“A system of capitalism presumes sound money, not fiat money manipulated by a central bank. Capitalism cherishes voluntary contracts and interest rates that are determined by savings, not credit creation by a central bank.” — Ron Paul
Interest rates are rising.
What should you do about it?
Should you sell, should you invest more, or should you hold your properties?
These are the questions you should be asking if you own any real estate or if you’re thinking about owning real estate.
Let’s jump into it!
1. Increased Interest Rates and Asset Prices
If interest rates go up, what does that do to asset prices right away and over time?
Anybody in 2008 who was simply looking at real estate could have lost a lot.
I know people who lost everything because they were paying attention to the real estate market and not to the global economic picture.
It’s really important to pay attention to that so you can preserve and grow your wealth.
In general, higher interest rates typically means asset prices will go down.
If interest rates are lower, then that typically means asset prices are moving higher.
Why is that?
The cost of borrowing is cheaper.
Typically, everybody is buying assets if they can borrow cheaply.
If they start raising rates in general, valuations go down.
I want to discuss this in the case of single family houses.
The long-term trends of single family houses are very inflationary.
We know that today housing prices have gone up a lot.
Where I live in Southern California, some areas tripled in the last eight or nine years.
It’s been crazy!
In the long run, we know in 20 or 30 years housing will cost significantly more than it costs now.
Why can I say that?
It’s because of inflation.
You can check on this chart.
It shows M2, which is the physical currency that exists, as well as money in bank accounts
The chart shows that the M2 has increased by close to 40% over the last couple years.
We don’t know exactly how much physical currency they’ve created.
There’s stuff beyond the financial system that’s been created in other parts of the world, which I can get into another time.
There’s been so much money created and poured in the system that it’s a long-term inflationary event.
In general, things will continue to cost more.
It’s happened for years in Southern California.
When these houses were built in the 50s, they only cost around $10,000.
Now they’re $1-$2 million!
It’s not just that the house costs that much more.
There are so many dollars out there chasing the same number of houses or chasing less goods.
This is why I pay attention to single family.
Even as a multifamily guy, I pay attention because it is the base of the real estate market.
If you want to know what’s happening in real estate, you can look at single family.
Let’s say there is a crash in single family, which I think could happen in the short run with affordability issues.
Historically, the single family pays 3.1x their salary for their mortgage payment.
If I make $100,000, then I would pay around $310,000 as an average housing cost.
For years, that was the standard model.
Now it’s gone up to 9.3x in some areas!
Now if I made $100,000, these houses in these neighborhoods are costing $930,000 on average.
Either wages haven’t caught up or we’re in a serious bubble and asset prices need to come down.
So that’s one affordability issue.
The other is if lending tightens as rates go up.
If that happens, lending standards also could tighten.
Some people could have difficulty getting loans and are paying much more for them.
Those are two things I pay attention to: increased housing prices and lending difficulties.
Again, these are more shorter term things.
The longer term trend is very inflationary.
My friend George Gammon says if you own a single family house, the house is not the asset.
The debt is the asset.
It’s a different way to think, but it’s an important angle to consider.
Let’s say you have a house that’s three or four bedrooms.
You have fixed long-term debt at 3- 4%.
The debt over the next 20 to 30 years will actually be the asset.
You have a super low interest rate, but inflation will likely be somewhere between 7-20%.
For the long run, debt probably will not be as cheap in a few years as it is now.
There are also some short-term risks.
The question then becomes: Are all assets the same?
Let’s compare multifamily and single family.
2. Single Family vs. Multifamily
What are the differences between single family versus multifamily?
We talked a little bit about single family.
So what happens with multifamily?
Isn’t it the same where asset prices go up and the value of multifamily will go down?
There are some differences here.
This chart shows how multifamily and rents go in tandem.
Rents are lagging indicators.
That means inflation will rise faster than rents.
If rates rise, what we’ll see is rents will rise with inflation.
Rising rents equal a higher cost of ownership.
If rates are going up at the same time rents are going up, the cost of owning that building will go up.
On top of that, income is also rising, which offsets some of the costs.
There is a chance that rates go up and multifamily cap rates also go up. This would bring the value of multifamily apartments down.
However, as long as rents themselves don’t also go down, this can lead to stable prices or prices continuing to go up.
The same thing exists here.
Over time, the long-term trend is very inflationary.
