October 1981
Vol 4 No 1

ARE WE ENTERING A NEW ERA?

I^‘ve been traveling this past year more than ever before attempting to assess the changes that are taking place in America. It seems to me that our changing society will require some new points of view if we are to continue to achieve financial independence through investment.

Let^‘s look at some fundamentals. Our population is aging and our markets reflect this. So will our social institutions. We^‘ll see this effect in our governmental budgets at all levels. It will force changes in retailing, travel, home building and urban planning whether we like it or not! Each month there^‘s a net increase of 300,000 people in our population. They^‘ll need food, clothing, transportation, housing, medical care and social services – and jobs. We are seeing the beginnings of mass migration from some areas of the country into Sun-belt and Energy resource regions as people continue to seek out improved opportunities to meet their needs.

This is having a profound influence on the political spectrum which is swinging more to the right toward the entrepreneur and in favor of military supremacy and away from entrenched social programs, centralized Federal controls, and overall permissiveness. We can see the new attitude of Government reflected in the new budget and Economic Recovery Act of 1981 which may soon be termed the Real Estate Relief Act. As re-apportionment of Congressional Districts continues over the decade, the traditional power blocks will lose their constituencies. Politicians will scramble for position. We^‘ll see the emergence of powerful new political organizations such as Jesse Helms Congressional Club, Robert White^‘s Duck Clubs, and a variety of ^“Hard Money” organizations.

Disruptions in the financial markets are already causing cracks in the foundations of our biggest financial institutions. They will cause ripples around the world which will create new alignments between Nations creating new friends – and enemies for our country. The threat of WAR will become more tangible. Emphasis of guns over butter will generate strains in social, political, and financial institutions which will affect us all. We^‘ve seen some of this in the budget cut-back squabbles. But there’s lots more to come.

Capital markets are being squeezed as never before. The problem is timing. Reagan got his tax cut, but it takes effect before his budget cuts. Both the Government and the banks have been borrowing short at high interest rates and lending long at low interest rates. They^‘ve both become ^“money junky’s^“ who must continue to borrow in order to survive. They^‘re like a couple of Addicts who need a fix and the pusher’s only got enough to supply one of them. They^‘ll either have to fight over the money, or ^“cut it” diluting it with printing press dollars. And this won^‘t really solve the problem, since their need will be even greater when this fix wears off.

Total Federal debt OBLIGATIONS exceed 11 THOUSAND BILLION DOLLARS today! They will admit only to one trillion dollars of debt. 15% of every tax dollar is needed just to pay interest. And they keep going deeper in the hole.  65,000,000,000. must be borrowed in the next 6 months just to keep the government afloat! Do you really believe that interest rates will come down? Some forecasters predict Treasury Bonds that will carry a 20% yield! How will this impact upon the private sector? Will Banks and S&L^‘s stay solvent? Will Builders? Brokers? YOU? What should you be doing to stay financially healthy for tomorrow?

 

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NOW, MORE THAN EVER BEFORE, LIQUIDITY IS IMPORTANT.

I^‘ve been reviewing previous letters over the past year. Over and over we^‘ve stressed the importance of avoiding ruinous interest rate financing and of converting some of your assets to cash through creative selling, moving of mortgages, discounting of paper, etc. In the next 12 months these defensive moves are going to reap huge profits! In fact, now is the time to place emphasis upon generating cash flow from your rentals, operating funds, and business activities. Let^‘s deal with these one at a time.

First of all, for those who heeded our advice and began to accumulate cash, now is a time for patience and caution. Except for short term operating funds, it might be a good idea to switch from Money Market Funds into Treasury Bills. I prefer 91 day bills because they tend to hedge against inflation better than longer term instruments, and I see increasing levels of inflation as a result of Reagan^‘s budget problems. Limited amounts of cash left in Funds upon which checks may be drawn will probably be safe, but the Money Market Funds have your money invested in the debt obligations of commercial companies who will be sorely pressed to meet profit objectives in the coming capital squeeze. I elect to give up a couple of interest points in the interests of safety. By buying T-Bills directly from the U.S. Treasury or the Federal Reserve Bank, you avoid using the banking system. Otherwise, instead of a T-Bill, you^‘ll only have a receipt from a banking institution which would be cold comfort if that particular bank should go broke. Why run the risk?

