When inflation is zero, it doesn’t mean property operating costs remain flat. In the title of this article, I have connected zero inflation with cost-cutting measures in property operations. Why? Because, usually, zero inflation means that property owners have no pricing power to raise rents.
Sure, rents can rise in hot markets, or there is a significant imbalance between supply and demand. Otherwise no. Just no – there will be no rental increases, no rent growth when inflation is zero. That doesn’t mean property operating expenses will remain flat, however.
What to do When Inflation When Inflation is Zero
If a utility decides its time to raise rates, as a property owner, your costs rise. The same is true for increases in insurance or property taxes – you have no authority to sidestep increases in these expenses.
The “yea but” arguments are outliers. Thus, when inflation is zero, and fixed costs are rising, you need property-specific costs-cutting strategies to keep the ship afloat and make a path forward with less financial pain. For this reason, I have connected zero inflation to property operations cost-cutting measures.
Will 2020 be the First Year of Zero Inflation?
The year 2020 could be the first time the U.S. inflation rate registers at zero. Projections right now are for just over one half of one percent. The closest we have come to the goose egg – when inflation is zero – in recent times was 2009 when the official inflation rate was 0.1%.
According to the U.S. Inflation Calculator, since 2010, inflation has ranged from 1.2% – 3.0%. The year-end number for 2020 will likely fall below this range, with 2021 projected at 2.1%. In this conversation, I am excluding the possibility of deflation. However, given the rise in unemployment, it may be more than a whisper if the economy suffers successive quarters of downward pricing pressures from a lack of demand.
Deflation: An Overview. Inflation occurs when the prices of goods and services rise, while deflation occurs when those prices decrease. The balance between these two economic conditions, opposite sides of the same coin, is delicate, and an economy can quickly swing from one situation to the other. Inflation vs. Deflation, What’s the Difference? – Investopedia
Inflation and Appreciation
The primary driver of appreciation is inflation. When inflation is zero, appreciation is hard to come by. When real estate property prices begin to decline, the tipping point is no respecter of rising property operating costs; the cost to operating and maintain real estate assets can continue to grow.
As the costs of individual inputs increase, so does the price of the final output. A simple example is that if both lumber and drywall costs increase, then the costs of newly constructed homes are higher as these items represent a large part of the cost of materials in a new home. But when demand drops, so do prices; on materials and labor.
There are five basic ways to make money in real estate; one way is with appreciation. Read more in my post, “Five Ways Investors Make Money in Real Estate.”
Should Real Estate Investors Chase Appreciation?
Let’s stretch our thinking beyond the basics. When appreciation is only regional, do you chase it? The U.S. coastal markets have seen some significant upside for years. Well, what if you live somewhere else? Do you re-direct your real estate investment to the “hot” markets? Probably not.
The herd mentality always shows up late, like the lineage of people who purchased Apple stock at $700 and followed it down to $377 without a stop-loss anywhere in sight (the cycle never ends).
Most people who invest in real estate assets under $5M place all of their real estate investment allocation their money into deals near their zip code. This form of real estate investing is seldom a good strategy, particularly since it negates geographic diversity.
I get it – people are most comfortable in geography they know. Recognize, however, investment yield doesn’t care about your sentiment or whereabouts. Investment yield doesn’t care what your friends think; it follows opportunity, wherever the opportunity.
What Happens if We Stop Chasing Appreciation?
With appreciation removed from the overall yield-enhancing equation, real estate investors must focus on financing and operations. Pick a city, any city post-recession. Phoenix Arizona saw genuine appreciation with residential prices moving up 20%+. Yet, even with this move, home prices remained severely below pre-recession levels.
What happens if real estate investors stop chasing appreciation? What happens if inflation never rises to save us from our operational malaise? Real estate investors must focus on long-term operational stability and rent growth. The best strategy is to perform cost-cutting where you can and taking price (rental increases) at every opportunity it presents. Real estate has never been a passive investment. When a yield driver (appreciation) disappears from view, this necessitates more attention to our remaining attributes.
Back to the Basics, Back to G.R.A.C.E.
Growing revenue and controlling expenses requires real estate investors to focus on present-day operations and away from potential appreciation as an operational “savior.” It makes real estate investors realize that appreciation in real estate value is a gift and not a right.
Growing Revenue and Controlling Expenses (G.R.A.C.E) is impossible without healthy relationships in the apartment business, with customers, staff, service providers, and vendors.
Without outstanding relationships surrounding your assets, failure is assured. It’s fine to focus on the numbers, but it is our people; property management, contractors, vendors, lenders, and banks that create the momentum necessary to make good progress. The three things in a perpetual dance in property ownership are; our people (named above), the paperwork (from leases to mortgages, insurance binders and vendor contracts), and the property.
Regarding appreciation from inflationary occurrences, it is a beautiful thing for property owners. However, it’s a thing we can’t control or force to occur. The proactive mode is to work on those things we can control. Review each asset in your portfolio and consider the following thirteen cost-cutting strategies:
- What expenses can you eliminate without negatively affecting the delivery of a consistent operational product to the marketplace?
- Have a brain-storming session with site staff- nobody knows the property better.
- Are you recording incoming phone calls to check for quality assurance?
- Is each available apartment unit offered to the marketplace at current market rents? Is the price point moving product? If not, adjust and adapt in real-time.
- Can pest control be moved from monthly to six times a year without a negative impact?
- Are marketing channels delivering qualified leads? If not, why are you keeping them?
- Are average days-on-market increasing? Slowly or exponentially (what is the pace of change?).
- Are you exploring added means of income from existing assets (Ancillary Income)?
- Have you recently re-bid contracts that seem un-competitive?
- Property-wide, are lease terms getting shorter? If yes, you can expect more turnover and higher costs so prepare in advance so as not to be surprised by this.
- Can you buy certain items in bulk with proper tracking (and use) to assure capturing real savings?
- Are there state or Federal programs offer products or providing installation of water heaters, light fixtures, weatherization materials at low or no costs to the property?
- If you have more than one asset, are your people cross-trained to fill more than one role on the property?
These methods do not require asset appreciation to create value.
Will inflation return? Of course. It always does. But like stocks, we can’t time the market, so direct your professional efforts to create value within your real estate holdings during any market condition utilizing professional property management, local market expertise, common sense, and knowledge of the business.