7/31/11: Joining or Starting a Real Estate Club

Bargain basement prices.  Highly motivated sellers.  Record low interest rates.  A growing numbers of renters.  No new inventory coming out of the ground.

Wow.  Talk about a perfect storm of opportunity for real estate investors.

If you’re a newbie, getting in on the action can be a little intimidating.  There’s a lot to learn and mistakes can be expensive!  And for seasoned veterans, getting into more deal flow and finding good investment partners can be a full time job.

In either case, getting involved in a good real estate club can be a great solution.  So we decided to dedicate this episode of The Real Estate Guys™ radio show to sharing some important things we’ve learned after more than a decade of running and visiting a lot of different clubs.

Behind the microphones in our plush country club studio:

  • Your hardly handicapped host, Robert Helms
  • Co-host and highly handicapped caddy, Russell Gray

Real estate clubs are a great place to increase your education, expand your network, get into the deal flow or find investment partners.  But like any investor, not all clubs are the same.  So knowing what you want and what to look for are essential in finding a club that’s a good match for you.

Your handsome hosts have been running various clubs for over a decade.  We’ve had educational mentoring clubs, market and property promoting “deal clubs”, and even a club of investors who all went into deals together.   We’ve also visited a lot of different clubs as guest speakers, so while we may not have seen it all, we’ve seen a lot.

So we have some ideas about what to look for in a club and how to decide if it’s a good match for you.  And if you just can’t find what you’re looking for, we also share our thoughts on some things to think about if you decide to step out and start a club of your own.

As a special bonus for listening all the way to the end (or in this case, reading this entire blog), we put together a free report on 12 Things To Ask When Joining or Starting a Real Estate Club.  If you’re super impatient, you can visit our Special Reports page an get it right now!  But if you’re serious about getting out on the green to do some clubbing (did we just badly mix metaphors?), be sure to listen to the podcast too!

The Real Estate Guys™ radio show and podcast provides real estate investing news, education, training and resources to help real estate investors succeed.

Five Lessons Washington Could Learn From Real Estate Investors

With all the news about the debt ceiling crisis, it’s hard not to think about policy making. And while we think there are some great lessons available for real estate investors, we also think the politicians would benefit from looking at the situation like a real estate investor.

Since we recently interviewed two presidential candidates (watch for those interviews to be released soon!), maybe some policymakers are paying attention to our lowly blog?  Who knows.  But you’re here (which we appreciate), so let’s get on with it.

Lesson #1:  Add New Customers

For a real estate investor, this means acquiring more revenue producing units.  Notice that this isn’t “raising rents”. Raise rents in a weak economy and you LOSE customers, not gain them.  In fact, if you tell tenants you’re thinking about raising rents, new people won’t move in and existing tenants will start looking for someplace else to live.

For Washington, businesses are “customers”.  Like tenants, businesses and the people they employ get up every day and go to work.  Then they send a portion of their earnings to Uncle Sam (in the form of taxes) just like a tenant sends a real estate investor a portion of his earnings in the form of rent.

So if a new tenant will not move in or an existing tenant will move out if rental increases are being hinted at, is it any surprise that businesses aren’t being formed, won’t hire, or move out of the country when higher taxes (or other similar government imposed burdens) are being threatened?  Consider how General Electric and Google have organized themselves (legally) to move their profits off shore, or how Amazon recently canceled contracts with all their California based affiliate marketers.  Did those companies want to invest time and effort to do those things? No.  But they decided is was the lesser of evils.

As a landlord, if you want to attract new tenants, you must provide a safe, affordable place to live. If Washington wants to “create jobs”, the focus needs to be on providing a safe, affordable place to do business.  We look to acquire rental real estate in places that are friendly to business.

Lesson #2: High Overhead Slows Growth

The bigger your real estate portfolio grows, the more people you’ll need to help you manage it.  These include your tax advisor, estate planning attorney, asset protection attorney, insurance broker, mortgage broker, etc.  You’ll also have property managers, maintenance people and a bevy of sub-contractors.

All these people must be supported by your rental income.  But you have to add tenants before you add team members.  If you get it backwards, you go broke, even though you have a “big” business.  “Big” isn’t necessarily profitable.

When you watch the news coming out of Washington, ask yourself if Uncle Sam is growing government in response to a growing number of businesses, or independently of economic growth.  In other words, private sector employment should be growing first and faster.  If not, then expenses will go up and revenues won’t and you’ll be hemorrhaging cash.  And if you think raising rents on your tenants in a soft economy is the answer, go back to Lesson #1.

Lesson #3:  Cash Flow is Not Profit

As a real estate investor, it’s important to make payments on time.  It preserves a strong credit rating, which is a very useful tool for investing.  But if your rents decline and you’re using credit lines to make your payments, it may seem to you and the outside world that you have everything under control.  However, you’re headed for disaster.

At some point, you’ll run out of credit.  And even if your lenders are dumb enough to keep raising your credit limit, all you’re doing is delaying the inevitable because each month more of your available cash flow goes to interest until that’s all there is.  The real problem is that you’re not running a profitable business.

When an investor is faced with this problem (and it happens all the time), he has some choices:

  • Increase revenue.  This can be done by raising rents on the existing tenants (if the economy will permit it – see Lesson #1) or by acquiring new profitable tenants (if you act before you’ve depleted your remaining cash and credit).
  • Decrease expenses. This is hard to do, but it’s going to happen anyway if you don’t fix the problem, so better to be proactive.

When we mentor investors, we encourage them to act like they’re on a space ship in trouble (think Apollo 13).  To survive, you have to make a limited amount of resources last until you can get out of trouble.  This means cutting all non-essentials quickly and deeply.  If you just lost your job, using your “free time” and credit cards to repaint the house, put on a new roof, re-carpet and update the plumbing is probably not the kind of “investment in infrastructure” that will lead to long term prosperity.  Better to go acquire more revenue producing doors.  To survive, you have to keep the main thing the main thing.  And the main thing is to increase revenue (acquire more customers) faster than you increase expenses (hire more employees).

Lesson #4:  Inflation is Not Wealth

In a financial system that is designed to inflate (a topic too big for this article), it’s easy to be deceived into thinking your successful when you’re not.  WARNING: Math Ahead. 😉

For example, if you own a rental property that has 10 units renting for $100 a month in 1960, your gross income is $1000 a month.  So the building might be worth $12,000.  Assume for now it’s paid for, so that’s $12,000 of equity for you.

If in 2010, units in that same building are renting for $1,000 a month, your gross income is now $10,000 a month.  So this property many be worth $1.2 million.  Again, it’s paid for, so it’s all equity.  Are you richer?

Well, think about that.  Let’s assume that you could buy a new car in 1960 for $2000.  So your building is worth 60 cars. ($120,000/$2000 = 60)

What about in 2010?

If a new car in 2010 is $20,000, then your building is still worth 60 cars. ($1,200,000 / $20,000 = 60)

Hmmm….in 2010, the building still houses 10 people and is still worth 60 cars.  So in terms of relative value and utility, it hasn’t changed.  But now you’re a “millionaire”.

If instead, over the years, you re-invested the income and equity (see Bob’s Big Boo Boo in Equity Happens), and you acquired 10 more buildings from 1960 to 2010, now you have a properties which will house 100 people and is worth 600 cars.  NOW you’re richer.  Why?  You have more property.

