If you look at some of the wealthiest people in this country, you will notice that a lot of them are real estate owners. Picking up from where we left off, we finish laying down the seven powerful tools that these real estate tycoons have used to create and build legacy wealth. Still with Kirk Chisholm from Innovative Advisory Group, we talk about inflation and deflation and how you can take advantage of those, as well as debt reduction and the tax benefits of real estate. Learn more about these tools as you discover why real estate is considered as one of the best investments to be in. Combine what you have learned in this two-part series and create your own long-term strategy to start building wealth.
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This is part two of the Seven Powerful Tools to Create Legacy Wealth from Real Estate. On our previous episode, we were talking with Kirk Chisholm. We are going to pick up where we left off.
If you missed our last episode, be sure to listen to 7 Powerful Tools To Create Legacy Wealth From Real Estate.
Enjoy the show!
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7 Powerful Tools To Create Legacy Wealth From Real Estate (Part 2)
Inflation is very closely tied to virtually all these seven benefits that we’re talking about, but it’s very closely tied to everything about real estate. I was actually with Peter Schiff, hanging out with him and a few other people. He’s always about doomsday. Everything’s going to hell in a handbasket. He is very much in the camp that we have inflation. We’re going to continue to have inflation and we could potentially even see hyperinflation. It may sound great if you’re a real estate investor, but it has its other blowback and implications. The thing is, as far as I understand it, we live in this country, in this economy, in this world market that we have. We live in an inflationary environment.
Even the Federal Reserve has a stated mandate of having a 2% annual inflation rate. Real inflation is probably higher than 2%. It is probably closer to 4% to 5%, maybe more. If we have to have an inflationary environment in order to sustain the type of economy and economic structure that we have, I don’t think there are a lot to worry about as a real estate investor when it comes to inflation. You listen to a guy like Harry Dent who is also very much of the mind that we will have a long-term inflationary environment. He’s the type of person to believe that we’re going to see a deflationary environment first. We’re going to see deflation and then followed by a strong inflationary environment or hyperinflation. I’d like to ask you what you think. What are your long-term predictions for inflation? Do you think we’re going to have a deflation before a continued inflationary environment? Do you have any opinion on that?
Harry Dent and Peter Schiff must be very smart and a lot smarter than me if they can predict the future because I can’t. I could tell you this, I’d love to be hanging outside their offices selling caves because they’re telling everybody to go live in a cave with their guns and their gold and protect themselves. That sells a lot of newspapers. I’m picking on them. It’s not just them. A lot of people are out there saying it’s the end of the world. We’re going to have hyperinflation or we’re going to have deflation. It’s going to destroy everything. The point is, it sells newsletters, it sells newspapers. The reality is usually much more nuanced than that. When 2008 happened, I predicted that we’d have higher unemployment than we did and ended up getting there.
I also actually wrote a few articles back then because I thought that many people were missing the boat. One of the articles I wrote talked a lot about the reality of inflation that people were missing. In 2008, we had deflation. It’s hard to argue that because asset prices went down and everything went down. You remove that from the picture for a moment. The challenge is in that because in the late ‘90s, we had higher inflation than normal because of asset prices. Everything was going up but that was a bubble. In 2008, when the market dropped, that was the inverse of a bubble popping.
We do a lot of research in the last ten years since the crisis. My contention through most of that time was we were actually in deflation and nobody was talking about it. People were talking about it, but the Fed wasn’t. The Fed was saying, “We’re doing fine.” The reality is inflation and deflation are very susceptible to this concept called reflexivity. Inflation is a perfect example of this. Reflexivity says that if I believe there’s inflation, I’m going to spend my money as if there’s inflation. I’m going to spend my money because it’s going to be worth less tomorrow. That’s how I would act if there’s inflation. If there’s deflation, I’m going to save my cash because it will be worth more tomorrow. That’s the simplified version.
