Adding fuel to the high housing price fire …

High housing prices continue to be a concern in many major markets.

While there are varying opinions on how to solve the problem, history says … and recent headlines concur … that adding fuel to the fire will be the likely “solution.”

Here’s how it works and why it’s likely to create a lot of equity right up until it doesn’t …

First, it’s important to remember prices are “discovered” when willing buyers and sellers meet in the marketplace and cut a deal.

Buyers want the lowest price and sellers want the highest. They meet somewhere in the middle based on the supply and demand dynamic.

When there are lots of buyers for every deal and a seller has the ability to wait for the best price, buyers compete with each other and bid the price up.

When there are lots of sellers relative to buyers, sellers compete with each other by dropping the price or offering more favorable terms and concessions.

Duh. That’s real estate deal making 101.

Of course, the real world is a little more complex … especially when you have powerful wizards working to manipulate the market for whatever reasons.

To our way of thinking, “capacity to pay” needs to be broken out of “demand” when looking at the supply and demand dynamic.

After all, if you’re crawling through the desert dying of thirst and you come across a vending machine with bottled water for sale at $100 per bottle, you’re probably willing to pay.

But if you don’t have any money in your pocket, limited supply and high demand alone don’t matter. You have no capacity to pay.

When it comes to housing, capacity to pay is a combination of income, interest rates, and mortgage availability.

To empower purchasers with more capacity to pay, you need higher real incomes, lower interest rates, money to lend, and looser lending guidelines.

Of course, these do NOTHING to help make housing less expensive.

In fact, they actually make housing more expensive because they simply increase the buyers’ ability to pay MORE.

Yet, this is where the wizards focus their attention. And to no surprise, they have an excellent track record of creating real estate equity (inflating real estate bubbles).

And that’s exactly why real estate is such a fabulous hedge against inflation.

While renters watch prices run away from them, owners ride the equity wave up … and up … and up.

And when paired with debt, real estate becomes a super-charged wealth builder … growing equity much faster than inflation, while still hedging against deflation.

After all, if you put $20,000 down on a $100,000 property and the price falls to $80,000 and NEVER recovers … eventually the tenants pay the property off.

Now your $20,000 investment has grown to $80,000 … even though the property deflated 20 percent.

But it’s hard to imagine any serious sustained deflation will hit real estate absent a catastrophic sustained economic collapse.

Of course, it’s probably smart to have some cash, gold, and debt free real estate as a hedge against catastrophe … but probably not the lion’s share of your portfolio.

That’s because the history and headlines favor higher prices over the long haul.

This brings up a very important point for every serious student of real estate investing …

The ONLY real way to truly lower housing prices in the face of growing population is to increase supply.

But there’s NO motivation for the wizards to reduce housing prices.

They’ll SAY they want to, but they can’t deliver.

Think about it …

No politician wants to face home-owning voters who are watching their home values fall.

No banker wants to have a portfolio of loans secured by homes whose values are falling.

And in spite of their sometimes-public spats, politicians and bankers have a long track history of working together to enrich and empower themselves.

So does it make sense that politicians and bankers are really going to do anything meaningful to cause housing prices to fall?

We don’t think so. All the motivation is to cause housing prices to rise.

And as we saw in 2008, on those rare occasions where housing prices fall, bankers and politicians rally to revive them as quickly as possible.

Your mission is to structure your holdings to maintain control if prices take a temporary dip. And of course, positive cash flow is the key.

Meanwhile, the Wizards are hard at work to make expensive housing more affordable …

This means fostering an environment to increase jobs and real wages, lower interest rates, loosen lending guidelines, and get more money flowing into funding mortgages.

Are these acts of frantic Wizards desperate to keep the equity rally going into an election year? Maybe.

But until and if a total financial crisis happens again (which you should be diligently prepared for) …

… we think the bubbliest markets will see softness, even as nearby affordable markets increase as priced out home-buyers migrate.

Nonetheless, keep in mind that real estate is not an asset class … even a singular niche like housing. Every market, property, and deal is unique.

So it’s possible to find deals in hot markets, and it’s possible to overpay in a depressed market. Think big, but work small.

And while the financial media complains about over-priced housing and rings the bubble bell, consider that if housing remains unaffordable to buyers, it only creates more demand for rentals.

The properties you lose the most on are the good deals you pass on because you’re focused on price and not cash flow.

Is the housing boom … like the stock market boom … late in the cycle? Probably. But that doesn’t mean there’s not a lot of opportunity out there right now.

Podcast: Clues in the News – Stocks, Negative Rates, Oil, Gold and You

Easy money is both a symptom and a sickness …

As of this writing, we’re not sure what the Fed will do with interest rates, though it’s widely expected they’ll cut.

So as much as we’d like to talk about what it means to real estate investors, we’ll wait to see what happens.

