From the early 1970s to 2009, Jack Miller wrote a monthly newsletter. In the Commonwealth Letters, Jack shared his views of what was going on in the world and how it would affect real estate investors.
The Commonwealth Letter was the first newsletter designed specifically for single family house investors. In each publication, Jack offered his advice about what to do or not do based on what was happening in the world, in government, and in the economy. Those who followed Jack’s advice made millions and avoided losses.
Many thousands of subscribers stopped whatever they were doing the minute they got their Commonwealth Letter in the mail so they could read Jack’s sage advice. I did too!
Jack’s Commonwealth Letters are now available at CashFlowDepot.com for members.
So what’s the advantage in reading these old newsletters? You can look back at a similar situation or economy in history to see what Jack’s advice was for investors.
So, today, I looked at the April 2003 edition. This was shortly after the US invaded Iraq.
Since there is unfortunately a possibility that the United States will start another war they cannot afford, I was wondering what Jack’s advice was in 2003. How did the war in 2003 affect real estate investing? I was surprised at what I found. You’d think Jack was writing about the situation today… IT S LIKE NOTHING HAS IMPROVED IN 10 YEARS.
In fact, it is MUCH worse today than it was in 2003. Under Obama, the US debt is almost 20 Trillion dollars and we've reached yet another debt ceiling, out of control spending by the government and they still want to spend (BORROWED) money an another war, printing trillions of dollars which devalues the US dollar, more people on food stamps and living in poverty IN the US, Social Security and Medicaid are broke and filled with fraud, sky rocketing health care costs and Obamacare which will make it worse, there is one scandal after another tied directly to the Administration (who is seemingly out of touch with reality), corruption and moral decline at the highest levels, many major metro cities are in big debt some have declared bankruptcy and many more will follow, house equity and wealth was wiped out during the 2008 -2009 economic crash.. and another crash, even bigger, is predicted to happen in 2014/2015. The list goes on and on….
So, what does all this mean for real estate investors? Read Jack's April 2003 Commonwealth Letter for a glimpse of the future by looking at the past…. there is a silver lining.
2003 is shaping up as an odd year. Except for those who are directly involved, people seem unfazed by war in Iraq or North Korea's nuclear arms threat. Social Security and Medicare are still going broke. Prescription costs continue to soar. We saw a weak retail selling season from Halloween through the February; and what people bought primarily consisted of foreign-made goods. Even as companies lay off employees and transfer both white and blue-collar jobs overseas, Americans still spend much more for imported goods than we get for our exports. Look around your house and note the foreign-made cars, stereos, TVs, DVD/VCRs, computers, clothing, etc. you own. American Dollars are piling up off shore causing a dollar-flight into other currencies. Surging gold prices attest to the dollar's loss in value.
In the first two years of the president’s administration, few seem concerned that … he has increased both the national debt and the money supply by trillions of dollars. Citizens have done little more than complain about .. the many scandals. Other than some whimpering, there has been no public outrage over corporate (and city/state)under-funding of retirement plans … nor about the tide of layoffs, which have cost 2.8 million jobs.(these were 2003 numbers)
Because of monetary stimulation by the FED, low interest rates and falling prices have enabled more Americans in history to own homes.
In spite of bankruptcies and credit card defaults that continue to grow to all-time highs, credit has never been easier to get or to pay for. Mortgage interest rates are almost at 50-year lows. Home owners are still being offered home-equity loans at more than appraised value; the most recent offering I've received quoted 4.99% for a fixed rate mortgage, and 3.75% for an adjustable rate mortgage. Some mortgages now allow borrowers to skip any two payments out of twelve without being in default. I've been buying and selling real estate since the 1950s but I've never seen credit markets like this before.
Even with States running $80 billion in deficits, the new budget proposal places heavier burdens on them to fund social spending.
Through some magical alchemy, with the highest national debt in history, a monetary base at historic levels, soaring energy prices, one of the longest and the deepest bear markets in memory, and income taxes at levels not seen in generations, America is supposed to shrug off deflation and stave off recession without creating inflation. Call me skeptical, but I think sooner or later we're going to have to pay the piper. I intend to keep my money in houses until the other shoe drops.
