Who's at the most financial/leverage risk in a recession?

Who's at the most financial/leverage risk in a recession?

Scott TrenchPro Member
Rental Property Investor · Denver, CO · Member since 2014 · 2k+ posts · 6k+ votes

Hi Team - I wanted to walk through a couple of quick thoughts on what I see as the most at-risk parties in a potential recession. 

1) Middle-Class Homeowners - A middle-class homeowner reliant on one source of income, with a large mortgage payment on a recent purchase or refinance is at the highest risk of all parties involved in the real estate world that I can think of. Their wealth is likely highly concentrated in a single asset that is levered many multiples of their annual income. If they lose their job, they are screwed. If the property's value declines, their net worth becomes negative. Their saving grace is if they have a very long-term outlook and plan to live in the property indefinitely. They can, in this case, likely wait out any market timing issues, so long as they can cash flow the mortgage payments through thick and thin.

2) Syndicators, real estate private equity, and hedge funds - These folks scoop up properties, using other people's capital, and generate wealth on carried interest. Their debt is often financed with variable interest rates, balloon payments, and shorter amortization periods. They are also heavily dependent on market timing. While their terms may be flexible, they generally promise 2-5 year hold periods, and investors generally expect to exit within this timeframe. If the market drops, and does not recover, they are in trouble. If interest rates rise quickly, they see cap rates rise, and be unable to refinance or sell the assets. 

3) Small Mom and Pop Landlords using Creative Finance: DSCR, Seller financing, and other forms of private capital put these investors at substantial risk. If interest rates rise, they may be unable to refinance the debt at attractive rates, or sell the property. If rents and prices fall, the terms of their debt may force an exit at an inopportune moment.

4) Small Mom and Pop Landlords Using Conventional Loan Products - These folks are impacted by falling rents and prices, sure. But, if well-capitalized, they have tenants paying some/all of the mortgage payment on a cash flowing asset. They have their wealth spread across at least a few properties, rather than a single asset. They likely have a 30-year mortgage locked in at a fixed interest rate. They are in complete control of their selling time horizon, and can keep the property indefinitely until prices return.


While all of these players can win, I think it's important to recognize the risk profile and how the types of debt used to buy property can dramatically change the risk profile. The small time real estate investor using conventional financing is not getting rich as quickly in a bull market as some of the more "creative" investors. But, they are much less likely to lose their property or find themselves in a liquidity crunch in downturns as well. And, be smart about who you syndicate with, and understand that the projection models WILL NOT usually cover scenarios where cap rates rise by hundreds of basis points - and that scenario is all too realistic in a rising interest rate environment. 

No one can predict the market accurately, but we can understand the risks. 

Most of all, don't be the middle-class homeowner with the mortgage payment that stretches you to your financial limits. Unfortunately, that's the population that will get hit first and hardest in a real estate market downturn. The grind to dig out of that hole could cost many years of life. 

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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
4y

Scott,

You missed the safest player of them all.. the investor who pays all cash and slowly builds up a portfolio with zero or very limited debt.. All assets no debt.. there are more of these investors than many on BP probably realize and of course up until now the limited debt investors get drowned out on BP as crazy.. your leaving equity in the deal its dead equity blah blah blah.

But those are the folks that can weather any storm  I have bought many a foreclosure from number 4 when tenants trashed the units they could not get them up and running and just walked away disgruntled..

I know its not a popular position on BP  but since you brought it up.. So there is a balance for sure.. and that is why I like to suggest investors try to pay down debt when they can and try to have paid for assets and be very cautious on what type of assets they take debt on. 

See this reply in the discussion

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  • Realtor · Cumming, GA · Member since 2018 · 158 posts · 127 votes
    4y

    Great post, Scott!

    I worry about a specific group of folks who have overleveraged themselves on short term rentals with thin margins because they weren't conservative enough in their revenue forecasts. Should these people be those that quit their jobs on the income or are relying heavily on the STR income, they could find themselves in a bad spot if they don't have proper reserves.

  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    4y

    Scott,

    You missed the safest player of them all.. the investor who pays all cash and slowly builds up a portfolio with zero or very limited debt.. All assets no debt.. there are more of these investors than many on BP probably realize and of course up until now the limited debt investors get drowned out on BP as crazy.. your leaving equity in the deal its dead equity blah blah blah.

