We have talked in the past about the importance of investing in real estate to protect your wealth from inflation. With another 8.3% annualized inflation clocked for September, let’s revisit the perils of inflation using a simple metaphor — the price of a cup of coffee.
How Inflation Erodes Purchasing Power
Let’s say the average cost of a cup of coffee at Starbucks is $5. If inflation averages 8% over the next 2 years, two years from now, that same cup of coffee will cost $5.83.
Boo hoo, right? Maybe you’ll have gotten a raise, or tightened your belt, or won the lottery, or moved to South America, and you’ve been meaning to cut back on caffeine anyway. Why worry?
Let’s apply the cup of coffee metaphor to your wealth and net worth…
You have $25,000. How many cups of coffee can you afford today? 5,000 cups of coffee at $5 a cup.
Let’s say you decide to keep that $25,000 in the bank, how many cups of coffee can you afford two years from now? Only 4,288 cups of coffee. 712 fewer cups of coffee in 2 years! The same amount of money buys less coffee. Effectively, you’re a lot poorer than you were two years ago. The solution and your goal should be to invest your money to outpace inflation.
Chasing After Yield
Let’s say you invest in a security that has a 9% yield, which is an average stock market return. In two years, your $25,000 is worth $29,700.
How many cups of coffee can you buy then? You have enough for 5,094 coffees at $5.83 a cup. The challenge here is to consistently achieve high returns. Can you achieve 9% return on your investment every year?
The Power of Real Estate
Here’s the amazing thing about real estate investing in times of inflation — it causes asset values to increase, but it causes the value of debt to decrease. After all, that debt is measured in dollars, which has lost purchasing power at a rate of 8% per year!
Let’s say you use your $25,000 to purchase a real estate rental property worth $100,000. You pay $5,000 in closing costs, put $20,000 as down payment, and get a $80,000 mortgage.
If this property appreciates at a modest 2% a year, your property is worth $104,000 two years from now. During that same period the property was rented out. The rent you collected paid for your mortgage, taxes, insurance and property management fees, AND over 2 years, you generated $6,000 in positive cash flow. On top of that, the rent also reduced the amount of your loan to $78,500 (you paid down $1,500.)
Now, how much is your investment worth? At the end of two years your $25,000 investment is worth $32,500.
How many Starbucks can you afford now? Over 5,574! 480 more cups of caffeine than the stock market investment. In a very short two year period, you increased your purchasing power significantly, whereas in the first two examples (stashing cash and a 9% stock market investment) you either lost purchasing power or barely maintained it by taking significant risks.
And guess what — it gets even more excitingly dramatic as you increase the investment period. The most positive results are possible through appreciation and leverage.
If you know it’s time to get serious about inflation, reach out to MartelTurnkey today. We have cash-flowing, fully-renovated homes ready to go for investors. Protect your wealth the wise way. And as a bonus, our cash flow spreadsheets include 10 year projections too.