September 1981
Vol 3 No 12
Amateur landlords across the country are feeling the crunch of negative cash flow because they do not rigidly enforce late fees in their rental contracts. Our policy is to immediately contact the tenant by phone and inform them that in the event they do not pay the rent plus the discount lost immediately, we will take measures to evict. The next day should we not receive the rent plus the discount we personally serve them with a three day notice, to pay up or move. If you rented to the right type of people this measure should be enough to call their bluff and they will pay the rent promptly thereafter. As the economy continues to worsen and interest rates remain high everyone will have cash flow problems. Make sure you remain on the top of your tenant’s list of who to pay first by rigidly enforcing your discount provisions.
Buying second mortgages at a discount can do wonders for your cash flow. However, the problem is, where can you find a constant source of these mortgages? Tom Moore, a past student from Las Vegas, makes a practice of contacting people who have sold property and carried back a purchase money mortgage. What makes his approach interesting is that Tom contacts these mortgagees exactly one year after the sale has closed.
He gets their names from year old legal publications which he saves for one year before he contacts the people. The people who sold one year ago today probably charged an interest rate of 12 or 13% and realized that now with higher rates in the event they sell they will have to take a discount. In addition, many of these people are themselves in a tight cash flow position and need a lump sum of cash rather than a small amount trickling in.
Jimmy Napier in his Money Makers Seminars talks of an idea to increase the yield on existing paper by offering payers a 50% reduction in their interest rate in the event that they double up on their payments each month. Bankers in California are catching on and sending form letters to all of their mortgagors with low interest rate loans offering them the same program that Jimmy has been using. Let’s look at the benefit to both parties when the interest rate is halved in consideration of the mortgagee doubling up on their payments.
Loan Interest Payment Present Value Total Interest
Balance Rate Discounted to 30% Paid
Original
Loan 23,456 8% 183.44 7,331 52,830
Plan A 23,456 4% 366.88 12,193 2,959
Plan B 24,456 0% 600.00 14,838 -0-
You can see by the above example that the borrower will save a tremendous amount of interest by increasing the amount of his payments in exchange for lower interest rate, and that the yield to the investor increases dramatically as we shorten the term of the loan.
In the event that the lenders in your area have not adopted this strategy, you may realize some interesting profits by offering to buy some of their existing low interest rate long term loans with paper secured by other properties that you own. Of course, you would want to be selective about which loans you purchased from the bank, and would want to contact the borrowers prior to purchasing these loans to ensure that they would be receptive to the above plan.
In the event that you could create a blanket mortgage secured by several of your properties in the amount of $125,000 payable at 12% over 25 years and purchased $100,000 worth of 8% loans with remaining terms of 25 years, plus $25,000 cash, and them implement the above strategy, you could increase your cash flow by over $500 a month, not to mention the $25,000. This same strategy will work when purchasing existing notes and mortgages from private lenders. You should be alert to a situation where a borrower may be in a position to double up on his payments and try to purchase these notes with you note giving better interest rate and maybe even better security.
I experienced my first fire I a house last week, which reinforced several points that you may want to review in your rental program. First, we carry nearly all of our insurance with one Agent. When I learned of the fire, we contacted that Agent personally and reminded him of all the business given him during the past years. I clearly stated that I expected no problem in immediate settlement of the claim and the message apparently got across as we received a check for damages within a week.
The second problem was getting the tenants to remove their possessions from the property, many of which were damaged by smoke, fire or water. Fortunately, I have a clause in my lease which allows us to remove and store at the tenant’s expense any belongings he leaves in the building 15 days after he abandons the property. Our tenants have insurance on their possessions, as our rental agreement requests them to, so we had no problem with them filing claims against us or our insurance.
I found that the insurance companies’ favorite contractor bid the job at nearly double what it will actually cost to do the repairs. We found numerous contractors who had experience in repairing fire damage, and were anxious to get the work. As with any major repair job, you should always solicit at least two bids to ensure that you are not paying half again what you should for the job.
In Las Vegas there is a car dealer who is advertising that he will sell you a new car with no money down in the event that you secure a loan in the amount of the purchase of your house. Several years ago, in a newsletter, we proposed this strategy as a way to raise some quick cash in the event you found yourself in cash flow bind. As the loan for the car is secured by your house and not the car, it is relatively easy to buy a car for ten thousand dollars with the loan secured by your house and them immediately resell the car for 8 or 9 thousand dollars and pocket the cash. This dealer had quite a selection of cars including New Mercedes.
Car dealers have really been hurt by inflation as the value of their inventory has probably more than doubled during the last decade, interest rates have more than doubled, and the volume of new car buyers slowed to a trickle. In the event you have some equity and would like to drive a new car for awhile, now appears to be an excellent time to make this type of offer.
Attention long distance travelers, anyone planning a trip (perhaps to a fabulous three-day seminar) you should check your local travel section in the classified ads of your paper. I often see tickets to a certain destination advertised at far less than their actual value. Apparently, these are special fare tickets which the owner would rather sell for cash, than give back to the airline company for a nominal rebate. Make sure you can use them before you pay cash. You may wish to use a bank draft to purchase these tickets which wouldn’t clear until you got your seat on the plane.
A most discussed subject in financial circles these days is when the interest rates will decline. My best guess is that they will stay high until early next year when the party in power will use their influences to lower the rates to try to buy votes for next year’s congressional elections. Notice that the high rates are depressing the price of gold, which we may buy back with cheap dollars.
