Freedom, responsibility, opportunity and hard work …

We’re a little late with this week’s muse … we’ve been busy finishing up an EPIC collection of interviews for our soon-to-be-released COVID-19 Crisis Investing Webinar Series.

The original plan was to do a simple webinar with a collection of our big-brained friends. It turned into a MUCH bigger undertaking … in a GREAT way.

Obviously, there’s a LOT happening in the economy and financial system right now …

… and the issues are much deeper than debates about wearing masks … or whether tearing down statues falls under the heading of peaceful protests.

Meanwhile, as Americans head into our Independence Day celebration, there’s a lot to think about … both at the macro-policy level and the micro-investing strategy level.

Remember … your business and investments operate inside a complex, yet delicate ecology made up of people, resources, organizations, policies, procedures, and a physical environment which sometimes tosses a curveball.

Like your body, this ecology is a finely tuned machine … and though it’s often flexible and resilient … it has its limits.

Injury, disfigurement or worse are often on the other side of exceeding limits. Pain is usually the telltale sign you’re approaching the danger zone.

Ignoring the warning signs almost always ends badly. Yet even mature adults revert to childlike “covering their eyes” trying to hide from scary realities.

You can ignore reality, but you can’t ignore the consequences of ignoring reality.

Of course, pessimists only see the downside and are often paralyzed.

Optimists see only the upside … and sometimes get blindsided by dangers which are obvious in hindsight. We know. We’ve done it.

As real estate investing legend, Sam Zell says … the secret to success is the ability to pursue the upside while keeping the downside in view so it can be managed.

In other words, Sam Zell is a realist … which is probably an appropriate word for a successful real estate investor.

Our world is FULL of downside right now. Pain is everywhere.

It’s fairly obvious that people, businesses, markets, financial systems, and even society itself are all approaching their limits.

Will they bend or will they break? If they break, what does that look like? Do YOU have a plan?

Not only are those frightening contemplations, they’re hard work.

But if you love the freedom to pursue opportunity, own property, build wealth, and retain and enjoy the fruits of your efforts, it’s hard work you’ll need to do.

“Most people do not really want freedom, because freedom involves responsibility, and most people are frightened of responsibility.”
– Sigmund Freud

“If you don’t design your own life plan, chances are you’ll fall into someone else’s plan. And guess what they have planned for you? Not much.”
– Jim Rohn

“Power over a man’s subsistence is power over his will.”
– Alexander Hamilton

(That last one is a little disturbing in a “lockdown” world …)

The challenges all freedom-loving entrepreneurs and investors face in this current crisis are multi-faceted but can be distilled into a few macro and micro components.

In the macro, this could be the endgame for the 49-year experiment of a global debt-based financial system.

Or maybe it’s just a bigger crash on the way to some future endgame.

Most of the bright folks we’ve talked to think the system most of us have operated in for virtually our entire lives is dangerously close to collapse and reset (again) …

… or perhaps even full-blown replacement.

All of which begs the questions … what’s going to happen in the macro and how do you prepare in the micro?

Of course, no one knows what’s going to happen, so it’s important to analyze and anticipate possibilities and probabilities.

It may seem complicated, but it’s really a simple, though potentially catastrophic, sequence of events.

It’s important to be mindful of where we are in the process … and how likely we are to advance the next level of “yikes”.

The health crisis led to the economic shutdown, which has the potential to create a financial system crisis or collapse.

So the Federal Reserve is risking a currency crisis (or collapse) by printing many trillions of dollars trying to stop it.

Will they succeed? And if they don’t, when will we know and how will it impact all of us?

More importantly, what can we each do to prepare for a worst-case scenario?

These are the issues concerned investors are wrestling with … and the subject of our conversations both on and off the mic with our COVID-19 Crisis Investing Webinar Series faculty.

For now, here are some important concepts and actions to consider …

Incomes, whether active or passive, are based on economic activity. When commerce stops, so does revenue, and consequently rents and loan payments.

You might be a little late to the party, but if you don’t have solid liquid reserves, it’s something you probably want to get in place quickly.

The longer this crisis continues, the more likely your revenue will be negatively impacted. Liquidity is essential when revenue wanes.

Liquidity is also a VERY powerful tool when credit markets seize … often taking asset prices down with them.

The best bargains are often found by brave, bold, and liquid investors in the pit of a financial crisis.

Meanwhile, at the macro level, all those missed payments could create major problems not just in credit markets, but the banking system too.

Remember … there were already symptoms of a sick banking system just a few months before the COVID-19 crisis came to light.

