SS47: How To Reduce Your Real Estate Debt With Inflation

Charles discusses how to take full advantage of low interest rates by utilizing inflation.

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Talking Points:

Inflation has picked up in 2021; while interest rates have been hovering around historic lows
- During the first half of 2021; the CPI was increasing by about .5% each month or 5.4% over the past 12 months
- It is widely believed by many economists that the CPI is understated, and I agree with that
- I feel the true inflation is most likely nearly twice or at least 50% higher; just review what you spent for; rent, groceries, insurance, and gas; today vs. 6-12 months ago.
- The government is creating lots of debt and families are taking on a lot of debt; the average family has $16k in credit card debt, $176k in mortgages, $28k in auto loans, and $49k in student loans – in all; the government now needs to spend a lot more money to keep everything going; all resulting in more inflation – the government and the American public on average are all going to get into more debt in 2021 and 2022
- The Federal Reserve said in 2020 that inflation will be above 2% for some time; admitting to the fact that inflation will start ticking up; which we have seen in 2021
Inflation was defined to me years back as; you live on an island and there are 1,000 coconuts and 1,000 dollar bills; an airplane drops 1,000 dollar bills on the island and now you have 2,000 dollars chasing 1,000 coconuts; what happens to the price of those coconuts? That is what is happening today; shortages and prices increasing since too many dollars chasing too few resources – inflation steals away your savings and erodes your debt – eroding your debt and the gov’t debt
The real losers are savers, retirees/workers on fixed incomes, borrowers with variable debt
The winners are debtors with fixed debt, governments with high debt, owners of physical assets
Just to clarify; I am not suggesting people go out and purchase depreciating assets with cheap debt – I am however suggesting that people purchase real estate or refinance real estate with fixed long-term debt
How can real estate investors erode their debt with inflation?
- If you can find an asset that cashflows; leverage 75% of the asset (or if you are house hacking 96.5% of the asset) with fixed long-term debt, you will be able to hedge inflation – your expenses will increase, your rent will also increase but your debt will stay fixed)
- Every month that you pay your mortgage, you are paying with dollars that are worth less than the month before. For example; the CPI said inflation was .9% in June of 2021; the dollars you paid your mortgage within July were worth nearly 1% less than when you paid your mortgage in June. $100 in June had the purchasing power of $99.10 in July
When there is massive inflation;
- fixed debt is no longer a liability but it becomes an asset
- Your savings becomes a liability
- Real estate is your ticket to hedging inflation
Don’t take my word on inflation; do some research into the inflation of the 70s and the 80s – inflation was 13.3% in 1979 and 12.5% in 1980 – while in 1980 the fed funds rate (The interest rate at which banks and other depository institutions lend money to each other, usually on an overnight basis.) was 18% (today it is .25%)

Transcript:

Charles:
Welcome to Strategy Saturday; I’m Charles Carillo and today we’re going to be discussing how do you reduce your real estate debt with inflation? And it’s a little bit more of an advanced topic, but I want to explain how inflation along with fixed term debt and real estate can really be to the benefit of the real estate investor. So inflation is definitely picked up here in 2021. Well, interest rates have been hovering around historic lows during the first half of 2021. The CPI consumer price index was increasing at about a half percent each month or 5.4%. Over the past 12 months, it is widely believed by many economists that the CPI is understated, which I agree with fully. You know, I feel the true inflation is most likely nearly twice or at least 50% higher. Just review what you spent for rent groceries, insurance gas today versus six to 12 months ago.

Charles:
I mean, you’re definitely going to see an increase. The government is creating lots of debt and families are taking on a lot of debt as well. And average family has about $16,000 in credit card debt, $175,000 in mortgages of almost $30,000 in auto loans and nearly $50,000 in student loans in all the government now needs to spend a lot more money to keep everything going all resulting in more inflation. The government and the American public on average are all going to get into more debt in 2021 and into 2022, the federal reserve said in 2020, that inflation will be above 2% for some time admitting to the fact that inflation will start taking up, which we have definitely seen over the last 12 to 18 months. Now, inflation was defined to me years back as you live on an island and there are a thousand coconuts, and then there were $1,001 bills and the airplane comes by and drops another thousand $1 bills on the island.

