The Role of the Monetary Premium in Real Estate

How real estate became so valuable

Historically, money—particularly in forms tied to gold or other stable assets—served as the primary store of value, maintaining purchasing power over time. However, when the global financial system underwent a profound change in 1971, this shift to fiat currencies, which are not backed by stable assets, allowed for an unprecedented expansion of the monetary base.

The Nixon shock

This pivotal moment known as the Nixon shock marked the transition away from a quasi gold-backed currency system and ushered in an era of fiat money.

In 1971, the United States transitioned from a gold based system to a fiat currency system, following President Richard Nixon's announcement on August 15th that the U.S. dollar would no longer be convertible into gold at a fixed rate. Prior to this shift, 27 years earlier, the Bretton Woods Agreement, convened in 1944, by 44 allied nations in Bretton Woods, New Hampshire, USA, aimed to create a new international monetary system in the aftermath of World War II.

By then, the U.S. held about three-fourths of the world's gold reserves, making a pure gold standard untenable. The agreement pegged all allied nations' currencies to the U.S. dollar, which was convertible to gold at a fixed rate of 1/35th of an ounce per dollar, thereby positioning the U.S. dollar as the global reserve currency and moving the world away from a pure gold standard.

However, as the dollar was backed by gold, it hampered the U.S.'s ability to spend. This situation was exacerbated by extensive expenditures on foreign military operations, notably in Vietnam, leading to a depletion of the U.S. gold reserves by 1970 and precipitating a liquidity crisis. In response, president Nixon announced that the United States would abandon the gold standard, a decision that had global repercussions due to the dollar's position as the world's reserve currency.

The fiat-based monetary system

The significant shift towards a fiat-based monetary system, characterized by floating exchange rates and the absence of a fixed currency standard, has transformed the global financial landscape and created the role of real estate as a key tool for preserving wealth in the face of soaring monetary inflation.

This becomes clear when looking at the increase in the money supply M2, as depicted in the graph below. This measure reflects the spectrum of funds available for spending and investment.

The Nixon shock had far-reaching implications for the world economy, including its impact on interest rates, inflation, and asset prices. Therefore, examining housing prices from 1971 onwards provides valuable insight into the long-term trends and changes in real estate values in the context of shifting monetary policies.

Since 1971, the average sales price of a house in the U.S. roae from $27,000 to $492,000 in 2023, indicating a significant appreciation in property values over this period of around 1,700%. The substantial increase highlights the dramatic inflation in housing costs over the span of five decades, underscoring the profound influence of shifting monetary policies on real estate values.

Since an increase in the money supply diminishes the purchasing power of the existing monetary base, the expansion of the money supply compelled market participants to seek investment avenues to safeguard their wealth against inflation. With real estate, due to its scarcity, cheap financing options, and the perception that it would appreciate or at least maintain value over time in the face of depreciating fiat currencies, emerging as one of the most favored options.

Analysis of the compound annual growth rates (CAGR) of the M2 money supply and housing sales prices shows a clear correlation between them. Since 1971, the M2 money supply has had a compound annual growth rate (CAGR) of 6.9%, which closely parallels housing sales prices, which have increased at a CAGR of 5.7% (a detailed calculation breakdown can be found at the bottom of this article).

The monetary premium in real estate

As a result, real estate began to accumulate a significant monetary premium. This premium reflects the collective belief in real estate's capacity to function as a store of value, a role traditionally fulfilled by hard money, which refers to currency backed by scarce assets like gold or silver, which historically ensured its value. 

Accurately determining the portion of a property’s value derived from its role as a store of value is difficult, given the scarcity of statistical analyses focusing specifically on this aspect. But the evolution of real estate prices sheds light on their substantial appreciation since 1971 and other periods marked by significant monetary expansion. This trend highlights the significant impact of an excessive increase in the money supply on real estate valuation.

In Munich, Germany, for example, land prices for residential construction have tripled since 2008, coinciding with central banks globally injecting unprecedented amounts of money into the economy. This monetary expansion was aimed at sustaining the global financial system during the aftermath of the 2007-2008 financial crisis (*Reiß-Schmidt, 2018).

It is challenging to determine the exact share of the monetary premium of real estate in Munich, i.e. the invested capital, that is attributable to its function as a store of value. However, property costs can represent up to 70% of a condominium's purchase price (*Reiß-Schmidt, 2018), this indicates that real estate has accumulated a significant monetary premium. Were it not for this function, construction costs and labor would likely comprise a larger portion of the purchase price, which underscores the importance of real estate for wealth preservation in the market's pricing structure.

Conclusion

Munich’s real estate market trajectory mirrors the financialization of the asset class globally, a shift significantly shaped by central banks moving away from a gold standard following the Nixon shock in 1971. This connection is demonstrated by the expansion of the money supply and the concurrent rise in real estate prices, driven by low interest rates and continuous credit expansion. It follows that the primary appeal of real estate, especially in high-demand areas, lies in its perceived ability to maintain value over time, rather than its ability to generate income through rent or its utility value, a function now challenged by bitcoin's emergence.

Bitcoin vs. real estate

Since the introduction of Bitcoin in 2009, real estate is facing competition in its function as a store of value from bitcoin, which is proving to be a near perfect digital store of value. The supply is finite, it is easily portable, divisible, durable, fungible, censorship-resistant and noncustodial. The reality is that real estate can not compete with bitcoin as a store of value. Bitcoin is rarer, cheaper to maintain, more liquid, easier to move and harder to confiscate, tax or destroy. It can be sent anywhere in the world at the speed of light at relatively low cost. Therefore, bitcoin is likely to attract the monetary premium currently held by real estate, potentially recalibrating property values more closely to their utility value.

If you're interested in exploring how Bitcoin could influence the real estate market and how real estate developers and investors can capitalize on this transformation, I recommend the following articles:

More on Bitcoin & Real Estate

• Bitcoin vs Real Estate: What is the better store of value?
• Bitcoin vs. Real Estate: Which is the more resilient store of value in times of crisis?
• Real estate vs. Bitcoin: Dismantling the cash flow narrative
• Why bitcoin is digital real estate
• Why every real estate investor should own bitcoin
• Bitcoin & Real Estate 101: Maintenance reserves
• Why bitcoin is pristine collateral for lending
• Bitcoin & Real Estate 102: Is leveraging real estate to buy bitcoin a good idea

*Reiß-Schmidt, S. (2018) ‘Wachsende Stadt, entfesselter Bodenmarkt – wo bleibt der soziale Frieden?’, Immobilienwirtschaft. vhw FWS 3 / Mai – Juni 2018, pp. 119–122.

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