Your property might never appreciate in value.
Yet at the same time, this property can increase your affluence, even if it provides zero income or tax efficiency.
All else equal, how could that be true? It’s because you are confusing appreciation with inflation.
Inflation is the rate at which the purchasing power of your dollar, yen, euro, or peso declines annually.
If you bought your $100,000 property a year ago and now it’s worth $103,000, it appears to have appreciated $3,000.
You might even tell others, “It went up in value.” But if the rate of inflation was also 3%, then its price changed but its value remained the same.
Now your home fetches 3% more dollars, but each one is worth 3% less.
This reflects 3% inflation, not appreciation.
Therefore, everything else being equal, it appears that you have a “wash”.
Here’s the twist. Say that you put a 25% down payment on the property at purchase. Your “skin in the game”, or equity, was $25,000.
Now it’s $28,000.
That’s a 12% return on your equity, or $3K / $25K.
Note: Don’t confuse Return On Equity with Return From Equity, which is always zero.
Rather than treading financial water, now you’re more affluent.
Because you have a loan on the property, you just 4x’ed inflation!
No one will trade away more of their prosperity to buy it from you. They’ll merely offer you more dollars.
Then what exactly led to your greater affluence? The $75,000 that you’ve borrowed from the bank helped you leverage inflation (25% down, 4:1 leverage). You did not leverage any appreciation.
In this simplified example, your property became no more valuable. It merely took more dollars to buy it.
Price and value are not the same. Warren Buffett said, “Price is what you pay. Value is what you get.”
“What you get” didn’t change. Last year, your home slept three people, had two bathrooms, a yard that’s too steep for wiffle ball, and a built-in microwave, just like it did this year.
Your property didn’t become any more valuable to society. It is not any closer to employment centers. Its utility didn’t change. Its intrinsic value remained stable.
It is not worth any more in “real” dollars, only 3% more “nominal” dollars. Nominal means “in name only”.
The good news is that if you have a loan, you don’t ever need your property to appreciate at all in order to make you more prosperous.
Note: Inflation erodes away your loan debt at the same time.
Think about this instead: if it takes 8% more dollars to buy your property next year, it might be 5% appreciation and 3% inflation. Because inflation is local and complex, you won’t actually know.
Here’s hoping that these simple examples better help you understand the often-overlooked difference between inflation and appreciation.
When you have a loan on your property, inflation is your friend.
I discuss this and other groundbreaking wealth tactics on the Get Rich Education podcast. Don’t know how to listen to podcasts? Grab our free Get Rich Education app.
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