Chart: Adjusting Value Perceptions for the Recent Inflation Surge

U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items in U.S. City Average [CPIAUCSL], retrieved from FRED, Federal Reserve Bank of St. Louis; Five Years Ending December 2022; https://fred.stlouisfed.org/series/CPIAUCSL, January 17, 2023.

I’ve had a few buyers say something to me along the lines of “I’m going to wait for prices to drop to where they were.” When they mention a level, I notice that it tends to be a value from about five years ago. They could be right; this post has nothing to say about where prices will be in the future. Instead, this post is about perceptions with regard to prices returning to where they were.

We had an exceedingly long stretch of low inflation. In the five years that ended five years ago (2012 to 2017), prices as measured by the CPI increased a mere 7.17% total, a 1.39% annualized rate. It had been this way for so long, people in general forgot how to adjust their valuation perceptions. We intuitively consider value to be largely set, i.e. to not generally move over time. This new way (values don’t change) has become the old way, and we are stuck in it. I’m not immune myself as, you know, I’m human. I’m aware of it, however, and thus can think past this perception quicksand.

In the past five years ending December 2022, prices increased by 20.3%, a 3.77% annualized rate, again as measured by the CPI. Thus, whereas a person that used a $100 valuation five years ago for something five years prior to that (thus 10 years ago, keeping up?) was only off by $7, now a person doing the same would be off by $20. Putting a real number on it, a buyer waiting for a particular type of industrial property to return to $180 where it was five years ago is using an internal benchmark that is $36.54 too low ($180 x 120.3% – $180). It might happen, but is not so likely, as it would require a drop to levels 16.9% below where they were five years ago, adjusting for inflation {1 – ($180 / [$180 x 120.3%])}. If one uses a standard deviation of 6.5% and a mean appreciation of 3%, a drop like that would be 3 standard deviations away, which according to the empirical rule would only happen 0.3% of the time. That goes down as unlikely in my book, not impossible, but most definitely unlikely.