Get Ready for Inflation

With the recent government aid caused by the covid-19 pandemic a massive shift is coming. The value of your money is going down. There is nothing you can do to stop it. But there may be something you can do to protect yourself from it and even make it work to your advantage.

What is inflation?

Inflation is the devolution of money. It is the expansion or inflation of the money supply. There is more money available so the value of each dollar is less. It becomes less rare. It means that the dollar has a reduced purchasing power. We see it in many forms. Did your Grandparents ever say they used to go to the movie theater for 25 cents? You could take a family of four to see a movie for $1.00. Now, even at the cheapest matinee prices, you would spend around $20.00.

When I was a young teenager in the 1990’s I could buy a concert ticket for $20 and the t-shirts sold at the concert were also $20. Have you been to a concert recently? Most are anywhere between $75-200 and the t-shirts are $50.

The cost of consumer goods increases over time. The same item costs more now than it did before. I have seen this from first hand knowledge. When I worked at Dairy Queen in the mid 1990’s a large blizzard cost $2.25. Now a small blizzard costs more than that. The same large blizzard is closer to $5.00.

Sometimes the producers of goods try to hide the cost. You may see little price increase for the product, but the product itself has shrunk. A dollar menu cheeseburger from 10 years ago was bigger than it is now.

Most recently I noticed that the width of a toilet paper roll has gone down. Instead of increasing the price of the toilet paper, they kept the cost to the consumer the same, but lowered their production cost by making each roll narrower. This has gone unnoticed for a long time. If you notice the width of a toilet paper holder, it is much wider than the roll. The width of the spindles hasn’t changed. 20-30 years ago the roll itself was almost as wide as the spindle. 

One dollar today is worth about 1/26th of what it was 100 years ago.

Inflation also affects investments. Often when dealing with investment advisors, they focus on “nominal” returns, which means “in name only”. So say you get a 10% return on your investment. That is pretty good. But it does not account for inflation. Taking away maybe 4% for inflation, your actual return is about 6%. If the returns you are seeing do not say “inflation adjusted” then you need to lower that return.

How to win against inflation

If you can’t win against inflation, since you have no control over the government printing money and their policies, do you just accept it and try to not think about it? NO! You can hedge against it and actually use it to your benefit.

How? By purchasing real estate using leveraged debt from a bank. This is actually pretty cool so pay attention. It may take some time to think about this and let it sink in.

Purchase cash producing rental real estate to take advantage of price increases, debt paydown, and better cash flow. Just like the price of the blizzard went up over time, so does real estate. Let’s say for example that you buy a $100,000 property. Over time we’ll say the price of that property went up 20%. Now you have a property valued at $120,000. Well the value of the dollar has also decreased, so are you any better off? Remember $1 bought more than it does now so the value increase could be nullified by the decreased dollar value. 

But, since you have a mortgage on that property, we’ll say $80,000, assuming you put 20% down on it when purchased. Meaning you had 20% equity. So your equity of $20k, has now gone up to $40k. That is a 100% gain in equity even though inflation went up 20%. You got a return not only on the money you put down but also on the money leveraged from the bank. If you had used less leverage, meaning put more money down, you would have had a smaller percent gain in equity. If you had $80k down and $20k borrowed and still went up to $120k value, your equity only went up by 25%.

Inflation debases your equity and debt. Having more in debt helps combat the effects of debasing equity. To benefit from inflation you need to be a borrower, not a saver. Keeping money in a bank savings account earning even 1% interest is actually losing money because it does not keep up with inflation. Inflation transfers wealth from lenders to borrowers.

Stocks vs Real Estate

With inflation, if you have $250,000 of stocks or mutual funds, you effectively have just that, $250k worth of stocks you can’t control. Inflation affects that as well. However if you have $250k in equity in a real estate portfolio, that means you likely have at least $1,000,000 worth of real estate, or about $750k in debt. But not bad debt, in cash producing assets with leveraged debt.

The bank does not ask to be paid back in inflation adjusted dollars, just nominal dollars.Those dollars lose their purchasing power over time. So with the same 4% inflation, the $750k in debt is only $720k after a year, then about $690k the year after that and so on. Remember, all the payments for the property expenses are completely covered from the rent income. The tenants are paying it for you. The inflation devalue of the debt is an automatic $30k/year benefit that most people don’t consider or even understand. This same debt debasement occurs even in your primary residence, if you have leveraged debt. That is an automatic benefit to everyone who uses leveraged debt. You don’t get that with stocks.

Inflation provides greater cash flow

Historically, rent prices are more stable than housing prices. During the 2008 housing market crash, home values plummeted. But what happend to rent prices? In some places they actually went up. Why is that? There are several factors but let’s just consider two of them. When that happened, banks got very tight and stringent on giving loans. So it became much harder to borrow. If people can’t qualify to buy a house, they have to rent. And also fear. With housing prices falling, nobody wants to buy a house that is going to go down in value. Many people preferred to wait it out and then buy once things stabilized again. This created a huge demand for rentals and therefore the rent prices went up.

