Jason Hartman uses this episode to discuss inflation. He goes into why inflation is a benefit for prudent real estate investors. While it is a hidden tax for the average citizen, it can be used to create wealth through the use of leverage. He explains why having a large loan balance is part of his strategy and goes through the concept of inflation-induced debt destruction.
Welcome to this week’s edition of flashback Friday, your opportunity to get some good review by listening to episodes from the past that Jason is handpicked to help you today in the present, and propel you into the future. Enjoy.
Welcome to creating wealth with Jason Hartman. During this program, Jason is going to tell you some really exciting things that you probably haven’t thought of before and a new slant on investing fresh new approaches to America’s best investment that will enable you to create more wealth and happiness than you ever thought possible. Jason is a genuine self made multimillionaire who not only talks the talk but walks the walk. He’s been a successful investor for 20 years and currently owns properties in 11 states and 17 cities. This program will help you follow in Jason’s footsteps on the road to financial freedom, you really can do it. And now here’s your host, Jason Hartman with the complete solution for real estate investors.
Jason Hartman 1:12
Good afternoon This is Jason Hartman with Platinum properties investor network broadcasting today’s podcast number 18, from the OC here in Orange County, California. Today I would like to talk about inflation. But really I’d like to talk about leverage, but leverage specifically as it relates to the concept and the reality of inflation. When you use leverage or borrowed money, there are many, many benefits. The prudent proper use of leverage, very powerful tool could be a destructive tool. Some people get themselves into trouble with it, but when you use it the right way, especially when investing in real estate. It is an incredibly powerful tool. The main benefits Although there are many others and in our other podcasts you hear us talk about leverage is to reduce risk and increase return on investment. However, this podcast is specifically geared toward inflation. In fact, I call it the great inflation payoff. Now, if you ever have a chance to attend one of our seminars, or meet or talk with one of our investment counselors, they will be glad to run some phenomenal inflation calculations for you. And these will show you how much benefit and that’s right I said it right benefit you are actually getting from inflation as a real estate investor. So let me just say this to make it simple. Think about this, if you were to purchase six single family homes, and the aggregate value of those single family homes was $1 million. And if you were to put 5% down on those properties as soon You could qualify based on 5% down, your loan balances would be $950,000. Think about this. If inflation is 4% in one year, if you’ve paid down no principal whatsoever, your loan balance reduced just because of inflation to just $912,000. Essentially, inflation paid off, if you will. $38,000 of your loan balance for you. This is what we call the great inflation payoff. borrowed money offers those two great benefits, reducing your risk and increasing your returns. But better than all of those is the benefit of inflation. Because better to borrow money today and pay it back later. than to pay money back today. And real estate has some special beneficial features with inflation because what happens Think about it, our rental properties, the loans on them, the debt on them, is paid back by our tenant rather than by us, or at least as much as possible, the tenant pays off our loan balances for us. So more on this later, I’d like to just play for you part of a recent live seminar, where I talk about the great inflation payoff and some of these benefits of inflation. Now also, you have to understand that since you cannot see the visual aids being presented, you may have a question or two that is apparent and obvious to the live audience. So just give any of our investment counselors a call, they’ll be glad to give you visual aids or explain things in more detail to you. And I will be back at the end of this podcast to tell you more about the inflation payoff and just sort of wrap this up. Thanks for listening. And let’s tune into a recent live seminar. Now let’s talk again about inflation. If you’d go on to Google and type in inflation calculator, you can find these all over the internet. These are just two screenshots of inflation calculators that I found typing that into Google. So remember, I asked you earlier today, would you rather have 100,000 today or 100,000 in 10 years, and everybody said today, they’d rather have the money. Then I asked you, would you rather pay 100,000 today or pay it in 10 years? You all said I’ll pay later. Take it today. Right answer definitely. If you have $100,000 mortgage on your property, and say it’s an interest only loan, we’re not paying the principal down. It’s just interest only. And it’s a 10 year loan, if you believe which