1276 FBF: Asset Inflation Keeping People Out of The Investor Class, Stagnation, Hard Money Lending, Wage Growth with Mike Zlotnik

Today's Flashback Friday comes from episode 837, originally published in May 2017.

Welcome to this week's edition of Flashback Friday. Your opportunity to get some good review by listening to episodes from the past that Jason has hand picked to help you today in the present and propel you into the future. Enjoy.

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 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 the Creating wealth show. This is your host, Jason Hartman with episode number 837. 837. Thank you so much for joining me today. We always appreciate you tuning in three times a week, every Monday, Wednesday and Friday. Friday is kind of a special day, Flashback Friday. And then of course, you know, every 10th episode we go off topic and we talk about something of general interest. Sometimes that lands on a Flashback Friday and we repeat one of our 10th show episodes. But mostly it doesn't. I guess we would need a mathematician to kind of figure out how that works. It's. It's almost like an algorithm, right? It happens a few times a year. Speaking of which, today we have got one of the brightest mathematical minds I know with us today, and he is our Venture alliance member, and that is Mr. Mike Zlotnik, who is a hard money. He is a founder of Tempo Funding. Mike, welcome. How you doing?

Hi, Jason. Thank you for having me.

It's good to have you here. You're coming to us from the Big Apple. You're actually outside of the Big Apple. Well, I don't know. Is Brooklyn the Big Apple? Is that, is that considered New York City? Do you call it New York City?

Absolutely. Brooklyn is a part of New York City. And did you know that there are more people who live in Brooklyn and Manhattan?

I did not know that. I guess that's because Manhattan's more business and office than residential, right?

That's right. But New York City is composed of five boroughs. Staten Island, Brooklyn, Queens, Manhattan and Bronx, that's the Big Apple.

See folks, we're getting a geography lesson here today. This is good. Well, Mike, I want to ask you about the economy a little bit and you know, sitting in your chair and doing what you do all day financing real estate deals, you've got a unique perspective. I would just love for you to share a little bit of that with your listeners. Today we will be playing a clip from a live event that I did time permitting. If not, we'll play it next week. Let's just dive in a little bit and talk about, you know, what you see going on in the marketplace. You talk to me a lot about cap rate compression, as you call it, or yield compression. And I'd like to, you know, give our listeners a little insight, a little definition on what that means first and insight into what's happening and why it's happening and some thoughts and predictions for the future of interest rates, inflation, etc. So Mike, tell our listeners what you mean about yield compression and cap rate compression.

Sure, Jason. So yield compression is simply reduction of the yield that investors receive on the investment for the same level of risk that they take. So you invest your capital and before you used to make 10%, now you're making 9% and the day after tomorrow you're going to make 8%. It's an event that happens when there's a lot of capital chasing the same deal flow and the capital is going to take less of a return because there's more capital and there's less supply of deals.

Right. So it's simply the supply demand curve that dictates or causes yield compression or yield expansion. It's similar to inflation because the way you said that, Mike, was interesting. It was almost really sort of that classic reason that inflation occurs, right? You have a increasing supply of dollars or whatever fiat currency chasing a limited supply of assets. So this is what happens in the investing world. There's a ton of capital out there chasing deals, whether they be the physical assets wanting to buy a property. And certainly we're seeing that. I mean, in, in my career of dealing with 100% investors starting in 2004, this is 13th year of doing this. And of course I've been in the real estate business longer, but just on the investor only side for the past 13 plus years, this is one of the lowest inventory times I have ever seen. Inventory is very scarce because you have huge amounts of capital chasing in a limited supply of assets. So of course on our side, on the physical asset side, the actual property ownership Side, you see the yields compressing, right? You see lower cash on cash returns, lower cap rates, lower overall return on investment. But I tell you, it's like I said to one of our investors who actually was on the podcast a few years ago, that's Drew, we just traded voxer messages on this the other day. He said, I can't find any good deals. I've got capital, I want to invest and I want to buy more properties. And you know, none of these deals look that great. And I'm like, Drew, you know, just wait a few years and those deals are going to look awesome. It always happens that way, you know, we always have to. The psychology always lags the market, doesn't it? And do you find that true with your investors? With yours, they're not buying the hard money or they're not buying the hard asset, the property, they're just putting money into financing a deal for somebody else, loaning the money, right?

