According to US Bureau of Labor Statistics, the US consumer price index for all urban consumers (CPI-U) in May 2008 was 4.2% higher than in May 2007 (refer to the article “Indexes Investors Should Know" for more info about CPI). In previous years, the increases were somewhat mild: 2.8% in 2007, 3.2% in 2006, 2.8% in 2005, 2.6% in 2004, 2.3% in 2003, 1.6% in 2002, and 2.8% in 2001. The average increase for the first 5 months of 2008 has been 4.06%. 4.2% increase in the CPI-U means it now costs 4.2% more to buy the same thing compared to a year ago. Another way to look at this is the same one dollar bill is now worth 4.2% less compared to a year ago. This is expected as rising fuel prices have driven significant increases in the cost of food and other basic goods and services. There is evidence that the inflation is expected to rise in foreseeable future. J. P. Morgan economist Michael Feroli predicts the consumer price index will be up at an annual rate of 5.1% in August 2008, the biggest year-over-year increase since 1991.
If you borrow to finance your real estate purchase, inflation is good for you from a real estate investment viewpoint. The same loan you borrow is actually worth 4.2% less compared to a year ago due to inflation. When the cap rate is higher than the interest rate, you get double benefits. You make a profit on the loan you borrow and also earn a 4.2% “bonus" because the loan is worth 4.2% less compared to a year ago. So it is a good idea to maximize leverage during the period of high inflation.
If you are a landlord of commercial properties then long term leases with fixed rent increases, e. g. 20 years NNN lease with 2% annual rent increase will not be in your favor. The 2% rent increase is less than the inflation so your rent is actually worth less next year. Long term leases from credit tenants like Walgreen's are the worst performers as the rent is flat. So you will have to make a difficult decision if the corporate guaranty from a good tenant is worth it when you purchase the property. Shorter leases, e. g. 3 to 5 years will give you an opportunity to increase to higher market rent when the tenants sign new leases or exercise the options. Higher rents in turn will have positive impact on the value of your properties when it's time to sell.David V. Tran is the President and Chief Investment Adviser of eFunding Inc. , a commercial real estate & loan brokerage, property management & leasing, and TIC company in San Jose, CA. His website is http://www.efundingcom.com He may be contacted at (408) 288-5500. eFunding does business in all 50 states. He is selected as Pensco Trust's (a major self-directed IRA custodian) Preferred Professional and is the #1 US commercial real estate expert author. David currently offers 3 FREE real estate investment seminars :
- How to invest in commercial real estate for retirement income NOW.
- How to maximize cash flow with 1031 tax-deferred exchange.
- TIC: Fractional ownership in high-value commercial properties.
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