Real Estate Is The Best Hedge Against Inflation
Posted on February 23, 2007
Inflation has been with us for more than 50 years and there is no indication that it is not going to be with us for another 50 years. Granted, we aren’t currently experiencing runaway double digit inflation, but nonetheless it’s still with us. Inflation is like a cancer that slowly eats away at the value of our currency. Each year, as inflation creeps up, even if it’s only one or two percent, the dollar buys less than it did the year before. For this reason, it’s critically important that investments offer some protection against being slowly consumed by the inflation monster.
Real estate is a terrific hedge on inflation; in fact it may be the best hedge, because it usually increases in value at or above the inflation rate. All one has to do is look at what has happened to property values over the past five years to understand what I’m talking about. In some markets real estate values have increased at rates in excess of 10 percent per year. Let’s compare this with other options.
Assume that you have $100,000 to invest and inflation is averaging three percent per year. If you invested the money for five years in a bank CD that paid four percent interest per year, you would have to pay taxes on the earnings, and although you would have more than $100,000 at the end of five years, the money wouldn’t buy any more than what the original $100,000 would buy today. That’s the effect of inflation. If you don’t trust banks and decide to put the money under your mattress, in five years you’d have to add about $15,000 to it to buy what your $100,000 would purchase today.
Now let’s look at real estate. Assume you invested your $100,000 in a rental house instead of the bank CD. Throughout the five years you would collect many thousands of dollars in rent; most, if not all of which would be tax free, and the value of the property may have increased by 30-50 percent. In many areas, property values have doubled in the last five years.
But let’s take it a step further. Let’s assume that instead of investing the entire $100,000 in one rental house, you split it into five amounts and made 20 percent down payments of $20,000 each on five $100,000 rental houses. If purchased properly, the income from the rentals would pay the mortgage payments, all expenses and still provide you with spendable income. But the most important thing about this investment is you would gain the inflation growth on $500,000 worth of property rather than just $100,000 worth. At a five percent annual increase in value, just the appreciated value of the investments would amount to about 25 percent per year return on the cash invested and this doesn’t even count any income you might have received.
What makes real estate such a great hedge on inflation is the fact that the interest, depreciation and other expense deductions you are allowed to take when filing your tax return usually makes the income you receive tax free. Plus the increased value that comes from inflation is not taxed until the properties are sold and then only at a much lower capital gains rate. Under certain circumstances, you can even reinvest the gain and still not pay taxes on it. But, wait there’s still more! While inflation is increasing the value of the properties, it’s also increasing the rental income, which is used to make the mortgage payments. As payments are made the amount you owe goes down and your equity grows even more. Now, can you see why I say that real estate is the best hedge against inflation?
One has to ask, “With all these advantages, why isn’t everyone investing in real estate?” The answer is simple. Most people are afraid. Real estate is more complicated than and certainly not as liquid as investing in bank CDs. Plus, all the horror stories they’ve heard from friends and relatives about the things that can go wrong with real estate investments; tenants not paying rent, damaging properties and maintenance nightmares have scared them away from this most lucrative investment.
Here’s a tip! Invest in real estate as a way to build wealth, not to replace the income from you current job. Treat real estate as a long-term investment that will grow and mature over time. It’s a part time investment that you can spend as much or as little time on as you want. My Weekend Millionaire books, tapes and audio programs are focused on how to convert some of your spare time on the weekends into wealth for a lifetime. They don’t contain get-rich-quick schemes that come with high risks. In fact, you’ll find nearly as much about what not to do as you will about what to do.
I know that starting with just one small rental house, over time, ordinary working people can build portfolios of investment properties that can allow them to retire early and have higher standards of living than they could with virtually any other investment. All it takes is time, patience and a willingness to learn. Real estate investing is not rocket science and for those who apply the conservative principle contained in the Weekend Millionaire series, success is not a question of “if,” but “when.” Happy investing!
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