Well, that's right, but it's very similar to what you mentioned. It is capital chasing deals. And in our case, when we make our hard money loan, it's still a property that secures the loan. And as there are a number of properties out there on the market going down as the reduction of inventory, the capital available to finance these properties is still abundant. And the consequences that the rates borrowers pay on these hard money loans are coming down. That's the same concept as people are buying properties, the owners of the property seeing yield compression, the return. So cash on cash returns is compressing cap rate in the lending space. Exactly the same effect taking place. The lenders are receiving lower rate of return on their capital. So it's the same concept. Both parties are sort of suffering.

Okay, so why has this happened though? I mean, is there suddenly more capital than there was three years ago? I mean, what happened?

I think both the deal flow was much more abundant after the crash of 2008, 2009. And as the deal flow was abundant, the capital was scarce. Everybody was scared to put the money in the market, both in equity deals or debt deals. And over years as economy recovered, more and more people started looking for deals and the low hanging fruit has been picked. The deal flow has sort of slowed down, the short sales slow down, the REO properties inventory is reduced. So on the inventory side there are fewer deals and they're harder to find deals. And then on the lending side, there's been major inflow of capital from the Wall street sort of entering the industry in the form of hedge fund capital providing liquidity to a lot of bigger hard money originators, and they're coming in, in drones, offering cheaper and cheaper capital just to get the business. So it's a little bit of a dangerous model when the capital is chasing deals, but it's happening. And large institutional capital has a problem of utilization. They want to put a lot of money to work and they want to do it fast. When they do that, they care less about quality, they care about volume. And that's. Yeah, that's a fortunate.

I'm so glad you mentioned that because we've talked about this on the show over the years of how large amounts of institutional capital flowing into the real estate market, or flowing into any asset class for that matter, will accept really low, meager returns. And that's always blown my mind because I always thought, you know, the more money I have, the better deal I should get. But that's actually counterintuitive. That's actually not necessarily true. In fact, I'd say arguably, maybe most of the time it's the opposite. Because when they have so much capital to deploy, you know, the, the old saying is what gets re, what gets rewarded gets repeated, right? They get rewarded for deploying capital, for investing that money. And if some fund manager has $200 million sitting on the sideline and it's not invested, they're in trouble, right? It's, it's kind of like, it's kind of like, you know, backwards thinking in a way. It's sort of the way government works, right? Every year, every, every friend of mine I know or, and every person I've ever talked to that is a government contractor, whether they sell computers or whatever to the government, right? Every fall, when, you know, these agencies need to spend money because if they don't spend all their budget, then they can't ask for an increase or they won't even get the same budget. Their budget will be reduced the following year. So they just spend wildly and stupidly to, in essence, deploy capital. And sort of the same thing happens with these big institutional investors, which is why, listeners, the lesson, what's the lesson here, right? The lesson is if you are investing with one of these institutional investors and you're the little pawn putting your life savings, your retirement money in with them, look at how, how they're doing it, right? They're, they're not really combing through deals. I mean, when we've had, you know, when we haven't had many of them, but we've had a few hedge funds and private equity groups over the years buying properties from Us, you know, they're not picky, let me tell you. They just buy stuff because they, it just doesn't matter, right. If they pay ten grand too much for a house, so what? Like in the big picture, to them it's meaningless. But if you're, if you're the investor in that fund, then, hey, you know, there, there goes your, your return. Right? Yeah.

