CW 965 FBF - Reduce Risk & Benefit from Inflation As a Prudent Real Estate Investors

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Good afternoon, this is Jason Hartman with Platinum Properties Investor Network Broadcasting. Today's podcast number 18 from the OC here in Orange County, California. Today I would like to talk about inflation, but really I'd like to talk about leverage. But leverage specifically as it relates to the concept and the reality of inflation. When you use leverage or borrowed money, there are many, many benefits. The prudent, proper use of leverage, a very powerful tool, could be a destructive tool. Some people get themselves into trouble with it. But when you use it the right way, especially when investing in real estate, it is an incredibly power tool. The main benefits, although there are many others and in our other podcasts you hear us talk about leverage, is to reduce risk and increase return on investment. However, this podcast is specifically geared toward inflation. In fact, I call it the Great Inflation Payoff. Now, if you ever have a chance to attend one of our seminars or meet or talk with one of our investment counselors, they will be glad to run some phenomenal inflation campaign calculations for you. And these will show you how much benefit. That's right. I said it right. Benefit you are actually getting from inflation as a real estate investor. So let me just say this to make it simple. Think about this. If you were to purchase six single family homes and the aggregate value of those single family homes was $1 million. And if you were to put 5% down on those properties, assuming you could qualify based on 5% down, your loan balances would be $950,000. Think about this. If inflation is 4% in one year, if you've paid down no principal whatsoever, your loan balance reduced just because of inflation to just $912,000, essentially, inflation paid off, if you will, $38,000 of your loan balance for you. This is what we call the great inflation payoff. Borrowed money offers those two great benefits, reducing your risk and increasing your returns. But better than all of those is the benefit of inflation, because better to borrow money today and pay it back later than to pay money back today. And real estate has some especially beneficial features with inflation, because what happens, think about it, our rental properties, the loans on them, the debt on them is paid back by our tenant rather than by us. Or at least as much as possible, the tenant pays off our loan balances for us.

So more on this later.

I'd like to just play for you part of a recent live seminar where I talk about the great inflation payoff and some of these benefits of inflation. Now also, you have to understand that since you cannot see the visual aids being presented, you may have a question or two that is apparent and obvious to the live audience. So just give any of our investment counselors a call. They'll be glad to give you visual aids or explain things in more detail to you. And I will be back at the end of this podcast to tell you more about the inflation payoff and just sort of wrap this up. Thanks for listening and let's tune into a recent live seminar.

Now let's talk again about inflation. If you go onto Google and type in inflation calculator, you can find these all over the Internet. These are just two screenshots of inflation calculators that I found typing that into Google. So remember I asked you earlier today, would you rather have 100,000 today or 100,000 in 10 years? And everybody said today they'd rather have the money. Then I asked you, would you rather pay 100,000 today or pay it in 10 years? You all said, I'll pay later, take it today. Right answer. Definitely. If you have a $100,000 mortgage on your property and say it's an interest only loan, we're not paying the principal down, it's just interest only and it's a 10 year loan. If you believe which you'd be crazy to believe it. But if you believe that inflation is only around 4% a year, as the government would have you believe, then after 10 years, if your loan is interest only, your statement says it still says $100,000 on it. But remember, you're paying in depreciated future dollars. So you're really only paying back $66,000 ten years from now. Better to pay later than to pay today.

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What if inflation is 8%? Personally, I think it's 10 to 12%. That's my opinion. Hundred thousand dollars, 8% inflation. Ten years go by, you're really only paying $43,000 in $2017. So debt works for you really well when you're the borrower. When you're the lender, debt really hurts you. When you buy bonds, you are the lender when you buy bonds in a company or government bonds. That's why bonds are lousy, because I don't like being the lender. You know, Shakespeare a long time ago said, neither a borrower nor a lender be. Shakespeare was wrong. Be a borrower, don't be a lender. Lender, no.

Lousy.

I ask you a question about borrowing and lending. How many of you have ever loaned money to a friend or family member who was in control of that transaction? The lender or the borrower? Like I said, be the borrower. That's where you have control. So let's look at this example. Here's the bank. You go to the bank and you say, bank, I'm a real estate investor. I want to borrow money to buy this house. My name's Donald Trump. I got a comb over and I'm going to buy this house. And I want you to loan me the money to buy this asset. But look, bank, I'm going to own the asset. You're just financing it for me. You're not going to get any of the tax benefits. You're not going to get any of the appreciation. All you're going to get is interest on the loan. And then I think, well, this sounds like a pretty good deal for me, the real estate investor. But the only problem is I got to pay the mortgage back. I've got to pay the loan back to the bank. What if I could avoid paying the loan back? Wouldn't that be neat? So what do I do? I rent the house out to Heather Locklear, one of my personal favorites. So Heather becomes my tenant. And I'm going to say, look, Heather, effectively you're going to pay the bank back for me. But it gets better than this. I borrow money from the bank, say, at 7.5% blended rate. What that means in the blended rate is if I get two loans to put minimum down payment. Say I do 80% on my first loan, 15% on my second loan, 5% of my own cash down. The blended rate, okay, is the blending of the two loans, the 80% loan is a larger balance at maybe 6.75%, for example. And the second loan is a more risky loan for the bank to make. So they're going to charge me a higher interest rate. Because they're in second position when it comes to collecting. So they might say, well, I want it 12%. But it's only a small amount of money. It's only 15% of the purchase price. So the blending of the two might come out to 7 and a half percent. So that's the effective blended rate. All right, So I pay the bank, or really Heather Locklear pays the bank in depreciated future dollars. Okay? And the asset historically appreciates faster than the rate of inflation. Now, most people see how they win the game in real estate this way. But they don't see how they win the game in real estate this way. You don't win one way, you win two ways by borrowing money. The problem is the bank isn't stupid. They understand inflation. I mean, how many MBAs are working in any bank? Lots of them, right? They went to school, business school.

