November 1984
Vol 7 No 2
CAN THE LEOPARD CHANGE ITS SPOTS?
Reagan or Mondale – who cares? Four years ago here's what this letter said about the Reagan victory: ” . .we'll still be seeing inflation, inter-party squabbling, several additional layers of red tape, war – or threat of war, and an increasingly higher percentage of our effort confiscated by taxes.“ It's becoming more and more evident that the American citizen is going to see his individual freedom eroded away regardless of the promises made by individual presidential candidates. So long as we continue to reward those who gain office by assuring us that they'll rob others and deliver a share of the proceeds to us, we can expect little improvement in either the quality of government or the quality of life we'll enjoy under it.
The political battle will be won or lost in Congress. Citizens are safest in their homes when at least one house is in opposition to the other or to the President. That's the situation our founding fathers had in mind – a balance of powers. In this coming election the Senate could be vulnerable if the Republicans lost too many seats. Had it not been for their majority control over the past 4 years very little would have been accomplished. And continued Republican control is essential for the next four years in the event the Democrats gain the Presidency or more seats in the house. Spread the word.
Beware of falling for promises made on election eve! It's. doubtful that either party will respect you in the morning. Face facts! Everyone running for election at any level is looking for a government job. That job offers winners leverage which will control POWER and MONEY over which you'll have little control until the next election. And the past 4 years have demonstrated that few crimes committed by office holders are punished by much more than a wrist slap. Heaven help the citizen caught conducting business Congressional moral or ethical standards. You'll have to survive by virtue of your ability to perform regardless of the new tax laws and regulations. I'll try to help.
FINANCING: IT'S A JUNGLE OUT THERE. .
Last month we took a brief look at the new 1984 tax act. We're continuing to study it and the more we look, the more we see. Apparently this act was put together by several committees who never spoke to each other. Contradictions appear in many places and only the courts will be able to sort it out. Your best course of action will be to select the most advantageous sections and structure your transactions according to them. Possibly the most damaging effect of the act will be to introduce uncertainty into real estate transactions. Already we see agents advising sellers NOT TO SELL with carry back financing, even though the act doesn't affect some transactions until 1985. Commerce Clearing House offers an analysis of the act together with excerpts from various working papers. Once you learn for yourself what the act really says, you can start to structure transactions to benefit from it.
Options, Leases, Ground Leases, Carved-out Interests, Remainders, Rolling Options, Equity Exchanges, Lease/Options, Leasehold Interests all offer possible routes for gaining control of properties or for selling them without triggering imputed interest taxes when structured properly. In the recent BIG-1 presented for subscribers in Orlando Chuck Considine presented his insights on appropriate strategies. We've offered current subscribers a complete library of all prior issues of this letter for $95 so that you'll be able to research many of these techniques which were presented in prior issues. Heck, we even throw in an index so you can find them.
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(888) 282-1882 Exchanging also offers formulas which side-step the act where no “paper“ is to be carried back. Gary Mansfield's discounted bond formula revealed in MAY 1980 issue of the CommonWealth Letters (and later claimed by a host of other “creative” wizards) is one other way to combine foibles of the law with exchange techniques since debt instruments listed on security exchanges are specifically exempted. As interest rates rise, all the buyer does is to buy discounted bonds on margin, use them to balance the equity in an exchange, then use the property as collateral to borrow sufficient money to repay the bond purchase margin account.
For the most part, those who formerly relied upon creative financing are going to have to return to institutional lenders to finance their transactions. BEWARE! There are loads of pitfalls in the financial jungle. The shaky condition of many of the nation's banks and savings & loan associations is being reflected in lending policies. And as the big lenders gobble up the small ones, their policies tend to become more rigid. Their loan risks increase. Their portfolios are comprised of higher percentages of ARMs. Their mortgage insurance rates go up, followed by their interest rates. The costs of financing and holding properties with these loans is going to be prohibitive for first time buyers.