I wanted to comment on this. So pretty simple. They get paid for doing deals. They're not getting paid necessarily for performance. So every time they originate, they put the money to work, they collect the fee. From their perspective, they need these fees. They don't really care if they're lending the money at 7% rate, 8%, 9%, as long as the money is coming out, they're collecting the fees. So sort of these origination fees is what they care about. And it is counterintuitive. We take an opposite approach. We want to make sure that our investors return, risk adjusted return is maximized so we care about putting the money at healthy rates. So as a small operator, we pay attention. The big shops, don't they have so much money to deploy that the money burns a hole in the pocket if it sits idle. It's a bigger problem for them than putting it to work at the rates that are lower than what they should be.

This is counterintuitive, folks. Most people would not think of it this way. And that's almost like, you know, the, the bigger the fund, the more meager the returns they will accept. Oddly, you think, I don't know, maybe it's just me, but I would think it'd be the opposite. I would think if I have a ton of money, I'm going to get a volume discount, I'm going to get a bulk discount, right? Not true. It's opposite, you know. Yeah.

The only other quick thought here is that the yield compression has been happening the last couple of years. It continues to take place. And what's strange is we don't know where the bottom is. The more I speak with people, it just appears that the greed of the Wall street and their desire to just put the money to work exceeds reasonable thinking. So they're flooding the market with capital and the consequences, obviously they're going to inflate asset inflation and one day it can, the balloon can pop. So it's.

It sure can and it sure will. What goes up must come down, you know, and this is why I say, as on the real estate side of this, I mean, of course you're talking about the stock market and stuff I know to a large extent. But on the real estate side of it, look, be in the linear conservative markets because they're, you don't have a big bubble pop risk. But if you are in these high flying markets, boy, watch out because number one, I know for sure you bought assets or you're thinking of buying assets that don't make sense the day you buy them. They don't cash flow. You're a speculator, a capital appreciation investor and you know commandment number five is thou shalt not gamble. So the nice conservative yield oriented investments are the thing to do. Mike, we talked a little bit, you know, we've talked a lot over the years and at the venture alliance meetings and so forth. We've got one coming up. I'll see you in Chicago here real soon. About three weeks away. But what do you think? You know, what's your take on sort of where the economy is now? The Trump administration, Inflation, deflation, interest rates. I think you're like me that you believe inflation is coming, right?

Yeah, absolutely. So. Well it's already here, but more is coming, accelerating unfortunately. What's happening is this real simple on a grand scale of things. US Government continues to have terrible balance sheet and every year it's getting worse. More people retire, entitlements are growing and the federal budget continues to get worse and worse. What's the only solution? They flood, they borrow more and the unfunded liabilities become real liabilities and the consequence of it is just more money chasing all kinds of assets. So that's a classic inflation because of the more capital is out there getting printed every year. The Federal Reserve banks just printing capital, printing money. So I think that's happening everywhere as far as your day in and day out asset inflation. Well, New York City is booming, but it's an advert not everywhere else. And I can tell you because we are hard money lender, we're in various markets, the markets are softening up. So I'll give you example. Miami, we're already seeing significant slowdown in the condo market. There's already fluff is beginning to show up and the consequence of there's going to be some level of correction in these super hot markets.

No question about it. Get ready folks because it's coming. I, I, I've told you a million times that there's, you know, there's no way any of these markets aren't way past their fundamentals. These high flying cyclical markets, you know, Miami, New York, Louisiana, Washington, D.C. you know, the, the west coast, just anywhere you know, Boston, blah blah blah. They go on and on. Paris, New York or not. I mentioned New York, Hong Kong, you know, et cetera, et cetera. Right, yeah, Dubai. Yeah.

But I will beg to differ just about only New York City because I know the market.

I know you always.

Residential market in New York City seems to be pretty strong, although the condom continues and one day we'll slow down. So it's inevitable. People can't be paying for the square foot what they're paying now. It's almost like gotta watch the movie called Rent Control. Talking about New York City, any of the listeners.

Oh, I didn't know that, that, oh boy, I'd probably screaming at the TV if I watch that. I hate Rent Control. It's such a scam. Yeah, very interesting, very interesting. I do need to see that. I didn't know there was. Is that a documentary?

