It is often said that buying a house is your best ‘hedge’ against inflation. I didn’t really understand what that meant until recently.
Inflation is the yearly increases we feel in the prices for everyday items we need or use in our daily lives. As an example, the Costco roasted chicken was one of the best values in the store at $4.99 for a whole chicken, ready to eat. I noticed a few months ago that they raised the price to $5.99 and just this past week I noticed it is now up to $6.49. That is a 30% price increase in less than a year and I’m sure you can find similar stories about other products that you buy regularly.
If inflation is kept “in check” by the Feds, it will likely be around 2.5%-3% per year and generally speaking, we all get pay raises at or above the inflation level. This helps us feel like we are not paying more for daily life as a percentage of our income. Essentially there is nothing we can do to control the prices of gasoline, cereal, or pizza — but there may be something we can do to control a big percent of our monthly expenses.
When renting a home or apartment, the monthly rent will increase according to inflation and sometimes even higher. Most of the time I see 5% per year on average and this is what we coach our investor clients to expect from their rental properties.
Lets say you rent a place for $2,000 per month. With 5% increases each year, this same place will be renting for $2,550 after 5 years — this seems believable. As for your income, lets say you make $10,000 per month now and only see 2.5% raises each year. You will be making $11,314 per month after 5 years — again, this is probably believable.
Since housing is the majority of our monthly expenses, it makes sense that if we can control the increases in our housing expenses it will provide the biggest relief as inflation increases other prices each year. This is where buying a home comes in.
It’s hard to go to your landlord and say you won’t allow them to increase your rent (but I never tried so let me know if it works for you.) But when you buy a home that is exactly what you are doing. If you use a standard loan program like a 30-year fixed mortgage or a 7/1 ARM, you are essentially locking in your payment at today’s rate for at least 7 years. So in our example, if your $2,000 per month rent was a mortgage payment instead, it would still be $2,000 per month after 5 years and the extra $550 per month would stay in your pocket.
This is why buying a home is considered a big step toward reducing your exposure to inflation since the biggest monthly expense (housing) is controlled as prices of other items continue to increase. I do believe that it takes a somewhat “long-term” viewpoint because most people won’t think that a $100 per month increase in rent is a big deal, but after 5 years, it is a big deal.
That’s how it works. Are you in control of inflation or is it controlling you?