    But those are the folks that can weather any storm  I have bought many a foreclosure from number 4 when tenants trashed the units they could not get them up and running and just walked away disgruntled..

    I know its not a popular position on BP  but since you brought it up.. So there is a balance for sure.. and that is why I like to suggest investors try to pay down debt when they can and try to have paid for assets and be very cautious on what type of assets they take debt on. 

  • Scott TrenchPro Member
    OP
    Rental Property Investor · Denver, CO · Member since 2014 · 2k+ posts · 6k+ votes
    4y

    Great point, @Jay Hinrichs. I believe that within the next 5-7 years, I will begin transitioning my portfolio to become debt free for a variety of reasons. The most important of which being my "why" - I want a stable portfolio that comfortably provides way more cash flow than I need, and which is indexed more or less to inflation. 

    How do we find and amplify the voices of the all-cash investors who have been getting rich slowly? 

  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    4y
    Quote from @Scott Trench:

    Great point, @Jay Hinrichs. I believe that within the next 5-7 years, I will begin transitioning my portfolio to become debt free for a variety of reasons. The most important of which being my "why" - I want a stable portfolio that comfortably provides way more cash flow than I need, and which is indexed more or less to inflation. 

    How do we find and amplify the voices of the all-cash investors who have been getting rich slowly? 


    You have them on BP  Gary in Ohio and Bill down in Vegas to name a few .. plus one of the guys I really admire for his fantastic advice is Steve up in Wenatchee.  

    What I think the homeowner safety net is going to be is the fact that I dont know how many millions of mortgages were written sub 3.5% but its a ton.. and for those with where rents are the only way they lose their home is over  JOB  Divorce or health and those things happen in all economy's and to all walks of life..   Playing in the distressed asset field for all these years this is the root cause along with simply being very poor money managers and using too much credit to their detriment.. you know the 250k house with 100k in cars the boat and the RV. LOL

  • Member since 2019 · 7k+ posts · 4k+ votes
    4y

    Either recession or no recession, most RE riskiest investment from top to bottom:
    a) > 80% LTV, epecially with I/O only or too short-term ARM and need to be refinanced within a few years from 2022
    b) 50-75% LTV
    c)  <50% LTV
    d) those who doesn't have adequate reserves.

    In any good/bad time scenario, it's prudent to have at very least 25-30% LTV. 

    I actually do notice some of HML underwriter has better guidelines than FM. They ask folks to invest at 50% LTV. Agree.

    However from all investors, there's nothing crazier than Microstrategy, this is the only company on earth that's accumulating crypto in their book and having more crypto as collateral. I'm thinking this kind of company to be wiped out soon. Very soon the banks that are holding their asset may need to be rescued. 

  • Alex BreshearsBusiness Member
    Lender · Springfield, MO · Member since 2020 · 354 posts · 504 votes
    4y

    I agree with this 100%. The syndication space and the equity fund space is a bit scary right now. Some of these pitch decks are using some pretty aggressive underwriting in their pro forma to show really nice IRR, Equity Multiples, and Cash on Cash returns. There's no mention of the debt structure and terms in these pitch decks, and never any mention of the type of insurance involved in the properties the passive investors will be contribution their capital towards. Those two things and really wreck a deal quick! Plus they are showing exiting at an even lower cap rate! They are already buying them at the 3 and 4 cap rate mark, and in an environment with rising rates, inflation, etc it will get harder to find qualified tenants with enough income to qualify. I'm not saying duck and run, but make sure you really understand what you are investing in and with whom you are investing!

  • Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes
    4y

    I think it depends on details of what happens in the economy. We may be moving into a recession....but accompanied by high inflation.  If so, prices may actually go up, rather than down. Including rents. But people will have difficulty affording the high prices. In a high inflationary environment  wouldn't having low, fixed rate income producing debt be attractive? Or any debt that is lower than the inflation rate. And it's  an open question as to just how far the Fed will be willing to raise interest rates if/when we go into a deepening recession. 

  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    4y
    Quote from @Eric James:

    I think it depends on details of what happens in the economy. We may be moving into a recession....but accompanied by high inflation.  If so, prices may actually go up, rather than down. Including rents. But people will have difficulty affording the high prices. In a high inflationary environment  wouldn't having low, fixed rate income producing debt be attractive? Or any debt that is lower than the inflation rate. And it's  an open question as to just how far the Fed will be willing to raise interest rates if/when we go into a deepening recession. 