Yeah, it's an old movie. It's a classic. It's a comedy. It's a great, great movie. I don't know anybody who will not enjoy this movie. But talking about New York City. Yeah, just. But asset inflation continues here, people paying more and more. I think there's more money in people's pockets. So there definitely appears to be more capital chasing deals and there are fewer and fewer asset classes. So foreign capital continues to flow into New York as it needs to be parked somewhere. I have conversation with folks who live in different countries and they just don't want to keep the money there. That's why the money flows here. It's really safety of the capital.

Well, you've certainly seen that in Vancouver too and that market is changing quite a bit. But it's been one of these high flying places. And the amazing thing is, and this just is such a testament for how good America is as a place to invest. I mean, even though it's all messed up and got a ton of problems, but comparatively right, that wealthy foreigners use US real estate as a bank, quite literally. And my building where I live in Las Vegas is, you know, and Mike, you've been to my house here, you know, when, when you and Elizabeth and folks, Fernando and I met here and we had like a day long meeting at my house during our Venture alliance trip here in Las Vegas. The last one is the amazing thing is so many of these units are just vacant. You know, they might be furnished, they might not be furnished, but the people never come here, they just buy them. Especially Chinese buyers, they just buy them and they use the unit as a bank. It's like putting your money in the bank. They're not even really necessarily buying them with any huge appreciation expectation, which, you know, if they get it, that's icing on the cake. I don't know that they will or they won't. But you know, that's a different discussion. But they're just, they're just banking their money. You know, they're just looking for a safe place to put it. And the US has always been known as the Brinks truck. And you know, it can't all be in banks. There's a lot of bank account restrictions. Right. But it's easy to buy real estate. You know, the US is very open to FDI foreign direct investment. So. So, yeah. Interesting. Very interesting stuff. So why do you think inflation is coming?

GDP growth is incredibly weak. I mean, we're basically, if we're going to be at two and a quarter or two and a half, we'll be very happy with low gdp. The US economy is not growing fast enough as its financial obligations and on a federal level, I mean, I just mentioned entitlements, they're going to continue to get worse. There's also a massive problem on the state level. So the budgets continue to get worse and worse. And we're probably going to see sort of a thing called stagflation where the salaries are going to grow slower than the inflation and the money will be chasing more assets, but the incomes are not. So it's a bizarre scenario. But if you were to define what's likely going to happen, in my opinion, stagflation is a likely scenario in the United States, strangers.

So stagflation, that's an ugly scenario. It's no fun. It means people's standard of living will decline, but the assets will keep appreciating. So here's a, here's a distinction I want to help the listeners with. And it's not the first time I've talked about it, but it's important. We haven't talked about it a ton. So let's just go into it for a moment. And you've alluded to it. It because you've used the phrase a few times, asset inflation. Like, okay, so you know, there's a tendency, and I'm guilty of this as well, to just say it generically, inflation. Right. Like inflation. Yet you look at the cost of consumer electronics, you look at the cost of a lot of things and they keep getting better and cheaper, or at least they get better. They don't get cheaper, but they get better, which in effect, effect by the hedonic indexing, the amount of pleasure you get from the item, it makes it cheaper. So what, what people never consider really too much, and it's not considered in the consumer price index in terms of inflation, but it, it really hurts people and leaves them behind is that concept of asset inflation. So even though all of the consumer goods they buy in their life, clothing, electronics, might be relatively cheap or even getting cheaper. How about trying to buy a house? How about trying to enter what I call the investor class, Right? How about trying to buy a share of stock in Amazon.com right. It's incredibly expensive. And that's asset inflation, right? If you want to become an investor, all the real estate has become a lot more expensive. And what that does is it leaves people out. People can't get in that game. And if they can't get in that game, then they're unlikely to be able to build any real wealth. They're always going to be on the treadmill and in the rat race, as Robert Kiyosaki puts it, right, where they're always, you know, paycheck, paycheck, save money. You know, try and save money, try and get ahead, but you never really can because the only thing that has real leverage are investments, assets. So you've got to own assets. And if you have asset inflation, you get left out of the investor class, right? Nobody really considers that too much.

