Only Cash Flow Matters

by Jeffrey Smith cashflow

2014 Q1 is almost over.

The lamestream media says everything is rosy (yeah, right). The problem with a cliff, even a demographic cliff, is that it is such a sharp drop-off that most folks can’t see the cliff until they are teetering the brink, especially when they are moving fast and thinking about something else.

Two realty brokerage firms in Las Vegas NV (ground zero of 2008 crash) are contradicting each other. One says there is a major downturn coming this year (wait a few months to buy when prices are lower), and the other says buy now before prices skyrocket. Who shall we believe?

The triggers for crashing real estate are: (1) Lack of debt financing and (2) lack of cash flow to service debt. The 2008 crash was caused by #1 when Wall St ran out of Other People’s Money (OPM), and then it was “solved” by the FED buying toxic mortgages with money printed out of thin air. #2 will happen when a sudden shift in demographics causes job losses and a sharp reduction in spendable income. The FED cannot “solve” that problem.

How much debt the FED buys won’t matter when there is insufficient spendable income to service that debt. Any financial calculator will show how Present Value (PV) and periodic payment (PMT) vary proportionately for a certain periodic interest (RATE). The PV and RATE vary inversely for a certain PMT (when RATE goes up the PV goes down). The FED can set rates to zero to try to prop up PV (to hide bank insolvency), but when PMT goes down, the PV must also go down. Everything else in the economy depends on real estate. Real estate depends on debt financing. Debt financing depends on cash flow. Without cash flow (PMT) to service debt, the PV of real estate crashes.

Look for a sharp decline in private sector employment income due to job losses and wage reductions. Strangely, increasing the minimum wage will hasten the collapse due to losing jobs when the government mandates higher wages (and ACA taxes on health insurance). Fewer people in the private sector who are earning less money and paying higher taxes will have much less spendable income to service debt.

Less debt service (PMT) means lower PV, which means real estate prices collapse. Whether the real estate is owner occupied or renter occupied, residential or commercial, it doesn’t matter. Only cash flow matters.