At the time of this writing in 2021, the demand for rentals is skyrocketing but for different reasons than in 2008. The problem now is because of inflation. The current home prices have gone up so much that people are being priced out of being able to afford to buy a house. Banks have not changed their policies so if someone was qualified for a $150k home, they could have bought that a few years ago. But now that same $150k house is selling for $300k. But that person’s income has not gone up that dramatically and therefore is still only qualified for $150k. But there are no $150k houses to buy. This leaves that person with no other choice but to rent.

However, there are also so few houses on the market and even people who owned rentals are selling them to take advantage of the high housing prices which is forcing more renters out. And now more people than ever are looking to rent as well. When a reasonably priced house is listed for sale they have been getting 12-20 offers or more. And selling above asking. A similar situation is happening with rentals. Just a week ago I listed an apartment for rent. At first I listed it for $850/mo. Within the first 24 hours I had over 20 requests. I had to raise the rent. I could have asked for much more but I only raised it to $900. After one week I selected a qualified applicant but I had in total 1300 views, 75+ inquiries, and over a dozen applications. The reason is because there are so few rentals right now. This one unit of a fourplex.

Enhanced and increasing rental income is what helps your cashflow during a time of inflation. Let’s use that one rental unit as an example. We’ll consider it individually, not with the fourplex as a whole. The rent was previously at $800/mo. Breaking down the fourplex we’ll say the mortgage alone is $392/mo, Insurance is $33/mo and taxes are $125/mo. Maintenance is $25 and management is $80/mo. At the $800/mo level this left a cash flow of $145. We won’t include the inflation adjusted numbers for this example. But you are still getting hit with it for good and bad. 

But because of the inflationary housing prices and the increased rental demand, this same unit without doing any major upgrades now rents for $900/mo. How does that change the numbers? Everything else remains the same, the management will go up slightly since it is based on the rent. The mortgage is fixed so it will never change, the taxes and insurance may go up some over time but usually never a huge amount and it can only change once per year, for this example we’ll say a 10% increase over time due to inflation. The cashflow now becomes $218/mo. That is an increase of $73 which is a 50% increase! That by far outpaces inflation! Let’s look at that a little closer so you can visualize it.

Rent	$800	$900
Mortgage	$392	$392
Taxes	$125	$137
Insurance	$33	$36
Maintenance	$25	$27
Management	$80	$90
Cashflow	$145	$218

As you can see, over time this only gets better. With that fixed debt portion, inflation helps to increase cashflow over time. If every 3-5 years inflation caused all of the numbers to increase by 10%, your actual cashflow will continue to be multiplied by more than 10%. This is how you win at inflation and reach financial independence. This is why financially free beats being debt free. If you had no debt on this property, the cashflow percentage increases would not be as much. You would actually be worse off because you get no return from the equity. To visualize this, let’s review the above example but remove the mortgage from the list of expenses.

Rent	$800	$900
Taxes	$125	$137
Insurance	$33	$36
Maintenance	$25	$27
Management	$80	$90
Cashflow	$537	$610

It is still the same $73 increase, however, it is only a 13.6% increase to the cashflow. Only barely beating out inflation. If there were ever a period of super high inflation, you may fall behind. Having good debt helps.

Here in the United States our government tries to control inflation and deflation by printing or creating more dollars and using interest rates to control borrowing demand. We have had periods of high inflation and high deflation, but never hyperinflation as some other countries have seen. Either of those happening here would likely create worldwide panic as many countries depend on the US Dollars to support their economies. We are likely to see a steady low to moderate inflation over time. There are not many guarantees when it comes to investing, but based on the dollar value chart shown at the beginning, it is highly likely that the dollar will continue to lose value. And your best bet against a decreasing dollar is using leverage to purchase cash flowing real estate.

Inflation, Debt, and Taxes

For most people, Inflation makes it harder to get by, debt can destroy them, and increased taxes causes frustration. When you live paycheck to paycheck getting hit with any one of these, but even worse by all three, can be devastating. However, when you use them to your advantage as discussed in this post, you can win! They are tools that can create wealth if you know how to use them. Learning all of this means nothing, unless you just want to know how and why you are losing. Take Action! By knowing how to defeat inflation you can now take specific actions to use it to your advantage. Take the first step. If you are not already a real estate investor, get educated and find your first property. It will be hard in the current market but it can be done. If your market is way too expensive or competitive, look into another market or even one maybe just one hour away from where you are. Right now the tertiary markets are becoming favorable because even renters and home buyers can’t find a place where they want to live so they have to move further out to where they can afford.

Keeping your money in a savings account will lose value. This is why the well known author, Robert Kiyosaki says, “Savers are losers, and debtors are winners.” Don’t be confused now. That does not mean bad debtors are winners. Don’t go buy a $60k truck to be a debtor. Go buy a great cash-flowing real asset using leveraged low interest debt and be a WINNER!

The day of this posting is July 5th, 2021. If you haven’t already done so, go back and read my post from a year ago and decide to make today your Financial Independence Day! And click on my credit cards/travel rewards tab to learn how you can use travel rewards to take vacations without spending extra money to do it.