November 1978
Vol 1 No 3
DATE LINE LAS VEGAS! A turnaround crowd of over 110 enthusiastic investors from fourteen states, Virginia to California, representing over 27 million dollars in SFH assets, descended upon the Sahara Hotel for the first MILLER/SCHAUB Graduate Seminar. Joanne Reese and Dan Redmon led a rowdy Los Angeles area contingent, who kept Jack and John or their toes by booing, and cheering at the appropriate times. Joanne was awarded the second annual “Coveted White Belt Award” given each year to the student who shows the most perspicacity while implementing what they have learned. The highlight of the two days was the introduction of two hot-off-the-press MILLER/SCHAUB books. The blue book titled, “Advanced Option Techniques and Investment Survival Strategies,” along with the red book “How to Buy, Hold and Pyramid Houses for Investment” are in limited production and will be distributed to those attending the graduate seminars. Due to the dozens of last minute registrations, we had a problem finding enough seats and materials, so please register today for either the Graduate Class at Washington, D.C. (November 13 and 14) or Tampa, Fla. (November 16 and 17) to insure yourself a seat. These are the last graduate classes to be held this year and there will be only two (dates to be announced) in 1979.
The big news is still inflation! The Federal Reserve Bank Board of Governors recently admitted that they had understated the money supply (M1) by five hundred million dollars in March and by one billion dollars in August. Translated into rates of inflation, this would mean our current rate has been understated by better than one percent since that time. All we read and hear about in the media any more is inflation, and the danger is that the public is getting accustomed to it. Do not underestimate the effect of a minimum of 10% annual inflation on your long and short term investments, especially paper of any kind (leases, notes, time deposits, etc.).
Is the Government still growing? In 1950 the average per family cost of Government services was $1600. That figure has increased to over $9000 per year per family today. The Government debt is increasing four times faster than goods and services produced, with the Federal debt going up at a rate of over one billion dollars per week. We will break through the eight hundred billion dollar level by the end of 1978 and the problem then will not be reducing the Federal debt, but servicing the interest on the Federal debt. With the Treasury in the process of raising over seven million a month to pay that interest, and with foreign investors getting nervous about the soundness of the dollar, it is probable that we will see a continued increase in short term interest rates as the Government continues to go to the private market with high interest rate Government securities.
What’s the latest on Proposition 13? As noted in last month’s letter, several California municipalities have reacted to the tax cut, notably Los Angeles County with its rent controls, and Oakland with their one percent fee on all salaries paid in that city. The newest twists are in San Marino where the city fathers are asking all of its residents to tithe back to the city 15% of their property tax savings. Officials are hopeful that 80% of the city’s taxpayers will respond, noting that the average contribution would be between $250 and $300. That is true democracy when you can elect whether or not to pay taxes. The long term effects of Proposition 13 may be somewhat unsettling for the city administrators and city dwellers alike. It seems that the first items to be cut from the budgets are proposed capital expenditures, i.e., new schools, new sewer and water facilities, new roads and sidewalks, etc., and not the salaries of these officials or the operating expenses attributed to their jobs. If this trend continues, it will further restrict growth in many areas where there is already a shortage of housing. This will naturally continue to drive up the cost of available lots and houses as the demand continues to outstrip the supply. Look for this same type of reaction in other states that are considering similar types of legislation.
Rudie Timpte reports that state Missouri has passed a new law which will require licensing of people who buy and sell real estate even in their own account. The law excludes attorneys (naturally). Apparently the intent is to regulate those who buy and sell real estate for a living. This type of legislation would not affect those who buy and hold property for investments. We have requested a copy of the law and will comment further on its ramifications after reading it thoroughly.
The short term outlook for residential and commercial loans looks slim. Reports from around the country note that in several states no money is available due to low usury rates, and in states where money is available rarely can it be borrowed by other than an owner-occupant. Many states have an increase in usury rates scheduled to go in effect next year, and the lenders in these states are refusing to make loans until they can charge the higher rates. We look for credit to continue to tighten through the first quarter of ’79, the result being an increase in foreclosures and opportunities in the real estate market.
