April 1979
Vol 1 No 8
CONDOS AND CO-OPS ARE ON THE MOVE in Chicago, New York, Washington, Boston, Houston, Santa Monica, Milwaukee, and points East, South, West, and North! IN SOME MARKETS, CONDOS ARE APPRECIATING AT A RATE 2%-3% ABOVE THE RATE FOR SINGLE FAMILY HOUSES. While we have long been leery of any involvement with Condos, the purpose of this letter is to give us all a changing perspective to match our changing times. Maybe this would be a good time to take a hard look at the ranges of opportunities in these multi-family situations.
First of all, Co-Operative Apartments are usually comprised of one or more apartment buildings which are held by a Corporation. RATHER THAN BUYING THE FEE-TITLE TO A PARTICULAR UNIT, THE PURCHASER OF A CO-OP IS ACTUALLY BUYING SHARES in the corporation in an amount which represents the value of the specific apartment. As a share holder, the purchaser gains the right to occupy the unit he wants.
In contrast, THE CONDO BUYER ACTUALLY BUYS FEE-TITLE TO A SPECIFIC APARTMENT UNIT. He or she also is deeded a small percentage of any common areas such as the halls, balconies, sauna, tennis courts, pool, docks, etc. (or in earlier Condos, a leasehold interest was conveyed for 99 years or some such period). Condo owners and Co-Operative share holders are charged an additional fee for management and maintenance which is based on the value of their units.
With this arrangement, THERE IS GOOD NEWS AND BAD NEWS. The good news is, that all maintenance requirements are taken care of. The bad news is that IT CAN BE A VERY EXPENSIVE SERVICE. Looking at it another way, for the investor who has neither the time nor inclination to perform maintenance and management chores. THESE RESPONSIBILITIES ARE PROVIDED FOR WITHOUT THE HASSLE OF LOCATING AND SUPERVISING A HOST OF SUB-CONTRACTORS to mow lawns, clean pools, paint, vacuum, repair water heaters and air conditioners. Bookkeeping is provided to account for expenses. The owner escapes having to file all the various employee taxes reports to report on amounts paid and withheld. And because of the difficulty in accurately assessing the land-to-improvement allocations in Condos, THE ENTIRE COST OF THE UNIT CAN BE DEPRECIATED WITHOUT FIRST SUBTRACTING THE VALUE OF THE LAND.
The bad news is that the investor-owner is better off avoiding Condos located in attractive recreational areas as investments. Tax laws since the TAX REFORM ACT OF 1976 HAVE BEEN RESTRICTIVE IN ALLOWING ANY DEDUCTIONS FOR DEPRECIATION and or management charges on units occupied by owners. Rentals in these areas are usually furnished, which increases the necessary investment costs. OCCUPANCY IS CHANCY AT BEST. During the 1976-77 winters in Western resort areas, many recreational Condos went into foreclosure because the LACK OF SNOW CAUSED A LACK OF INCOME FROM SKI ENTHUSIASTS. The same thing can happen with cold weather in Florida.
MAINTENANCE CAN BE ANOTHER WILD CARD IN CONDOMINIUM INVESTMENTS! Under the old recreational leases, while the Lessor might be rapacious, there’s a good chance he won’t be stupid. Now, Condominium Associations generally own the common areas in Condo projects. Their meetings resemble P.T.A. conventions with a lot of amateurs making motions and taking votes which obligate all members to spend money. I have owned both types of Condos over the past few years. REGARDLESS WHO MAKES THE DECISIONS, I HAVE DISPOSED OF MY UNITS BECAUSE THE MAINTENANCE/MANAGEMENT FEES REDUCED THE BENEFITS TO THE POINT OF NO RETURN.
Now the worm may be turning. Where before Condos generally realized about the half the rate of appreciation as houses, in some locations they are growing in value at a faster rate. IN THE EVENT THAT RENT CONTROLS ARE IMPOSED, CONVERSION OF EXISTING APARTMENTS TO CONDOS WILL MAKE THIS TYPE OF OWNERSHIP AVAILABLE IN MANY AREAS WHERE THE SUPPLY IS NOW LIMITED. The security aspects of limited access residential housing coupled with favorable financing could make Condos a real goody.
Having just returned from the annual Creative Real Estate “EXPO” in Las Vegas, we are armed with several new formula and concepts gleaned from others in our SFH business. Here are some of the tid-bits we found interesting:
Jo Ann Reese, the West Coast winner of our White Belt Award for 1978, has taken a completely different approach to her fortune-building program. She has tackled an entire development of SFH and multiples up to 4-plex units. Jo Ann saw the opportunity inherent in a situation where LOW CLASS TENANTS HAD DESTROYED THE EQUITIES OF MANY OWNERS BY CREATING A NEIGHBORHOOD WHERE GOOD TENANTS REFUSED TO LIVE OR PAY REASONABLE RENTS. (Gresham’s Law of Real Estate says that “bad tenants will always drive out the good.”)
