How Does Real Estate Fare in Inflation?

Unless you have variable rate financing inflation can be beneficial to investors. In this article we explain why this is the case.

Recurring Cost Elements

The example data below is based on a $180,000 investment property, financed with 20% down, 30 year fixed and 5% financing, property taxes 0.8%, management fee is 8%, insurance is $450/Yr. and monthly rent is $1,150. The cost components are shown in the table below along with the relative percentage of the total cost:

Cost Component Monthly Total Cost %
Debt Service 615 70%
Management 92 11%
Property Tax 129 15%
Insurance 38 4%
Total Recurring 874  

The largest cost component is debt service and is a fixed cost. Fixed cost financing is one of the biggest advantages of real estate so the payment remains constant. In most cases, the management percentage does not change while property tax and landlord insurance will rise slowly.

Inflation Effects

The following table shows the relative effects of 10 years of inflation on income and recurring costs at various inflation rates. Note that annual property tax increases are typically capped so I only increased them by 3% annually and management remains at 8% of rent.

Recurring Cost Current Values 3% 5% 7% 10%
Rent 1150 1546 1873 2262 2983
Debt service -615 -615 -615 -615 -615
Management -92 -124 -150 -181 -239
Property Tax -129 -173 -173 -173 -173
Insurance -38 -51 -62 -75 -99
Cash Flow 276 582 873 1218 1857

As you can see in the above table, rent tracks with inflation but the largest cost element, debt service, is fixed so cash flow increases. The table below shows the changing cost component percentages at the end of 10 years at various inflation rates.

Recurring Cost Current Values 3% 5% 7% 10%
Debt service 70% 64% 61% 59% 55%
Management 11% 13% 15% 17% 21%
Property Tax 15% 18% 17% 17% 15%
Insurance 4% 5% 6% 7% 9%

Inflation has additional benefits to real estate investments:

  • Since debt is fixed, you pay off the debt with inflated dollars effectively reducing the total price.
  • When inflation happens interest rates rise. As interest rates rise the affordability of homes goes down leading to more renters, which causes more demand thus further increases rents and the value of the properties.
  • As long as you buy investment real estate in a good area, all but the worst purchase mistakes will be corrected over time through appreciation, inflation and rent increases.

Summary

In this article we looked at the effects of inflation on rental income. As long as the property is in a good locations and your loan rate is fixed, your return should increase with inflation.


Want to know more about investing in Las Vegas real estate? Contact us today. You will be glad you did.

Eric Fernwood, Realtor | 702-358-8884 | EricFernwood@gmail.com
Cleo Li, Realtor | 512-296-0425 | CleoYLi@gmail.com

Vegas International Properties Group (VIP Realty Group)
7570 Norman Rockwell, Suite 140
Las Vegas NV 89143