The Australian Bureau of Statistics (ABS) this week confirmed that Australia is experiencing its highest rate of inflation since June 2001.
Inflation is a term used to measure the increase in the cost of goods and services.
The rate of inflation in Australia is 5.1 per cent today, meaning the cost of goods and services today is 5.1 per cent higher than the same time last year.
But you probably already knew that!
The spike to inflation was headlined by costs of transport (up 13.7 per cent), housing (up 6.7 per cent) and household furnishings and equipment (up 4.9 per cent).
Makes sense, given that things like petrol, timber and couches are primarily imported from overseas.
We’ve got a war going on in Ukraine which is impacting fuel supplies from Russia, we’re still dealing with the pandemic (China is still locking down entire cities) and we have just dealt with a one in one-hundred-year flood event.
As a result, inflation is being driven by supply challenges, rather than a surge in demand from us, the consumers.
It’s for this reason that the Reserve Bank of Australia (RBA) prefer to use a different measure for inflation called ‘underlying inflation’.
Underlying inflation is essentially the inflation number, if you removed the outliers affected by unusual events like wars, pandemics, and floods.
Underlying inflation today is 3.7 per cent. Which is still high – in fact, highest Australia has seen since March 2009 – and higher than the RBA’s target range of 2 per cent to 3 per cent.
It’s lead to the RBA increasing rates for the first time in 11 years.
I dealt with that in last week’s blog; if interest rates increase, it will be because the RBA is comfortable with wages increasing, too.
The RBA cash rate today is 0.35 per cent.
The 10-year average is 1.6 per cent and the 20-year average is 3.4 per cent. Interest rates have to go up at some point.
Here’s the biggest reason I’m not worried about inflation (or interest rates increasing): rents.
Over the past 50 years, rents have increased at a rate of 2 per cent above inflation.
It doesn’t matter how far you go back; how high or low inflation was; rents have increased by a rate of 2 per cent above inflation.
The rental vacancy rate in Australia today is 1 per cent – the lowest it’s been since 2006 – well below the 2 to 3 per cent that is considered a balanced market.
Rents are up, on average, by 8 per cent across Australia over the past 12 months. (Technically, that puts rents up by 3 per cent above inflation).
We’ve got a rental crisis in Australia.
The vacancy rate is 1 per cent and we’re about to increase net overseas migration to 200,000 people per annum. That will require another 70,000 new rentals to be built each year, and we’ve only built 70,000 new rental properties in the entire time since the pandemic started (over 2 years).
It’s hard not to see rents increasing faster than inflation for some time to come.
As I wrote in Bulletproof Investing, you can’t remove risk when it comes to investing, you just have to manage the risk.
The biggest risk when it comes to any investment is cash flow. We don’t have any control over interest costs. But we have a lot of control over the rent we collect to pay for that interest.
Getting properties in areas with strong population growth, proximity to jobs and infrastructure investment are ways to manage that risk. Population growth creates demand for housing, people need jobs and infrastructure makes population growth sustainable.
Another way is to ensure the property can be rented for 30 per cent of the median weekly household income in the area you’re buying.
For example, if the median weekly household income for an area is $1,600 per week, you want to make sure the rent you’re seeking to charge on the property you are buying is no more than $480 per week (which is 30 per cent of $1,600 per week).
This ensures your property is affordable to people in the area. The typical household can afford to put 30 per cent of their income towards rent.
Finally, you want to ensure the rent grows over time. For this, you can look at the average age of people in the area you are buying in.
That number should be below the age of 35, and more than a third (higher the better) of people in the area should be between the ages of 25 to 45. Reason being is this is the demographic whose income grows fastest. As your tenants’ income increases, so too will your rent.
Inflation and interest rates are beyond our control, how we manage them as risks to our personal finances is something we can control.