And even though mainstream financial media are finally paying attention to gold and the future of the dollar … these are topics we’ve been covering for some time.

But if you’re new to all this, consider gorging on our past blog posts …

… and be sure to download the Real Asset Investing report …

… and for the uber-inquisitive, check out the Future of Money and Wealth video series.

After all, this is your financial future … and there’s a LOT going on.

In fact, today there’s a somewhat esoteric and anecdotal sign the world might be on the precipice of its next major financial earthquake.

But before you go full-fetal, this isn’t doom and gloom. We’re too happy-go-lucky for that.

It’s more an adaptation of a principle from Jim Collins’ classic business book, Good to Great …

Confront the brutal clues.

Of course, the original phrase is “Confront the brutal facts.” But as great as data is, sometimes data shows up too late to help.

So, while facts may confirm or deny a conclusion … clues provide awareness and advance warning.

But just like with facts, you must be willing to go where the clues lead.

In this case, we’re just going to look at one clue which has a history of presaging a crack up boom.

For those unfamiliar, a crack up boom is the asset price flare up and flame out that occurs at the end of an excessive and unsustainable credit expansion.

In other words, before everything goes down, they go UP … in spectacular fashion.

Here’s a chart of the housing boom that eventually busted in 2008 …

See the bubble that peaked in 2007? It’s hard to miss … in hindsight. It’s hard to see when you’re in the middle of it.

Peter Schiff saw it in 2005 and published his book, Crash Proof, in 2006 to warn everyone. Few listened. Some mocked.

In 2008 it became painfully obvious to everyone.

Of course, for true real estate investors … those busy accumulating tenants and focusing on the long-term collection of rental income …

… asset prices are only interesting when you buy, refinance, or sell.

As long as you stay in control of when you buy, refinance, or sell … you can largely ride out the bust which often occurs on the back end of a boom.

And if you’re paying attention, you use boom time as prime time to prep … and the bust as the best time to buy.

Today it’s safe to say, just based on asset prices alone, we’re probably closer to a bust than another big boom.

But the current run-up could still have more room to boom. As we said, it’s hard to tell when you’re in the middle of it.

Shrinking cap rates are one of the most followed metrics for measuring a boom.

Cap rates compress when investors are willing to pay more for the same income. That is, they pay more (bid up the asset price) for the same income.

But when the Fed says low-interest rates are the new normal, maybe it means so are low cap rates.

It’s one of MANY ways Fed policy ripples through the economy … even real estate.

But there’s another sign that’s hard to see unless you’re an industry insider, and while not scientific or statistical, it still makes a compelling argument the end is nearing …

Lending guidelines.

Think about it … booms are fueled by credit. It’s like the explosive fuel which propels rising asset prices.

The only way to keep the boom going is to continually expand credit.

But any responsible head of household knows you can’t expand credit indefinitely … and certainly not in excess of your capacity to debt service.

At some point, the best borrowers are tapped out. So to keep the party going, lenders need to let more people in. That means lowering their standards.

We still have a “backstage pass” to the mortgage industry and see insider communications about lenders and loan programs.

When this subject line popped up in our inbox, we took notice …

24 Months of Bank Statements NO LONGER REQUIRED

To a mortgage industry outsider that seems like a lame subject line. But to a mortgage broker trying to find loans for marginal borrowers, it’s seductive.

It suggests less stringent lending criteria. Easier money.

Sure, the rates are certainly higher than prime money. But with all interest rates so low, they’re probably still pretty good.

And these are loans with down payments as low as 10% for borrowers just 2 years out of foreclosure or short-sale. Hardly a low risk borrower.

Usually, lenders want to see TWO years of tax returns and a P&L for self-employed borrowers. They’re looking for proof of real and durable income.

Not these guys. Just deposits from the last 12 months banks statements. And they’ll count 100% of the deposits as income, and won’t look at withdrawals.

So a borrower could just recycle money through an account to show “income” based solely on deposits.

The lender is making it STUPID EASY for marginal borrowers to qualify.

All of this begs two questions:

First, why would a lender do this?

And second, why would a borrower fabricate income to leverage into a house they may not be able to afford?

We think it’s because they both expect the house to go UP in value and the lender is growing increasingly desperate to put money to work at a decent yield.

Pursuit of yield is the the same reason money is flowing into junk bonds.

And if the Fed drops rates as expected, it’s likely even more money will move to marginal borrowers in search of yield.

Today, MANY things could ignite the debt bomb the way sub-prime did in 2008. Consumer, corporate, and government debt are at all-time highs.

Paradoxically, lower interest rates take pressure off marginal borrowers … while adding to their ranks.

It’s hard to perfectly time the boom-bust cycle.

But careful attention to cash-flow protects you … whether structuring a new purchase or refinance. It means you can ride out the storm.

