In today’s episode of the Actively Passive Investing Show, Travis discusses how to maintain the purchasing power of the dollar during inflation. He talks about keeping up with inflation and how to level up your assets, three ways inflation can actually benefit you as an investor, and three ways to succeed in syndications during an inflationary period.
Click here to know more about our sponsors:
Travis Watts: Hey, everybody, and welcome back to another exciting episode of The Actively Passive Show. I’m your host, Travis Watts. As always, I really appreciate you being here. Thank you for tuning in. Today’s episode is very timely. It’s on a lot of people’s minds. I called it “Rising Tides: How to Profit from Inflation”.
Obviously, a lot of scary headlines out there on the news about inflation and about the Consumer Price Index. We’re going to talk about all that and a lot more, and really, what I want to do in this episode is what benefits can actually come from inflation, especially in the real estate sector. So stay tuned. We’ve got a great show for you.
I put up a post on social media about a week ago, maybe it’s a couple of weeks back, and it said, quite simply, “If you believe that real estate prices will be higher in 10 years, then why not invest today?”It kind of gets back to the old Chinese proverb of, “The best time to plant a trese was 20 years ago”, and “The second best time is now.” Some things are simple, but profound. So we’ll use that as a foundation for our conversation today. Keep that in the back of your mind.
Let’s just talk real quick about inflation. I think everyone pretty much knows what inflation is. I guess simply put, it’s the declining purchasing power of the dollar. So the government for many, many years, and especially in the recent decade, has been printing astronomical amounts of money, and as we saw with the COVID pandemic, and the stimulus checks, and the unemployment perks, and all these different things, this is just creating money out of thin air, pumping it into the system, and it’s as simple as supply and demand. So we have much more supply now of dollars in the system. So it takes more dollars to purchase the same items that we used to be able to buy with less dollars.
So for example, in 1980 a loaf of bread, I just looked this up, was 50 cents, and today it’s roughly $3. So that’s an example of inflation. We have many more dollars in circulation, therefore it takes many more dollars to purchase the same item.
Another example would be the median home price in 1980 was $50,000 in the US for a house. So today, it’s around $350,000 to buy the same house. The house has done nothing but age and get older and dilapidate, but yet, here we are, with an inflationary period.
So where do we track inflation? How do we know what to believe, and what stats to look at? Obviously, there’s a lot of conspiracy theories in a lot of different websites that have kind of their own spin on this; but if you just go with the US Government statistics – I’m going to use that, because it seems like the most reasonable metric to mention with the most amount of people reading this information and hearing this information on the news… You can actually go to bls.gov/cpi. CPI stands for Consumer Price Index. You can also go to bls.gov/ppi, and PPI is the Producer Price Index; that is basically the metrics on manufacturers. So how much is it costing to make different things and then the Consumer Price Index is what people are actually paying for items and how inflationary that is.
So those are two sites to go check out. I recommend you do so just for further education, but for the sake of this conversation, I’m simply using data off these resource sites. So you might say, “Well, inflation is much higher than what you’re talking about.” Well, that’s what we had to go by, as far as what our government tells us. It’s at least a metric to consider; not saying it’s perfect, not saying it’s the most accurate, but it’s the most widely known, I’ll put it that way.
So let’s talk quickly about the CPI, the Consumer Price Index. So that is again, what people are paying for items, that is hovering over last 12 month period at around 5% to 6% annually. That means, quite simply, that loaf of bread is 5% to 6% higher on average than it was a year ago. A new car is 5% to 6% higher. A new home, as we all know, is actually higher… So it’s a basket of goods is how they come up with this data. So they’re taking a bunch of things into consideration and lumping them together and saying, “On average, they’re about 5% to 6% more.” Okay, that is CPI.
