How prudent real estate investors BENEFIT from inflation in two big ways! Here is how to use leverage prudently to maximize returns and reduce risks.
Announcer: Welcome to Creating Wealth with Jason Hartman, President of Platinum Properties Investor Network in Newport Beach, California. During this weekly program, Jason is going to tell you some really exciting things that you probably haven’t thought of before, or a new slant on real estate, 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 nine states. This program will help you follow in Jason’s footsteps on the road to financial freedom through real estate. You really can do it. And now, here’s your host, Jason Hartman.
Jason Hartman: Good afternoon. Jason Hartman with Platinum Properties Investor Network broadcasting today’s podcast No. 18 from the O.C., here in Orange County, California. Today, I would like to talk about inflation, but really, I’d like to talk about leverage, but leverage specifically as it relates to the concept and the reality of inflation. When you use leverage or borrowed money, there are many, many benefits, the prudent proper use of leverage. A very powerful tool. It 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 on 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 – yeah, 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 percent down on those properties, assuming you could qualify based on 5 percent down, your loan balances would be $950,000.00. Think about this. If inflation is 4 percent, in one year, if you’ve paid down no principle whatsoever, your loan balance reduced just because of inflation to just $912,000.00.
Essentially, inflation paid off, if you will, $38,000.00 of your loan balance for you. This is what we call the Great Inflation Payoff. Borrowed money offers those two great benefits, reducing your risk and increasing your returns. But better than all of those is the benefit of inflation because better to borrow money today and pay it back later, than to pay money back today. And real estate has some especially beneficial features with inflation because what happens? Think about it. Our rental properties, the loans on them, the debt on them, is paid back by our tenant, rather than by us, or at least, as much as possible, the tenant pays off our loan balances for us. So more on this later.
I’d like to just play for you part of a recent live seminar where I talk about the Great Inflation Payoff and some of these benefits of inflation. Now, also, you have to understand that since you cannot see the visual aids being presented, you may have a question or two that is apparent and obvious to the live audience. So just give any of our investment counselors a call. They’ll be glad to give you visual aids or explain things in more detail to you and I will be back at the end of this podcast to tell you more about the inflation payoff and just sort of wrap this up. Thanks for listening and let’s tune in to a recent live seminar.
Now, let’s talk again about inflation. If you go onto Google and type in inflation calculator, you can find these all over the internet. These are just two screen shots of inflation calculators that I found typing that into Google. So remember I asked you earlier today, would you rather have a $100,000.00 today or $100,000.00 in ten years and everybody said today, they’d rather have the money. And then I asked you, would you rather pay $100,000.00 today or pay it in ten years. You all said I’ll pay later; take it today. Right answer, definitely.
If you have $100,000.00 mortgage on your property and say it’s an interest only loan – we’re not paying the principle down; it’s just interest only – and it’s a ten-year loan. If you believe, which you would be crazy to believe it, but if you believe that inflation is only around 4 percent a year, as the government would have you believe, then after ten years, if your loan is interest only, your statement still says $100,000.00 on it. But remember you’re paying in depreciated future dollars, so you’re really only paying back $66,000.00 ten years from now. Better to pay later than to pay today.
What if inflation is 8 percent? Personally, I think it’s 10 – 12 percent. That’s my opinion. $100,000.00, 8 percent inflation, ten years go by; you’re really only paying $43,000.00 in $2017.00. 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, you’re government bonds. That’s why bonds are lousy because I don’t like being the lender.
You know, Shakespeare, a long time ago, said, “Neither a borrower nor a lender be.” Shakespeare was wrong. Be a borrower. Don’t be a lender. Lender, no, lousy. I’ll 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?
Jason Hartman: 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 wanna borrow money to buy this house. My name’s Donald Trump. I’ve got a comb-over and I’m gonna buy this house, and I want you to loan me the money to buy this asset. But look, Bank, I’m gonna own the asset. You’re just financing it for me. You’re not gonna get any of the tax benefits. You’re not gonna get any of the appreciation. All you’re going to get is interest on the loan.”
