Consider The Yoyo . . .


July 2009
Vol 32 No 10

          At one point in their lives, virtually everybody has played with a YoYo.  Basic models simply run down a string until they reach the bottom, then come right back up to where they started.  Advanced models run down the string then sit there and spin until a tug on the string brings them back up.  These are the models that are the most fun; but which require the most skill to do tricks with.  

          In some ways, house pricing resembles the YoYo.  In areas where there has been the least speculation or political manipulation, house prices tend to rise and fall with a certain amount of predictability; almost totally controlled by demographics and the availability of affordable credit.  In “bubble” areas – now depressed — where there were extraordinary price changes, demographics had very little to do with either the increases or decreases in prices.  With easy financing and low down payments, credit-driven speculation was the dominant factor that drove up prices.  When credit dried up, so did demand; and prices dropped to the bottom.  In many areas, prices today are hovering around “pre-boom” levels; and falling.  

          This is good news for the consumer.  It’s also good news for investors and speculators willing to stay active in today’s changing market.  The only problem is that government is manipulating prices.  As a result, instead of acting like the good old simple, predictable market YoYo, government manipulation has turned the house market into the kind of YoYO that requires a tug to keep it from staying at the bottom of the string; continuing to just sit there and spin.  The problem is that only certain “politically sensitive” market sectors are going to get that tug.  

          What are these market sectors?  For first time home buyers, in depressed inner-city areas, up-side down homeowners, sub-prime borrowers, Go-Zone victims, and for those who will build or invest in affordable multi-family housing, the string is being tugged and the market is beginning to move.  As houses are sold, more houses are being bought, albeit only at lower retail and wholesale price points.  Just as in the recent “boom” where prices rose while inflation didn’t, the opportunity to buy really decent real estate at deep discount to true market value is a once-in-a-lifetime opportunity that can be exploited.  This can be done in a number of ways.

          Investors, speculators, and future homeowners with access to cash can attend foreclosure sales, instigate “Short Sales”, buy through designated brokers from HUD, buy directly from investors, buy or lease REO properties directly from lenders, or lend to those who do.  Buying for cash without any financing conditions is how the deepest discounts and highest profits can be obtained.  

          On the other hand, using cash from new private or institutional loans – with or without creative financing – to take title subject to existing loans, and buying pre-foreclosures to hold for the long term, or to wholesale to investors, or to sell at retail to consumers is a route to the top that those without cash can access.  To do this, entrepreneurs must use hard work, chutzpa, persuasion, management skills, and often a share of future profits to get the money they need.  So long as they are willing to dedicate most of their time to finding and buying good deals, then selling them to pay off debt and raise operating cash, they can make a lot of money.  That’s how I exploited the last bubble.  

          I worked like a demon 24/7 during the last down turn and wound up buying and selling over 500 houses.  When the terms and cash flow made sense, and the house would generate positive rental income, I kept about 25% of the houses I bought, selling the majority to the first buyer I could find — often with very low markups – so I wouldn’t have to use any of my meager cash to actually take title to them.  In this changing market, even greater opportunities to buy and sell are                    
emerging.  They could greatly accelerate the speed with which you could get rich.

          Government promises and commitments made in public proclamations somehow never quite reach down to the man on the street.  On the other hand, a lot of those who work within the beltway, and their pals, seem to do quite well financially year in and year out regardless of the unemployment rate, business and bank failures,  falling stock, bond, credit, and real estate markets.  Obama, who gained office by promising “change”, has done very little other than to reward friends at the expense of others.  The new housing law gives tenants 90 days from the end of their lease to occupy their rentals.  A foreclosing lender, or new owner, will be saddled with all the maintenance, management, and liability.  Foreclosure bidders will bid a lot less for an occupied house than a vacant one, and REO departments will be sorely pressed to establish management departments to respond to tenants in residence.  This is going to distort the market, creating both new problems and new opportunities.  

          In his column, George Will reported that The Troubled Asset Relief Program (TARP) is being used by Obama as a slush fund to advance his own political agenda.  It seems the TARP billions are being allocated carefully to buy the cooperation of servile bankers and reward the loyalty of the unions.  For example, in the case of Chrysler, Obama ignored the sanctity of contracts that gave secured creditors priority over the unions.  He has proposed that creditors get 28 cents on the dollar of the $7 billion owed them while unions get repaid 43% plus 55% of the company to settle $11 billion in debt owed to them.  In order to get their mitts on the bailout money, “pet” banks have gone along.  Equity funds holding Chrysler debt were singled out for abuse because they refused to breach their fiduciary with the individuals and institutional pension funds whose financial futures are in their hands.  

