Today's Economy and Real Estate

Make Sure Your Assumptions Are Right!

My academic work was and is in economics – “The Dismal Science” as per Adam Smith’s contemporaries.

My best classes were money and banking. In 4th year undergrad honors classes I loaded up on all the classes I could on that topic. I even went for dinner with a great professor from the Chicago “school” of monetary policy. Look it up. It’s a thing.

I loved it!

And still do.

The “fiat” money system. Money created out of thin air by debit and credit entries at the bank. Money created through debt – your debt! The subtle mechanism of monetary policy used by policy makers to expand and contract the economy. So amazing!

Last week at our rapid round (“Ask me any question on any topic) two business owners asked me what I thought would happen to their real estate. One was a real estate investor with rental houses. The other was a tourism operator with an amazing B&B.

Each was concerned about what would happen to their net worth in the coming recession and interest rate hikes.

My response:

  • Interest rate hikes are just beginning.
  • Inflation is already higher than the official numbers.
  • It’s going to get worse.

My assumptions were:

  • The attempt to sanction Russia and hit the ruble is not going to work.
  • So the west will need Russian gas and oil. There is plenty of evidence.
  • The west has been suffering a form of “de-industrialization” for decades due to offshoring. This we know.
  • The debt piled up during the free money era of the last two years is an “overhang” problem that will only go away through inflation and a destructive recession or depression. Economic theory shows this. So does history. Get ready.

My specific advice was:

  • Pay down mortgage and line of credit debt on properties to at least the point where you can mathematically stand a 20% hit in the value of your portfolio without going “upside down”. For some crazy fun do a 50% analysis.
  • Don’t pay down all your mortgages because inflation will actually help as the value of your property rises. But be careful. It’s a roller coaster and you’d better be right.
  • Keep some powder dry – cash. Enough but not too much because it’s being devalued all the time.
  • Remember the chicken or the egg: Inflation can be good for you.

Post WW2 inflation of property values has created a lot of household wealth. But inflation has also cut your purchasing power big time.

Interest rate hikes can prevent you from qualifying for a mortgage, can suck up all your income to pay debt, and can turn you “upside down” on your property. But it can allow you to raise rents and prices.

I could see they were really asking me: “How do I know if this will come true?”

I have to tell you: My answer was “It depends on your assumptions!”

I wasn’t being flippant.

Work your numbers. Learn how to do simple spreadsheet analysis to simulate different assumptions about different scenarios.

That’s how smart business people roll these days!

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