January 1979
Vol 1 No 5
“A title wave of new home seeking families will sweep the Unites States for the rest of the century”. That is my kind of prediction and was made by Nathaniel Rogg past Executive Vice President of the National Association of Home Builders. He bases his forecast on the number of Americans reaching 30 years of age in the next two decades. Over 84 million will achieve that fateful age in the coming twenty years compared to 55 million in the past twenty years, (over a fifty percent gain). Not bad news for the owner of a home or two or twenty.
We have some of the cheapest interest in the world. Not in the percentage rates, but in actual cost to the borrower after the effect of inflation. With a prime rate less than 12 percent and an inflation rate equal to or approaching that figure the actual cost of borrowing money for investment is nominal. Compare our rates to Germany (inflation rate 2%, interest 6%); England (inflation rate 6%, interest 12%) and Japan (inflation rate 4.5%, and interest 7%). Traditionally lenders have tried to maintain at least a two point spread which they will certainly try to achieve again as the new year begins. Look for interest rates to go up at least one and probably two points next year.
Will someone ball out Cleveland? Cleveland’s Mayor has appealed to both the state and federal governments to solve his cities’ problem. His solution to cut back on the number of working people (firemen, policemen, garbage men, etc.) is typical of his boy genius wisdom. Californians after the Proposition 13 adventure are coming to their senses and asking the officials running their cities to cut back on the number of administrative personnel, not the working people. The government typically threatens the public with the loss of strategic services, i.e. teachers, policemen, etc. whenever faced with the proposition of losing any part of their revenue, hoping to blackmail the public into submission to higher taxes. If they would use just a hint of common sense when dealing with these budget problems and cut all the spending (including the salaries of the administrators, even the Mayor) and even put the top administrators on a bonus system the amount of which would be based on a reduction in spending, maybe we would begin taking steps forward toward balancing government budgets.
New Union contract negotiations will compound inflation problems in 1979. The railway clerks are due to strike on January 14th after rejecting an arbitrated contract offer. UAW President, Douglas Frazier, whose contract comes up for negotiation early next year states that he will insist on a one year contract due to our run-away inflation and also sees the four day work week as a reality in the near future. He expressed hopes that the UAW would rejoin the AFL-CIO to lend more strength to both groups. Watch for the unions to flex their muscles next year when Carter tries to enforce his wage and price controls.
A disturbing trend is the aggressive action that the AFL-CIO is taking to organize all public employees, i.e. policemen, firemen, teachers, nurses, sanitation employees, etc. Recent strikes in Memphis and Dayton are indicative of the problems ahead for big cities in the next decade. A general strike of public employees is more than many cities could cope with. Cleveland’s problems may give us some insight on what to expect when cities lay off great numbers of public employees.
Where has the money gone? December is the month that the first wave of six month savings certificates which are pegged to 26 week treasury bills come due for renewal. The big question is will the banks renew these certificates at rates a full 3 points higher than six months ago. Note that Federal Credit Unions may now issue these CD’s but most will stay out of the market until the rates drop. Usury limits in many states are prohibiting lenders from making new loans. We look for a lot of builders to be out of work by early spring.
Small builders across the country, especially those with houses in the upper middle income range are having marketing problems. Ron Hannert of Salt Lake City who operates a new home marketing company reports that sales have slowed even in their hot market which has no usury problems. Many builders will be receptive to offers of no cash down just to gain relief from the mortgage payments as the interest clock ticks on. These are outstanding buys for people in high tax brackets who can shelter ordinary income today and take out long term capital gains several years from now when the property has appreciated. New homes are generally the easiest to rent and have the lowest maintenance costs.
