Real Estate as an Inflation Hedge

by Mr. Cheap

I’m not very passionate about asset allocation yet (although I know its an important area I need to educate myself about). The one aspect I have considered is the impact of inflation on savings. Back when interests rates were running at 10-12% (in the early 80’s), people were happy, but what they were foolishly ignoring was that they were being heavily taxed on this (treated as full income) and inflation was knocking it down further.

The funny thing is, and I realized this shortly after buying my condo, is that when you’re in debt inflation is a great thing. My mortgage is currently in the low $90K, and if 90K is worth less then it was in the past, that makes my mortgage easier to pay off. Inflation will drive up what I’m able to collect for rent, while making the mortgage easier to pay (increasing the cash flow).

If your salary was going to double, but the cost of everything would also double, is this a good thing or a bad thing? Ignoring taxes and whatnot, it obviously wouldn’t make a difference if you had no savings or debt. If you have savings, it would effectively cut them in half (since the price of everything has doubled). If you have debts, it would also cut them in half (since you’d be making double the salary). In a nutshell, this is the effect of inflation.

High interest apparently can hammer the stock market, and as it leads to inflation, it would also make dividend payments less valuable. Apparently inflation hurts most businesses, as people have less money and they buy less from them (which prevents them from increasing their dividend).

In “The Intelligent Investor” (which I’m reading right now), they recommend REIT’s as an inflation hedge, clearly owning real property works in pretty much the same manner (you’re just accepting increased volatility since your personal holdings will clearly be less diversified than even the smallest REIT. The one thing I don’t like about REIT’s is that they’re so easy to abuse – the people running it can easily get kick-backs from people doing work on the properties and steal from shareholders). Gold is also popular as an inflation hedge (basically any time you put money into stuff), but its apparently far more speculative then real estate (sometimes goes up a huge amount, and sometimes doesn’t move much for years). I’d also be afraid with gold that a cheap way to produce it will appear (similar to artificial diamonds) and that would wipe out their value (this seems less likely to happen to land and living spaces).

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