Meanwhile, it’s smart to prepare … from liquefying equity to building your credit profile to building a network of prospective investors …

… so if the bust happens, you have resources ready to “clean up” in a way that’s positive for both you and the market.

No one knows for sure what’s around the corner … but there are signs flashing “opportunity” or “hazard”.

Both are present, but what happens to you depends on whether you’re aware and prepared … or not.

Until next time … good investing!

More From The Real Estate Guys™…

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Where We Are in the Cycle and What You Can Do About It

What goes up, must come down. 

It’s true in gravity … elevators … and the real estate market. 

The constant ups and downs can give investors anxiety. It’s hard to enjoy a boom when you’re always wondering … is it all about to come crashing back down?

The good news is that markets rise and fall in cyclical motion. 

History repeats itself … and there are signs and patterns to look for that signal when you need to move and when it is best to sit back and wait it out. 

Listen in as we discuss where we are in this infamous cycle … and what you can do about it.

In this episode of The Real Estate Guys™ show, hear from:

• Your upstanding host, Robert Helms
• His downright delightful co-host, Russell Gray 

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Riding and driving the cycle

Real estate markets work in cycles … we’re either at the bottom, in the middle, or at the top. 

So, where are we at? And what can investors do about it?

First off, it’s important to remember that real estate isn’t an asset class itself … there are so many different categories. 

Each of those categories operates in its own market … and the cycles don’t always align. 

Office buildings could be up while residential is down … and agricultural could be sitting right in the middle … ALL AT THE SAME TIME. 

So, when you think about where you are in a cycle, you need to think of both macro and micro levels. 

Part of what’s going on will be influenced by the macro … like interest rates, what’s going on with the Fed, tax breaks, and Opportunity Zones. 

The other part deals with the micro … what’s going on in a particular industry and the demographics it serves.

The challenge for a real estate investor is that there is no one key indicator for where the market is heading. In fact, it’s so confusing that nobody gets it completely right. 

But there are things you can look for … and things you can do … to set yourself up for the best chance of success. 

Understanding the big picture

One of the big picture items to look for, understand, and act on is interest rates. 

When we talk about real estate investing, it’s really all a derivative of income … of cash flow. 

Someone can only afford to pay a price for a house based on their income and how much income that will mortgage into the purchase price of a house. 

If you take a look at the major inputs going into a mortgage, you’ll find interest rates and tax consequences. 

So, if you can lower interest rates and lower taxes … the same amount of income will buy more houses. 

With the new tax code and incentives like Opportunity Zones, there is a good chance that the upside of the cycle will be extended for a few more years … but is it sustainable?

Understand that every day we’re closer to the next market top. 

So, what can you do as we get near the top?

Don’t sit on the sidelines

What you don’t want to do is sit on the sidelines. You do need to act. 

If you take prudent moves to protect yourself in the case of a downturn … and there isn’t one … you aren’t any worse off. 

The good news is that real estate investors and markets move slowly … we’re not flash traders. 

Your tenants don’t look at the newspaper, see a headline, and move the next day. 

As investors, it’s a balance of being aware of those macro events and keeping specific trends in mind. 

Right now, mortgage rates are low, and the dollar is relatively strong. Interest rates are dropping in treasuries … and people are buying there looking for a safe place to ride out market dips. 

This gives real estate investors the opportunity to go into the market and lock that low pricing and low interest rate long term. It’s like having a sale on money. 

And if you buy a property that has good cash flow with that low interest locked in, you’re putting yourself in a great spot to hold through any downturn in the cycle. 

People who sit on the sidelines are guaranteed to make zero return. Instead, look at the idea of recession resistant price points. 

Recession resistant means you are renting to a clientele that is likely to always be there … and the price point is typically something just below the median home price. 

Many of these recession resistant price points work great in a good economy AND they’ll also be a little more protective in a down cycle. 

This is a time to be super prudent when it comes to underwriting … both the analysis of the market and the performance of the property. 

When it comes to the performance of the property, there are a couple of big picture things to keep in mind. 

You want to live in a landlord friendly state. If there’s a problem, you want laws that favor a landlord and can help you get a tenant out quickly. 

You’ll also want to talk to your property manager about rental trends. 

What have people been paying in rent recently? How many people are applying for leases now compared to other years? Have they had to change the kind of tenant they accept?

Another way you can make the most of the market cycle is to focus on top markets. 

There are lots of investment funds and real estate investment trusts that focus only on the top 50 metropolitan statistical areas (MSAs). 

These are the top cities in the U.S. where there is always real estate movement and a depth of demand. 

When you go into a market that has already proven itself with solid infrastructure, there’s a greater probability that in tough times people will gravitate there. 

Changing your strategy for success

We’re certainly proponents of continuing to invest through cycles … just change your strategy a bit. 

It makes a lot of sense to have some cash when you are nearing the top of a market cycle for a lot of reasons. 

If you end up having problems with properties that perform differently than you expect during a downturn, you want to be prepared for that. 

