Cutting Edge Insights
with Dr. Lee

Will the Real Asset Please Stand Up?

Assets and Liabilities.

They occupy opposite columns on a balance sheet, or a listing of what you “own” and what you “owe”.  I’m not a CPA, although I took an accounting class in 1995.  But I didn’t sleep at a Holiday Inn Express last night.

Robert Kiyosaki, author of Rich Dad, Poor Dad goes to great extents in this book and others explaining the difference between the two.  “An asset is something that puts money in your pocket,’ he is known to say. And, “A liability is something that takes money out of your pocket.”

Taken a step further, it is apparent that debt on a real asset is good debt.  Debt on toys is bad debt.  Refinancing a mortgage to acquire an income-producing piece of real estate creates good debt.  Refinancing a mortgage to pay off your credit cards creates bad debt.

It has become not only obvious, but also universally understood, that income producing real estate is an asset whether or not it is secured by debt.

Q:  Aren’t I better off owning it free and clear?

A: No.  If that helps you sleep better at night, fine.  The trajectory of your wealth-building will suffer greatly over the ensuing years to decades if you don’t keep leverage on your real estate investments.

Q: But I don’t want to manage real estate!

A: Then hire a property manager. Or invest in a syndication. That’s a rabbit-hole concern for the larger topic of discussion here.

But….

In our current inflationary environment, the likes of which we haven’t seen since the 1970s according to many economists (if you haven’t seen it yet, wait….you will…) the value and utility of the fixed rate mortgage in real asset acquisition can’t be overstated.

I’ve written about inflation many times – peruse our archives at www.CEassets.com/blog to catch up on them – but the essence of inflation is that you are able to pay back debt with tomorrow’s dollars, which are less valuable than today’s dollars.

On a 30-year mortgage executed today, what do you think the value of the monthly payments will be in 2051 as you make your final payments?

Let’s be very conservative and assume that inflation stays even at 4% per year for 30 years.

(We know it’s higher than that right now and probably will be for quite some time, but I think the point can be made with conservative estimates).

Here we go:

(Your Mortgage Payment) x (1.04)^30

=3.24 x your mortgage payment

In other words, if you have a $500 mortgage payment in 2021, and inflation remains at 4% for the next 30 years (I promise you it will be higher), your payment will be $500 in 2051 as you make your last few payments.

But it would otherwise take $1,621.70 in 2051 to purchase what $500 did in 2021!

Let that sink in.

Your rents went up (and ostensibly, so did your expenses of property taxes, insurance, repairs, etc.), but your payment remained the same.

That, of course, assumes that you never refinanced to pull out equity and re-leverage…which you should if the deal pencils – if the interest rates make sense, if you’re not buying at the top of a bubble, and if you’re not Fannied or Freddied out.

Q: Wait, are you telling me to hold on to the mortgage or are you telling me to refinance and purchase more real estate? I’m getting mixed signals here.

A: Both. I’m telling you that inflation will cause your returns to increase dramatically, and I’m also telling you that your returns will increase further orders of magnitude if you keep your investments appropriately (but conservatively) leveraged. Perhaps maintain no less than 25-30% equity and an appropriate reserve fund.

Another analogy is a private placement or syndication – which are typically structured for a liquidity event in 5 or 10 years – sometimes sale with return of principal along with gains, and sometimes return of principal but retention of ownership in the deal along with future returns (which then produces an infinite return on investment from that point forward – ask me if that needs clarification).

When you consider the benefits that you, a real estate investor, derive from a fixed rate mortgage in an inflationary environment, it is reasonable to conclude that the mortgage is the asset and the property is the liability.

Similar to how you’ve heard some say, “You really don’t want a drill, you want a hole…. {I disagree with that – I need a drill to produce torque, which is rotational force around an axis, which can produce either a hole or the ability to drive a fastener}”

It is reasonable to say in 2021,

The mortgage is my asset and my property is my liability.

As you think about that, remember that in order to think outside the box, you first need to understand what’s in the box.

For guidance on how you can leverage real estate to escape the rat race, download our eBook immediately below.

Until next time,

Dr. Lee Newton

As always, I give ideas, not advice.

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Will the Real Asset Please Stand Up?

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