Leveraged Inflation - A nice upside or am I crazy?
I've been modeling out tons of deals over the past month and refining my model (I'm a newbie and have made a couple offers, but nothing that has stuck yet - fingers crossed on one I'm negotiating price with now). I had an interesting scenario that I've been playing with and have temporarily named it "leveraged inflation increase" until I find out whether there is an existing term out there.
Here's how it works - Assuming your property is in a market where rents and all of your expenses generally rise with inflation, one thing doesn't change from year to year, which is your mortgage payment. When it first occurred to me and I started modeling I was expecting this to be a slight boost to my cash flow each year by maybe 1-2%, but turns out the year-over-year cash flow increase above the inflation-adjusted cash flow from the prior year is much larger and keeps growing from year to year! Huh??
Example (without getting into the weeds on my model):
Year 1 cash flow is $10,000 and inflation is 3% for all years. With 25% down and about 45% expenses (as a % of gross rents)
Year 2 cash flow is $10,525, but the inflation adjusted $10k is just $10,350, so a boost of $165 or 1.25% additional increase in cash flows after factoring in 3% inflation. No big deal.
Year 3 cash flow is $11,000 on the again inflation adjusted $10,670, so a boost of $330 or 2.63%.
Year 4 cash flow is $11,500 on the again inflation adjusted $10,990, so a boost of $510 or 3.79%.
Year 5 cash flow is $12,000 on the again inflation adjusted $11,320, so a boost of $690 or 4.85%.
Year 6 cash flow is $12,540 on the again inflation adjusted $11,660, so a boost of $880 or 5.82%.... See where this is going?
Not a huge deal, but adds up when you're modeling out future cash flows. Am I way too in the weeds? Has anyone seen this occurrence or have a name for it?
Thanks for bearing with me...