Are You Winning Or Are You Losing?

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August 1991
Vol 14 No 10

In George Plimpton’s book, ‘Paper Lion’, one of the football players reportedly said that their team hadn’t lost, it had just run out of time. Are you running out of time too? Before you can answer that question objectively, you have to know (a) the name of the game, (b) whether you’re actually playing or not, (c) what you have to do to put points onto the score board, (d) how many points it takes to win, (e) how much time you’ve got left to play and (f) how many points you already have on the board. As we enter this summer of 1991, might not this be a good time to take stock? Let’s see if we can answer some of the above questions in an effort to see how we’re doing. We’ll start with the name of the game.

Victor Frankl once said that more people die of boredom than of stress. To get the most out of life, find a game that’s worth playing, and then play it to win. If you can’t find a game, make one up! Let’s deal with the last statement. If you’re going to make up a game, it’s got to have a beginning, a middle and end. And an objective. Because most of our subscribers are real estate entrepreneurs, we’ll consider that profit is our objective. Sounds simple enough, but it’s amazing how often people substitute other goals such as listings, sales, numbers of properties, image, ego satisfaction, growth/size, etc. for profit WHEN THE NAME OF THE GAME IS PROFIT!

You’d think that starting the game would be the easiest part, but it can be the hardest for many people. Each of us has a little computer disk in our head that has to be programmed with PERMISSION TO PLAY THE GAME. This is our subconscious mind. The good news is that it is open for business 24 hours a day. It never forgets, never gets tired, is always there to help us. The bad news is that the conscious mind has to find a way to program the subconscious and to access it. Like a program in a computer, it may contain every fact you’d ever want to know, but without the code words and key strokes, it stays locked up forever. Programming the subconscious mind is a prerequisite to getting permission to start. Access to it keeps us playing when the game gets rough.

The best thing about learning to program your own mind is that you already know how to do it! What wakes you up in time for work? What helps you diet or stop smoking? What makes you competitive? Sociable? Inquisitive? Moral? Law abiding and ethical? The programming that has already been done. Of course, each of the above traits has an opposite which might also have been programmed in. I think much of the societal problems we have today are the result of negative programming. But, the point is that each of us can control when we start the game and how we play it by self-programming.

Joe Karbo, in his book ‘The Lazy Man’s Way to Riches’ suggested that we each make a list of 10 things we absolutely want to own, do, or become in our lifetime. Every night before we go to bed, and the first thing every morning we are to take 5 minutes to read this list aloud and to visualize each item in specific terms. By doing this repeatedly, we can program our subconscious mind. IT WORKS! I turned myself from 28 years as a wage earner into an entrepreneur living solely on commissions in 6 months by using his technique to program my subconscious. Of course, you have to know what you want. What you personal goals are and how the game you play will achieve those. And you have to know what you’re willing to give up in time, money and relationships to win your game. By taking the time to do this, you’ll find it both easier to begin playing and to maintain your winning effort when playing the game requires a surge of extra effort. Being able to continue the game when others less motivated might have dropped out is a major factor in winning.

PATIENCE, PERSISTENCE, FORTITUDE AND ADAPTIBILITY ARE A MAJOR PART OF WINNING . . .

Success isn’t supposed to come easily. It’s measured in terms of distance you’ve come from where you started in comparison with others. It’s relative, not absolute. Having the patience and persistence to grind out little victories one at a time over a number of years is a hallmark of the successful person. Having the fortitude to adapt to changes, putting aside old ways and acquiring fresh knowledge and skills is essential to the process. An example of this is learning to survive when credit dries up.

Long before there was any money or credit there was trade and commerce based on that oldest of techniques, barter. Horse trading. This is a valuable technique for you to learn if you’re going to be able to keep on keeping on when lenders say no. when you trade properties, you measure everything against the equity over the loans, so free and clear properties trade more easily than those that are leveraged. When values aren’t equal, you throw in more properties; add benefits or mortgages until they match.

Benefits in property are crucial bargaining chips in an exchange even though they’re often ignored in a straight purchase or sale. They can make or break an exchange. What are some benefits? Income. Appreciation. Rights. Occupancy. Management and/or Management-Relief. Harvest. Pride of Ownership. Leverage. Liquidity. Amortization. Zoning. Assemblage. Development. Use. Locale. Mixing and matching assorted benefits and properties to suit various parties is the essence of exchanging.