     Eric,  I think personally and its just me but there has to be a ceiling to rent.. cant just keep raising it because investors are paying more or interest rates went up.. especially those that are pay check to pay check and now their living expenses have gone way up.. IE gas  food  and other commodities that have gone up so quickly.  I mean I look at the meat counter at Costco and steaks are now 15 to 30 bucks a pound  salmon ( granted line caught and fresh) is 25. a pound etc etc..  Avocados have doubled ..   I have to think the beef industry at these prices is going to lose a lot of market share.  Pork and chicken are still somewhat affordable proteins. 

  • Rental Property Investor · Los Angeles · Member since 2018 · 844 posts · 1k+ votes
    4y
    Quote from @Alex Breshears:

    I agree with this 100%. The syndication space and the equity fund space is a bit scary right now. Some of these pitch decks are using some pretty aggressive underwriting in their pro forma to show really nice IRR, Equity Multiples, and Cash on Cash returns. There's no mention of the debt structure and terms in these pitch decks, and never any mention of the type of insurance involved in the properties the passive investors will be contribution their capital towards. Those two things and really wreck a deal quick! Plus they are showing exiting at an even lower cap rate! They are already buying them at the 3 and 4 cap rate mark, and in an environment with rising rates, inflation, etc it will get harder to find qualified tenants with enough income to qualify. I'm not saying duck and run, but make sure you really understand what you are investing in and with whom you are investing!

    I've noticed that much of the IRR numbers I'm seeing in my inbox from syndicators sending out spam are getting larger and larger. I just don't see how that's possible given the cap environment you just described! And a lot of the Johnnie-come-lately syndicators who have never operated in a down-cycle will really be tested. I can't help but imagine that a lot of newbie LP's will lose their shirts in these investments after being promised IRR's north of 20%. One of the criteria I generally use when evaluating an investment is to see how many full cycle deals are under the sponsor's belt....especially if the investment began prior to the GFC. I agree that it's really important to have a set criteria for evaluating an investment objectively and understanding the risks that are involved.

  • Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
    4y

    Great post.

    High leverage is higher risk for the lender than for the owner, who does not have much capital in the property and can walk away.  Call me crazy but with high inflation and excessive government debt, it's risky to not own (prudent) debt and assets.  The non-property owner is getting creamed right now...that's the riskiest proposition.

    I'm a big proponent that debt structure is paramount in risk mitigation.  Separately, I feel that location plays a huge role as well.  If we purchase properties in locations with little risk of extended vacancy or with high intrinsic or added value, we should do fine regardless of market conditions.

  • Rental Property Investor · Dallas, TX · Member since 2020 · 161 posts · 88 votes
    4y

    @Scott Trench, I've been getting rich slowly for 24 years in my hometown of Dallas.

  • Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    4y

    Very well said Scott and thank you for the soft mention, Jay. 

    I couldn't have stated better the leverage risks you mention and why, Scott.  Commercial loan terms and seller financing risks are what drove me to begin accelerating my RE debt down aggeessively beginning in 2017. 

    I have mostly exited via seller-financing in this rising rate environment and am grabbing popcorn. My career arc naturally peaked and I want time freedom more than timing or predicting chicken little.   Good discussion👍

  • Member since 2019 · 7k+ posts · 4k+ votes
    4y
    Quote from @Jay Hinrichs:
    Quote from @Eric James:

    I think it depends on details of what happens in the economy. We may be moving into a recession....but accompanied by high inflation.  If so, prices may actually go up, rather than down. Including rents. But people will have difficulty affording the high prices. In a high inflationary environment  wouldn't having low, fixed rate income producing debt be attractive? Or any debt that is lower than the inflation rate. And it's  an open question as to just how far the Fed will be willing to raise interest rates if/when we go into a deepening recession. 


     Eric,  I think personally and its just me but there has to be a ceiling to rent.. cant just keep raising it because investors are paying more or interest rates went up.. especially those that are pay check to pay check and now their living expenses have gone way up.. IE gas  food  and other commodities that have gone up so quickly.  I mean I look at the meat counter at Costco and steaks are now 15 to 30 bucks a pound  salmon ( granted line caught and fresh) is 25. a pound etc etc..  Avocados have doubled ..   I have to think the beef industry at these prices is going to lose a lot of market share.  Pork and chicken are still somewhat affordable proteins. 

