Let’s say that you buy a $1 million apartment building with a $200,000 down payment. After a couple of years, say that there’s 10% total inflation. Your building just appreciated in price to $1.1 million. And you might be wondering, “How am I any better off if I have 10% more dollars but each dollar is worth 10% less? Aren’t I right back where I started?”
The answer is “no.” This is because you have an $800,000 loan on this property. The mortgage debt payments are outsourced to tenants. Your $200,000 of equity just grew to $300,000. That’s a 50% return on your equity despite 10% inflation. You just beat inflation by five times because you leveraged the bank’s loan and the tenants’ income.
In this different example, let’s say that you own a mobile home park with $1 million of debt on it. If there’s 5% annual inflation, you only owe the bank back $950,000 of inflation-adjusted dollars after year one, $900,000 after year two and so on.
See, the bank does not ask you to repay them in inflation-adjusted dollars, only nominal dollars. Nominal means “in name only.” Again, the tenant pays the mortgage principal and interest for you. You have a $50,000 annual tailwind that you’ve probably never even thought about.
In a third example, let’s say that you have a rental house with $1,000 of monthly rental income, minus a $500 mortgage payment, minus $300 in operating expenses. This means that you have $200 of passive monthly cash flow after all of your property’s expenses are paid.
With 10% inflation after a couple of years, say that your rent is then $1,100. Your mortgage payment of $500 remains fixed, and your inflation—indexed operating expenses jump up to $330. Now your residual cash flow is $270. Well, this is 35% more than the $200 that you received prior to the 10% monetary inflation.
So, despite 10% inflation, how did you achieve 35% more money in your pocket every month? This is because the property’s greatest expense, the principal and interest payment, remains fixed over time. Imagine extrapolating this powerful effect across every property in your portfolio. In my opinion, the ability to secure property with a 30-year fixed amortizing loan is remarkable; the U.S. is one of the very few nations in the world where one has this benefit.
Disclaimer: There are no implied or expressed guarantees of the above projections. Real estate investments are subject to risk and loss of capital. The above projections are based on both current and historical data, however, future performance cannot be guaranteed as markets and economies shift. Rents, property taxes, insurance, loan rates, maintenance, and vacancy costs all vary depending on micro and macro-economic factors. Buyers should perform their own due diligence to best forecast the potential performance. The interest rates above are based on today’s rates for a buyer with good credit,these rates may change. The tax savings above is based on the depreciation of the asset over 27.5 years and a taxable rate of37%. Please consult with your tax professional related to your specific tax planning.
Weinhold, Keith. “How Real Estate Investors Win The Inflation Triple Crown.” Forbes, Forbes Business Council, 13 Dec. 2021, https://www.forbes.com/sites/forbesbusinesscouncil/2021/12/13/how-real-estate-investors-win-the-inflation-triple-crown/?sh=341db90b1326.