LET' S PLAY SOME GUESSING GAMES
If one were in possession of all the facts, it might be possible to extrapolate what might happen in the future. But all we have to go on is media conjecture. We're confronted with allegations of fraudulent overstatement of corporate earnings that don't take into effect under-funded pension plans. In lieu of hard news, our leaders engage in political posturing about war in Iraq and Korea (substitute Syria) while giving us mixed signals about the economy. As a result, about all we can do is to imagine a variety of scenarios, and to see what we might do to deal with them. We'll use a format of starting with what we know, then guessing at results:
INFLATION: Inflation is caused by too much money chasing too few goods. We don't have that problem today. As mentioned previously, it is in the national interest to keep even marginal companies operating to keep as many people employed as possible. That has resulted in more products being manufactured than the market can dispose of. So, what we have today is a lot of money chasing a lot of goods; or chasing a lot of borrowers. In either case, what the FED has tried to do is to match demand to production by making low cost money available to consumers. That helps to explain why, despite record credit card defaults, credit card companies continue to send out millions of unsolicited credit cards, some at zero interest, because the banks that back them are able to obtain low cost infusions of cash from the FED.
Of course, spending billions of dollars on defense materials that are going to be destroyed is a grand way to keep millions of Americans employed at high wages which in turn can be spent to keep America's consumer juggernaut running at full speed. So long as the supply of goods and services exceeds market demand, it is unlikely that inflation is going to be much of a threat. But, a war that dries up sources of oil, or which creates shortages of skilled labor and materials could create inflation fairly rapidly. Rising prices would lead to higher interest rates which would create a completely different situation in the housing market.
When house prices inflate rapidly, mortgage interest rates also rise to build in inflation protection. The good news is that borrowers with fixed rate mortgages are getting richer by leaps and bounds. The bad news is that what they own is getting more illiquid. Even with more demand, there are fewer cash buyers. With higher down payments and monthly payments, fewer people can qualify to buy a house; so it becomes increasingly difficult to sell houses for cash. So sellers who must sell will be more receptive to creative financing. This provides a window of opportunity for holders of fixed rate investments such as long term leases, Bonds, and mortgages to trade them for motivated sellers' houses. To do this, they must be able to negotiate creative financing and to structure creative transactions. Fortunes can be made this way by those who know how to help others do it.
DEFLATION: Deflation occurs when prices decline. Companies see profit margins disappear. Deflation breeds rampant business failures and loss of jobs. This is the phenomenon we see happening today in the airline industry. Entrepreneurs who run the risk of being wiped out on a day to day basis may have little sympathy for corporations that fail, but there's much more to this than meets the eye. Many of the Americas corporations have been investing employee retirement funds in their own stock. When they fail and their stock becomes worthless, so does the value of their employees retirement savings.
Because of falling stock prices, many corporations in the S&P 500 Index owe billions of dollars to their employee pension funds. Do names like General Motors, Exxon, Pfizer, Proctor and Gamble and Goodyear sound familiar? Plan trustees have also invested heavily in corporate bonds that are now in default, leaving many corporate pension funds high and dry. Defaulting companies include Enron, K-Mart, Sunbeam Corp., Polaroid Corp., Borden Chemicals, Burlington Industries, Global Crossing, plus many others.
As the baby boomers reach retirement age without any savings other than Social Security and their corporate pension funds, millions of today's consumers will become tomorrow's government dependants. But those who have based their retirement on free and clear rentals will do fine.
HOUSES WIN IN ALMOST EVERY ECONOMIC SCENARIO
I get a kick out of watching financial pundits without any comprehension of the housing market describe rising house prices in terms of “bubbles” and “booms” that are certain to collapse. As leading indicators, house prices lead inflation and lag deflation, so they seem to ride economic crests better than almost every other form of investment. Unlike most competing long term investments, houses can be used to shelter their owners, or to produce rents. By virtue of the leverage that attends most house purchases, they can produce yields like nothing else. A typical down payment on a FHA house produced a compound yield of over 50% annually during the decade of the 1970s after America stopped supporting gold at $35 per ounce and the Carter inflation prevailed. During this period, the Dow dropped below 600.
It seems odd that Holland's “Tulip Mania” is mentioned is when house prices are rising but never when stocks are rising. The talking heads that appear on CNBC treat housing as a commodity. What the financial gurus fail to take into account is that people NEED housing in order to survive, but none of them need to buy stocks. House prices may level off and remain flat for many years, but they rarely collapse the way that stocks have done many times. Certainly, house values have dropped precipitously at places and periods of time in the past, but, in terms of national averages, it's a rare occasion when prices don't recover quickly. In Houston in 1988, lenders sold four year old houses, that had been priced at $70,000 when new, for around $20,000. Today those same houses sell for $165,000.
It's interesting to compare long term rentals to AAA rated Bonds. A Bond acts like a first mortgage with “interest-only” payments coupled with a balloon note. If held to maturity, an 8% Bond yields 8%. If sold prior to maturity, it is discounted by a factor derived from Moody's Bond ratings, the rate of inflation, the way in which it is taxed, and the prevailing rate of interest on similar investments over its remaining life. So war, inflation, high interest rates, and higher tax on gain such as we experienced in 1987 all reduce the value of a Bond to investors.
