I got a call recently from a young person who met me socially over 15 years ago. He was getting ready to enter college at that time. He graduated with a Degree in business, and bumped around a little, then found himself with a Real Estate license selling houses by sifting on new model homes and taking orders.
As the real estate boom took flight, he opened up his own brokerage office, then a Mortgage Brokerage, then a Title Company. He made a bundle as business fell into his lap from all directions. He took the fantastic profits he made from his business, and what he didn't use supporting a lavish lifestyle, he used to speculate in upscale houses.
When the bloom came off the real estate rose, he found himself with 20 heavily mortgaged upscale houses, and three formerly very successful businesses that now couldn't even meet day to day expenses. His negative cash flow from all his houses and his businesses was $900,000 per year. He was trying to borrow his way out of trouble by putting second mortgages on his already highly leveraged properties. It was at this point that he called me.
Ordinarily, 1 wouldn't spend much time sympathizing with an over-leveraged speculator who had flailed to heed two years of warnings in my newsletters and seminars about selling and sifting out these uncertain times; but he had subscribed to my newsletter and that earned him a chance to tell me his story.
Thus far, his plight was no different from that of thousands of other speculators who got caught with diminishing cash flow and increasing expenses; but he was a more interesting case for several reasons. First of all, his businesses, which he had built up in the space of 10 short years, had been grossing in excess of two million dollars per year; out of which he had been drawing a $600,000 salary, most of which he had used to speculate in expensive houses. That alone was astounding. What was even more astounding was that he had run all these businesses and earned all this money without even knowing the basics of real estate, mortgages, or title law. In the boom, he had been able to hire people who knew what was needed. Now, unable to pay their salaries, he had let them go.
When I tried to tell him some of the ways that he might solve his problem, he admitted that he had never spent any time “on the street” buying houses, negotiating deals, using creative financing, etc. He didn't know how to draft a contract, write a Note, structure an Option, or figure out how much to pay for a house. He'd been too busy making money to spend any of it investing in himself trying to learn the fundamentals. Even now, he didn't know enough to even begin the process of extricating himself from the financial mess he's gotten himself into.
My recommendation to him was to shut down all his losing businesses and to stop the hemorrhaging cash flow, they were causing, as soon as he could. My next suggestion was to sell the 20 upscale houses he was supporting to anyone who would get him off the loan; either by refinancing them, or by assuming the existing 7% loans and getting him released from liability.
When he protested that his houses had a paper equity of about $300,000 each, I told him explain to any buyer, that he was giving the buyer a chance to live in a $750,000 home for $450,000 because he was going to retain an Option to buy it back for $500,000 at any time in the next 5 years (when hopefully the market for in this price range will have returned).
He won't have to wait the full 5 years to cash in his equity, nor will he actually have to come up with $50,000. All he has to do is to find a buyer for the house and either sell him his Option, or have the current occupant paid $50,000 out of the sale proceeds and pocket the remaining sale proceeds after paying off the mortgage.
If he follows my advice, he'll save the $100,000 per year in negative cash flow that is choking him. He'll have protected any equity he has, to the extent it exceeds the $50,000 he'll have to pay the occupant when he sells the house, or buys it back. If the house still can't be sold during the five year Option period, that's proof positive that he had paid too much in the first place, and was well out of the property.
I don't know whether or not he'll heed my advice; but maybe we can all learn a little from his plight; to wit: To learn the basics of real estate, mortgages, and title law before going into any of these business. To be prudent about speculating in pre-construction projects and being stuck with new homes in a price range that nobody is buying. And to be willing to let go of paper equity if it means saving real dollars that will be needed to tide one over until the market returns. I hope this helps someone out there who is confronting a similar situation.
