Your morning shot of what's new in the world of real estate investing. Daily real estate investment outlook from investor, syndicator, developer and author Victor J. Menasce, so that you can compress timeframes as a real estate investor or developer. Weekday shows are 5 minutes of high energy, high impact awesomeness. The weekend edition consists of interviews with notable guests including Robert Kiyosaki, Robert Helms, Peter Schiff, Chris Martenson, Mark Victor Hansen, George Ross, Ed Griffin, Dr. Doug Duncan, and many more.
Stock Market Distortions
On today’s show we’re breaking down specifically how the low interest rate environment has translated into inflated asset prices in the stock market. Unless you’re deeply immersed in the system, it may not be obvious how and why that relationship has happened.
We’re going to connect the dots for you so that you understand how compensation structures are design in most public companies, and how those structures are being manipulated to maximize compensation for directors and officers at the expense of investors.
Let’s imagine that you are the CEO or CFO of a public company. You negotiated bonuses and restricted share grants that reward the officers of the company for improving the profitability of the company for shareholders. The key metric is the earnings per share.
In the good old days, company executives focused on growth of revenue and growth of earnings as the pathway to maximizing earnings per share.
But remember, we’re maximizing earnings per share. There are two ways to increase that metric. One is to increase the earnings. The second is to reduce the number of shares in circulation. If there are fewer shares in existence, then by definition, the earnings per share went up.
Of course by now, since the start of the year we are seeing that it takes more than share buybacks to sustain growth of share prices. Meanwhile these companies are now saddled with a lot more debt that they will need to find a way to pay back from future earnings.
When we say that so much of the money printed over the past two years went straight into wall street, this is what we’re talking about.
Who Really Sets Interest Rates?
On today’s show we’re going to break down the lending market into its constituent components and examine each of them independently.
The lender is the loan originator who underwrites the loan. The loan servicer is the one who collects the interest. The Investor set an interest rate at which they’re willing to lend money and its up to the loan originator to find a borrower with the correct risk profile that meets the risk tolerance of the investor.
Investors in the bond market are also lenders. So when a bank lends money to a borrower, they have to be mindful of the bond buyer who is ultimately going to securitize the debt.
Back in the old days, banks would take in deposits and depending on the amount held in deposit, the bank would lend accordingly.
Over the past 20 years, we’ve seen an increasing amount of shadow banking. This is where banks sell their debt in bond offerings to the commercial mortgage backed securities market. This takes those loans off the bank’s balance sheet and allows the bank to originate more loans.
Banks make money on the differential between the interest collected on their loan portfolio and the interest paid to depositors, multiplied by the bank’s leverage. So for example if a bank charges 5% interest, and they pay 1% interest to their depositors, they collect 5% interest, multiplied by the bank leverage. If they must maintain 10% in reserve, then they collect 9 x 5% = 45%, and they pay out 1%, for a net profit of 44% of the funds on deposit. ‘
It sounds like a good gig and it is.
But the banks ultimately want to get these loans off their balance sheet so they can originate more loans. Why? Because banks get paid an origination fee, in addition to the interest rate. If they sign a 30 year loan, then those funds don’t become available for lending again until the loan matures. That means the bank gets to collect their origination fee once every 30 years. But if they sell the loan into a secondary market, they can put that exact same money to work again and collect a new origination fee in addition to the interest on the loan.
Private lenders are different from banks in that they don’t have leverage. They can only lend out money that they have in their immediate possession. These lenders lend to private equity firms, private mortgage investment corporations, and they purchase bonds.
Private loan originators want to keep their loans recirculating as well. The originator gets to keep the origination fee, and the loan interest gets paid to the investors in the mortgage fund. If the loan term is too long, then the originator stops collecting fees and eventually goes out of business. So private lenders like the shorter loan terms to they can continue collecting fees.
Here too, the interest rate is determined by the risk premium that is being attached to the borrower by the lender.
I believe we are about to experience another liquidity crisis in the US and elsewhere in the world. If you are unconvinced, then ask yourself this simple question. If the currency is being devalued at a rate of 8.6% per year, would you be willing to lend money to a borrower at 5%? No? How about 6%? How about 7%? Still no?
How high would interest rates need to be for you to lend funds to a low risk borrower on a low risk project?
You have probably figured out by now that the private lenders and investors are in search of higher yield in order to compensate for the high rate of inflation. So if private lenders are not injecting liquidity into the market, then the only lender left is the lender of last resort and that is the central bank.
On today's show, Rod and I are talking about the market inflection point we are experiencing. Rod is also hosting a three day bootcamp in Denver at the end of July. To learn more about this three day event, visit rodindenver.com
Host: Victor Menasce
George Ross on Economy
On today's show we're talking about how to navigate the current economic uncertainty. George puts forth some risk reduction ideas that are pure gold. Listen to what he has to say.
Host: Victor Menasce
BOM - "Fed Up" by Danielle DiMartino Booth
Our book this month is called “Fed up” by Danielle DiMartino Booth. Danielle worked at the federal reserve bank of Dallas for nine years where she ascended to the inner sanctum of those tasked with crafting Fed policy.
Last month we reviewed Ben Bernanke’s newest book, “21st Century Monetary Policy “.
The contrast between these two books that deal roughly with the same historic timeframe is dramatic.
It was clear when I read Ben Bernanke’s book that there was some revision of history at play to better match Mr. Bernanke’s narrative.
Some of those revisions were laid bare in Danielle’s book.
Host: Victor Menasce
Crypto Counter Party Risk
On today’s show we are taking a look at counter party risk. This is a term that every investor should be familiar with.
It’s an issue that we investors face on a daily basis. We are waiting for another transaction to close before a loan can be paid off. That’s counter party risk. We’re waiting for materials to arrive in order to complete a certificate of occupancy in order to switch from construction financing to permanent financing. That’s counter party risk.
Your cousin who you loaned $10k to lost their job and now you need that $10k for something else. That’s counter party risk.
Virtually everyone became familiar with counter party risk in the wake of the 2008 financial crisis, and again in the wake of the Greek Sovereign debt crisis that threatened to topple banks in continental Europe.
Here we are again.
Two weeks ago, crypto lending platform Celsius froze user accounts. The idea behind crypto is that if you are holding assets in your own wallet, then nobody can take them from you. But what happens if you are holding assets in a lending platform, or perhaps in the account at a crypto exchange? What happens if that crypto exchange goes bust?
Host: Victor Menasce
One of my new fav shows!
Victor and Neal Bawa has great chemistry. Great topics!
Resonates so well
I’ve listened to your episode with Alexandria Ali and I find it really interesting.
I completely agree with her assessment of real estate as a means of serving others. It struck a chord with me since I know a lot of people who are doing similar things not for the money but to help and connect with others.
Thank you for bringing in such a remarkable person that actually motivates others.