That's right. That's exactly right. I had conversations with a couple of friends, cow kids, ice skate together, and there are professionals, doctors and lawyers. And what's strange is when they go to buy a property here in New York, they find it more and more difficult to buy because the income doesn't grow fast enough as the assets price and income growth significantly lags and will continue to lag after inflation? And they're very different things. People refer to the word inflation, but inflation is two components. It's income inflation in assets, in prices for goods and services, and if they don't keep up, right?

It's consumer price index. It's CPI style inflation, which of course is always understated, but that's another discussion understated with weighting, substitution and hedonics, which I've talked to you about before. It's also the asset classes, right? So it's buying a home in which to live. It's entering the investor class. You know, when, when the stock market is on a tear, when the real estate market's on a tear. Can you even enter the investor class at all when there's a ton of asset inflation and it's very deceiving because that is not reflected in the cpi, is it?

No, it's not. And you absolutely right. The markets to enter are the good cash flow markets. Mid America are much better markets to enter than the high flying markets. It's very hard to even enter a high flying market. You want to buy a property here in New York, well put 30% down, you're going to barely break even on the cash flow. How does that sound?

Oh, you're not even going to break even at 30% down. You're kidding me. Because you're going to end up with a condo in one of those high flying markets with eight to twelve hundred dollar a month HOA fees. You know, it's just, it just doesn't work. I mean it's just out of control in those markets. I mean you just can't even, can't even get close, you know, I mean I think you're being very optimistic. 30 down, break even, aren't you?

Yeah, when I probably two or three family house in Brooklyn. Here you could barely break even limit to the three, you know, but you're right, Macondo, forget it. Condos are terrible. You know what's interesting is the appreciation has been very spotty. The condos appreciated terribly in comparison to housing in, in Brooklyn housing and appreciate much more so.

Well, you know me, I don't like condos. I mean the, yeah, I'm not saying I'll never buy one, but the deal's got to be awfully good to look at a condo. So it's interesting though Mike, that you think there's really going to be that much stagnation in the wages. I think there definitely are some factors against that, but one of them I think is for it is our child president in adult body and that's Trump. Okay. You know who, who's really surprisingly immature. You see there, I said it. Folks don't think I'm some big Trump fan over here. Okay, I don't want to hear that anymore. I'm not, I'm very critical of Trump. But, but I do think we're gonna see some decent wage growth under Trump because you know, you get immigration under control, which means you stop importing, deflationary pressures on the labor market. And if his protectionist trade policies occur, I think that's gonna be more American jobs. You know, this is, it's always a trade off, isn't it?

Yeah, maybe Trump is inflationary for income in theory with the anti immigration policy, but the money's got to come from somewhere. And incomes typically grow as corporate earnings accelerate. Corporations pay more, they're able to hire more folks on the grand scale of things is gdp. If GDP doesn't grow fast enough, where is the excess capital going to come from to pay people higher salaries? So it may be, I may be wrong.

Well, I think it comes out of price growth. I mean if the companies raise prices through inflation, then they have more money to pay in salaries. I mean, you know, it's, it's just gonna, they're gonna have to, if you can't keep importing cheap labor from south of the border to create this fake deflationary pressure, which in my opinion is my big conspiracy theory that I been espousing for over 10 years now about why, you know, why won't anybody control the border? Right. The reason they don't want to, because letting the immigration occur makes inflation seem lower. It, it, it makes it seem like there's no inflationary pressure. That is definitely baked in to the terrible fiscal policies we've had for the last 50 years. It's baked in. But you know, if you, if you import cheap goods from Asia, right. And you import cheap labor from Mexico, that's going to tame the inflation monster that really is baked into the cake. And they, that's a good way to hide it. I mean it's a pretty good business plan for government. I can totally understand why they do it.