More property, not more dollars, make you rich. This is very important when dollars are losing value.  For an extreme example, think how many trillionaires there are in Zimbabwe.

So for Washington to measure economic growth in terms of dollars is very confusing.  And you can’t run a business with confusing numbers.  Did the economy grow or didn’t it?  Our we in recovery or aren’t we?

Think about it this way.  If an economy produces 1 million widgets at $100 each, then you have a $100 million economy.  If the price of the widgets increases to $120, you have a $120 million economy.  But did your economy really grow 20%?  The dollars say so, but production and employment say you didn’t.  You’re still only making 1 million widgets.  And your’re still only employing however many people it takes to build 1 million widgets.  So you didn’t grow at all.

Not to belabor the point (but we’re going to anyway), what if the widgets are $120 and you only make 900,000 of them and then lay off a corresponding 10% of your workforce?  Your economy “grew” from $100 million to $108 million (900,000 widgest at $120 each = $108 million).  An 8% increase!  But you produced less and have higher unemployment.  That’s called a jobless recovery or staglflation.

In real estate, if you own 1 property now and in 50 years you own 1 property, you might have a higher dollar denominated cash flow and net worth, but you aren’t any richer if everything else around you also inflated.  You don’t have any more property.

More property means more tenants.  Tenants who work (produce) means more productivity.  More productivity (not inflated dollars) is what makes you (and a country) richer. A wise real estate investor will focus on acquiring more tenants. See Lesson #1.

Lesson #5: Not All Jobs Are Equal

When a real estate investor considers a geographic region as a place to invest, jobs are the single most important factor.  Tenants have a much easier time paying rent when they have jobs.

But not all jobs are created equal.  And the difference is where the money comes from.

So businesses (the source of jobs) can be divided into two categories: Primary and Secondary.

A “Primary” business is one that sells products (derives revenue) from OUTSIDE the region.  That is, a Primary business pulls money in from elsewhere and funnels it into the local economy through their local vendors and employees.

So when a Primary business uses local business for office supplies, printing, temporary help, insurance, maintenance, utilities, sub-contract work, etc., they are effectively distributing the outside money into the local economy through these “Secondary” or support businesses.  Then all those employees further distribute the money as it passes through their hands and into the local economy.

But the key to a region’s prosperity is having a strong base of Primary businesses.  As investors, we avoid markets which don’t have a strong base of Primary businesses. Without Primary businesses, the Secondary businesses can’t thrive.  And each time a Primary business is lost, you lose not only the Primary business’ jobs, but many of the Secondary business’ jobs as well.  It weakens the entire regional economy.

It would be a like a family of brothers all living in the same house.  If one brother has a good job outside the home, he can hire one brother to wash the cars and mow the grass.  He can hire another to cook and clean.  He could rent another brother’s boat for a fun day at the lake.  He is the Primary earner and he can then trade his outside money for various goods and services within the household.  But he is really supporting the whole family, though no one is getting charity.  The prosperity is distributed to each brother according to his contribution.  However, all the brothers would be wise to be nice to the Primary earner.  If he moves out, everyone loses their jobs.

So imagine that one day, the Primary earning brother finds out that one his other brothers took some money out of his wallet without working for it.  He gets mad and decides to move, taking his primary income with him. Now all the remaining brothers are sitting home trying to figure out that to do next.

One brother decides to use his credit card to get an advance and then hires one of his other brother to mow the lawn.  Then that brother uses his “earnings” to hire another brother to cook and clean.  And that other brother uses his “earnings” to rent the boat.  To the outside world, and maybe to the brothers themselves, it looks the same as before.  But now they are simply trading with borrowed money.  How long can that last?

Sooner or later, that credit card has to be paid.  And someone better get a job outside the home and bring in some real money in, or everyone will eventually be broke and homeless.  A higher credit limit might put the problem off a while, but it isn’t a long term solution.  You can’t lose your Primary earners and expect to be prosperous long term.

A country, like a state, like a local region, like a family, better have some Primary earners. And the more, the better.  Without money coming in from the outside, deficits pile up and everyone is just passing borrowed money around and feigning prosperity while a financial time bomb is ticking in the background.  See Lesson #1.

The Real Estate Guys™ Radio Show and podcast provides real estate investing news, education, training and resources to helps real estate investors succeed.  Subscribe to the free podcast!

The Great Debt Ceiling Debate – Part 5

This is the fifth and final part of our five part series on the “great debt ceiling debate” written as an accompaniment to our radio show broadcast and podcast, “Raising the Roof – How the Great Debt Ceiling Debate Impacts You”.  You can download the episode on iTunes or find it on our Listen page.

Here we are at our grand finale!  Glad you made it.  Please put on your seatbelt and keep your arms and legs inside the bus at all times.

The Debt Ceiling: What if They Do and What if They Don’t?

For starters, let’s just get clear on what the debt ceiling is.  Since we have people all over the world listening to our podcasts and reading our blogs, we don’t want to assume that everyone understands what the debt ceiling is or even how the U.S. government is organized.  And since there may be a few U.S. citizens who slept through Civics class, it’s probably good to lay a quick foundation.

The debt ceiling is the amount of borrowing the Congress will permit.  Congress (not the President) is in charge of setting the budget.  The President may (and does) submit a proposal, but Congress has the final say.  Then the President’s job is to do what Congress tells him to do.  He’s the Executive, and his job is to execute the will of the people as delivered to him by the people’s representatives, Congress.  Sometimes a President acts like Congress works for him (a dictatorship), or that he works directly for the people (a democracy).  In reality, the U.S. system is really a representative republic.  That’s a whole other discussion, but something you should think about if you’re a U.S. citizen.

Now the Treasury is part of the Executive Branch, so it works for the President.  That is, the Treasury reports to the President, who reports to the Congress, who report to the people.  The Treasury can’t borrow money past the limit Congress says unless the people’s representatives (the Congress) say it’s okay.  What Congress is finding out is that they can’t just say it’s okay if the people (those are the folks who actually have to pay for it all) say it’s not okay.  Right now, there’s a large and loud group of people who are not okay with more borrowing, hence the big debt ceiling debate.

Right now, the Congress has set a ceiling on how much Treasury can borrow, and Uncle Sam has hit it.  If Treasury borrows past that, then the Executive Branch has exceeded its Constitutional authority (like THAT never happens…oops, sorry, did a little sarcasm sneak out?), which, if it happens, would spark a completely different and heated debate.

As stated in our first installment in this series, we’re not here to say what SHOULD happen.  And no one can say with authority what WILL happen.  What we want to do is be prepared for a variety of possibilities. So let’s talk about what some of those various possibilities might be.

What if they DO raise the debt ceiling?

If Congress agrees to raise the debt ceiling, it will rile Tea Party conservatives, but it will calm the markets.  The U.S. will retain its pristine record of having never defaulted.  This may be the closest Uncle Sam has come to defaulting, but it isn’t the first time there’s been a debate about the debt ceiling and warnings from credit rating agencies. Some have said that Uncle Sam’s credit rating is going to take a hit anyway.  It’s something to watch, because a lower credit rating will mean higher borrowing costs for Uncle Sam (higher interest rates paid on Treasury bonds), which means higher interest rates will ripple through ALL types of debt.

