Why Inflation is Not All Bad News

burning-money-2113914_960_720

What is the most successful movie of all time in terms of domestic box office gross?  Titanic? Star Wars?

One of the slew of recent superhero movies? In actual dollars, the answer would be Star Wars: The Force Awakens. Released in 2015, it ended its box office run with a final domestic take of $936,662,225 – an impressive number no doubt. But no discussion about the true box office champion would be complete without discussing inflation. So why bring inflation into the mix? The rationale is that the accurate measure of a movie’s success is the number of tickets sold not the amount of money made at the box office because a ticket costs a lot more today than it did 30, 60, 80 years ago.

Factoring for inflation, you would be surprised to know that the most successful movie of all time was released nearly 80 years ago and that movie was Gone with the Wind with a total domestic box office take of $1,850,728,800, adjusted for inflation.  Adjusting for inflation, Star Wars: The Force Awakens only comes in at 11 on the all-time box office list.

Discussing inflation in the context of movie box office is an amusing exercise, but most real-life discussions of inflation are not usually this light-hearted. In fact, most discussion surrounding inflation are often cynical and downtrodden I’d like to offer a different perspective when it comes to inflation. I suggest that when discussing inflation in reasonable tones, it’s important to remember not to shoot the messenger. Inflation doesn’t have to be the enemy.

After all, it’s merely an index, not the living, breathing destructive force everyone from the public to pundits make it out to be. So what exactly does inflation measure? In simplest terms, inflation measures how much more expensive a set of goods and services has become over a certain period, usually a year. A frequent discussion surrounding inflation is how much a dollar will buy today compared to a certain point in time in the past. Obviously, a dollar had a lot more purchasing power back in 1918 vs. today in 2018.

Although the experts and pundits would argue otherwise: in economic downtimes, it’s not inflation that should be blamed for society’s woes, and it’s the underlying causes and policies that caused the inflation in the first place. Inflation is merely the messenger, telling us the underlying state of the economy. But this unfair characterization of inflation has long been held, by even top bankers, leaders, and politicians. Did you know inflation was once declared Public Enemy No. 1 by President Gerald Ford in 1974? How many politicians have stormed into office promising to battle inflation? And how many central bankers have designated themselves inflation busters?

Did you know inflation was once declared Public Enemy No. 1 by President Gerald Ford in 1974?

Against this negative backdrop, inflation has been making waves in the news lately. Earlier this month, the Bureau of Labor Statistics announced that the consumer-price index (“CPI”) increased 2.8% in the past 12 months – the fastest rate since early 2012. What is the CPI? The CPI refers to the rate at which prices for certain products have increased.

Specifically, the CPI measures the price increases for a basket of products and services – including food, gas, energy, utilities, clothes, automobiles, plus transportation and medical services — and is a widely regarded economic indicator, influencing people’s confidence in the economy and their willingness to spend. Recent Wall Street volatility has been blamed on inflation, with investors fearing the Federal Reserve will raise interest rates in response with a resulting recession on the horizon.

As an investor, the more you understand inflation, the less you’ll have to fear. In that regard, the most important thing to know about inflation is that it’s a fact of life and if recent history is any indication, inflation will generally be steady and constant. There have been periods of inflation and deflation throughout history, but in the past 50 years, we have experienced only inflation. With this knowledge, it is best to tailor your investment strategy against this backdrop of inflation. Knowledge is power and knowing that inflation will always be steady and upward, tailoring an investment strategy around rising prices can, in fact, turn inflation from foe to friend.

The biggest lesson for you, the investor, is that any investment that doesn’t keep pace with inflation is a loser in the long run. We’re talking to you, “Mr. put-your-money-under-the-mattress.” A $100 under the mattress will be worthless in 10 years than it is today because of inflation. Most savings accounts and CD’s will also not keep up with inflation. Stocks are volatile and are also not reliable for keeping up with inflation. In fact, in an economic downturn, stocks will assuredly run the other way. Therefore, the ideal investment should appreciate and produce income to stay ahead of inflation to avoid losing value over time like money under the mattress, savings, and unappreciating tangible assets.

The key to outpacing inflation can be found in plain sight in the recent government CPI report. The government identified the most significant factors for the biggest jump in CPI since 2012 as coming from an increase in the price of gas, medical care, housing, and shelter. So you would like to get in on the action in one of those fields? Investing in gas would be impractical. Where would you store it? Medical care? How do you invest in medical care? Unless you’re a doctor or have extensive experience in the medical field, this would also pose a challenge. But housing and shelter?