Let’s see how this might work. I had 94 acres in Maine awaiting development, a deeded Time Share week, a small rural house. I wanted to concentrate my equity and to move my assets closer to me. Benefits – was seeking were: Appreciation, Income, Tax Shelter, Liquidity, Ease of Management, Pride of Ownership. I was willing to accept a mortgaged property if need be, so would also have the benefit of loan amortization and leverage. I was dealing with an owner of a mortgaged house who wanted mortgage relief and more cash flow from a free and clear property. We needed some other players, so found a fellow with a free and clear house who needed an office building. (Use) Our final player was a company in Iowa with an empty office building in Florida. He needed debt and management relief. With all the players in place, here’s what we did:

                   
I traded my 94 acres to the man in Iowa. We traded his office building together with my rural house and time share to the guy with the free and clear house. That guy traded his house to the fellow with the leveraged house. I wound up with his nice house in a waterfront community. It produced more rental income than my original properties. This sounds complicated, but it was all done at a simultaneous closing without the need for any financing or cash other than to pay closing costs.

Sometimes the equity numbers don’t quite match, but this is easily overcome by adding property, cash, mortgages and/or notes until everyone is satisfied. For instance, suppose you and I were making an exchange. You have a $100,000 house with an assumable mortgage of $40,000. I have a parcel of land that’s worth $80,000. It’s encumbered by a $10,000 loan. Your EQUITY is $60,000. Mine is $70,00.

All you have to do is to give me $10,000 either in cash, or additional property equity, or in mortgage ‘paper’ secured by another property, or I can add a $10,000 2nd mortgage to my property, or I can ‘wrap’ the existing loan with $10,000 to raise the debt on my property to $20,000, or I can borrow an additional $10,000 in cash against my property and let you pay back my loan, or trade it to you and let you borrow the $10,000 and give it to me. As you can see, once reasonable people agree to make a fair exchange, all the problems can be resolved. There’s another way to balance equities.

POSSESSION and OCCUPANCY can be used to balance equities. Let’s start with occupancy. In the distress markets, it’s commonplace to allow the distressed owner to remain in the premises for a time rent free in return for his signing over the property to the buyer. Similarly, in an exchange, equities can be balanced by letting one party continue to use a commercial property for a time, and assigning a value to that use. Possession means almost the same thing, but not quite. Suppose we agreed that I’d have the right to possess a property after I’d exchanged it to you. That means that I’d be entitled to any rents paid by my former tenants. Or I could lease the property if it had previously been occupied by my business, and collect the rents until I gave up possession. This has some hidden benefits.

When I keep possession of a property, the tenants don’t perceive that a property transfer has taken place. No new policies. No special rent increases. They don’t get nervous and move out. My income remains fairly constant. When I lease up a property, then turn the property over to you all filled up, this saves you money in two ways: first, you don’t have the time; trouble and expense of leasing up the property yourself. Second, you don’t have to bear the expense of refurbishment and vacancies while you’re doing the lease-up. Under the proper circumstances, the terms of our exchange might easily include a GUARANTEED LEASE-BACK by one or both parties to balance equities.
Income properties are valued in multiples of net rents collected. Suppose I was willing to pay 10 times the net rents. If you guaranteed $10,000 per year NET, I’d be able to assign a value of $100,000 to your property, assuming there was no physical or economic obsolescence in the property itself. If you guaranteed $15,000, I could justify $150,000. Let’s suppose that the property would command $12,000 in true market rents, in the first instance, you’d be giving me a bargain price in return for the chance to capture $2000 per year in income – and to possibly continue to use the property yourself. But in the latter case, you could obtain a higher equity price by giving up $3000 per year in income. Isn’t this a lot like borrowing $50,000 and paying it back over the lease period? Don’t overlook LEASE-BACKS when balancing your equities.

SAVED TAXES CONTINUE TO COMPOUND FOREVER . . .

With the exception of property held in inventory or for personal use, Section 1031 of the IRC permits all real estate to be exchanged for real estate and all personal property to be exchanged for personal property without recognizing gain or loss. There are lots of technical requirements, but this is a real fortune builder that’s under-appreciated. Let’s look at an example involving a $100,000 rental with a $40,000 mortgage and basis.