One thing new is that with recent financial reform, ratings agencies have less discretion about not downgrading a debt issuer’s rating when problems are apparent.   A problem with the mortgage mess is that the rating agencies overlooked obvious problems and investors got snookered into buying debt that was far riskier than they bargained for.  When the underlying loans started going bad, bond investors got spooked and quit buying.  That meant the flow of money into mortgages stopped, and liquidity drained out of the real estate bathtub causing all real estate “boats” that were floating in that sea of money to drop.

The point is that, like any other borrower, if Uncle Sam’s credit rating drops, then the interest rates he pays will rise.

Let’s stop here and re-visit a previous thought, because it will be part of a recurring theme.

We think Big Ben wants low interest rates because low interest rates will encourage more borrowing and spending, which he thinks is the path to prosperity.  You may or may not agree, but it doesn’t matter what you (or we) think.  Big Ben has the Magic Checkbook (the one whose checks never bounce), so it only matters what he thinks.

So, if anything happens to cause interest rates to rise, the Fed is likely to step in with its Magic Checkbook as “the buyer of last resort” to create demand and bring down interest rates.  And, as we’ve discussed in previous installments, when the Magic Checkbook comes out, inflation happens.  Keep this in mind at all times.

Now, an increase in the debt ceiling means more borrowing, more interest, and more currency expansion.  Why?  Because the open market (think Bill Gross and PIMCO, plus all the warnings from the Chinese) doesn’t appear to have enough appetite for all the bonds Uncle Sam wants to issue at an interest rate that works for Ben and Sam.  So, either interest rates will have to rise to attract more Treasury buyers or the Fed’s Magic Checkbook comes out.  You may have already heard the hints about a possible QE3 coming to a theater near you.

Bottom line:  If Congress raises the debt ceiling, then slow, steady inflation is the best case scenario.  If productivity doesn’t increase (adding more products to the economy) to absorb some of the excess money, prices will rise at a rate that upsets the people and alerts the lenders (the bond buyers) that they’re going to get paid back with devalued dollars.  So slow and steady inflation is the “mandate” that Big Ben talks about all the time.  It’s what he wants to happen.

Of course, if you’re a non-Fed bond buyer (such as China) and you realize the currency of the bond you’re holding (dollars) is dropping by say 5% a year, then you’ll want 5% plus a little bit more to make sure that you really make a profit.  And if you want a higher yield and Uncle Sam needs your money, then either Sam pays or another buyer needs to come in and give Sam a better deal.  Again, that’s when Big Ben steps in with his Magic Checkbook to try and bring yields back down to keep Sam happy, keep bond values worldwide stable (a collapse in the bond market would be a worldwide economic wipe out), and keep interest rates low so consumers can borrow and spend.  Remember, Big Ben subscribes to the notion that borrowing and spending is the path to prosperity.

Yes.  It’s a vicious cycle of persistent inflation.  Go look at a chart of inflation since the U.S. came off the gold standard unofficially in 1933 and then officially in 1971.  What you’ll see is a clear picture of rising debt and rising prices.

What if they DON’T raise the debt ceiling?

There has been a real war going on in the U.S. government about raising the debt ceiling.  What’s all the fuss about?  It isn’t like Congress hasn’t raised the debt ceiling a jillion times before.

It seems that a big and loud faction of the American people is tired of the spending more than you make and borrowing to cover the difference.  There is real pressure on their representatives to stop it.  For them, it starts with refusing to authorize further borrowing.  At least not until an agreement is hammered out as to how to cut spending.

Whatever the details, if the debt ceiling isn’t raised, there are two primary possible outcomes, neither of which is pretty.  And as we’ve already seen, raising the debt ceiling isn’t all that pretty either.  In other words, the U.S. economic picture isn’t pretty, no matter how you look at it.  But remember, inside of all the problems are opportunities, so don’t be discouraged.  Be excited…and keep expanding your education.

So, if the debt ceiling is not raised, then the Fed will need to decide if they want to make the Treasury’s bank account magic also.  That is, the Fed can allow the Treasury to write checks that clear even though there isn’t any money.  This means no default on U.S. obligations.  How can they do that you say?  Well, since the Fed clears the Treasury’s checks, and no one knows what goes on inside the Fed, how would anyone really know when Uncle Sam ran out of money as long as the checks keep clearing?

But overtly giving the Treasury they’re own magic checkbook lets the world know the whole system is a sham, depending on how much visibility anyone has into Uncle Sam’s revenues and expenditures.  Since it’s Treasury’s job to report all of that, we’d guess they’d work to cover it all up.  Some have speculated that it’s already happening.  Who knows?

However, at whatever point the world realizes that the Treasury has a magic check book, investors all over the world will begin to dump dollars and buy stronger currencies and commodities.  Why?  Because they know that spending will continue far in excess of production, and the Treasury can simply expand the money supply at will to cover the deficit.  More dollars out of thin air outpacing production means falling purchasing power (more dollars chasing less goods).  Combine that with worldwide investors dumping dollars, and you have a recipe for hyper-inflation.

Hyper-inflation means that anything denominated in dollars will go up in price fast.  Think Zimbabwe: a trillion dollars for a roll of toilet paper.  Foreigners will be snapping up U.S. real estate (they already are).  And Americans will lose purchasing power all around the world.  Very ugly for Americans and anyone holding dollars.  Look at what gold has done in the weeks leading up to the debt ceiling deadline.  It seems the markets are prepping for long term inflation.

And of course there is the eventual outrage as the American people realize the Executive Branch has now completely circumvented Congress and is at liberty to spend without restriction.  How will the American people respond to that in this age of social media?

Default:  The Doomsday Scenario

The other possibility is outright default.  That is, Treasury will tell the world, “Sorry, I can’t pay you.”

This scenario is being described as financial Armageddon.  Since Uncle Sam has never defaulted, no one can say with certainty what would happen, but common sense says that interest rates would sky rocket.  Why?  Because U.S. debt would no longer be considered risk free and investors would demand a big premium to buy it.

We could speculate on which debt offering would take over as the foundation (“safest in the world”) of all debt risk pricing (interest rates).  But no one knows.  What matters is how the Fed would respond to rising interest rates on Treasuries.

If the Fed is true to form, they will whip out the Magic Checkbook and step into the bond market to create demand in an effort drive interest rates down. Or at least slow down their ascent.

Of course, the amount of Treasury bonds the Fed would need to buy will depend on how the rest of market responds.  But it’s safe to say that it will take LARGE purchases (QE4, 5, 6 & 7?) in order to keep interest rates down.  Remember what that means:  Lots of new money coming into the economy.  It wouldn’t surprise us if they set up straw buyers to hide the fact that the Fed is flooding the system with new money.  But as we said earlier, the excess funds will eventually trickle through the economy and land at the doorstep of the American public in the form of higher prices.

Further, it isn’t likely U.S. productivity could increase enough to offset the volume of new money entering the system, so once again inflation is the likely outcome.  Commodities will spike and prices will rise as the cost of raw materials works their way through the supply chain.

Now you know why Peter Schiff thinks gold will hit $5,000.  It also helps explain why Robert Kiyosaki says “savers are losers”.  Holding dollars in any of the aforementioned scenarios is a sure path to lose purchasing power.  Savvy people will be dumping dollars and purchasing anything real.  Go do a quick study of the Weimar Republic in pre-World War II Germany and you’ll get the idea.  Never in America?  That’s what they said about a default by Uncle Sam.

