Real Estate Makes a Great Hedge Against Inflation
Real estate is the answer to your need for a hedge against inflation. As everyone worries about what the future has in store for us in terms of our individual circumstances, and what role inflation will play, one is compelled to look deeply into the Perfect Storm. Inflation: as the impending inflation emerges and the value of the dollar decreases, how does one protect their net worth? One has to look at those things they can control and leverage, versus things we have no controls over. Inflation may be imminent and, if so, you as an individual may not have a lot of control over it. You can however, control the outcome of your personal dollars by freezing your future dollars in the current time. As inflation increases, the dollar will buy less home. Let’s take a look at this...
When you purchase a property today (for let’s say $100,000) and you put a mortgage on that property, your principal and interest payments are fixed over a 30 year mortgage. Let’s say that your 30 year mortgage payment for principal and interest is fixed at today’s interest rate of 4.5%, you would have a monthly payment of $506.60.
Now let’s fast forward 5 years. For a moment, let’s forget about all the appreciation benefits, tax benefits, etc. relating to owning property, and let’s just look at the $100,000 property purchase price used in this example. If inflation rose at the current rate of 1.7% (many expect a sharper rise), that same $100,000 home in 5 years would be priced at $110,838.61 (see inflation calculator).
If the interest rates went unchanged (highly unlikely as they are projected to rise), the same property now priced at an inflation rate of $110,838 would have a mortgage payment of $561.60. In this example, you would have leveraged your money by $6.60 per month or $739.20 per year.
Now let’s look at a more realistic example.
As inflation rises, interest rates tend to soar as well to keep up with inflation. Let’s just take a conservative look of just 1% interest rate hike over the next few years. That 100K property now valued at $110,838K with as 5.5 % interest rate would have monthly mortgage payment of $629.33. This is an increase of $122.73 per month or $1,472.76 per year.
These may be a very conservative look at what the actual inflation may do. No one knows for sure. The illustration shows, however, how you have the ability to hedge against inflation and put the inflation rate of the next 30 years locked into today’s time by executing a purchase and a mortgage with fixed rate expenses. Now, factor into the equation that the rental rates will rise with inflation, the dollars you are taking in each month, year after year will rise as well. Meanwhile your fixed expenses that are locked in time (the principal and interest) will stay frozen. This gives you further hedge against inflation.
When one factors in the normal (National average of 6%) appreciation, the tax benefits, the rising monthly cash flow, equity build up while your tenants make your mortgage payment for you, and the leverage gained by using the bank's money for 80% of the purchase price, you can easily see how you can control your dollars against inflation and why the seasoned investors are saying real estate today is the perfect storm.
Oh, and we did not even get into the abnormal low pricing today, it sort of puts a chill down your spine doesn’t it? Question, "What is a hedge against inflation?" Answer: Real estate is a great hedge against inflation!
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