A Fighting Chance Finance

For a long time, the interest rate on borrowed money was actually lower than inflation. This was especially the case during high inflation years post COVID. However, the party is over and even mortgage debt (the safest, lowest cost kind) is 6%+ compared to inflation in the mid 3's.

This is a good thing, because it will push investors to think twice about making risky leveraged investments and only use debt when safe to do so, such as when the investment produces a safe income stream sufficient to service the debt.

The bigger question is.. what happens to all of the low rate debt that will term out soon on investments purchased that will no longer produce enough income to service the new higher rate?

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It's been a while since I've posted - apologies!

What an interesting time it is in financial markets right now. Stock markets are hitting new highs on the expectation that the days of high interest rates may be coming to an end, leading to an expectation of higher consumer spending, higher corporate profits and a general bullish sentiment.

However, if central banks lower rates, that stimulates people and businesses into borrowing more money to spend and invest. Inflation needs to be dead for this to make sense. How can inflation die when the US government is running multi Trillion dollar deficits that can only be funded 1 of 3 ways - taxes, borrowing or money printing.

I am expecting interest rates to drop slightly to appease voters in an election year, but only 50-75bps.

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A lot of real estate investors are on the sidelines right now because interest rates are high. It's expensive to finance a purchase and people are afraid of buying when values may fall further. However, we are at the peak of the interest rate cycle over the next couple months. When rates fall, typically real estate values go up because people can afford to buy a higher purchase price with lower rates. Therefore, if you sign a contract at today's prices (high rates) and don't have to close for a couple years (while rates fall), there is a good chance that values will appreciate.

There are risks of course. If the economic shock that causes rates to fall (recession) is too great, the loss of economic buying power can outweigh the decreased rates and keep real estate values low. The pre-sale project itself could have completion risks. The city the project is in might see negative migration. There are others.

On balance though, buying at today's values and closing in the future when rates are lower is likely to lead to equity growth. Each project, city and location is unique so it is important to look at all demand and supply drivers when making a big decision like a real estate purchase.

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Inflation in a picture

As tensions with Russia and China escalate, the so-called BRICS countries (Brazil, Russia, India, China, and South Africa) are preparing to strike a blow against U.S. dollar. These are massive economies. If this happens, they will need to buy gold to back up their currency and there is a finite supply. The price of gold would need to rise dramatically and capital would flow out of USD to some degree. Keep this in mind in your investment strategy and don't overly weight to USD denominated assets. Keep emerging markets in mind that have the potential to be denominated in this new currency and grow at faster rates than mature economies. Food for thought.

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Quality of life for today's adults just isn't what it was for the last generation. In the 1980's and 1990's, a family could afford a single family home, a couple of cars, a few vacations per year and put away a little for retirement on a single income. These days, even two incomes are not enough to replicate what once was. Therefore, I think that the parents of adult children in the coming years will decide to pass along wealth while their children are still young adults given that the parents enjoyed outsides wealth creation during a prolonged period of low interest rates, while their children are entering what looks to be a very challenging economy and lower standard of living. This will be balanced with parents having to afford a more expensive retirement due to higher costs of living. Do you agree?

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The other day I was thinking about whether I should upgrade my home to a larger priced one, and got nervous that if I don't upgrade now, I might miss out forever as prices get away from me. But then I remembered that the better question is "If I leave my capital invested, will those investments grow faster than the growth in house prices such that if I wait five years I will be able to overcome the growth in house prices as well as have extra net worth?". It is important to remember that money always has an alternative use, and if you put aside the emotions and think purely objectively about your decisions, sometimes you'll come to a different conclusion.

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The US government is about to pass the "Fiscal Responsibility Act of 2023". Are you kidding me? The bill is to increase the debt ceiling and doesn't make any cuts to the major categories of spending like defense. It is the oppose of fiscal responsibility. This appetite for debt and deficits is highly risky to the value of the US dollar and the US economy in general. Expect inflation and interest rates to stay high or potentially go higher in years to come. Who would want to buy government bonds when the money they will be repaid with will keep getting less and less valueable?

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Change your mentality towards present day accumulation of "things" and "experiences" and turn your attention towards your financial future.

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Check out my latest podcast appearance on the "Real Estate Investing Demystified" show with August Biniaz and Ava Benesocky. We discuss all things wealth creation including challenging status quo financial thinking, different ways of getting into real estate investing and understanding the foundations of finances.

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For the economy to be healthy, there needs to be an real cost (not just a nominal cost) to borrowing money. For a long time, the interest rate on borrowed funds was less than inflation, meaning people could borrow money and then the funds they pay the loan back with are worth less than the money borrowed plus interest. In effect, people have been making "real" gains on just borrowing money before even taking into account any investments they make. On the flip side, investors who invested in short term instruments had their money reduce in real value as the interest rate didn't keep up with the depreciation of the cash.

But now, we are seeing rates rise above inflation. This is good. But don't forget the taxes - the real test of whether there is a cost to money is whether the post-tax interest income exceeds the rate of inflation. If it doesn't, the money an investor gets back including interest is worth less than what they put in.

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A lot of people just come up with a retirement number using "the 4% rule". That is, if you want a $75,000 income when you retire, just multiply by 25. $75,000 * 25 is $1.875m. Based on my math, that would leave you $250,000 short of what you need. I tend to err on the side of assuming my life will go longer than I think. Medical science continues to progress such that some believe the first people to live past 125 are alive today. As I say in my book, everyone needs to determine their end game, their lifestyle they want after they retire and then work backwards. Do not retire on a hope and a prayer.

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