Inflation: a sustained increase in the general level of prices for goods and services. In more lay terms, it means as time goes on and inflation goes up, your buying power becomes less and less with the same amount of money.
Remember in the mid-90s when 1 million ringgit Malaysia seemed like you were ready to retire for life? Fast forward to 2020 and that same amount seems like it would barely suffice for a few years. Here’s an example. In 2000, a cane of Cola you could buy with RM1, however it now it cost between RM 1.50 and RM1.60. That’s a 55% cumulative rate of inflation over 20 years. Doesn’t sound too terrible?
Let’s take a more significant item. If you were buying a house for RM 100,000.00 in 2000, in 2020 it would require RM 240,000.00 or more. Keep in mind, this doesn’t consider any appreciation that the home has acquired. It solely takes into account the spending power and value of the money that has been changed due to inflation. The question becomes, how can you fight and even profit from inflation? The answer: real estate. Here are the reasons.
Appreciating value: One of the most beneficial aspects of real estate is appreciation. On average, property values appreciate between 3% and 5% annually. To illustrate, if you buy a house for RM100,000.00, assuming an annual appreciation of 5%, you’d have a property valued at RM171,000.00 in just 10 years. Even at a more conservative 4%, the property would be valued at RM148,000. As you can see, you’ve not only kept up with inflation through real estate investments, but you’ve added value and gained appreciation with the investment.
Increasing income (rents): The awesome aspect of owning turnkey real estate investments or using a buy-and-hold strategy is the cash flow generated from tenants. Smart investments in rental properties will not only cover your monthly expenses, some rental could be cover your principal loan balance, interest, taxes and insurance (MRTA), but will also generate RM 100 - RM 200 per month in cash flow. Even better, rental properties, if managed wisely, can garner rent increases annually generating even more cash flow than your original investment. If you have a property that generates RM1,000 in rent per month, if you gave an increase of only RM 20 per year, in 10 years, you’d be receiving an additional RM 200 per month in cash flow. Granted, some expenses like taxes and insurance can increase over time as well. However, your increased rental income will help to cover those expenses, plus add additional cash flow for you. With the increasing rents, you’re fighting the inflation that may occur affecting your taxes, insurance and maintenance costs.
Depreciating debt: Just as your real estate asset is appreciating in value, your debt owed on the property is actually depreciating in value with the rate of inflation. To simplify, your $750 mortgage payment in year one is worth RM 750. However, in 10 years, with inflation, that debt is going to be worth far less. For consistency, we will use the 2009-2019 inflation rate. If your payment is worth RM 750 in 2009, by 2019, it will only be worth about RM 630 due to inflation. When you use leverage, or financing, to invest in real estate, you get to take advantage of depreciating debt. Of course, your monthly payment is the same. You will still be making that RM 750 payment per month year after year (assuming an amortized loan). But, the value of that payment will be less as time goes on.
Inflation is inevitable. It’s either a high rate, a steady rate or somewhere in between. Even in our down economy, between 2015 and 2016, the inflation rate still averaged around 2%. One of the best ways to fight inflation, and even win the game against it, is through inflation hedge investments like buy-and-hold real estate properties.
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