How risky are the savings institutions? If they could be hospitalized, they would be in the intensive care unit and reports would offer little hope for survival. If they had to compute their net worth positions as stringently as they make borrowers compute theirs, the S&L^‘s would be bankrupt NOW! It’s only because they ignore present value when they add their present low yield mortgage portfolios to their assets that they show any value at all! FSLIC who supposedly insures depositors against failure of the S&L only has about 1% of the reserves needed to pay off all depositors in the thrift institutions. Normally, when there^‘s a bank failure, others rush in to lend a hand, but when literally thousands of S&L^‘s are in trouble a major failure could trigger a domino effect on the entire industry.

The proof of the pudding lies in the extra-ordinary measures being taken by FNMA and the Government to shore up a teetering colossus. In order to help the more than 400 S&L^‘c under ^“critical surveillance^“, the Government has instituted the All Saver Certificate. This will hopefully bring some $150 Billion into the thrift institutions for use in the home-building industry – but it could back-fire as well. In the first place, the law limits the interest paid to 70% of that available from T-Bills. One has to be above the 30% bracket for this to have any real benefit in terms of after tax income. One might be wiser to invest in T-Bills and to shelter taxes with single family houses. In the second place, this is a one-year program. Suppose the thrifts do attract all those billions. Next year they’ll have a $150,000,000,000 Balloon Note coming due as those funds depart for the next highest bidder. These certificates may be the straw that breaks the camel’s back!

FNMA is helping too. First they agreed to wrapping their old mortgages in order to increase their own portfolio yields. Then, under pressure, they agreed to buy mortgages subsidized by builders (Builder Buy Downs) to aid the construction and real estate sales industries. Now they^‘ve agreed to buy low yield mortgages to raise cash for troubled S&Ls. And the Government has started talks relating to a FEDERAL DUE-ON-SALE POLICY to further increase the cash-flows to distressed lenders. You’ll notice that a distressed PUBLIC has no input to these talks or policies! It is becoming more and more important to acquire assumable low interest rate mortgages before a law is passed precluding this on FHA or VA loans too. Every body wants to see the return of low mortgage rates. How will this happen?

Let^‘s face it. 1982 will be a Congressional election year. Don^‘t be surprised if there is a miraculous ^“break through^“ in long term interest rates for a period long enough for the public to forget the current market. Remember 1980 when Carter was trying to be re-elected. The Prime Rate fell to about 6% overnight. Mortgage rates came down to about 11 1/2%. Home sales (and house prices) soared as millions of people came into the market. It may happen again next Spring and Summer, but at the expense of massive inflation. When there is demand for money, the only way to sell it ^“cheap” is to lower the cost of producing it. Voila – government counterfeiting! Cheap money spells cheap inflation for a time. Our products become more competitive abroad. Employment rises

There are two chickens in every pot, two cars in every garage, and two wage earners in every family. Optimistic business men expand to meet increased market demand. The loan window at the bank does a booming business, generating excessive dollars to pursue the increasingly expensive products and another round of inflation arrives on schedule. And rents go up, house prices go up, investors’ leveraged assets drive net worth’s skyward.

 

ASSET MANAGEMENT IS THE KEY TO RIDING THE ROLLER COASTER!

Cash is King yesterday, today, and tomorrow. We’ve continuously hammered on that point when we told you to use ^“nothing down and nothing a month” financing. And when we told you to avoid negative cash flow and hazardous balloon notes. And most recently when. we developed a Cash Flow Management course to show investors how to increase net cash rental income from SFH. In the February 1981 letter we devoted it almost entirely to ways to convert DEBT to EQUITY to increase cash flows and to reduce liability and vulnerability. If you haven^‘t done it yet, this may be your last great opportunity. Let^‘s review some ways.

Exchange properties with high interest rate loans for smaller, cheaper, or free and clear properties. You’ll incur some recognized gain, but today’s tax costs are lower than ever before. ^“Walk^“ mortgages and Trust Deeds over to other properties by offering the Mortgagee an incentive in the form of quicker pay-off, higher interest rates, higher cash flows, etc. Then sell or exchange the heavily encumbered property to rid yourself of the debt load. You can sell using indexed paper (March 79) even in a slow market and avoid all but the lightest tax burden under the new installment sale laws. You can design ^“Split Wrap^“ mortgages to divest yourself of bad loans while creating additional cash flow.

For those properties that you feel are relatively safe, an aggressive rental management program is a must to increase occupancy rates, maintain rents and net cash flows to offset inflation, and hold vacancy, turn-over, and maintenance to a minimum. Now is an ideal time to take advantage of slow market conditions in bartering space for services, supplies, materials, appliances, and labor. Conserve your cash by doling it out sparingly only when it absolutely cannot be avoided. Take the time to establish an analytical book keeping and accounting system so that you can identify poor performers which you can sell to raise cash. Don^‘t overlook the technique of creating paper or options and selling them, or of buying ^“hard goods^“ such as new automobiles from distressed Dealers using mortgages. Later, you can sell them at discount in a hard-money market because the buyer will be able to get a loan against a car much more easily than you would be able to hock the mortgage.

