Can someone please confirm my view on the following is right:
Rise of the inflation wouldn’t have much impact on equities and real estates because both cashflows and discount rates are expected to rise.
What I conclude from this is that there would be an offsetting effect between rising cashflows (positive effect) and rising discount rates (negative effect), so the valuation would somewhat remain unaffected. (i.e. using DCF methods for valuating)
All opinions are very welcome.
so i’ve thought of this a lot. what ur saying is true. but keep in mind thats if you foolishly use a lower rate to begin with jus because risk free rates are at an all time low. heres a quote from buffett regarding this topic.
“Just because interest rates are at 1.5% doesn’t mean we like an investment that yields 2-3%. We have minimum thresholds in our mind that are a whole lot higher than government rates. When we’re looking at a business, we’re looking at holding it forever, so we don’t assume rates will always be this low.”
but lets get granular on this and tackle equiteis and real estate separely.
so real estate. most will have a very long term debt, ranging from 10 to 30 yrs at a very low rate right now. so the payments will be fixed. but as inflation rises, you could prolly increase the rent you charge which would make more money. rent is the most basic thing in cpi, so its almost guaranteed. so for real estate its a very good thing.
stocks. most of their cost structure will rise due to inflation. but in terms of revenue. it’ll vary. not all companies will be able to pass that inflation to consumers so they’ll face tighter margins. most consumer may even choose to cut back on spending as prices rise, so volumes could drop implying that profits will drop overall. but assuming you could pass the cost to consumers cuz u have a wonderful biz, and your cash flows do rise. the amount of corp taxes will rise with it, so its still heavily constrained overall. in terms of multiple valuation, they also tighten historically. it could be due to the risk of inflation as stated, or because rates may rise to control inflation thereby increasing opp cost.
not sure what happens to real estate multiples, but tax has a less of an effect on them. a recent acquisition may cash flow but may not even be profitable in terms of taxes due to depreciation. but imo inflation is better for real estate.
so anyways back to your question in nominal terms! yes in an inflationary world, things are better in absolute value. but ocne you factor inflation in real terms, the value of that company would prolly be lower for a variety of factors, taxes being first and foremost. inflation is a hidden tax! a couple quotes from buffett:
“But an inflationary world is not a good thing. We try to own good businesses. I think Berkshire wouldn’t do as well in real terms during periods of high rates of inflation vs. low rates, but we’d probably do better than most businesses.”
read this article. wealth of info. if no access there a free csinvesting file on google. it goes in further detail on other things such as book vs market effects. but i just like taxes since it eats away the majority of your earning power.
I would just stick to the curriculum —
Inflation has a positive impact on real estate values (due to higher rent income, etc)
Inflation won’t have much effect on stocks IF inflation is within an expected range.
In terms of the exam, I wouldn’t overthink it much more than that.
o lol didnt kno this was l3 forum. apologies. thought this was the wc. yea stick to the bullet point answers. dont write them an essay lol.
Real estate generally benefits from inflation because you can lock in a mortgage at low current rates. Inflation will increase your rent income and capital appreciation. But your borrowing rate is not increasing with future rate increases. You’ve already locked it in. Cheers.
Thanks everyone for their contribution! It was of help and hope very practial for many of us
. . . unless you have long-term, fixed-rate leases.
Most commercial leases have inflation adjustment in them Bill. Most residential leases are for 5 years or less and they also often have inflation increases built in . You get capital appreciation on both. The borrowing is locked in for both from when you either buy the property or when you do your takeout loan. The idea of a long term fixed lease is mostly an academic notion. You can see it sometimes with anchor tenants like a supermarket in a mall complex. But the idea there is to leverage their presence into better deals from the remaining tenants, often with percentage leases based on their sales output which is then again correlated to inflation.
Not surprising, but not my area of expertise.
Thanks!
Cheers man