you’d be crazy to believe it. But if you believe that inflation is only around 4% a year as the government would have you believe, then after 10 years, if you’re alone is interest, only. Your statement still says $100,000 on it. But remember, you’re paying and depreciated future dollars. So you’re really only paying back $66,000 10 years from now. Better to pay later, and to pay today. Remember, you’re listening to flashback Friday. Our new episodes are published every Monday and Wednesday. What if inflation is 8%? Personally, I think it’s 10 to 12%. That’s my opinion. hundred thousand dollars 8% inflation 10 years go by, you’re really only paying $43,000 in $2,017. So debt works for you really well, when you’re the borrower. When you’re the lender debt really hurts you. When you buy bonds. You are the lender. When you buy bonds in a company or government bonds. That’s why bonds are lousy because I don’t want Being lender. You know, Shakespeare A long time ago said neither a borrower nor a lender be Shakespeare was wrong. Be a borrower. Don’t be a lender, lender. No. How’s it I ask you a question about borrowing and lending? How many of you have ever loaned money to a friend or family member who was in control of that transaction, the lender or the borrower? Like I said, Be the borrower, that’s where you have control. So let’s look at this example. Here’s the bank. You go to the bank, and you say, bank, I’m a real estate investor, I want to borrow money to buy this house. My name is Donald Trump, I got a comb over and and I’m going to buy this house. And I want you to loan me the money to buy this asset. But look, bank, I’m going to own the asset, you’re just financing it for me. You’re not going to get any of the tax benefits. You’re not going to get any other appreciation. All you’re going to get is interest on the loan. I think well, this sounds like a pretty good deal for me the real estate investor, but the only problem is I got to pay the mortgage back, I’ve got to pay the loan back to the bank. What if I could avoid paying the loan back? Wouldn’t that be neat? So what do I do? I rent the house out to Heather luckily one of my personal favorites. So Heather becomes my tenant. And I’m going to say, look, Heather, effectively, you’re going to pay the bank back for me, but it gets better than this. I borrowed money from the bank, say at seven and a half percent blended rate. What that means in the blended rate is if I get two loans to put minimum downpayment, say I do 80% on my first loan 15% on my second loan 5% of my own cash down the blended rate, okay is the is the blending of the two loans. The 80% loan is a larger balance at maybe 6.6 point seven 5%, for example, and the second loan is a more risky loan for the bank to make. So they’re going to charge me a higher interest rate because they’re in second position when it comes to collecting. So they might say, well, I want a 12%. But it’s only a small amount of money. It’s only 15% of the purchase price. So the blending of the two might come out to seven and a half percent. So that’s the effective blended rate. All right. So I pay the bank or really Heather Locklear pays the bank in depreciated future dollars, okay. And the asset historically appreciates faster than the rate of inflation. Now most people see how they win the game in real estate this way, but they don’t see how they win the game in real estate this way. You don’t win one way you win two ways, by borrowing money. The problem is the bank isn’t stupid. They understand inflation. I mean, how many MBAs are working in any bank lots of right. They went to school business school they learned about inflation. So They know this is out there. But they think inflation is only 4%. Like the government tells us all right. But they also realize that look, if we want our money not to depreciate, we’ve got to charge an interest rate higher than the rate of inflation to offset that. So we might loan the money out at seven and a half percent, believing inflation is 4%. So our margin effectively is three and a half percent. That’s our profit to the bank, if you will. It’s more complicated than that. But simplified example. So the bank knows this. So they’re going to charge me a rate higher than inflation. So see, if I bought vacant land, or if I didn’t rent my house out, I would actually suffer because I’m not getting the tenant to pay my mortgage back for me. But we call this tenant backed or tenant finance debt. That’s when debt is good when someone else pays it off for you. Okay, you get the benefit of inflation. There is destructive debt, which is coming assumer debt. This is how people get into trouble with debt. They get into debt over the appearances of wealth, clothes, cars, vacations, plasma TVs, stuff that depreciates in value that you can’t run out. I remember, about a year and a half ago, I got a call from a gold dealer. Monica, that’s a local company here in Newport Beach, you may have heard of them. And he calls me up and says, Mr. Hartman, we think you should invest in gold because all the fundamentals are right, blah, blah, blah. It’s $420 an ounce now, and