How to Have Inflation Work for You!

[Chris Good]

It’s no secret the inflation has been running rampant the past 2 plus years causing a significant price increase on just about everything. While we can grumble and complain about how our money system is mismanaged and how our government officials on both sides don’t know what they are doing, unfortunately grumbling and complaining most likely is not going to help us. So, we kind-of have to just figure out a way to play the hand we’ve been dealt and make the most of it. Monetary inflation has been around for thousands of years but became more apparent to our generation over the past couple years. And you can have it work for you by using debt to purchase cash flowing real estate! This might sound like a crazy idea but hear me out before you completely throw out this idea, please. 😊

Most of the thoughts I’ll be sharing here are a combination of ideas from Keith Weinhold, host of the GRE podcast, and from Victor Menasce, host of the Real Estate Espresso podcast, along with a few thoughts of my own.

1. Price Inflation benefit

Let’s say we purchased an investment property for 1 million dollars. If our down payment was 200K (20%) and we borrowed the remaining 800K and If inflation was at 2% each year for 5 years for a combined rate of 10%, our 1-million-dollar property would now be worth 1.1 million. So how is that a gain? Isn’t that just an example of how our money is losing purchasing power?

Remember, when we purchased the property, we put 200K of our own money into it, so we started with 200K in equity in the property. But now, because of inflation, an additional 100K of equity (10% of 1 million) was added, bringing the total equity in our property to 300K which is a 20% return on your original investment each year, simply because you borrowed the money and let inflation do its work. Inflation worked in our favor because it raised the value of the entire asset, not just our initial investment of 200K.

Another thing to keep in mind is inflation erodes the value of your debt just like it does the value of your money sitting in your bank account. Which bring us to point #2

2. Debt Debasement Benefit

Let’s look at what happens to a 1-million-dollar loan with a 6.75% interest rate over 25yrs with an inflation rate of 3% (the federal reserve’s target inflation rate is 2%).

In that case we would be paying 2.07 million in principal and interest payments over the life of the loan. However, because inflation is continually eroding purchasing power (including debt) that 2.07 million is worth $967,000 in 25yrs in inflation adjusted dollars.

And if the inflation rate is at 2%, that 2.07 million is worth 1.25 million in 25 yrs. (a little more than you paid for the property)

So how can a 2% interest rate devalue the currency faster than the life of the loan? It’s because of the way a loan is amortized, after we reach about the halfway point, the payment, which remains the same through-out the life of the loan, has an ever-increasing portion going towards our principle pay-down.

If inflation remained at 9%, 2.07 million would be worth 196K in 25yrs!

Inflation can work for you by eroding the value of your debt!

3. Increased Cash-Flow

Let’s say we purchase a 10 unit building for 1 million.

Each apartment leases for $1,400 for a total of $180K a year

Your 6.75% mortgage is $82,908 a year.

Property Taxes $12,000

Management fees $14,400

Maintenance $7,500

Vacancy $6000

Trash $4,800

Water/Sewer $21,600

Electric $3,000

Insurance $5,000

Which would leave you with about $22,792 at the end of the year.

Now let’s see what happens to our cashflow in 5yrs. with 2% year over year inflation on rents and expenses. Your loan will remain the same because we have it locked at 6.75%

Rents $198000

Mortgage $82,908

Property Taxes $13,200

Management Fees $15,840

Maintenance $8,250

Vacancy $6,600

Trash $5,280

Water/Sewer $23,760

Electric $3,300

Insurance $5,500

Our cash flow is now $33,362. Inflation worked to our benefit by increasing our cashflow.

This is what happens in a “normal” market over time just from inflation, this does not factor in the rents and property values increasing higher than inflation like we have just experienced, or a loan locked in lower than 6.75% etc... which would only improve these numbers.

So, this is how inflation can work for you, it doesn’t matter the size the property or loan to have it work in your favor, but the key is to take action and put yourself in a position to capture the benefits. : )

I would love to hear your thoughts!