Billionaire investor Warren Buffett is warning about a major storm that is about to strike the US real estate market. This 1.4 TRILLION dollar debt fueled tsunami has already started to hit the real estate market as we speak. However, this is just the beginning of the quote “consequences” Buffett sees of this real estate bubble. The real impact is set to start in just a few months. Here’s what Buffett had to say.
Over the last 15 years, the US real estate market has been fueled by massive amounts of cheap debt. Take a look at this chart of the US federal funds effective rate, a proxy for interest rates in the economy. We can see here that interest rates spent the better part of the last 15 years at 0%. These low interest rates incentivized the use of massive amounts of debt and pushed real estate values to sky high levels. Let me explain.
Imagine someone is buying an office building in your hometown. For a nice round number, let’s say the cost of this building is 1 million dollars. The buyer of this building likely doesn’t have an extra 1 million dollars of cash sitting in his bank account to purchase this building outright. Likely what this buyer is going to do is go to a bank to get a loan to fund the majority of the purchase price. In this example, our buyer here is contributing 350,000 dollars of the purchase in the form of what is referred to as “equity”. Think of this as just a fancy word for downpayment like when someone is purchasing a house. Our buyer then goes to a small, local bank to get a loan for the remaining $650,000. How profitable this purchase is for the buyer is dependent on many things, but one of the most important is the interest rate on the loan.
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