we think it’s gonna go 2000 by the end of the year. Well, it didn’t, but it did go up. I bought it. So I said to the guy said, Look, I will send you 5000 bucks, you send me the 12 gold coins. And so you’ve made the sale. But I have two questions for you. I’m gonna buy it. But I want to know two more things. Number one thing I want to know is will you finance my purchase for three decades for 30 years at some of the lowest interest rates in 40 years tax deductible interest And he says we don’t do that. And then I said, Okay, fine, I’ll pay cash. Then I want to know, can I rent my gold coins out to someone? And he says, I don’t think anybody rents gold coins. See, that’s why that doesn’t work as an investment. Anything you can’t buy, get someone else to finance for you take huge tax deductions in between and you have a renter generating income is not a good investment. That’s why I don’t buy vacant land, because I can’t rent it out. Unless it’s a parking lot. I guess. That might work. But that’s the reason this works so well. Don’t get into debt over the butter of life, get into debt with guns, the guns and butter philosophy. Guns are things that create well, butter is the luxuries of life. The things that really diminish wealth over time, the entire tax code, and the US banking system encouraged this. Do what they want. play their game. diversify yourself. equity for greater safety moved it, move it out of the high price market into the better value markets where the properties makes sense. Today you buy them. constructive debt is investment grade debt. Okay. Jay, Paul Getty said, Well, he said, If you owe the bank $100, that’s your problem. Peel the bank 100 million dollars. That’s the bank’s problem. So the borrower is in a position of power, just remember that. A couple things I want to mention to you is that during the break, Cliff came up to me and he talked about the RV ratio, and why we move out of markets, actually, when we move out of the market, a lot of times it’s good news for the people that already bought there. And the reason is, is that the way markets play out, at least what I’ve noticed over the years, is that prices will start to appreciate. And then behind that you have the lagging indicator of rental income of rents, and think about what’s happening in Orange County right now. The RV ratio is typically about a point three so here a million dollar house rents for About 3000 a month. And I know that because Marcus sold his house, Marcus Melton, who was just up and rented one, and he rents a house that’s worth about a million bucks for 3000 I think 3100 a month and it was really a good idea to sell his house now he has four kids, and his wife Marjorie, just about how to fit when said, we’re selling the house in Madeira Ranch, and we’re gonna go rent, huh? No, we’re not. Yeah, I’ll call my attorney. But really, it is a much better deal to rent a house here right now than to own one at the moment. So what happens is you’ll see the prices appreciate that’s the leading indicator, then you’ll see the rents follow. That’s the lagging indicator, so they get so out of sync. And what may confuse you is that you might read in the media right now that rents are going up in the bubble markets. They’re going up more than they are in the non mobile markets. And that is true, but they have they’re so out of sync here. It’s ridiculous. Think about what has to happen here. The million dollar house needs to rent not for 3000 a month. For 7000 a month for this market to work again. And I believe that the RV ratio is a predictor of appreciation. And here’s how, when you get to about the point five RV ratio, that’s what I think is sort of the equilibrium rate, what will happen in Orange County, and my prediction is you’ll have the million dollar house, it’ll decline in value to about 800,000. And this is really all of California largely. So that’ll decline in value as rents creep up, and they’ll sort of meet at the point of equilibrium, which will be the $800,000 house renting for 4000 a month, point five, it was a million went down by 800. The rents went up from 3000 to 4000. And you’re at the equilibrium point, and that’s the sign the market is starting to get healthy again. And then the last thing is, I want you to consider the assets you have in your life. Most people look at a balance sheet. You all of course know what a balance sheet is on one side. It’s got your assets, the other side, it’s got your liability. But one of the assets that people generally don’t count and they don’t even think about that they have is their credit, their ability to borrow. And in this game has we’ve demonstrated to you today, the ability to borrow and leverage and investment is an incredibly good asset. So remember, when you’re looking when you’re thinking of a balance sheet, count your liabilities, all the debt you have, but also count as part of your assets, your ability to borrow. And remember, the concept of your financial life is you always want to make all your assets work as hard as you possibly can. So if you’re not using your credit, to borrow and put it to work for you, then