But downturns are also often where opportunities are … opportunities to buy. 

As real estate investors, we make our money when we buy … so it is good to keep some cash in reserves if the right opportunity presents itself to invest in a property with promise.

One last idea to consider when it comes to being at the top of the market is that there are certain demographics that don’t suffer as much in a downturn. 

Generally, this is affluent groups of people. When times get bad … they get bad for the middle and bottom part of the socioeconomic ladder. 

So, it’s always an interesting strategy to market to the affluent. One of the ways we love to market to this demographic is through residential assisted living. 

Remember, your customer is not the person staying in the facility. It’s the family members who look out for them and place them there. 

Another strategic investment is hospitality. In downturns … the rich still go on vacation. 

Many times in an economic slump, entertainment does well because people are trying to get away from the doom and gloom. 

If you believe we’re at the top of the market, there are proven things to think through. 

Analyze your portfolio and ask yourself, “What happens if pricing and demand were to go down?” Take a look at your financing. Are you getting the best, lowest rates?

If you take proven steps now, when the market cycle starts heading downward … you’ll be glad you did.

Tune in over the next several weeks as we dive into more strategies you can take to thrive even when the market isn’t doing the same.

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

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Main Street needs Main Street investors …

China’s ready to launch …

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More From The Real Estate Guys™…

• Sign up for The Real Estate Guys™ Free Newsletter and visit our Special Reports library.
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• Stay connected with The Real Estate Guys™ on Facebook and our Feedback page.

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

When it rains, it pours …

If you’re a mass consumer of financial punditry as we are, you’ve probably heard the term “black swan”. 

In the context of investing, a black swan is some completely unexpected event that has a substantial impact on financial markets and investors …

… like back-to-back mega-hurricanes which wreak many hundreds of billions of dollars of damage.

Even as the millions of affected people are working through the enormous task of sorting through the damage and cleaning up the mess …

… investors far away from the stricken areas are assessing the potential ramifications of these huge and unexpected events.

As we discussed in a recent broadcast, there’s certainly opportunity and a role for investors to play in helping these areas bounce back from disaster.

But it could be the affliction isn’t purely physical.

Consider this recent CNBC headline … 

Harvey’s hit to mortgages could be four times worse than predicted—and then there’s Irma

“As many as 300,000 borrowers could become delinquent on their loans after Hurricane Harvey …”

“The sheer volume of homes hit by Hurricane Irma will likely cause an increase in mortgage delinquencies as well …”

The article references a report produced by Black Knight Financial Services … so we took a look and found these notable excerpts:

“More than 3.1 million properties are now included in FEMA-designated Irma disaster areas, representing approximately $517 billion in unpaid principal balances.”

“Harvey-related disaster areas held 1.18 million properties – more than twice as many as with Hurricane Katrina in 2005 – with a combined unpaid principal balance of $179 billion.”

That’s $696 billion of mortgages that could potentially go bad because property owners are underinsured, have negative equity, or are owned by displaced people in financial distress.

For context, according to this 2007 article from Associated Press:

“Subprime mortgages totaled $600 billion last year [2006], accounting for about one-fifth of the U.S. home loan market. An estimated $1.3 trillion in subprime mortgages are currently outstanding.”

In other words, the value of outstanding mortgages on ONLY those properties inside the disaster areas is over half of what the TOTAL of ALL subprime mortgages were leading into the 2008 financial crisis.

But, you say, all those mortgages aren’t sub-prime.  Prime borrowers wouldn’t walk on their mortgages … potentially triggering another debt crisis … would they?

Of course, no one knows what property owners affected by the CURRENT crisis will do … or how helpful banks and the government will be this time …

… but thanks to a research report by the National Bureau of Economic Research, we know the REAL reason people defaulted on their mortgages during the 2008 crisis was … lack of equity.

“ … data show that the crisis was not solely, or even primarily, a subprime sector event.”

“… but … a much bigger and broader event dominated by prime borrowers …”

“Current LTV is a powerful predictor of home loss, regardless of borrower type.” (LTV is loan-to-value)

“… the role of negative equity remains very powerful.”

Basically, people who own underwater properties (no pun intended … okay, maybe a little intentional) are more likely to walk on their mortgages.

So if that’s true, and these afflicted area properties lose substantial value, it’s possible the next “storm” will be a surge of bad mortgages … to the tune of hundreds of billions of dollars.

In other words, it’s not just the mortgages on PHYSICALLY damaged properties, but ALL properties in the region whose values are dragged down …

… the way prime borrowers’ properties were dragged down by sub-prime borrowers’ foreclosures in 2008.

Does this mean another bad mortgage fueled financial crisis is looming?

That’s hard to say.  If Wall Street has once again levered to the moon and issued trillions in derivatives against these mortgages, then things could get ugly.

