Investing: How to be a Smart Investor in a Tumultuous Economy – Part III

Investing: How to be a smart investor in a Tumultuous Economy – Part III: Specific Real Estate Investments that do well in a deflationary environment

What would profitable real estate investing look like if you knew real estate prices were going to go down drastically? Drastically like an average of 60% across the board drastically?

Frightening thought right? It doesn’t have to be however.

I will go on record to say that this is the way I believe our economy will wind down, through a massive deflationary collapse. To review, a deflationary scenario is where everything falls in price. Oil, houses, land, food, gold, silver, you just about name it; everything goes down in price similar to what happened in the 1930’s. It is not because money is not available. It is because everyone’s mood sours and the population becomes obsessed with saving once again. Unemployment goes up and our general standard of living goes down as people seriously down-size the way they live. The downsizing would involve downgrading their home and business locations.

The counter to this would be a hyperinflationary explosion argument. Even the hyperinflationary scenario eventually gets us to a deflationary collapse. The reason I do not believe that we will experience a hyperinflationary scenario first, even though the powers that be may desire this because it puts off the inevitable, is there is no mechanism in our country that can boost wages if the government decided they wanted to hyper-stimulate the economy.

Without a mechanism to boost wages, there will be no coordinated way to get more money in the hands of the people to drive prices higher. To do this, the government would effectively have to take over every business that pays wages. That isn’t going to happen without some mechanism that I cannot even contemplate.

The end result of stagflation (the simultaneous rising of prices and the falling of asset values) will be a massive decrease in consumer spending.

Nouriel Roubini (economist for New York City University) put these coming events that will domino upon each other best:

• Step one is the worst housing recession in US history. House prices will, he says, fall by 20 to 30 per cent from their peak, which would wipe out between $4,000bn and $6,000bn in household wealth. Ten million households will end up with negative equity and so with a huge incentive to put the house keys in the post and depart for greener fields. Many more home-builders will be bankrupted.

• Step two would be further losses, beyond the $250bn-$300bn now estimated, for subprime mortgages. About 60 per cent of all mortgage origination between 2005 and 2007 had “reckless or toxic features”. Goldman Sachs estimates mortgage losses at $400bn. But if home prices fell by more than 20 per cent, losses would be bigger. That would further impair the banks’ ability to offer credit.

• Step three would be big losses on unsecured consumer debt: credit cards, auto loans, student loans and so forth. The “credit crunch” would then spread from mortgages to a wide range of consumer credit.

• Step four would be the downgrading of the monoline insurers, which do not deserve the AAA rating on which their business depends. A further $150bn writedown of asset-backed securities would then ensue.

• Step five would be the meltdown of the commercial property market.

• Step six would be bankruptcy of a large regional or national bank.

• Step seven would be big losses on reckless leveraged buy-outs. Hundreds of billions of dollars of such loans are now stuck on the balance sheets of financial institutions.

• Step eight would be a wave of corporate defaults. On average, US companies are in decent shape, but a “fat tail” of companies has low profitability and heavy debt. Such defaults would spread losses in “credit default swaps”, which insure such debt. The losses could be $250bn. Some insurers might go bankrupt.

• Step nine would be a meltdown in the “shadow financial system”. Dealing with the distress of hedge funds, special investment vehicles and so forth will be made more difficult by the fact that they have no direct access to lending from central banks.

• Step 10 would be a further collapse in stock prices. Failures of hedge funds, margin calls and shorting could lead to cascading falls in prices.

• Step 11 would be a drying-up of liquidity in a range of financial markets, including interbank and money markets. Behind this would be a jump in concerns about solvency.

• Step 12 would be “a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices”. 60 – 70% reduction in real estate values.

And we are left with massive deflation.

We are then left with this question. How do you make out? How do you profit in real estate under these situations? Very simply, become as much like a bank as possible right now. Do what the banks are doing. What are they doing? They are raising as much cash as possible at the moment. Why? They see it and they want to whether the coming economic storm and to counter-act the effect of having to write down billions in assets. They have faith in the dollar and I do too, ultimately.

Cash is king in a deflationary scenario. When our market hits bottom, you can then make your money on the purchase. Cash out and wait for the coming drastic bottom.

Owner financing would be another way to keep your hooks into devaluing real estate. Just make sure your exposure is small.

Sell out, raise cash, and when the time is right, get back in.

There you have it…..not sure how to follow that up…..but I have heard it time and time again…..from the likes of Robert Prechter, Robert Kiyosaki, John Williams, and Harry S. Dent, just to name a few.

Interesting interview with John William earlier this year on CNN:

Commercial Real Estate News and “How to” articles……

Until nest time…….rob