With the world slowly awakening from the coronavirus pandemic, the markets have become bullish. This is great news for investors, but one potential downside of the booming stock market is the increase in inflation rates being recorded in many countries.
For people looking to borrow to invest, this could appear to be a double-edged sword. On one hand, the value of their asset is likely to rise. On the other hand, governments and central banks may be forced to increase interest rates, pushing up the repayments due on their loans and mortgages.
In this article, we look at whether credit-financed real estate investments in times of inflation are a safe bet.
Inflation and how it can affect investments
Inflation is the sustained increase in commodities and goods prices. For the average person in the street, this means that as times rolls on and inflation increases your buying power decreases with the same amount of money.
For example, an item that you could purchase for £100 in 1996 will cost you somewhere around £170 in today’s money. Over the period, this equates to a 70% cumulative rate of inflation over 25 years.
For traditional investments, this cumulative inflation can negate any gains. Consider someone starting a retirement account in 1991 with a £50,000 pension in mind. Thirty years on and
with a cumulative inflation rate of 109% over the thirty years, they would now need £104,500.
Can real estate investment beat inflation?
Real estate investments are often considered “Inflation Hedge Investments”. These are typically assets that are anticipated to increase in value over time, or in the worst-case scenario, at least maintain their value.
Borrowing capital to invest in real estate can be broken down into three aspects that can help defeat inflation.
Appreciating Value – The property market can be volatile and can be subject to periods of deflation. However, if you consider the UK market as an example and with a longer-term view, over the last ten years property values have increased over 38% in the past decade and tripled over the past twenty years.
In effect, this means that a property purchased for £500,000 in 2011 now has a market value of £690,000.
Increasing Income from Rents – Rents paid by tenants in investment properties are also subject to inflation. If handled correctly these rents can be used to both offset the cost of your borrowing and bring in additional cash flow.
As an example, if you own a property that brings in £1,000 per month in rent and increase the rent by £25 annually, after ten years you will be receiving an additional £250 per month in rental payments. Much of this increase can be used to offset inflation costs on items like property maintenance and taxes.
Debit Depreciation – As your property increases in value, your debt can be heading in the other direction. Depending on the type of loan you took out, after ten years the money you pay each month is depreciating at the rate of inflation.
Credit-financed investments in real estate, if done correctly, can be successfully used to defeat inflation.
Connect with MaindlVentures to get the most out of your investment and save your money from inflation.