Charles:
And now you have $2,000 chasing the thousand coconuts. Now what happens to the price of those coconuts? Well, that is what’s happening today. Shortages and price increases since too many dollars are chasing too few resources. You know, the government can’t just go in print, apartment buildings, they can’t go in print lumber. They can just print money. Now, inflation steals away your savings and erodes your debt, but eroding your debt and the government debt at the same time. That’s very important. I mean, they there’s taxing you know, the American public, we always hear about taxes and people want lower taxes and some people want higher taxes, but the tax that no one really talks about is the inflation tax and the inflation tax hurts middle and lower income individuals because their money is not working at inflation or above inflation and their wages aren’t increasing at the rate of inflation.

Charles:
So they become the real losers. I mean, the real losers are savers, retirees and workers on fixed incomes and borrowers with variable debt because as inflation goes up, the debt will go up, right? The rate will go up. The winners are debtors with fixed debt and government with high debts and owners of physical assets. Because if you can mix all that together and you have, you’re an owner of a physical asset and you can that’s why we love the one year on year leases on properties because we can keep on adjusting our rent to hold up with inflation. It’s very difficult for people that have long-term leases, unless they’ve worked something into there to be able to adjust their rent with inflation. So something to keep in keeping keep in mind. Now, the other thing too is with the governments with high debt, they, as they, as the inflation happens, it erodes their debt as well, which is the main reason of how we’ve really been paying for all this debt.

Charles:
We’ve been printing. It’s not really going to get paid by anybody cause you only tax people so much. But the thing though is that we’re paying for it with inflation and who’s really paying for it. Well, it’s a lower and middle middle-class now just to clarify, I’m not suggesting people go out and purchase depreciating assets with cheap debt. I am however suggesting that people purchase real estate or refinance real estate with fixed long-term debt. And that’s the key. So how can real estate investors erode their debt with inflation? Well, if you find an asset that cashflows say, leverage them 75% of the asset, or if you’re house hacking 96 and a half percent of the asset with an FHA loan with fixed long-term debt, you’ll be able to hedge inflation, okay, your expenses will increase. Your rent will also increase, increase, but your debt will stay fixed.

Charles:
So look at when you’re paying this mortgage, it’s probably other expenses to the side. But in your mortgage payment on a, on a house, heck let’s just say, and everything’s put together in one and you have your mortgage principal interest, okay. Which is the biggest portion of it. And then you’re going to have insurance in taxes. Now taxes will go with inflation and you’re gonna have your insurance, which will go up with inflation, but principal interest will be fixed. And that’s gonna be the largest portion of what you’re paying on a monthly basis. Now, if your insurance goes up 5%, you know, it it’s really not that much. If you’re in taxes, go up 5% or whatever it is, it’s really not that much. You can adjust your renters, rent up 5% for them, right? Or with whatever the market’s happening in your area.

Charles:
But the thing that was that principal and interest, the large portion of your monthly payments are not going up. Okay. They’re gonna stay fixed. So every month that you pay your mortgage, you’re paying with dollars that are worth less than one month before. For example, the CPI said inflation was 0.9% in June of 2021. So the dollars you paid your mortgage with in July were worth nearly 1% less than when you paid your mortgage in June. So a hundred dollars in June had the purchasing price pro purchasing power of $99 and 10 cents in July. When there is massive inflation fixed, that is no longer a liability. It becomes really an asset and your savings becomes a liability because it’s getting a roaded every month. So if you’re like they’ve said from July, 2020 to July, 2021, 5.4% has been the inflation of the CPI, which is most likely higher than that.

Charles:
And you were paid, let’s say half percent at your bank you lost your money loss 4.9% over that 12 month period. So it just goes to show you how your savings, it just erodes and becomes a liability with inflation. But the key is that real estate is your ticket to hedging inflation. It’s really what you want to be focusing on and acquiring. Okay. Now don’t take my word on inflation. Do some research into inflation of the seventies and eighties. I mean, inflation was 13.3% in 1979 and 12.5% in 1980 while in 1980, the fed funds rate, which means the interest rate at which banks and other depository institutions lend money to each other, usually on an overnight basis was 18%. That’s how high it was today. It’s 25 basis points, right? It’s a quarter percent. I mean, it’s crazy where we’ve come, but so when you’re buying real estate, look for long-term fixed debt on your properties make sure the property cash flows, and you’re going to be able to have put your money in one of the safest assets. That’s going to be able to readjust because you’re able to readjust your income, readjust what your clients, what your tenants are paying every month, every year. So that when your expenses go up, your rents can follow right behind him, but your debt will not be increasing. So please remember to rate review, subscribe, submit comments, and potential show topics at global investors, podcast.com. Look forward to two more episodes next week. See you then.

Speaker 3:
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