Like an old college roommate, inflation showed up uninvited to the party, got a little out of control, and stayed much longer than any of us anticipated. Could our dear friend actually have any redeeming qualities?
The party supplies cost substantially more than they did a year or two ago, and no one likes to pay more money to get the same thing. There is a flip side to inflation, though, and some people can benefit from its seemingly unpleasant behavior.
Dr. Peter Kim tells us that real estate investors are among those that can more easily look on the bright side, and he’s here to tell us why.
This Saturday Selection was originally published on Passive Income MD.
If you’ve turned on the news or opened social media in the past few months, you’ve probably heard the word inflation. Repeatedly.
Rising inflation rates have a lot of people worried about their money and their futures. Should you be worried about how inflation will affect real estate investments? Let’s cover the inflation basic first.
What is Inflation?
You can think of inflation in two ways.
It’s the devaluation of currency over time or the decrease in purchasing power of a currency.
Either way, it means the same thing for our wallets. Money just doesn’t stretch as far as it once did. Even if we haven’t spent or lost any money at all, we can’t buy as much with what we have.
Inflation is often measured by the Consumer Price Index, which tracks the cost of a long list of goods and services at a given time. Current prices can then be compared to past prices to determine how much costs have risen. When prices go up, it’s inflation. When they go down, it’s deflation.
For instance, milk cost $1 a gallon in 1960. In September of this year, a gallon of whole milk cost, on average, $3.68. Do you remember when gas used to cost less than $1 a gallon? Well, it currently averages $3.40 nationally.
While prices in certain sectors ebb and flow naturally due to various industry factors and demand, they have mostly slowly but steadily increased over the years.
Over the past decade or so, we’ve experienced relatively low inflation rates. They typically average 2%-3% per year, but the inflation rate from 2010-2020 averaged just 1.8%. The last twelve months? They’re a different story. Inflation rates in the last year have reached peaks not seen for more than 30 years, as is shown in this chart from the New York Times.
What Has Caused the Inflation We’re Seeing Now?
There’s not a simple answer to this question besides, “It’s complicated.” Even economists don’t agree on the reason for inflation. The fact is that it’s situational and caused by several factors.
The explanation that makes the most sense to me is that inflation occurs when money supply growth outpaces economic growth. Well, the government recently printed $3 trillion dollars meaning that 40% of all the money supply in circulation has been created in the last 12 months.
When more money is being thrown around and at the same product while demand remains the same, the price of that product will increase over time.
So when your cash is sitting in a low-yield savings account or other super-conservative investment options and inflation is occurring around it, that money is actually decreasing in value.
How can you stop that from happening?
Well it means that we have to smartly invest in order to at least keep up with the rate of inflation.
Real estate investment is known as the great hedge against inflation for a reason. In fact, inflation can be a good thing for real estate investors if they play their cards right.
How Real Estate Investors Can Benefit from Inflation
Here are 3 ways that real estate investors can benefit from Inflation:
Inflation Can Help Erode Debt
One of the most powerful tools to accelerate wealth and profits in real estate investing is the use of leverage or debt. You can take advantage of this both as an active and passive real estate investor.
Inflation erodes the cash in your pocket but it also erodes the outstanding debt that you have assuming it’s at a lower variable or fixed interest rate.
For example, if you have a 30 year fixed rate mortgage at 3.5% interest and you’re paying $4,000 a month, you’ll still be paying that $4,000 per month payment in year 25. However, due to inflation, that $4000 you’re paying is actually worth quite a bit less in the future. Assuming a standard 2.5% rate of inflation, that $4000 payment in 25 years would be equivalent to about half that amount today ($2157).
So, debt tends to lose its value while…
When inflation strikes, rents tend to increase. It is essentially a “goods or services” that follows the inflation line.
Demand for rentals also tends to increase during times of rapid inflation, as well. As I’ll mention next, people tend to get priced out of buying homes and so demand for rentals increases. Increased demand equals increased rents.
I don’t think it’s a coincidence that home prices across the country still continue to increase at a rapid rate. Interest rates are low, inflation is high, and there is a ton of cash out there.
So prices are appreciating rapidly, building equity for rental property owners.
Most real estate investors tend to use leverage and debt and they’re able to massively benefit from gains in the value in properties while only having put down 20-30%.
Trends have shown that real estate values tend to keep up with inflation at the very least and oftentimes even exceed it.
We’ve been living in a pretty low inflationary environment for years and it sounds like higher rates of inflation are here to stay for the time being. Investors will have to adjust their strategies to keep ahead of the rate of inflation.
So, if you’re thinking about how to not only hedge against inflation but profit from it, real estate investing might be a great opportunity at this time.
How do you plan to hedge against inflation? What are your experiences with real estate investing?