And now with big debtors like Chesapeake Energy and Hertz leading a parade of bad debt and corporate bankruptcies …

… the Federal Reserve is printing dollars to not only buy up corporate debtmunicipal debtmortgages …

… but some allege the Fed is indirectly supplying freshly printed dollars to prop up stock prices.

We don’t know. But it seems like there’s a WHOLE lot of printing going on. The big question is whether the dollar is strong enough to endure this severe dilution.

Meanwhile, it seems clear credit markets are full of potentially toxic assets no one but the Fed will buy. That’s a significant warning sign.

So, at the micro-level, consider your dependence on and exposure to credit markets and the banking system.

You might find your credit lines being cut off or reduced without warning through no fault of your own. That’s what happened in the lead up to 2008.

And if you’re not familiar with the concepts of “counterparty risk” and “bail-ins”, this is a good time to expand your financial vocabulary. You may have both in your future.

Remember … these are unprecedented times.

Unimaginable things may not be likely (yet), but they’re definitely moving up the ladder of possibility.

Ignoring the possibilities doesn’t make them go away.

But unless the preparation itself is exorbitantly costly or complicated, it’s better to be prepared and not have a crisis than to have a crisis and not be prepared.

After all, inconvenient or novel isn’t the same as costly or complicated.

Many people are counting on their “leaders” and “advisors” to tackle the tough tasks, stand the night watch, and provide adequate warnings.

Maybe not such a good plan.

So as we consider what America’s founders sought to accomplish when creating the United States of America, it’s important to remember …

… the American system was built by and designed for people who wanted massive freedom and are willing to accept massive responsibility to obtain and retain it.

“Those who would give up essential liberty to purchase a little temporary safety deserve neither liberty nor safety.”
– Benjamin Franklin

This freedom … to own businesses and property, speak freely and debate ideas, succeed and fail based on individual effort and ingenuity versus a pedigree or birthright …

… are all based on one singular foundation: individual freedom and personal responsibility.

We can debate whether this is the best system, but the founders made it clear …

“Our Constitution was made only for a moral and religious people. It is wholly inadequate to the government of any other.”
– John Adams

Of course, the freedom we have allows us to debate the details of what morals and religions are best … and those are debates worth having.

But the core basis of both morals and religion are generally accepted to be personal responsibility.

We think it’s clear we’re in Act Two of a four phase cascading crisis.

And while we’re all in this together, we’re each individually responsible to mind our own business first. Just like when the oxygen masks drop in a crisis on an airplane.

So JOB ONE is to get into and stay in a position of excess strength, wisdom, time, and capacity so you can help those in your sphere.

Because if everyone is waiting for somebody to do something then nobody does anything. That’s obviously not good … and a weak, desperate society is often taken advantage of.

So we encourage you to work diligently on what you can control so you’re better positioned to respond strongly to the many things you can’t control.

Study, think, act, learn, and then share your wisdom with the people around you.

This isn’t the time to be passive.

The next stop in the coronavirus cascading crisis tour …

If you’re tired of hearing about the COVID-19 coronavirus crisis … get over it.

We’re on the front end of a series of cascading crises that will likely affect every investor on the planet … including YOU.

Pretending it’s not happening … or blindly trusting the great and powerful wizards behind the curtains … or pulling the covers over your head and hoping for the best …

… will NOT make any of it go away.

Of course, HOW it affects you could depend on how well you pay attention, understand what’s happening, and take effective action.

There will be WINNERS … and LOSERS.

We’re far from experts, but we’re fortunate to have access to some of the smartest folks on the planet. And they’re ALL monitoring the crisis VERY closely. Seems like a good idea.

As you may know, we’re organizing an EPIC mega-webinar featuring discussions with MANY of our big brained friends to find out what they’re seeing, thinking, and doing.

We realize you’re being bombarded with information … we all are … so rather than just pile more on, let’s focus on creating some context to process all the info better.

It’s important to think about how the crisis is likely to spread …

What started out as a health crisis quickly mutated into an economic crisis as cities, states and nations worldwide virtually shut down in unison.

These lock-downs have suppressed both the supply and demand for all kinds of good and services.

Because the decreases in production and demand aren’t perfectly synced, there have been both shortages (toilet paper) and gluts (oil) … the effects of which range from inconvenient to devastating (no toilet paper?!?).

But that’s just the beginning …

Lock-downs stop revenue, profits and paychecks … which stops debt service.

This is where the economic crisis mutates into a financial system crisis. 

