March 1982
Vol 4 No 5
A lot of people are going to get burned in 1982! The State of the Union speech left little doubt that we’re in for some rough sledding before things get BETTER. For the past two years we’ve warned against short term, high interest rate borrowing. And institutional loans used with ‘Creative Financing” can be lethal. STAGFLATION is once again rearing its ugly head, providing both risks as well as opportunities for single family house investors over the next few months.
Not EVERYONE in EVERY area will be affected the same way. Although inflation is a national phenomenon – even international, recession tends to be more regional. The Mid-West has felt the brunt of the past couple of years’ economic problems more than other areas, especially in the automobile and related industries. Farmers have been taking a bath with the high interest rates too. But the coming CREDIT CRUNCH is going to affect us all as it filters down to our respective areas.
INCREASING YOUR CASH RESERVES IS CRUCIAL. Now is the time to seek out new “sandwich positions” in discounted Trust Deeds and Mortgages, Leases, perhaps even high yield securities. Vigorous collection and rent raise policies should be set in motion on income property to increase cash-flow. Investors should be enticed with our better properties to become EQUITY participants who will fund negative cash flow and provide PRIVATE LINES OF CREDIT. They’ll be needed if we go into depression.
We’ve already counseled that liquid funds should be placed into Money Market Funds which are 100% invested in U.S. Government obligations with short maturities. Capital Preservation Fund II, for example, averages a 3 day maturity on its portfolio. A recent study showed that a true liquidity crisis is impending for many major corporations which could bring on a wave of bankruptcies. Some have as little as 10 cents on the dollar to meet short term debt. Laker Airlines demonstrated how swiftly a company can go broke. Now’s the time to hold funds with an eye toward safety rather than yield until things clear up a little. You’ll be able to make up yields when you re-enter the market, picking up property from those who haven’t prepared.
WILL SINGLE FAMILY INVESTMENT HOUSES CRASH – OR BOOM?
Interest rates and demand control SFH performance more than any other factors. Currently, Horace Greeley’s advice: GO WEST, YOUNG MAN was never more apropos. For the “distress buyer”, southern California is beginning to hold opportunities. For the person just starting, Nevada, Arizona, Wyoming, Colorado, Utah all offer high growth rates for jobs, population, and incomes. Florida is the best area in the East. Still, each area will have opportunities, even in the most seriously distressed regions.
Look at your own area critically. Are the lenders sound? Is there much activity in development, construction, sales? Is mortgage money available on reasonable terms? Are people moving in? Are the long term prospects good? Single family houses respond more to local markets than national statistics. Ignore the headlines. Use your own judgment to decide whether your own area is still a sound place to invest. Of course, no matter how the local market is doing, YOU may be in jeopardy personally.
HOW CAN SOMEONE WHO’S IN TOO DEEP SALVAGE HIS ASSETS?
After several years of buying in distress markets, I find that avarice goes hand in hand with a distress situation. The person in trouble could have avoided it had they been willing to settle for a little less, earlier in the game. In times of depression, property reverts to its rightful owners – those who can afford it. Just as inflation transfers assets from the lender to the borrower, the reverse is true in a depression. When firefighters see a blaze going out of control, they start a back fire. They sacrifice some property to protect the rest. Let’s look at a couple of investors, Mr. Wheeler and Mr. Walker, to see how they might respond to the market.
Wheeler owns a house worth $100,000. It has a $56,000 first lien, 8%, with payments of $526 PITI. It also has a 2nd of $30,000, $521 payments and a 3rd with a balloon payment of $5000 in four months. Wheeler got carried away with the “nothing down” process and leveraged himself into a hole. Then he “equity shared” with a tenant who promptly defaulted. After 8 months of fighting in the courts, Wheeler had spent all his money. He can’t borrow any more. By “equity sharing” with a tenant instead of a cash investor, Wheeler cut himself off from a private line of credit. Here are some ways he might extricate himself from his problem and still keep some equity.
A. Refinance the property with either the first or 2nd lender, stretching out the loan to provide over all lower payments. He’d have to generate enough cash to pay off the junior liens. If the 1st lien holder won’t lend anymore, he might try the 2nd lien holder. Then he’d only need enough cash to pay off the 3rd at any discount he might be able to negotiate. Bear in mind that the 3rd lien holder PROBABLY DOESN’T WANT TO OWN THE PROPERTY and to make the other payments, so he’ll be cooperative.