My strategy based on the above scenario is patience. With each passing day, I see more opportunities to spend hard cash and buy properties well below market values. The key to large profits in the next five years will be as always, timing. Across the country the housing market is in the doldrums. The high interest rates have effectively flattened out the growth curve for nearly all kinds of real estate and any increase in prices we see is due solely to inflation.
I have received literally dozens of calls from builders and speculators who have short term balloon notes due this fall, and cannot renegotiate these notes. Unfortunately, many of these people owe more than the property is really worth. One way to solve this problem is to buy the property on which they owe the balloon note only in the event that they will sell you another property which they own at a lower than market price. A twist on the same strategy would be to buy the property with the balloon note and ask for a mortgage payable to you secured by another property that they own. You could keep this mortgage for the cash flow, or resell it to an investor to regenerate some cash.
Of course, these strategies are only useful when you have access to cash to pay the balloon note yourself, or can convince the lender to extend the term of the note for a reasonable period of time. Often, the lender will be receptive to a change in terms when a new borrower signs the note. An institutional lender can claim this as a new loan on the books and it will get the auditors off their backs for another year.
At the Common-Wealth Trust meeting in Louisville, following the three-day MILLER/SCHAUB Seminar, Barbara Heiny gave us a variation of Jimmy Napier’s split wrap technique which even further increases your yields. Below I have diagrammed both the way that Jimmy split wraps his loans and the way Barbara has developed to split wrap hers. Notice what Barbara does is to wrap both the underlying first loan and a new second which she creates to buy other properties with. Now she wraps both loans and sells the property to another investor or a user, retaining the spread on the entire amount. This increases the yield over 50%.
EXAMPLE
SPLIT WRAP A SPLIT WRAP B
25,000 3rd at 9% 66,000 Wrap at 12%
41,000 Wrap at 12% 25,000 2nd at 9%
40,000 1st at 9% 40,000 1st at 9%
Interest Spread $1,320 Interest Spread $2,070
Warren Harding enlightened us as to a new way to avoid due on sale clauses which are gaining more popularity in the states in which we do business. Warren is using the vertical break-up technique which he teaches in his 6-day seminar, where he keeps title to the land, and sells only the improvements, leasing the land to the new owners of the improvements. By doing this, he remains on the title, continues to make tax and insurance payments and the mortgage payments, so the lender never catches on.
Warren also came across a Louisville attorney, Charles W. Hebel, Jr., who has designed what he titles a metro-real estate option which he and his clients use to acquire properties and circumvent bank due on sale clauses. The option states that the optionee, purchaser, will pay an amount equal to a normal down payment as option consideration. In addition, the optionee will take possession of the property and pay an amount equal to the mortgage payments on a monthly basis plus be responsible for all taxes, insurance, and maintenance of the property during the period of the option. It provides that the option shall automatically renew itself from year to year, and is truly an option as it allows the optionees to abandon the property and their monies paid in at any time without any recourse on the part of the seller.
As the courts continue to rule in favor of the bank, the banks are bound to become more aggressive in pursuing their rights under the due on sale clauses. By using techniques like Harding’s, and Hebel’s, you may continue to acquire properties under old interest rates while others sit around talking about the good old days when you could assume loans.
Speaking of assumable loans, we have found literally hundreds of assumable FHA and VA loans in all of the listing books in the two county areas where I live. I am systematically making offers on all of these properties knowing that these loans are worth several thousand dollars each today and will be the source of bountiful cash flows in the years to come when we sell these houses on long term “wraps”. My standard offer is to pay enough cash down to cover the brokerage commission and give the seller a second mortgage, NOT A WRAPAROUND, with no payments for several years. Although I’m quite rigid on the amount I’m willing to put down, I’ll negotiate on the payments on the second as long as I am assured of a positive cash flow. In the event I need to increase my cash flow, I can resell the property with a low-low down payment and a high interest rate. This will yield me cash flow for now and a large share of the profits at a point in the future.
The Eighties will be known as the decade of Equity Sharing. The banks are now heavily into this concept with their variable interest rate loans, graduated payment loans, and Shared Appreciation Mortgages. In each of these loans, the bank is participating in the profits. Often, the bank’s loan balance increases faster than the house value.
Why not structure your own Equity Participation program when you sell your house? You can do this by charging a high rate of interest, structuring payments the buyer can afford today. For example, take a $50,000 house which you sell for $5,000 down payment and a $45,000 loan at 18%. Payments might be only $500 per month in this case to fit the buyer. The buyer would pay $6,000 per year in interest; however the total interest accruing would be $8,100 annually. The $2,100 in unpaid interest would accrue and compound at 18% each year. This would effectively transfer part of the equity in the house back to you as it continued to compound. Five years from today the buyer will owe you $16, 837 more than they did at the date the loan was originated. Hence, you share in their appreciation.
In the event that you intend to use this type of instrument in selling, all parties should thoroughly understand the benefits to all. These include lower cash flows to the buyer for 5 years and a higher profit to the seller. The loan will have to be renegotiated at the end of that period. Given current rates of appreciation, the property should increase in value in excess of the growing mortgage sufficiently to enable a buyer with good credit to secure institutional financing after five years, and perhaps at a lower interest rate.
It might be wise to formulate a buying-budget over the next 12 month period. This guideline could keep you from going wild and biting off more than you can chew during a period when people seem to be GIVING their properties away. Remember the old adage: BULLS AND BEARS MAKE MONEY, BUT PIGS GET SLAUGHTERED!
Copyright Sunjon Trust All Rights Reserved
Quotation not permitted. Material may not be reproduced in whole or in part in any form whatsoever.
1-888-282-1882 www.CashFlowDepot.com