But unlike toilet paper and oil, the signs of stress in the financial system are harder to see. That’s why financial system failures blind-side many Main Streeters.

Yet there are many clues in the news IF you know what to watch for.

It starts with obvious headlines …

Coronavirus-caused spike of homeowners in forbearance surges on
– Fox Business via Yahoo Finance, 5/4/20

Of course, this surprises no one.

When people don’t have jobs and incomes, they can’t make mortgage payments. For those old enough, this elicits flashbacks to 2008.

Except now, it’s not just mortgages. It’s corporate debtconsumer debtmunicipal debt, public and private pensions, and much more.

Basically, virtually all IOU’s everywhere are in danger of going bad.

This is counter-party risk … when your asset is someone else’s liability … if they fail to perform, your asset loses some or all of its value.

Even your bank account (your asset) is your bank’s liability (they owe you). If the bank fails and you have more than the insured amount, YOU could have a problem.

Counter-party risk is EVERYWHERE in today’s debt-based system.

Yet while bad debt is one level of awful, it gets worse when gamblers in the Wall Street casinos use derivatives to magnify their gains.

Of course, the extreme leverage created through derivatives cuts TWO ways.

Sure, extreme leverage turns tiny gains into massive profits … but it can also turn bad bets into a systemic crisis.

We’ve gotten into the weeds of how all that works in the past, so we won’t rehash it now.

But the first clue in the news indicating stress in the financial system is when asset prices are falling and cash is running low …

… as everyone is madly selling everything and the kitchen sink to raise cash to cover margin calls on their bad bets.

Of course, that’s also when quality assets get caught in the downdraft, so if you’re aware and prepared (i.e., liquid), you can step in and snap up bargains.

Which leads to another clue in the news … savvy investors sitting on huge war chests of cash.

According to a recent Bloomberg article …

“assets in money-market funds have soared to a record $4.77 trillion amid a flight to safety by investors this year.”

Business Insider reports Warren Buffet’s Berkshire Hathaway has a record $137 billion cash pile.

Yet as Buffet explains …

“Berkshire’s cash pile isn’t overkill given the cataclysmic risks posed by the coronavirus pandemic.”

(Buffet is the same guy who called derivatives “weapons of mass financial destruction.“)

Now, with all these demands for cash, it isn’t surprising to see headlines hinting that there’s not enough to go around.

Interestingly, as you may recall, the current cash crunch didn’t grow out of the coronavirus crisis. It preceded it.

We noticed this back in September when the Federal Reserve started pumping billions of dollars per day into the repo market.

(The repo market is like a pawn shop for banks to hock T-Bills for dollars.)

Since then, the Fed has injected trillions of dollars directly and through Uncle Sam … driving interest rates down to zero … and perhaps negative …

… and stepping in to buy debt no one else can or will, including U.S. Treasuries, and now for the first time ever, corporate debt.

This is very similar to how the Fed put in a bottom to the free-falling mortgage-backed securities market back in 2008 … except WAY bigger.

All this suggests the financial system could be far more stressed than the wizards behind the curtain let on.

Which brings us to the final stop in our progression of dominoes from health crisis to economic crisis to financial crisis …

… a dollar crisis.

As we’ve been pointing out, the financial bondo the Fed is slathering all over the dents in the economy and financial system are dollars.

ALL the pressure is on the dollar, which should concern EVERYONE who earns, owes, spends, and denominates wealth in dollars.

The coronavirus health scare alerted the American politicians and public to a sick dependency on China for critical supplies like masks and medicines.

Naturally, Americans are uncomfortable with this dependency and lawmakers are preparing bills to bring the medical supply chain back to the USA.

Of course, as real estate investors, this interests us because it could mean the creation of new jobs in whatever regions land these factories.

But our point today is that just as Americans realize they don’t want to depend on an adversary for something as critical as life-saving medicines …

… Chinese (and Russians and others) similarly don’t want to depend on the U.S. for something as essential to commerce and prosperity as currency.

So as we first pointed out way back in 2013 in our Real Asset Investing Report, and later updated in our Future of Money and Wealth presentation, The Dollar Under Attack …

… the calls continue for a global alternative to the U.S. dollar as the world’s reserve currency.

And with the Fed conjuring trillions of new dollars out of thin air to prop up sagging asset prices, hold together collapsing credit markets, backstop virtually all insolvent corporations, states, plus the federal government, and suppress interest rates …

… the final stop on this cascading coronavirus crisis tour could be a dollar crisis.