    Agree there's rent to ceiling. Regarding inflation... actually only vegetable and salad still has no inflation.


    while the Korean BBQ joint that I usually visited, raise the price from $22 to $39 just like that. But Vietnameese pho can still maintain single digit price. I don't know why such a discrepancy.

  • New to Real Estate · Atlanta, GA · Member since 2020 · 10 posts · 4 votes
    4y
    Quote from @Eric James:

    I think it depends on details of what happens in the economy. We may be moving into a recession....but accompanied by high inflation.  If so, prices may actually go up, rather than down. Including rents. But people will have difficulty affording the high prices. In a high inflationary environment  wouldn't having low, fixed rate income producing debt be attractive? Or any debt that is lower than the inflation rate. And it's  an open question as to just how far the Fed will be willing to raise interest rates if/when we go into a deepening recession. 

    Inflation increases when money supply increases. Money supply = all cash AND credit in the economy. By lowering interest rates you would incentive more people to borrow money since it’s so cheap. Now there is more money and supply and same production levels.

    Imagine an economy of an island that only produces coconuts. Let’s say there is 20 coconuts produced per year. Money supply is $100. If everyone spends their money the coconuts are $5/coconut. Next year government makes interest rate 0% so banks can loan money at any interest rate to make money so they offer .05% interest loans. Now people rush in to get all this credit and the money supply explodes to $200 in the economy. No change in production. Same number of coconut trees and coconut farmers, etc. Now there is $200 in the economy and 20 coconuts. Everyone spends their money and coconuts end up at $10/coconut. Inflation rose 100%. Obviously our economy is more complicated but that is why low interest rates produce inflation and why the Fed is so gung-ho about jacking them up.

  • Member since 2019 · 7k+ posts · 4k+ votes
    4y
    Quote from @Toby Kim:
    Quote from @Eric James:

    I think it depends on details of what happens in the economy. We may be moving into a recession....but accompanied by high inflation.  If so, prices may actually go up, rather than down. Including rents. But people will have difficulty affording the high prices. In a high inflationary environment  wouldn't having low, fixed rate income producing debt be attractive? Or any debt that is lower than the inflation rate. And it's  an open question as to just how far the Fed will be willing to raise interest rates if/when we go into a deepening recession. 

    Inflation increases when money supply increases. Money supply = all cash AND credit in the economy. By lowering interest rates you would incentive more people to borrow money since it’s so cheap. Now there is more money and supply and same production levels.

    Imagine an economy of an island that only produces coconuts. Let’s say there is 20 coconuts produced per year. Money supply is $100. If everyone spends their money the coconuts are $5/coconut. Next year government makes interest rate 0% so banks can loan money at any interest rate to make money so they offer .05% interest loans. Now people rush in to get all this credit and the money supply explodes to $200 in the economy. No change in production. Same number of coconut trees and coconut farmers, etc. Now there is $200 in the economy and 20 coconuts. Everyone spends their money and coconuts end up at $10/coconut. Inflation rose 100%. Obviously our economy is more complicated but that is why low interest rates produce inflation and why the Fed is so gung-ho about jacking them up.


     Most folk thinks the source of inflation is mainly from Fed printing money, but if we examine the CPI closely, the crazy inflation only occurred mainly in two sectors: Energy and gas. It started in Feb after Ukraine invasion and russia oil embargo by the western country. I think what we see today is the effect of oil price going to $120, but when this oil issue is resolved by itself in the next few months, CPI will go back to 5-6% (just like during covid). When CPI goes back to 5%, 30Y Mortgage is going back to 4-5% hopefully. Usually oil crisis is very shortlived.

  • Scott TrenchPro Member
    OP
    Rental Property Investor · Denver, CO · Member since 2014 · 2k+ posts · 6k+ votes
    4y
    Quote from @Carlos Ptriawan:
    Quote from @Toby Kim:
    Quote from @Eric James:

    I think it depends on details of what happens in the economy. We may be moving into a recession....but accompanied by high inflation.  If so, prices may actually go up, rather than down. Including rents. But people will have difficulty affording the high prices. In a high inflationary environment  wouldn't having low, fixed rate income producing debt be attractive? Or any debt that is lower than the inflation rate. And it's  an open question as to just how far the Fed will be willing to raise interest rates if/when we go into a deepening recession. 

