The Inflation Interest Rate Paradox: Why You Must Continuously Invest

Inflation Is A Main Reason To Own Real EstateDon’t fight inflation. It will beat you with a stick. Ride inflation, so you can beat its ass instead.
I’m afraid there are a lot of anti-real estate people out there who are missing a crucial economic paradox that will leave them in worse financial shape when they no longer have the ability or desire to work.
It’s one thing to be against real estate because you can’t afford it or don’t know where you want to live for the next 10 years. It’s OK to be against real estate if you’ve wisely invested in stocks, bonds, and other assets classes that have a history of going up over time. It’s not OK to be against real estate if you don’t fully grasp the fundamentals or have never owned and therefore don’t see both sides of the story.

The Government And Their Economic Lies

The government likes to tell us there is little-to-no inflation. They point to the Consumer Price Index (CPI) hovering at 1-2% as proof inflation is under control. Yes, inflation has been coming down since the late 1980s, but you and I know the CPI or any other inflation index the government points to isn’t telling the whole truth.
Inflation is running MUCH higher for everything we actually spend money on: medical care, college tuition, energy, food, and housing. Sure, oil prices have declined 50% from its peak, but gas prices are still 3X what they were in 1995. Don’t you remember 90 cents a gallon? Apparently new vehicle prices have barely kept up with CPI. But when the median price of a car is now close to $34,000 according to KBB, something must be up!
See this latest price change chart for various consumer goods and services. Unless you plan not to go to college, not have kids, not get sick, not eat, and not live under a roof, you are feeling inflation at work. At least we can buy all the TVs, software, and toys we want!
Inflation Of Goods And Services
Given any adult who’s been spending money for at least 10 years can easily compare prices then to where they are now, it stands to reason government inflation and economic figures can’t be fully trusted.
So why does the government manufacture misleading economic figures? The desire for social and economic stability. The Federal Reserve’s job is to maintain a target inflation rate of 2% and help ensure maximum employment. As long as the public thinks everything will be OK, there’s a greater chance that everything will be OK. There won’t be mass hysteria or a revolution as we’ve seen all throughout history. Remember, the #1 goal for all politicians is to stay relevant and powerful.
Imagine if the government reported the true inflation rate of say 6% per annum. Producers would raise prices more aggressively. Input costs for everything would go up. Interest rates would rise. Demand would eventually drop, the stock market would collapse, unemployment would skyrocket, and the economy would eventually come to a halt.
Drastic changes in the economy over a short period of time wreak havoc. Instead, the government and the Fed tries its best to minimize boom / bust cycles by reporting more innocuous figures.
Note: If you’re wondering why the CPI can stay low despite everything that we spend money on goes up much faster than CPI, all you’ve got to do is adjust the weightings of the variables to determine CPI. For example, the government can overweight Clothing and TVs while underweighting Tuition and Medical Costs. 

How Are Consumers So Easily Confused?

After publishing Buy Real Estate As Young As You Possibly Can Possible, a reader disagreed with my truth after I just locked in a 2.375% 5/1 ARM. Here’s what I wrote,
“Despite inflation, interest rates keep coming down. This is the goldilocks scenario for all real estate investors who get to take advantage of record low mortgage rates while also raising rents.”
His response, “No. Rates keeps coming down because inflation is nowhere to be seen. Rest assured if inflation ever revives, rates will rise too.”
This reader’s response should be MUSIC to any government official’s ears because the government has successfully convinced this person to believe there is no inflation.
Rent outpacing income and inflationWhen you believe there is no inflation, you are much more amenable to paying $4+/gallon for gas, $41,000 for private school tuition, $25 for a t-shirt, $24,000 for an economy car, $12 for a salad and $3,600 for a one bedroom apartment without rioting. But just look at the national rent versus median income chart. It’s obvious rent is outpacing median income growth.
Here’s another comment I left on an ABC article on inflation, “Interest rates will only rise if the Demand for money rises. Demand for money rises when there is an acceleration in the global economy. Guess what happens in such a scenario? The value of your house also inflates at an accelerated pace as well.”
And this was one person’s response, “Interest rates rise when central banks raise interest rates. Demand has almost nothing to do with it.”
Demand has almost nothing to do with it? My head is hurting. The general public has no idea what they are talking about when it comes to economics and finance. Central banks raise their interbank lending rates to fight inflation and reduce the demand for money. Demand has everything to do with interest rates and inflation.
The market largely determines mortgage interest rates. For a deeper understanding of how the Fed can raise the Fed Funds rate, yet mortgages can still come down like they have since December 2015, please read: Should I Buy A Home In A Rising Interest Rate Environment? Explaining The Fed
Let’s say you are STILL unconvinced there is inflation. Look at my chart again and focus only on the Cost To Rent and Cost To Own columns for a house I own in San Francisco.
Rent Cost versus Ownership Mortgage Cost

