Why Is Real Estate a Smart Play?

With all the uncertainty in the economy, most people are pulling back on spending hoping to survive any loss of income they may experience. This reaction is understandable and makes sense when you consider basic human behavior. However, the smart investor understands what is happening in the US and the world economies and sees the opportunity, not the fears.

As I type these words, the US Census report has just revealed that the population of the US grew to 309 million people in 2010, almost 10% more than in 2000. I assume that the real population is actually higher due to illegal aliens and people that work to stay out of the “system”. The census confirms that population growth in the United States is still growing regardless of lowered birth rates. This is great news for real estate investors. Every one of those 309 plus million people need the basics of life, including a place to lie in bed at night. A home is not a luxury, it is a necessity.

In order to prosper in this environment, you need to understand some basics about the US (and world) economy. The US removed the dollar from the gold standard in 1971. This freed the central bank in the US (the Federal Reserve, or Fed) to print as much currency as they wished since the only thing backing the dollar is the “full faith and credit of the United States”. The Fed encouraged banks to ramp up lending which grows the economy fast. Let me stop here and give a very brief lesson on how our economy works.

Until 1971 the dollar was pegged to some degree to gold. This meant that the value of the dollar (its buying power) was tied to the value of gold and this helped prevent wild fluctuations in the value of the dollar. When President Nixon freed dollars and gold from each other, he unleashed the true potential of the Fed in creating currency. The Fed is not a governmental entity. It is a privately held bank that was granted currency creation powers by the US Congress in 1913. Until 1971, the Fed was required to maintain a reserve in gold at the US Treasury that was equal to a percentage of currency it printed. Once the dollar and gold were separated, the Fed could create currency at will.

The Fed creates currency by loaning currency to the government of the US. This means that every time the government wants to spend money, they just go to the Fed with bonds (T Bills, bonds, etc.) and the Fed “buys” them using newly created currency. Putting it simply, the Fed just writes check to the government for whatever amount the government wants. This “check” from the Fed is not charged against any account the Fed has. It is simply a book entry.

So, the Fed creates currency at the stroke of a pen and the government puts this currency into circulation in the form of dollars when the government pays its bills. The real kicker here is that the Fed is then due interest payments from the government on the currency the Fed just created out of thin air! This interest is payable from the tax revenues the government collects from the US citizens. It is interesting to note that the law permitting the government to collect income taxes was passed in 1913 as well.

The government, and the organizers/owners of the Fed, knew the government would need more tax revenues to pay the interest payments due on this new borrowed currency. This is why we can NEVER pay off the debt the country owes. We keep borrowing currency from the Fed in which we owe them interest payable in dollars which are borrowed, over and over. It is THE main Ponzi scheme in the world and the US is the biggest player.

The second part of this economic equation is the process of fractional banking. This simply means that for every dollar deposited into a bank, the bank can make loans for greater then the deposits on hand. Currently in the US, that ratio is 10% required deposit reserves. So, if you deposit $100 into your savings account at the bank, the bank can loan out $900 to other borrowers.

This money is not sitting in their vaults, it is simply new currency created when the borrower signed the loan documents. When you consider that this loan is then deposited into the borrower’s checking account that means his bank can now make additional loans.

Look at it this way. I deposit $100 into my bank. You borrow $900 from my bank (they can do this now per the Fed reserve requirements of keeping only $10 on hand for each $100 deposited). You deposit the $900 check from my bank into your bank. Your bank then loans $9,000 to your neighbor who buys a car. The seller of the car then deposits the $9,000 into her bank and her bank loans out $90,000 to your coworker for a new house.

All of this started with your simple $100 deposit. This is how the US economy works every day. We are encouraged to borrow and spend because this causes the supply of currency to grow, which means more dollars circulate and even more goods and services get provided. As the currency expands, we say that the economy is growing and everybody seems really happy. THE ONLY WAY FOR THE ECONOMY TO GROW IS TO KEEP THE CURRENCY SUPPLY EXPANDING. THIS MEANS WE MUST CONTINUE TO BORROW AND SPEND MORE EVERY DAY (CONSUMERS, BUSINESSES AND GOVERNMENT).

