1249: Compound Interest, Understanding Home Prices & Mortgage Payments in Real Dollars

I really need to thank you and Sarah for being there for me. You guys could have easily said, this isn't my problem, this is your problem. Your lack of due diligence is entirely your fault and not done anything at all. But you guys have been there for me every step of the way. You responded on Voxer at 3:42 in the morning. I know it might have been 6:42 depending on where you were, but honestly, who works at that time? So just the fact that you guys were there for me, I appreciate it so much.

Welcome to the Creating wealth show with Jason Hartman. You're about to learn a new slant on investing, some exciting techniques and fresh new approaches to the world's most historically proven asset class that will enable you to create more wealth and freedom than you ever thought possible. Jason is a genuine, self made multimillionaire who's actually been there and done it.

He's.

She's a successful investor, lender, developer and entrepreneur who's owned properties in 11 states, had hundreds of tenants and been involved in thousands of real estate transactions. This program will help you follow in Jason's footsteps on the road to your financial Independence Day. You really can do it. And now here's your host, Jason Hartman with the complete solution for real estate investors.

Welcome to episode 1249. 1249? Yes. That means 1250 is tomorrow and of course that is a 10th episode show where we talk about something of general interest that is not necessarily but sometimes is related to investing in the most historically proven asset class in the entire world. And that is of course income property. We will have that for you tomorrow. But today we have our in house economist back on to discuss a project I had him do a while ago. I asked him to do this last year right before our Profits in Paradise event in Hawaii. And by the way, of course that event will be coming up again. We are going to host that this year in Orlando. We had to make a change from Fort Lauderdale, still paradise nonetheless because we had a little change with our Cuba cruise and the Feds shutting down cruise ships going to Cuba. So now we are of course going on a cruise, fall foliage cruise, something I've always wanted to do. I absolutely feel so, so inspired. In the fall you've got that cool crisp air, the leaves changing. Of course we don't get that where I live in Florida. We didn't get that in Arizona or California much either. But we certainly will have that on our October fall foliage cruise. Well, you know, it depends a little bit on nature, but I think the timing Looks good. You know, they can actually chart the fall foliage. There are websites of course that do this and so join us for that Jason hartman.com Cruise but anyway, back to Thomas. That was a little tangent, wasn't it? Back to Thomas and our in house economist and the project. So right before our profits in paradise event last year I asked him to do a research project and it's quite fascinating. We'll share that with you today. But first I want to talk to you about home price appreciation for a moment. And of course you understand as a regular listener as I've talked about over the last 14, 15 years on this show, how income property is such a wonderful multi dimensional asset class, you don't earn those returns from just appreciation, just cash flow. It's multi dimensional. There are many ways in which you earn those returns and one of them of course is appreciation. And we look at this as kind of the icing on the cake. But hey, that icing can be pretty great sometimes. Einstein called compound interest the eighth wonder of the world. And appreciation works just like compound interest. And this works against debtors and for creditors. However, when you're a debtor on an income property with a good long term fixed rate investment grade mortgage, of course you know, there are huge benefits to that, benefits that I use my trademark phrase inflation induced debt destruction to describe. But on the appreciation side, it compounds also. And so that can be very significant compounding. And I'm just going to go through a little example for you. This is that I think will be interesting on the opposite side of it. I purchased a mortgage note. I purchased a loan once and this was many years ago. And the borrowers after they took out the loan got the money, I guess spent the money, they paid their lender for a little while, then their lender sold that loan to me. They paid me for a little while and then they just stopped paying for many, many years. And their interest rate compounded because they just didn't pay year after year after year. And the Great Recession happened and the equity dissipated and then the equity came back and I remember I contacted them once and I said, hey, are you going to start paying on this loan again? You know, you can easily refinance now and take care of paying me off or just at least making the payments. And you know, as typical, they made a bunch of excuses and never paid. So then I started the foreclosure process and then they sued to stop the foreclosure. And this is yet to be