By buying the majority of the units on soft terms – often with cash back at closing – Jo Ann was able to withstand the negative cash flows resulting from her wholesale eviction of the undesirables. NOW SHE HAS REPLACED MOST OF THEM WITH GOOD TENANTS AND IS SEEING HER CAPITAL VALUES SKYROCKET as her units re-enter the market as middle class neighborhoods. Lots of hard work and worry have given her a comfortable cash flow and enormous profits in her equities.
Joe West of Pascagoula, Miss, uses another approach. JOE NEITHER WANTS RISK NOR MANAGEMENT RESPONSIBILITIES! He has systematically identified and become acquainted with several outstanding managers in other small towns in his area. Joe can now work with investors this way: HE OFFERS THEM AN UNDIVIDED ½ INTEREST IN THE PROPERTY PROVIDING THEY PROVIDE ALL THE CASH needed to buy it and service it. He then offers a ¼ interest to the manager for all management and maintenance services excluding materials. Where there is a cash flow margin over the mortgage servicing, he might also offer a cash management fee. JOE RETAINS ¼ INTEREST FOR HIMSELF. With no investment nor management responsibilities he has provided himself with terrific estate building benefits on a risk-free basis simply BECAUSE HE IS A GOOD BUYER IN THE MARKET.
Bill Broadbent, well known for his pioneering approach to Buyer’s Brokerage and non-contingent fees has informed us that UP-FRONT FEES ARE BEING WATCHED VERY CLOSELY IN CALIFORNIA. He urges us to become completely familiar with the legalities of this approach prior to accepting such fees, and to use the appropriate documentation to support our fiduciary position. Attorney Fred Crane, 3610 Central Avenue, Suite 111, Riverside, Ca. 92506 offers a standard Buyer’s agreement which might serve to alleviate this problem at nominal cost.
Jack Evans of Hernando Beach, Fla. has sent us an article concerning the crackdown by the IRS on BARTER. AN ESTIMATED 175 BILLION DOLLARS OF COMMERCE IS TRANSACTED EACH YEAR WITHOUT BEING REPORTED AS INCOME! Aside from the revenue dollars the Treasury loses, an error of this magnitude in government statistics throws off all the economists’ econometric computer models. Ultimately THEIR PREDICTIONS ARE TOTALLY UNRELIABLE (as witness their predictions of the 1974 slump and the 1978-79 slump thus far). This overflows into the budget deficit and the inflation rate. The message is, if you barter, don’t leave a business card unless you like audits. BARTER IS TAXED AS INCOME!
MANAGEMENT CONTINUES TO BE THE KEY TO PRODUCTION OF WEALTH FROM SFH! When management is combined with creative financing an incredible array of benefits can be produced for the investor. Let’s look at some structures.
In times of stark depression when foreclosures are commonplace lenders share a common dilemma: what to do with houses once they have bought them back. ONE THING A LENDER LEARNS RIGHT AWAY IS THAT AN OWNER ALWAYS PAYS MARKET INTEREST FOR HIS EQUITY! For example, if a home worth $75,000 is owned free and clear with no payments to be made, the owner could sell his property and re-invest his interest at market rates, thereby earning (i.e.) 10% on his equitable interest. This translates to $7500.00 or about $625.00 PER MONTH THAT THE OWNER IS FOREGOING RATHER THAN INVESTING TO LIVE IN HIS F&C HOUSE.
A lender who forecloses property is in precisely the same position, with an important difference. The VALUE OF THE FORECLOSED LOAN MIGHT BE CREDITED AGAINST HIS RESERVE RATIO, limiting his lending ability by a factor of about 6 to 1 for each dollar of foreclosed loans. BESIDES COSTING HIM INTEREST, HIS FORECLOSURES REFLECT ON THE JUDGMENT OF HIS LOAN COMMITTEE! Maintenance and management of SFH can be much more expensive for lenders holding empty houses than for experienced investors with management in place. This presents an outstanding opportunity for both investor and lender.
ONCE THE LENDER REALIZES HE HAS A NEW TITLE: “OWNER,” HE IS READY TO MAKE A DEAL! Suppose you, as a skilled investor/manager propose that you net lease all the foreclosed houses for the lender (or for MGIC, FHA, etc.) at a rate well below market. Your lease will provide for all maintenance, management, etc. It will contain an option-to-purchase which may be exercised at anytime that the agreed upon price can be provided by AN 80% LOAN BY THE LENDER. YOU MAY ONLY EXERCISE THIS OPTION IF YOU ARE MEETING YOUR LEASE OBLIGATIONS. The lender solves his problem as to management. His return is enhanced. He can now sell the property to his trust department or pension trust fund since the return can be structured to meet their requirements. He cures his default problem and cleans up his books in the process. THE INVESTOR CAN STRUCTURE A CASH-FLOW YIELD FOR HIS EFFORT WHILE NAILING DOWN THE COST OF HIS SFH TO PROVIDE FOR UNTAXABLE PROFITS in the form of 100% leveraged appreciation brought about by a returning market up-swing and his own maintenance efforts. Depending upon specific dollar values, THIS CAN BE TRANSLATED INTO MILLIONS OF DOLLARS for both lender and investor. Remember, we profit most in a down market!
