Don't Underestimate the Power of Inflation

Inflation’s not exciting. Nor is it sexy. It’s not a blockbuster movie with mind-blowing special effects. All it does is sit there and grind the purchasing power of every single dollar you own down to a nub of its former glory. On the flip side, you can put the power of inflation to work for you by investing in long-term, fixed rate mortgages tied to a piece of income producing residential property. Employed properly, that strategy reduces the mortgage year by year.

Did you catch that last bit? In terms of real value, the result of the erosive effects of inflation is that you pay less for that mortgage than the scary-big number that occupied the “selling price” line on the last investment property you bought. Recent  articles have focused on describing how this works, but a graphic Jason Hartman presented on his podcast does a bang-up job in illustrating just how much inflation can reduce your mortgage sum.

We’re going to get into a little math here, but don’t worry. It’s not the complicated kind. For this example, let’s say you’ve taken out a cool million dollar mortgage for a four-plex in your favorite city. We’ll further assume a 5.1 percent annual inflation rate for five years.

Year One

You signed a note for a million dollar loan on January 1 and paid nothing but interest for the next 365 days. During that time, the dollar depreciated (thanks to inflation) at a rate of 5.1 percent. The bottom line is that a dollar at year’s end buys a little less than .95 cents worth of goods and services when compared to a dollar at the start of the year. This is an economic reality that applies to any asset valued in dollars. You couldn’t change it if you wanted.

Moving on, $1,000,000 multiplied by a 5.1 percent inflation rate equals $51,000. Subtract that from your mortgage balance and you’re left with $949,000. Like magic, the real value of the amount owed decreases by a substantial chunk of change. In case you haven’t picked up on it, this is exciting news for mortgage holders. Keep in mind there’s nothing remarkable about this hypothetical first year. The same process takes place each and every year we experience inflation in this country, which, for all practical purposes, means it happens every year. Let’s expand the example to the second year of your income property mortgage.

Year Two

Remember we’re beginning with a real mortgage value of $949,000 from the first year. The inflation rate repeats itself, meaning we multiply the new mortgage amount by 5.1 percent, which yields a depreciated dollar value of $48,399. That’s how far the value of your mortgage balance drops by the end of the second year. Subtract that amount and you’re left with $900,601 owed the bank compared to the initial currency strength the day you took out the loan - two years and the payback amount has dropped 10 percent.

None of this is magic or sleight of hand, but rather cold, hard economic truth that reflects the reality of a depreciating dollar in an inflationary economy. Do we think you should take all this into account with your next income property deal? Heck yeah! To ignore inflation while crafting an investment strategy is like scoffing at gravity whilst leaping from the top of a tall building clad in a homemade red cape emblazoned with a Magic Marker “S.” In short, you won’t fly far and should expect the landing will hurt – a lot.

The JasonHartman.com Team

“The Complete Solution for Real Estate Investors”