If I think there’s deflation, then I’m saving my cash. If enough people think there’s deflation, they’re doing the same thing and actually they will end up causing deflation because they think that there’s deflation. Reflexivity is basically in some ways, manipulation. It’s manipulating the markets to believe that a certain thing is true so people act that way and it will come true. Based on the numbers I was seeing, we had deflation for quite a few years during the last ten years. It wasn’t until the Fed took the gloves off and said, “We’re starting to see inflation taking off,” and people believed it and that actually caused inflation and pulled us out of it.
Deflation is very dangerous because the Fed does not have monetary tools to combat it. With inflation, they do. They raise interest rates. They have tools to do that. With deflation, there are not a lot of tools. Japan is a good example of this. They’ve been trying to get out of deflation for 30 years and they can’t. I don’t look at deflation as bad, but our culture and most countries around the world do because the whole economic system is built around inflation as you said. We all accept it as the norm. If you look back a hundred years, the norm was one-year inflation, one-year deflation. It was normal to fluctuate every other year. The Federal Reserve has done a good job at stabilizing that. The ‘50s was the last time we had deflation or more than deflate. I don’t count 2008, but except for that it was back in the ‘50s. It’s an important concept to understand. I’m not fearful of it in by and large because I think the Federal Reserve has done a good job at, I don’t want to say policing it so that people don’t think that we’re caught up in this.
If we get to a point where they run out of tools, then that’s where I start to worry. I don’t worry about it right now. I was worried about it a few years ago. It’s not the thing that’s going to catch you off guard. If you own real estate, you’re not going to wake up tomorrow and be like, “Deflation got me.” It’s going to take years to get the impact. There’s plenty of time to plan around it and to make adjustments. It’s not something I would worry about. It’s just something to keep an eye on so you understand where the trends are going.
Are you saying we’ve had a deflationary environment for the last ten years?
I would say at least three of the last ten years we did but it was being masked. Even now, look at commodity prices. If we were in a sustained bull market, commodity prices should be going through the roof and they’re not. Some of them are at historically low points, but definitely ten to twenty-year lows. There are certain indicators we look at that show. We used to do this thing called the inflation monitor and we stopped doing it because it was getting tiresome. As we were running the data, we were seeing all these indicators and they’re all showing deflation. We almost changed the name to deflation monitor because every quarter, we’d see the same numbers. It was deflationary. It’s also a concept that’s malleable. Inflation is X. You can look at the definition and say, “Yes, it is or it isn’t.” In reality, it’s a lot more nuanced and it will say whatever you want it to say. We try to look at it unbiased to see if how it’s going to affect us in ways that people aren’t noticing.
That is very interesting because I know when you look at student loan debt, the cost of education, particularly post-secondary education and healthcare, those have been off the charts in terms of inflation.
When you look at them, those are the only things that are showing high inflation. You look at the cost of colleges and cost of medical. What was the other one you said?
Postsecondary education and healthcare.
There are four categories that are showing high inflation. Everything else is flat and it’s been flat for years. It’s a handful of things that are pushing the needle and the rest of them are full. Think about the cost of your computer. When’s the last time that went up? It’s been the same for the last twenty years. That’s one example. When you’re calculating inflation, the Federal Reserve play with the numbers a little bit. They say, “It’s a better computer,” and all that. It doesn’t matter. The price hasn’t gone up. I don’t care what the quality is. The price hasn’t changed. The cost of eggs, the cost of milk has not changed in twenty years. You look at what you’re paying on a day-to-day basis, some things have gone up, like the cost of electricity and stuff like that. It’s gone up but generally speaking, a lot of stuff hasn’t.
You can’t just look at it in this test tube. You have to look at everything together and that’s hard. How do you judge which is more important? If you’re living day-to-day, paycheck-to-paycheck, then the cost of food, the cost of rent and the cost of utilities is very important. If you’re worth $10 million, those things are negligible and you’re more concerned about the cost of assets. It’s totally based on the context that you’re putting it in. We tried to have a holistic view of it and what we found is mostly deflationary. That has started to change. It’s just to reinforce that point. I’m not saying we’re out of it, but the Fed has done a good job of using that reflexivity to its benefit and causing more of an inflationary trend.
