Inflation: An Upside for Investors?

Third quarter statistics for 2012, and projections for the next five years, reflect the impact of inflation on consumer life in the US. With inflation rates hovering at 2 to 3 percent, virtually everyone feels the impact of a dollar that doesn’t go as far as it used to. There’s no real upside to inflation – or is there? In the world of rental income property investing, inflation can be a very positive thing.

According to Jason Hartman, inflation redistributes wealth in numerous ways, but particularly from lenders to borrowers, and reduces the value of debt. That’s why

it’s a sounder investing strategy to keep properties refinanced rather than paying off mortgages and owning them free and clear.

It’s been said that owning real estate free and clear is the ultimate hedge against inflation because equity represents security. But within the framework of Jason Hartman’s investing strategies, debt is a tool that can be used creatively to protect an investor’s income flow from mortgaged properties and offer some safeguards against the hazards associated with equity.

Equity from properties that are completely mortgage-free is vulnerable to the effects of inflation without any of its benefits. That means that a mortgage with rates fixed for thirty years is safer than owning properties outright – the mortgage is a hedge against income loss, and inflation reduces the value of the debt itself over time.

The return on investment, or ROI, for income properties, might also be called “return on inflation.” The

ROI, so important in property investing, is derived from a set of factors including appreciation of the assets, cash flow, tax benefits and principal reduction – which is actually aided by inflation. As the value of the dollar shrinks, so too does the “real” value of a mortgage debt.

Inflation’s benefits for income property investors hinges on the difference between nominal and real value. As the value of the dollar goes down, with less buying power than before, so too does the debt it represents. As an example, under 10% inflation, a mortgage nominally worth $1 million would actually be worth $900,000 – a reduction in the value of that million-dollar mortgage of $100,000.

Combined with the ongoing income from tenant rents, which also contribute to paying down debt, inflation reduces the “value” of mortgage debt. And maintaining mortgage debt is the key to successful real estate investment, allowing investors to reap the tax and cash flow benefits of property ownership without a loss of their own assets.

Inflation touches every aspect of consumer life. For many people, the fact that a dollar doesn’t seem to buy a dollar’s worth of goods during periods of inflation means financial hardship. But for investors in income property, rising inflation rates mean a reduction in the real value of mortgage debt – a reduction in loan principal that helps to maximize the return on their investment and offer a hedge against losses. (Top image: Flickr/shawncampbell)

The American Monetary Association Team

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