So don’t get tired or bored of watching a slow-motion train wreck. Slow means you have time to get out of the way.

If you’ve been asleep up until now, it’s time to wake up. Because things are picking up speed.

Are you aware and prepared? Stay tuned …

At this rate, something’s gotta give …

Real estate investors tend to like low interest rates.  

After all, low rates mean lower payments for the same size mortgage … or a bigger mortgage for the same payments.  Nice.

The current Wizard of Rates is Fed chair Jerome Powell.  And he just showed up on 60 Minutes and told everyone …

“‘We don’t feel any hurry’ to raise rates this year.”

Many Fed followers consider this a bit of an about face.

And those who use the Fed’s actions as a barometer of economic health and stability are asking what this more dovish stance means.

After all, isn’t the motive of low rates to goose a sluggish economy?  So then what’s all that healthy economy talk?

Also weird is that just over six months ago, Powell stood at a podium and defended his plan to RAISE rates.

Then two months ago he said, ‘The case for raising rates has weakened …”

Last summer, he apparently couldn’t see six months ahead … and now all of the sudden he’s clear for a year? 

Maybe the answer is here …

Fed Chair Powell: ‘The US federal government is on an unsustainable fiscal path’
– Yahoo Finance, 2/26/19

Summit faculty member Peter Schiff constantly reminds us … the economy is addicted to cheap money and Uncle Sam is addicted to spending.

Of course, addicts … and their enablers … sometimes take extreme steps to keep the party going.

So that could mean more money printing … because that’s how the Fed keeps rates down.  And as any debt-ridden household knows, lower interest rates help make a giant debt load a little easier to service.

That’s probably more important than anyone’s letting on.

Because with record corporate, consumer, and government debt … there’s a lot of cheap money junkies out there.

So … maybe the Fed’s just trying to keep them all supplied?

Of course, we have no way of really knowing what data or philosophy is driving Jerome Powell’s decisions.  We just watch and react.

But based on all the green lights flashing across stocks, bonds, oil, and precious metals … it looks like asset price inflation is the bet du jour.

At least for now.

But even though it’s party time in the Wall Street casinos, real estate investors need to play the game differently.

We don’t have the luxury of jumping in and out of positions on a moment’s notice.  Besides, that’s not our game.

We’re not trying to buy low and sell high.  Real estate investors work to find a spread between the cost of capital and the cash flow on capital invested.

So let’s switch from the macro view and get a little closer to Main Street … and glean some lessons from self-storage investors.

But before you tune out, this isn’t about self-storage … it’s about how real estate investors are reacting to an big influx of capital. 

Because as cheap capital floods any market (niche, geography, asset class) it affects prices and yields.   So sooner or later, investors move around searching for opportunities.

And that’s what’s happening in self-storage … 

Self-Storage Investors Start Looking at Smaller Markets to Capture Higher Yields
National Real Estate Investor, 3/11/19

This headline caught our attention because of what the Fed is doing with interest rates.  And as we dug deeper, we found some notable excerpts …

“Investors are being more careful about which assets to bet on …”

“ … worried about the number of new … properties …”

 “To avoid competition from new properties coming on-line … buyers have turned their attention to secondary markets …”

“ … buyers in overbuilt markets are taking more time to underwrite their deals, double-checking assumptions about future leasing and rent growth.”

There’s more, but let’s stop and process these thoughts …

First, these are lessons investors in ANY income-property niche should take note of.  So it’s not just about what’s happening in self-storage.

Notice the attention to supply and demand. 

We see lots of rookie real estate investors crunch the numbers of the property … but completely ignore the inventory pipeline of the market.

And of course, there’s also the supply of prospective renters in a market.  That’s why we also look at population and migration trends.

The article also highlights something we’ve been talking about for a while …

People, businesses, and investors will “overflow” from mature primary markets into emerging secondary markets in search of affordability.

The danger is getting into an emerging market ahead of a migrating problem.

Think about it …

If investors are moving into secondary markets to find better opportunities than in an over-built market … what happens when builders move in for the same reason?

Cheap money makes building easy.  Developers love it.

But Austrian economists warn of “malinvestment” … when bad investments look good primarily because money is cheap.

All long-term debt needs stable long-term cash-flow to service it.  If supply exceeds demand, and rents and cash flows fall … debt can go bad fast.

So when looking at markets, pay attention to the capacity of market to absorb more inventory without collapsing rents.

Because if you go in with optimistic underwriting (tight cash flow) and supply expands faster than demand and rents fall … you could be in trouble.