It’s a perfect segue back to number four of these powerful tools to create legacy wealth. The fourth one I have on my list here is debt reduction via inflation. This will probably be easier to understand now that we’ve talked about inflation for a bit as the benefit of debt reduction. I love this one by the way. Why don’t you explain how that works?
This is one of the magics of real estate. Most of us, if you own real estate, you probably have a mortgage on the property. If you look at the cost of a mortgage, any sort of debt, it’s fixed. You take out $100,000 mortgage on a property and that $100,00 over the next 30 years will disappear as you pay it down. That $100,000 amount doesn’t change. It’s fixed. Your inflation is going to reduce the value of that. Let’s say you have inflation of 7% a year. In ten years, that $100,000 mortgage in real dollars, inflation-adjusted, will be worth $50,000 because the prices have gone up, have doubled in that time. The mortgage actually has not gone up. It stayed the same. In effect, it’s been cut in half in terms of what it’s worth. You’re paying interest on the mortgage and that’s the accounting for the difference of inflation and any profits that they make. If you get a mortgage, over time it’s paid down and over time inflation deteriorates the value of that. In 30 years, that $100,000 mortgage might be worth $20,000 in future dollars. It’s a great way to reduce your debt. You’re not going to necessarily see this on a day-to-day basis but long-term, it’s a powerful tool to take advantage of inflation.
An important thing to understand about that is your monthly mortgage payment, as you said, is fixed. It doesn’t change. That $500 mortgage payment this month will be $500 five years from now and $500 ten years from now. Over time, your rents will increase because of supply and demand and because of inflation. That’s a great segue to the fifth point and that’s limited supply in constant demand for real estate. Can you explain that?
We all know real estate is about location. It was Mark Twain who said, “Buy a land. They’re not making any more of it.” If you think about real estate, let’s say you buy beachfront property, they’re not making any more beachfront property. You could argue global warming and deterioration of oceanfront or whatever. Let’s leave that aside because as I said, I can’t predict the future but I know that there’s a certain amount of ocean front property right now in the US. Unless some earthquake happens, we’re not going to get any more of it. We have a static amount of real estate in the United States. If you think about it, our population is growing. It’s not shrinking, it’s growing, which means more people are going to be buying it, which puts pressure on the price of real estate, which means it’s pushing prices up or over time. Buying land, unless something bad happens, it’s hard to imagine that’s going to go down in value. That’s where that comes from. It’s looking at supply and demand curve. There are more demand and static supply, which means that the price goes up.
That demand is increasing year-over-year. We’re not producing enough new housing units to keep up with the growing population.
That’s a problem in Boston. They don’t have room to build more houses. It’s interesting because I think myself, “What’s going to cause this housing bubble to burst?” because Boston’s expensive. They’re not making more housing. There’s no room. There are more people. It’s a tough mental gymnastics they have to play with, but I know a lot more places with similar problems.
San Francisco is just as bad, if not worse because they’ve got an incredibly expensive real estate. The demand is still there because there are a lot of jobs there, but they just don’t have land to build. They’re landlocked. They’ve got water on one side and they’re completely developed on the other side, so you can only go up. A big problem is the lack of supply and strong demand. That’s why you don’t see prices coming down or crashing is because there’s still enough demand to keep those prices afloat.
It segues nicely into the next one, which is basically inflation as pegged to real estate. If you look at that same concept, the population’s increasing. Wages are not increasing, but generally over time they do because inflation affects everything over time. If you have a 3% inflation, everything in your life financially should go up 3%, real estate prices, wages, the cost of goods and services. That’s what inflation does. It causes prices to match the price of inflation. There are things like education or health care that will exceed that inflation. There are things like computers, which will be less than inflation, but on average over time things should mimic that. If you look at real estate, it’s scary how close real estate does to mimic the rate of inflation. This gets back to the first point of capital appreciation.
Over time, over 100 years of data you can look at real estate as closely mimicking the inflation rate. If inflation is 5%, real estate on average will go up 5%. Except for 2000 to 2010 which is when things were out of control, if you ignore that part of it, it’s scary as to how close inflation is to it. Effectively inflation is going to cause whatever the inflation rate is. It’s going to cause your rents, your asset prices, the amount that people have to pay the rent. All of it should match that inflation rate. If you know what the inflation rate is, then you can probably closely approximate what your capital appreciation is as well.
