The principal “arbitrage” opportunity in real estate is realized by locking in a fixed cost of borrowing (which can be re-financed in the future if interest rates drop) and generating cash flow to cover your costs. In this situation, you have a very limited downside risk because of recurring cash flows, but a tremendous opportunity for leveraged appreciation from market growth and inflation.
The importance of this phenomenon is that future growth in value is very difficult to predict. By investing in a manner such that your costs are covered by income from the asset, you have the luxury of “waiting out the storm” during times of price volatility for values to increase.
In addition to this, there is a significant opportunity to directly benefit from inflation that results from irresponsible government spending policies. This opportunity comes from the fixed-rate financing that is frequently used to finance real estate deals.
As the impact of inflation ripples through the economy, it will push up interest rates, rents, and prices for homes, stocks, food, and commodities. However, the payment on your mortgage will stay flat if it is a fixed-rate product.
Because of this, you will experience an increase in the rental income and value of your real estate asset, but the largest portion of your expenses will remain flat, resulting in higher profits. Thus, inflation becomes a very real way to capture tangible profits from government irresponsibility. Situations such as prudent real estate investing with a small to negligible downside and significant to infinite upside are what economists call a “free option” . . . principally because the investment volatility runs mostly in the “up” direction due to the downside risk mitigation. Needless to say, these are the investments that we would like to create.