determined and I'll let you know. Of course what happens with it. But I sure hope I get paid because they owe me about three times what they originally borrowed because they haven't made a payment in maybe, I don't know, what is it now, a decade? This is absolutely ridiculous. I could have made a lot more money with that money had they paid me or paid me off. But this is the way it goes. And thus the perils of being a lender. I do not like being a lender very much. Although I do it, it's okay. It's my second choice income property being my first choice. Owning the actual physical asset because it has the multidimensional characteristics is really the better deal. So here's the example on appreciation. Let's take a $400,000 portfolio. So say you four $100,000 properties@jason hartman.com clicking on the properties section. Of course. Actually, nowadays there's so little available on our website, you really have to be working with one of our investment counselors to source a property. So just reach out through jasonhartman.com get one of our investment counselors working for you and notifying you the moment a good property comes up. And also be sure to subscribe to our propertycast, that is a podcast with property performance. So check that out. You can subscribe on all the podcast platforms. Just type in Jason Hartman propertycast and you'll find that that was a little invention of my own. Kind of a neat idea. No one had really ever done that before, at least not that I ever noticed. So check out the property cast as well to be informed of the latest and greatest income properties. Okay, so you've got this $400,000 portfolio. And let's just take an example. Say that it appreciates at a rate of 5% annually. Now, of course, there are ups and downs. That's a projection. Could be better, could be worse, who knows? But let's just take 5% as the local appreciation rate on each of those four properties. That means it'll appreciate $20,000 in the first year. So you take your $20,000 in appreciation, 5% of 400,000, you add it to the base, which is 400,000, the portfolio value, and now your portfolio is worth 420,000 at the end of the first year. But then it compounds because now you're taking that $420,000 number and you're compounding it in year two at 5%. So you get an extra thousand dollars. Right. Instead of just getting $20,000 in appreciation, you get 21,000. Now your portfolio value is 441,000. You go into year three with 441,000 as your principal balance, if you will, 5%. And now you get another thousand and fifty dollars in extra appreciation. So you get 22,050 bucks plus your $441,000 base, and now you're at 463,000. Hey, it's only been three years. It's only been three years. And remember, hopefully you've leveraged this portfolio. So these are leveraged returns. We're not even talking about the beauty of that. We're just talking about the base, the simplistic appreciation. So now you go into year four, and instead of having $400,000 that you started out with three years earlier, you're starting year four off with $463,050. Take that up 5%. And instead of getting the $20,000 you got the first year in appreciation, you're now getting $3,153 extra. Okay, for 23,153. Add that to your new base that you started year four with of $463,050 and you're now up to $486,203. You start year five with that amount as your base, your sort of principal balance, if you will. Sort of saying that because it's kind of, I'm likening it to a loan balance, right? Or a investment in, in a fund or the stock market or something. That's your principal balance. So now you're at 486,000 in portfolio value, 486,202 to be exact, goes up 5%. And this year you're going to make $24,310. Of course, we're not including cash flow, tax benefits, we're not including inflation induced debt destruction or anything in this. This is just apprec. One dimension, just one dimension of the portfolio. So you've got $4,310 extra this year from the starting, right? Because instead of $20,000 in appreciation, you got 24,310. Add that to your new higher principal balance, your portfolio value of 486,203, and you've got $510,513, $510,513. You're $110,513 above the original portfolio value in only five years. And this is only one dimension, one beautiful dimension of income properties at a 5% appreciation rate, which, you know, look at the historical numbers, depends how you look, what survey you look at probably pretty darn achievable. Okay, so income property is the most historically proven asset class in the world. Go to jasonhartman.com to find out more. And but wait, there is more because you're going to hear another amazing thing in this segment with Thomas. So let's jump over to that right now.

We wanted to do a little segment to help you understand the reality of home prices and to help you see how you are constantly being misled. Yes, misled by the thought leaders, the media, the vast stock market conspiracy, whatever you want to call it. And this is a study in, you know, a recession prediction and home prices. So we're going to dive into that today. I've got Thomas, our in house economist on board with us. Thomas, welcome back.

Yeah, good to be with you.