         We can expect more of the same as various constituencies are singled out to be penalized or rewarded as the case may be.  The new credit card law victimizes banks that carry billions in credit card debt.  It has been proposed that they not be able to charge interest on unpaid balances for 60 days.  The banks have fought back by announcing that this cost will be spread to those who always pay credit card debt in the form of higher fees and lower credit card limits.  This will effectively dry up credit for those who most need it, and reduce the earnings of just about every business that accepts credit cards.  As Uncle Sam’s credit rating is driven down by the creation of debt and money, Bond investors demand higher yields.  With each up-tick in Bond interest rates, Bond holders lose money and credit tightens.

          Somehow, the link between business profitability and employment seems to have been overlooked in the spate of government bailouts.  When you separate true earnings from government gifts, there doesn’t seem to be much good news to offset the slow sinking of the economy.  Indeed, plant closings and layoffs of thousands of people each week are continuing.  It makes sense to plan on much slower growth in all sectors for the next few years; to focus on income yield rather than growth.  

          What about housing?  The market is changing.  The government already owns GNMA and Freddie Mac.  It has replaced some top personnel and announced a number of financing programs for new homebuyers.  The $8000 credit is up and operating, but will expire on December 1st.  Home mortgage rates are drifting lower, but the banks are being very selective and deliberate when approving loan applications.  Bank of America is drowning in bad loans and REOs they inherited from Countrywide.  Sooner or later this dam is going to break as houses are liquidated at fractions of their replacement value.  That’s the good news.  The bad news is that little credit is available for non-owner occupants who buy, fix-up, hold, or sell pre-existing homes

          Just as happened in the 1970s when a similar scenario unfolded, to remain in the house market, buyers, sellers, and mortgage brokers are going to have to look for alternative long and short term financing sources.  These include Credit Unions, private investors, Insurance companies, Seller financing, House-Trading, and Options.  The game will be harder to play, but there will be far fewer players in it.  By learning how to continue to exploit today’s market without access to conventional loans, a lot of money is going to be made by those who don’t give up.        

          The essence of creative financing is to be able to transfer equity between buyer and seller without the need for much cash.  This requires at least two highly motivated parties who are willing to work together, and knowledgeable enough to make a deal.  When a third party “deal-maker” is added to the mix, part of the profit can be carved out without any investment at all.  Learning how to become that third party is a major key to being able to earn profits on every buy/sell/lease/Option transaction.  To jog your imagination, here are ten ways that a deal can be made using creative financing with very little cash; but you’ve got to propose it.

Buy Low, Sell High:  We all know how this makes money, but a way must be found to get cash to a seller.  When a homeowner needs cash, get him to put a HELOC on the house, then buy and sell it using contracts, AITDs, or wrap-around mortgages.

Buy High and Sell Low:  Buy with seller financing that incorporates a high price with easy stretched out payments and a “substitution of collateral” clause; then re-sell by wrapping both price and terms so that your buyer will pay a much lower price, but with higher payments combined with a balloon Note that will mature over a shorter period.  Take your profit in the form of high principal payments and cash.

Buy and Sell on “Paper”, Sell the Paper:  When buying, structure two separate loans: one with high payments that you can sell for a high cash price that gives the seller cash, and one at zero interest with no payments until the first loan is paid off.

Pay With Discounted Bonds:  When interest rates rise, good corporate and US Zero coupon bonds can be bought at deep discount to face value, then used to buy houses at face value from homeowners who rather trust them than your promissory Note.

Horse-Trade:  Trade something the seller wants more than his leveraged house; such as a nice free and clear lot, Mobile Home, Vacation Hide-a-Way, or toys like RVs and boats.  The key is to be able to obtain what you trade for less than its trade value using any of the creative financing techniques listed here.

Don’t Buy, Lend:  Offer payment assistance in the form of a stream of interest-only payments that can be converted to equity when the owner sells.

Equity-Share With the Owner: When an owner simply can’t afford his home, buy half of the equity with a zero payment, zero interest Note that pays less than half of the payment.  He’ll get to keep his lifestyle, and you’ll get management free equity.

