All Forum Posts by: George Gammon

Way back when in my finance courses I remember a few key lessons on how valuation happens. One is to start with a "risk free rate of return", usually the rate on US treasuries, and add on a "risk premium" to compensate the investor for the risk they are taking. Well, if the "risk free" treasuries turn out to be not so risk free and in a bubble, and every single investment asset is priced this way, who knows what will happen since the very foundation for pricing is not at all stable or predictable.

Second is the net present value calculation, and how your cost of capital in this equation effects value. You can make the value of just about anything that produces cash flow go up to nearly infinity if you assume a low enough discount rate ... I think WB even alluded to this in the interview. But what happens when that discount rate goes up? BTW, I hear you about being a contrarian and feel the same way, but I respectfully disagree that deflation is a "crowded trade" so to speak at the moment. Yes there is a lot of chicken-little talk (which may end up being true) but I see more talk than investment dollar flow to back up their convictions.

Finally, I'm interested in poking a bit at your leverage strategy (50/50 debt/cash). Personally, I would think that free and clear (with cash reserves, of course) is the safer bet, but lower potential return. Free and clear RE is the only thing I can think of that would be ok under hyper-inflation OR deflation AND still perform reasonably well if neither occur. I could see how cash and fixed interest debt could hedge your bets, but also increase your operating expenses and risk in a potentially highly volatile environment. I do not see how even high quality RE would offer much liquidity in a tumultuous environment ... beautiful mansions in Beverly Hills could not easily be sold even at steep discounts in 2008. On the other hand, that extra "dry powder" in hand would come in handy so likely higher reward too.

Speaking of inflation, everybody is afraid of it but when it comes to inflation, I think it would help a lot of people. Imagine having loans for 4% on real property with an inflation rate of 5, 6, or 10%. In real terms your actually getting paid to borrow the money. At first it would be a shock to home prices as people have less purchasing power due to high interest rates/inflation, but eventually the market would stabilize and home prices would keep up with high inflation, all while you're only paying 4% for the borrowed funds.

Fantastic point Gloria on fixed rate debt and inflation. I don't think most investors understand that strategy very well. Also, it's a big win on the equity if you're levered. Because the value of the home is more than the equity, you make an inflation adjusted return even if the price of the home is only keeping pace with the rate of inflation...

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Originally posted by @David Faulkner:

Awesome post David, thank you.

I think Jim Grant said it well when referring to treasuries, he called them "return free risk" ;) It's so true though, price discovery is out the window when the cost of money, or one half of every transaction, is manipulated.

That's interesting...maybe it's just all the people I've been talking too? I've got to start watching CNBC again!

Great observations, you hit the nail on the head. Free and clear RE is absolutely the safest. It historically is a good store of value in any environment (if purchased at a price near its historical mean or if you can get it under cost of construction even better). So I try to throw a twist on that by pulling the equity out once I've paid cash. Assuming I can take out every dollar I put in, this gives me the 50/50 balance you mentioned. I've got my inflation/deflation hedge and I've got my equity out so I can't take a loss on principle and I can deploy it in the event of a downturn...that's the easy part.

The hard part is what to do with the cash once you've got it out of the property and back in the bank. It's endless risk/reward analysis...I'll ask myself "should I just sit on the cash and wait to see if the market corrects? That gives me the greatest degree of liquidity but then I have the opportunity cost of that cash not working. And then what if the market doesn't go down for 10 years?" or to your point "should I do a flip and put the money to work but then risk putting myself into an illiquid situation and is it wise to put the cash to work in the same market I'm waiting on to go down?" I'm sure all investors are feeling my frustration of the fed forcing you further out the risk curve.

That's the main reason I started investing overseas. I felt I was actually taking on less risk outside the US because of the crazy macro environment. I like RE markets with very little debt in them. Maybe it gives me a false sense of security? Only time will tell... ;)

Thanks again for the post,

George

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@Gloria Mirzathere's absolutely no question that lower interest rates mean lower monthly payments. Lower monthly payments increases purchasing power, which in turn, puts upward pressure on prices. And of course the opposite is true when rates go up. Interestingly enough though it doesn't always play out that way in the market place.