This all works great until people start realizing that the amount of currency in circulation starts buying less and less stuff. This means we start to see that a loaf of bread now costs $10 when it used to be $2. This is called inflation and it means that each dollar is now worth less and less. The highest value a dollar has is when it is “born” at the Fed. As it circulates and “ages” it becomes worth less because more and more dollar siblings are being born every day.

When people start realizing that it takes more money to survive, they start getting cautious and then start hoarding their dollars. This means that people don’t borrow and spend as much money. This in turn causes the currency supply to contract which means the economy is in a recession. If you don’t borrow money to buy a new car, the car dealer can’t stay in business. He then lays off salesmen who cannot buy new furniture at your store. You then have to close shop and release all of your employees and the cycle continues until a depression hits.

The Fed and the government don’t like this as it affects their ability to stay in power and make money, so they try and stimulate the economy. They do this by lowering interest rates so that people will be enticed to borrow money. They also create policies and legislation to spend more money using public works and social programs. The intent is to create more currency in circulation so that people will want to spend and borrow again, thereby causing the economy to expand and end the recession.

Eventually, after so many recession/expansion cycles the market will correct itself and the true value of goods and services will be determined in the currency circulated. This normally happens after some huge “bubble” pops in some asset category and people lose significant amounts of their wealth due to inflation. The process can only be repeated so many times before the currency is destroyed and nobody wants to accept it for payment of goods and services. People then start demanding other types of payment such as real estate, livestock, precious metals, etc (stuff you can hold and use) and then the economy collapses along with the currency.

It is important to note that everyone who holds their wealth in currency (US Dollars) will lose the majority of their wealth when inflation hits. That $500,000 IRA account will not buy nearly the amount of goods and services it did prior to the high inflation event. That is why investors move out of "cash" and stocks and into commodities and real estate when high inflation is anticipated. Commodities and real estate provide a "hedge" against inflation as they amount of dollars required to buy these items grows in tandem with the rate of inflation, thereby preserving the investors wealth.

It is the job of the smart investor to figure out where he is in this cycle so he can invest his money wisely. If he does not, he can lose his entire wealth over night. I have taken the time to explain the economy and currency so that you can better understand what is happening in the US and the world right now. You need to determine if you should hold your wealth in vast amounts of currency, or should it be transferred into something else.

It is my opinion that cash flowing assets are the safer bet at this time. That is why I am passionate about real estate. People must have shelter, it can be leveraged and still provide POSITIVE cash flow, AND it is tangible which means it has real, intrinsic value (unlike the dollar).

Keep this in mind. Even if the “value” of a house goes down, the payment required to rent it will usually stay constant or rise with inflation. This means that you can invest cash into investment real estate and “hedge” your risk of inflation. Hedging means that you reduce the risk of your cash losing value as inflation in prices outpaces the ability of your cash to buy products and services.

I want to leave you with one final comparison. Let’s says you buy a rental house today with your cash and rent it for $900/month. Let’s further assume that the “value” of this house declines by 50% over the next year. You are still getting $900 every month off of this investment. If you paid $100,000 for the house, you were getting $10,800, or about 10% in return for your investment. Even if the house value goes down, it means nothing to you as you are not selling. You still get $10,800 every year off of that investment. Eventually inflation will come knocking and that house will go way up in value again (not to mention the rents!). You win either way as the name of the game is cash flow.

If, however, you put that $100,000 into a CD, you will make about $2,000 per year. The value of your investment is actually decreasing each year as the current inflation rate is higher than that. This means that if you cash in your CD for $102,000 in 12 months, you will not be able to buy as much as you could have 12 months earlier for $100,000. You are losing money every day. If you add the possibility of higher inflation, you could lose far more than you think possible as the value of your cash will go down as inflation rises (exponentially, not linearly).

As long as the inflation rate in the economy exceeds your rate of return, you will lose. You must realize that the bank you deposit your money in will always pay less than the rate of inflation. That is how they make money. It is just like gambling in Vegas. Eventually the house (bank) will always win.

Call me or email me so you can get started in real estate investing today. Today is the day for action.