That’s true in general terms. There are local factors, local drivers in every market that will affect prices, whether it’s going up or down. For example, population growth or migration trends that are positive or negative. Those will obviously affect the price of real estate, but all else being equal, the effects of inflation should be pretty much uniform across the board. You’ve got to keep that in mind in terms of picking markets because we’re sensitive in terms of where to invest. What markets, what neighborhoods, not just the real estate? It’s about more of a contextual thing. Where do I invest? Those supply and demand dynamics certainly play into that decision making.
Where you’re investing is important. You know a lot more of this than I do because you’re living this day-to-day. What we’ve noticed from some of our real estate clients is a few years ago this, they stopped investing in the primary markets and start focusing on the secondary and even tertiary markets. They did it because they had to. They weren’t willing to accept 3% cashflows. They wanted whatever they wanted. They stretched beyond what was acceptable into other markets. Californians were buying places in Portland, Maine. One of my clients works up there in commercial real estate and he’s like, “I can’t tell you how many Californians I have seen here because our rates are better than theirs.” That’s great. Historically their market is way overvalued.
He’s telling me his story and how some of the old-timers who read this blog. The people eat, sleep, breathe real estate and every nickel they ever earned goes back into real estate. These people never sell. They buy in their 1031 or whatever. These prices were so high. These people are actually selling real estate and paying taxes. That’s how high the prices where they’re willing to pay taxes on these properties because it would still be better than owning overpriced properties. It’s a scary thought to think about. That’s some of the craziness. I’ve seen people rushing out to Montana to buy property. I have some clients out there and just shake my head and say, “Why are you going to Montana?” They’re desperate. They want cashflow and they’re not getting it anywhere else.
You mentioned taxes. It’s a perfect segue to number seven. That’s the tax benefits of real estate.
Real estate is great. You look a lot of investments and you don’t get the same tax benefits. If you’re buying a stock, let’s say you can hold it for twelve months and get long-term capital gains, but that’s pretty much it. You don’t get much tax benefits. There are some MLPs you can sometimes get some tax benefits from, but generally speaking you’re not getting many tax benefits. With real estate, you get a bunch of tax benefits. We’re piling on to some of the other topics we already talked about. In addition to that, you’ve got the fact that with the depreciation of the of the property over time, you’ve got expenses. You’re operating a property. You are earning $20,000 year in rent and you’re paying out $10,000 in expenses. Some of those expenses are hiring people to fix the roof. Some of it is you driving around your properties. There are all sorts of expenses that people can tie in there. It’s like owning a business, you get the benefits of those expenses.
If you look at some of the wealthiest people in this country, a lot of them are real estate owners. I don’t want to raise any political ire on your audience, but you look at a guy like Donald Trump who’s been a real estate owner for many years and he’s gotten wealthy off of it. He’s even taken it to another level, which is not even owning real estate, but just leasing his name to it, which gives him less exposure. From the tax benefits, how many times has he filed for bankruptcy or reorganization? It’s not just him. A lot of people do that. You get burned and you say, “Let’s reorganize this and we’ll do it again.” There are tons of benefits for owning real estate. Tax is certainly one of them. For the person who’s got a good accountant, it’s a great thing to do.
I was talking to Tom Wheelwright, who’s Robert Kiyosaki’s CPA and tax advisor. He was telling me that as of right now, real estate is the best tax-favored vehicle of any investment class in the US. I believe it was oil and gas prior to that but now real estate because of the new Tax Bill or something that just happened. Real estate has become the number one best investment to be in from a tax perspective.
In the new Tax Bill, there are so many nuances in that Tax Bill. Most of the people I talk to don’t even know them all because it’s so deep. There was a time where oil and gas had some favorable tax treatment. They still do. There were these things called a master limited partnership. In Canada, they were called Canadian Royalty Trust that had some phenomenal tax benefits to them. I think overall, you’re right, real estate is by far and away the best that that I’m aware of.
