All Forum Posts by: George Gammon

Charlie the chart looks the same for the fed funds rate. Here's a chart of the prime rate which obviously is applicable to commercial, HML and ARM's...they're all the same. I used the 10 year because most people associate that with mortgage rates. Bottom line is interest rates, in general, have been going down since 1981. Are real estate investors (including lenders) prepared, if rates do what they've done throughout history, and start going up for 30 years?

Below is a chart of the interest rate on the 10 year going back to 1880. As we all know the 10 year is a reasonable benchmark for mortgage rates. In other words, or what matters to investors, the 10 year determines how much your monthly payment will be to the bank (consistent on a fixed rate, fluctuating on an adjustable rate). I'll list my key take aways below the chart and I'd love to hear the BP communities thoughts on the chart as it pertains to current day REI strategy and future RE prices.

My take aways and questions I ask myself...

1.  Bull and bear markets in the 10 year normally last around 30 years.

2.  Interest rates have been going down since 1981.  Since lower interest rates decreases monthly payments (which increases purchasing power, which increases the price of home affordable, which increases home prices), has the rise in home prices since 1981 been exclusively a result of lower interest rates?  What happens to home prices if we go into a 30 year bear market (interest rates go up) in the 10 year? 

3.  Massive increase in volatility since going off the gold standard in 1971.  How could that volatility affect the debt in a real estate portfolio? 

4.  The US national debt is 19 trillion.  The average interest rate on that 19 trillion is approximately 2% making annual debt payments around 400 billion (interest only).  If rates just went to 4% (still very low historically) the annual interest payments would rise to 800 billion.  If the government has 400 billion less to spend into the economy how does that affect overall consumer spending and how does that trickle down to home affordability and prices?  Taking it a step further what happens to the debt payments if the 10 year enters a 30 year bear market (interest rates going up).  At 15%, where we were in 1981, 100% of tax revenue would go to pay the interest on the debt...how would that affect real estate prices?   

5.  How much of consumer spending/economic activity is based on credit?  If interest rates go up, consumers have higher monthly payments on their credit cards, this will decrease spending.  If the US economy is 70% consumer spending how does a long term reduction in that spending affect real estate prices?  

6.  Taking it a step further...interest is the cost of money and money is one half of every single transaction.  If the interest or the cost of money increases steadily over the next 5 years, 10 years, 30 years how will that affect everything sold in the economy and/or real estate? 

7.  If interest rates rise corporate profits decrease because debt payments consume a higher percentage of profits.  If overall profits decrease that will put massive downward pressure on stocks?  What does that do to 401k's?  If people have far less money to retire, due to corporate profits decreasing, does that affect spending?  If so, how does that affect RE?

8.  Finally, fixed rate debt seems incredibly prudent.  Any deal with a ballon payment must include an extremely conservative amount of equity.  There's a much higher than average risk that inflation adjusted real estate prices will be lower in the future.  

9.  Negative real interest rates are the only solution for the government and the economy.  If the federal reserve can pull that off, what does that look like, and how should my RE portfolio be structured to prepare and hopefully take advantage of it?  

I could go on but I'd like to hear what other people think about the chart above.  

George

 Congratulations Jeremy.  This is one of the smartest things a young person can do.  I may go so far is to say it's THE smartest thing a young person can do.  I constantly try to encourage people, even my own family members, to use the strategy of buying a triplex or fourplex, living in one unit and renting out the others to not only cover the mortgage but have some positive cash flow.  

As other posters have pointed out, I wouldn't get too fixated on ratios, formulas, rules etc....assuming it's in a A or B area, bottom line is will the rents conservatively cover the expenses?  If you've got a little saved up for unexpected maintenance, I'd pull the trigger.  

I'm sure you've done the math but most young people haven't.  Here's why this is a brilliant strategy.  

For most Americans their number one expense every month is living expense (rent, mortgage), on average, people spend about $2,000 on housing per month.  What if, at age 25, you could no longer have that expense and you just took the $2,000 a month/$24,000 a year and parlayed that into an investment making a 10% return and did that until you were age 55?  

Depending on your math you'd have about $4,000,000.  Even at $1000 a month you'd have $2,000,000.  The beauty of compounding returns.  

Above the obvious, what I love so much about this strategy is it doesn't really affect an individuals lifestyle.  You don't have to save and pinch.  Just keep expanding your rental portfolio from the savings of not having a living expense.  

Great thinking Jeremy, keep it up.  

George

 monthly rent/value (or price paid) for property.  100k prop getting $1300 a month for rent would have a monthly R/V ratio of 1.3...I think some people may use annual rents, I've always used monthly rents.    