And then I think, well, this sounds like a pretty good deal for me, the real estate investor, but the only problem is, I’ve gotta pay the mortgage back. I’ve gotta pay the loan back to the bank. What if I could avoid paying the loan back? Wouldn’t that be neat?
So what do I do? I rent the house out to Heather Locklear, one of my personal favorites, so Heather becomes my tenant and I’m gonna say, “Look, Heather, effectively, you’re gonna pay the bank back for me.”
But it gets better than this. I borrowed money from the bank say at 7.5 percent blended rate. What that means in the blended rate is if I get two loans to put minimum down payment, say I do 80 percent on my first loan, 15 percent on my second loan, 5 percent of my own cash down. The blended rate, okay, is the blending of the two loans. The 80 percent loan is a larger balance at maybe 6.75 percent, for example, and the second loan is a more risky loan for the bank to make, so they’re gonna charge me a higher interest rate because they’re in second position when it comes to collecting. So they might say, well, I want it 12 percent, but it’s only a small amount of money. It’s only 15 percent of the purchase price. So the blending of the two might come out to 7.5 percent, so that’s the effective blended rate. All right?
So I pay the bank, or really, Heather Locklear pays the bank, in depreciated future dollars. Okay. And the asset, historically, appreciates faster than the rate of inflation. Now, most people see how they win the game in real estate this way, but they don’t see how they win the game in real estate this way. You don’t win one way. You win two ways, by borrowing money.
The problem is the bank isn’t stupid. They understand inflation. I mean how many MBAs are working in any bank? Lots of them, right? They went to school, business school. They learned about inflation, so they know this is out there. But they think inflation is only 4 percent, like the government tells us all, right, but they also realize that, look, if we want our money not to depreciate, we’ve gotta charge an interest rate higher than the rate of inflation to offset that. So we might loan the money out at 7.5 percent, believing that inflation is 4 percent, so our margin, effectively, is 3.5 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 gonna 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-Financed Debt. That’s when debt is good, when someone else pays it off for you. Okay. You get the benefit of inflation.
There is destructive debt, which is consumer debt. This is how people get into trouble with debt. They get into debt over the appearances of wealth; clothes, cars, vacations, plasma TVs, stuff that depreciates in value that you can’t rent out. I remember about a year and a half ago, I got a call from a gold dealer. Monex, it’s a local company here in Newport Beach. You may have heard of them. And he calls me up and says, “Mr. Hartman, we think you should invest in gold because all the fundamentals are right, blah, blah, blah. It’s $420.00 an ounce now and we think it’s gonna go to $1000.00 by the end of the year.”
Well, it didn’t, but it did go up. I bought it. So I said to the guy, I said, look, I will send you $5000.00; 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 wanna two more things. No. 1 thing I wanna 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 wanna know can I rent my gold coins out to someone? And he says, I don’t think anybody rents gold coins. See that’s why that doesn’t work as an investment. Anything you can’t buy, get someone else to finance for you, take huge tax deductions in between, and you have a renter generating income, is not a good investment. That’s why I don’t buy vacant land because I can’t rent it out, unless it’s a parking lot, I guess. That might work.
But that’s the reason this works so well. Don’t get into debt over the butter of life. Get into debt with guns, the guns and butter philosophy. Guns are things that create wealth; butter is the luxuries of life, the things that really diminish wealth over time. The entire tax code and the U.S. banking system encourage this. Do what they want. Play their game.
Diversify your equity for greater safety. Move it out of the high price market into the better value markets. That’s where the properties make sense the day you buy them. Constructive debt is investment-grade debt, okay? J. Paul Getty said it well. He said if you owe the bank $100.00, that’s your problem. If you owe the bank $100 million, that’s the bank’s problem. So the borrower’s in the position of power. Just remember that.
A couple things I wanna mention to you is that, during the break, Cliff came up to me and he talked about the RV ratio and why we move out of markets. Actually, when we move out of a market, a lot of times, it’s good news for the people that already bought there, and the reason is that the way market’s 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 .3, so here a million dollar house rents for about $3,000.00 a month and I know that because Marcus sold his house – Marcus Meleton who was just up – and rented one, and he rents a house that’s worth about $1 million for $3,000.00, I think $3,100.00 a month. And it was really a good idea to sell his house now. He has four kids and his wife, Marjorie, just about had a fit when he said we’re selling the house in Ladera Ranch and we’re gonna go rent. “Huh? No, we’re not. I’ll call my attorney.”