So you had picked out a video to tee up this discussion and it's a good one. I saw this video a few months ago and interestingly, you pick the same one. And in watching it again, I realized just how misleading the renowned Nobel prize winning economist Robert Shiller Case Shiller Index, you definitely heard his name. How misleading he is. Robert, come on the show, let's talk about this because I don't know that you mean to mislead people, but you know, there's just a lot to this discussion you didn't mention. So I'm going to let you talk first and then we'll talk about it. Okay, here's the video. A portion of it.

The nominal home prices according to the s and P CoreLogic case Shiller index that I've been talking about is essentially at a record high if you don't correct for inflation. And if you do correct for inflation, it's not a record high, but it's, it's pretty high. It's gone up since 2012 at a good pace. I counted as the third largest expansion of home prices since 1890 late last year.

So you've got this graph that he's showing and basically it's just the chart with the prices going up. Right. You know, no surprise. I'm sure all of you know that we all agree how that's happened, but he's using that to say that we are on the verge of a recession because of this. And that may be true anyway, but this isn't the reason, that's all I'm saying. Because, and we're gonna, we're gonna dive into that in a moment.

We got a lot of attention in the news media to the idea that we're in the longest bull market ever. We've had the longest period of near zero interest rate. Well, they're not quite near zero. They're still on the low side. According to the National Bureau of Economic Research, we will have set a record for the length of an expansion if there isn't a recession by June of this year. So all those things together suggest to me that a lot of people are.

And it's now almost August. Just for the record, there are thinking.

That this is getting late in the stages of a boom and you know, if history repeats, we're in for a good chance of another recession.

Recessions are hard to predict until they're upon you. Remember, we're trying to predict human behavior and humans thrive on surprising us, surprising each other. And things have happened like the election of Donald Trump. Nobody thought that would happen back in 2015, but here it is, we've got them. And the same kinds of things can happen again. Just like wildfires in California appeared, we had a really bad year on that. That's just another example of surprises in history. But the problem is that we tend to magnify them. We may read into the California wildfires, for example, more than is justified.

I don't even know what he's talking about with the wildfires. What does that have to do with the price of tea in China? Thomas, any thoughts on the wildfire connection?

Yeah, that's probably just the first thing that came to mind. I don't. Wildfires aren't connected with a whole lot of economic impact stuff, you know, I.

Mean, is he getting a little senile? I don't. That just. That just doesn't have a connection that I can quite see. But whatever. Anyway, Thomas, when we first brought you on board, I had asked you to do a study and you did it. And we still haven't even talked about it. In fact, we were going to talk about this when you spoke at our Profits in Paradise event last November in Hawaii. We didn't get time. So let's just talk about it now. What I asked you to do is a little research project and you're great at this stuff. I asked you to look at the first home that I bought for myself. This was on at 147 Remington street in Irvine, California. Now, I had purchased a couple years before that my first rental property. I bought my first rental property when I was 20. Then I bought this condo for myself. And that's when I moved out of mom's house and, you know, moved into a home that I owned. And I already owned one rental property plus the home I owned that I moved into. Right. So that was pretty cool. Not, not a common occurrence. And now for the past six years or so, or actually eight years, I've been telling people, hey, if you get a higher end home, it's a better deal to rent it. So isn't it interesting how our views change? I never would have thought that back then. So here's the thing. When you remember what I've said, often, listeners, people don't buy a house on the price. They buy it on the payment. So when you look back and you look at that first property that I moved into and you look at the price of that property, it's appreciated very, very nicely over the many years. However, the mortgage payment, when you take the actual mortgage payment, the monthly payment, that's really the price people are paying for a house they buy on a payment, not the price. When you take the mortgage payment on that house and you adjust it for the official rate of inflation. Thomas, we're in for some big revelations here, aren't we, listeners? Are you ready? Are you listening? This is significant. Tell us about it.

Well, you set it up. I wish I had. I wish I could come in with a big bang. Remington, so 147. Remington, 1987. The mortgage payment on that would have been around 800 bucks per month.

If you look at the end of 2018, it was around 1200 bucks. On an inflation adjusted basis. If you go back to 1989, it was around 1100. So 100 bucks more today than it was in 1989.