I just noticed this the other day. Look at the chart of housing prices again.

And now check out a chart of the 10 year treasury (loosely tied to mortgage rates).

You'll notice, that at times, prices don't solely go up or down based on lower or higher monthly payments due to interest rates. There's obviously a lot of noise but it seems what might matter most is where prices are at the time of the interest rate move (at least since we left the gold standard in 1971)? That's by no means an opinion just thinking out loud. Also, it's odd that since leaving the gold standard the time between cycles has increased and we've had higher highs and higher lows. I'm not sure if that means anything but it's interesting...

Thanks for the feedback,

George

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Originally posted by @Gloria Mirza:

Negative rates will have an effect on home prices. For example, if you can afford to pay $1000 a month on your mortgage, at 6% that would be a 170k house, at 4% that is a 210k house. As a result people will spend more on the house. The thing we have to remember is that interest rates are not the only factor here. There are still cities selling off distressed homes at low prices and communities that have yet to fully recover from the housing crash. Personally I think prices in some areas areas still have room to grow.

Solid points, I'd point out the following.

1. Very true. But how many people have the money for a down payment and haven't purchased yet due to interest rates being too high? Again, I'm concerned about demand decreasing going forward counter balancing the upward pressure neg interest rates should have. Lowering interest rates, QE etc. empirically has diminishing rates of return. I see demand possibly increasing from the investment side due to reasons stated above.

2. Interest rates are not the only factor going down but they would be the only factor that mattered going up ;)

3. I hear what you're saying but I'm leery. Prices going up due to a further expansion of credit (unsustainable) I don't like, prices going up because of real wage growth (sustainable) I do like...I don't think anyone would argue prices are/have gone up due to the later. The Nasdaq had room to grow in 1999, so did housing in 2005.

Those are some of my thoughts.

Thanks again for the post.

George

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From my experience as an entrepreneur, and more recently an investor, I'm surprised by how many people never really think about inflation. Here's the case schiller inflation adjusted housing chart going back to the year 1895. Notice the price difference in the average home in 1895 and 2011...zero. And on a apples to apples comparison home prices may be lower in 2011 due to the fact that the "average" home size has increased so much.

To be clear, I think real estate is a fantastic bet...one of the biggest reasons being inflation!

What does everyone else think? Does anyone have any good strategies to profit from inflation?

Thanks,

George

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Originally posted by @Nick L.:

@George GammonGreat link!

My guess is that long term negative rates will not have a huge effect on residential OO real estate. The whole reason for the negative rates is a weak middle class with diminished earning/spending power, with no more Fed firepower to help out. That same middle class is not going to be rushing out and splurging on McMansions any time soon.

On the investment side, I believe long term negative rates will boost prices at first but settle over time. The initial boost will come as people watch their stocks and bonds decline from negative rates and a weak middle class economy, and look to take charge of their nest eggs. Investment real estate is a natural fit and low interest rates will boost lending. As millennials are weighed down by student debt, auto loans and fewer/worse jobs, they will increasingly turn to renting as they did in the last recession.

But over time all the new real estate capital will have been deployed. Plus commercial non-residential will slowly decline for the same reasons as the rest of the economy, and residential investment properties can't get too far out of whack from residential OO. So the boost will not last forever.

Of course all of this is total speculation, but as WB himself said, this has never happened before and all anyone can do is to speculate. Do you have any quant data to provide insights, like you provide on local housing markets?

On the subject of WB, I just read his new annual letter to shareholders and he made the point that America's GDP growth is not in question. What people are arguing over, and will continue to argue over, is how that GDP pie will be divided.

This is a great point but I feel he is missing the permanent structural changes in the economy due to automation and increased globalization which are permanently benefiting the capital owning class at the expense of the economy as a whole. As a real estate owner I feel this is a good thing but as a member of society I know it is not.

Nick, thanks for the response. I totally agree with most of what you're saying but I see it from a little different angle.