    Inflation increases when money supply increases. Money supply = all cash AND credit in the economy. By lowering interest rates you would incentive more people to borrow money since it’s so cheap. Now there is more money and supply and same production levels.

    Imagine an economy of an island that only produces coconuts. Let’s say there is 20 coconuts produced per year. Money supply is $100. If everyone spends their money the coconuts are $5/coconut. Next year government makes interest rate 0% so banks can loan money at any interest rate to make money so they offer .05% interest loans. Now people rush in to get all this credit and the money supply explodes to $200 in the economy. No change in production. Same number of coconut trees and coconut farmers, etc. Now there is $200 in the economy and 20 coconuts. Everyone spends their money and coconuts end up at $10/coconut. Inflation rose 100%. Obviously our economy is more complicated but that is why low interest rates produce inflation and why the Fed is so gung-ho about jacking them up.


     Most folk thinks the source of inflation is mainly from Fed printing money, but if we examine the CPI closely, the crazy inflation only occurred mainly in two sectors: Energy and gas. It started in Feb after Ukraine invasion and russia oil embargo by the western country. I think what we see today is the effect of oil price going to $120, but when this oil issue is resolved by itself in the next few months, CPI will go back to 5-6% (just like during covid). When CPI goes back to 5%, 30Y Mortgage is going back to 4-5% hopefully. Usually oil crisis is very shortlived.

    Oil Gas impacts the price of almost everything. It’s involved in so many manufacturing processes. Not to mention the transportation of goods and services. Until this gets under control, I think inflation will remain high.

    with regards to them dropping mortgage rates, I don’t think the fed will do that unless unemployment gets too high or we start seeing deflation or inflation less than the 2% target.

    rates are still super low by historical contexts, the Fed won’t drop them unless there’s a reason to in my opinion. 
  • Member since 2019 · 7k+ posts · 4k+ votes
    4y
    Quote from @Scott Trench:
    Quote from @Carlos Ptriawan:
    Quote from @Toby Kim:
    Quote from @Eric James:

    I think it depends on details of what happens in the economy. We may be moving into a recession....but accompanied by high inflation.  If so, prices may actually go up, rather than down. Including rents. But people will have difficulty affording the high prices. In a high inflationary environment  wouldn't having low, fixed rate income producing debt be attractive? Or any debt that is lower than the inflation rate. And it's  an open question as to just how far the Fed will be willing to raise interest rates if/when we go into a deepening recession. 

    Inflation increases when money supply increases. Money supply = all cash AND credit in the economy. By lowering interest rates you would incentive more people to borrow money since it’s so cheap. Now there is more money and supply and same production levels.

    Imagine an economy of an island that only produces coconuts. Let’s say there is 20 coconuts produced per year. Money supply is $100. If everyone spends their money the coconuts are $5/coconut. Next year government makes interest rate 0% so banks can loan money at any interest rate to make money so they offer .05% interest loans. Now people rush in to get all this credit and the money supply explodes to $200 in the economy. No change in production. Same number of coconut trees and coconut farmers, etc. Now there is $200 in the economy and 20 coconuts. Everyone spends their money and coconuts end up at $10/coconut. Inflation rose 100%. Obviously our economy is more complicated but that is why low interest rates produce inflation and why the Fed is so gung-ho about jacking them up.


     Most folk thinks the source of inflation is mainly from Fed printing money, but if we examine the CPI closely, the crazy inflation only occurred mainly in two sectors: Energy and gas. It started in Feb after Ukraine invasion and russia oil embargo by the western country. I think what we see today is the effect of oil price going to $120, but when this oil issue is resolved by itself in the next few months, CPI will go back to 5-6% (just like during covid). When CPI goes back to 5%, 30Y Mortgage is going back to 4-5% hopefully. Usually oil crisis is very shortlived.

    Oil Gas impacts the price of almost everything. It’s involved in so many manufacturing processes. Not to mention the transportation of goods and services. Until this gets under control, I think inflation will remain high.

    with regards to them dropping mortgage rates, I don’t think the fed will do that unless unemployment gets too high or we start seeing deflation or inflation less than the 2% target.

    rates are still super low by historical contexts, the Fed won’t drop them unless there’s a reason to in my opinion. 