Now, the PPI – a lot of people don’t talk about it, the Producer Price Index. So this is kind of a lesser-known metric, but again bls.gov/ppi. This would be for example, new construction on a new home is about $35,000 more expensive than it was a year ago. This is directly related to the PPI. So the PPI is actually running higher than the CPI. Somewhere in the ballpark of 7% to 8%. What that means is it’s costing more to manufacture products than what people are actually paying. There’s a bit of an arbitrage. Now, as we all know, it’s like a bag of hot potatoes, right? No one wants to hold the bag. If a company’s having to pay more for something, they obviously want to pass that cost along to the consumer. So the home builder – if it’s costing them $35,000 more to build a home, they’re not just going to take the loss, and then sell you the home $35,000 at a discount, just because homes were that price last year; they’re obviously going to tag that into the price and charge you for it. Same with your Apple products and Microsoft products and everything else that’s out there on the market.
And by the way, that data, as far as the home construction actually was on nahb.org. That’s the National Association of Homebuilders. So if you want to go check that out for yourself, it was not the bls.gov.
So think about it from the producer perspective, not just the builder, but from an investor perspective. If I’m an investor – let’s use a single-family home as an example, because that’s what we’re talking about. If I have to now go buy a single-family home for $300,000, when just a year ago it was $250,000 for the same property – well, guess what? I have higher property tax. I have higher insurance costs, potentially more closing costs… I just have more overhead, because I bought a more expensive home. I don’t want to absorb that cost. I want a return on my investment. So what do I do? I have to raise my rent in order to get a return on investment, right? I don’t just want to keep dwindling my return on investment down to zero over the years; I want to keep up with inflation. And rightfully so, I want to get a decent return off the properties. So this is an example of passing along to the consumer. In this case, the consumer is my resident, my tenant, my renter.
Travis Watts: So as you’re starting to kind of see the pattern as a consumer, you are hit hard with inflation if your wages are not keeping up with inflation. So if we’re saying that the CPI is 5% to 6% annually, that means that your wages and your money, by the way, your investable money, your cash needs to be keeping up with that, needs to be making an additional 5% to 6%. So if you’re not getting a 5% to 6% raise from your company, and your money in the bank is only making, let’s say, 1%, not 5% or 6%, you are losing money, effectively. You’re falling behind in purchasing power.
But let’s talk about how inflation, to the point and theme of this episode, can actually benefit you as a real estate investor. There’s really three things to think about if you’re going to invest in property, whether it’s single-family, multifamily syndications, whatever it may be.
Number one is we have a unique situation in 2021 and 2020, and all recent years, really, and probably looking forward as well, in the next year or two, to lock in very low interest rate debt. So if you’re going to go get a mortgage for rental property, or you’re going to invest in a syndication a lot of times, you’re able to find a mortgage in today’s world at say, around 3%, when the inflation is actually higher, it’s nearly double according to government metrics, then what you’re able to lock in. So the benefit to that is again, it’s an arbitrage play.
And what I mean by arbitrage is you’re locking in and paying back at 3%, but inflation and everything’s going up at 5% or 6%. So if you zoom out years from now, dollars might be worth a lot less. Single-family homes might be $500,000 for the average home price, and multifamily might 2x or 3x over time. Who knows? I’m not here to predict that. What I’m saying is if we continue on an inflationary path, you can use cheaper dollars in the future to pay off your existing mortgage that you locked in at a fixed rate at 3%. Even simply put, if interest rates go up in the future to 5%, 6%, 7%, you still were able to lock in and 2021 at low-interest rates. So that’s the first benefit to real estate in 2021, being an investor.
Number two is price inflation. So real estate is an inflation hedge. And what I mean is, as the cost of materials and labor go up, so does the cost of real estate, both new and pre-existing. So if you’re looking to buy a property today at, say, $300,000, in hopes that one day you’ll sell it for $400,000, you might have a good chance at that, given inflation’s so high, and that if it continues forward at even a modest percentage at 3%, 4% or 5%, something like that, you may be able to make that happen long term.
And number three is cash flow. I’ve talked about this so much on the show, but I’m so passionate about it. I invest for cash flow. Cash flow is king. Cash flow is number one. I don’t do a real estate deal if it does not cash flow. The reason is, let’s say I bought a property in a market that is hard to get cash flow in. Let’s use Los Angeles or San Francisco, Manhattan, whatever it is, and I’m going to buy a single-family home or a condo or whatever. Let’s say it doesn’t cash flow, okay? Let’s say that every month I charge $3000 in rent, and my mortgage and overhead and expenses are also $3000 per month, okay? So I’m breaking even, but I’m hoping that it’s going to go up in value. Okay?