Rent has risen from $5,500 in 2005 to $9,000 in 2016. Seems like a huge jump, but it’s only a 4.85% increase a year.
The putative cost to rent has gone from $5,500 to $9,000 today, an 81% increase in 11 years. Meanwhile, the cost to own has fallen from $4,800 to $3,000, a 38% decline during the same period due to mortgage refinancing as interest rates declined. What a paradox!
Despite an 81% rise in rent, why does this reader still believe there is no inflation? I refuse to believe he can’t read the chart. Therefore, the only likely reason for disbelief is due to the seemingly silent but powerful effect of compound inflation.
To get from $5,500 to $9,000 a month in rent in 11 years only requires 4.85% compound annual growth. But you can see how just a 2-3% difference above stated CPI can lead to huge numbers over time.
Compound annual growth is why saving early and investing often is important. Compound annual growth is why having an appropriate asset allocation to match your risk tolerance is also extremely important. Compound annual growth is why paying expensive fees or having revolving credit card debt can really hurt your retirement goals.
And compound annual growth is why younger readers are almost always the ones who object to my wealth target charts because they haven’t invested long enough to see compounding in action!
If the cost to own stayed flat while rents kept increasing 4.85% a year, that would be good enough for most homeowners and landlords. However, over the past 35 years, every single homeowner with at least 20% equity in their homes has been eligible to refinance and reduce their mortgage interest costs by 30%+.
Once the mortgage is paid off by 2025, the rent for this home will likely be over $10,000 a month and $8,000 after expenses into perpetuity. This is a valuable asset class that should continue to get more valuable thanks to inflation.
You can highlight how people who bought at the very top of the market in XYZ city are still underwater to help justify your reason to rent. You can say that homeownership restricts your freedom to be a vagabond job hopper. You might even convince yourself that you always “save the difference” by investing in can’t lose investments. Just know that shorting inflation by renting is a losing proposition long term. There are actually people who bought equities at the top of the market and sold at the bottom too you know.
Do not be in denial.

Heads You Win, Tails You Win

If you want to gain wealth become a price dictator, not a price taker. Here are three scenarios where a real asset owner wins:
1) Let’s say there really is no inflation as the government and the reader says. Take advantage of low interest rates and refinance your mortgage to lower your cost. Or, consider taking on cheap debt to invest or grow a business.
2) Let’s say inflation is growing at a fast rate. You can now raise rents an equal or greater amount on your rentals while making the same mortgage payment.
3) Let’s say there’s hyperinflation. Wonderful! Your real asset is hyper-inflating as well because it is part of what defines inflation. Rent is also rising like crazy. You can’t refinance because rates are higher, but at least your monthly mortgage payment still stays the same.
What about during downturns? Well of course your asset will deflate in value just like everything else. So are you really hurting since everything is relative? In a downturn, interest rates decline because investors seek the safety of bonds, allowing you to refinance. But rents are generally sticky on the way down due to one year leases and the pain of moving.
You can believe all you want that getting neutral inflation by owning your own property is a bad financial move. But there is a reason the median net worth of homeowners is 31 – 46 times greater than the median net worth of renters according to the Federal Reserve Survey Of Consumer Finances. Inflation is too powerful a force to combat.
Just don’t be a mad gambler and tie up 80%+ of your net worth in your home like the median homeowner does. Build out your net worth with multiple asset classes.

Don’t Need To Be A Genius

Thanks to inflation, you don’t need to be a real estate investing genius to do well over the long term. We will go through down-cycles. There will always be people who bought too much house at the top of the market or couldn’t hold on during a downturn. But for those who do buy within their means at an appropriate time, things will probably turn out just fine.
This exact same argument can be applied to investing in the stock market. It’s foolish to bash one investment class over another because it all depends on where you are in life, your goals, and your current financial situation. I so happen to place a large premium on living in a home where I now spend 10 – 15 hours each day.
Eventually, the US and other developing nations might turn into Japan, where interest rates go negative and more asset prices fall beyond just electronics and apparel. But today is not that day because the U.S. demographic is younger, we are more productive, and we have a hire and fire culture that allows for more rapid innovation.

Investment Recommendations

RealtyShares – If you don’t have the downpayment to buy a property or don’t want to tie up your liquidity in physical real estate, but still want real estate exposure for all the reasons I’ve written in this article, look into real estate crowdsourcing. I plan to methodically invest $5,000 – $10,000 into various real estate investment projects in higher yielding parts of the country for diversification, exposure, and less hassle. I also plan to diversify away from single family residents and into commercial properties.
Motif Investing – You can build a portfolio of up to 30 positions for only $9.95. Not only do you save on costs, you’ll work with an interface that helps you invest according to your risk tolerance. The biggest mistake I see investors make is getting too aggressive with to few positions. There are hundreds of professionally built Motifs to invest in if you don’t want to create your own. It’s free to sign up and you get up to $150 in free trading credit.