What’s a Real Estate Investor to Do?

Are you freaked out yet?  You should be concerned and aware, but don’t hit the panic button.  Just keep getting educated, watch the developments, and think through the possibilities.  Then take action as you deem appropriate.  We think you’ll find it helpful to be a part of a “master mind” group of similarly concerned and informed people, so you can discuss issues and bounce ideas off each other.  It’s a big reason why we continue to run our Mentoring Clubs and annual Investor Summit at Sea™.  Look to join or start a group in your area.

As real estate guys, we can no longer just think about real estate outside the context of currency, commodities and Fed policy. Those days are gone – at least in the U.S.

But if we pay attention, then we can use commodities and foreign currencies to protect the value of our cash reserves, go aggressively into debt to acquire properties that will likely increase in dollar denominated value against fix dollar debt (equity happens!), and purchase properties that are most likely to appeal to Americans who are growing poorer, and foreigners who are growing richer.

Take some time and think about that last statement, because that’s there the rubber really meets the road.  We’ll talk more about all this as the weeks and months roll by.  And it will be a major topic of conversation on our 2012 Investor Summit at Sea™, where we will have Robert Kiyosaki with us for an entire week – plus an all-star faculty of experts in a wide variety of relevant subjects.

In closing, let us say that while these are certainly uncertain times, those who are best educated and well-connected will prosper, while those who aren’t are more likely to sell assets, avoid debt and hoard dollars as they’re being squeezed by inflation.  Think through where that will lead. Selling things that are real in order to collect paper dollars which have no intrinsic value and are losing purchasing power.  Does that sound like a formula for success?

Now just one final illustration to make a point, then class is dismissed. Thanks for sticking with us this far!

Imagine if you purchased a $125,000 rental property in a market that produced something the world rally needed- something like oil and gas.  Even if Americans can’t afford much, the hot economies like China will need it and be willing to pay for it.  So it’s likely there will be jobs in any U.S. region that produces energy.  Jobs mean people, and people mean housing.  So an area like that will have a demand for rental housing.  Best, those jobs can’t move away from the region because the product is locked into the land itself.

Now, imagine that you put down $25,000 of cash, which, if left in the bank would go down in value as the dollar falls through inflation.  You get a $100,000 loan at a today’s low interest rates and lock it in for the long haul.  Then you rent the property out for a positive $200 a month.

Big whoop, right?  But at least the property is feeding you and not vice versa.

Then let’s say that you use the extra money to buy a little gold and silver every month.  Of course, you run the risk that the dollar could get strong against gold, so you have to decide what you think is the most likely outcome.  You could also use foreign currencies to hedge against a falling dollar.

Now, doomsday comes.  Zimbabwe-like inflation hits and it now takes $100,000 to buy a loaf bread.  Those $200 a month investments in gold and silver will have held their purchasing power, so you take a small fraction of your gold and COMPLETELY pay off your rental property (not that you would, but you could).

Meanwhile, gas and oil are selling to China so your tenant is earning good money.  Now there’s probably lots of competition for tenants, so your rents aren’t through the roof (though they probably would be thanks to inflation), but you have cash flow.  Or, you have a house that’s paid for that you could live in if you had to.

The point is that the right real estate in the right market, when structured properly, is a great way to benefit from inflation, whether it’s slow and steady (like the Fed prefers), uncomfortable (if Uncle Sam doesn’t slow down the pace of the growth of its debt), or out of control (if Uncle Sam defaults and the magic checkbooks start working overtime).

Your mission, should you choose to accept it, is to understand the economic mechanics of the flow of money and where and how it’s likely to flow. Then position yourself to benefit from as many of the most likely scenarios as possible. As illustrated, we like real estate for this reason.  And if we had time, we could show that even if deflation occurred, you can still win with real estate.  But that’s a topic for another day.

Our Prediction

You thought we forgot, didn’t you?

We think after all the yelling and screaming, that a compromise will be reached and the debt ceiling will be raised.  And whether it comes through a higher debt ceiling or a secret Magic Checkbook in the hands of the Treasury, the U.S. will not default.  Of course, that’s just our opinion and we could be wrong.  We’ll see.

Now take a shower. That was a long workout.  We’re going to buy a bag of popcorn and watch to see how the movie ends.  See you on the radio!

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The Great Debt Ceiling Debate – Part 4

This is part 4 of a multi-part series on the “great debt ceiling debate” written as an accompaniment to our radio show broadcast and podcast, “Raising the Roof – How the Great Debt Ceiling Debate Impacts You”.  You can download the episode on iTunes or find it on our Listen page.

We’re excited you’re here.  In case you missed the header, this is Part 4, so if you just got on the bus, be sure to go back and read parts 1-3 before jumping into this one.  For those who’ve been on board since the beginning, welcome back!  Now go grab an espresso and let’s get into it!

How the Fed’s Purchase of Treasuries Affects the Money Supply

Most people who pay attention to the economy have heard of “quantitative easing”.  But in talking to lots of people and teaching this topic in seminars, we’ve found most people don’t really understand how it works.  Since there’s been a lot of QE’ing going on, and potentially more to come, it’s important for all investors, real estate and otherwise, to really understand how it works.  And the topic is especially relevant in light of the current debt ceiling debate.

As you should recall from previous installments in this series, the Fed has a Magic Checkbook.  We explored how and why Big Ben is inclined to use it.  Now we’re going to discuss what happens when he does.

The Sound Money Concept

Big picture economics can be intimidating and confusing.  But a global economy is simply a collection of national economies.  And a national economy is simply a collection of many citizens’ economies.  So if you understand basic economic principles on a small scale, when everything blows up (figuratively speaking, at least so far), the numbers get bigger, but the principles still apply.

So, let’s imagine that you show up at a Treasury auction and you decide to buy Treasury bonds.

When your write your check and hand it over to the Treasury, they deposit it into their bank account (with the Fed) and the Treasury’s bank balance is increased by the amount of check.  When your check clears, your bank balance is reduced by the same amount.  What you have done is exchanged the cash in your bank for Uncle Sam’s bond.  This is your basic everyday transaction.  Just like buying furniture.

Now imagine that you and Uncle Sam are the only two people in the economy.  If, between both of you, there were $100,000 divided evenly, then you would each have $50,000.  When you buy $10,000 worth of bonds from Uncle Sam, you write a check and Uncle Sam’s now has $60,000 cash, while your balance is now $40,000.  You have a $10,000 asset (Uncle Sam’s bond) and Uncle Sam has a $10,000 liability (the debt to you).  But when you add it all up, it balances.  This is a “sound money” system because after the transaction is closed, everything balances.  That is, the same amount of money ($100,000) is in the economy is before, it is just allocated differently between the parties as a result of the transaction.

The Funny Money Concept

Now let’s look at what happens when Big Ben Bernanke buys a U.S. Treasury bond using his Magic Checkbook.  Remember, Ben doesn’t have any money in his checkbook.  He doesn’t need any because his checks never bounce. They’re magic.

Big Ben buys $10,000 worth of bonds from Uncle Sam.  Uncle Sam’s bank account goes up by $10,000 and Big Ben gets the bond.  Seems normal right?

Well, let’s take a closer look.