1985 will see record numbers of investors seeking re-financing for their balloon payments which will be falling due by the thousands. Additional millions of owners will find their payments jumping drastically even without inflation. And those with indexed loans will be the first to suffer should the government choose to re-flate to pay its debts. Traditionally the courts have not been sympathetic to those caught in the web. In a recent California Supreme Court ease, it was ruled that Security Pacific National Bank could enforce the “rule of 78s“ even though the borrower owed more than the original amount of his loan under this method of calculating interest even after having paid. in almost $10,000. The moral of this story is to read every institutional note, mortgage or trust deed very carefully and refuse any loan which might victimize the borrower, carry unlimited liability or a heavy prepayment penalty.
Everyone's getting nervous about sneaky ARM loans. Negative amortization loans, Balloon Notes, Graduated Payment Loans, Shared Appreciation Loans are all coming under scrutiny by consumer agencies. Lenders are adjusting their terms to make them slightly more palatable. FNMA is offering an ARM with a 5 year fixed payment. After 5 years it can be converted to a fixed rate mortgage or a new 5 year payment period may be elected. On owner occupied homes a 5% down payment can be used. On a $60,000 loan at 12.75% payments would be $652 for the first 5 years. There are lots of new approaches being offered.
There are the new “Grannie Mae“ loans being promoted by the Golden Retirement Annuity Mortgage Association. Under this program, older home owners sell their homes and lease them back. Lenders in 40 states have reportedly signed up for the program and the Occidental Life Insurance company will underwrite the loans together with John Hancock Life Insurance Company. FNMA and the Federal Home Loan Mortgage Corporation are expected to provide a secondary market for these loans. For more information, write to Family Backed Mortgage Association, Ste 900, 180 Grand Avenue, Oakland, CA 94612.
“Daddy Mac“ helps young people buy homes with the help of their parents using the same network of lenders as Grannie Mae. Outside investors can also participate in the place of parents or relatives. Standardized contracts, leases, even financial analysis, equity sharing agreements and tax benefits are spelled out as provided under the program. 75% of the down payment is put up by the investor who gets 75% of the depreciation. He get 50% of the insurance and property tax deductions and 50% ownership. The occupant pays 50% of the fair market rent for the half of the house he doesn't own. The IRS has tentatively approved this arrangement, but it takes about a 30% marginal tax bracket to make sense. For details, write to the same address as for Grannie Mae. –
Freddie Mac has instituted loan qualification criteria which tightens up loan availability for many buyers. Now they require that the borrower be able to qualify for the payments over the projected life of the loan rather than merely for the early period. They're returning to the rule which says that a borrower's total housing expense shouldn't exceed 25% of his total gross income PLUS he'll need a 10% down payment. Consumer's Union advises that the borrower first seek out a fixed rate loan. Failing in this the next choice should be an ARM with a cap no more than 5% over the initial rate over the entire life of the loan and no more than 2% in any single year increase in payments.
Today's financing is mind boggling. FNMA offers a “CONSUMER GUIDE TO ADJUSTABLE RATE MORTGAGES. To get a freebie copy, write: FNMA ARMS GUIDE, P.O. BOX 23867, BALTIMORE, MD 21203. It includes a worksheet in the back to help you calculate your costs.
CONSUMERS ARE FIGHTING BACK!
House Majority Leader Jim Wright has proposed that Adjustable Interest Rate Loans be abolished by act of Congress. Representative Wright in a recent letter to the National Association of Realtors as quoted in the Washington Post declared that no member of either the Senate or the House drafted the imputed interest rules included in the 1984 Tax Act, but rather that it was inserted without any elected official's knowledge by an unnamed federal employee of the Treasury Department. One might ask what other laws are on the books passed by Congress and signed by the President without being either drafted, discussed, seen, read, understood, ratified or comprehended by the representatives of the citizens. It seems odd that we fought a revolution over “taxation without representation“ because of a 1% stamp tax yet we go quietly into the night with a 15%+ imputed tax.
A recent court ruling disallowed a prepayment penalty where a due-on-sale clause was being enforced which required the property to be refinanced. Seems the lender can't force you to pay off early and then penalize you too. The Federal Trade Commission's Staff Attorney, Suzanne Bonamici (stands for good friend in Italian), Bureau of Consumer Protection, Division of Credit Practices in Washington, DC 20580 asks to be contacted any time a lender gives you a hard time when you are trying to assume an assumable mortgage.