That’s why self-storage investors are “taking more time to underwrite their deals”.  Maybe you should too.

Hot markets can be intoxicating for investors.  It’s easy to jump on a hot trend hoping to catch a nice ride …

Despite these worries … investors keep paying higher and higher prices … relative to income.  Cap rates … are at their lowest point on record.”

“They continue to trend lower even though interest rates have begun to rise …”

“There is a tremendous amount of capital chasing yield.

That’s what happens when interest rates are low.

Don’t get us wrong.  We’re not complaining.  We like low-cut interest rates as much as the next guy.  But hot markets can be fickle. 

So the moral of this muse is to stay sober and diligent about your underwriting … and be very wary of using short term money to invest long.

Until next time … good investing!


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The dichotomy economy …

Have you noticed a bit of division in the news … over just about EVERYTHING?

As you may know, we obsess on all things economic and how they affect Main Street real estate investors … and try to steer clear of the more divisive topics.

But even the financial news is a polarized collection of confusing banter.

On the one hand, we see reports about low unemploymentGDP growth over 4 percentrising consumer confidence, and record high small business optimism.

That all sounds awesome.

On the other hand, we read about record levels of household debtstagnant real wages, and growing government deficits … at a time when interest rates are rising.

Then there’s the ballooning corporate debtgrossly underfunded pensions even as boomers are retiring at 10,000 plus per day … and the hard-to-understand impact of a strong dollar on pretty much everything.

All that sounds mostly scary.

Sure, you could say it all blends together into a balanced and comfortable investing climate …

But that’s like saying if you have one foot in a bucket of boiling water and the other in a bucket of ice water … on average you’re comfortable.  Probably not.

But before you pull the sheets over your head and hope it all blows over, consider this pearl of wisdom from Atlas Shrugged author, Ayn Rand …

“You can avoid reality, but you cannot avoid the consequences of avoiding reality.”

Of course, we’ll never unpack all this with today’s simple commentary …

… but we hope to encourage you to watch what’s happening, get in conversations with similarly engaged folks, and consider how all these things can and do affect YOU and YOUR investing.  Because they do.

For now, let’s just take a VERY simple investing principle and see if it helps us make sense of this schizophrenic financial world …

Would you borrow money at 2 percent if you could invest it at 4 percent?

 Most investors and businesspeople would.  So on its face, the borrowing isn’t the big problem.  It’s maintaining a positive spread.

This is the world real estate investors live in … borrowing and investing at a positive spread.

Of course, it gets a little trickier when rates are rising.   But the fundamentals of the game remain the same.  When rates rise, you MUST increase earnings, or you lose.

So it’s not just how much you borrow, but what you do with the proceeds.  If you borrow to consume or retire less expensive debt, you’re in trouble.

If you borrow to invest in growth, to acquire higher-yielding assets, to start profitable businesses … debt can be your most valuable tool.

Right now, Uncle Sam is borrowing and spending at a wicked pace.  The multi-trillion-dollar question is whether the borrowing will pay off.

The most recent 10-year Treasury auction saw a record amount of U.S. debt offered and scooped up by investors … at a yield under 3 percent.

(We watch the 10-year because it’s the most correlated to mortgage rates)

So it seems bond investors aren’t overly concerned about Uncle Sam’s debt-levels and capacity to repay with a comparably valued dollar.  For now.

And in spite of the highly touted tax cuts, federal income tax receipts actually GREW nearly 8 percent in the first 10 months of 2018.

BUT … while income is up, deficits and debt are up MORE.

As investors, we understand it sometimes takes time for investments to pay off, so it’s probably not time to judge … yet.

However, this is something we’ll continue to watch carefully.

If the investments pay off, especially in a way that resurrects rust belt markets… there could be some serious real estate investing opportunities on the horizon.

If they don’t, and this is all just a debt-driven faux boom, the end game could be a collapsed currency, ugly recession, and interest rates even the Fed can’t hold down.

Of course, if all the “bad” stuff happens, there’ll be lots of quality assets available at fire-sale prices … for those with enough foresight to liquefy some “boom” equity and keep it at the ready.

Of course, probably the BIGGEST opportunity in either scenario is to have a large network of aware and prepared investors on speed-dial … so you can put together investment funds to ride the wave or pick up the pieces after a crash.

The bottom-line is …

… it’s not external circumstances that primarily control individual success or failure, but rather the individual investor’s awareness, preparedness, and propensity to ACT as circumstances unfold.

How are YOU preparing?

Until next time … good investing!

More From The Real Estate Guys™…

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