In our two person economy (you and Uncle Sam), you each had $50,000 for a total money supply of $100,000.  But when Big Ben buys the bond, Uncle Sam gets $10,000 for a total of $60,000 and you still have your $50,000 for a total money supply of $110,000.  The money supply just grew!  The technical term for expanding the money supply in this fashion is “Quantitative Easing”.  You may have heard of it.  There’s a lot of it going on lately.

Take It Queasy

What is the effect of this “quantitative easing” on an economy?

Remember, you can’t use money itself for anything, so it’s only valuable when you can use it to purchase products.  Money (for the purists: technically, “currency”, since real money is a product, which is what make it real)  isn’t a product.  Money is simply a means of storing value until you can convert it to something useful (i.e., buy something).

Let’s say that in our little economy, we have 1000 bottles of water, 1000 sandwiches, 1000 magazines, and 1000 more of 7 other things so there’s a total of 10,000 products.  In the real world, the price of each product would reflect the effort to locate and convert the raw materials into finished goods, and then prices would fluctuate based on supply and demand.  But to keep it super simple, imagine that all the products are priced equally, so the $100,000 in our economy is divided equally among the 10,000 products.  Now each product is worth $10.  $100,000 / 10,000 = $10

But if our money supply expanded to $110,000 courtesy of Big Ben’s Magic Checkbook (when he bought the $10,000 of Treasury bonds), then each product is worth $11.00 because $110,000 /  10,000 = $11.00.  That’s inflation.  More dollars divided over the same productivity.

So simply stated, inflation occurs when the amount of purchasing power (money, credit) goes up faster than the supply of goods (production).  In a stagnant economy (one that isn’t producing more stuff), when you add new money, prices go up.

The important thing to know is that when people with regular checkbooks (like you) buy Treasuries, the transaction balances out because the buyer’s checkbook balance decreases while Uncle Sam’s increases.  But when Big Ben uses his Magic Checkbook, NEW money enters the system because Uncle Sam’s balance goes up, while all the regular checkbooks stay the same.  Again, this is Quantitative Easing and it’s inflationary.

In the real world there are lots of moving parts, but if you just stick to the basic principles, you can clearly see what’s happening.  Because it all gets blended in with real world supply and demand dynamics (and confusing econo-speak), a lot of inflation can be hidden for awhile.  But not forever.  After a while it all “trickles down” to the man on the street and first prices rise (you know, like food, gas, clothing, etc.), and then eventually in wages (that one hasn’t hit yet).

Got it?

If you want to understand this “trickle down inflation” better, listen to our 2/20/11 radio episode The Coming Wave of Inflation – Profiting When the Levee Breaks, available on iTunes.

So now that you have all of this under your belt (just think how much fun you’re going to have at your next cocktail party!), in our fifth and final installment, we will finally look at how all this affects the Great Debt Ceiling debate.  And, we’ll unveil our bold prediction of what we think Congress will actually do about the debt ceiling.

The Great Debt Ceiling Debate – Part 3

This is part 3 of a multi-part series on the “great debt ceiling debate” written as an accompaniment to our radio show broadcast and podcast, “Raising the Roof – How the Great Debt Ceiling Debate Impacts You”.  You can download the episode on iTunes or find it on our Listen page.

In our last installment, we explored the bond market and how interest rates are established in the open market.  Bonds are debts and the interest rates are set by risk, reward, supply and demand.  Now we will explore how the Federal Reserve Bank affects interest rates.  You should already know how interest rates affect you. 😉

How the Fed Influences Interest Rates

The Federal Reserve

The Federal Reserve Bank (the Fed) is the bank of the Treasury.  The Treasury is the government.  The Federal Reserve is NOT the government.  If you want to learn more about the Fed, we highly recommend reading The Creature from Jekyll Island, which is conveniently located in The Real Estate Guys™ Recommended Reading area.

The Magic Checkbook

For now, you only need to know that the Fed can write checks on itself that will not bounce.  In other words, it doesn’t need money.  It creates money simply by writing a check.  That may sound unbelievable, but for now, just take our word for it.  This isn’t an expose on the Fed, so you can look it up in your spare time.

Now that we know how the Fed’s magic checkbook works, let’s imagine that Uncle Sam shows up to hold a Treasury bond auction.  But there isn’t enough demand, so interest rates start to go up.  In prior installments, we discussed what happens to the value of all the existing debt out there when interest rates go up (it goes down), but to toss in some extra motivation for the Fed, the current Fed leadership believes that low interest rates stimulates borrowing, which stimulates spending, which stimulates production, which stimulates hiring.  This is a “Keynesian” view of economics.  That is, that borrowing and spending is the key to growth and job creation (how’s that working out so far?).

Side note: For an opposing viewpoint, may we recommend you look into “Austrian” economic theory, which puts forth the idea that one must actually produce before one can consume or borrow, and that production and savings are the keys to economic growth.  In other words, in its most rudimentary terms, before you can eat, you need to grow or hunt food.  And if you have more food than you need, then you have something of value to trade with.  If you don’t have anything to eat and nothing of value to trade with, you need to either beg, borrow or steal from someone who actually does produce.  And the only way to have trading partners is if they produce more than they consume, so there’s something extra for you to trade for.  The bottom line is that production, not spending, is the key to prosperity. That’s why printing money or stimulating consumption doesn’t create jobs.  And as real estate investors, we want to invest where jobs are being created.  Because unless you’re renting to people subsidized by the government, your best tenants will need jobs to pay you rent. Now, back to our main feature….

Now if you, like Big Ben Bernanke, believe that borrowing is the key to prosperity, where do you think interest rates need to be?  Hint: LOW interest rates attract borrowers.  Sorry, was that hint TOO obvious?

Let’s get back to our Treasury auction.  Uncle Sam is there holding his bonds out for sale, but not enough buyers show up. So Uncle Sam has to start lowering his price (increasing the yield) and interest rates start going up.  Big Ben thinks this is bad.  So he gets out his Magic Checkbook and buys, say $600 billion of Uncle Sam’s bonds (does the term QE2 some to mind?), to help create some extra demand.  Shazam! Interest rates stay low.

Well, if you’re a government addicted to debt, deficits and spending, this makes you very happy.  Just like when the interest rate on your growing credit card balance stays low.  With low interest rates, you can borrow more for the same payments.  No need to cut spending. Let the good times roll!  The only thing better than low interest rates is an increase in your credit line (isn’t there some discussion about that?)

To summarize, when the Fed buys Uncle Sam’s Treasury bonds in the open market, the extra demand drives the bond prices up and their yields (interest rates) down.  Then, the ripple effect of interest rate pricing kicks in, as all riskier debt pivots off the interest rate of Uncle Sam’s “safest debt in the world”.  That is, if Treasuries pay x, then a riskier debt pays x plus a little bit more (usually denominated in “basis points”, which are 1/100 of a percentage. So 25 basis points is 1/4 of 1% or .25).  The farther away you move up the risk scale, the more expensive the debt is for the borrower.  This is why everyone has their undies in a bunch over Uncle Sam’s credit rating.  It he loses his coveted super-duper AAA rating, then interest rates go up….and Big Ben may need to step in with his Magic Checkbook.

But what happens when Big Ben uses his Magic Checkbook?  Are there any side effects we should be considering?  Hmmm….?  Inquiring minds want to know!