Bill Reid reports from Waukegan that their market in houses has softened due to many people moving South. His informal survey shows that 40% of those selling houses in his area are moving South, 25% are reinvesting in larger houses, and 25% are cashing out and renting. People seem to be taking advantage of their cash reserves and this market with high employment, trying to relocate to warmer climates while the economy still will support them. A check of other northern big city markets shows similar trends.
One function of this letter will be to propose solutions to problems which we encounter in acquisition and financing and properties. Jack will address himself to management problems in the GREEN letter, so in the event you are stumped by either an acquisition, financing, or management problem, write and we will publish one question and answer each month which would seem to have the greatest benefit to the entire readership. When writing, please use your investor number for identification, your name is optional. This month’s “Dear John” comes from a Chicago area investor, who writes, “When using Redondo’s formula for acquiring house equities with free and clear land, I often have trouble satisfying the house owner as to the value of the property. Although he is willing to take land for his equity, we cannot agree on price. “SOLUTION: Keep your priorities in order. Your objective is not to exchange the land for the house necessarily, but to acquire the house without using any cash. Try offering the seller the house a note secured by a first mortgage on the land and also secured by a second mortgage on his house for his equity. In the event he was willing to take title to land with no cash flow, perhaps you can structure the terms on the mortgage so there will be no cash flow for a period of time. By placing the mortgage on both the house and the land, he has double collateral, which should satisfy his security need. When using a “blanket” mortgage, try to structure a release clause so that in the event one of the properties is sold, you do not have to satisfy the entire mortgage. By using a mortgage secured by the lot, rather than the lot itself, you will profit by any appreciation the lot enjoys during your holding period, and you will not incur any tax liability as a result of the transaction.
In August, the city of Chicago subsidized in effect new first mortgage loans to the rate of 7.99%. These loans were not geared toward low income housing and were available to applicants with incomes up to $40,000. They funded these loans by issuing one hundred million dollars worth of long term bonds, paying 6.99% interest tax free which sold out in one day. The city is trying to encourage the middle class tax payer to remain in the downtown areas. Similar programs are scheduled for Denver and Pueblo, Colorado, this month.
John Luger, a Minneapolis builder, reports that he has been successfully using the option technique described in last month’s letter to co-invest with owner-occupant users who are short on their down payments. John supplies approximately two-thirds of the down payment needed for an option to acquire the house for a two-year period at a price slightly above the buyer’s purchase price. The buyer gets to live in a new home in a nicer area, builds a good credit rating, and John acquires a house with a low interest rate loan, with no management problems, and in an area which should appreciate at a higher than normal rate. This and other option formulas will be discussed in detail in the first day of our Graduate class, along with all necessary documents needed to close.
What happens when things get tough? Currently there are over twenty-six thousand FHA loans in default facing eminent foreclosure. Many of these foreclosures are in large cities as Atlanta, Chicago, Detroit, New York, and Philadelphia. The National People’s Action, a Chicago based public interest group, has made enough noise that HUD department secretary, Patricia Harris, has modified HUD policies to allow home buyers who default on their mortgage to pay rent until a new buyer is found. In 1976 U.S. District Judge, Hewbert Will, of Chicago, ordered HUD to give extension to those who fell behind on their payment schedules as a result of temporary economic troubles. This may be a sign of things to come. What if everyone stopped making their payments the same day?
What happens when we have rent control? Over three hundred communities across the country now have some type of rent control ordinance, Washington, D.C., whose ordinance was enacted in ’74, gets the most publicity. In each of these areas we find similar results. First the landlords cut back on the maintenance, next the property becomes uninhabitable because of the lack of maintenance, and often units are converted to condominiums which are in turn sold to the upper middle class, not to low income people whom the rent control was to benefit. In addition, construction of new units usually ceases because the lenders and investors won’t finance them. Often financing for rehabilitation or improvements is not even available. The last chapter is that the assessed value of these properties is reduced on the tax rolls and the burden is shifted to the commercial buildings and single family homes in the immediate area. In a recent election in Madison, Wisconsin, where eighty-five thousand of the city’s one hundred seventy thousand people are renters, the voters rejected the proposed rent control ordinance in every precinct. When the intelligent public is educated as to the final results of rent control, only the illogical could support it. To quote Senator Thomas Eagleton from Missouri, “rent control eventually works against the people it is supposed to help.”