All these techniques and more have been explained thoroughly in prior Commonwealth Letters. A complete index of past issues is being included with this letter to enable you to review these more creative techniques. If you need past issues, they are available, but they are worthless unless you implement some of them to help you gain a safe vantage point.

For those who have stored up a few chestnuts against the current cold season, there are noteworthy opportunities. From time to time I’m finding good 2nd mortgages with high yields – approaching 40% per year to maturity. The key to buying these is to verify that they are truly secured by property worth much more than the combined total of all liens. Furthermore, you should avoid dealing with anyone without a spotless credit history and a proven capacity to make the payments. Remember, you^‘re the banker when you buy a mortgage.

Distressed sales are becoming more frequent in many areas. Subscribe to the legal notices newspaper in your area. Or better yet, check out the LIS PENDENS file in your local court house to find out about impending sales. If you have cash – or can attract those who do – you should be able to buy at about 60c on the dollar. But beware. Stick to feasible properties which you can rent for good cash returns on your investment. It will be some time before you^‘ll be able to ^“finance out^“ at reasonable interest rates. And take a hard look at potential bankruptcy of people from whom you are buying. Florida’s cases are up 25% this year in a reasonably healthy State economy. You could have your sale reversed in the event you purchased from someone who declared bankruptcy a few months later.

In order to buy effectively in the distressed market it’s essential that you find distressed sellers early enough to assume their defaulted loans before it is too late. Then you can structure purchases in ways which will meet their needs. In one instance a lender was adamant about my assuming the existing 9% loan until he realized that he might become the owner of the property after additional months of receiving NO PAYMENTS. Under today^‘s precarious economic conditions, astute lenders are reluctant to foreclose on houses that they might have to retain in their inventory. It helps if you point out to them that a foreclosed house in their inventory is equivalent to a non-interest bearing loan equal to the amount of the loan they might have foreclosed. And in this high-interest rate market, they could remain the owners for a long time. Herein lies their vulnerability to attack.

From a purely theoretical point of view, suppose readers in a single area ganged up on a single lender and bought 10 houses ^“subject to the loans^“. They might offer the lender a choice of foreclosing all 10 houses or of foreclosing none of them. If the houses had been picked up for the back payments in the distress market, this would place even more pressure on the lender. He would have to choose between curing bad loans, and being paid the originally scheduled payments, or of acquiring 10 houses. Would that work in your area?

Of course there are always risks when one tries to circumvent lender policies. We received a letter from one person who held an unrecorded deed to avoid the Due-On-Sale problem only to have the insurance company renege on payment for a major fire loss because he didn’t have an ^“insurable interest^“. We^‘ve advised him to contact the State Insurance Commissioner and it wouldn^‘t be a bad idea for you to establish your rights in your own area if you are using this same device. As we^‘ve said before, the best house to buy will have an assumable FHA or VA loan already on it, so this shouldn^‘t be a problem.

IN THE POTPOURRI DEPARTMENT:

Our readers are being solicited by various organizations to join groups or to buy insurance in the name of the CommonWealth Trust. WE DO NOT ENDORSE ANYONE SELLING ANY FORM OF PRODUCT OR SERVICE! Nor do we make our subscriber list available to anyone – EVER! We urge prior students to avoid distribution of any class rosters under any circumstances.

We^‘ve heard excellent reports from people using Options and Lease/Option techniques in areas in which rents fall below loan payments. As long as all legal bases are touched and the rights of all parties protected adequately, the Option can be a powerful tool.

Here^‘s a neat way to collect rents automatically. Get your tenant to open a checking account in YOUR bank. Give him 12 deposit slips and he can pay the rent by check at any of the convenient branch banks. IT WILL CLEAR IMMEDIATELY IN THE BANK COMPUTER OR BE REJECTED. This way, you can avoid the delay in discovering bad checks – and bad tenants.

Steve Rubenstein has sent us statistics from Mass. The housing market has rebounded! Sales up 19% and prices up 15%. Maybe it^‘s time for the smart money to take a hard look at the major cities like Baltimore, Pittsburg, Cleveland, Chicago. The tide may be turning. The new tax law offers terrific incentives for older residential and low income housing.

Copyright © Sunjon Trust All Rights Reserved, www.CashFlowDepot.com.  (888) 282-1882
Quotation not permitted.  Material may not be reproduced in whole or part in any form whatsoever.