it’s an unused asset, earning nothing for you. I constantly have people that kind of brag about, well, you know, I have an 800 FICO score. Well, you have no debt, of course, you have an 800 FICO score, but you’re also going to end up poor And other people are gonna end up rich, because you’re not using that asset, your credit asset. When you buy these properties, your credit score will go down initially, it goes down and then in about six months, it sort of starts to recover. So as long as you maintain a credit score above 720, you’re in very good shape. But remember, their credit doesn’t do anything for them unless they use it. So use your credit, it is an asset. So keep that in mind. Don’t just let it sit there not working for you. All right. So what’s the plan with this? Well, the plan is divide your debt strategy into stages. Stage One is the launch stage when something is on sale. I don’t know about you. But when something is on sale, I stock up. Money is on sale debt is on sale. It’s on sale and not one way low interest rates, but two ways, ease of qualifying and that’s gotten harder and the rates have gone up just a tad. But when I got into the business in 1985, interest rates were 14% Yeah, it was easy. I know. I agree. That’s okay. We put those up there but we never use the easy buttons. You know, we just thought it was kind of a cute gimmick. Just a reminder, you’re listening to flashback Friday. Our new episodes are published every Monday and every Wednesday. So when something’s on sale, stock up money or debt is on sale, look at folks in five years, 10 years, I’ll bet you people are going to say, God, I wish I had borrowed more money when it was so cheap. I wish I had taken out more mortgages when I could have done them with five or even 10% down. Now it’s 20% down and the rate is 10% or 14%, or whatever it is. I don’t know what the rates will be. But I know that now it’s a mighty good deal. So in stage one of your wealth building plan, you stock up on high quality, fixed rate, fixed rate only investment grade debt. The debt is like the booster rockets in The Space Shuttle without the booster rockets, you could never get into orbit. So stage two is you jettison the booster rockets, you know, you can let them go if you want, I still don’t recommend it. But really what we say here is don’t jettison the debt, use the Rifai till you die plan. And what you’re doing here in the stage two is you’re starting to enjoy increase rents appreciation and tax savings over the years. And remember, this is five years, we’re talking about seven years we’re talking about. And then in stage three, that’s the orbit stage where you continue to refi till you die over and over again, and enjoy living on the tax free proceeds of the refinance. So I hope you enjoy that piece from a recent live event. And we hope you’ll be able to attend one in person sometime for more and more details. But just remember that inflation calculator example that I used in the beginning, if you were to purchase $1 million worth of properties, say for example, in our network, that might be six single family Homes in diversified markets spread around the country so that all your eggs are not in one basket, you’re spread out, you’re diversified for greater safety. Now, you borrow 950,005% down just like the example I talked about earlier. And the inflation rate for the next 10 years on this interest only loan, the rate of inflation is only 4% per year. It’s really quite a bit higher than that, but that is a much longer other discussion for a future podcast. At the end of the 10 years, remember yet an interest only loan. So it’s now 2017 10 years in the future. Your statements still show a loan balance of $950,000 $950,000. But because of the beneficial effects of inflation, your loan balance is really only about $912,000 your total return Turn on inflation is about 250%. That’s another way to say ROI. Remember, the traditional understanding of ROI is return on investment. And that’s true. And that’s a good thing to look at. And if you check out our previous podcast ROI, some people just don’t get it. We explain in depth, how to calculate return on investment. But a new definition for ROI, since we’re moving on to more advanced techniques here is return on inflation. That’s right return on inflation from the benefits of inflation. And any of our investment counselors here at our orange county office would be glad to run a projection in the scenario and fax or email or mail it to you or sit down with you in person of how much benefit you’re getting from inflation. But remember, the inflation benefit is twofold. Number one, when you buy real estate, you’re investing in an inflation indexed asset, an asset that is traditionally a great hedge against inflation. That’s one benefit. That’s the obvious one. most investors understand that. But the other benefit is that you are paying back the debt on the real estate in depreciated. Future dollars, would rather have a million dollars today than a million dollars in 10 years. So the benefits of inflation are two fold. Not just one thing, two very big benefits of it.