Very long term property investment and inflation

The Herengracht Index was a very long study (1628 - 1973) of house prices of a particular property development in Amsterdam where the buildings have persistently remained of constant high quality over time. 

The study compared:

  1. a real terms price index linked to the use value of the property; with
  2. the nominal value of the property (i.e. cash value). 

The study demonstrated that in the very long run house prices generally rise with inflation. There are market cycles but this is the very long term trend.

Data points: 1628 - 1973 - biennial logarithmic price changes in the Herengracht index

  • Nominal index: mean 1.83 standard deviation 17.65
  • Real index: mean: 0.45 standard deviation 18.50

Note the wide standard deviations reflecting price volatility.

Another key observation is that there was a jump in nominal price in the face of an essentially flat real index after the Second World War. This jump arose (and continues) because the reserve currency of the world, the US dollar, came off the gold standard taking other world currencies with it. As the link between the World's reserve currency and the real value standard of gold was broken increases in the quantity of fiat money were no longer constrained by the underlying real value of the assets held by the national bank.

The true nature of what had occurred can be seen from the following facts:

  1. on 5th April 1933 the US required that all gold and gold certificates worth more than $100 held in private hands was handed over to the US Government at a fixed rate of $20.67 per ounce;
  2. on 5th June 1933 Congress removed the right of creditors to demand payment in gold effectively taking the US dollar off the gold standard.
  3. in 1934 the US Government price of gold was increased to $35, increasing the value of the gold held on the US balance sheet by 69% (Gold Reserve Act of 1934 especially section 12)
It is this printing of fiat money that creates inflation. Inflation consumes people's savings. This is most clear when the savings rate is less than the inflation rate resulting in erosion of the real value of the savings over time.

Whilst there is a complex relationship between the the quantity of notes and coins in the economy and the change in money supply created by credit, in essence it is the credit cycle that creates the market cycles that drive market volatility - see: creation of credit. This is different to the general uptrend in nominal prices flowing from inflation.

The take away message is that despite a degree of volatility, property can be a hedge against inflation for investors who remain invested into the long term. Property owners do not necessarily get rich, however they do tend to avoid having their savings taken through the insidious tool of seigniorage expressing itself as inflation.

The reason that this works, as the Herengracht Index seems to demonstrate, is because, in general whilst :

  1. the nominal price of property tends to increase with the amount of cash and credit in the economy; but
  2. the use value of property does not tend to change much with time.

Thus, if the use value of the property is not changing over time then owing property secures the use value of the property for the investor over that time. Thus, because the quantity of money in the economy is growing, literally inflating, then owing property over time will secure the intrinsic value of the initial investment because the nominal value of property will grow in a way that is linked to the rate of monetary inflation.

Clearly the choice of property and timing of the purchase within the credit cycle make an important difference here. But having said that, whilst there are other investments that can hedge against inflation, this is an interesting observation for investors looking to invest into the long term.

R Mohindra

(c) 2021


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