If you bought a house by assuming a mortgage any time since 1970 you may have a check coming. Many lenders overcharged for assumptions on Freddie Mac owned mortgages. If you think you were one of them, a random walk through-your old assumption papers might produce a windfall profit. If you think you have a case, call the Freddie Mac Hot Line. Freddie Mac will “encourage“ the lender to refund you your overcharges if they own the loan.
When your FHA loans are refinanced or when the property is sold and a new loan obtained, you're entitled to a refund of any unused FHA mortgage premium. Send HUD form 2042 to the US DEPT OF HOUSING AND URBAN DEVELOPMENT, FHA, WASHINGTON, DC 20412 and cite the appropriate details. Request a refund. If you need a form, ask them for it. You could fall heir to a couple hundred dollars. Maybe more. It's your money. Ask for it!
Here's a real twist. It's been reported that a Seattle S&L (unnamed) is in the distressed housing business. It contacts owners of properties with balloon payments or high interest rate mortgage problems and offers to buy the properties at below market prices. Next it re-sells the property using a combination of low interest rate terms at a high price, or vice versa. One can imagine a certain market advantage that a lender would have over an individual, especially when it comes to availability of financing. Rather than resenting this competition, why not find ways to work with it. Suppose you created a joint venture project with any lender. You locate the properties and negotiate quick cash prices. With an institutional lender's backing, you should be able to buy properties with or without assumable first mortgages because of your financial strength. If you did all the “field” work to find, fix-'-up and sell the properties and divided profits with the lender who would generate a new loan, solve a defaulted loan problem and earn a high yield on its old loan portfolio by virtue of your generating an early payoff, it seems logical that the lender would co-venture this activity with you. Of course, you could also offer management services for those properties which might require more time to market or which the lender might prefer to place into its own or its Trust Department investment holdings.
CHANGING LAWS REQUIRE CHANGING TECHNIQUES.
Under the new tax law, the imputed interest provisions don't apply to debt instruments traded on recognized exchanges, tax-free entities such as Pension Plans, or leases. Here are some concepts which might work in transactions after January 1st:
(a) Instead of buying a property with a single payment note buy a municipal ZERO COUPON BOND. Give it to the seller for his equity. He pays no interest during its life and pays capital gains when it matures. You can buy the bond at a fraction of its value based upon the present value of its value at maturity. You can find these in the financial pages or through a bond broker. Adjust the value of the Bond to the amount needed to pay the owner. This works where the owner doesn't need cash now.
(b) Buy for cash with tax-free-pension-plan funds. Title the property in the pension plan or in a corporation wholly owned by a plan. Sell with carry back financing and declare the entire sum of the paper at face value. Since the fund doesn't pay taxes, any imputed tax liability wouldn't matter nor would any profits of the plan.
(c) Do the formula in (a) above, except arrange for a series of payments with tax free bonds which mature in successive years. This will provide a series of long term capital gains payments, payable each year in cash to the seller.
(d) Buy the property a slice at a time either by paying an annual cash payment equal to your agreed upon price and terms for an undivided interest at a specified % of the total as tenant in common, buying a partnership share, beneficial interest in a trust, share of stock representing a negotiated % of interest. In each instance the payment would be in cash with the partial interest conveyed at that time. In following years the interest in the property could–be increased just as principal increases with an amortized loan until the entire property has been purchased. Remember, property can be divided horizontally as when acreage is subdivided. It can be divided vertically as when the improvements are separated from the land with a ground lease. It can be divided in time with a Life Estate or various estates for years. It can be divided as to use the way many time share projects are divided with leasehold estates and rights to use. In each case, sellers and buyers would avoid the use of “carry back“ paper in structuring their transaction so as to avoid the imputed interest liability. Of course there would have to be a business reason for such a structure. Fortunately each of the above structures conveys completely different business benefits too.
(e) Exchange another piece of property for the equity. Suppose instead of offering the seller a Note for his equity, I offered him another property which I could lease back for an income stream roughly equivalent to 8% of the equity value. Furthermore, we'll assume that the lease payments were at market and my lease extended for several years. The rent I'd pay would be taxed to both of us the same as interest but it would be exempt from imputed interest problems. As the buyer, I'd be using other equities to pyramid. If my lease terms were set below the price I could sub-lease the property for, I'd even get positive cash flow. So would the seller. That's good business.