Well, let’s say it goes up from $500,000 to $550,000 to $575,000, but then we have a softening of the market and all the prices shakedown and simmer and settle, and now, that property goes back to $500,000, where I bought in. And let’s say that took five years to happen. Where did that leave me? Absolutely nowhere. I made no money the whole time, and I’m back where I started, at the same purchase price, with an older property and a liability on my hands. This is why cash flow is so important if you’re going to invest.
Now, again, this is only my opinion; I’m not giving anybody investment advice. Always seek licensed advice. I’m just saying that if that same property was pumping out, let’s say $10,000 per year in cash flow to me from rents, where would I be in five years? I would be $50,000 ahead, regardless of what happened to the price of the property. I may have bought at five, and it sunk to 490k, then it sunk to 480k, but guess what? What’s important is every month, cash flow is coming into my pocket.
So for those that are more familiar with the stock market, there’s what’s called the Lost Decade and it was a 10 year period, where had you bought near the top, and then the big crash, and then the recovery, it took almost 10 years to break-even, to get right back where you started, as far as the price. So I look a lot less on price, than I do on, “What is this property going into cash flow?” Because, to me, it’s all about passive income and cash flow.
The nice thing about being in an inflationary period in 2021 versus 1980 is in 1980 you had skyrocketing interest rates. It made it very unaffordable to buy real estate. We had some mortgage rates that were nearly 18%, and today we have 3%. So back in 1980, what the smart play would have been, let’s say, is to pay off your house, because then you don’t have to pay 18% interest. And housing prices were much cheaper.
But in today’s world, in my opinion, the play is to leverage long-term, low-interest, fixed-rate debt. That’s the play. Why would you pay off a mortgage or interest rate that’s 2.75% or 3% when inflation is 5% or 6%? You want to lever up. That’s my opinion. That’s what I do, and again, I’m not telling you what to do. That’s the play that I’m making in 2021.
Alright, so let’s pause just for a minute, and I want to talk about syndications. I want to talk about real estate private placements, something that’s an underlying theme on the show, and I want to relay these three ways that you win with an inflationary period in 2021 in real estate with syndications, with private placements.
To recap, the three – it was to lock in low-interest, fixed-rate debt, number two was how you benefit off price inflation, and number three was cash flow investing.
Travis Watts: Let’s plug in an example. Let’s say that I’m going to invest in a syndication today, where it’s a 400-unit apartment building. And let’s just say, for the sake of conversation — let’s be a little more modest than what we’re seeing the Government’s statistics. They’re saying, 5% or 6% CPI… Let’s go with 4% for this example. If we go $150,000 price per door x 400 units, that’s $60 million. So say this syndication group is going to put under contract a $60 million multifamily deal, zooming out from the single-family examples. So if they put 25% down, and they lever up 75% loan-to-price, loan-to-value, that means that they’re taking $45 million in debt to make the purchase.
So number one, if inflation really was 4%, for example purposes, we get to pay back that $45 million in cheaper dollars as we move forward, and as inflation is occurring. So if you take 4% off $45 million, that’s $1.8 million per year that we’re able to essentially save by using inflation-adjusted dollars to pay off the mortgage. That alone is huge, but that’s just one way that you benefit from investing in real estate.
Number two, the price inflation. So again, using 4% inflation as our example on a $60 million property gives you $2.4 million per year in price appreciation as the cost of labor, materials, and just general inflation increases and moves forward. That too is even more massive, but that’s only two ways that you benefit.
The last way, number three, is from buying a cash-flowing asset. So let’s just be modest and say that this multifamily deal is projected to cash-flow – that’s basically the income after all the expenses and debt are paid – is 6% a year. Well, 6% a year is $3.6 million per year money in your pocket. Obviously, that’s going to be prorated and split among the general partners and the LPs and all that kind of stuff, but at the property level, $3.6 million, if it cash flows 6% a year. So if you add all that up, that is $7.8 million per year on a purchase price of something that was $60 million, and if you add that together as a return on investment, that’s 13% annualized.