You mean real estate? Now that’s something anybody could invest in, and just like inflation, the value of real estate has risen reliably and consistently throughout recent history. It has had its ups and downs, but real estate has always trended upward and will always continue to do so. Real estate is the one investment that appreciates with inflation, as a matter of fact, in economic downturns, some classes of real estate such as affordable housing and rentals experience higher demand as people downsize with a shrinking economy.

Real estate has historically been one of the best ways to invest your money – along with income producing businesses. With real estate, you can build and grow your money, rather than watching it lose value. If you don’t get your money to work for you, you will be left behind. Unlike other investments, real estate is a truly essential product. People need a roof over their head and a place to call home, no matter what. Because real property is necessary, its price rises with inflation. While other investments lose value in an inflating economy, real estate assets retain or even gain value. If you invest in real estate, the rest of the investing world will experience significant losses to inflation while you will watch your investment appreciate. In fact, some real estate investments outpace inflation, making inflation a positive.

In the real estate world, appreciation is only one side of the story. With most classes of real estate, appreciation alone will protect you from inflation. But what about an investment that will cash flow even in a downturn? That would be the golden goose of inflation hedges. Well, we are here to tell you that the golden goose is not a myth. That golden goose is rental properties -providing monthly income that is independent of world news or changes in the stock market.

And just like with real estate values in general, rental prices also rise with inflation. The reason why is related to the nature of an inflating economy. In an inflating economy, the price of everything is increasing and so are worker wages. While your costs are going up, generally, so are your wages. Because worker wages are on the rise, property owners can raise their rent accordingly and not lose tenants. As a result, just like with property value, the rental income you collect as an investor will rise with inflation.

Keeping in mind that the inflation trends of the last 50 years will likely continue, your gas, food, and housing will also follow this trend, making your hard-earned cash less valuable. But the once daunting subject of inflation can now be turned into a positive if you are a smart investor. Smart investors can stay ahead of inflation by investing in real estate. And investing in the right class of real estate, like rental properties, can protect you from inflation in two ways.

First, its value will rise with inflation. Second, the rental income it creates can be raised to match inflation. These factors, together make real estate entirely inflation resistant, and even inflation-friendly in the case of affordable housing. The value and income creation of your investment will likely rise even faster than inflation, helping you thrive in an environment where others falter. In the end, inflation need not be feared. In fact, by accepting it and embracing it for what it is, you can turn the investment tables and thrive in a downturn instead of drowning.

Comments (1)

Nice write-up, Andrew… I know you’ve not yet had a chance to read my new book (barely in print), but I thought you might enjoy seeing a conclusion I draw concerning inflation as I describe my very first transaction as a real estate broker, in which I help four engineers start their new investment property business with the purchase of a 6-plex in Silicon valley, which they purchased for ~ $108,000 in 1980…Here’s what I said about inflation:

There Is another HUGE lesson In real estate Investing Illustrated here In Chapter Two:
“Time and Inflation Are NOT Your Enemy as a Real Estate Investor! ¬¬¬¬“
Suppose YOU had been the investor who decided to purchase this six-plex in 1980, and it became the first investment property in your portfolio. Today you could still own it free and clear, and the combination of time and inflation would have caused the rents to have risen from $200 per month per unit, to at least $1800.00 per month per unit, thereby increasing the gross annual income to $129,600 (which is 1.2 times what you paid for the entire building in 1980)!
Let’s assume that the operating expenses are still about 30% of the property’s current income, but the mortgage has been paid off years ago. This property is now what is often called a “cash cow” and produces a net cash flow of approximately 70% after expenses, or some $90,720/year. While we can’t be sure what the property would sell for in today’s market, a review of comparable properties listed for sale in the area indicates a market value of about $400,000/rental unit, or $2,400,000 total.
So, let’s recount what happened:
1.) YOU were the Buyer, and you initially spent $35,613.00 to acquire the property.
2.) You continued to receive (positive) cash-flow throughout your ownership period.
3.) The six units are now delivering $90,720/year in cash-flow, and their market value is about $2,400,000.00, which is your free-and-clear equity.
4.) How many similar properties do you wish you had bought over that same period?
The reason we build a portfolio of such properties is to have our money working for us to produce the lifestyle we prefer, and to allow us to have that income from our properties as long as we choose to own them, whether we continue to work or not!

…just another way to look at inflation…

Best regards

Bob Helms

Leave a comment

You must be logged in to post a comment.