1. The reason the fed lowers interest rates is to pull more spending into the present from the future. They're all Keynesian economists, therefore believe spending is the cure for all economic issues. How much more spending could they possibly pull forward? How many people have been saying "as soon as interest rates go negative I'll start a new business, hire more employees and buy a new house!"? I'm guessing zero. Essentially we're saying the same things.

2. Yes. If I had to make a bullish argument for inflation adjusted home prices rising it would be due to capital flows rotating out of cash to avoid paying interest on deposits or just chasing yield because negative interest rates pulling down returns even lower. My big concern there is that would incentivize people to go further and further out the risk curve. Generally that ends badly. The millennial situation is certainly bullish for rents. Although if the negative interest rates don't keep the economy from deleveraging employment rates might go up substantially even with these crazy labor force participation numbers. You're main deflationary risk with rentals is always population decline in the city or nieghborhood where you have rentals though.

3. Seems very probable. I submit Japan

4. My favorite chart is always the historic inflation adjusted home prices.

Here are some observations I made on another post...

First, notice that every RE decline has needed less of an interest rate hike as a catalyst (1980/8%, 1990/2%, 2008/1%). This makes sense because the amount of credit in the system has been exponentially higher at each point in time. This provides a very bearish case for US RE prices if interest rates on the 10 year go up modestly. Second, envision an approximate historic average. Looks like it would be around 135. Notice where RE prices fell when the market finally bottomed in 2012...just about 135. I don't think this is coincidental. It's obvious the rising prices of 2002-2006 were a result of expanding credit not increasing real incomes. Naturally when there's a deleveraging you'll have a reversion to the mean (where home prices should be based on real incomes). So then the question becomes where are we now? Definitely not to the 2006 highs but far above the mean. If you look at real wage growth, or lack thereof, it becomes obvious that this recent rising of real estate prices is a result of something other than real wage growth, which implies prices are artificially high again. Housing prices haven't "recovered" they've "reflated". The great news is it gives us a good proxy on where to start buying if/when prices come back down.

5. Personally I don't put much weight into that. I think he really has to watch what he says about the american economy for political reasons and since his views are so scrutinized by the public/media. Our economy is so reliant upon the expansion of debt, confidence is paramount. I think he knows that, and realizes his influence over that public confidence.

6. Totally agree about the real issue being structural...I see different structural issues being more problematic though. I believe the biggest issue is overall debt. See chart below of overall debt to GDP. The capital owning class always is the biggest beneficiary of asset inflation caused by the fed.

Real estate is tough to beat ;)

Thanks again for the response,

George

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Originally posted by @Account Closed:

George,

You're talking about something that has a very low chance of occurrence IMO. In general, higher interest rate is typically a result of an overheating economy. The cap rate tends to get compressed towards the end of the housing cycle. If history is any indication, higher interest rate = higher home prices. Can you show me a period in history where interest rate went up and RE prices went down?

Off the top of my head, this is how CA real estate had performed in the past

1970-1980, interest rate went from 7% - 18%, RE prices tripled

1980 - 1990, interest rate went from 18% - 10%, RE prices doubled

1990 - 2000, interest rate went from 10% - 8%, RE prices upped 25%

2000 - 2010, interest rate went from 8% - 4.5%, RE prices upped 25%

2010 - 2020, interest goes from 4.5% - ???, RE prices ?????

QE has ended for almost 1.5 years now? Why did mortgage interest rate remain relative flat? Did QE have that much of an impact on interest rate?

Balloon or not ballon is not really relevant. First Republic Bank is offering 5/1 ARM with a 10 year ballon, which should be long enough for people to ride through a full housing cycle. Chase is offering 5/1 ARM loans with 30 year amortization and NO BALLOON. Once you understand how to hedge your bet, you will understand that fixed mortgages come at a premium price. Worth it or not? Who are the ones getting 30-year fixed? Do you want to be part of the fixed mortgage herd, or would you like to join the 1% and understand how to use ARM loans to your advantage?

I don't know if you will buy this theory. If the Great Recession 2009 is similar to the Great Depression 1929, does this mean there's a chance that interest rate may keep trending down until 2021? Is it possible for the 10-year treasury to drop to 1% and 30-year fixed mortgage rate to drop to 2.75% during the next recession? Your guess is as good as mine.