In contrast to Bonds, rental income can be indexed. Leases on houses are usually adjusted to market rents each year, so income is automatically increased during inflationary periods. What's more, today when AAA Bonds might yield 5% before taxes at best, a house at the median point of the market will yield about 7% after taxes. At the same time, the residual value of the house upon sale rises at a faster rate than inflation. Best of all, $500,000 of the gain on sale of a house used as the owners' primary residence can be tax-free. As a result, the total return on a house investment is several times as high as that of Bonds.
RECESSION: What happens to houses in a recession? Recession relates more to loss of jobs than to falling prices. At some point, government can no longer continue to reduce interest rates. In 1929 T-Bills produced one quarter percent per year. In Japan, Bond interest rates have dropped to zero. When this happens, nobody buys Bonds. Businesses, unable to raise money from Bond sales to continue to operate, shut down. They lay off workers, creating recession; in turn, drying up sales of just about everything. This causes the recession scenario to spread. As more people join the unemployment rolls, costs of social programs increase. States and municipalities quickly run out of money so they raise taxes. This usually makes the recession worse. States turn to the Feds for financial aid. The Treasury provides funding by selling T-Bills to the FED. It literally manufactures money to pay for them. This money is then spread around to help cities and States survive.
During a recession, home owners with high leverage and payments to match often find themselves out of work; unable to make payments. They often deed their homes to those who can take over loan payments. Many homes are sold at bargain basement foreclosure prices. Lenders often voluntarily lower the amount they'll accept as payment in full. Sometimes, in the absence of bidders, lenders must take the homes back. If later they fail, houses they hold are sold at bankruptcy sales. So, recession creates opportunity for those who can ante up cash to buy houses.
HOUSES WORK BETTER THAN GOVERNMENT OR CORPORATE PROMISES
Once upon a time I (Jack MIller) was fired from my corporate job. I had two valuable assets, a supportive family and zero debt. I was able to survive by selling houses to earn commissions. I eventually learned enough to open my own brokerage business. Later, I saved enough money and learned enough to begin investing in houses and to become a landlord. I learned to manage rental properties so I could pay them off. It was then that I realized that I had created my financial security without relying upon the promises made either by government or a corporation. Just a few free and clear houses could provide an income stream and serve as a store of value that neither inflation nor deflation could wipe out – for the rest of my life.
WAR: War is something that only politicians can start or end. It subjects everyone to the Law of Unintended Consequences during which uncontrollable things can happen. When a country goes to war, great physical damage can be suffered by houses, but in mainland America, homes haven't been damaged by war since the Civil War. On the other hand, investors and landlords have been afflicted by the Soldiers and Sailors Relief Act of 1940. This Act gives the government the right to stop foreclosures and evictions of servicemen and women; and their families. This can wreak havoc with leveraged landlords who rent to active service personnel. One major advantage that single family houses have over multi-family rentals is that, if war jeopardizes cash flow, owners of single family houses can sell them; usually at a profit.
TAXES: When government needs money, it has three choices: (1) Borrow, (2)Raise taxes, (3) Manufacture money. Borrowing increases interest rates. This slows new construction which increases rental demand; hence rents. Increased taxes can be passed along to tenants in the form of higher rents. If rent control should raise its ugly head, single family landlords can always sell to occupants. Manufacturing money pyramids equity over fixed rate low interest rate loans such as we now have.
How would this affect the economy? The Bond market would crash! Who'd buy Bonds when they could buy stocks and receive tax-free dividends? Since Bonds are what fund pension plans, insurance companies, industrial development, municipal spending, and the federal government, they'd all lose their funding. Spending for social services, federal grants, and the pensions of most Americans would crater. Government would be forced to start manufacturing money on a much larger scale to replace taxes untaxed dividends would eliminate. Roth IRAs would lose their appeal when people could simply invest in a high-dividend-paying stock? In any event, the single family house would still be a preferred way for Americans to live, whether they owned it or leased it; and owners would still be able to enjoy a comfortable retirement buying, selling, exchanging, renting, and fixing up single family houses.
Over the years, government fiscal and monetary policies, and corporations, will come and go. During inflation, deflation, recession or war, single family house investors will still be able to earn high profits via buying and selling for cash, creative financing, or exchanging; or by buying and holding houses for rental income and appreciation. Increases in taxes and operating costs will be paid for with higher rents; or landlords will simply sell out and use their capital to buy something that works better. For 10,000 years, people have placed the importance of their abode above war, pestilence, famine, and plagues of locusts because ownership of a home represents more financial security than mere promises given by anyone.
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