23) Get Paid to Invest
As inflation has been increasing, the Feds start tightening the money supply but increasing interest rates. Effectively, this leads to less borrowing and should start reducing the demand for money. As the demand for money declines, inflation will start decreasing as the Feds predicted and as history has shown many, many times in the past.
So why is it good to purchase assets in an inflationary environment? Obviously as interest rates go up, the cost of borrowing increases, causing a hit on the net operating income and reducing cash flow. Theoretically, it’s not a good idea to purchase any assets right now. Or is it?
In order to understand this, you need to understand the difference between nominal interest rates and real interest rates. The nominal rate is the rate published by the Feds and what your borrowing is based on, which is currently 4.25-4.50%. The real interest rate, however, is the inflation adjusted rate. If inflation is 8%, you take the nominal rate of 4.5%-8%=-3.5%. This means that the Federal government is paying you to borrow money for investments! Mind you, this only works with investments and not purchasing depreciating cars or taking vacations.
Let’s take a closer look at an example. As a result of inflation, the Feds increased interest rates so demand for investment property has decreased. In the case of multifamily properties, prices have gone down 10%-15%. And that’s because nominal interest rates are higher. A higher rate will decrease the Net Operating Income (NOI) which decreases the value of the property.
Rents are going up as a result of inflation. If rents increase by 8% per year (in line with inflation) and the interest rate on your property is fixed, you may have lower cash flow in the first year, but in the consecutive years, your cash flow will increase assuming rents grow in line with inflation. So if you borrowed at 5.5% and inflation is at 8%, you’re still coming out 2.5% ahead, as long as the nominal interest rate is lower than inflation.
Inflation shifts wealth from savers to borrowers. As the cost of things go up, the value of the dollar goes down. If inflation remains at 8%, then the cost of properties, goods and services will increase 216% in 10 years.