B. DEFINANCE. That means he could offer the holder of the 3rd ½ interest in the property in return for cancellation of the debt. Instead of perhaps never getting any cash, the 3rd lien holder would get ½ of $14,000 in equity or $7000. He’d also get ½ the ACRS tax benefits and appreciation. Wheeler would eliminate his problem and also have someone who could help out with ½ the cash flow problem if needed in the future.
C. Wheeler might seek out ANY investor, and offer him/her the same deal as he’d offered the 3rd lien holder above. Any investor who could sign a $5,000 note at the bank, or pledge low yielding bonds or C.D.’s could convert securities into real estate, picking up tax shelter in the process without any actual cash investment. Jewelry, art, or other valuable bric-a-brac might thus be converted in this slow market without the owner taking a loss. This should be pretty attractive to many high bracket investors.
D. Wheeler might consider selling a non-depreciable interest in his property too. For example, he could sell an Option for $5000 and pay off the third. He’d be giving up some appreciation but protecting his equity which would grow by $5000 once he’d paid off the 3rd lien. Or he might sell a ground lease to a cash heavy pension plan. It would get a high, tax-free yield provided Wheeler’s cash flow rents could afford it. Wheeler could secure the ground lease with other property by means of a collateral assignment of a Deed or Chattel Mortgage on personal property, or his residence.
E. Wheeler could just bail out of the property and let someone else pay off the $5000. He could exchange his $9000 equity for a $5000 free and clear building lot. Or he might take a car, boat, motor home, gems, surplus inventory, and mini-computer. The buyer would be disposing of something he no longer wanted and getting a bargain. Wheeler would be protecting his credit and he might even realize some cash if he resold it.
F. Under HUD regulations, Wheeler could accept personal property at fair market value as a down payment, allowing the buyer (a USER) to refinance the property as a primary residence with long term financing. He might even generate some cash from sale proceeds.
G. To make the deal attractive to a buyer, Wheeler might throw in another property with good cash flow and lease it back. The lease back could divide the property as well as the cash flow between Wheeler and the buyer as needed to make it attractive. For instance, if Wheeler wanted all the cash flow, he’d lease it back “break even”. If he wanted the appreciation, he’d give all the cash flow to the buyer and keep an Option to buy it at the current appraised value. He could always sell the option later for cash!
Wheeler must recognize that the market responds to a bargain whether in the form of service, products, or financial gain. He should shape his solution intelligently, to attract necessary funds rather than resigning himself to default and foreclosure.
THOSE WITH CASH RESERVES WILL DOMINATE THE SINGLE FAMILY HOUSE MARKET
Mr. Walker has been a conservative investor. He has bought only those houses with positive cash flow from rentals. He’s avoided non-income producing assets such as gold, gems, stamps. Surplus cash rests safely in a Money Market Fund. He now has bargaining power that he can use to acquire a wide range of benefits.It’s not difficult to see how Mr. Walker might fit into Mr. Wheeler’s cash flow situation to their mutual benefit.
In the preceding example, he might do any number of things to generate profits. Let’s see what other opportunities he has.
A. Walker can advertise that he’ll provide the down payment for anyone who has just been turned down for a home loan because of the recent interest rate hike. Only a few hundred dollars might help someone qualify for a home loan. In return he can either take an interest in the property, a ground lease, or an option. The disappointed buyer won’t like sharing his equity, but it’s a solution which is better than no home at all. Walker can always allow him to buy the interest back later – at a profit.
B. As an alternative, Walker can buy an interest in the property with a note which will effectively reduce the payments he buyer has to make on a new, high interest rate loan. He’ll have a high basis in the property for tax purposes. FNMA now will allow just about any kind of 3rd party assistance in down payments, buy-downs of the interest rate, etc. so this opens up a wide range of opportunity for Walker. I’m currently arranging to buy the IMPROVEMENTS ONLY on 7 properties, allowing the owner to retain the ground with a 35 year ground lease to relieve this same cash problem.
C. Walker can get free management for his cash investment. When he buys on terms which include a net lease-back with a stipulated cash flow, he can afford to pay the full fair market value for the property, taking back his profit in the form of 9% loans, cash flow from the lease-back, and depreciation under ACRS. A word of caution: if someone leases back a house that they owned in 1980, the IRS won’t allow the new 15 year schedules automatically. The old depreciation rules will apply.
