BiggerPockets

I don't understand fully how we as investors might be affected if the government gets serious about paying off debt and actually does it.

Let's assume for a second that the government comes up with a plan to pay off all government debt in 25 years. Certaintly programs will need to be cut, but what will this do to the money supply? What about interest rates? Will this lead to deflation?

I'm counting on the mortgage interest tax deduction to be an almost certain victim of coming austerity measures. This was proposed by the bi partisan debt commission recently and will resurface, but not until after the 2012 elections.

Cuts in defense budget are also certain to follow. With this will be the dismantling of the ubiquitous U.S. presence throughout the world in the form of 1) global military bases, 2) satellite regimes propped up with 'foreign aid,' and 3) wars and other covert activities to promote U.S. interests.

What concerns me with the dismantling of the U.S. empire is that other interests (most particularly our largest creditor) will fill the void through military escalation, leapfrogging the U.S. in naval capabilities, and will begin to exert its muscle just as the U.S. recedes.

I don't believe we'll ever pay our debt, at least not in the conventional way typical individuals/organizations pay their debt. It's simply too large to pay off and it will take 100 years of austerity measures, massive cuts to entitlements, the military, coupled with huge tax hikes. That will never happen, you can look back 20 years from now and you'll remember someone on some real estate message board said so.

What might happen though, and what would fit under the "unconventional" means, is for the Fed to inflate our way out of it - think about paying off a trillion dollar of debt in what's equivalent to $100 billion today, it's happened at some countries in the past and I fear we're on that path. There's also the possibility, and I know many people think it's unimaginable right now, is that the developed world total debt will become so huge that the powers that be decide to wipe everyone's slate clear, and declare a single, new currency.

As far as people like us are concerned, I think we should be okay if either scenario occurs - we own hard assets and people will always need a place to live, and they'll have to pay for it whether it's dollars, gold, or the new world currency. If inflation sets in, those with leveraged and mortgaged properties will pay for it with cheaper dollars, if there's a depression and deflation happens, then God help us all.

I think it will be done with a variety to things too Roger. However, I think the dominant mechanism the gov-mint will use is inflation. Inflation is a stealth tax that the voting public doesn't understand very well. It is more politically palatable to pull this lever than anything related to tax policy.

Tax policy does need to be changed too as do the entitlements that are the root cause of our future insolvency. These items will only be touched when our back is against the wall though. Good luck getting someone to vote rationally on this stuff with the way our system is set up.

Shadowstats has the REAL inflation rate at 7% right now. Compounded 7% inflation will erode the value of your long-term, fixed-rate debt very rapidly. My thought is to make my balance sheet look as close to the gov-mint's as possible and ride the inflation wave to prosperity.

For 5+ years I have been loading up on debt because, in my mind, it is free in real terms. GSE-backed, fixed-rate 30-year debt is completely nonsensical from an investment standpoint and is something only a government could come up with. As long as you don't go crazy with things and over-leverage I think it makes sense to carry a multiple of your equity in debt. Mine peaked at about 2.5X my equity and I have been working to reduce it recently. We're at 1.52ish right now.

There is an inordinate amount of effort given to writing about the 50% rule of thumb on this forum. While agree this is a good rule of thumb for some I disagree it applies to many people's portfolios. Many people do not plan to live on the $100/door for the rest of their lives. Their profession affords them a nice lifestyle and they are happy doing what they are doing. In these instances either "betting on appreciation" or riding the principal pay down and dollar devaluation makes perfect sense. You also get a tax benefit to boot while controlling much more in assets that you could control by investing your own cash.

If you have some time model out the PI portion of your payment and how it will be impacted by inflation over time if your rents just manage to keep pace with inflation. At 7% or even 5% over many years that annuity payment to the lender evaporates in real terms. That is one of the principal benefits of owning real estate that is completely ignored by a simplistic 50% rule of thumb analysis that is prevalent on the forums. Tax benefits, amortization, and appreciation are important too...but debt monetization and dollar devaluation is MORE important given the current state of affairs IMO. In fact, I would lobby to have this called a 5th chief profit center for real estate. I would gladly break even on buildings knowing that the inflation hedge is my dominant concern since I have other nice sources of income to pay the bills. In fact...I would (gasp!) also lobby for negative month-to-month cash flow projects in many instances to combat the stealth tax that is all but inevitable. Those projects will turn cash flow positive over time as the PI becomes worth less and less in real terms.

Everyone invests differently, has different goals, different resources, different sources of income, different utility for stability, etc. The one-size-fits-all rule of thumb approach is brute forcing what is a much more rich and complicated discussion about investing.

Anyway...I could go on and on. To each his own. Hopefully this helps Jim.

I believe the gist of Bryan's argument is that the US government will monetize the debt by printing money. Dollars will be devalued because there are so many of them and that will result in higher inflation that we've experienced over the last 15-20 years. Indeed, 30 years ago inflation was MUCH higher and it made sense to load up with debt because you could borrow valuable dollars right now and pay them back with less valuable future dollars later.

Of course that works only with fixed rate debt, such as 30 year fixed rate mortgages. It doesn't work with any sort of adjustable rate debt, such as any sort of ARMs, balloon loans, or credit cards. Those debts will have their interest rates raised by the lenders if inflation kicks up.