Take Over Car/Truck/Boat Payments:  Many people value their toys more than their homes.  Often, payments for these are less than house payments.  When you see that keeping their toys is a high priority, help them keep them for an equity share.

Don’t Buy, Don’t Sell:  Lease an ugly fixer-upper long term for only marginal rents.  Fix it up and sub-lease it at market rents.  Keep the cash flow.

Don’t Buy, Sell:  The easiest, safest, and least expensive way to make a profit on a house is to sign up a good deal and to record a contract that contains a few contingencies that can be resolved over time.  This will buy you time.  The next step is to find another buyer who will pay you a profit, and sell your contract to him; or take your profit in the form of a share of the equity.

           If you can learn how to structure, negotiate, and document any or all of the foregoing concepts, you’ll be able to remain active in this market without any help from the government, loan sharks, or institutional lenders.  As new and complicated as the world of creative financing might seem at first look, once you become comfortable with the concept of transferring equity from seller to buyer and back again using debt instruments that you help draft, you’ll never again be held hostage by lenders who dictate all the terms, timing, and ultimately, your profits.

          An ideal time for buyers to enter the market is when prices are still falling and optimism is at an all time low.  Sellers are motivated to sell before their equities drop even more.  Nightly Business Report estimates $9 Trillion is sitting on the sidelines waiting for clear signs that the bottom has been reached and prices are going to rise.  Once that happens, buyers will rush back into the market, driving prices back up.  Ultimately, because they are unwilling to buy into a falling market, they wind up paying more and making less profit than those who do.

          It takes a lot of courage for a person to buy a house and watch the equity shrink for a time until the market begins to recover, but that’s the only way to beat the rush once prices start back up.  Furthermore, a lot of cash as well as cash flow can be tied up for an indefinite period until sales resume and a profit can be realized.  The solution is to tie up a property and to freeze the price now, but avoid closing on the purchase until a later period when the bottom has passed, or the market is close to it.  There are a number of ways to do this that on the surface may not appear to be Options, but their effect is the same; to delay the transfer of much money until a later period when values and timing can be more accurately calculated.  Here are some of the ways this can be done today:

Short Sale Offers:  with almost half of house sales in distressed areas being submitted to lenders as Short Sales, a lot of time transpires between the date of the contract offer, and the approval by the lender.  Added to this time can be the closing of necessary buyer loans.  It has been my experience that lenders who approve a specific Short Sale offer aren’t very sensitive to having a third party actually close on the property at that price.  They understand that a homebuyer has very limited patience when it comes to being able to buy and move into a new house.  Buyers often walk away right in the middle of the Short Sale approval process.  If, in the interim, the house price sinks below the offered price, a new offer could be made, or the offer simply abandoned with no penalty.  The advantage is to the buyer.

HUD REO Bids:  HUD usually accepts of rejects an email bid fairly quickly, but won’t close if the identity of the end-buyer differs from that of the identity of the Bidder.  Once a bid is accepted, they usually give you 48 hours to send in a couple thousand dollars, but ordinarily extend the settlement date for 60 days, if not longer.  If the bidder has the cash with which to close, he can resell the property without any penalty.  But if he doesn’t, the delay gives him a reasonable time to find a buyer who can raise the needed cash; but there’s a hitch:  If you expect to resell the property in order to raise the cash needed to close on it, you need to bid in the name of a fresh new Trust, LLC, or Corporation.  Then, instead of transferring title to the end-buyer, simply transfer ownership of the entity.

Contingent Contracts:  One fellow I know is buying lots of houses on contracts that have contingences that must be cleared before settlement can take place.  These run the gamut from obtaining financing with specific terms, to clearing title exception, to getting a variety of inspections performed.  These might include testing for Lead Based Paint, Asbestos, Mold, Expanding Soil, Termites, and insuring the structure, roof, wiring, and plumbing are up to code.  The more contingencies, the less likely the buyer is to sign the contract.  When the Purchaser agrees to either pay for the inspections, or to waive them, that softens their impact.  An all purpose phrase is:

“This Agreement is not final until the conditions of title, financing, and condition of the physical premises has been inspected and approved by the buyer.”

Full Liquidated Damages:  Most standard form Purchase and Sale Agreements carry a statement that more or less says that if the buyer fails to perform, that all money deposited to bind the contract will be forfeited as “partial liquidated damages.”  This leaves the door wide open for additional damages.  If the word “partial” is replaced with “full”, then the buyer will lose his token deposit, but nothing more.  

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