Welcome back to Gary's economics.

Today, we're going to explain why

rent, profits and interest are all the same thing.

So I wanted to bring it back to basics

and do a nice educational video

that is going to help you to understand

the way the economy works.

Now, I've always considered rent,

profits and interest

to be basically transformations of the same thing,

but I don't think many people think of them in that way.

So I want to explain why I think this

I think is going to help you explain

basically the structure of our economy.

Now, the first thing to say is

the title is not to be taken exactly, literally, of course.

There are important differences

between rent, profits and interests.

And we're going to explain them

in more detail in this video.

But in a very real important sense,

these three things are all the same thing.

And the way they can basically be described

is all three, rent, profits and interests

are payments

that are made by poorer people, the non owners of assets,

to richer people,

the owners of assets in order to use those assets.

And I think the best way to explain

how that works is to go through an example.

So let's say I've got half a million pounds

and you are a person who has nowhere to live

and you need somewhere to live.

So you come to me

and you say, alright

Gary, I've got nowhere to live,

you've got a half million pounds,

can you help me to get a house to live in?

We can do this

and we can structure this in three different ways.

So number one, the most obvious way, is

I use that half million pounds to buy a house,

I rent that house to you.

This is the classic landlord tenant relationship.

I buy the house.

I rent it to you. You pay me £25,000 a year rent.

Number one,

rents.

The second way we can do is I lend you the money.

I lend you the half million pounds.

You buy the house

and then you pay me

£25,000 interest every year, in order to live in the house.

So now you're paying £25,000, the same amount,

but in interest.

And the third way

that we construct this is, I set up a company,

I use the company to buy a house.

You live in the house.

You pay £25,000 a year rent to the company.

That company makes £25,000

a year profits, and it pays it to me in dividends.

So in all three of these cases,

I use my half million pounds to buy a house.

I'm allowing you to live in that house

and you are paying me £25,000 a year to live in the house.

But in situation one, I receive rent.

In situation number two, I receive interest.

And in situation number three,

I receive dividends from profits.

So you see from the perspective of me

as a wealthy person, as an investor,

once I have a certain amount of wealth,

I can buy, in this case,

the exact same asset, the exact same house

in three different ways.

And the financial structure

I choose around that purchase

basically determines

whether I receive rent, interest or dividends.

So for me as an investor, they're basically the same thing.

I have half a million pounds.

I want to receive some sort of passive income stream

and I can choose what to do. And for me

it's really easy to transfer between the two.

So let's say I chose the third option

and I bought the house in a company.

Eventually, I’m thinking, okay,

the structure of a company is not working for me.

I'm going to collapse the company.

I'm going to take direct ownership of the property.

Now I'm receiving rent directly,

so I don't want to receive rent anymore.

I want to start receiving interests.

Okay, well, I sell the house.

I'll buy government bonds.

Now I'm receiving interest from the government.

I can sell those government bonds

and I can buy mortgage bonds.

Now I'm receiving, again

your mortgage interest payments for the house.

That's not working for me. I sell it.

I buy the stock market.

Now I'm receiving company profits.

So from the perspective of the individual, it's

super easy to transfer between these things.

And I think,

I think ordinary people don't tend to realise that.

Basically, once you are a wealthy person,

you own a certain amount of assets.

Even by buying just the same asset,

you can choose to receive rent, interest, dividends,

which is profit. They're basically the same thing.

And in all three cases

that cash flow,

you know, many people describe these cash

flows on the internet as passive income.

In all three cases, it's not really passive income.

It's money that comes from you.

I own the house,

you live in the house and you're paying me your salary

to live in the house.

And this is basically what all of these things are.

These are payments made by you.

A poorer person who does not have assets

to me, a rich person who has assets

in order to use those assets.

And it goes a lot beyond housing.

Let's say you book a flight, you go to Portugal with EasyJet,

you go to the barber, let's take the flight situation.

You need a plane.

So as a very wealthy person,

I could own a plane and I could rent it to EasyJet.

And part of your ticket

will go towards that rental of the plane, which goes to me.

Or I could buy EasyJet stock. Part of your

ticket price goes towards EasyJet profits,

which comes to me.

Or I can lend money to EasyJet,

in which case part of your ticket

goes to interest payments again, to me.

So once again,

when you buy this ticket,

some of that money is going to me

as the owner of the assets.

If you go to the barber,

somebody owns that barber shop

and it could be that the barber is paying

rent to the owner of the property,

or it could be that the owner has taken a loan

to buy that property to pay interest to use the property.

Or it could be that

that barber is part

of a big barber corporation

and all of those properties are owned by the shareholders

and they receive the profits.

So in both cases, whether you’re taking a plane,

living in a house,

going to get your haircut,

you are paying some amount of money

to the owners of the physical assets that are being used.

The owners receive that in either profits, interest

or rent directly.

And you know,

this is even the case with the other

basic essentials that you need.

You know,

when you buy food, a big chunk of that goes

towards the owners of the farmland.

And again, that can take any one of these forms.

When you use energy to heat your home,

a big part of that money goes towards the owners

of the energy production infrastructure in our country.

Now, I want to talk a little bit about

a couple of big exceptions,

because I know there's going to be people

out there that say, listen,

if I buy a property

with a mortgage that's totally different from renting,

renting is money down the drain.

If I buy a house with a mortgage,

I can pay the mortgage off over time, I'm building up

equity in my house over time.

These two things are totally different,

and from one perspective, that is totally true.

