05 May 2013
Words Tim Admin

Make Inflation Your Friend!

Inflation. We’ve all been conditioned over decades to fear it as the economic bogeyman. And with the carbon tax now in place, many are warning Australia will face an inflation spike. For accommodation operators, however, there is a way to turn this to your advantage. Inflation is the rate at which prices rise and purchasing power falls. It can be demand-driven, when the demand for goods and services exceeds their supply. Or it can be cost-driven, when businesses raise their prices to cover higher supply and production costs, in order to maintain profit levels. The latter is our current concern in relation to the carbon tax – that the tax imposed on major emitters will be passed on down the line, increasing the cost to consumers for just about everything from food to fuel, equipment to electricity. Most economists agree moderate inflation is a sign of a growing economy. Yet research shows that just about everyone else views it as harmful, something to be feared and avoided. Inflation is seen as pushing up prices ahead of wages and pensions, thus lowering standards of living. The popular media is perhaps somewhat to blame for this widely-held perception. Inflation is one of the most commonly used economic term in news bulletins. Politicians, central bankers and commentators are always being quoted on the need to keep inflation “under control”, “in check” or “within the target band”. While Australia’s current inflation rate is quite moderate, there have been numerous predictions that the introduction of the carbon tax, combined with rising wages in the resources sector and a weaker Australian dollar, will put upward pressure on inflation. Most of us are already watching prices for utilities, insurances and fuel, to name a few, climb at a frightening rate while incomes do not seem to be rising to compensate. No surprise then that financial advisers are warning us to be adequately protected or ‘hedged’ against inflation. Put simply, this means investing in assets which reduce or negate the adverse effects of inflation. Property, particularly commercial property, has long been considered a good inflation hedge. Rental rates are either linked to turnover, which rises directly with inflation, or to the Consumer Price Index (CPI). So income tends to rise along with inflation. In our industry, owners of accommodation properties and businesses are even better placed to not only keep pace with inflation, but benefit from it. Here’s how: If you have a motel of 25 units, in the recent economic environment where inflation has bumped along in the 1% - 3% range, you would be hard pressed to put tariffs up by much more than $5 a year. But, if inflation were to rise to say 6%, you could increase tariffs by double that – lifting them by $5 on 1 January, and again by $5 on 1 July. Let’s look at the impact of a tariff increase somewhere in that range – say the mid-way mark of $7.50. An extra $7.50 per unit per night at the average occupancy of 60% ($7.50 x 25 units x 365 days x 60%) equals a $41,000 increase in turnover. Of course your operating costs will rise too, at the new inflation rate of 6%. If those costs are assumed to be 40% of gross income, which is usually the case, they would rise by $16,400 ($41,000 x 40%). That means, thanks to the higher inflation rate, your profit will be $24,600 higher. Not only is that great news for your bottom line, it enhances the value of your property. An extra $24,600 per year would add $80,000 in extra value to your lease! So our message to the accommodation industry is this: don’t be afraid of inflation. Inflation builds equity. Harness it. Put it to work for you.