In our last newsletter, I discussed what is front and center on everyone’s mind right now, including the news. I know it seems like we can’t get away from this topic — it’s everywhere!
We discussed the concept of inflation, what causes it, and various investment options that can be a good hedge against inflation.
I also introduced the concept that there are certain strategies investors can implement to use inflation to their advantage.
It might be hard to imagine what you could do to make inflation help you. You might be thinking, “If everything costs more, how can that possibly be to my advantage?” Well, like many things in life, entrepreneurs and other very resourceful people can find a way to make it work in their favor.
Historically, inflation is a part of life. Certainly it’s part of any healthy economy’s lifecycle. It’s generally thought that healthy inflation is approximately 2% per year. How does this help our economy?
Inflation causes prices to rise. That leads to increased short term demand which in turn boosts our economic growth.
That’s because people would rather pay for a product now rather than wait for it to be more costly in the future due to inflation. They are anticipating an increase and will purchase now to avoid large price hikes.
In addition, inflation removes the risk of deflation — which can be incredibly harmful. When prices drop, people tend to wait to see if they drop more.
This might make common sense, but this has the effect of reducing demand. This causes businesses to reduce their inventory… causes people to be laid off… and causes the economy to stagnate in general.
Moderate inflation is beneficial in that it enables the adjustment of wages. Inflation makes it difficult to cut nominal wages.
However if average wages are rising, it’s easier to increase the wages of productive workers and keep unproductive workers’ wages frozen. This then effectively causes a wage cut.
This is because your previous wage no longer buys as much as it could last year.
There are clear winners and losers but how can inflation be a benefit for real estate investors?
Well… inflation can erode debt. One of a real estate investor’s most powerful tools to accelerate profits and wealth is by leveraging debt. This is done by both active and passive investors.
Not only does inflation erode or reduce the value of cash in your pocket or bank account, but it also erodes the amount of debt you owe in the future.
If you pay $4000 a month for debt service, you will still pay $4000 a month in the future but that will actually be worth less than it is now. Thus, the value of your debt “decreases” over time.
At the same time, like many other goods and services, rent increases.
During an inflationary economy or during a time of high inflation, many people are not able to buy homes so the demand for rentals increases. Increased demand leads to increased rents. That’s music to the ears of multi-family real estate investors.
Additionally, as real estate prices appreciate due to inflation. This helps rental properties owners build equity more quickly.
The value of the debt decreases and the equity increases which can lead to significant gains for both passive and active investors. As the value of the debt decreases and the equity increases, this leads to significant gains for both passive and active investors.
As you can imagine, the economy is in a very complex interplay of many different factors.
It’s hard to argue with the fact that investing in hard assets like real estate and specifically commercial real estate can be a very smart play during various different types of economies— including a high inflationary economy.
If you would like to learn more about how we help people invest to hedge against inflation, or you are interested in what kind of multifamily deals we are using to mitigate it or inflation, please schedule a call and let’s connect!