Minh, I really appreciate your response. I'd like to clarify a couple points and push back a little on some of your theories.

1. I agree over the short/mid term and disagree over the long term regarding another 30 year interest rate cycle (please keep in mind I means test my portfolio for different scenarios, which is what I was discussing above, it's not to imply I feel theres a high probability of the outcome) . Interest rates in the US, going back to 1870 have run in approximately 30 year cycles (please see chart of 10 year bond, which is loosely tied to mortgage rates). The last cycle peaked in 1981 so 30 years puts us at 2011. based on almost 150 years of american history, we are due.

2. Increasing interest rates on long bonds can often be a result of the economy heating up but it can also be a result of many other things. I'll take that further when I address your QE comments.

3. I haven't researched cycles of cap rate compression. I can tell you that currently cap rates are compressed.

4. higher rates = higher home prices...I'm not sure where to start on this one? A general rule of basic economics, when prices go up demand goes down. Therefore, when the price of money (interest) goes up demand for money goes down. This puts downward pressure on prices. If what you're saying is true, home prices in the US would've skyrocketed in 1982 after Volcker raised interest rates north of 15%. Also, the fed wouldn't lower interest rates to boost economic activity they'd raise them. I could go on and on but the facts are strongly against you here.

5. Can I give you a time in history when interest rates went up and RE prices went down? How about 2007? If I recall RE prices went down then...;) Joking aside, every drop in real estate prices since 1980 has proceeded an increase in interest rates. RE price declined in 1980,1990, 2008 see chart below. Then see chart above to see the rise in interest rates that preceded the RE decline.

A few observations I'd like to point out. First, notice that every RE decline has needed less of an interest rate hike as a catalyst (1980/8%, 1990/2%, 2008/1%). This makes sense because the amount of credit in the system has been exponentially higher at each point in time. This provides a very bearish case for US RE prices if interest rates on the 10 year go up modestly. Second, envision an approximate historic average. Looks like it would be around 135. Notice where RE prices fell when the market finally bottomed in 2012...just about 135. I don't think this is coincidental. It's obvious the rising prices of 2002-2006 were a result of expanding credit not increasing real incomes. Naturally when there's a deleveraging you'll have a reversion to the mean (where home prices should be based on real incomes). So then the question becomes where are we now? Definitely not to the 2006 highs but far above the mean. If you look at real wage growth, or lack thereof, it becomes obvious that this recent rising of real estate prices is a result of something other than real wage growth, which implies prices are artificially high again. Housing prices haven't "recovered" they've "reflated". The great news is it gives us a good proxy on where to start buying if/when prices come back down. Finally Minh, I think the big difference in our analysis is inflation. And with all due respect, I think its a huge mistake most real estate investors make. They look at nominal data and don't consider real (inflation adjusted data). As an example, if you own a home and the price increases by 50% but the cost of goods and services increase by 100% you've lost purchasing power although your asset has increased in price. In constant dollars home prices were the same in 2011 as they were in 1895 (see chart above). Said another way, if you would've bought an average house in 1895 and sold it in 2011 you would've broke even. When you include maintenance, taxes, insurance obviously you would lost a tremendous amount of money. This is why I always look at the data in real terms.

6. Your view of CA real estate is nominal not inflation adjusted. Also, you must account for home size to have an apples to apples comparison of home prices. If average home prices doubled but the average size of home doubled does that me prices went up? see below

I used to have an office in San Jose, at the prune yard. My guess is the average size home in silicon valley has increased far more than the above pic would indicate. ;) Let's look at an inflation adjusted chart of the San Fran market, it was the closest thing I could find to San Jose so I'll use that as a proxy.

You say 1970-80 prices tripled. Unfortunately my chart doesn't go back to 1970 but if you recall that was a decade of hyper inflation. Prices on some things rose 20%+ per year so this compounded over 10 years would lead me to the conclusion housing prices in CA may have actually gone down 1970-1980 in real terms. Especially when you further adjust for home size.

