Why Real Estate Works – The Truth!

Why Real Estate Works – The Truth!

7 min read
Ben Leybovich Read More

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Most of us on BiggerPockets are of the opinion that Real Estate represents the best opportunity for us to get ahead. But why – really?

I am of the opinion that if we are going to involve ourselves with real estate, it pays to understand precisely why things work the way that they do. Frankly – most people do not… This article is for those of you who enjoy thinking, once in a while.

Not too often, naturally, as we all know that thinking too much is bad for our health.  However, most realize that the act of thinking once in a while is good for our business, so here we go:

What is Money?

There are countless ways to describe the concept of money, but I think that we can all agree that in our society at its’ core money is just a medium of exchange.

In the early monetary systems, the value of money, which is to say value of “stuff” that one unit of money buys, was underpinned by tangible “things”.  Most of you likely immediately assume those “tangible things” are precious metals.

However, many of the books that I read to my children tell stories of value delivered through heads of heard, Persian rugs, and even salt, which believe it or not was very rare and therefore valued in certain cultures at certain times.

However, an obvious problem with paying for stuff with heads of herd is simply that while valuable, a herd of animals is difficult to store and transport.  Aside for storing universally accepted value, a medium of exchange should also be convenient and utilitarian in order to be effective…a herd is neither.

As people continued to search for a more utilitarian unit of money, they eventually arrived at precious metals which, it was felt, due to their relative rarity possessed intrinsic value, but which could be minted into small coins making them easier to transport and utilize in trade.

Well, while metal coins were much more convenient than anything that came before, carrying around a bag of gold coins still left something to be desired relative to comfort.

After all – imagine going through the day trying to keep your pants from falling due to being weighted down by two-kilo bags of coins in each pocket…

Who is Best at Solving Problems?

You guessed it – bankers.

Yeah baby, these guys are always the smartest people in the room (specifically when they are the only people in the room) and they always have the answers.

Related: How to Create a Compelling Elevator Pitch to Your Lender

The bankers said: Hey guys – we know this money is hard to schlep around town all day, so why don’t you leave your coins in our vault, and we’ll give you a little paper Bank Note in the amount equal to your deposit.  You can come back and use this Note to redeem your coins any time you want, and in the mean time you can simply conduct your trade with them – our Bank Notes are good as gold!

How convenient – now all folks had to carry around were a few pieces of paper…

This Was the Beginning of the Problem

Why – you ask?

Because it didn’t take the bankers long to get wise to the idea that the chances of all of the depositors showing up and demanding every ounce of the money they had on deposit at the same time was negligible.

Sure, the bank has to have a certain amount of money available to pay out to those people who do come in and claim their deposits, but this amount is a fraction of the total amount on deposit – let’s say 10% for example.

Naturally there is much more to this, but the end result was that only a small percentage of all money in circulation was real, or collateralized by intrinsic value of the precious metals in the volts of the banks.

The rest were just IOUs.  Say hello to Fractional Reserve Banking! But, needing to collateralize even 10% of the money soon became impossible since there wasn’t enough gold in existence, which led to an eventual decoupling from the metal all together.

Say hello to Fiat Currency. Now the banks can create as much money as they want, which is convenient for the governments since they can pay for wars and social programs without worrying about running out of money…NICE, everyone is happy! Moving along:

How Money is Created

Banks don’t lend money that they have.

Instead, they create as much money out of thin air as they need. When you go in to ask for a loan, and you are approved, an entry is simply created on the bank’s balance sheet indicating that a loan has been made.

This entry creates fiat money which enters the circulation.  That simple… Robert Kiyosaki explains to us that this loan is an asset for the bank and the entry is made in the asset section of the bank’s balance sheet.  Not a bad set-up if you ask me.  The rest of us have to “buy” assets with our hard-earned cash, but not the banks – they just create the money.

But, I’ll go a step further than Kiyosaki in saying that it’s not the loan that constitutes the bank’s freshly minted asset – it’s the borrower! Having created this money, the bank now expects you to pay it back – do they not?

Of course they do!  And not only that, but you are also expected to pay interest on this money.  Think about this – the bank creates money it did not have before, to lend it to you, so you can pay interest on this money and make the bank rich.

Pretty cool set-up – if you are the bank. Question: Can you, just like the bank, create money out of thin air with which to pay the back your debt and interest? No?  What a shame! This means that what you must do is work, work, and work some more to EARN the money with which to pay the bank back. You are the banks asset, and that’s putting very mildly…

A Way to Look at This:

Looking at this situation we could say that having created money to lend to you out of thin air with just a stroke of a pen (or by pushing down a few keys on a computer keyboard), the banks are then able to generate profits by charging interest that you must “earn”.

Banks do not create monetary supply with which you can pay the interest; they only create monetary supply that is the principal.  This means that you MUST work to earn the money – it’s the only way (for most people)!

This is important: In our economy, due to what I just described, debt is an asset to the economy and to the government because in a debt economy such as ours debt necessitates your (and everyone else’s) productivity.  The more debt you carry, the more productive you must be to support your habits, which is why I choose to live rather frugally (wink, wink).

So, do you see that by borrowing money to support your life-style you relinquish control over your productivity to the bank and our economic system at large?

A few banks, who belong to private shareholders, who are at the top of the economic food-chain, and who control most of the investable wealth in the world, lend money out to the rest of us in return for interest which ropes most of us up into trading hours for dollars for the rest of our lives…

There is Another Way – Income-Producing Real Estate

While I could go on about this kind of stuff for hours, and this barely scratches the essence of the beast that is the fractional reserve banking system, which, incidentally, will most definitely for reasons none other than simple math be our downfall in the end, I must inject some positive perspective into this otherwise gloomy and some-what disturbing article.

Related: Income Real Estate Investors: Learn How to Analyze a Property before you Get Burned!

This positive perspective will come at a price of humility, but at least it’s something… While it is virtually impossible to avoid being economically controlled unless you are independently wealthy, it is indeed possible to offset the effects. Think about it…I borrow fake money at the bank.  I then convert this money into income-producing real estate.

And if I do it right, the rents coming in from my tenants pay the principal and interest associated with my borrowing.  In this way, while I am still on the hook to the bank, chances are better than not that OTHER PEOPLE will pay off my debt.  Put another way, it is my tenants working hard trading dollars for hours at their jobs – not me, and in this way I escape the system of productivity!

Furthermore, as my notes to the banks get paid off, I will gain access to equity which I can liquefy and – become a lender myself!  That’s right, I will be able to turn the tables in my favor… Do I feel great about having to effectively lay all of the burden of my financial gain on the shoulders of my tenants – no; I do not!

But, I do it because the system is designed in a way that forces me to do it, and I sure as hell don’t want to waste myself trying to change the system. There is a game going on, and several statements seem true relative to this:

  1. You can’t win if you don’t play
  2. You can’t win if you don’t know the rules
  3. You can’t win if you don’t have the right tools

Conclusion

Much more needs to be said, but in more ways than one this story really is just about grabbing a piece for yourself while there’s still time.

This isn’t a right vs. left, progressive vs. conservative, democrat vs. republican story.  EVERYONE at the top of the economic food-chain is all in at this stage of the game.

My advice to you – learn the game and try like hell to grab a piece!

OK; this is enough thinking for a Tuesday morning…

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