Capitalist Hero - Financial News and Commentary
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Hedge Inflation
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Hedge Inflation...Buy a House! - by Capitalist Hero
In these days of multi-trillion dollar bailouts, stimulus rebate checks, and helicopter Ben, inflation is inevitable. We can have scholarly discussions about money supply and the velocity of money, but the fact is that we infusing trillions of dollars into the economy and we are producing less goods and services. That means big time inflation probably 12% - 20%. Inflation is great for one group...debtors.
How do you hedge against inflation if you don't have the means or sophistication to get into the commodities and precious metals market? Answer: Go into debt and buy a house! Buying a house is great hedge against inflation. I know this sounds counter intuitive as house prices continue to plummet, but it is a reasonable idea once you do the math. In order to simplify things, I will ignore property tax, maintenance cost, insurance, but I will also ignore the money you will save on rent and state income tax.
Let's say you live in Las Vegas and buy a house, that sold for $200,000 in 2006, for $125,000. You make a 20% down payment of $25,000 and get a 30 year fixed mortgage at 5%. Let's assume you are in the highest tax bracket, soon to be 39.5% thanks to Obama. Because of the mortgage interest deduction, your effective interest rate is only 3.00%. Assuming inflation averages 12% over the next 30 years, your real interest rate is -9.00% (3.00% - 12%). Furthermore, in the setting of high inflation, all real assets will have a nominal appreciation. Again assuming a 12% inflation rate and an average annual appreciation on your house of 7% , your house's annual real appreciation would be -5% (your house is losing value in real terms). Over 30 years, your total interest and principal payments are $193,256 and total tax saving of $36,840. The value of your house would be $951,532. Using the equation Net Gain = (Value of House) - (Interest and Principal Payments) - (Down Payment) + (Tax Savings), your net gain would be $770,116 ($951,532 - $193,256 - $25,000 + $36,840 = $770,116). The annualized rate of return on your $25,000 down payment is 12.1% which is slightly better than the 12% assumed annual rate of inflation.
With the purchase of a home you have a nearly perfect hedge against inflation with the added benefit of having a place to live. In this example we assumed that your house would depreciate in value 5% in real terms every year for 30 years. If you assume that your house remains even with inflation then after 30 years the value of your house would be $3,744,990 with a net gain $3,563,574. In this case, the annualized rate of return on your $25,000 down payment is 18% with a real return of 6% (18%-12% (rate of inflation)). Historically, houses have appreciated at a rate 0.7% over the level of inflation. In this scenario, after 30 years the value of your house would be $4,514,685. Your net gain would be $4,333, 269, your nominal rate of return would be 18.74%, and your real rate of turn would be 6.74%.
Housing also has other benefits as a hedge. Many states have homestead acts which protect the homeowner's equity in the case bankruptcy or lawsuit. Also, when the government is unable to sell anymore t-bills and starts foraging around for money to feed their bailouts and social programs, your house is probably the last thing they will take. I can see them confiscating your 401(k) or your business, but even the most progressive of politicians would be hard pressed to take your primary residence.
While it is true that housing has not yet bottomed, it is an excellent low risk hedge. Right now we havethe perfect storm where you can obtain a fixed 30 year mortgage at historical lows with long term hyperinflation on the horizon. It sounds cliche, but now is the buying opportunity of a lifetime.
Sponsored Links:
Hedge Inflation...Buy a House! - by Capitalist Hero
In these days of multi-trillion dollar bailouts, stimulus rebate checks, and helicopter Ben, inflation is inevitable. We can have scholarly discussions about money supply and the velocity of money, but the fact is that we infusing trillions of dollars into the economy and we are producing less goods and services. That means big time inflation probably 12% - 20%. Inflation is great for one group...debtors.
How do you hedge against inflation if you don't have the means or sophistication to get into the commodities and precious metals market? Answer: Go into debt and buy a house! Buying a house is great hedge against inflation. I know this sounds counter intuitive as house prices continue to plummet, but it is a reasonable idea once you do the math. In order to simplify things, I will ignore property tax, maintenance cost, insurance, but I will also ignore the money you will save on rent and state income tax.
Let's say you live in Las Vegas and buy a house, that sold for $200,000 in 2006, for $125,000. You make a 20% down payment of $25,000 and get a 30 year fixed mortgage at 5%. Let's assume you are in the highest tax bracket, soon to be 39.5% thanks to Obama. Because of the mortgage interest deduction, your effective interest rate is only 3.00%. Assuming inflation averages 12% over the next 30 years, your real interest rate is -9.00% (3.00% - 12%). Furthermore, in the setting of high inflation, all real assets will have a nominal appreciation. Again assuming a 12% inflation rate and an average annual appreciation on your house of 7% , your house's annual real appreciation would be -5% (your house is losing value in real terms). Over 30 years, your total interest and principal payments are $193,256 and total tax saving of $36,840. The value of your house would be $951,532. Using the equation Net Gain = (Value of House) - (Interest and Principal Payments) - (Down Payment) + (Tax Savings), your net gain would be $770,116 ($951,532 - $193,256 - $25,000 + $36,840 = $770,116). The annualized rate of return on your $25,000 down payment is 12.1% which is slightly better than the 12% assumed annual rate of inflation.
With the purchase of a home you have a nearly perfect hedge against inflation with the added benefit of having a place to live. In this example we assumed that your house would depreciate in value 5% in real terms every year for 30 years. If you assume that your house remains even with inflation then after 30 years the value of your house would be $3,744,990 with a net gain $3,563,574. In this case, the annualized rate of return on your $25,000 down payment is 18% with a real return of 6% (18%-12% (rate of inflation)). Historically, houses have appreciated at a rate 0.7% over the level of inflation. In this scenario, after 30 years the value of your house would be $4,514,685. Your net gain would be $4,333, 269, your nominal rate of return would be 18.74%, and your real rate of turn would be 6.74%.
Housing also has other benefits as a hedge. Many states have homestead acts which protect the homeowner's equity in the case bankruptcy or lawsuit. Also, when the government is unable to sell anymore t-bills and starts foraging around for money to feed their bailouts and social programs, your house is probably the last thing they will take. I can see them confiscating your 401(k) or your business, but even the most progressive of politicians would be hard pressed to take your primary residence.
While it is true that housing has not yet bottomed, it is an excellent low risk hedge. Right now we havethe perfect storm where you can obtain a fixed 30 year mortgage at historical lows with long term hyperinflation on the horizon. It sounds cliche, but now is the buying opportunity of a lifetime.
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