Inflation and Real Estate Investment
Inflation, as defined by the Merriam-Webster dictionary, is a “continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services.” Inflation can arise because of many factors, including an increase in money supply, reduced interest rates, changing demographics across the nation, and more.
While inflation can be detrimental to some products in national industry, for those in the real estate investment business, inflation can be a great deal. Real estate is one of very few industries that actually benefits from a rise in inflation. Unlike cash, which loses value when held over time, holding investments in real estate can actually turn your cash into positive equity.
When it comes to real estate, the industry is essentially inflation proof, for the investor. Housing prices over the last 120 years have remained steadily in line with inflation prices, so investors never feel the hit of a rise in inflation costs. One of the major reasons for this match in pace is that housing is, essentially, a primary human need. Regardless of cost, housing will always be required.
When it comes to real estate, most of the advantages to holding this asset are predictable. Things like tax benefits, rents, and debt reduction are all expected. The only unpredictable factor when working with real estate investments is the rise and fall of price appreciation. However, price appreciation does usually fall in line with inflation—and this equals multiple benefits for investors when comparing real estate to other forms of investment.
Inflation vs Cash Flow
When investing in real estate, cash flow is generally the main key investors are looking for in a rental property. The end game, when purchasing a property, is have a steady, increasing revenue stream, generally as passive income—meaning with little to no input from the investor. Cash flow is what is left over from a tenant’s monthly rental payment after all expenses have been deducted. As most tenants work for a living wage, their wages will tend to increase as inflation increases. As inflation rises, so does cost of living, allowing investors to slowly increase rental rates over time to keep in line with fair market averages.
Debt Reduction via Inflation
One of the keys to leveraging inflation to your benefit is having a fixed debt, or a mortgage. Very few things aren’t adjusted to keep in line with inflation—cash and fixed debts are the rare two items untouched by inflation changes. As the value of your property increases, your debt does not change, leaving you with positive leverage.
This positive leverage due to inflation can actually help you reduce your debt over time. While inflation can cause prices to rise over time, it actually causes your debt to reduce. At the current rate of inflation, your fixed debt will be reduced by 2% each year. This is a huge benefit to any property owner—one that is not discussed nearly enough.