So join us next time, as we delve into How the Fed’s Purchase of Treasuries Affects the Money Supply.  Hint: “Trickle Down” isn’t just for supply-siders any more.

The Great Debt Ceiling Debate – Part 2

This is part 2 of a multi-part series on the “great debt ceiling debate” written as an accompaniment to our radio show broadcast and podcast, “Raising the Roof – How the Great Debt Ceiling Debate Impacts You”.  You can download the episode on iTunes or find it on our Listen page.

How does the Fed affect the interest rates on Treasury Bonds and why does it matter?

Good question.  We’ll divide our answer into three parts (though we won’t get to them all in this installment):

  1. How Treasury rates affect interest rates on mortgages, corporate and muni-bonds and most all other debt.
  2. How the Fed influences interest rates in the bond markets.
  3. How the money supply is affected when the Fed purchases Treasuries.

After all that (and you should go grab a double espresso to make you stay awake for the whole trip), we’ll talk about what happens if Congress raises the debt ceiling, and what happens if they don’t.  Then as a special prize for your time and attention, we’ll throw out our crystal ball prediction.  So go grab that espresso and hurry back!

1. How Treasury Rates Affect Interest Rates on Almost Every Kind of Debt

Bond prices are determined in the open market.  That means buyers and sellers coming together and negotiating a price.  In actuality, the negotiation is done by auction.  Think e-Bay.

When Uncle Sam (the Treasury) goes into the open market to sell bonds (borrow), investors bid on the bonds.  If there are lots of buyers, the bids go up, which drives yields (interest) down.

The Inverse Relationship Between Bond Prices and Yields

Time out.  Because we teach this at live seminars, this is where some people go “puppy dog” – their heads goes sideways and they get a confused (but cute) look on their faces.  Since it’s important that you understand the inverse relationship between bond PRICES and bond YIELDS, we want to take a minute to explain it.  It isn’t that complicated once you get the math, but it’s important that you understand because once you do, it’s easier to understand which direction interest rates are likely to go and why.

To use extreme examples with simple math:

If you pay $100,000 for a bond (a promise to pay) with a face amount of $100,000 and it yields 5% per year, then you earn $5,000 per year on your $100,000 investment.  If the bond has a 30 year maturity, then at the end of 30 years, you get paid the face amount ($100,000).  You earn interest along the way, then get paid the principal back at the end.  Pretty simple.

Here’s where it gets tricky.

If you have bought a $100,000 bond when yields were 5% and the market changes, then the fair market value of your bond changes.  That is, while the face amount and interest rate stays the same, what someone would actually pay you for your second hand bond in the open market (if you wanted cash now) will depend on what else is available to them at the time.

For example, if new bonds are yielding 10%, then a new $100,000 bond would pay $10,000 of interest per year.  That’s obviously better to the bond holder (the lender) than the $5,000 your old $100,000 bond is paying.

So if you wanted to sell your bond in the open market, you would have to discount it (sell it for less than the face value) until the yield was comparable to the going rate in the open market.  If you don’t, who would want to buy your “second hand” bond?  This is an important principle even if you couldn’t care less about Treasuries because it’s the same principal used with discounted notes, which is a staple for in creative real estate.  But we digress (how unusual!).

Back to bonds.  So if someone wanted a 10% yield on their cash and your bond is paying $5,000 per year, what do you have to sell it for to attract a buyer?  Do you remember the high school algebra you never thought you’d use?  It’s time to use it.

$5,000 = 10% of what?

The answer is $50,000.  Because 10% of $50,000 is $5,000.

Ouch!  That’s a big haircut.  Your $100,000 bond dropped in value to $50,000 in order to pay the same yield.

Now in the REAL world, it’s not that simple.  Because the $100,000 bond will still pay $100,000 at maturity, that also gets factored in.  But it makes the math too difficult for this article.  And then it gets more complicated, because smart investors are going to factor in inflation (the decrease in the purchasing power of the dollar over time).

For purpose of our current discussion, the main point is that when a buyer pays more for a bond, the yield goes down and vice versa.  So when lots of buyers show up (high demand) at a Treasury auction, interest rates go down.  Conversely, when there are few buyers (low demand), interest rates go up.  If you didn’t track with that, take a sip of espresso and a deep breath (not at the same time or you’ll choke), then read it again and noodle through it.  Trust us.  This is important for you to understand, not just as a real estate investor, but as a taxpayer and a voter.

Now the bonus lesson is that when interest rates rise, the value of the bonds you already bought goes down.  Back in March, Bill Gross, the guy who manages the world’s largest bond fund (PIMCO), sold ALL his Treasuries.  Where do you think HE thinks rates are headed?

Treasuries as the Foundation of All Interest Rates

Now, let’s talk about how Treasuries affect interest rates on everything else important to you, like mortgages.

Because Treasuries are considered the world’s safest debt, imagine their yields (interest rate) at the center of a target.  Each ring away from the target is another type of debt.  The farther away you get from the center of the target (ultimate safety), the riskier the debt is.  And the riskier the debt is, the more the borrower has to pay to attract your money away from the center.  After all, as a bond investor, you’re only going to buy something less safe than a Treasury if it pays you better, right?

So you could say that the yields on Treasuries are the foundation for all debt pricing.  When Treasuries go up, it creates a ripple effect to all other debt offerings.  And all the money that people borrow, from mortgages, to cars, to credit cards, etc. all gets packaged up and sold to investors as various forms of bond (to say nothing of derivatives!).  It’s no surprise that the bond market dwarfs all other markets, including the stock market.  In other words the world is swimming in debt.

To bring it back down to earth so you can relate to it, think about it this way:  If you’re a real estate investor sitting on a portfolio of adjustable rate mortgages which you’re using to control millions of dollars of real estate, what happens to your cash flow if interest rates rise?  It drops.

And when more of your rental revenue is being used to pay interest, do you have more or less profit to invest in maintenance, repairs, improvements and new acquisitions? Less.

Take that same principle and apply it to a government.

When a government is sitting on a large portfolio of debt (bonds it has issued), big chunks come due (mature) constantly.  With each set of maturations, the bond holders expect to get paid the face value of the bond.  But where does the bond issuer (the borrower) get get the money to pay off the bond?

If you had a loan come due on a property, you would have to pay it from your savings (Uncle Sam has none), sell the collateral (US bonds are only secured by the “full faith and credit” of the government, so there’s no property to sell), or refinance.  Bingo!  Uncle Sam needs to borrow more.  Just like if you were spending more than you earn and running up your credit cards.  You need the credit card company to raise your credit limit, so you can borrow more to pay off the old credit cards.

And how does Uncle Sam borrow?  He sells bonds in the open market.

Now if current interest rates are higher than the rate of the bonds being paid off (retired), then the interest payable on the freshly issued bonds will be higher, and the debt service (interest payments) will take a bigger bite out of revenue.

But if you, or in this case, Uncle Sam, are already upside down (negative cash flow, i.e., budget deficits), then the rate at which you must borrow increases.  You’re borrowing to pay interest on borrowed money.  It’s a crushing, compounding effect.

Do you see a problem?  It’s a vicious cycle of continual, perpetual debt.  And you either have to find a way to out produce the problem (earn a lot more, as in higher taxes) or you have to make drastic cuts, or both.