On the tax front, good news for Real Estate Brokers. It looks like the Congress is going to bar the IRS from classifying independent contractors, i.e., salesmen, as employees. One brownie point for REPAC! Smilin’ has promised to sign the tax bill passed by both Houses of Congress last week. Significant cuts in the capital gains tax effective November 1, 1978 and the exemption of a one-time $100,000 profit on sale of a personal residence for those over 55 effective July 26, 1978 may affect your tax strategy. Probably all capital gains tax rates will be reduced substantially in ’79. If you must sell a property this year which would qualify for capital gains, consider using an installment sale with a very low down payment, i.e., one percent, with a balance due either next year or in the following years which would qualify for more favorable tax treatment. The Tax Reform Act of 1978 changed the estate tax law to provide that heirs would pay taxes on gains on all property which occurred after 1976. The CPAs and Attorneys, who are aware of this provision, are apparently botching up the returns so badly that the IRTS is probably going to grant a two-year extension on the enforcement date. It would then apply to the heirs of people who die after 1978. The Senate has passed solar heat and insulation tax credits in maximum amounts of $2200 and $400 respectively. The credits would apply retroactively to cover purchases made since April 20, 1977.
For you money speculators you can now buy foreign currencies on your Master Charge or Visa. This may be a good idea if you are planning on traveling abroad in the near future or just hedging. For information, contact Deak-Perera, a foreign currency specialist at 29 Broadway, New York, N.Y., 10006. Fees for purchasing usually run $2.50 plus 2 to 4%, about the same as a bank or foreign exchange firm. To go one step further, if you want to use your Master Charge or Visa and not pay it off, there are two states which charge only 12% interest on your outstanding balance on these bank cards, Washington and Minnesota. I would imagine that banks in these states would look at a new Master Charge account rather skeptically unless you were a customer at the bank, perhaps with a CD or checking account there.
Speaking of foreign currencies, I have run across a new clause using Krugerrands. When leasing a property to someone, giving them the option to buy that property from you, specify that the option price will be either in cash or a specified number of krugerrands at your choice. This way, if the price of gold continues to appreciate and krugerrands become more valuable, you will have hedged the gold without giving up the benefits of owning the real estate now. This technique works quite well when you have acquired a property in a distressed situation, and are leasing it back to the owner, giving him an option to repurchase his property from you at a later specified date.
Did you ever wonder why New York City has problems? The average New York employee is paid $26,654.00 a year and New York has an average of 49 city workers per thousand. Compare this to Texas where the city of Dallas has 16 workers per thousand, and Houston has 12 per thousand. New York spends three times as much per ton to remove garbage in comparison to Texas and pays welfare families more than three times the Texan average. To quote New York Governor, Hugh Cary, “We will never need a bail out again and we won’t come back for help. We are going to make it.” Last week President Carter signed a bill which will federally guarantee all of New York’s debts. New York City’s budget is currently still one billion dollars in the red.
I just finished Harry Browne’s book, “How I Found Freedom in an Unfree World.” Browne is a noted Economist who also authored “How to Profit from the Coming Devaluation,” and “A Complete Guide to Swiss Banks,” but in this book, he takes off in a different direction. I have enjoyed listening to Browne speak on his economic forecast, but enjoyed his book even more. It deals with the philosophy of life mingled with generous amounts of good common sense and subtle economic viewpoints. It’s the easiest reading of any of Browne’s books and would be a good opportunity to become familiar with his point of view.
Our Oyster of the Month Award goes to Los Angeles County Supervisor, Kenneth Hahn, one of our loyal public servants, who commented upon the passage of Proposition 13, “the public is ugly, the citizens are mean.”
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