November 1994
Vol 18 No 3
Investors, have the constant problem of finding real estate in which to invest their money. Starters are able to uncover opportunity, but lack capital and credit sources with which to exploit it. By seeking out eager starters and lending them money with which to fund their properties, investors can create a synergism which benefits both parties. But once properties are bought, the need for competent management will become a paramount issue that must be dealt with.
This might be a good time to discuss ways in which Managers fit into the equation with Starters, Finishers and Financiers. A long time ago an old landlord named Bockl wrote a book in which he advised landlords to lease and Option their properties to eager young starters. Their energy combined with the wisdom of the tired landlords would enable both to reach their goals while benefiting the other.
The retired landlord would thus be able to keep a rising income stream from a high percentage of the net rents generated by the Manager. He'd eventually realize capital gains upon sale without any selling costs and share the profits with the Manager by dividing the gain under the Option terms.
The starter through his mastery of management chores would reap the profits ownership of his Option produced. In return for his willingness to sacrifice current rental income, working as a manager, he'd side step years of saving that would be required if he were to try to buy his own property. Both would win.
MANAGEMENT CONVERTS EQUITY INTO INCOME . . .
Regardless how astute the buyer of income property might be, managers are the only people who can really convert real estate investment into net income. As such, managers fill a pivotal role in determining how many years and how much property will be required for any investor to be able to retire comfortably on rental income. This gives starters, finishers and investors a reason to seek out managers and to include them in their profit seeking enterprises.
Only those who can manage can fully profit from lease sandwich arrangements under which they pay lower rents and sub-lease for higher rents to create income and profit. When income property is valued as a multiple of the net income it produces, a good manager can be worth his weight in gold. A property appraised at ten times gross rents, will increase in value by $10 for each dollar of additional rents the manager can get. This is a fundamental key to building wealth.
A few days ago I spoke to a subscriber who had made a fortune building commercial buildings. Despite the fact that they'd cost millions of dollars, he'd been able to build them free and clear without mortgaging. His security lay in the leases and credit worthiness of his tenants. The financiers secured their loans with assignments of the lease income, which was sufficient to repay the loans. This left the buildings free and clear of debt. Over the course of a lifetime of making these arrangements, my friend now owns millions of dollars worth of free and clear buildings together with the income streams they produce.
COMPETENT MANAGEMENT IS THE KEY TO FINANCING . . .
In smaller deals, the prudent private financier is going to look first to the quality, quality and durability of the income stream produced by management. After the recent wash out of real estate values caused by defaulting borrowers, lenders are looking much more critically at the income streams of non-owner occupied real estate that are going to produce the money with which to repay loans. Without proven management, financing is going to be in short supply regardless of how nice the property looks.
One 'starter' I know was trying to open a management business with little success. Then he chanced upon a land developer and a builder who needed him. They relied heavily upon investors to buy condos and apartments they wanted to build, but had been unable to attract any in the current market because of the lack of income guarantees on the properties for sale. SEC regulations prohibit selling real estate on the basis of profits to be produced by third parties. They were stumped until our manager came up with this idea.
They formed a new corporation, and each put in $100 in return for one-third of the stock. Since they were all officers of the corporation, it could guarantee a certain level of income from properties they were selling to investors. It could contract to lease the properties back at a guaranteed cash flow level which in-house management could provide at reasonable cost. It worked better than they'd imagined in the long run.
The land developer was able to sell his lots to the corporation at a profit. The builder was able to get the corporation to hire him to build out the property at a profitable mark up. The manager was able to earn management fees from the corporation with no competition from other managers. The corporation was able to make a profit from its sales, and they all split this according to their ownership interests. All won.
EVERYONE LOVES THE GAMBLERS . . .
Someone has to risk capital or nothing would ever happen. I'm constantly amazed at Steve Win, the guy who bought and blew up the Dunes Casino in Las Vegas. As a comparatively young man, he's built and/or managed the Golden Nugget, The Mirage, Treasure Island, and several river boat casinos in other locations. He's willing to bet a $Billion that he's right and lose it if he's wrong. And speculators don't always win. A few years ago, Donald Trump was worth a reported $3 Billion based on personal debt. Sure, he's lost some of it, but he's got a little of it left. Much more than he'd have had if he'd worked at a safe job in some big company.
