Plan for actual inflation, account for expectations

I've seen debate over what future real estate growth might be. An article today claimed real estate is a good investment during times of inflation. My opinion is that's it's a bit more nuanced. In short, there is a difference between inflation and inflation expectations. When the two are the same, it does not make much difference. Inflation expectations is reflected in the price you pay for real estate. Actual inflation is reflected in the value growth of your real estate. 

In the early 1980s, inflation expectations were double digits, reflecting recent inflation rates of 10-15%. Over the following ten years actual inflation continually declined, and a lot of people who bought property in 1980 or 1981 got killed. They paid prices based on expectations, but their real estate growth reflected actual inflation.

Over the last thirty years, inflation and inflation expectations were very close. Not only did the difference not matter to people, but people also grew accustomed to ignoring the difference and became complacent to it.

I once heard a large real estate investor say many analysts like to type in 3% for rent growth across their pro formas. When he asks them why they used 3%, they say, "I don't know. Do you think I should use something else?"

Over the next few years, I see inflation and inflation expectations running starkly different from each other.

I think a good approach to valuing real estate is to use actual future inflation, not current inflation expectations, and consider that the asking price make reflect expectations but not future reality. Of course, inflation is only one variable that contributes to value growth of real estate, but miss judging it can be distasterous. You must also consider other market variables too, such as population growth, jobs growth, types of jobs, and specific types of real estate people desire. Just be sure to accurately estimate future inflation and put it into value your ROI calculations, but don't expect the price to reflect it.