However, this potential crisis is different than last time …

One major problem leading up to the 2008 financial crisis was household debt service payments as a percent of disposable personal income was sky high.

Back then, borrowers across the United States were tapped out.

Sub-prime borrowers were at the margin.  So when teaser rate loans reset higher, mortgage payments became unaffordable and sub-prime borrowers defaulted.

But these defaults were scattered over many markets because it wasn’t a geographic problem … it was demographic. So MANY markets were affected.

When prices fell, they took the values of prime borrowers’ properties with them … and prime borrowers began to default too … not because of affordability, but because of lack of equity.

Each new default put more downward pressure on home values, eroding more equity, and drawing more prime borrowers into default.

Today, at least according to this chart from the St Louis Fed, debt service to income is much lower.

Of course, if interest rates rise, wages fall, or inflation erodes purchasing power,  once again, borrowers at the margin could default … and that could trigger widespread defaults and collapsing prices.

But that’s a worry for a different day. 

As far as the fallout from these hurricanes, our bet is defaults and falling values are likely to happen primarily only in the affected areas.

However, we also suspect any spike in defaults is likely to be mitigated quickly because of the lessons gleaned from 2008.

Lenders know playing hardball with distressed borrowers only makes the problem worse. We’re guessing they’ll be much more flexible with loan workouts and short sales this time.

And because this is a physical disaster, not a financial disaster … government aid is likely to be fast and generous … at least on behalf of homeowners.

Plus, Uncle Sam knows if they don’t put out the fire fast, it could quickly spread and burn up their banker buddies.  We doubt they’ll let that happen.

Better to bail the bankers out BEFORE an implosion by helping afflicted property owners and preventing price crushing foreclosures.

So … with all that said, we think there could be some serious TEMPORARY downward pressure on prices …

…and opportunities for private investors to step in with fresh funds, pick up some bargains, and help distressed property owners out of untenable situations.

That’s because owners of investment properties may not get the same level of help as owner-occupants.  They’ll need to turn to private capital for assistance.

Fortunately, both Houston and most of the affected markets in Florida were strong investment markets before the disasters.

And in spite of the horrific damage, most of the basic market fundamentals remain unchanged.  So when rebuilt, they’ll probably solid investment markets.

Even better, these areas are likely to see a spike in economic activity as money is invested in reconstruction.  A lot of money will be pouring into these regions.

So we’re watching these areas carefully … because when the window of acquisition opportunity opens, it may only last for a short while.

Until next time … good investing!

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 More From The Real Estate Guys™…

• Sign up for The Real Estate Guys™ Free Newsletter and visit our Special Reports library.
• Don’t miss an episode of The Real Estate Guys™ radio show. Subscribe on iTunes or Android or YouTube!
• Stay connected with The Real Estate Guys™ on Facebook and our Feedback page.

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

The dollar could be dangerous right now …

If you earn, save, borrow, invest, or denominate wealth in dollars, this CNBC headline might concern you:

Why Being Long the Dollar is “Very Very Dangerous Right Now”

Comments from readers showed people were confused …

“Why being long the US dollar is ‘very very dangerous’ right now” … what the hell does that mean?”

“1st prize for ambiguous headline”

This commenter feels trapped …

“All Americans are long on the Dollar. There is no other place to be right now.”

As we often say, mainstream financial news and its readers tend not to understand real estate investing. Conversely, many real estate investors get confused by mainstream commentary.

So let’s break this down for real estate investors …

Being “long” just means you own it.  If you’re long a stock, you own it for the long haul.  You think its future is bright.

Being “short” means you’ve sold it.  With stocks, “short selling” is borrowing a stock you don’t own to sell at today’s price.

You’re betting the stock will go down, so you can buy it back cheaper later to pay back the broker you borrowed it from.

It may seem weird to sell something you don’t own.  But it’s not any weirder than spending money you don’t have.  People do that all the time.

So “long” the dollar is holding cash or dollar denominated bonds.  Being a bond holder is basically the same as being a lender.  You lend dollars and accept dollars in repayment.

Borrowing is being short the dollar.  You’d rather “sell” (i.e., spend or invest) dollars today at today’s value … and then pay back later with cheaper (inflated) dollars.

So if you think the dollar will get stronger over time, you’d pay off debt and save cash.

This chart might influence your opinion:

Source: https://fred.stlouisfed.org/series/CUUR0000SA0R

If you think the dollar will continue it’s 104-year slide, you’d “short” the dollar … by borrowing and converting dollars into real assets.

The author of the subject article is clearly bearish on the dollar.  He thinks it’s “very, very dangerous” to be long the dollar.

So the commenters who complain the headline is ambiguous or confusing simply don’t understand history … or the concepts of long and short.

And the comment that “all Americans are long the dollar” and “there’s no place else to be right now” isn’t accurate either.

Real estate can be a great way to short the dollar.

