Inflation and Rents

I am an advocate of buying investment residential real estate, if you are in the right position.  To be in the right position, you need to have some emergency money.  If you have an unexpected repair (you should expect repairs though) or if your place goes unrented for a month or two, you need to have some extra savings to hold you over.

In addition, you should be in a good location, or at least willing to buy in a good location.  It should be in an area that is not in a steep decline.  You should also avoid areas with extremely high property taxes.

The biggest thing, when investing in residential real estate, is that you have good cash flow.  You should not invest if there is negative cash flow.  This would assume a down payment between 10 to 20 percent.  If your mortgage payment, taxes, insurance, and incidentals are more than you can collect in rent, then you should not do the deal.

Taking on a 30-year fixed rate mortgage is a good hedge against inflation.  You lock in your monthly payments and pay back the loan in depreciating money.  I think your ultimate goal should be to pay off the mortgage and own property that is debt free.  But you can take advantage of the fixed rate loans, knowing that inflation is likely.  You do have to consider that taxes and insurance are not necessarily fixed, but this should make up a smaller portion of your costs than your mortgage.

One criticism I often see with this strategy is from people saying that rents won’t increase with inflation.  I see some critics say that people will be so poor that they won’t be able to afford to pay rent.  But I don’t think these critics are thinking things through.

If there is massive inflation, then money is flooding the market.  People have a lot of money.  It is just that it doesn’t buy you much.  To take an extreme example, there are stories of Weimar Germany during the period of hyperinflation in the 1920′s, where people would take wheelbarrows full of money to the grocery store and hurry up and spend it before prices went up again.  People had money.  It just didn’t buy much.

Most people have a tendency to pay their rent.  For someone struggling to pay their bills, rent and electricity are usually the first ones paid.  They will pay credit cards and other loans last.  Even poor people understand that a landlord can evict them in a rather short period of time.  I am not talking about people who “own” houses where they don’t pay the bank and end up getting foreclosed on.  This is much different than people actually renting.

In an environment with high inflation, people will have money.  If you are renting to someone who doesn’t pay the rent, then you can evict them and find someone who will pay the rent.  If you have a house in a desirable neighborhood, you are likely to find someone who will rent it at the right price.

In a period of high inflation, rents may go down in real, inflation adjusted, terms.  In other words, if price inflation is rising at 20% per year, maybe rents will only go up by 5% or 10% per year.  But rents are likely to still go up in nominal terms.  And that is all that matters to you as a landlord.  Remember, your mortgage payment is fixed.

Let’s say that your mortgage payment is fixed at $1,000 per month.  You are collecting rent of $1,200 per month.  Inflation goes to 20%.  Your rent only rises by 10%.  The rent you are collecting increases by 10% to $1,320.  But your mortgage payment is still fixed at $1,000.  Is it a bad investment because your rent can’t be increased by 20% in tandem with price inflation?

In conclusion, inflation is actually a good reason to buy investment real estate.  It is the bust that you have to watch out for.  This is why you should buy a place with good positive cash flow and you should have the ultimate goal of paying off your mortgage.