Now, now hang on though a second. What if you look at the sales prices along the way, now what we'll see that property's changed hands many. So it was first purchased for $102,000 and then it was sold for $160,000. I'm rounding slightly. I don't think it was exactly 160, but like 159 and change. And then today, how much is it worth? About 460,000 or something like that.

Yeah, almost 500,000.

Okay. All right. And keep in mind, listeners, this is a little 944 square foot, two bedroom, two bath condo. Okay? So amazingly, amazingly, today, the inflation adjusted mortgage payment on that property, or you may not have the today number, Thomas, but at the end of 2018, you tell us which number you have, and let's compare it to what it would have been back when it was new, back when it was sold for 160,000. Just looking at this property and trying to really determine if it's overpriced or underpriced or reasonably priced today. I mean, we must look at the monthly cost, not just the overall cost, because very few people buy a house with cash, especially first time buyers.

Tell us those numbers in 1989. 1100 bucks in today's dollars. And you know, if you take the end of 2018, then we're at 1200 bucks. The average 2018 mortgage rate was 4.5%. You take that down to today's mortgage.

Rate, it's even lower.

Yeah. So the, the actual monthly mortgage payment is lower than what it was in 1989.

Did you all really catch that? That is truly amazing. Now, let me tell you what's even more amazing about it. That's only based on the official inflation numbers. I'm sure everybody listening agrees with me and agrees with you, Thomas, that the official numbers are understated. So if you were to calculate, and this is what we should do to get an even more realistic view of it. So, Thomas, that's your homework. Your mission, should you decide to accept it, is to pick an unofficial but realistic rate of inflation and calculate these numbers based on that. And I bet you can do this with many houses across the country, and you will see that real estate prices in terms of a monthly payment really haven't gone up at all. Isn't that incredible? That's incredible. Incredible.

You know, the one thing I was thinking today is I talked to millennials. They keep telling me they're waiting for home prices to drop before they get into a home.

Well, not my favorite millennial, Lisa, who's probably listening. She's not waiting for them to drop. She's buying up properties left and right. But go ahead.

I think that's the right way to go. I think if they're waiting for home prices to drop, they're going to be waiting a long, long, long time.

Now, the distinction, though, is that home prices already are dropping in the cyclical markets. And the property we're talking about is, of course, in a cyclical market. Those cyclical market prices are adjusting. And I don't know what you'll say, Thomas, but I'll say they needed to adjust, they got over the top, okay? So rightfully, they're adjusting. But when you look overall, if you're not looking at the misleading Case Shiller Index, which is weighted toward, you know, approximately 75% cyclical markets and only 25% linear markets, if you're not looking at the Case Shiller Index, which will totally mislead you nationwide, home prices really aren't as high as you think they are. Okay. They are just not nearly as high as you think they are in inflation adjusted monthly payment terms. In mortgage payment terms.

Oh, yeah, I agree. If I was a millennial waiting to get in the housing market, I'd get in now when mortgage rates are still incredibly low.

And the housing market hasn't had a, you know, it's gone up, it's been a very good expansion, but it hasn't been the type of expansion where the housing prices are growing at 20% year over year. You know, it's, it's a good priced home appreciate. You know, the market's been, has seen home prices appreciate at a good amount, but not at, not at, you know, exuberant levels.