You should develop an alternate source of short term cash. At this point, unless you are an honored customer of your bank, new short term lines of credit will be difficult to come by. Inventory your assets, both liquid (autos, cash value insurance policies, notes and mortgages receivable, etc.) and your real estate assets and determine which would be the most attractive to an investor-buyer. Then spread the word among people that you know have either cash reserves, or borrowing power (holders of CD’s or bonds) that you will pay higher than market interest rates and give the lender complete security. Now offer to sell one of your more conservative, larger equity assets ( a house works extremely well) to the investor at a below market price and agree to lease it back, retaining an option to repurchase at a higher price several years down the road. Often a yield of 15% per annum simple interest will pacify the investor and you should profit handsomely by taking advantage of distress situations which will appear in the coming months with your new found cash.
Consumer debt remains highest in U.S. history and car repossessions are up dramatically across the country. Construction workers are having trouble finding work in areas of the South which will spread as new construction loans become scarcer. Look for large defaults in consumer loans followed shortly by defaults on home mortgages early in the new year. Contact companies making debt consolidation loans for leads to opportunities. Often these loans once in default can be purchased at substantial discounts and then you can approach the homeowner and renegotiate terms that he can live with, making a substantial paper profit.
The South will rise again, with the help of old man winter. As the Northeast and Midwest continue to lose population, the South contributes to grow the fastest percentage wise followed closely by the West. Even in cities that are steadily losing population, big profits are being made by those investors who locate those neighborhoods in their area which are the most popular and therefore increasing steadily in value because more people are trying to get in than sell. Keep in mind that although our friend inflation is helping us today by pushing up all values, you should always buy property which is economically viable without a falling dollar.
As credit becomes harder to acquire people will start disposing of assets and among the first to go will be that second mortgage or trust deed that will not pay off for another four years. A balanced real estate portfolio should contain some property held strictly for income which could be leases, mortgages, notes, deeds of trust, etc. One advantage of these investments is that often they can be purchased at large discounts from the face value and will yield far in excess of most passive intangible investments like stocks and bonds and without the corresponding risk. True one can lose in these purchases, but with a little education and experience (the former is far cheaper) you can learn to identify the problem paper and learn how to structure your purchases, in order to maximize your return. First paper secured by real estate you would not mind owning is second only to free and clear real estate in my strategy against bad times. To learn more about analyzing and acquiring paper I strongly recommend Jay Turner and Pete Fortunato’s course “Profits in Paper.” For dates and places contact Jay or Pete at 15 Derby Square, Salem, Mass. 10970. (617) 745-8268. These guys have been buying paper for several years and their course will both educate the layman and fascinate the experienced investor.
This month’s “Dear John” comes from the Midwest where they have a lot of VA and FHA loans in default already. The problem is that the balance due on the loan is often in excess of the value of the property because of high financing costs, commissions and large builder profits which are built into the amount financed. Should these houses be purchased and, if so, how? First, you must determine whether the fact that many homes can be picked up for little or nothing down will adversely affect the rental market. Often other homes can be rented for less than the payments on these, so most renters shy away from the high monthly payments. When this is the case, we are assured of a negative cash flow and must project an after tax cash flow to see the real affect upon our annual income. Often, another investor will be brought in for a relatively nominal cash contribution which will “feed” the mortgage for the first year or two. A seventy five dollar negative for two years only amounts to $1800 which could be little, relative to the appreciation the property should enjoy and the tax shelter benefits one would derive. Caution should always be observed, however, because when it seems too good to be true, it usually is.
Have you been audited lately? As the new year begins and income tax time approaches, you may wish to ponder the following statistics which relate to frequency of audits by the IRS. Overall, 68 of all returns are audited. In the event you itemize your deductions, your chances are six times as great. Twelve percent of those returns showing income of over $50,000 are selected, and special attention is also given to those brave souls who file a schedule “C” (a one in seven shot if your schedule C income is over $30,000). All partnerships remain a favorite and on the bright side the returns which are audited the least are fiduciary returns. Still thinking about forming that Trust?
