Friday, September 28, 2012

I, Slumlord

Well, I've been hard at it lately, and don't have much to talk about. So, I suppose I'll talk about what I've been hard at.

I never wanted to be a real estate guy, but sometimes these things just happen. I had looked into real estate rather exhaustively for a number of years, and could never see how people made the numbers work. I always supposed that they must be doing some kind of tax maneuvering to make it worth it, and I am not much disposed to that kind of thing, because it is usually just a trap to control your behavior and limit your future options...so that you get to keep the tax benefits which were necessary to make the investment worthwhile in the first place.

Bad idea, and besides, I just don't like real estate.  I don't have the right personality for it.

Well, things have changed, and you'd have to be brain dead not to be in rental houses -- even if you don't like them, at least in my area. So, I'll soon be a landlord.

I'm moving to a larger house to make room for another kid (plus, of course, to make the wife happy). So I was left having to decide what to do with the one I'm in. Let this be a lesson to the wise.

I could have sold it, and basically gotten back out of it what I put in a few years ago. But my realtor advised us to hold it for a bit 'until the market comes back in a couple of years' which no doubt you already know my own views of the prospect of that. But, just because, I looked into the numbers to see how it would work out as a rental.

Holy moly!

First, I guessed that it would generate about 5% rental outcome, just because of the tendency for capital to uniformly return the natural rate of interest, supposing it is a fairly competitive market -- which real estate generally is. Turns out, deducting expenses and maintenance, this was more or less correct (it was actually about 6%, which for most people, after taxes would be 5%).

I do not really want to own real estate making the 5%, as this would be very foolish. It would be paying me some income, yes, but it would be in a slumping market, the market value of my asset unlikely to keep up with inflation, despite the income.

So, I looked into ways of holding it and putting my cash elsewhere in the meantime. Which is to say, borrowing against it and using the money to purchase a different asset, while at the same time using the income it generates to pay off the loan.

Now, theoretically, I should not be able to do this and make it work. If I borrow, say, 80% of the equity, the interest should theoretically eat up 80% of the income the property generates -- because the loan rate should be in equilibrium with the natural rate. So, this strategy should be a useless wash.

As it turns out -- not so! Not at all! The interest rates on loans are so low right now (and prices low, and rents high) that I can effectively give up 80% of the equity and retain 62% of the income! Outrageous!

If you do the math (which will be difficult for you, as I'm suppressing the actual numbers, as I have to have SOME privacy), that works out to a 16% return! And the freedom to invest the balance of my equity any way I want -- i.e. in an actual appreciating asset!

Granted, the majority of the income is in the form of equity in the house, but who cares?  The longer it goes on, the surer my position, until I'm no longer leveraged at all -- at somebody else's expense.

I know that when I went on that whole Veblen tangent, I lost a lot of people. I hope you, gentle reader, sees this for what it is -- free income, an economic abomination, courtesy of somebody out there who is getting fleeced. I will be adding absolutely nothing to the economy except the use of my capital, which should earn me about 5%. I'll be making three times that. I will become a member of the parasitic rent-seeking class, thanks to the crazy money system, laws and policies of this country -- that all too many people want to dismiss people like me for criticizing.

Keep it up. Meanwhile, I'll be sucking you dry, without the slightest remorse. I will explore every opportunity to exploit this situation, while you keep shoveling money in the black hole of your 401K. And when the banks collapse, and the government men inform you that you're broke and have to keep working, because your accounts don't exist anymore, and neither does Social Security, I'll be sitting pretty on physical, income generating assets. My critics may say what they like -- I'm putting my money where my mouth is. Oh, and I'll also be doing my part to help devalue the currency, drive up prices, and hastening the impending financial Armageddon.

And you know what? You're welcome.

Think about this. If you're, say, 50 years old, with $500K to invest, you could put down $100K on $500K worth of house, generate $16K per year of income, and have the other $400K to invest however you want. If you get into trouble, you just cash out the investment and pay off the debt. Or sell the houses.  Or let the bank have them.  Piece of cake.

Like I said, no brainer. Or you could, you know, keep investing in the stock and bond markets, and pray.

In case you hadn't noticed, gold is back on a tear, up about $200 per ounce in a couple of months. In case you hadn't noticed, the Europeans are going all-in for yet another round of inflationary mass-bailout. In case you hadn't noticed, the FED has basically announced an open-ended QE until...who knows?

The money-printing is not going to end anytime soon -- but at some point, the low rates will. Prices are going up. Debts will be devalued.

Think about it.  Anyway, whatever you choose to do, I know what I'm doing.




3 comments:

Mark Butterworth said...

I'm not so sure about inflation anymore. I'm looking at deflation coming as it did from 1929 on.

Why? Well, the debt load of the entire country, private and public is something like 54 trillion, but the money supply is only 9 trillion.

The govt. would have to increase the money supp;y five times or more to start to inflate our debts out of existence.

Even so, I have no idea which way things will go, except wages are beginning to plunge. Less in wages less to spend, more things deflate to get themselves sold. A vicious cycle.

Mark Butterworth said...

BTW, how is this "kid" being acquired? You express it pretty casually. Is this to be a blessed event an adoption, foster child, or a returnee?

Just wondering because I'd like to congratulate you on something, but I'm not sure what. Sounds exciting if you're having a new person enter your life.

Scott said...

Thanks. I already have 2 kids. We want to have another, so we need a bit more space than at present (at least my wife thinks so...)

Inflation pretty much won't get us out of the debt. Too many obligations are indexed, plus voters wouldn't put up with it if it were that simple and obvious. We won't get inflation because of that, mostly. It will be because of 1)present deficit spending (Washington must borrow, and if there are no lenders, the FED becomes the lender of last resort, should Washington decide to strong-arm it) 2)the banks need solvency as their positions unwind in their faces. Actually, that should probably be #1. That's why we've had most of the growth of the monetary base so far, to bail out the banks.

Also, remember that the banks own a very large fraction of Treasury debt. They would be in heaps of trouble if Washington missed a payment. It's the same as with Greece. Nobody wants to bail them out, but the banks are in charge, Greece owes the money to them, and it's their loss if Greece doesn't pay. German voters don't want Merkel to bail out Greece. German banks do.

Basically, same thing here.