1980-90 prices doubled. Remember inflation didn't go back down to a moderate 4% until the mid 80's. An aggregate total inflation was still very high in the 80's compared to post 1990. In fact if you take a 7% a year average compounded rate of inflation, in 10 years prices double. Therefore, inflation adjusted prices were most likely close to flat.

1990-2000 up 25%. inflation adjusted prices were flat.

2000-2010 up 25%. inflation adjusted slight rise but close to flat.

2010-2020 ???. My guess, based on history...close to flat.

I'm hoping everybody is noticing that home prices, on average, don't really go up over the long term they tend to only keep up with inflation. Granted, you can have neighborhoods or cities or times that get hot but thats speculative.

7. I'm not sure what your point is regarding QE? I'll assume your implying the market interest rate is low because you didn't see bonds spike when they tapered. I could write another 10 pages on this but for the sake of time I'll just say that this was a result of demand for bonds increasing as the fed was tapering because of global macro and it's not wise to take the short term past and assume that will proceed into the long term future.

8. Do I want to be a part of the fixed rate "herd"? Actually...very much so. I like the fact that I'm capping my long term exposure to interest rate risk at zero and if rates go further down I can refi. It maybe the most asymmetrical investment strategy I've ever seen. That said, I'd love for you to tell me how you hedge your portfolio against interest rate risk to take advantage of the lower ARM rates. One thing I think is interesting is that's that you're so willing to take on interest rate risk past 5 years but none of the banks you're borrowing from are?

9. I absolutely buy your theory. Is it possible? no question. Is it probable? based on the 1930's I'm not sure because we were only into a bond bull market for 10 years, currently we've been in a bond bull market for 35 years...big difference. But I'd say probability is over 20%. I'd say an equally strong argument for interest rates going lower until 2021 is Japan.

In conclusion, I'm not trying to persuade anyone of anything other than to start paying attention to macro econ when making your investment decisions. Look at all the people on BP that obsessively scrutinize every negligible risk...what if someone trips on my driveway and sues me? what if my house catches fire? what if my house is destroyed via a terrorist attack? Yet ask these same people if they've hedged against the risk of interest rates rising or the dollar losing it's reserve currency status and most look at you like you're crazy.

Rigorously means test your portfolio and constantly question you're strategy. Consider inflation, deflation, high rates, low rates, falling demand, rising demand, high commodity prices, low commodity prices, consumer and government debt levels, etc. I can promise you you'll be no worse off as a result.

Look forward to more fun discussion in the future Minh!

George

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@J. Martinfantastic post! Let me try to respond in order...

1. Ok, so FF guarantees the debt they sell. Goes back to my original statement: much of the risk is held by the tax payer.

2. I agree but I'm really concerned about the trickle down effect from those defaults. Combined with consumer purchasing power going down if credit card rates go up (thinking through my 30 year interest rate rising cycle scenario) and the purchasing power with home purchases collapsing due to interest rates rising. Higher rates means less purchasing power means lower home prices. But I definitely think neg rates are more probable over the short/mid term.

3. Exactly. I'm always most confident when everyone's on the other side of the boat.

3a. The craziness in the VC world, or asset world in general, is artificially low interest rates force people to go further and further out on the risk curve. That's why I'm very apprehensive about neg rates...how far out on that risk curve will people go to find yield? The more malinvestment we have the bigger potential problem we're creating.

4. No we're saying the same thing. I was just jumping from one to the other in my head without writing down how I'm connecting the dots. I'm not as thorough when I respond to your posts because I know you get it.

5. Yes, it's actually easier with less money to a certain extent because once you do the cash out refi you have less capital to allocate. It's much easier to find 250k worth of deals than 1 mil. As far as the opportunity costs, I just try to find flips outside the US to put the cash to work while I wait to see what happens with the US. Email me and I can explain further if you'd like.

6. Couldn't agree more! ;)

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The gravitational pull of interest rates according to Warren Buffett. How does this affect housing prices? must watch video for real estate investors.

click here for video of Buffett discussing interest rates

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Originally posted by @J. Martin:

Originally posted by @George Gammon:

Originally posted by @Chris Mason:

@George Gammon- You're absolutely right I view things through a narrow lens. It's the lens I'm familiar with, being that I'm not an economist and do not pretend to be. :)

"It sounds like you're in residential lending so you know very few banks will keep long term fixed rate debt on their books. They immediately sell it to fannie/freddie. Why don't they want to keep it on their books? Because its a bad bet."