The best tax strategy according to Charles Considine continues to be a low profile. Jack and I just completed Considines Tax Course for the third time (a must for anyone in real estate investments). In the event that your income bracket becomes too noticeable consider forming a closely held corporation. The corporate tax rates are lower than ever (17% for the first $25,000; 20% for the second 25,000; 30% for the third 25,000, etc.) so those with high incomes can drastically reduce their tax liability. Note that these rates are much lower even than capital gain rates so that one who owns dealer property can still take advantage of a low rate on gains via corporate ownership of those properties.
Can a lender accelerate? The answer depends on your state law. In a lengthy conversation with Fred Crane this week (Mr. Crane is the Attorney who litigated the Wellencamp case in California), he stated that now in California no lender can accelerate unless his loan is placed in jeopardy. This includes private lenders, credit unions, banks, and S & L’s. Several savings and loans, notably California Federal, are still trying to intimidate new buyers who acquire property subject to an existing loan but in no case have the lenders succeeded in accelerating a loan under these circumstances. The Glendale Federal S & L case which will decide whether the same law will apply to a Federal Savings and Loan is in the court system and must be appealed to the State Supreme Court before it will be respected. This process may take until 1981 or 82 and in the meantime the lenders will bark loudly and hold their bite.
Recommended reading for the month is “The Philosophy of Real Estate” by Charles R. Considine (published 1977 Vantage Press). Although the book will be easily read by the laymen, every investor will profit from the knowledge gained from three decades of successful real estate investing which Mr. Considine generously passes along. This is a book to read, read again and then given to your client to read: not a book to be shelved.
Rehabbing of Houses is not recommended for the average passive investor but our students continue to pocket serious money by attacking problems from which most shy away. Joanne Reese, our coveted White Belt Winner, from Pomona, California, rehabs not only houses, but entire streets. She buys properties which have been vandalized and therefore have distressed owners and takes title to them with the insurance policies and proceeds due from the vandalism intact. This way she can buy on nothing down terms, and pocket the insurance proceeds while she has her new, upgraded tenant trade out repair work for rent.
With insurance in mind, periodically review your coverage with your agent so that you develop a personal relationship with him/her. As no one ever reads all the fine print on those policies, it is important to be able to really communicate without any hard luck stories from his end in your time of need. Especially important is that often people will let their insurance lapse when money is short and possibly you may be able to help some people with house equities solve their problems if you can identify those people.
The most often asked question is “will there be another depression and when? Rather than worry about that academic point, everyone should take immediate steps to arrange their personal economic affairs so that they have a hedge against what they visualize as the “depression.” Many are far more worried about losing their health or war that they feel is impending than any type of economic collapse. My ideal hedge is a free and clear house in the town where I want to continue to live no matter what happens. My rational is that in today’s economy, the money I can collect for one month’s rental will purchase approximately six weeks’ worth of groceries. As the house should be rent-able in any economy, it should always produce enough income to buy six weeks’ worth of food whether it costs ten dollars or ten thousand dollars that particular day. This line of reasoning can be expanded and you can project that with five free and clear houses you can maintain your current lifestyle regardless of the economy.
Now it is obvious that not everybody can free and clear one house this week, much less five, so how do we start? Get something paid off! Start with your car if necessary recognizing however, in a classical depression there will not be much of a market for leasing cars so you will probably have to sell your asset. On the bright side, a free and clear $6,000 car today should generate enough to live comfortably for a couple of months while you contemplate your next move. One thing certain, all that money tied up in the bank or in the stock and bond market probably will be hard to get your hands on even if you do not lose it. Remember that tragedy rarely telegraphs its punch. To quote a Latin proverb, “While we consider when to begin, it becomes too late.”
Our Oyster of the Month Award goes to Dennis Kucinich, Mayor of Cleveland, who states that Cleveland’s problems are a result of the unreasonable demands of the Cleveland Trust Bank which he described as “the worst of the robber barons.” How totally unreasonable to expect a loan to be paid when it is due … Will an elected official ever admit that maybe they are in some way responsible for some of our cities problems?
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