Using a purchase or cash-out mortgage, you can leverage the income from a rental property to borrow (short) dollars with a mortgage.

Just pay attention to cash flow and the spread.

If you can borrow money at 5% and buy a property cash flowing at 8%, you’re earning a 3% spread on the borrowed money. Nice.

For liquid savings, you can use other currencies, precious metals, Bitcoin, or other highly liquid dollar alternatives.  You don’t need to save dollars just because you earn them.

Real estate is also awesome because you can “straddle” … basically going long and short at the same time.

To straddle using real estate, you’d use a cash out mortgage (debt) to short the dollar.

Let’s say it costs you 6%, which would be deductible in most cases (check with your tax pro).  So your net cost might only be 4%.

You can go long the dollar by lending the loan proceeds against a high equity property at 9%.

Now, you’re long and short equal amounts at the same time.  You’ve got a positive spread (9% income against 4-6% expense) and positive cash flow.

Plus, the loan you made is backed by a property you’d be happy to own if the borrower defaults.  High equity and good cash flow.  If there’s not, you shouldn’t have made the loan to start with.

Now, you’re prepared for a strong or falling dollar.

Think about it.

If the dollar falls (inflation), you’re in good shape.

Inflation causes real assets and income, like real estate and rents, to go up in dollar terms.  Meanwhile, your debt and debt service remains fixed.  You win.

Meanwhile, even though you’re long the dollar with the loan you made, the cost of the funds (your debt) is fixed.  So you’re fixed on both sides.  You’re even.  And with a positive spread, you win.

Plus, inflation causes the property you loaned against and the income it produces to go up in dollar terms.  So the loan you made is safer because the collateral got better.  You win.

But what if the dollar gets strong?

First, let’s define “strong.”

There’s “strong” compared to other currencies, like what’s been happening over the last few years.  That’s very different than “strong” in terms of purchasing power and against real assets.

The former is relative strength.  The latter is REAL strength.

Recently, the dollar has gotten strong relative to other currencies.  Yet real estate and rents both went up.  A relatively strong dollar didn’t hurt real estate.

It would take REAL dollar strength to push down the dollar-denominated price of real estate and wages. That’s REAL deflation.

MAYBE that could happen.  But imagine the reaction of the Fed, the politicians, the banks, and the voters, to falling real estate prices and wages.

You don’t have to imagine.  We all know… because it’s what happened in 2008.  They pulled out ALL the stops to reflate everything.  They had to.

That’s because the banks hold trillions in debt, and the federal government owes trillions.  Inflation serves them both best. They’re scared to death of deflation.

That’s because banks need property values to hold or increase … otherwise, upside down borrowers walk.  Banks fear holding non-performing loans against negative equity properties.

And no one’s more motivated to pay back cheaper dollars than the world’s biggest debtor, Uncle Sam. Debtors LOVE inflation.  It makes their debt easier to pay.

So … the long and the short of the dollar is it’s that it’s probably better to be short for the long haul. And nothing lets you do that better than leveraged income producing real estate.

Until next time … good investing!

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Mortgage rates rising at record pace…

Well, that didn’t take long…

We recently alluded to the possibility of rising rates…whether the Fed raised them or not.

Then lo and behold, this headline popped up in our news feed:

Treasury Yields, Mortgage Rates Rising at Record Pace

Of course, rates are still crazy low.

But the move is noteworthy… beyond the obvious impact on the cost of the debt we use to acquire real estate and reposition equity.

The REAL Problem with Rising Rates

So what if interest rates rise?

It’s complicated, but important. Because the debt markets (bonds and their derivatives) are BY FAR the largest financial markets in the world.

The problem isn’t simply borrowing costs. It’s what rising rates due to big players’ balance sheets… and what that means to Main Street investors.

Famed bond fund manager Ray Dalio recently suggested that just a 1% rate increase could destroy over $2 TRILLION of balance sheet wealth.

In fact, without ANY move from the Fed… $1 TRILLION in wealth disappeared right after the election.

How can this happen? And how does it trickle down to Main Street?

Bond… Licensed to Kill

Remember two basic concepts:

When bond values go down, interest rates go up… and vice versa; and…

When bond values go down, anyone holding bonds as an asset, sees their net worth go down.

The latter is arguably the BIGGEST THREAT to your portfolio… not necessarily because YOU own bonds, but because of how bonds affect the financial system your investments float in.

The Daisy Chain

Many players in the paper markets borrow against their bonds the way you borrow against your real estate.

The loans they take out become their liability just like your mortgage becomes your liability.

But that same loan also becomes the lender’s asset, just like your mortgage becomes your lender’s asset.

Make sense?

When you get a bunch of players in the market all borrowing against bonds to create new bonds… that the next guy borrows against, you have a daisy chain of counter-party risk. Counter-party risk is when one person’s asset is another’s liability. If the person owing goes bust, the value of the asset collapses.