Not sure how that wandered off into a rant against the 50% rule. All evidence has pointed to that being a pretty hard and fast rule of thumb that one ignores at their peril.

OTOH, I think there is an underlying idea that owning a rental that currently has negative cash flow when the 50% rule is properly considered may be acceptable. I agree with that idea. If inflation kicks up, then rents and expenses should rise along with inflation. If your property is leveraged with 30 year, fixed rate debt, and we do have a long stretch of inflation, then such a cash flow negative property will turn into a cash flow positive property. Inflation was between 6% and 10% between about 1973 and 1983. That means prices doubled, roughtly, over that span. So, a property that currently rents for $1000 and has a P&I of $600 might be cash flow negative right now, but if the rent rises to $2000 while the P&I stays at $600, this property becomes nicely cash flow positive.

Of course, there are no guarantees inflation will rise, which is why many investors want at least a little cash flow right now.

There's a good chance, in my opinion, that just the reverse could happen. We could have an ugly round of deflation. If that $1000 rent turns into $500, the investor is in a VERY bad position. That's exactly what's happened in Japan, though perhaps not quite that bad.

And, its not easy to get fixed rate, 30 year financing on anything but a few small properties. You're not going to get a 30 year fixed rate loan on a 100, 10, or even five unit apartment building. Those are 3-5 year fixed rates with either adjustments or balloons. That tells you lenders think rates are going up in the future.

We will see debt repudiation and deflation, like that of the 30's. We've already seen it in housing and the private sector. But baby, you ain't seen nothing yet. The government spending bubble is the biggest of them all, when it "pops" you're really gonna hear it.

And it's not about the stupid debt ceiling deal. This has been building for decades. It's called keynesian economics. We've run defecits pretty much every year since 1965. It's like herion addiction. If you've been on that stuff long enough, needing higher and higher amounts to get a sufficient "high", there is just no way to get off painlessly. The scary part is what will be the political ramifications on our liberty.

Getting of smack results in massive chills, nausea, convulsions, vomitting, hot sweat and more. Most deflationary collapses end in war, chaos, upheavel, poverty and depression.

PG

The reason the 50% rule is brought up is because it guides the bulk of the discussion about which properties are suitable to purchase on the forums. Ignoring 3/4 (or 4/5 if you include inflation) of the profit centers is also something you should do at your own peril

There are none so blind as those who will not see.

Bryan, you are mixing up two totally different things.

The 50% rule tells you how much of the rent will be consumed by expenses, capital and vacancy. ABSOLUTELY NOTHING MORE.

Whether you choose to accept a negative cash flow sitaution or want your investments to be cash flow positive has ABSOLUTELY FREAKING NOTHING TO DO WITH THE 50% RULE. NOTHING!!!

Applying the 50% rule gives you a realistic estimate of long term expenses for a portfolio of properties. NOTHING MORE!

I'd swear the way you rant against this rule makes me think you're about to go into business trying to sell junk rentals to naive investors. I don't really think that's the case, so I don't see why you have to drag this discussion down this rathole. I've already supported your argument that a high inflation environment will improve cash flow when you have long term fixed rate financing.

You bring up doing subject to deals. Yep, a reasonable way to get past the limits on fixed rate financing. Provided interest rates don't spike. If interest rates do jump up to where they where in the early 80's, 15+% OO rates, you can rest assured lenders will be calling all those loans that have been taken over subject to. I actually don't think it will take anything near 15% before they start calling loans.

The Fed has so much skin in the game right now with their inflated balance sheet that they have no choice but to inflate or else face insolvency. The immediate concern regarding Deflation should not be focused on U.S. deficit reduction but rather on concerns over Euro Zone debt defaults, most notably Italy. A recent run up in Italy's CDS and 10 year yields approaching the so called "point of no return" had markets plunging and Deflation concerns resurfacing. The market has been able to thus far digest worries over Greece, Portugal, Ireland, and even Spain, but Italy is a different story. They are the world's 8th largest economy and banks all over Europe and even in the U.S. have large exposure (one reason Bank of America's stock took a nose dive). Also, last week rumors were flying that bailing out Italy would cost France it's AAA rating and even Germany eventually.

If the Euro Zone cannot stop this contagion, then it will surely lead to another banking crisis and that will plunge us into a global deflationary depression rather quickly (as evidenced by the recent global market's tanking). Market's have somewhat recovered on news that Merkel, Sarkosy, and Trichet are meeting to come up with a solution, so we shall see. Either Europe finds a solution to backstop and firewall this Euro zone debt contagion once and for all or else we are surely headed for Deflationary Depression ASAP.

Unlike Europe, we have the luxury or the curse to print our own $ at will. This will be the likely course of action as the U.S. will never actually default on it's debt. So assuming Euro Zone and all other default related crisis events (which are highly deflationary) can be prevented, then get ready for INFLATION! Let's cross our fingers and hope that all the Dollar printing doesn't lead us to a Hyperinflationary depression.

If the Feds get serious about cutting government spending, one of the areas that will be cut are rent supports such as Section 8. Even the plans run by states will likely see cutbacks as so much of a modern state's revenue comes from Washington.