They learned about inflation.

So they know this is out there. But they think inflation is only 4% like the government tells us. All right, but they also realize that, look, if we want our money not to depreciate. We've got to charge an interest rate higher than the rate of inflation to offset that. So we might loan the money out at 7.5% believing inflation is 4%. So our margin effectively is 3.5%. That's our profit to the bank, if you will. It's more complicated than that, but simplified example. So the bank knows this. So they're going to charge me a rate higher than inflation. So see, if I bought vacant land or if I didn't rent my house out, I would actually suffer. Because I'm not getting the tenant to pay my mortgage back for me. But we call this tenant backed or tenant finance debt. That's when debt is good. When someone else pays it off for you, okay? You get the benefit of inflation. There is destructive debt, which is consumer debt. This is how people get into trouble with debt. They get into debt over the appearances of wealth. Clothes, cars, vacations, plasma TVs. Stuff that depreciates in value that you can't rent out. I remember about a year and a half ago I got a call from a gold dealer, Monix. It's a local company here in Newport beach, you may have heard of them. And he calls me up and says, Mr. Hartman, we think you should invest in gold because all the fundamentals are right, blah blah, blah. It's $420 an ounce now and we think it's going to go to a thousand by the end of the year. Well, it didn't, but it did go up. I bought it. So I said to the guy, I said, look, I will send you 5,000 bucks. You send me the 12 gold coins. And so you've made the sale. But I have two questions for you. I'm going to buy it, but I want to know two more things. Number one thing I want to know is will you finance my purchase for three decades, for 30 years at some of the lowest interest rates in 40 years? Tax deductible interest. And he says we don't do that. And then I said, okay, fine, I'll pay cash. Then I want to know can I rent my gold coins out to someone? And he says, I don't think anybody rents gold coins. See, that's why that doesn't work as an investment. Anything you can't buy, get someone else to finance for you. Take huge tax deductions in between and you have a renter. Generating income is not a good investment. That's why I don't buy vacant land, because I can't rent it out unless it's a parking lot. I guess that might work, but that's the reason this works so well. Don't get into debt over the butter of life. Get into debt with guns. The guns and butter philosophy. Guns are things that create wealth. Butter is the luxuries of life. The things that really diminish wealth over time. The entire tax code and the US banking system encourage this. Do what they want, play their game. Diversify your equity for greater safety. Move it out of the high price market into the better value markets where the properties make sense the day you buy them. Constructive debt is investment grade debt. Okay, J. Paul Getty said it. Well, he said if you owe the bank $100, that's your problem. If you owe the bank $100 million, that's the bank's problem. So the borrower is in a position of power. Just remember that. Couple things I want to mention to you is that during the break, Cliff came up to me and he talked about the RV ratio and why we move out of markets. Actually, when we move out of a market, a lot of times it's good news for the people that already bought there. And the reason is, is that the way markets play out, at least what I've noticed over the years is that prices will start to Appreciate. And then behind that you have the lagging indicator of rental income of rents. And think about what's happening in Orange county right now. The argument RV ratio is typically about a three. So here a million dollar house rents for about 3,000amonth. And I know that because Marcus sold his house, Marcus Milliton, who was just up and rented one and he rents a house that's worth about a million bucks for 3,000, I think 3,100amonth. And it was really a good idea to sell his house. Now he has four kids and his wife Marjorie just about had a fit when he said we're selling the house on Ladera Ranch and we're going to go rent.

Huh?

