Wednesday, December 12, 2012

Real Estate in an Era of Hyperinflation

3:51 PM
Today's blog is by guest blogger John Reed, and it is so good, I just had to share:
It looks like real estate investors may have a once-in-a-lifetime opportunity in the present market. I'm not talking about the recent upsurge in home sales or rents in many parts of the country. That is pretty normal during a growth period and at the end of a stagnant period when prices have hit bottom. And there is no shortage of home seekers or investors jumping in. No great opportunity there. But there are two unique, unprecedented things happening. 1. Mortgage interest rates have never been this low. Never! 2. Neither Congress nor the President show any interest in ending their reckless borrowing and spending. Interest rates Interest rates pretty much cannot go any lower. There is no room. Does that mean they will go up? Well, they could also stay where they are. But there is great and growing fear of higher inflation. What is the cure for high inflation? The Fed selling U.S government bonds and raising interest rates. For example, in 1980, we had 13.5% inflation and Fed chairman Paul Volcker raised interest rates such that mortgages averaged 16.55% in 1981. Word to the wise. Buy with a mortgage or refinance to get the current market rates. Hyperinflation danger Our elected officials in Washington have lost their minds. Our current national-debt-to-GDP ratio is 105%. The last time it was that high was 1945—the end of World War II. But it was not a concern then because the war was ending and everyone knew federal government spending was about to plummet. Indeed, federal spending was cut 60% as the soldiers were discharged. But this is not 1945. There is no world war. The "war" in Afghanistan is actually what used to be called a post-war occupation. The active U.S. military today is tiny—1.5 million people which is 1.5 million ÷ 315 million = 7 tenths of one percent of the population. In 1945, we had 12 million in uniform and a total population of just 140 million or 12 ÷ 140 = 9% of the population. Furthermore, 60% cuts were well-known to be coming. Today's Congress and president are not going to cut federal spending 60%. They are not going to cut even 6%. I would be surprised if they cut 6 tenths of one percent! Almost certainly, they will increase the national-debt-to-GDP ratio! In November 2008, that ratio was 75%. Today, it is 105%, a 30% increase in four years or 30% ÷ 4 = 7.5% per year. At that rate we will be at 105% + 7.5% = 112.5% in November 2013 and 120% in 2014—the all-time record hit 1946 just after World War II. Then we're going to 127.5% in 2015. Like I said, Congress and the president have lost their minds. And people who own U.S. dollar-denominated assets are about to lose their asses. Real estate in hyperinflation What about the people who own real estate? I researched that. In Germany and Austria during those countries' early 1920s hyperinflation, real estate owners did very well, especially if they had fixed-interest rate mortgages. Actually, that was the only kind of mortgage back then, but I say it here because we now have adjustables and you profit less in hyperinflation if you have an adjustable-rate mortgage. In theory, real estate holds its real (after adjustment for inflation) value during hyperinflation. In reality, it actually does a little better than that during the hyperinflation because people are so desperate to trade the currency that is hyperinflating for hard assets and real estate lets them do that on a large scale. If you don't sell until after the hyperinflation, that premium goes away. But the main thing is owning real estate that has a substantial fixed-rate mortgage. When you do that during hyperinflation, your real (after adjustment for inflation) equity goes up substantially. The fact is a lot of people got rich in Austria and Germany during their hyperinflation. Same thing happened in Latin America and other hyperinflated countries. The formula is simple: a combination of hard assets or well-managed (by the government that printed it) foreign currency and fixed-interest rate debt in the hyperinflated currency. Basically, during hyperinflation, debts become extremely easy to pay as the purchasing power of the dollar falls. What kind of property is best?Basic-need stuff, like a place to live, farms and ranches that actually produce food or other commodities like fish, game, fuel, or timber, single-family owner-occupied homes. You already have one? Buy another and move into it. You don't have to sell the old one just because you moved. What about rental property? Second best but still probably good to own. It is hard to get a self-amortizing mortgage and balloon payments are even more dangerous in hyperinflation than in normal times because they could cause you to lose the property. Also, the same government that causes hyperinflation almost certainly will enact rent controls as part of their effort to deflect blame for the hyperinflation. In Germany in the early 1920s, they allowed NO rent increases whatsoever during the entire period of World War I and the subsequent hyperinflation—ten years. At the end, tenants who originally paid about 25% of their income for rent were paying only.14%! You also need to worry about your tenants' source of income. If they rely on fixed dollar amount incomes like Social Security or bond interest or annuities, they will not be able to pay the rent. But if you can survive the rent controls, and stay current on your payments, you should profit substantially from rental properties during hyperinflation. Indeed, farm owners and home owners made so much profit during Germany's hyperinflation that some legislatures passed claw-back laws to take back some of those profits after it ended. So if you are or could be a real estate owner, you now have a once-in a lifetime opportunity. Interest rates have never ever been lower and the Congress and president are rushing head-long into hyperinflation. My wife and I just refinanced our home. My son, with my blessing sold his and is trying to buy a bigger one with a bigger mortgage. I suggest you do the same. In the next five or ten years, everyone is going to recognize, in hindsight, what a great opportunity they had back in 2012. Right now, few recognize it. Happy Holidays, John T. Reed


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