Eh, I'm going to disagree with you here a little bit.

We sell it on the secondary market because we need that money to lend to the next guy, not because it's bad debt (we're flippers like you might do with houses, but we flip debt). Not all of it goes to fannie/freddie, but a lot of it does. If rates go up to 7% on 30 year fixed loans, the selling price of a loan @ 7% on the secondary market will actually be identical to a loan of the same amount at 4% when 4% was prevailing (yup we don't care about your rate, only where it is relative to what fannie will pay for it). This is true regardless of if it's a GSE buying it, or a South Korean Teacher's Pension Fund.

Fannie/freddie build the expectation of that interest rate, some chance of foreclosure, some chance of being paid back early, etc etc, into their calculations. They are for-profit enterprises, essentially buying high stability low return annuities. They have so dang many of these mortgages that they can afford to pay themselves with that little 4%. They are 100% perfectly fine with getting the 4% they were promised, it's when everyone goes belly up (2009 etc) that the taxpayers are on the hook.

If rates go up and they need to unload those loans to buy some at future-higher rates because they want to make more money, they can sell the older lower rate 4% loans off on that same secondary market to gain access to that capital needed to buy some 7% loans. Or, if the prices offered for it aren't right, they can sit tight and still remain perfectly solvent collecting 4%.

Think about it this way. Suppose rates go up. Suppose you've got, oh I don't know, $10bn in assets at 4% and your only job is to process the checks coming in. You're not even a landlord any more that has to fix the properties, you just collect the checks! If I give you $33m each and every month, do you think you could maybe find a way to process that $33m, maybe by using part of that $33m? I think you could find a way. In fact, I think you could find a way to process that $33m in monthly payments, AND have enough left over to purchase the sexy new investments available at 7%.

Oh look at that! You just purchased some of that sexy 7% debt over the course of the last year. Now you don't just have $33m coming in each month, now you've got $38m coming in! Sweet. Let's process those checks, baby, and keep the money factory going.

The GSE model works because of scale. You as a single individual, or even a modest sized firm, would indeed be in a tough spot with all your capital tied up earning only 4%. But the GSEs are GIANT, that's why it works for them.

Great insight Chris. I'm not following you on being able to sell 4% loans for the same price they're purchased for if rates go to 7%? maybe I'm misunderstanding you?

I'm basing my analysis on the market value of a loan going down if interest rates go up and the market value going up if interest rates go down...like a bond. Assuming this is true for F/F, if they have to liquidate assets due to higher than expected defaults they'd take a big loss if interest rates were higher when they're forced to sell.

They're for profit and backstopped by the tax payer. The profits are private and the losses are public naturally incentivizing them to take excessive risk.

I'm by no means an expert on the secondary debt market so thanks again for the dialogue. :)

George

George, I think Chris is saying that the mortgage brokers/bankers lock the rates in with the existing customers, on the back-end with interest rate futures contracts and/or a purchase contract with the bulk buyers in the MBS market. So they're going to sell the 4% loans with a rate lock on it for the 30 or so day period until they can sell it to the MBS investors who are locked in at 4% without taking a hit (or they get compensated by changes with the interest rate futures hedges).

Then that portfolio gets cleared out, and they start originating, locking, and selling 7% loans to the next batch of MBS pools. So they don't really care about the rate. Because they are doing the throughput game, presumably with adequate interest rate risk management and rate locks or contracts (on the back end) to mitigate the risk of a sudden change in rates on the pricing of the pipeline product.

As long as no one defaults on the loans, Fannie/Freddie/GSE's don't pay anything on the credit guarantee. Only the private MBS holders lose on market value of the MBS pool, but continue to clip their 4% coupons.. There is a little confusion on the quote regarding the private seller re-selling the 4% pool into the 7% market though. There would certainly be losses - . But his other point is that they don't need to sell, and they will just buy some more 7% coupons in the next pool, and whatever it is after that. They have to constantly invest, so they just dollar-cost-average in..

