periods, above average inflation years were compared to the following year’s change to the new housing price index and farmland value. Any amount exceeding 1.87%, the average inflation rate of the time period, was considered above average. As such, above average inflation was observed in 2000, 2001, 2002, 2003, 2005, 2006, 2007, 2011, 2014, 2018, and 2019 (Statista, 2021).
Every year following an above average inflationary period, the new price housing index appreciated (Figure 7). Changes to the new price housing index ranged from 0.1% to 7.3% for an average of 3.0%, exceeding the mean inflation rates (2.3%) explored.
Similarly, farmland values also increased after above average inflationary periods (Figure 8). Changes to farmland values ranged from 1.4% to 19.5% for an average of 7.8%, exceeding the mean inflation rates (2.3%) explored.
Based on the 20-year comparison of cumulative inflation to residential real estate and farmland value appreciations (Figure 5 & 6) and high inflation years as compared to the immediate year’s residential real estate and farmland value appreciations (Figure 7 & 8), it was evident that both acted as an inflation hedge. Although inflation, let alone investments, can never be fully anticipated, the best known predictor of the future is the past.
The macroeconomics trends, including the stimulus package, expected GDP gains, and anticipated reduction in unemployment, indicate impending inflation in Canada. In this extraordinarily uncertain time, prudent investors seek to protect the value of their money. Previously, Canadian residential real estate and farmland have proved to be strategic inflation hedges. If history repeats, Mark Twain’s famous quote to “invest in land, as they’re not making it anymore” will all the more ring true.
Carmichael, K. (2021). Low inflation skeptics are right, just not as high as they think they are. Financial Post. https://financialpost.com/news/economy/low-inflation-skeptics-are-right-just-not-as-right-as-they-think-they-are
Ersel, H., & Özatay, F. (2008). Fiscal dominance and inflation targeting: Lessons from Turkey. Emerging Markets Finance and Trade, 44(6), 38-51.
Farm Credit Canada. (2019). 1985-2018 historic FCC farmland values report. https://www.fcc-fac.ca/fcc/about-fcc/reports/2018-farmland-values-historic-report-e.pdf
Farm Credit Canada. (2020). 2019 farmland values report. https://www.fcc-fac.ca/fcc/resources/2019-farmland-values-report-e.pdf
Hartzell, D., Hekman, J. S., & Miles, M. E. (1987). Real estate returns and inflation. Real Estate Economics, 15(1), 617-637.
Hoesli, M. (1994). Real estate as a hedge against inflation: Learning from the Swiss case. Journal of Property Valuation and Investment, 12(3), 51-59
Janson, R. A. (2021). How inflation caused by pandemic stimulus may come back to bite the middle class. https://financialpost.com/investing/investing-pro/how-inflation-caused-by-pandemic-stimulus-may-come-back-to-bite-the-middle-class
Lee, C. L., & Lee, M. L. (2014). Do European real estate stocks hedge inflation? Evidence from developed and emerging markets. International Journal of Strategic Property Management, 18(2), 178-197.
Lumsden, K. G. (2011). Economics. Edinburgh Business School Heriot-Watt University.
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McKinsey & Company. (2020). Total stimulus for the COVID-19 crisis already triple that for the entire 2008–09 recession. https://www.mckinsey.com/featured-insights/coronavirus-leading-through-the-crisis/charting-the-path-to-the-next-normal/total-stimulus-for-the-covid-19-crisis-already-triple-that-for-the-entire-2008-09-recession#
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Statista. (2021). Canada: Inflation rate from 1985 to 2025. https://www.statista.com/statistics/271247/inflation-rate-in-canada/
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Statistics Canada. (2021a). Latest snapshot of the CPI, December 2020. https://www150.statcan.gc.ca/n1/pub/71-607-x/2018016/cpi-ipc-eng.htm
Statistics Canada. (2021b). New housing price index, monthly. https://www150.statcan.gc.ca/t1/tbl1/en/tv.action?pid=1810020501&pickMembers%5B0%5D=1.1&cubeTimeFrame.startMonth=12&cubeTimeFrame.startYear=1989&cubeTimeFrame.endMonth=12&cubeTimeFrame.endYear=2020&referencePeriods=19891201%2C20201201
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