In a straight sale, you’d recognize a $60,000 profit and $60,000 in cash. This would be taxed at 28% currently. In addition to the Federal capital gains taxes you’d pay state tax where applicable. Let’s say this would be an additional 5%. ALMOST ONE THIRD OF YOUR PROFIT WOULD BE TAXED AWAY! Taxes are deceptively insidious in that the more leverage you have, the higher your equity is taxed. In the above example, 33% tax results in a reduction of your equity profit from $60,000 to $40,200. But if the same property was free and clear, with the same basis, the $19,200 in tax would only amount to 19% of the $100,000 equity. This gets to be really serious when equity loans are placed on property in EXCESS OF BASIS. If the above property was mortgaged at $85,000, there would only be $15,000 in sale proceeds to pay the $19,200 in taxes.

By exchanging the property, you could avoid the $19,200 tax. If this was to be invested for 30 years at 10%, it would compound to $335,028. That would yield $35,000 per year in retirement income forever (before taxes). And that’s only on one deal in one year. Think of the fortunes being wasted because people don’t know how to exchange. With delayed exchanges it gets to be a lot more impressive.

Delayed exchanges are technically complicated. If you’d like to learn more about them, contact The American Exchangor, 1116 Holly Oak Circle, San Jose, CA 95120 and ask for a sample copy of their brand new newsletter. It’s written by Warren Harding who was instrumental in bringing me into exchanging 18 years ago. Basically, instead of accepting taxable proceeds from a buyer, you deed the property to a FACILITATOR (Harding is also one of these) who accepts the money, then goes out and buys you a replacement property of your choice with the money. He then deeds the replacement property to you to complete the exchange.

Delayed exchanging has the advantage of allowing you to be a cash seller in a cash market, and a cash buyer in a distressed market. Suppose you could buy a $130,000 property for $100,000 cash proceeds from a sale of the above free and clear property by going from an active market to Texas. You’d have increased your equity via exchanging by 30% while avoiding Gains Tax. THAT’S A BIG SWING IN YOUR COMPOUNDING EQUITY. That additional $49,800 compounded at 10% for 30 years equals $868,980 to fund your retirement.


PROGRESS SHOULD BE MEASURED IN TERMS OF MONEY AND TIME
. . .

Life’s like an hourglass which has its top half concealed. All we ever see is the sand that’s run through. We never see how much is left in the glass. Do this exercise. Start with 85, and subtract your age. We’ll use 85 as an arbitrary lifespan. Subtract from the above figure the number of years you don’t expect to remain actively earning income. Suppose you were now 40, you’d have 45 years of life to look forward to. But if you wanted to quit the game in 20 years at age 60, that would leave you 25 years during which you’d have to support yourself with the nest egg you’d accumulated.

Now we come to the serious part of the problem. Take today’s lifestyle costs at the level you’d like to live. Let’s say this is $1000 per week in 1991 dollars. AFTER TAXES AND AFTER INFLATION. Can you see that anytime government borrows money to give away freebies today, it will have to come out of your retirement income and lifestyle? We’d better do some more math.

Assume that today’s Federal tax rate (historically at the lowest point for retirement income for the past 50 years) and add the tax rate in your home state to it. Let’s say this would add 5% to the 28% Federal bracket – at which a $52,000 retirement income would be taxed. That leaves you with only 67% of your income after taxes. So you’ll need $1333 per month, not $1000 to enjoy that $100 per week. Lifestyle. Now, suppose you were able to invest your money safely at 10%, you’d need to have 52 x $1333 x 10 or $693,160 on your scoreboard to avoid spending your principal. Accumulating that sum over the next 20 years will require that you invest $12,102 at 10% each year NET after taxes and inflation. Of course, if you’re having fun, why retire?


RETIREMENT, INC. – THE ONLY WAY TO GO
. . .

So why not start now by assuming that YOU’RE GOING TO WORK AS LONG AS YOU’RE ABLE? If you’d adopt this attitude (I certainly have), you’d start finding a way to transition into a line of work that you enjoy. And if you’d incorporate your own business, you’d see some marvelous results. First of all, as the owner of your own business, nobody could hand you a gold watch and put you out to pasture. You could CONTRACT your services out to others and bear the brunt of any liability for FICA, FUTA, Workman’s Comp (Most states exempt corporate Presidents), etc. Since your CORPORATION would be earning the money, you could continue to get any Social Security payments that came your way, and it’s all perfectly legal.

Now, suppose the corporation earned the same $52,000 we’ve been discussing. First of all, it would only be in the 15% tax bracket up to the first $50,000. It could pay you a deductible salary up to your Social Security limits, which they’d be able to largely offset with personal deductions. It could offer a comprehensive benefits package that would enable you to pay lots of your retirement expenses with pretax dollars. It’s time to get started. If you think it’s too early for you, is it too late for your parents?

 

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