@Eric KangI've seen a lot of people suggest Kansas City which is a good market to consider.  I purchased several properties there in 2012, commercial and residential so I know the market well.  

If you're considering KC I'd suggest looking more at the MO side than the KS side because laws were much more favorable for landlords (that was back in 2012, I'm assuming they're the same now but they could've changed).  

On the MO side you want to focus on areas like Blue Springs, Lees Summit, SE Independence, Grain Valley and very limited parts of KC proper.  Turnkey providers will sell you properties in KC with decent R/V ratios but they're in C areas, something I'd advise against.  

Like every other market, KC has it's areas that are solid and areas you wouldn't want to go without a gun, so make sure you're paying attention and do the boots on the ground research, not only with the location of properties but with property managers as well.  

Good luck, and if you have any question regarding KC don't hesitate to ask.

George 

 Anyone can buy in the places I've mentioned but that doesn't mean anyone should. ;) 

I always just start with a Google search and go from there.  If you're interested in Medellin, Montenegro, split Croatia, quito Ecuador, Vilnius Lithuania let me know.  I've got really good agents in those markets that I'm happy to refer you too.  

Remember prices may go north too Aditya (please see my bullish case for housing prices above) it's all about each person analyzing the probabilities thoroughly and executing a game plan, based on those probabilities, that's right for them.  

Good luck

@Mark ByrgeI'd think about this very carefully.  Please read @Jon Holdmanposts carefully.  

Remember you're getting this loan with interest rates at all time historic lows.  Some young investors might not even know this but the fed funds rate is normally between 5% and 7% not 0%.  So if you're getting a loan now at 5% interest for those first 5 years, when you go to rifi, rates could be "normal" and the interest rate on your new loan could be in the 8%-12% range.   And that's if you can get a loan, what if banks are tight then due to another downturn?  The monthly payment on a 5% 1 mil loan amortized over 20 years is roughly $6,600.  The monthly payment on a 9% 1 mil loan amortized over 20 years is $9,000.  

On a deal that has a current DSCR of 1.25 that increase in monthly payment would make the deal cash flow negative. Also, if interest rates go up that high cap rates will have most likely gone up, decreasing the resale value of the property.

That said, we could have interest rates stay the same for the next 20 years (look at Japan), interest rates could be negative in fact, no one really knows.  So what I'm saying is think about all possible macro scenarios when analyzing the risk/reward of a deal.  Means test the deal for higher interest rates, lower interest rates, deflation, inflation, higher cap rates, lower cap rates, easy credit, tight credit etc.  Then if the deal still makes sense you know you've got a great deal. 

Good luck,

George 

@Aditya Varyou're welcome....

quick tip: if you type in the @ symbol and start typing the name of the person you want to mention slowly their name will pop up.  Click on it and that'll create the blue hyper link at mention you see everywhere.  

1.  Sorry it's a little tough to follow.  Basically multiple small homes usually provide more total rent than one big home.  

2.  If R/V ratios are good in your area then I'd say it's wise to have the rental props there so you can keep an eye on them.

3.  Have you done any flips?  Maybe you could buy a house to live in and remodel it to add some value? That added equity could give you some wiggle room... The big problem I'd be trying to solve, if I was in your shoes, is how do I protect the equity I currently have (in any home) against housing prices going down.  That's why I talk about linear markets, adding value to homes, and extracting equity via cash out rifi's.  

4.  That's great if your current home would cash flow nicely as a rental.  Again, my concern is protecting your current equity regardless of whether it's in your current home or a new home.  

5.  If you're referring to the fed funds rate...yes.  I'd give it 65%.  It wouldn't be the end of the world it's just something we as investors need to think through and means test our portfolios for that type of environment.  

*If you're a little leery of the current market you can always sell your current home, rent a new place and sit on the cash until you feel more comfortable.  

I'd strongly suggest Quickbooks for many of the reasons listed above but make sure you buy a version that allows you to organize entries by "class".  I'd also recommend it for the following reasons:

1.  90% of accountants are familiar with Quickbooks making tax preparation far easier and fewer mistakes.

2.  If you ever want to sell your business all investors will be able to understand Quickbooks.

3.  If you're ever audited by the IRS or need "audited" financials to raise money or sell equity/debt auditors will all know Quickbooks making the process far easier.  

4.  It syncs up with most online bank accounts making data entry more streamlined and monthly reconciliation more efficient.  

5.  If you want/need GAAP numbers you won't have a problem.