This is because they’re creating more and more currency.
There’s a combination of inflationary and deflationary forces.
If rates rise, that is a deflationary trend.
The value of assets generally go down.
However, we are creating so much currency, and it causes values to rise.
In the great recession with multifamily, we saw some areas where rents dipped a little, but in general they did not drop that much.
If they dropped, it was for a very short period of time.
After that, they continued to rise.
It’s typically a trend line, steady over time, how rents rise.
On another note – we don’t really buy our stuff in areas where there’s rent control.
Even if rents go way up, we’re able to raise rents over time and not be limited on how much we can raise.
We love using leverage in multifamily.
When you put less money down, you’re able to really see a lot of increase in your value.
In a multifamily deal, we typically put 20-25% down.
We’re able to see if things rise – such as an outsized return.
For example, if we buy a property and we put 20% down.
The value increases to $10 million.
We only put $2 million down.
Let’s say the property increases by 20% up to $12 million.
Now the equity is $4 million.
That means we’ve had a 100% increase in the value of our equity.
Isn’t that amazing?
We have a high return even though we only had a 20% increase in the total value.
That’s the really unique thing about real estate:
Even if things go down temporarily, if you hold long enough, things tend to correct themselves over time.
With multifamily, you’re somewhat inflation hedged because the cost of ownership goes up.
3. The Decreasing Value of Dollars
Step number three is the decreasing value of dollars.
The long-term trend of dollars is that they will be worth less over time because they print more and more.
I think that’s crazy!
It really steals from the community.
When more dollars are in circulation, the purchasing power of those dollars continually goes down.
Recently, the current administration was asked in an interview about inflation being so high.
In response, the President said if we pass the $2 trillion Build Back Better Act, we’d combat inflation.
Politicians don’t understand that when they put more money in the system, it’s only in the short term.
People will have more cash, but everything continues to cost more and more.
Inflation actually gets worse rather than getting better.
A lot of politicians don’t understand economics.
They have something called MMT, or modern monetary theory.
MMT believes you can continue to print, print, print.
As long as you don’t see inflation, it’s okay.
They can fudge the numbers and say inflation is not 15-20%, it’s actually 8%.
It’s really important to educate yourself with posts like these and keep learning.
What we’re continuing to do is buy more assets while debt is cheap.
Over time, assets will continue to appreciate.
This is in line with what Robert Kiyosaki talks about:
He says that savers are losers.
The value of the dollars you hold are worth less over time.
Ray Dalio is talking about this as well.
Some other billionaires are talking about moving out of cash and into assets as well as those that pay you to hold them.
You’re hedging yourself against inflation by getting out of cash.
You’re getting the things that actually have real value.
This is also seen in the quote we have at the top of this article:
“A system of capitalism presumes sound money, not fiat money manipulated by a central bank. Capitalism cherishes voluntary contracts and interest rates that are determined by savings, not credit creation by a central bank.”
When money is sound, it actually preserves value.
Assets preserve their value.
That’s why people do Bitcoin or have gold or get into real estate.
They’re hoping it will preserve value outside the dollar.
When money is not sound, when they create more and more and more, everything is worth less over time.
Now I want to hear from you!
What assets are you buying now to hedge yourself against rising rates and inflation?
Let us know in the comments and let’s start a conversation.
Before you leave, make sure to check out our special report about investing. It compares the stock market to real estate, and it also includes how the pandemic affects your investment future.
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Disclaimer: I am not your investment advisor. This is for educational purposes only. I am not giving specific advice on what you can do. I am simply giving my opinions.
Thanks Bronson good post!
I wanted to ask you about the many corporations and hedge funds (60 minutes had a recent episode on it), who are buying blocks of single family homes and converting them to single family rentals in various sunbelt states. I have personally seen this happening down here is Texas!! These companies obviously see the long term value of inflationary assets of SFR’s and are going to use their influence and purchasing power to ensure long term growth. Do you see this competing with multi-family as people look for ‘more space’? Or does this potentially have the opposite effect since these corporations are buyers many of the starter homes and lower value homes, it is displacing / delaying many first time home buyers even more that the only option is renting? And as inflation continues putting pressure on first time and lower cost home buyers with the increasing interest rates, could these block’s of SFR’s start attracting the renters from multi family to the point where vacancy rates start to go up on MFR’s?