Not as profitable for mortgage banking when rates are on their way up though. Because the big refi activity slows down.

George, to your point about a negative rate environment, and/or deflation, I'd always figured the "helicopter Ben" attitude would come out and the government would just stoke inflation. But then to stop it later, you have to bring short term rates up. If international long-term yields are still low and the US 10yr Treasury is low, do they invert the yield curve to stop inflation? Why hasn't Japan just dumped money until inflation starts?

Anyway, I've though more about this, as I have a big pile of debt too. I was always happy to pay back the inflated debt. But if RE prices continue going up like this, and we're looking at a deflationary recession in the future, I would consider cashing some properties out and just waiting on the side line..

Of course, I will be watching the market from my US road trip or SouthEast Asia, but I'm sure the diligent folks like Chris, yourself, and others, will hopefully keep us up to date on the market also :)

Yes I understand what you guys are saying. You can always just keep the debt and collect the interest. What I'm saying though is regardless of who is holding the debt IF we get large scale defaults whom ever is holding that debt will most likely have to sell for liquidity. IF they have to sell that debt and interest rates are higher they're going to lose a lot. I didn't realize F/F packaged and sold all the loans they buy from the originators, I was under the impression they kept a lot of that on their balance sheet? Makes sense they'd secruitze it.

If we see interest rates rise, it's hard for me to envision a scenario where we don't have large scale defaults.

But I have to say, one thing that actually makes me less bearish is not everyone is bullish on housing. And the only way for me to truly hold conviction on a thesis is if everyone is doing the opposite. In 2006 you couldn't find a person that wasn't immensely bullish on housing. In 2012 you couldn't find a person that wasn't immensely bullish on gold. In 2009 every analyst on earth thought we'd get hyper inflation we didn't. Now every analyst thinks we could get deflation, maybe now we'll get the inflation?

It just seems to be the way markets work.

Regarding helicopter ben...I've heard the next round of QE, if the do it, may go directly into the economy via infrastructure spending and/or tax cuts? Obviously their just trying to get velocity up. That said Japan's been spending on infrastructure for 25 years and can't move the needle on velocity so it's again tough to see a non deflationary scenario.

I totally get what you're saying about the real value of you debt increasing in your portfolio and putting pressure on your cash flow. What I personally do is make sure I have the same amount of cash as I do debt in my portfolio so I'm totally hedged in an inflationary environment or deflationary environment. I do this by paying cash for a rental, adding value and then cash out refi every dollar I put in so I secure my equity and have a 50/50 cash debt position that's paying me a bit of yield through the positive cash flow. If I see a good deal that I can get in and out of fast, so highly liquid, I deploy the cash. But I'm always cognizant of the amount of debt and cash I have.

One thing I'd point out J. is even in a deflationary cycle rents might be insulated. At least more so than other prices. It's incredibly tough to see rents fall if home prices are decreasing unless the population of the area in which you have the rental is decreasing. So if I had to choose between the risk reward of having too much debt and too much cash I might go for too much debt and roll the dice on inflation transferring that wealth to you?

But then you have the opportunity cost of not having enough cash if prices go down...

It's never easy. ;)

1 Vote

All Forum Posts by: George Gammon

George Gammon has started 15 posts and replied 172 times.

Post: "negative rates distort everything" warren buffet. how about RE?

Post: "negative rates distort everything" warren buffet. how about RE?

Post: "negative rates distort everything" warren buffet. how about RE?

Post: "negative rates distort everything" warren buffet. how about RE?

Post: Home Prices Haven't Gone Up in 100 Years. Is RE a Bad Bet?

Post: "negative rates distort everything" warren buffet. how about RE?

Post: Adjustable Rate/Ballon Payment Crisis Ahead?

Post: Adjustable Rate/Ballon Payment Crisis Ahead?

Post: "negative rates distort everything" warren buffet. how about RE?

Post: Adjustable Rate/Ballon Payment Crisis Ahead?