TAKE ADVANTAGE OF WEALTH TRANSFERS THROUGH PROPERTY
As I mentioned in the some recent posts, there is a transfer of wealth occurring that is set to change the way we think about money and debt. With interest rates dropping toward zero and inevitable inflation on the horizon, which is set to happen at a much quicker rate than ever before, people who are rich in savings will be the losers of the new monetary age. In contrast, those who have built an asset base of secure, wealth generating properties will be the winners.
If the world economy continues to head in this direction, it will be up to us to choose whether we want to merely make do, or thrive. So, how should we build wealth despite money losing its value?
By wiping out bad debt and leveraging ourselves at the right level, it is possible get the most out of borrowed money while paying it back at a quicker rate than ever before.
WHY DEBT WILL BE IRRELEVANT?
To recap my theory surrounding debt and the devaluation of money, if interest rates hit zero percent and stay down for a long period of time, more money becomes available and quicker cycles of inflation are likely to occur.
Property delivers both a capital value and a rental income that are both subject to inflation. If an investor can use borrowed money to build a property portfolio, not only will repayments be significantly less at zero per cent interest, but thanks to inflation, the investor will be able to wipe out their debt much quicker.
How? Let’s look at the finer details.
WHY WILL LEVERAGED PROPERTY PERFORM SO WELL IN THIS ENVIRONMENT?
First and foremost, the lower the interest rate, the lower the cost of repaying the debt. If the Reserve Bank sets rates at zero per cent, it is likely that banks will not be able to charge much interest at all.
As inflation sets in, the prices of goods and services, including property and rental prices, will rise.
The one thing that won’t go up in value is old mortgage debt.
We have all heard stories from our parents and grandparents about how much they bought the family home for 30, 40 or 50 years ago. My parents purchased their home for $13,000 in the late sixties. It is now worth over a million dollars. It wouldn’t take long to wipe out this debt in today’s money.
The difference now is that inflation is likely to come about in shorter cycles thanks to interest rates being the lowest they have ever been and the looming threat of another GFC on the horizon.
HOW CAN YOU WIPE AWAY DEBT TO CREATE A DEBT FREE INCOME EVEN QUICKER IN THIS KIND OF ENVIRONMENT?
Since the value of both the property and its rental income are subject to inflation, and debt is not, quicker cycles of inflation will provide an opportunity to pay down debt over a shorter period of time.
This may mean that within 20 years of purchasing your investment property, the weekly rent has gone up so much that the debt you incurred at the time of purchase will be like nothing. It will be a small debt, easy to pay off with only a year or two of rental income.
This will allow investors to achieve a passive income stream over a shorter period of time than ever before. As inflation surges on, the value of rent will rise – allowing investors to make money in inflated terms.
In a nutshell, this process uses leveraging to transfer savings into an asset base that pays an inflated income.
WHO WILL LOSE OUT IF THIS ECONOMIC SHIFT AND TRANSFER OF WEALTH OCCURS?
In this scenario, the losers will be those who have either overleveraged or underleveraged their finances.
This is when an individual is in too much debt, or when they have gotten themselves into “bad” debt. Bad debt can be thought of as debt that isn’t attached to an income generating asset. Credit card, personal loan and car loan debt are prime examples of bad debt.
Good debt can be thought of as debt that is attached to an income producing asset. Property investor loan debt can be good as long as the property has a neutral to positive cash flow and offers a strong prospect of growth.
WHAT ABOUT HOME LOAN DEBT?
The debt that is attached to your principal place of residence (PPOR) sits somewhere in between good and bad. It is attached to an asset that is likely to go up in value over time, however, because you live in your home, you can’t earn an income off it in the form of rent (unless you rent out a room or granny flat).
For this reason, homeowners with no investments may be at a disadvantage if inflation comes about more quickly.
This is when an individual has cash, but little or no assets. This will be problematic in an inflationary environment because at the same time that cash value is dwindling, property and other prices are increasing. This will make it more difficult to establish an asset base with cash savings as time goes by – especially if the individual is nearing retirement and has no future earning prospects.
WHO WILL BE THE WINNERS?
