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Hedging Against Deflation in an Inflationary World Using Seller Financing
By David Campbell On 02/14/2011 · Leave a Comment · In Newsletter
by Rob Kippel, Hassle-free Cashflow Investing Specialist
There is endless debate among economists right now on whether the US is heading for inflation or deflation. While these economists are content arguing back and forth, savvy investors are taking action. The stakes here are very high as being on the wrong side of this trade could be catastrophic while being correct could be outrageously profitable. Not taking a position and just sitting on the fence as most Americans are doing will be costly in either outcome.
Many of whom I consider the brightest economic minds are convinced we are on the precipice of an inflationary holocaust. I, for one, happen to agree but there are an equal number of great minds who have a very plausible argument for why the US will face crushing deflation in the years to come. Even those convinced of an inflationary demise for the dollar will often concede that we will experience a bout of deflation before we face the inevitable inflationary outcome.
Those placing all their bets on one side or the other will either end up tremendously more wealthy then they are today or completely wiped out. This is great if you came to the right conclusion but what if you are wrong? Or what if you were right but the trade goes against you just long enough so that you are unable to hold onto your long positions and you end up not profiting when you had the right strategy? This could certainly be the case if we were to see a severe bout of deflation prior to the spectacular inflation.
If you arrive at the conclusion that inflation is inescapable for the US, as I have, your knee-jerk reaction may be to structure all your investments to profit from Dollar devaluation. Although this position should be extremely profitable, the key is being able to hang onto it through a deflationary storm should it strike. This is where hedging through seller financing a portion of your portfolio can be effective.
A hedge is when an investor takes an opposing position to his core portfolio to help mitigate risk and decrease volatility. Although a hedge will usually lower your return slightly if your core position becomes profitable, it primarily serves to counteract loss on your core portfolio with profits made on the hedge position.
Let’s now see how we can place a hedge on our Hassle-Free Cash Flow Real Estate portfolio by becoming a lender through seller financing.
As David Campbell has shown us in previous newsletters (if you are not familiar with these articles, visit the blog page), purchasing highly leveraged undervalued cash-flowing real estate with long term, low fixed rate debt can be extremely profitable through inflationary times. This is one strategy I particularly like and personally employ in my portfolio, however, a large portfolio like this can get quite hairy during a bad bout of deflation and may cause you to actually lose a substantial amount of the portfolio that would have ultimately been profitable had you been able to hold on to it once inflationary economic conditions resume.
Becoming a lender through seller-financing is a tool you can use to weather the storm and hang on to your core portfolio while you wait for it to bear its fruit. During deflation, the price of your real estate as well as its stream of income will tend to decrease but the debt service remains constant making your debt load more burdensome. If your rental real estate becomes a negative cash flow that you must feed each month, the inability to keep up with the payments will lead to the loss of the property regardless of how much equity you have.
The same way fixed debt works against you as the borrower in deflation, it can work in your favor as the lender when you seller finance a property. As the holder of a seller financed note you will be receiving a fixed level of payments at the same time your expenses are going down in deflation, making the stream of income relatively more valuable. It is this relative increase in income right when you need it that can save a portfolio geared to profit from inflation.
In addition by selling a property with seller financing you will have locked in the price of the property at the sale which would have otherwise decreased during a deflationary episode. This protection does however come at a cost, as most hedges do. When selling a property with seller financing you do give up the other profit sources you would have realized had you simply held and rented that property (appreciation, amortization, and tax benefits).
In addition, in an inflationary environment the relative value of a fixed stream of income decreases as the cost of living increases. So you must ask yourself, “How much is the safety and protection of my portfolio worth?” This is a personal question and the answer will vary from person to person.
A final consideration is the performance of the hedged portfolio should we experience neither inflation nor deflation. The core portfolio of real estate described above hedged with your seller financed notes should provide you with steady returns and income in a normal economic environment. You will realize all the typical profit sources associated with buy-and-hold real estate as well as receiving higher levels of current cash flow from your notes.
Not all seller financing is created equal and it is important that you do it right. Here at Hassle Free Cash Flow Investing we have a world class team in place to help you successfully and properly build a real estate portfolio that can protect you and even profit from the coming inflation. We can subsequently help you increase your cash flow and hedge against deflation through seller financing some of those properties through our unique system.
The best part is that we can help you achieve this with little money down! This strategy is not suitable for everyone and is only applicable to those who are eligible. I would enjoy the opportunity to speak with you to determine your financial goals and eligibility. You can contact me and the team at Hassle Free Cash Flow Investing at (866) 931-9149 Ext. 1 or you can email me at Rob@hasslefreecashflowinvesting.com. Until next time, stay sharp!
Rob Kippel – Hassle-free Cashflow Investing Strategist