I recently attended a virtual economics conference where some brilliant minds shared their insights about where the economy is and where we are going. There were some common themes that should come as no surprise. Commodity prices (specifically lumber prices), inflation concerns, government stimulus, and capital gains tax hikes were all discussed.

As we are emerging from the scares of the pandemic, there is a lot to “normalize” in the world’s supply chains. Many of the key supply chains necessary for real estate are clogged and way behind demand.

Here are my quick takes on the above-mentioned hot topics and implications to multifamily investors.

Capital Gains Tax Increase

You have heard President Biden is proposing a ridiculous increase in the federal capital gains tax rate. Without getting into the particulars, it is not likely the bill will pass as proposed, but rather probable we will be paying more in capitals gains tax in the near future.

The government must pay for all their handouts somehow!

For multifamily investors, this is not the worst news ever. We have the 1031 Exchange to defer taxes and although there is chatter of changing that law, it is a long shot. If the 1031 stays in the tax code, one could still exit an asset and roll those gains forward without any immediate tax obligations.

Virtually all taxes create inefficiencies and a sub-optimal market outcome. I’m a free market kind of guy.

If the cap gains tax rate increases, fewer sellers will enter the market. This will reduce potential inventory for sale. Lower supply drives values up as demand remains the same. Definitely a good thing if you currently own multifamily assets.

The other nice thing about commercial real estate, is that any cash-out refinance is a non-taxable event. So rather than selling, I ant

icipate we will see more owners hold on to their property and liberate lazy equity by refinancing and pulling cash out rather creating a taxable event.

Lumber Prices

It is hard to have a conversation about multifamily development without talking about lumber prices. They have be

en through the roof. Lumber has shot up by 377% in the US over the last year. This has increased the replacement cost of a multifamily unit by about $13,0

00. That translates into an average rent increase to $119 per month if the market is

keeping up.

I anticipate higher commodity prices are here to stay for a while.

US Lumber demand plummeted by 49% after the great recession of 2009. 30+ large sawmills went

out of business. In the early 2000’s an infestation of beetles destroyed 44 million acres of forestland

killing 60% of British Columbia’s pine trees. (We get about 50% of our lumber from Canada). And wildfires in 2017 and 2018 consumes 6.2 million acres of lumber.

COVID-19 concerns caused production cutbacks, but demand did not slow down.

This will change the landscape of housing. The value of existing housing stock must increase if the replacement cost continues to go up. Prices and values will continue to increase so long as the demand is there to drive it.

As the elevated costs continue to rise, more and more people will be unable to afford home ownership and will be forced to rent. A larger renter pool is good news for the multifamily universe and rising costs to build will only hinder the market’s ability to absorb this demand. Expect rents to go up at or above pre-pandemic levels over the next couple of years.

The simple cost of lumber today is a huge thorn in developer’s sides. It’s brutal. It will slow development which will only exacerbate housing shortages and push multifamily values higher.

Inflation

This really dovetails nicely with the conversation about commodities. Inflation is very real right now. On a pessimistic level – I do not trust the federal government’s calculations of inflation. Their numbers on inflation are deflated.

With energy prices up 25% from a year ago, used vehicle prices up 21% over the year, and a 12% home price jump in February of 2021 alone – tell me inflation is quite a bit higher than the 4ish percent they are reporting.

No one likes to see the effects of inflation on their wallet or bank accounts, but real estate is historically one of the best true hedges of inflation. Property values tend to keep up with inflation. One could argue that appreciation in real estate values is just inflation all things being equal. I can get halfway on board with that, but that notion is over simplified.

Regardless – inflation was a big topic in the economic conference I participated in. Concerns about inflation are on the radar big time for Fortune 500 companies.

It is quite illogical to assume that multi-trillion-dollar stimulus packages have not done their job. In fact, they have done too good of a job. There is lots of money out there, limited supply of many goods and services people want, and a lot of pent up demand that is manifesting now.

The government wants inflation. It devalues their debt. And what works for them works for us. Inflation devalues your debt as well. For example, if you borrow $1 million today, and inflation over time makes that $1 million worth $900,000. You’re getting a bargain.

It’s a good time to load up on debt. Not only are the interest rates cheap, but that debt will lose its sting as inflation continues.

On the flip side, there are concerns about inflation getting out of control.

And what is the biggest lever the Federal Reserve has to slow the economy? Interest rates.

They have telegraphed they will keep rates low for the foreseeable future, but if inflation continues and the economy stays hot for a while, it is hard to believe rates will not be going up.

So – 2021 is going to be a great time for holders of real estate to refinance those value-add projects. As inflation pushes rents up, cash flow will increase year over year with the low-rate fixed debt structure.

In summary – we live in exciting times. There are always challenges. But as we’ve explored, there are some silver linings to current economic events and conditions that appear daunting and negative on the surface.