Inflation: a sustained increase in the general level of prices for goods and services. In more lay terms, it means as time goes on and inflation goes up, your buying power becomes less and less with the same amount of money. Remember in the mid-90s when $1 million dollars seemed like you were ready to retire for life? Fast forward to 2019 and that same amount seems like it would barely suffice for a few years. Here’s an example. In 1995, what you could buy with $1,000 would now cost between $1,650 and $1,700. That’s a 65% cumulative rate of inflation over 24 years. Doesn’t sound too terrible.
Let’s take a bigger item. If you were buying a house for $250,000 in 1995, in 2019 it would require $419,000 — or more. Keep in mind, this doesn’t consider any appreciation that the home has acquired. It solely takes into account the spending power and value of the dollar that has been changed due to inflation. The question becomes, how can you fight and even profit from inflation?
The answer: real estate.
First, let’s evaluate how you actually lose to inflation through traditional investments. For many people, we evaluate what we will need to retire based on our current lifestyle. If we’re making $100,000 a year, we might begin investing and set up our accounts based on what we deem will be comfortable. However, if you began a retirement account in 1989 with a $100,000 salary in mind, in 2019, you would actually need $209,910.82 due to the cumulative inflation rate of 109% over the past 30 years. Beyond that, the fees charged to manage many retirement accounts completely eat up the funds required to keep up with the inflation rate.
As one finance expert put it, this steady increase in pricing wouldn’t seem so challenging if the purchasing power of a dollar rose alongside it, but that’s not the case. “The only way to battle inflation is to make more money, but for most U.S. workers, real wages — that is, after inflation is taken into account — have been stagnant or even falling for decades (the famous middle-class squeeze).”
Now, let’s evaluate real estate as a tool to fight inflation and produce cash flow now and in retirement. Real estate investments are often seen as inflation hedge investments. Inflation hedge investments are typically assets that are expected to increase, or at least maintain, in value over a period of time. This plays into three aspects that make real estate a great tool to fight inflation: appreciating value, increasing income (rents) and depreciating debt.
Appreciating value: One of the most beneficial aspects of real estate is appreciation. On average, property values appreciate between 3% and 5% annually according to Zillow. In some markets, like the greater Dayton and Cincinnati, Ohio area, I’ve observed appreciation rates anywhere between 6% and 10%, depending on the year. To illustrate, if you buy a house for $100,000, assuming an annual appreciation of 6%, you’d have a property valued at $179,000 in just 10 years. Even at a more conservative 4%, the property would be valued at $148,000. Comparing it to inflation, from 2009 to 2019, there was roughly a 19% rate of inflation meaning your $100,000 purchase would cost you $119,000 to buy it again in 10 years. As you can see, you’ve not only kept up with inflation through real estate investments, but you’ve added value and gained appreciation with the investment.
Increasing income (rents): The awesome aspect of owning turnkey real estate investments or using a buy-and-hold strategy is the cash flow generated from tenants. Smart investments in rental properties will not only cover your monthly expenses, including your principal loan balance, interest, taxes and insurance (PITI), but will also generate $100-$400 per month in cash flow. Even better, rental properties, if managed wisely, can garner rent increases annually generating even more cash flow than your original investment. If you have a property that generates $1,000 in rent per month, if you gave an increase of only $20 per year, in 10 years, you’d be receiving an additional $200 per month in cash flow. Granted, some expenses like taxes and insurance can increase over time as well. However, your increased rental income will help to cover those expenses, plus add additional cash flow for you. With the increasing rents, you’re fighting the inflation that may occur affecting your taxes, insurance and maintenance costs.
Depreciating debt: Just as your real estate asset is appreciating in value, your debt owed on the property is actually depreciating in value with the rate of inflation. To simplify, your $750 mortgage payment in year one is worth $750. However, in 10 years, with inflation, that debt is going to be worth far less. For consistency, we will use the 2009-2019 inflation rate. If your payment is worth $750 in 2009, by 2019, it will only be worth about $640 due to inflation. When you use leverage, or financing, to invest in real estate, you get to take advantage of depreciating debt. Of course, your monthly payment is the same. You will still be making that $750 payment per month year after year (assuming an amortized loan). But, the value of that payment will be less as time goes on.
Inflation is inevitable. It’s either a high rate, a steady rate or somewhere in between. Even in our down economy, between 2009 and 2012, the inflation rate still averaged around 2%. One of the best ways to fight inflation, and even win the game against it, is through inflation hedge investments like buy-and-hold real estate properties.