We all need these risk takers to finance the shaky ventures, built the speculative properties, gamble everything they own on being in the right place at the right time. Land developers and builders fall into this category. They'll take on the personal liability of loans when we need someone to do it. They'll make a market for junk bonds and junkier real estate mortgages so long as they can earn above market yields.
A major builder in the Washington D.C. area got started by Optioning a prime lot. He placed a bad check for $25,000 into escrow together with instructions that it wouldn't be cashed until escrow closed. Next, he got a prominent architectural firm to do the design complete with drawings and a model in return for 10% of the whole venture. With the lot and model in hand, he was able to get construction financing and complete the transaction. He now builds 1,000,000 square feet each year. Without his willingness to gamble, he'd still be on the bottom looking up. Because of him the land seller, lender, architectural firm and construction company all made money without taking much risk.
How can we work with speculators in making money? For years, a local home builder has advertised: 'A Dollar and a Deed is All You Need.' The lot owner puts up the property as security for a building loan. The builder builds the house without any personal recourse, and the bank provides permanent financing once the house is completed. The lot owner didn't realize it, but he was the real risk taker in the deal.
The same principal holds true for the person who let's you Option his property rather than to buy it outright. Or the person who lends non-recourse money or carries back non-recourse financing on 'nothing down' terms. We might include the person who buys run-down houses and goes into full recourse personal debt secured by his personal residence to fix them up. He hopes to be able to pay off all the debt upon eventual sale and refinance. Managers, starters, finishers, financiers all benefit because these people are willing to take risks.
'FINISHERS, ARE OFTEN AN OVERLOOKED INGREDIENT
When I first went into the real estate business, I looked far and wide for the best possible office location. I finally found a small house that was perfectly situated on a prominent street and already zoned for my purposes. The floor plan was laid out just right for a real estate office. I approached the owner 'finisher'. He'd been a successful land developer for 40 years and was selling out all his real estate.
He sold me the office building I needed for $5000 down and a 11 year mortgage on which payments fell $10 per month for every $1000 of principal that I paid in. As he this gave me an incentive to pay him off early by making the loan progressively safer for both of us. He taught me a many things about real estate. Later he sold me a lot of property at very low prices and on very attractive terms once I'd demonstrated that I was serious about making money and paying my debts on time.
That's the key to dealing with 'finishers'. They don't want risk or trouble. They want a reliable income stream and they're willing to give up a lot of yield to get it. They've learned that high yields are often accompanied by early payoffs, or no payments at all. They want hassle-free income to last them all their lives. This opens a lot of doors to opportunity.
Consider that, those with good credit ratings can buy with maximum low cost leverage by giving finishers extra collateral and meeting their security needs. I one instance, my friend gave me Options on 3 adjacent parcels of commercial property in return for my leasing a management headache he no longer wanted to deal with. My 7 year Option price on all properties totaled $28,500 payable at the end of that time.
I paid him off at the end of the 7 year period, and sold the combined properties for $140,000 after a couple more years. During the entire Option period I controlled those properties without a dime down and with no interest. He understood this and didn't mind, because his serenity was more important to him than the profit. That's the key to finishers. Serenity!
Let's put this all together in one story. As a young broker I found a small apartment that needed a 'manager'. The owner was a 'finisher' who wanted out and was willing to give up lots of equity to get out fast. I started look for an 'investor' to put up the down payment. I eventually found a young man who was really both an 'investor' and a 'starter' He had a good job, but was looking for a management free income property that he could buy with maximum leverage.
Next, I had to locate a 'manager'. I discovered him among the apartment tenants. He'd managed similar properties before and was willing to trade management chores for a free unit. I found that there was no commercially available financing for this type of property in my area, so I proceeded to negotiate favorable terms with the 'finisher' who grudgingly agreed to lease/Option financing for one year to test me, followed by a 10 year mortgage if I proved myself to be reliable. Thus, he eventually also became a 'financier' and I closed the deal. Recognizing the role players and putting them together was my key to success.
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