If you as an individual rent a house,

you are not the legal owner of the house.

But if you take a mortgage and buy the house,

you are the legal owner of the house.

But let's go back to my example, right.

You know,

let's assume I've used half a million pounds to

buy a property, rent it to my sister.

She pays £25,000 a year rent.

If I lend £500,000 to my sister,

she buys the property, she pays £25,000 interest.

Now, assuming

she doesn't make any extra payments above the interest

in both cases, financially

her situation is exactly the same, basically.

She pays £25,000 a year rent

or she pays £25,000 a year interest.

So financially

there's no difference between these two things.

But there is one

very big important technical difference between buying with

a mortgage and renting,

which is who bears

the risk of changes in the price, changes in the value.

And I think this is the reason why people in this country

are so keen on buying with mortgages.

So if you rent and the price of the property goes up,

you are unaffected. You don't own the property,

but if you buy with the mortgage

and the price of the property goes up,

you take the, you take the profit, basically.

You take the upward movement in price.

And of course, in the last 30,

40 years, house prices in this country

and in most countries in the world have gone

very aggressively up

with only a few sort of downward hiccups,

which means that if you as an individual

have chosen to buy with a mortgage,

you would have done massively better

than if you have chosen to rent over the last 40 years.

But I think it's important

to realise the only real reason that

people have used mortgages

and paid interest

rather than people who have rented and paid rent have done

better is basically because prices have gone up

really aggressively.

If prices hadn't gone up

really aggressively., you'd be in

pretty much the exact same situation.

And I think it's worth

also recognising that if prices had gone down,

people who had bought with mortgages would have been

totally screwed.

If you buy a property with a big mortgage,

the price goes down.

You can become bankrupted extremely quickly.

This is what happened in Japan in the early nineties

when the housing market popped.

There was an enormous number of people

immediately bankrupted.

But I think it's

important to say I've said many times on this channel,

I think house prices will continue to go up.

So I'm not saying you shouldn't buy with mortgages,

but it's important to recognise that

both ways of doing it, buying with a mortgage or renting,

you will pay an enormous amount

of either rent or interest

to either

the guy who provided the loan or the owner of the house,

which is essentially the same thing.

There's no way of getting out of it,

If you do not own any wealth

and you want to live in a house,

you will pay these huge amounts of passive income,

either way. Using a mortgage or using rent.

The only difference is in one case you bear the price risk,

which is good if prices go up and they probably will,

but terrible if prices go down.

And the other way, you don't.

So I think the reason that this is important to understand

that rent, interest

and profits are the same thing

is because it helps us to recognise that underneath

these enormous amount of different cash flows,

which can take different names,

there exists a real country with real things.

There are

real houses, real commercial buildings,

there is real farmland, there are real natural resources.

And every time you use those things,

every time you live in a house,

every time you eat food, every time you use energy,

you are paying money to the owners

of those natural resources.

And whether it's called profits,

whether it's called interest, or whether it's called rent,

it's always the same thing, basically.

You as an individual

without wealth have to pay money to the individuals

who own the assets in order to basically live your life.

And this is essentially why

it's kind of inevitable that unless you

take some sort of preventative measures, wealth inequality

will and does tend to get higher over time.

And that's because, you know, you

as an individual,

you have an income of 30, 40 or 50 grand a year.

You spend the vast majority of that on

living in a house, eating food,

using energy, other essential costs.

And your salary goes in the form of profit, interest, rents

to the owners of the asset.

So after you've paid your essential costs,

you’re only maybe making,

you know, 10, 15 grand a year if you're lucky,

and the rest of your money has gone

to the owners of the assets.

So there's this massive constant drive of cash from the non

owners of assets, less rich people,

to the owners of assets, richer people.

And while that is happening,

these guys accumulate money

which they will inevitably use

to buy the rest of the assets.

So to conclude,

one of the big reasons I wanted to bring this up

is because I wanted people to realise that

because rent and interest are in many ways the same thing.

Owning property, but with

increasingly enormous amounts of debt

is very similar to not owning properties at all.

And the reason why it's important that you understand

this is generationally in this country,

whilst there is still a sort of big middle

class of property owners,

those property owners are increasingly needing

larger and larger amounts of debt

in order to own the properties.

So if we consider my granddad's generation, by 40

in many cases

they would have paid off the majority of their mortgage

and be close to owning their property.

Whereas my dad's generation

would probably be about halfway there by 40.

And my generation will, in many cases,

still having 90 or 80% mortgages

by the time they're 40 because they will

in many cases have only just bought.

And I think this ties in nicely to the video from last week

where we spoke about the illusion of improvement.

And the way that individuals

when they focus narrowly on their own

financial situation, may feel that they are improving,

whereas generationally

their family is getting poorer over time.

So individuals who own their own property with a mortgage,

they will be slowly paying their debt down

and they will often feel like I'm doing

when I'm getting richer without realising

that their children and grandchildren

are in a much worse situation,

largely because of the much higher property prices.

And will need to have much higher levels of debt.

So even though you

as individual are becoming less indebted over time,

you as a family are becoming more indebted over time.

This is really important to understand.

It's happening to our governments as well,

and governments are increasingly going in debt

to the rich, paying large amounts of interest to the rich.

Families are doing the same thing.

This is a big way that we lose our middle class

and our country falls into poverty.

So you need to be aware.

You need to understand interest,

rent, profits all the same thing.

Payments made

from poor people to rich people

that make wealth inequality get higher.

We're going to keep talking about it

until we understand it. Thank you very much.