Inflation is here. This is the ultimate hedge strategy.
Updated: May 29
Inflation is here.
What is inflation? It is the rate at which the price of goods and services increase over a period of time. This can also be explained as the decrease of the value of the US dollar. There are two main types of inflation:
Cost-Push: Production costs increase, like commodities and material, pushing prices of goods and services up.
Demand-Pull: More demand than supply. Too much money chasing too few goods.
In this snapshot in time in May 2021, we are experiencing a unique combination of both. People are purchasing more housing, cars, tv’s, computers, recreational toys, among other things, and the government has printed trillions of dollars. Inflation had previously been pretty steady at 3% per year up until 2020, where it is now skyrocketing. Or is it?
What is the ultimate hedge strategy against inflation?
Where are the jobs?
Have you seen the "help wanted" signs going up everywhere? The 2020 job outlook predicted 2,000,000 jobs would be filled, however, only 270,000 jobs were actually filled. Some McDonald's have been paying applicants $50 just for showing up to the interview.
Studies show people are still scared of the pandemic, some have had to stay home with their kids due to schools being closed, and businesses are competing against unemployment. The American Rescue Plan saw some folks are getting comparable income from unemployment benefits from their jobs, and simply are not rushing back to work.
Groceries prices are up. Costs trickle down... to us. Companies that have already announced price increases include: Clorox, Whirlpool, Kitchen Aid, Coca Cola, Procter & Gamble, Kimberly Clark, Pampers, Tampax, Always, Scott, Huggies, and General Mills have announced price hikes. Even coffee is going up.
Perfect storm brewing.
There is a very interesting perfect storm brewing right around us. Check out the below true statements:
Redfin recently reported the average home sale price increased to an all-time high this past year.
They also noted this is the first time on record a typical home has sold above its list price.
CoreLogic released a report showing 3.5-Million mortgages were behind, and 2.5-Million of these were over 90 days delinquent.
The federal rental moratorium did not allow for evictions due to lack of payment. A lot of landlords were not prepared, and so were not able to make their mortgage payments.
Unemployment claims continue to rise.
Businesses continue to close.
Residential construction is up 22% in the last year.
Non-residential construction is down in every major sector.
Because fiat money is not linked to commodities, cash risks losing value due to inflation
The gas is rising.
Prices at the pump have climbed dramatically in the first three months of the year, increasing more than 50 cents per gallon. Recent reports are showing that prices at the pump will average $2.78 a gallon from April to September in the U.S., more than 30% higher than last summer. Gasoline consumption from April to September will rise to 8.84 million barrels a day from 7.81 million in 2020. Consumption in 2021 will peak at 9.1 million barrels a day in August 2021.
Building supply material is called commodities. What’s driving construction costs up? What’s driving the cost of your goods to go up? Commodity costs have skyrocketed. Check out the underlying fundamental drivers:
Iron ore is up 80%
Steel is up 220%
Zinc is up 50%
Aluminum is up 50%
Freight to move the material is up 30%
Even appliances are affected. A recent survey by the National Association of Home Builders found that nearly 90% of builders had trouble getting appliances for their new homes. That’s slowing down construction and sales. Appliance shortages are just one factor causing delays. Builders also face shortages of lumber, windows and other materials, per Ali Wolf, chief economist of the research firm Zonda.
Why you should care about inflation.
We are taught to have our savings with the bank. Let’s say that savings is $10,000. For the last 10-years, calculating the inflation rates nets a 19.1% increase in inflation (per government data). This means that today, that $10,000 is actually worth 19.1% LESS, $8,090 in today's dollars. Every $1-dollar in your bank account is now worth about $.80-cents.
When you deposit your money into your bank account, it becomes a liability to that bank because they have to pay you a little bit of interest on it. In order for them to make money, the bank turns around and lends your money out to investors like me. As investors, we are then placed in fixed rate debt, also known as “Good Debt,” which means it’s invested in something that is growing in value. Our fixed rate debt is being paid off with devalued dollars.
Simply put, the fixed-rate debt that the lender gives us, the Good Debt, is actually being devalued year-over-year. It is getting cheaper for us, while we ride inflation up by getting more income from our properties because rents increase along with that inflation.
The devalued dollars are giving us investors long term fixed rate debt
Ronald Reagan once said, inflation is as bad a mugger, as frightening as an armed robber and as deadly as a hitman. It’s a hidden way to steal your money.
Who is affected by inflation.
Savers. Inflation is higher than the interest the bank is giving you.
Retirees. Their fixed income will not be cost-adjusted to future inflation rates.
Borrowers on variable rates. Interest rates will adjust to keep up with inflation.
Multifamily Real Estate. The ultimate hedge against inflation.
Inflation takes years to unravel, so I’m not sounding the crisis alarm. It is a lagging indicator. However, just like lava, if you ignore it will creep up and burn you. According to experts, the best way to hedge against inflation is by investing in assets. Simply put, investments pay you to own them. Like our apartment communities. Instead of putting your $10,000 in the bank, if you had invested it in one of these projects returning you 7% annually, you would have made 70% on your money while losing the same 19% to inflation. You net positive.
Note: this is not the same in residential real estate. This formula only applies to commercial multifamily.
Breaking down an apartment project:
As a group, we pool our down payment together to purchase a property. Call it 30%.
The bank provides 70% of the investment. They give us a 4% fixed rate in return.
As inflation creeps up, our 4% payment never changes. Fixed debt.
The rental income pays for the debt.
We receive income after all expenses are paid.
As inflation creeps up, rent prices will rise, increasing our income.
As our income increases, our property value increases.
Your investment not only just beat inflation, it is now worth more.
Watch out for the experts.
In great markets, everyone is an expert. What is driving the current stock market bull run? Demand is driving it… to me that’s not a fundamental foundation. My apartments, however, have real renters paying me real rent. The fixed debt allows me to earn my partners profit tomorrow on today money. In the meantime, the property values are increasing in value.
Good debt will be an asset.
Cash will be a liability.
Multifamily real estate will be a HEDGE.
As our income increases, our property value increases.
Disclaimer: I am not a wealth advisor nor a tax professional. I am a real estate investor.
Multifamily real estate, as a hedge, can not only be your source for wealth preservation, it be your insurance policy against inflation. That’s the ultimate hedge.
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