Think of a group of mountain climbers all chained together hanging off a cliff. If just ONE person falls, it’s a problem for EVERYONE.

Growing Debt Means Rising Prices

All this borrowing creates purchasing power, which pushes asset prices UP.

It’s just like when a college student gets a student loan. It pulls their future earnings into the present and bids UP the price of college today.

Debt doesn’t make things cheaper. It makes them more expensive.

As these bonds and derivatives (debt) are created, the excess purchasing power has been recycled into even more bonds and derivatives in a vicious cycle of exploding debt.

Observers are watching consumer price inflation (CPI) and conclude “inflation is stubbornly low”.

Maybe consumer inflation hasn’t happened…yet. But bond price inflation sure has.

Rates Went Down, Down, Down and the Bonds Went Higher

Because as debt begat debt begat debt, all that purchasing power bid UP the price of bonds, driving yields (interest rates) DOWN.

But after going down for over three decades, interest rates have hit “the zero bound”.

In fact, in several countries, bonds have been bid up into negative yields… for the first time in history.

Seems like rates don’t have much of anywhere to go but up… which means bond prices don’t have much of anywhere to go but DOWN.

This is where it gets messy…

I Owe You, You Owe Me, We Owe Them and We’re in Debt Together

Congratulations. You’re really a hardcore newsletter reader. Thanks for getting this far.

Because here’s the TICKING TIME BOMB in the financial system…

If rates go up or bond prices go down, then the daisy chain of counter-party risk starts to implode across the too-big-to-fail players’ balance sheets… taking asset prices with it.

Read that again and be sure you’re tracking.

Because here’s the fuse…

Your Margin’s Calling

When a bond pledged as collateral in these paper derivative markets falls too far, the borrower gets a margin call.

So the borrower needs to put up cash or risk having the collateral (their bonds) sold into a falling market.

This puts a nasty dent in the borrower’s balance sheet.

If this only happens to one player, no big deal. But remember, all these players are daisy chained together.

Call the Doctor… I Think I’m Gonna Crash

When bonds fall, everyone margined needs to come up with cash fast to meet their margin calls.

Wide scale margin calls suck cash out of the system. Lots of it. Economic activity slows way down.

For players who aren’t sitting on enough cash to make their margin calls, they’ll need to sell assets into an already falling market. This is like pouring gasoline on a fire.

That’s because if everyone is short of cash, who can buy the assets?

If the cash crisis is bad enough, the markets go “no bid” and prices fall faster and farther which compounds the problem.

All the daisy chained balance sheets start to implode… pulling the next one with them into a black hole.

Bad scene. This is what happened in 2008.

Is the REAL Crash Still Yet to Come?

Money manager, best-selling author, financial pundit and Summit at Sea™ faculty member Peter Schiff, predicted the 2008 disaster in his 2006 best-selling book Crash Proof.

Peter says none of the fundamental problems which caused the 2008 crisis have been fixed. In fact, Peter says, they’ve gotten worse… and The Real Crash is yet to come.

Last time, central banks printed TRILLIONS to buy the “toxic assets”… putting a bid in a no-bid market. This stopped the free fall.

But that exploded the Fed’s balance sheet from around $800 billion to nearly $5 trillion, where it is today.

Smart guys like Peter Schiff and Jim Rickards don’t think the Fed can do it again without destroying the dollar and causing hyper-inflation. That’s why on our last Summit at Sea™, both advised our Summiteers to hold some gold.

The Role of Real Estate in a Safe Haven Portfolio

You’ve read ALL this way… so before you go full fetal… remember GREAT FORTUNES were made in the wake of the crash.

Properly structured and liquid investors went on the shopping spree of a lifetime.

Income producing real estate is arguably one of the BEST havens in ANY storm. We’re planning a future episode to discuss this very topic.

A New Sheriff In Town

Headlines are currently dominated by all things political. It’s tempting to get caught up in that. Be careful.

While the U.S. switches out the Presidency, we choose to focus on things we can control. Like our own education for effective action.

The moral of this story?

Study. Network and converse with smart people. Be proactive with your portfolio.

We say “Plan and Do” is better than “Wait and See.”

Until next time,

Good Investing!

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

06/07/15: Ask The Guys – All About Loans with Two Expert Guests

After our last episode of Ask The Guys, we asked Walter, our email room manager, to rummage through our email inbox and gather up a bunch of listener questions about loans and lending.  And he came up with some gems!

So we dialed up our lending brain trust and convened in our Dallas studio to answer your questions about loans and lending.

Behind the microphones and ahead of the yield curve for this episode of The Real Estate Guys™ radio show:

• Your well-capitalized host, Robert Helms
• His living on borrowed time co-host, Russell Gray
• Residential investor lending specialist, Graham Parham
• Commercial lending specialist, Michael Becker

After several years of tight money, it’s nice to be able to talk about getting loans again.