Those who have used the right balance of debt in order to build a recession proof portfolio of bread and butter properties will be the winners of the new economic age.
By avoiding high end investments, and purchasing affordable properties under market value, with a good upside for growth and a neutral to positive cash flow, investors can use leveraging to establish an income producing asset base.
It also effectively widens the gap between small, old world debt and newer, inflated income. This may help to shorten the time it takes to pay off debt completely.
Buying with a good upside for growth minimizes the risk that property value will go backwards after purchase. This should make it easier to expand into a portfolio more quickly as it capital growth adds to the investor’s net worth position, having a positive effect on serviceability and the ability to create deposits.
Buying in a metropolitan, rather than regional, area is usually better in order to ensure more consistent levels of renter demand. This should protect against prolonged vacancies and achieving less than optimum rent.
Buying with a neutral to positive cash flow means that the property has its own respiratory system. It is paying for its own way, preventing the investor from burning their own pockets. This is important in order to minimize the risk of financial hardship that a sudden loss of income would cause.
As rents become inflated, cash flow will turn more and more positive against the old world debt. This will help to pay down debt more quickly, with minimal impact on the investor’s own cash flow.
HOW TO PLAN A FINANCIAL FUTURE AMIDST ECONOMIC UNCERTAINTY?
Don’t be scared. Although the world may face economic upheaval and uncertainty, it will keep on turning. The sun will rise every day and the world will not come to an end.
The most important thing you can do at this point is to ask yourself: what can I do in order to benefit from this situation? Having the right mindset and being able to adapt to change in order to profit from it will be the main thing that separates the winners from the losers in this new world economy.
The other thing that will determine your success in the future is whether you have the right team of professionals around you now. Having a financial advisor who knows what is happening in the global economy is indispensable for those who would like to maximize their financial position.
It’s the same for all of the professionals you deal with. Having a good mortgage broker, accountant and buyer’s agent, who each know how to help portfolio builders achieve success, can be the difference between owning one or two and 10 or 20 properties.
THE “SURTHRIVAL” PLAN FOR A NEW FINANCIAL AGE
In a recent post, I mentioned the importance of thriving while surviving. Dealing with a changing economy shouldn’t be a question of whether you will merely survive. Instead, it should be a time when you figure out how you will thrive and benefit most from the situation. Here are eight things you can do to ensure you surthrive while the world economy undergoes a transfer of wealth.
1) Rid yourself of bad debt that only weighs you down. Practice delayed gratification and question whether you really need something, or you simply want it. This will help you stick to a budget and clear that bad debt away.
2) Build a good team of professionals around you that will navigate you through any economic upheaval while helping you maintain and protect your assets. This includes a lawyer, accountant, financial planner, mortgage broker, buyer’s agent and property manager, in order to maximize and protect every single aspect of your investing.
3) Build a recession-proof property portfolio and follow the three keys of buying below market value, in a good growth area with a neutral to positive cash flow.
4) Stay committed to your strategy but be open to change. As markets fluctuate and different economic factors emerge, it is important to stay true to the core principles of your strategy but be flexible enough to accommodate changing circumstances in a beneficial way.
5) Do your homework and research your position, your strategy, different markets and property investing as a whole.
6) Keep up to date with world economic affairs. Be aware of what is driving our economy and the property market.
7) Regularly look at your position and scrutinize your financial capacity. Optimize your portfolio and regularly appraise rent and market value. Would refinancing be a good move? Keep in touch with your success team and make sure you are doing everything you can to get the most out of your financial situation without sacrificing your bottom line.
8) Have a buffer in place to cover any unforeseen circumstances or economic instability.
BY DOING NOTHING YOU ARE COMMITTING YOURSELF TO LOSING MONEY
If you have enough capital to begin building an asset base and you do nothing, you are choosing to miss out on the global transfer of wealth. If interest does stay down for the long term, and inflation comes about in quicker cycles, all of your hard earned savings will be at risk of dwindling into nothing.
Those who have converted their cash into income producing assets will be in a much better position, as long as they go about it the right way and minimize risk as much as possible.