     The mortgage rates is not dictated by the Fed action directly.

    The 30YFRM has more correlation with 10 Year Treasury notes. The notes are affected by the CPI number AND the 'market' expectation of how Fed reacts to such CPI number (thing is, we know that Fed is going to rise, but til how much was the disagreement until the last Friday). The CPI number, by itself, in reality, is highly correlated to energy/gas pricing (just for this inflation).  The tomato and vegetable pricing, actually still has no inflation. (Dont know why hahaha)

    What I'm saying is no matter what the Fed will do, (most likely) it will not affect much (of the inflation), meanwhile if energy/embargo oil allocation back to normal, the inflation for sure naturally going down by itself.

    This winter could be particularly bad as European country will need more energy & gas.

  • Real Estate Agent · Sisters, OR · Member since 2014 · 1k+ posts · 1k+ votes
    4y
    Quote from @Scott Trench:
    Quote from @Carlos Ptriawan:
    Quote from @Toby Kim:
    Quote from @Eric James:

    I think it depends on details of what happens in the economy. We may be moving into a recession....but accompanied by high inflation.  If so, prices may actually go up, rather than down. Including rents. But people will have difficulty affording the high prices. In a high inflationary environment  wouldn't having low, fixed rate income producing debt be attractive? Or any debt that is lower than the inflation rate. And it's  an open question as to just how far the Fed will be willing to raise interest rates if/when we go into a deepening recession. 

    Inflation increases when money supply increases. Money supply = all cash AND credit in the economy. By lowering interest rates you would incentive more people to borrow money since it’s so cheap. Now there is more money and supply and same production levels.

    Imagine an economy of an island that only produces coconuts. Let’s say there is 20 coconuts produced per year. Money supply is $100. If everyone spends their money the coconuts are $5/coconut. Next year government makes interest rate 0% so banks can loan money at any interest rate to make money so they offer .05% interest loans. Now people rush in to get all this credit and the money supply explodes to $200 in the economy. No change in production. Same number of coconut trees and coconut farmers, etc. Now there is $200 in the economy and 20 coconuts. Everyone spends their money and coconuts end up at $10/coconut. Inflation rose 100%. Obviously our economy is more complicated but that is why low interest rates produce inflation and why the Fed is so gung-ho about jacking them up.


     Most folk thinks the source of inflation is mainly from Fed printing money, but if we examine the CPI closely, the crazy inflation only occurred mainly in two sectors: Energy and gas. It started in Feb after Ukraine invasion and russia oil embargo by the western country. I think what we see today is the effect of oil price going to $120, but when this oil issue is resolved by itself in the next few months, CPI will go back to 5-6% (just like during covid). When CPI goes back to 5%, 30Y Mortgage is going back to 4-5% hopefully. Usually oil crisis is very shortlived.

    Oil Gas impacts the price of almost everything. It’s involved in so many manufacturing processes. Not to mention the transportation of goods and services. Until this gets under control, I think inflation will remain high.

    with regards to them dropping mortgage rates, I don’t think the fed will do that unless unemployment gets too high or we start seeing deflation or inflation less than the 2% target.

    rates are still super low by historical contexts, the Fed won’t drop them unless there’s a reason to in my opinion. 

     I think the Fed will not be able to raise rates enough to stop inflation something will break first, probably the stock market.  This debt needs to be inflated away even if it means the dollar losing some of its world reserve status.  


    Reading @Steve Vaughan does make me reflect on how emotionally involved in this crap I am.  Maybe I should switch a few things around so I can watch the Fed moves etc. like a normal person and not some maniac!  LOL

  • JD MartinBusiness Member
    Moderator
    Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes
    4y
    Quote from @Scott Trench:

    Great point, @Jay Hinrichs. I believe that within the next 5-7 years, I will begin transitioning my portfolio to become debt free for a variety of reasons. The most important of which being my "why" - I want a stable portfolio that comfortably provides way more cash flow than I need, and which is indexed more or less to inflation. 

    How do we find and amplify the voices of the all-cash investors who have been getting rich slowly? 