Right, right. You're taking the Robert Shiller who stole it from Alan Greenspan, but he wrote a couple books on it, Irrational exuberance. Right. And you're absolutely right because back before the Great Recession, we had absurd, absurd appreciation levels where I remember in Orange County, California where I owned a traditional real estate company, you know, we saw 26% per year. We saw Phoenix do 55% one year. I mean, that is completely unsustainable. Obviously there's going to be a correction when you see that kind of stuff, but in this cycle, you know, certainly things have appreciated, but it hasn't gone absolutely nuts like it did before. So that's good. Now here's the fly in the ointment though, folks, and here's what really could lead to the next down housing market, the next significant recession. In terms of real estate, I'm just talking about real estate here, but, well, the broader economy in general. And that is because rates now are so low that the Fed, and we've talked about this many times on other episodes, doesn't have any bullets in the gun, as the metaphor is. Right. The only way you can fix a faltering economy, well, not the only way, but a significant way, is to use the interest rate tool and to cut, cut, cut rates into the recession right when it comes. And it will eventually come. And that will make it softer. It'll make the landing softer. Or if you're already in it, you can get out of it by just pumping up the money supply. And you know, part of the significant way you do that is by reducing rates. You use the rates as a lever to stimulate economic growth. But if rates are already very, very low, you lose that tool. That tool is not available to the Fed and the powers that be. So that is a dangerous thing. Now, interestingly And Thomas, I want to have you back on another show. I just posted in our content group this morning an interesting article where Bernanke, our former Fed chair Ben Bernanke gave a speech and he talked about how negative interest rates were. Okay.

That'S a big one to tackle. But what do you think about what I just said, Thomas?

Oh, I think it's a sign of there's something wrong. I saw the, I think it's produced by Bloomberg that 25% of investment grade bonds are now yielding negative rates. It's, you know, they have negative yields on them. It's.

So basically, what does that mean? Tell the listeners what that means. Does that mean that in order to store your money in a bond, you know, invest in a bond to park your money, you actually lose money?

Oh no. So the bonds are still selling with positive coupons, you know, so at maturity, right? Yeah, yeah. The U.S. treasury goes out and says, you know, we'll, we'll do a 10 year note for 2%. They're still going to pay that 2%. But when it's sold on the market.

Because there's so much demand for the Treasuries, the yield on that, the yield is the earnings divided by price. So you know, it turns negative, it's because the price gets bid up.

Yeah, right, right. So that's in the trading aspect of it. Right. But if you're that buyer, then what I said is absolutely true. Right. Because if you pay that bid up price, then you're basically in a negative interest rate environment. Right?

Yeah. If you buy it now, you risk that interest rates turn flip positive. Right. If inflation comes back, then there's a giant amount of risk in there to work.

Why do companies and people buy these bonds? They must see that risk. Right?

Yeah. I just think money managers are almost over concerned of a recession to where they think, you know, we'll put it somewhere safe right now.

Right.

You know, it's better to basically earn nothing and have the risk of maybe losing some if interest rates rise versus putting money in an equity market situation to where there's, there's real.

It could really get slammed. Yeah, yeah. Right, right, right. So they're, they're doing the. Compared to what game? So, so you see why income property is so attractive and why the institutional players are getting into it. So interesting stuff, interesting stuff. So Thomas, please do that homework for us and let's look at the unofficial inflation rate, the more realistic one, and let's do the math on that and you know, maybe we ought to pick A couple other sample properties in some different types of market, like a. A linear, cyclical and hybrid market or something like that. And just look at this, because I think it's. It's fascinating and it's so amazing how the talking heads, including Nobel Prize winner Robert Shiller, they go on the news, they go on cnbc and they say this stuff and it's just. Everybody just accepts it as the gospel without thinking about it and really understanding the true dynamics. But, hey, those are all the dumb people. The smart people are listening to the show right now, so, you know, you're not going to be left out in the cold like, like, like the masses. So that's good. All right, Thomas, closing thought.

Oh, now is a perfect time to, you know, look at the housing market. Interest rates are still low and they. They can go lower, but not much.

Not much. Not much. And I want to qualify what you said, though, it's the linear housing market, because we do think. I think you agree with me that the cyclical markets have still got further to fall. At least that's what I think. I don't know. Do you agree with me on that? I'm curious.

Yeah. In places like San Francisco, they. They've got a good amount of downside risk.

Yeah. And New York and LA and Miami and. Yeah. All of those types of markets and globally, too. Do you. Do you agree about the other ones that I mentioned? The other markets?

New York for sure.

Yeah.

I might have to check Miami. Yeah. It wouldn't surprise me, you know. Yeah, There's a lot of downside risk there.

All the same. Good stuff. Good stuff. Okay. Hey, thanks for coming on and talking about this today, and we'll talk to you next time.

Okay. Good being with you.

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