No we're not. I'll call my attorney. But really it is a much better deal to rent a house here right now than to own one at the moment. So what happens is you'll see the prices appreciate. That's the leading indicator. Then you'll see the rents follow. That's the lagging indicator. So they get so out of sync. And what may confuse you is that you might read in the media right now that rents are going up in the bubble markets. They're going up more than they are in the non bubble markets in. And that is true. But they have, they're so out of sync here, it's ridiculous. Think about what has to happen here. The million dollar house needs to rent not for 3,000amonth, but for 7,000amonth for this market to work again. And I believe that the RV ratio is a predictor of appreciation. And here's how, when you get to about the 0.5 RV ratio, that's what I think is sort of the equilibrium rate. What will happen in Orange county in my prediction is you'll have the million dollar house, it'll decline in value to about 800,000. And this is really all of California largely. So that will decline in value as rents creep up and they'll sort of meet at the point of equilibrium which will be the $800,000 house renting for 4,000amonth. It was a million. It went down to 800. The rents went up from 3,000 to, to 4,000. And you're at the equilibrium point and that's the sign that the market is starting to get healthy again. And then the last thing is I want you to consider the assets you have in your life. Most people look at a balance sheet. You all of course know what a balance sheet is. On one side it's got your assets, the other side it's got your liabilities. But one of the assets that people generally don't count, and they don't even think about that they have is their credit, their ability to borrow. And in this game, as we've demonstrated to you today, the ability to borrow and leverage an investment is an incredibly good asset. So remember, when you're looking, when you're thinking of a balance sheet, count your liabilities, all the debt you have, but also count as part of your assets your ability to borrow. And remember, the concept of your financial life is you always want to make all your assets work as hard as you possibly can. So if you're not using your credit to borrow and put it to work for you, then it's an unused asset earning nothing for you. I constantly have people that kind of brag about, well, you know, I have an 800 FICO score. Well, you have no debt. Of course you have an 800 FICO score. But you're also going to end up poor and other people are going to end up rich because you're not using that asset, your credit asset. When you buy these properties, your credit score will go down. Initially, it goes down, and then in about six months, it sort of starts to recover. So as long as you maintain a credit score above 720, you're in very good shape. But remember, their credit doesn't do anything for them unless they use it. So use your credit. It is an asset. So keep that in mind. Don't just let it sit there not working for you. All right, so what's the plan with this? Well, the plan is divide your debt strategy into stages. Stage one is the launch stage, when something is on sale. I don't know about you, but when something is on sale, I stock up, money is on sale. Debt is on sale. It's on sale in not one way, low interest rates, but two ways. Ease of qualifying. And that's gotten harder, and the rates have gone up just a tad. But when I got into the business in 1985, interest rates were 14%.

Yeah, it was easy.

I know. I agree. That's okay. We put those up there. But we never use the easy buttons. You know, we just thought it was kind of a cute gimmick.

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So when something's on sale, stock up, money, or debt is on sale. Look at folks. In five years, ten years, I'll be. I bet you people are going to say, God, I wish I had borrowed more money. When it was so cheap. I wish I had taken out more mortgages when I could have done them with 5 or even 10% down. Now it's 20% down and the rate is 10% or 14% or whatever it is. I don't know what the rates will be, but I know that now it's a mighty good deal. So in stage one of your wealth building plan, you stock up on high quality fixed rate, fixed rate only investment grade debt. The debt is like the booster rockets in the space shuttle. Without the booster rockets you could never get into orbit. So stage two is you jettison the booster rockets. You know, you can let them go if you want. I still don't recommend it. But really what we say here is don't jettison the debt. Use the refi till you die plan. And what you're doing here in the stage two is you're starting to enjoy increased rents appreciation and tax savings over the years. And remember, this is five years we're talking about. Seven years we're talking about. And then in stage three, that's the orbit stage where you continue to refi till you die over and over again and enjoy living on the tax free proceeds of the refinance.

So I hope you enjoyed that piece.

From a recent live event and we.

Hope you'll be able to attend one in person sometime for more and more details. But just remember that inflation calculator example that I used in the beginning. If you were to purchase $1 million worth of property, say for example, in our network, that might be six single family homes in diversified markets spread around the country, so that all your eggs are not in one basket, you're spread out, you're diversified for greater safety. Now you borrow 950,000 5% down, just like the example I talked about earlier. And the inflation rate for the next 10 years on this interest only loan, the rate of inflation is only 4% per year. It's really quite a bit higher than that. But that is a much longer other discussion for a future podcast. At the end of the 10 years, remember you had an interest only loan. So it's now 2017, 10 years in the future, your statements still show a loan balance of $950,000. $950,000. But because of the beneficial effects of inflation, your loan balance is really only about $912,000. Your total return on inflation is about 250%. That's another way to say ROI. Remember, the traditional understanding of ROI is return on investment. And that's true. And that's a good thing to look at. And if you check out our previous podcast roi, some people just don't get it. We explain in depth how to calculate return on investment, but a new definition for roi, since we're moving on to more advanced techniques here, is return on inflation. That's right, return on inflation from the benefits of inflation. And any of our investment counselors here at our Orange county office would be glad to run a projection and a scenario and fax or email or mail it to you or sit down with you in person of how much benefit you're getting from inflation. But remember, the inflation benefit is twofold. Number one, when you buy real estate, you're investing in an inflation indexed asset, an asset that is traditionally a great hedge against inflation. That's one benefit. That's the obvious one. Most investors understand that. But the other benefit is that you are paying back the debt on the real estate in depreciated future dollars would rather have a million dollars today than a million dollars in 10 years. So the benefits of inflation are twofold, not just one thing. Two very big benefits of it.