     I started out in this all cash. Super conservative, mostly because I was a working stiff all my life and lost a big chunk of money on new construction (my podcast story). But after awhile, I realized that I couldn't save my way to a portfolio reasonably large enough to supplant my income. I could see housing prices were going to pick up, and substantially, and without some kind of leverage I would be stuck at maybe a house a year. That's fine if I started when I was 20 instead of when I was 40. So while I'm still pretty conservative, at least on BP (maybe 30% total leverage on my entire portfolio), leverage - smart leverage - was really the only thing that made sense because:

    1. Interest rates were ridiculously low. Below the rate of real inflation, honestly, not the published figures.

    2. Inflation destroys the value of the debt. You pay back debt with devalued dollars. 

    3. The same compounding effect that happens when you save your money happens when you borrow for income producing assets.

    When I say "smart leverage", I'm talking about enough cash flow that you can pay yourself and support the asset, that you've left enough behind in the deal to cover large depreciation issues (20% or more), and that the asset produces enough cash flow that you'll virtually never be forced to sell in a down market. 

    A large part of how you approach investing has to revolve around your income and your age. If you make a ton of money working, then you can be as conservative as you want. If you are 20 years old, you can either be slow and steady or you can take a few chances if you're a broke slob because you have time to recover. If you're more than halfway through your lifespan when you get started, you don't have time to lose everything nor do you have time to "get rich slowly" if you want to be able to enjoy any of those riches. In that case, you have to have something of an aggressive approach, but it also has to be smart because you won't have time to right the ship if you take a torpedo. 

    Anyway, to answer the question of "amplifying the voices of the all-cash investors", I think more people have to be willing to throw some cold water on the threads that give people a lot of false hope - like the ones such as "I'm broke and living in mom's basement but I want to own 50 units by this time next year, please help!"

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  • Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes
    4y
    Quote from @Toby Kim:
    Quote from @Eric James:

    I think it depends on details of what happens in the economy. We may be moving into a recession....but accompanied by high inflation.  If so, prices may actually go up, rather than down. Including rents. But people will have difficulty affording the high prices. In a high inflationary environment  wouldn't having low, fixed rate income producing debt be attractive? Or any debt that is lower than the inflation rate. And it's  an open question as to just how far the Fed will be willing to raise interest rates if/when we go into a deepening recession. 

    Inflation increases when money supply increases. Money supply = all cash AND credit in the economy. By lowering interest rates you would incentive more people to borrow money since it’s so cheap. Now there is more money and supply and same production levels.

    Imagine an economy of an island that only produces coconuts. Let’s say there is 20 coconuts produced per year. Money supply is $100. If everyone spends their money the coconuts are $5/coconut. Next year government makes interest rate 0% so banks can loan money at any interest rate to make money so they offer .05% interest loans. Now people rush in to get all this credit and the money supply explodes to $200 in the economy. No change in production. Same number of coconut trees and coconut farmers, etc. Now there is $200 in the economy and 20 coconuts. Everyone spends their money and coconuts end up at $10/coconut. Inflation rose 100%. Obviously our economy is more complicated but that is why low interest rates produce inflation and why the Fed is so gung-ho about jacking them up.


     Agree with all. Except Fed being gung ho about jacking up interest rates. They are talking tough, but if we go into recession the politicians won't be willing to lose elections to combat inflation seriously. 

  • Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes
    4y
    Quote from @Scott Trench:
    Quote from @Carlos Ptriawan:
    Quote from @Toby Kim:
    Quote from @Eric James:

    I think it depends on details of what happens in the economy. We may be moving into a recession....but accompanied by high inflation.  If so, prices may actually go up, rather than down. Including rents. But people will have difficulty affording the high prices. In a high inflationary environment  wouldn't having low, fixed rate income producing debt be attractive? Or any debt that is lower than the inflation rate. And it's  an open question as to just how far the Fed will be willing to raise interest rates if/when we go into a deepening recession. 

    Inflation increases when money supply increases. Money supply = all cash AND credit in the economy. By lowering interest rates you would incentive more people to borrow money since it’s so cheap. Now there is more money and supply and same production levels.

    Imagine an economy of an island that only produces coconuts. Let’s say there is 20 coconuts produced per year. Money supply is $100. If everyone spends their money the coconuts are $5/coconut. Next year government makes interest rate 0% so banks can loan money at any interest rate to make money so they offer .05% interest loans. Now people rush in to get all this credit and the money supply explodes to $200 in the economy. No change in production. Same number of coconut trees and coconut farmers, etc. Now there is $200 in the economy and 20 coconuts. Everyone spends their money and coconuts end up at $10/coconut. Inflation rose 100%. Obviously our economy is more complicated but that is why low interest rates produce inflation and why the Fed is so gung-ho about jacking them up.