Well, yeah, I mean, you're right. There might be some inflationary pressure, but they really have to watch what happens with interest rates. So if they let inflation accelerate a little too much, the interest rate's going to start climbing and that'll cause all kinds of grief, including the debt service on the US national debt is going to be potentially dust spiral per se. So I actually believe in a grand conspiracy theory where interest rates can't really go up a lot because the US government can't afford it. They need CPI low, they need to keep increases to Social Security beneficiaries low and need to keep interest rates low to sustain the US financial system.

But overall, you do think interest rates are on their way up, right?

Temporarily, they cannot go up too much. So I mean, this is sort of a good news for real estate from the point of view that the high interest rate obviously impact real estate negatively. But I just can't see the interest rate climbing too much and they can't get even to a normalized point where your 30 year mortgage is 6%. I don't think we're going to see that in the near future. Yeah. So it's, you know, who knows, who knows what happens to it? But we have to be prepared for either scenario for high interest rates and low interest rates in real estate seems to be the best class to hedge against inflation or even if inflation is low. Real estate does well too.

Yeah, no, it's an amazing asset class because it's multi dimensional and if we see higher interest rates, that will cause downward pressure on real estate prices, but it will cause upward pressure on real estate estate rents. So, you know, the beautiful thing about income property is you can always adjust your strategy. You can't do that with a big expensive home in which you live. Okay, there you can't adjust the strategy, but with the, the income property you can. And that's, that's another reason your home is not an asset. You know, you can't do this stuff with stocks or bonds or any other investment. It's a very, very unique investment. And speaking of investments, we gotta wrap it up. But Mike, your company basically does hard money lending. So if any of our listeners need financing for properties that they're buying or are interested in financing properties even though there's like no properties to finance basically because there's so much capital chasing, so few deals. And you know, the other problem with the hard money lending nowadays is the properties, they don't keep the loans long enough. You know, they repay them so quickly because the properties sell so fast that it's a challenge to keep your money in the game. Right?

Yeah. I mean in today's day and age, you're right, there's more money chasing deals and utilizing well available capital is a little bit harder than before. We do a couple of things. We obviously do hard money loans and just to be clear, we only finance short duration bridge loans for fix and flip or fix and refi projects. We don't do any long term loans. We raise a focus on the short duration, but also have a long term investment fund where we take advantage of the interesting diversified opportunities and we invest for long term in the projects in the mid states, not coastal markets. In these non sexy, non interesting cities you never heard about sometimes, and sometimes you've heard of these cities. But the projects we invest in are not your sexy projects. These projects generally perform better in downturn and at this point we're still in the last leg of the, of the growth. So. So that's what we do. We try to try to put the money to work on great projects and maximize risk adjusted return.

Yeah, Mike, I'm glad you said that. You know, as a general rule in life. It's not always true, but as a very general rule, sort of a first cut rule, the sexier the deal is, the lower the returns will be. You know, if it's a trophy property in Newport Beach, California, you're just not going to get the return that you're going to get for that, you know, not so sexy property in Indianapolis or Memphis or Atlanta or, you know, wherever. Right. You know, in any of the markets you'll find@jason hartman.com properties, right. Those, those aren't as sexy, but, but the returns are better and they're more solid. Hey, Mike, I look forward to seeing you in Chicago in about three weeks for our Venture Alliance Mastermind meeting, folks. We have two events coming up, of course, the Venture Alliance Mastermind meeting. You can go to venturealliancemastermind.com or Jason Hartman.com, click on Events and check that out. Talk to your investment counselor at our firm, if you have one, or just reach out to us through the website. And then also we've got our Oklahoma City City Jason Hartman University Live, which is where you really dive into the numbers. You dive into acquisition strategies on properties. And we're going to do something new at this event. We're going to do some panel discussions at the JHU Live coming up in Oklahoma City in July. We also have a property tour combined with that as well. So we're going to tour some great properties. I think you should definitely attend, attend those two events. So check those out at Jason hartman.com on the events section. And Mike, thank you so much for joining us today. I really appreciate having you, Jason, thank you kindly.

Looking forward to seeing Chicago at the Venture alliance in a couple of weeks.

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