That is, unless you have a Magic Checkbook (oooh, ahhh). And wouldn’t you like to know what a Magic Checkbook is?

Join us next time for the next exciting installment of The Great Debt Ceiling where we will discover How The Fed Influences Interest Rates and The Secret of the Magic Checkbook.  Don’t miss it!

Now please pick up your trash and move in an orderly fashion to the exits.  See you next time!

The Great Debt Ceiling Debate – Part 1

This is part 1 of a multi-part series on the “great debt ceiling debate” written as an accompaniment to our radio show broadcast and podcast, “Raising the Roof – How the Great Debt Ceiling Debate Impacts You”.  You can download the episode on iTunes or find it on our Listen page.

As the debate rages on about whether and how to raise the U.S. debt ceiling, it’s hard not to have any discussion of the topic degrade into political diatribes.

But as real estate investors, we’re not too concerned about what the policymakers SHOULD do (since we don’t have any direct control anyway).  Instead, we’re much more focused on what IS happening, what is LIKELY to happen, and what we can do in response to avoid loss and/or create a profit.

In short, we refer to discussions about opinions about what should or shouldn’t be done (or who’s to blame) as “political” discussions.  After all, politics is a pretty “shouldy” business.  But you already knew that, didn’t you?

We prefer that our discussions be more practical in terms of what’s likely to happen and developing a plan A, B or C to react to it.  We may have political opinions (some of which leak out from time to time), but you know what they say about opinions: Opinions are like armpits.  Everyone has them and most of them stink.  We don’t have to like each others’ political opinions to enjoy a healthy conversation about what’s happening and how it affects real estate investors.

Since the debt ceiling debate is a complex, polarizing topic with huge global economic consequences, we thought it was worthy of a bigger discussion than our regular broadcast blog.  So strap on your reading glasses and get ready for a big discussion.  And be sure to listen to the podcast on this topic also.  It doesn’t replace this article, but it will help if you’re new to all of this.

We STRONGLY encourage you to plow through it all because the discussion of the U.S. debt and financial system has a DIRECT impact on interest rates, availability of loans, job creation (the best tenants have jobs), wages and the value of your real estate – Just a few things that are probably pretty important to you.

In a Rising Tide, All Ships Rise and Vice-Versa

We all found out a few years ago that no matter where or what kind of real estate boat you were floating, when the MBS (mortgage backed securities) money drained out of the tub, values dropped.  Really astute investors paid attention to the macro trends BEFORE this happened and drained their own equity while the tide was still high (back in 2005 we did some shows on “equity hedging strategies”, which you can find in the Backstage archives).  The rest of us learned (the hard way) that we better pay closer attention to the big picture for next time.

The big question is: will there be a next time?  That is, will real estate values rise again?  If real estate is down, never to rise again, then you can still make money, but you need to approach the problem differently.  If the tide of currency (the money supply) rises, then real estate values are likely to rise over time and you would structure your portfolio accordingly.

So what’s LIKELY to happen? And how does the debt ceiling debate impact you?

You could say that prices are so low they can only go up.  Just like at the peak, when people said that prices were so high they could only go down.  Those are nice sayings, but even a broken clock is right twice a day.  What are the economics behind the predictions?  Is it all such a complicated mystery that merely guessing or listening to the loudest voice is the only way to know?

No.

Here’s the good news.  You can understand all this.  In fact, you may be surprised at how easy it is.  So the goal of this series of articles and the accompanying podcast is to give you a basic understanding of “the mechanics of the money”, so you can begin to plot cause and effect, then decide for yourself what you think will or won’t happen.  But keep in mind, the best strategy will consider all possibilities.

At a recent conference, we heard a quote that has become one of our favorites:

“Better to prepare, than to predict” – Henry Brock

So in this series we’ll take a look at what happens if the DO raise the debt ceiling and what happens if they DON’T.

Of course, who can resist the temptation to predict?  So, at the end, we’ll go out on a limb and make a prediction.  Just keep in mind that our prediction is just our own opinion, and probably about worth what you paid for it. 😉

Ready?  Here we go.

The U.S. Money Supply

First, let’s talk about how money gets into the U.S. system.  When the government needs money, the Treasury either taxes (takes it from the productivity of the people) or borrows (pledge the future productivity of the people).  Since the government has a chronic problem of spending more that it takes in (does that happen?), it’s no surprise that they both tax AND borrow.  In fact, most of the taxes go to pay the interest on the debt.  But no matter how you slice it, the productivity of the people pays the bill.

When Uncle Sam borrows, he writes IOU’s called bonds and sells them in the open market.  Uncle Sam’s bonds are called Treasuries and, at least up until recently, Treasuries have been considered the safest debt you can buy.  After all, they’re backed up by the “full faith and credit of the U.S. Government”, which is really an euphemism to say “the full power and authority of the I.R.S. to tax the earnings of the most productive people on the planet”.

Do you feel any temptation to talk politics?  Stay calm.  Keep your arms and ammunition in the vehicle until the ride comes to a full and complete stop.

So who buys Uncle Sam’s IOU’s?  Lots of people.  Private investors, banks and foreign governments to name a few.  Over the last several years, China has purchased trillions and is now the largest single foreign holder of U.S. debt.  Recently, there’s been another big buyer whom we’ll talk about momentarily.  But for now, let’s talk…

Interest Rates

If you’re already bored reading all this, just think about how important interest rates are to you.  From your savings account, to your mortgage, to your credit cards, to your car loans and all your investment properties, interest rates affect what you earn and what you pay.  More importantly, interest rates are at the heart of the great debt ceiling debate and the motivation behind much of the Fed’s monetary policy.  So stick with us, even if you’re not sure how the Fed’s policies affect you.  You’ll know before this is over.

Interest rates are the price the lender charges for the risk of making the loan.  That’s why if you have bad credit or bad collateral, the rates are higher.  Common sense, right?

But interest rates are also a function of supply and demand.  This means that when there’s lots of money to lend, but not too many borrowers, rates are low.  The lender lowers the price to entice you to borrow.  Low rates encourages borrowing.  High rates encourages saving.  Think about that one.  But not for too long, because we need to move on.

Conversely, if a borrower wants ( really needs, is desperate, etc.) to borrow, he may have to offer a higher interest rate to attract a lender’s money.  In other words, if there’s a big demand for loans, but not many lenders willing to lend, the interest rate a borrower must offer to a lender will rise until someone wants to buy the debt (make the loan). So far so good?

The Bond Market

Remember: Bonds are debt.  So when someone buys a bond, they are effectively lending to the bond issuer.  So when Uncle Sam wants to borrow, he goes into the open market to sell bonds.  This is elementary to some of our audience, but less so to others, so in keeping with our “no investor left behind” mantra, we wanted to make that clear before moving forward.

Now, let’s talk about that other big bond (debt) buyer we mentioned earlier: The Federal Reserve or “The Fed”.  That’s the private (as in, not Federal) network of international banks (that is, not U.S.) whose leader is  appointed (that is, not elected).  How accountable is the Fed to the United States citizenry?  You don’t want to know.  Let’s just say, not very.