     Most folk thinks the source of inflation is mainly from Fed printing money, but if we examine the CPI closely, the crazy inflation only occurred mainly in two sectors: Energy and gas. It started in Feb after Ukraine invasion and russia oil embargo by the western country. I think what we see today is the effect of oil price going to $120, but when this oil issue is resolved by itself in the next few months, CPI will go back to 5-6% (just like during covid). When CPI goes back to 5%, 30Y Mortgage is going back to 4-5% hopefully. Usually oil crisis is very shortlived.

    Oil Gas impacts the price of almost everything. It’s involved in so many manufacturing processes. Not to mention the transportation of goods and services. Until this gets under control, I think inflation will remain high.

    with regards to them dropping mortgage rates, I don’t think the fed will do that unless unemployment gets too high or we start seeing deflation or inflation less than the 2% target.

    rates are still super low by historical contexts, the Fed won’t drop them unless there’s a reason to in my opinion. 

     I wish I had your faith in politicians. What I see is they will do whatever it takes to get elected, and blame any resulting problems on someone else. The question isn't whether interest rates will be dropped.  It's whether they will be jacked up high enough to decrease inflation.  Doesn't seem likely to me.

  • Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes
    4y
    Quote from @Jay Hinrichs:

    Scott,

    You missed the safest player of them all.. the investor who pays all cash and slowly builds up a portfolio with zero or very limited debt.. All assets no debt.. there are more of these investors than many on BP probably realize and of course up until now the limited debt investors get drowned out on BP as crazy.. your leaving equity in the deal its dead equity blah blah blah.

    But those are the folks that can weather any storm  I have bought many a foreclosure from number 4 when tenants trashed the units they could not get them up and running and just walked away disgruntled..

    I know its not a popular position on BP  but since you brought it up.. So there is a balance for sure.. and that is why I like to suggest investors try to pay down debt when they can and try to have paid for assets and be very cautious on what type of assets they take debt on. 


     Jay..the sheer heresy!! But I agree with you. I have been saying that paid off rentals give the best consistent cash flow at the lowest risk. But that's just so unpopular here on BP.

  • Rental Property Investor · Miami, FL · Member since 2017 · 17 posts · 19 votes
    4y

    @Scott Trench

    When the line between education and sales is a blurred as it is there is always going to be more “noise” toward the investing strategy that benefits sales; in this instance more leverage.

    I have been strategically paying off (not down because, with a conventional mortgage, that increases risk as you reduce liquidity and have the same debt service obligations) “higher” interest loans. I look at it comparable to buying an annuity with no fees, a generally higher than market interest rate and no counterparty risk.

  • Real Estate Broker · Memphis, TN · Member since 2020 · 202 posts · 203 votes
    4y
    Quote from @Scott Trench:

    Great point, @Jay Hinrichs. I believe that within the next 5-7 years, I will begin transitioning my portfolio to become debt free for a variety of reasons. The most important of which being my "why" - I want a stable portfolio that comfortably provides way more cash flow than I need, and which is indexed more or less to inflation. 

    How do we find and amplify the voices of the all-cash investors who have been getting rich slowly? 


     Would love to see interviews with investors who take this approach. I have debated back and forth with myself about wanting to have a paid-off portfolio, but see almost no arguments for the approach other than Dave Ramsey! 

  • PA · Member since 2010 · 339 posts · 168 votes
    4y

    Inflation tends to be check marked (actually, upside down check marked) in that it happens quickly and takes years to recover. The FED has been dumping huge amounts of cash over the past decade in an effort to bring inflation up to 2%. I don’t quite understand why it hasn’t worked. The inflation we are seeing now results from supply chain issues and exacerbated by the quick rise in oil prices, problems that are somewhat transient. I don’t think inflation will be transient, though. IMHO, unemployment will remain low and interest rates will remain highish so we won’t have a recession—I’m an optimist :)

    I think another vulnerable group consist of commercial investors whose loan terms are coming up. If they are too leveraged and didn’t negotiate low basis point caps at reset, it might be tough.

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