But really, it is a much better deal to rent a house here right now than to own one, at the moment. So what happens is you’ll see the prices appreciate. That’s the leading indicator. Then you’ll see the rents follow. That’s the lagging indicator. So they get so out of sync and what may confuse you is that you might read in the media right now that rents are going up in the bubble markets. They’re going up more than they are in the non-bubble markets, and that is true. But they’re out of sync here. It’s ridiculous.
Think about what has to happen here. The million dollar house needs to rent not for $3,000.00 a month, but for $7,000.00 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 .5 RV ratio, that’s what I think is sort of the equilibrium rate. What’ll happen in Orange County in my prediction is you’ll have the million-dollar house. It’ll decline in value to about $800,000.00 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 $800,000.00 house renting for $4,000.00 a month, .5. It was a million. It went down to $800,000.00. The rents went up from $3,000.00 to $4,000.00 and you’re at the equilibrium point, and that’s the sign that the market is starting to get healthy again.
And then the last thing is I want you to consider the assets you have in your life. Most people look at a balance sheet. You all, of course, know what a balance sheet is. On one side, it’s got your assets. The other side, it’s got your liabilities. But what of the assets that people generally don’t count and they don’t even think about that they have. Is their credit, their ability to borrow, and in this game, as we’ve demonstrated to you today, the ability to borrow and leverage an investment is an incredibly good asset. So remember when you’re looking – when you’re thinking of a balance sheet, count your liabilities, all your debt that 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 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, I have an 800 FICO score. Well, you have no debt. Of course, you have an 800 FICO score, but you’re also gonna end up poorer 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 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 1 is the launch stage. When something is on sale, I don’t know about you, but when something is on sale, I stock up. Money is on sale; debt is on sale. It’s on sale in not one way, low interest rates, but two ways, ease of qualifying. And that’s gotten harder and the rates have gone up just a tad, but when I got into the business in 1985, interest rates were 14 percent.
Yeah, it was easy. I know, I agree. That’s okay. We put those up there, but we never use the easy buttons. We just thought it was kind of a cute gimmick.
So when something’s on sale, stock up. Money or debt is on sale. Look it, folks, in five years, ten years, I’ll bet you people are gonna say, “God, I wish I had borrowed more money when it was so cheap. I wish I had taken out more mortgages when I could have done them with 5 or even 10 percent down.” Now, it’s 20 percent down and the rate is 10 percent or 14 percent 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 1 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 2 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 re-fi till you die plan and what you’re doing here in the Stage 2 is you’re starting to enjoy increased rents, appreciation, and tax savings over the years. And remember this is five years we’re talking about here, seven years we’re talking about.
And then in Stage 3, that’s the orbit stage where you continue to re-fi till you die over and over again, and enjoy living on the tax-free proceeds of the refinance.
So I hope you enjoyed that piece from a recent live event and we hope you’ll be able to attend one in person sometimes for more and more details. But just remember that inflation calculator example that I used in the beginning. If you were to purchase $1 million worth of property, say, for example, in our network, that might be six single-family homes in diversified markets spread around the country, so that all your eggs are not in one basket. You’re spread out; you’re diversified for greater safety.
Now, you borrow $950,000.00, 5 percent down, just like the example I talked about earlier. And the inflation rate for the next ten years on this interest-only loan, the rate of inflation is only 4 percent per year. It’s really quite a bit higher than that, but that is a much longer, other discussion for future podcasts. At the end of the ten years – remember you had an interest-only loan, so it’s now 2017, ten years into the future – your statements still show a loan balance of $950,000.00, $950,000.00. But because of the beneficial effects of inflation, your loan balance is really only about $912,000.00. Your total return on inflation is about 250 percent. 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 podcasts, 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, a scenario, and fax or email or mail it to you, or sit down with you in person, of how much benefit you’re getting from inflation.