We’ve just finished another good book: TWO YEARS FOR FREEDOM BY BILL GREENE, P.O. Box 408, Mill Valley, Ca. 94941 ($15.00). Bill is more speculator than investor, yet his common sense approach to SFH rings true to our own experience. It’s difficult to get successful people to tell us how they did it. This book tells more than most at the nitty-gritty level.
We are being approached by more and more investors fleeing the “idiot-fringe” investments (movies, cattle feeding, stocks, “tax-shelters”) to get into SFH. NO LARGE COMPANY HAS YET MASTERED MANAGEMENT AND THIS KEEPS OUR MARKETS FREE FROM RUINOUS COMPETITION. As larger and larger amounts of capital are directed toward us we tend to lose control of the QUALITY of the investment in serving the needs of QUANTITY! We think we’ve found a formula which will allows us to capitalize our management skills.
WE OFFER TO SELL ½ INTEREST IN EACH SFH IN OUR PORTFOLIO AT A PRICE BASED ON 100% OF THE APPRAISED EQUITY LESS COSTS OF DEFERRED MAINTENANCE. As investors, WE bought some ½-houses from one of our former Coveted White Belt winners, Charlie Green of Pascagoula, Miss. We paid him the FHA appraised value less an amount we agreed upon to be subtracted for contingencies related to maintenance. When WE offer this proposition to our NEW INVESTOR, he secures in-place management because we still own ½ interest as Tenants-in-Common. THE INTEREST PURCHASE IS IN A HOUSE ALREADY SELECTED BU US FOR OUR OWN PORTFOLIO, SO WE HAVE BUILT IN ALL THE QUALITY WE NEED. If he needs large infusions of tax shelter, we can sell him hundreds of thousands of dollars worth of assets in a short time, thus obtaining for him the quantity he needs with little or no risk to either party!
OUR INVESTOR PAYS US WITH CASH BASED UPON TODAY’S MARKET VALUE. THUS WE RECAPTURE OUR ENTIRE INVESTMENT WHILE RETAINING ½ INTEREST! By re-investing the proceeds from this transaction, we stay in the market and service negative cash flows. The investor gets a passive investment with management locked in. WE GET A LONG-TERM RELATIONSHIP WITH A FINANCING SOURCE. EVERYBODY WINS.
Charles Considine, premier real estate CPA from San Diego addressed Expo 79. He outlined some applications for estate planning using the PRIVATE ANNUITY AS A PRIMARY TOOL FOR TAX-AVOIDANCE STRATEGY in passing an estate from one generation to another. SPECIAL TAX RULES APPLY TO PRIVATE ANNUITIES which have been carefully structured in accordance with Treasury guidelines. For example, Mom and Pop want to convert their property holdings to cash without creating a huge estate tax problem. They sell their property to their children who agree to pay under the terms of a private annuity. Their profit is taxed under a formula similar to the proceeds of an installment sale. THEY THEREBY SPREAD OUT THEIR TAX LIABILITY OVER A LONG PERIOD OF TIME. When they die, payments stop!
Meanwhile, the children find a cash buyer and sell the property for $1,000,000. Since their basis is $1,000,000 (the value of the annuity) THEY HAVE NO GAIN and thus no tax! THEY DO HAVE CASH! THE ESTATE HAS BEEN TRANSFERRED WITH MOM AND POP OBTAINING LIFE-TIME SECURITY. Mr. Considine teaches a bang-up tax course for those building an estate and for those concerned with estate problems. Put it on your agenda. Schedules and costs can be obtained from Creative Real Estate, P.O. Box 2446, Luecadia, Ca. 92024.
Tom McDonald of Vienna, Va. and Bill Broadbent of San Luis Obispo, Ca. both sent us notices of PROPOSED LEGISLATION WHICH IMPOSES CONFISCATORY TAXES ON SPECULATORS IN SFH. We’ve received similar reports from Missouri, Vermont, Massachusetts, and Washington D.C. According to Gary North, the regulators are coming and this legislation is consistent with a political solution to an economic problem. RATHER THEN REIN IN THEIR RAMPANT SPENDING, POLITICIANS IMPOSE ARTIFICIAL HORIZONS ON COMMERCE, trying to hold up the setting sun until the end of their personal careers. You can’t blame them, SINCE THEY DON’T KNOW HOW TO EARN A LIVING IN A COMPETITIVE ARENA, THEY TRY TO FIX THE FIGHT! We know that profits flow to unregulated sectors of the economy, and SINCE WE DON’T SPECULATE, THESE LAWS DON’T AFFECT US. Our strategies, already formed, await any attempt to tax long term appreciation. We’ll keep you advised.
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