So here’s my question to you. In a conservative manner, if you go out there and you look at the investing landscape, where else can you find a 13% annualized return, for example purposes, in 2021? You’re going to find it in the bank, you’re going to find it in bonds, you’re going to find it in Treasuries, you’re going to find it in Bitcoin. There’s not a lot of asset classes as great as real estate. Now, obviously, I’m very biased, I’m very pro real estate because it’s what I do full-time… But gosh, you guys, I’m trying to use the most conservative examples. I’m still very bullish on what it is I do. I’m not telling you what to do. I’m not even saying that you should be in this, I’m saying, think about it… Because if you’re not getting double-digit returns in other asset classes, this may be something that could benefit you.
So a few takeaways here… Number one, if you’re saving money and you’re not investing, you are getting eaten alive by inflation, and you will continue to be eaten alive by inflation as we move forward even if it’s a slight and moderate inflation like 2% or 3%. You are losing the purchasing power of the dollars that you do have, that you’re holding on to.
Number two, cash flow is king when investing. I say it all the time, I’ll say it again, cash flow is king when investing in real estate. And to that point, a side note, passive income is key when investing in general. So if you’re going to go do the stock thing or you’re going to go do the crypto thing, look for a way to generate passive income out of your investments; not just buy low, sell high, and hope things always go up.
Number four, invest in something that’s a hedge against inflation. It doesn’t have to be real estate, but seriously consider something that hedges inflation.
Last but not least, comments, questions, concerns, email@example.com, joefairless.com. Find me on social media, Travis Watts. I’m always happy to answer your guys’ questions. I love the questions you guys send in. I get a lot of messaging on LinkedIn or Instagram or Facebook, I thank you for that. If you ever want me to cover a 60-second question, which is a segment I do every week where I try to answer your questions in 60 seconds or less, feel free to, again, email me at firstname.lastname@example.org, or find me on social media.
As always, thank you guys so much. I’m so grateful to have this outlet to share with you, because quite frankly, my wife is sick of hearing about it. She’s sick of hearing about inflation every single day, so this is my venting, this is my outlet to you guys. Thank you for tuning in, thank you so much for being loyal listeners of not only Actively Passive Show, but the Best Ever Real Estate Investing Advice podcast. Have a fantastic week, everyone. We’ll see you next time.
This website, including the podcasts and other content herein, are made available by Joesta PF LLC solely for informational purposes. The information, statements, comments, views and opinions expressed in this website do not constitute and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action. Neither Joe Fairless nor Joesta PF LLC are providing or undertaking to provide any financial, economic, legal, accounting, tax or other advice in or by virtue of this website. The information, statements, comments, views and opinions provided in this website are general in nature, and such information, statements, comments, views and opinions are not intended to be and should not be construed as the provision of investment advice by Joe Fairless or Joesta PF LLC to that listener or generally, and do not result in any listener being considered a client or customer of Joe Fairless or Joesta PF LLC.
The information, statements, comments, views, and opinions expressed or provided in this website (including by speakers who are not officers, employees, or agents of Joe Fairless or Joesta PF LLC) are not necessarily those of Joe Fairless or Joesta PF LLC, and may not be current. Neither Joe Fairless nor Joesta PF LLC make any representation or warranty as to the accuracy or completeness of any of the information, statements, comments, views or opinions contained in this website, and any liability therefor (including in respect of direct, indirect or consequential loss or damage of any kind whatsoever) is expressly disclaimed. Neither Joe Fairless nor Joesta PF LLC undertake any obligation whatsoever to provide any form of update, amendment, change or correction to any of the information, statements, comments, views or opinions set forth in this podcast.
No part of this podcast may, without Joesta PF LLC’s prior written consent, be reproduced, redistributed, published, copied or duplicated in any form, by any means.
Joe Fairless serves as director of investor relations with Ashcroft Capital, a real estate investment firm. Ashcroft Capital is not affiliated with Joesta PF LLC or this website, and is not responsible for any of the content herein.
The views and opinions expressed in this podcast are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action. For more information, go to www.bestevershow.com.