Even better, lenders are beginning to to get more creative in looking for ways to attract new borrowers.

But while that’s good news, it means savvy investors need to stay on top of the ever-evolving underwriting guidelines.  That’s why it so important to have one or more mortgage pros on your team.

So when Walter dragged in a bag of emails full of lending questions, we called on our lending gurus, Graham Parham and Michael Becker, to help us answer.  In fact, we made them do all the work. 😉

We talk about what happens when you’re fortunate enough to have equity and want to use a cash out refinance to access it for additional investment.

We discover that…from a lending perspective…not all properties are the same.

For example, a condominium might be in great shape…and your credit score and debt-to-income ratios might be amazing…

But if there’s too many renters and not enough owners living in the complex, your condo might be “unwarrantable”.

That means the government subsidized lenders, Fannie Mae and Freddie Mac, don’t want to make the loan.

Bummer.  Now you can’t get the cheapest rates.

However, all is not lost.  Because while Fannie and Freddie might shun your deal, there’s an emerging group of private money lenders who can probably help you.

Of course, it’s more expensive compared to Fannie and Freddie.  But probably better than leaving your equity trapped and idle in a property.

We also talk about HELOCs (Home Equity Lines of Credit).  These are nifty tools that allow you to have what is essentially a revolving line of credit against the equity in your property.

For a while…in the wake of the mortgage meltdown…lenders were shutting these credit lines off en masse.

Today, lenders are advertising to attract HELOC borrowers.  Happy days are here again!

Of course, we don’t think it’s smart to count on HELOCs for essential liquidity.  After all, the lender can shut the line off at will.

But they can be VERY handy tools for tapping equity…and only paying interest when you have the funds drawn.  Nice.

One of the issues borrowers are facing is income documentation.

It SEEMS like documenting income is a good idea.  After all, who would lend to someone who doesn’t have enough income to make the payments?

BUT…as our good friend Robert Kiyosaki always reminds us…there are three sides of the coin.

In the case of income documentation, most self-employed people are working diligently with their tax advisor to MINIMIZE (legally) the amount of income showing in their tax returns.

But when it comes to borrowing, the lender wants to see LOTS of income.

It used to be that lenders understood this, and would allow a borrower to “state” their income…rather than prove it.

As long as they had good credit, savings, and a legitimate source of income, the lender assumed if the borrower was willing to risk their down payment and credit score, they probably had the means to repay…whether or not the tax returns proved it.

Of course, when real estate got “hot”…and everyone was rushing in and betting on never-ending price appreciation…borrowers and lenders got sloppy.  And we all know what happened.

So today, borrowers need to plan ahead.  That means preparing your income documentation…including your tax returns…TWO YEARS in advance of your purchase!

Obviously, it’s a REALLY good idea to work closely with your mortgage AND tax advisors.

Of course, if you decide to make the leap to commercial lending (more than 5 residential units or anything non-residential)…it’s the income of the PROPERTY that needs to qualify…and it’s your balance sheet…and not your income statement…that the lenders will be interested in.

There’s another group of people who are somewhat locked out from all the great cheap government subsidized loans.  Foreigners.   And foreigners have been very interested in buying up U.S. real estate.

Of course, where there’s demand, entrepreneurs (even lenders) will look for ways to create supply.  But as you  might imagine, those solutions don’t involve government programs.

Still…some leverage…even at higher interest rates…can be better than no leverage.

As we often say, “Do the math and the math will tell you what to do.”

Another question that came up has to do with Fixed Rate versus Adustable Rate…which is best?

The answer….as you might guess…is “IT DEPENDS!”

It’s hard to imagine interest rates falling too much farther.  So the probability is higher rates in the future.

With that said, asking the the lender to fix your rate for 30 years puts all that risk on them…which you might like…but it’s insurance you’ll pay a premium for.

So the decision to go fixed or adjustable can be largely based on YOUR plans for the property.  Do you plan to sell in 3-5 years?  Do you plan to hold for 30 years?

Also, if you decide to exit the property in a few years…will you buyer be able to get affordable financing?  You can’t always assume you can freely get out of the property…at least not at your price…because if rates are up…there will be less buyers and likely less appreciation.

We think it makes sense to look at the terms of your ARM…and if you can live with the WORST case scenario interest rates…and want to enjoy the low rates of adjustable in the meantime…and ARM could be a good choice.

On the other hand, if you’re squeezing into the property with thin cash flow based on a temporarily low interest rate…and you MUST get out in 3-5 years or you’ll go bust…an ARM can be a time bomb.

Be smart.

Just like picking your property carefully, it’s important to pick your financing carefully.  And your mortgage advisors can be VERY helpful in making good decisions.

For now, listen to our two expert guests and consider how you can be a smarter borrower.

Listen Now: 

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