What would you say is a good long-term strategy when it comes to building legacy wealth from real estate? When you combine everything you know and all the things you’re involved in, I know you’re involved with self-directed retirement accounts and all kinds of stuff. If you were to step back from all this and look at real estate as the powerful investment vehicle that it is, what would you say to someone to look at or consider as a long-term strategy when it comes to building legacy wealth from real estate?
I have this philosophy in that people should invest with their investor psychology. What I mean by that is if you look at a guy like Warren Buffett, everybody knows Warren Buffett and they know that he’s historical buy and hold guy and blue-chip companies and all that. Everybody thinks they know Warren Buffett. If you were to try to invest like Warren Buffett, you might not be the best person to do that. You may but you may not write or Carl Icahn. You think of all these people who have been successful investors. Their form of investing is different from everyone else’s. Ray Dalio is probably a bad example. You look at a guy like Carl Icahn, he probably wouldn’t be as successful trying to invest like Warren Buffett because he has a style. Every one of these guys has their own style and they found it works for them. What I find is my style is different from Warren Buffett’s and different from all these other guys, but I’ve figured out what works best for me based on how my mind works. I look at my weaknesses and my strengths. I know my weaknesses with investing and I’ve found ways to protect against that by using other strategies.
Each one of us as investors needs to do that. There’s no single best strategy for real estate in that way. What I will say is there are some strategies that I like, but some of these are also based on what’s going on trends too. Some strategies, I’ll vary them because I think it will appeal to a few different investors. Buy and hold investing for most people in real estate is great, assuming that you want to be a landlord of course, because that has its own challenges. Assuming that that’s your strategy, I think it’s great for most people if you do your research, you find the right tenants, you’re okay being a landlord or you have enough cashflow to pay for someone else to do it. That’s a great strategy. I keep coming back to the landlord thing because that brings its own challenges. That’s a good strategy. Some people don’t want to take the buy and hold risk. They need what I would call action. They need to be doing something. They can’t sit in a room quietly by themselves. They’re always moving. People like that might want to flip properties or they might want to flip contracts or something like that. That might be more attuned to their investor psychology.
Personally, I like private mortgages. We do a lot with private mortgages. I don’t get all the benefits of real estate but it does mitigate a lot of the risks that concern me. For me, that’s lower risk. You get some of the cashflows of real estate but you don’t get the risks of having to deal with tenants and destroying the place and all that. It’s much simpler. For me, that’s a strategy that works. Some people like to invest in tax liens or fishing rights or airspace rights. There are so many strategies out there. It’s hard to say just one, but if people understand what they should do is they should understand themselves. They should understand what they’re good at and what they’re bad at. They have to be honest with themselves.
If they’re saying, “I’m going to be a billionaire in real estate.” If you don’t have a background in it, it’s probably less likely. If you can be honest with yourself and say, “Here’s what I can do, here are my strengths,” then I think they’ll be much more likely to be successful. That’s the goal. A lot of people will buy real estate because they want that passive cashflow. They want to be independently wealthy. There are some attractive things about real estate that people want. There are plenty of ways to do that as long as they understand themselves and what works best for them.
That was a good way to describe it. I like to summarize it by saying that there are truly no bad investments. There are just bad investors. It comes down to a person’s financial education and what they understand and their risk tolerance because a bad deal for me might be a great deal for you and vice versa.
I would actually nuance that and say there are no bad investments, there are only bad prices. Any investment is a good investment at the right price.
Tell our audience about how they can find you or get more information about what you do and yourself.
If you want to learn more about us and me and what we do for our clients, you can go to InnovativeWealth.com. There are plenty of articles that I’ve written about real estate and self-directed IRAs and other topics. You can certainly find me on social media. I’m out there in all the usual places. We put together a free report for your readers on the Rent versus Buy Calculator. People will appreciate if they’re considering whether to buy or rent property. It makes it easy just by having a calculator You can put numbers in. You can go to InnovativeWealth.com/Marco.
Kirk, I appreciate you coming on. There are lots of great information. This has been very valuable for everybody. To our audience, help us spread the word, visit us on iTunes and leave us a rating and review. Thanks and we’ll see you on our next episode.
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