But remember the inflation benefit is twofold. No. 1, 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. Bu the other benefit is that you are paying back the debt on the real estate on depreciated future dollars. We’d rather have a million dollars today than a million dollars in ten years. So the benefits of inflation are twofold. Not just one thing; two very big benefits of it.
Anyway, thank you for listening today. We appreciate you joining us and join us for our next podcast. It should be up in the next week or so and also make sure you go into the archives and look at our past podcasts, especially the last few of them. I think they’ll be very beneficial to you. If you have any questions, if we can help you or advise you with your investment needs, give us a call here at our Newport Beach office at (714) 820-4200. That’s (714) 820-4200. Also, we’ve got some tremendous resources at our website, a whole bunch of educational videos, articles – lots of articles actually – on the inflation benefit, so surf around our website for a while. It’s a very deep website, a lot of content there. It’s all free content. You could spend hours there and it will really, really benefit you with your investments.
And just visit www.jasonhartman.com. That’s www.jasonhartman.com. Learn a lot more about the great inflation payoff and a whole bunch of other terrific and beneficial investment techniques. We’ll look forward to seeing you or talking to you on a future podcast, and until then, happy investing. I’m Jason Hartman.
I’m here with Area Manager and Investment Counselor Lynda Mulley, and she just returned from Kansas City and also Grand Junction, Colorado, and Lynda, tell us about what you saw in Kansas City.
Lynda Mulley: Kansas City is a great market, Jason. It’s very stable and solid. It’s a market where there’s good growth and lots of things going on, and there’s some great projects there that I took a look at that I think the investors would love to hear about.
Jason Hartman: Now one of the things we always do is you’ve gotta go buy your own house there if you wanna recommend the area to clients and of course, I’m already an owner in Kansas City. I bought a 4-plex there, but tell us what you’re recommending today in Kansas City.
Lynda Mulley: What we have is a great single-family home, three-bedroom, two-bath, about 1450 square feet, for $189,900.00.
Jason Hartman: Brand, spanking new, right?
Lynda Mulley: Brand new, rent ready, close to schools and a beautiful shopping center, big upscale shopping center called Zona Rosa, which I had lunch at and just fell in love with.
Jason Hartman: Excellent. What’s the projected return on investment?
Lynda Mulley: Projected investment return here is 34 percent based on our usual assumptions that we put on our performance projections in the loan that you could get.
Jason Hartman: Excellent. Boy, 34 percent annually. Don’t try that in a mutual fund or the stock market. You probably won’t get it. But you can do it pretty conservatively and prudently with the right real estate investments with the right structure. Lynda thanks so much for talking about the property in Kansas City.
Lynda Mulley: You bet. Thanks so much.
Jason Hartman: Hey, I just wanted to announce a couple of quick things for you. If you are interested in the Platinum Properties Investor Network franchise in your area, we are now approved for franchising in eighteen states. Please visit www.jasonhartman.com and click on the franchise link, and fill out the short application.
If you are able to come to one of our live events, we would love to see you and meet you in person. We’ve had people fly in from all over the U.S. for them. So hopefully you can join us for some of those events.
Also, if you are interested in career opportunities with us, our company is growing quickly and we would love to talk with you about career opportunities.
Also, remember our rental coordinator is here to help with your rental properties. If you need assistance with your rentals, your property managers, your advertising, remember we’re here to help and we stay with you through the life of the investment. So feel free to call our office anytime and ask for the rental coordinator for assistance on your rentals.
Also wanna remind you, listen to our old podcasts. At least go back to podcast No. 13 forward and listen to all the podcasts after that. You’re welcome to listen to all of them. The ones before No. 13 are older, but they’re also good, but the newer ones are No. 13 and forward, which are really good ones to listen to, so please take advantage of that.
Be sure to see appropriate disclaimers and disclosures on our website at www.jasonhartman.com. Remember that we are not tax or legal advisors. So give us a call on any of these issues, and remember, we are here to help, and we will look forward to talking to you on the next podcast.
This material is the copyrighted creative work of either Jason Hartman, the Hartman Media Company, Platinum Properties Investor Network, Incorporated or the J. Hartman Company, all rights reserved.
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Duration: 28 minutes