Contrary to popular myth, the Fed does NOT set interest rates – at least not directly for things like Treasury Bonds.  The interest rates the Fed sets are the rates at which the banks do business with each other. There’s two: the discount rate (what banks pay when they borrow from the Fed) and the federal funds rate (the rates banks pay when they borrow from each other).  We’re not going to talk about those now because they have nothing to do with the debt ceiling or Treasuries. Well, that’s not entirely true, since Treasuries are competing with banks for the savings of all the “A” students who produce more than the consume and save the excess.  So if the Fed wants Treasury rates low, the banks better be low too, or people would put their money in FDIC insured savings accounts.

Hmmm….there seems to be a relationship between the Fed, the banks and the bond market.  This would be a fun topic to explore, but we’ll leave that to you for extra credit.  For now, we just don’t want you to confuse the rates the Fed sets directly (the Discount Rate and the Federal Funds rate) with how yields (interest rates) are established in the open market where bonds are sold.

Summary of Key Points

  • Money gets into the system when the Fed purchases U.S. Treasury Bonds
  • Interest are determined in the open market by supply, demand and risk versus reward
  • Private investors, including the Fed, purchase U.S. Treasury Bonds, effectively lending to Uncle Sam
  • U.S. Treasuries are considered the safest of all all debt (so far) and are the basis for virtually all other bond offerings, with higher risk investments paying higher interest rates

In our next scintillating article in this series, we’ll discuss the mechanics of how the Fed affects interest rates on Treasury Bonds and why you should care. Don’t miss it!

7/24/11: Raising the Roof – How the Great Debt Ceiling Debate Impacts You

The U.S. debt ceiling debate of 2011 is one of the biggest financial stories since the mortgage meltdown set off a chain reaction of quantitative easing, government stimulus and swelling deficits.

For the average person, a lot of this is so big and far away from Main Street, that watching, waiting and wondering seems like the best you can do.  A few real adventurous souls are lighting up social media with political rhetoric and semi-serious calls for revolution.

But we’re just real estate guys.  Politics is about what SHOULD happen and who’s to blame when things go sideways.  We prefer a more practical discussion about what IS happening, what is LIKELY to happen and what we can do in response to either avoid loss or make money (or both!).  Let the politicians and the pundits solve the mysteries of the universe.

In the studio for a practical discussion of the great debt ceiling debate:

  • Your practically perfect host, Robert Helms
  • The partially politically incorrect co-host, Russell Gray

For this episode of The Real Estate Guys™ Radio Show, we take a look at the debt ceiling debate and what it potentially means for real estate investors.  And if you happen to be listening after some or all of the dust has settled, it’s still worth tuning in because this isn’t the first time Uncle Sam has faced this dilemma.  And it’s a safe bet it won’t be the last time.

Meanwhile, for those that are glued to their TV set watching the whole sordid affair unfold, we took some time and prepared a series of blogs on this issue.  Well, okay.  It’s more like a mini-book.  But if you’re interested in understanding how the deficit, the bond market, the Fed, interest rates and inflation are all inter-related, them watch for our special series of articles on The Great Debt Ceiling Debate.

Listen Now:

The Real Estate Guys™ Radio Show and podcast provides real estate investing news, education, training and resources to helps real estate investors succeed.

7/17/11: Creative Solutions to Today’s Property Problems

If necessity is the mother of invention, then surely distress is the mother of creativity.

It’s an age old principle in personal development: hard times have the potential to bring out the best in people depending on their mindset and peer group. The Bible says in James for believers to “count it all joy” when hard times come because that’s how faith is built.  Football teams bond during “hell week” at training camp in the heat of the summer.  Heroes are born against the backdrop of horrific tragedies such as natural disasters, terrorist attacks, or the deadly skirmishes of war.  It’s the quintessential pearl being formed in response to the irritation of the sand sand in the oyster’s shell.

For some real estate investors, the last few years have been difficult (to say the least!).  Many took horrific losses and lots of “wannabe” investors threw in the towel and quit.  But some investors have used the experiences to learn valuable lessons and develop creative ways to push through and find profit opportunities in the rubble.

And though the economic repercussions of the mortgage meltdown are still with us, it isn’t the dominate headline of a few years ago.  People are focusing forward, markets are slowly healing, and life goes on.

For the active real estate investor, the creative juices which were released during the disaster continue to flow. It’s that creativity that makes deals happen when lending is at a standstill.  For those who master the art of creative real estate, these are some of the most exciting times in recent memory!

For this episode of The Real Estate Guys™ Radio Show, we invited a guy who’s been finding interesting ways to close deals and generate profits – even in a “bad” economy.

In this studio for another exciting foray into the wonderful world of real estate investment talk:

  • Your host and creative genius, Robert Helms
  • Co-host and grain of sand, Russell Gray
  • Special guest, creative real estate investor, David Campbell

When you can buy property for below replacement cost, you’d think it would be easy to figure out how to make money. Then again, when a property is that cheap, it’s usually for a reason.  So what should be obvious often isn’t as easy as you might think.  That’s why it takes creative investors to lead the way out of any down market.  When any schmo can buy a property, finding a deal is the critical skill.  But when it’s hard to do a deal, deals are plentiful – but only for those who know how to get the deal done.

Since there isn’t any cookie cutter magic formula for creative real estate investing and every deal presents its own unique set of challenges and opportunities, the investor with real world experience and a large network of creative advisors has a competitive edge.  Hard problems are often solved with a team brainstorming session, which is why having your own mastermind group is a huge asset.  For us, our mentoring club and annual Investor Summit at Sea™ are where we grow and spend quality time with our mastermind group.  Of course, you’re invited to join us in 2012 when Robert and Kim Kiyosaki , plus Rich Dad Advisor Ken McElroy, along with attorney Mauricio Rauld and international developer Beth Clifford (and some other soon to be announced special guest faculty) spend an entire week together to talk real estate investing aboard a cruise ship in the beautiful Caribbean.

For now, listen in as we discuss specific real life lessons in creative real estate with special guest David Campbell.

Listen Now!

7/10/11: Ask The Guys – Flip It Quick or Hold On Long?

The Real Estate Guys™ dove into the email grab bag and pulled out some more of your amazing questions!

In the broadcast booth for another exciting Ask The Guys odyssey:

  • Host and Mister Know It All, Robert Helms
  • Co-Host and Mister Know a Few Things, Russell Gray
  • A man who has forgotten more real estate than most of will ever know, The Godfather of Real Estate, Bob Helms

We threw all your emails in a hopper, tossed them all around, and then pulled out the ones that floated to the top.  There’s always more than we can process, but we try not to rush.  We’re into quality over quantity.

For this episode, we addressed several great questions, but camped out on one we thought was very relevant and representative of a lot of the questions we get.  The gist of it is:  When you see a great deal with instant profit (“found equity” we like to call it), room for improvement (an opportunity to “force equity”), and it’s in a strong rental market (what’s not to like so far?), do you flip out of it for the quick bucks….OR take it long and slow, enjoying positive cash flow and long term equity growth?

Decisions, decisions!

To complicate the thought process, what about the current state of lending?  After all, a lot of the tools we used to have to liquidate equity have changed – or don’t even exist!  Then there are the tax ramifications to consider…

So much to talk about and so little time!

Listen in as Robert, Russ and Bob contemplate the quandary of quick cash now versus long term cash flow – all in the context of “compared to what?”!

To get your questions in for the next exciting episode of Ask The Guys, use our (are you ready?) Ask The Guys contact form.

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