Welcome to this week’s Urban Survival Newsletter, brought to you by the Fastest Way To Prepare Urban Survival Course.
Last week, we talked some about food inflation and how to use the subject to encourage loved ones to convert some of their emergency funds or rainy day funds over to food storage.
There are several reasons why we could experience food inflation in the US, including a weakened Dollar, natural disasters (including freezes), an increase in petroleum prices (The average distance that items travel to make it to the average family’s table travels an average of 1,400 miles, so transportation costs can be significant,) manmade disasters, and screwing around by the government (ethanol), and more.
As unrelated as they may seem, I think there’s a high probability that food inflation will have an impact on the residential housing market. In addition to food inflation’s potential impact on residential real estate prices, we’re going to talk about another factor that is likely to have a negative effect on real estate prices.
The common factor that’s at play is the fact that most people don’t buy a house based on the price…they buy it based on the payment that fits in their monthly budget. It doesn’t matter whether or not you paid cash or paid off your loan early…if you decide to sell, it will probably be to a buyer who uses a mortgage.
So, here’s how food inflation has an impact on real estate prices.
First, arable land has been shooting up as a result of demand for corn for ethanol. I just talked with one landowner this week who bought a great piece of property for $2,000 per acre 2 years ago. Another piece of land that’s MUCH lower in quality, but the same size across the road just sold for over $5,000 per acre.
Three items to think about here:
- If you want to buy farm land of any size, be aware that it’s a different world than it was a couple of years ago. People are buying land trying to get in on the “ethanol gold rush” at the same time that preparedness minded people are trying to buy land to support themselves on. As a result, land is going for what many would consider “stupid” or at least unsustainable prices.
- The more land that changes hands at these new, higher land prices, the longer it will take for food prices to come down if/when the ethanol mandate is reversed.
- If the ethanol mandate is increased, as the current administration is promising, it means that we can look forward to higher land prices, higher food prices, and an even longer period of time for these artificially high prices to work their way out of the market.
- I think there is a good chance that the increase in food prices will cause a DECREASE in the value of single family homes in urban areas. Here’s why:
According to the Department of Labor, the average US family spends 12.9% of their pre-tax income on food and 20.2% on rent/mortgage. If you squeeze a family by increasing the cost of their food by 10%, that money has to come from somewhere else. If it comes out of the money they have available for rent/mortgage, then it means they have roughly 5% less available. Here’s an example of what that means.
If someone has $1,000 a month to spend on a mortgage, they can get roughly $187,000 of house at 5% interest. If that $1,000 gets cut by 5%, or $50, than $950 per month will only get them roughly 177,000. This is bad if you bought your house before food inflation and need to sell it to a family with roughly the same budget as you after food inflation.
The second situation that I see happening with residential housing is a decrease in prices when mortgage interest rates return to sustainable levels.
Right now, 30 year mortgages are being advertised at 5% or less. Meanwhile, real inflation is 8.5% or higher. To explain why this is a problem, we need to look at banks quickly.
Some businesses are easy to understand. A hardware store buys a wrench for $1, sells it for $3, and if they sell it in a short enough period of time, and cover all of their expenses, they make 30-60 cents apiece. Do that enough times with enough items, and they stay in business.
The bank version of a wrench is cash. They buy dollars from customers in the form of CDs at a low interest rate, and they sell those dollars to other customers in the form of loans, like mortgages with a higher interest rate. So, a bank might offer 2% interest on CDs, turnaround and loan it out at 5%, and if the borrower pays on time, they’ll make 3%. Historically, the spread has been about 2.7%, but it tends to get smaller as rates go lower and get bigger as rates go higher.
With proper underwriting, this is a fairly stable system. Banks compete for CD money and usually have to pay customers close to the rate of inflation, or even a little more.
In recent years, this system has been turned upside down. Instead of borrowing money from customers in the form of CDs, banks are increasingly borrowing money from the Federal Reserve at incredibly low rates that have driven CD rates and mortgage rates down to unrealistic rates. In simplified terms, we’re borrowing money from China and other countries at rates that are lower than the rate of inflation, and that is propping up the real estate market.
At some point, China, other Treasury buyers, and CD buyers are going to demand a return on their money that is at or above the rate of inflation in the US. So, let’s see what would happen if banks started offering CDs at 8%, or slightly below our current 8.5% inflation rate, and they loaned it out at 10%.
That $1,000 payment that used to buy a $187,000 house at 5% only buys $114,000 worth of house at 10% interest. This is HUGE. That’s a 40% drop in value, and in my mind it’s not a matter of if it happens, it’s how soon and how quickly it happens once it starts.
Houses have historically gone up in value due to inflation and rising wages, more demand than supply, low interest rates, and poor underwriting. In most parts of the country, low interest rates is the only one of those factors that’s still having a positive effect on housing. Inflation without rising wages doesn’t necessarily help housing. More restrictive underwriting and higher down payment requirements has squeezed many buyers out of the market and made supply higher than demand. All in all, we’re starting to pay the piper for the artificial increases in real estate prices since 2001.
Enough of the doom and gloom…what can you do to put yourself in a good position if this happens?
The first thing is to not worry about it happening. You have control over the decisions you make, but there isn’t anything that you can do as an individual to keep food inflation or higher interest rates from happening. I see this playing out in one of two ways. Either prices will suddenly and catastrophically drop due to an event, or China will pressure the Fed to start raising rates gradually but consistently over the next several years.
If you have a home that you intend on staying in long term, enjoy it and don’t worry about the value.
If you just bought a home at “historically low” interest rates and don’t plan on staying there long term, you may want to reevaluate your plans with a trusted and competent financial advisor. As a former stock broker, I’d suggest finding someone who understands and enjoys macro and micro economics and real estate. This isn’t a conversation to have with someone who only understands insurance or only understands stocks. Forward this article to them, have them look at it, and get their thoughts. HOPEFULLY, I’m all wet and there’s no basis at all for my concerns.
If you are looking to buy a home in the near future, get to know the major players in the real estate investor community in your local area and try to buy a house that’s significantly under market value. There are incredible deals (25%-50% below retail) across the country right now that will give you some cushion if interest rates shoot up and prices drop.
If you’re currently living in an urban area and looking to buy a piece of rural land that you could use as a retreat location and grow food on, don’t waste any time but don’t make any rash decisions. Specifically, don’t pay too much for a bad piece of property. Also, look in non-conventional places to find properties for sale. As an example, if EVERYONE in your area looks in the MLS, Craigslist, and the newspaper to find properties, then make sure you’re also looking in the Thrifty Nickel and on Ebay.
Also keep in mind that the increase in farm prices, the drop in inventory, and increase in demand make it more likely that if a disaster happens in the near future that you’ll need to survive right where you currently live. Remember, the workable plan that you have in place will ALWAYS beat the perfect plan that you haven’t taken action on. Keep making daily forward progress in improving the survivability of your current living situation. And if you haven’t checked out the Fastest Way To Prepare Urban Survival Course lately, I encourage you to head over to Fastest Way To Prepare.com and check it out.
What are your thoughts on the effect of ethanol, food inflation, and interest rates on the price of homes? Please share your thoughts by commenting below.
Until next week, God bless & stay safe.