D. Walker can agree to buy Trust Deeds and Mortgages that are being generated by “Creative Financing” and carried back by Sellers. Because these can be more risky, he’ll want to buy them with high yields – possibly in excess of 35%. In this way he creates a market for paper when cash is king. He might have his pension plan buy the paper, taking the cash flow yield in tax free. And as a condition of making his money available, he might also insist on being able to buy a house at wholesale for his own account from the broker who needed his cash to complete the “paper” transaction. This way, he can get ACRS write downs personally while getting TAX FREE CASH on paper.
E. Of course, there’s always a brisk market for defaulted loans. Many institutions would rather sell property they’ve foreclosed for cash at discount in preference to having to manage idle assets. Once Walker points out that a $75,000 foreclosed house represents a non-interest bearing investment to the lender, he’ll be able to either buy at discount, or with below market-rate interest financing. 9% seems about right.
F. With many sellers currently unable to sell their property, Walker can lease/option properties which would otherwise be unavailable. Or he can buy with nothing-down terms and low effective interest rates on wraparound loans. Look at this case study. Walker buys a $175,000 house from the transferred owner with $5000 down. The owner’s payments are $400 per month on the underlying loan. Walker pays $7500 per year on his wraparound loan. Payments are applied first toward taxes, then insurance, then on interest. Balance due and payable in full in 10 years. He rents the property to a handpicked tenant for $850 per month. This is sufficient to pay back his $5000 loan for the down payment as well as his annual payments. ACRS just adds to his cash flow. Of course, if the lender should increase the interest rate as a result of the transfer, the increase in payments will be reflected in the underlying loan, NOT THE WRAPAROUND!
G. Walker might offer to buy a property partly with cash and partly with bonds AT FACE VALUE! This way he can unload his discounted bond portfolio at par instead of waiting for any recovery. He’ll effectively be buying his real estate at discount. Of course, if he runs out of bonds, he can always buy more, trading them at face value.
James Harris, address: 6420 Fair Oaks, Blvd., #207, Carmichael, CA 95608 has a booklet on California foreclosures. Written by D. Lawrence Martin, it retails for $29.95 but Jim got a batch of copies he’ll sell subscribers for $19.95. It’s a small book, but essential for someone who wants to buy in California’s foreclosure market. It contains abstracts of all the various laws and statutes affecting sales.
Jim is a 1981 Coveted White Award Winner. He has a group of investors who meet periodically in the Sacramento area. He’s experimenting with computer programs which will lend themselves to investment and management of single family houses. Anyone who has knowledge or an interest in helping develop a mini-computer program for the Radio Shack Computer should get in touch with him. Vern Blanchard, Donna Milling, and several others are also trying to get programs working. Why not cooperate?
LONG TERM PROJECTIONS BODE WELL FOR SINGLE FAMILY HOUSES OVER THE NEXT DECADE
Doug Casey, at Howard Ruff’s convention, was quoted as saying real estate will crash because the single family house has outperformed gold 2 to 1 the past few years. Well, he’s half right. Hard money investors forget that our investment house is valued at the price someone else must pay for a HOME. Gold has very little USER VALUE, no income, no tax benefits, and high carrying costs. No wonder it doesn’t perform as well as basic shelter. But there are more compelling long term projections.
We’re forming families that require housing almost twice as fast as we’re building residential units. In multi-family dwellings, only ¼ of these are being built by private funding. Condominium conversions are erasing apartments everywhere. Rent Control advocates are now whining about the lack of any apartments to control. Financing is going to get much tougher before it gets easier. More about this next month. But the population growth, general economic trends, and new tax laws will bring investors first, then millions of buyers into the markets as never before in this decade. I predict a 25% increase in single family house market prices as soon as the costs of financing enable buyers to re-enter the market. The investors who are able to take advantage of the current distress market will reap fortunes almost automatically.
I’ve been contacted by a raft of syndicators who need to buy houses. Those who plan to attend the CommonWealth Convention at the Cash Management Seminar should come prepared to transact business on a bigger scale than last year. That means they should have photos, descriptions, terms, area forecasts, etc. so that potential buyers can make on-the-spot decisions. CommonWealth Press Inc. doesn’t get involved in any marketing; however, a time will be set aside for those who are interested to meet.
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