March 1983
Vol 5 No 6
Warren G. Harding – not the President, but rather one of America's foremost real estate Exchangers and founder of The Academy of Real Estate – for years told students in his seminars about experiments in which mice were taught to find their ways through intricate mazes and traps in search of their eventual reward of cheese at the end. Once they'd solved the riddle, the cheese would be moved to another location and the search would start all over. Ultimately the levels of frustration would drive the mice insane or they'd stop trying and refuse to make the effort necessary for their own survival.
For many investors, 1983 will be the year they moved the cheese. President Reagan's State of the Union speech left me with the feeling that he'd become some sort of National Tooth Fair y promising to bring rewards to everyone in exchange for just a little pain. Two chickens in every pot, two cars in every garage, peace in our time, prosperity, bigger defense, improved social services, less inflation, more employment. About all he missed were mom and puppies. Either he's beginning to run scared. or he's divided his enemies as each makes his own grab for the goodies at the expense of the organization and the citizen producers in our economy.
During the next few, months we'll probably see long term rates for mortgages drop a little more. A real effort it being made to clear the way for access by FNMA into the European money markets. Billions are available for quality, long term investment in the U.S.A. Similarly, various State and Local mortgage bond issues are coming on line, aiding builders, developers, lenders, real estate sales in many areas. Pent up demand will absorb this money fairly quickly, but already we're seeing the results. Construction up 35%. Re-emergence of 30 year, fully amortized, level payment financing. FHA investor loans at favorable rates. I expect interest rates to begin to shut down markets by Autumn as mortgage funds compete with government financing at all levels for investor dollars.
On the Tax front, changes are taking place which will place added burdens on the real estate industry. I saw a new 1040 form which said: “HOW MUCH DID YOU MAKE?“. The following line said: “SEND IT IN!“ TE&FRA of 1982 is going to change our lives somewhat. The Alternate Minimum Tax is going to change the way we look at interest, taxes, and capital gains in our strategies. Loans made from Pension Plans, or renegotiated after August 13, 1982, NOT for the purpose of acquiring or remodeling a personal residence must be for no more than 5 years term or be taxed as a distribution. Renegotiated discounts on existing loans will be taxed as ordinary income when you pay them off early. Pension Plan strategies will require revamping under limitations taking effect this year. Now, more than ever, you'll need the advice of a tax strategist. And you'll need to become involved in your own taxes so that you can be an intelligent adjunct to him or her.
The mood of the country is speculative. When people perceive that they can't win through hard work, prudence, and thrift they turn to gambling. With little to lose and much to gain, they by-pass more pedestrian investments for easy money wins, playing a form of Russian Roulette in which they bet their few remaining assets against the mob. I see rational investors borrow against good real estate to buy gold, silver, commodities, market rate futures, options. They lose more often than they win. They don't think it through. What drives Gold up? A change in intrinsic value? Or the anticipation that someone else will bid more dollars for it? Once it has been driven up, when should one sell? If you knew the date, would you be willing to sell then? Would anyone buy from you: Few did at the peak in 1980, and few made fortunes that real estate people did by NOT selling. The explosive run-up in stocks is based upon the same speculative fever. Many will lose.
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PLANNING RATIONAL MOVES IS THE TRUE KEY TO PROFITS AND SECURITY.
To start any plan, we'll need a premise. In 1983, suppose OPEC prices drift on down a few dollars, no major political changes occur including war, long term interest rates stabilize at 11.5% before starting upward again in late summer or early fall, the FED continues to reflate until the 3rd quarter then falls back. Here's one scenario for SFH.
Many buyers will enter into the market, some for the first time. FHA and VA loans will be sought in the millions delaying property transfers. Closing costs will rise together with prices for houses. Most of the market action will be in the low middle ranges of the market in any particular area. We'll see emergence of off-site constructed housing, mobile home subdivisions, bread and butter priced condos as major market trends. As funds dry up, interest rates will begin to rise. Sales will fall off, catching many who got started too late or who paid too much for their project and financing. There will be another brisk distress market at this time next year where cash will be king. Long term energy and water requirements will hold down growth in Florida, California, and Texas creating high demand. Overlooked areas where the environmental needs have been met and where there is potential for high tech industry will offer uncommon opportunities. These could well be in areas of the mid-West and Northeast where long tradition of well rounded education and disciplined labor prevail. The Charlotte, Atlanta, Greensboro areas too.
First on your priority list should be to use the lower interest rates to fund your immediate cash needs and to restructure your hazardous debt. Early refinancing with attractive, assumable loans will enable you to avoid the rush once the market turns. You can wrap your loans and carry back the remaining profit. Once sales perk up, it might be wise just to sell any marginal properties, or good properties in marginal areas. If you can make an advantageous exchange of several smaller properties into one larger equity then sell that single property your costs and effort will be much lower. The recipient would get the benefit of an existing portfolio which he could keep or sell piecemeal as he chose. You'd rid yourself of what ever poor loans or marginal equities you might include and be able to convert your profit to cash on your high-equity rental houses at the same time.
Availability of cash offers you the opportunity of discounting private loans you owe, buying them back rather than paying them off early and leaving them of record against your properties. This way, you'll have an opportunity for structuring some creative wraps in the event you should sell them once the market tightens up again. Or you can use your cash to “sweeten“ exchanges where you want to relocate some properties to more desirable areas. Use the exchange markets to rebuild your portfolio carefully. Select good houses in the correct neighborhoods, with the right financing, in top locales. This might be the last chance you'll have.
If my scenario works out, your cash will work wonders for you in the fall and winter. Keep it liquid, but keep it working. You can buy 91 day Treasury Bills from the FED or directly from the Bureau of Public Debt, Dept. F, Washington, D.C. 20226. Call (202) 287-4113 to get instructions or (202)287-4100 to get quoted rates. Save the fees. Try to avoid the temptations of the market unless you really know what you're doing. Since 1977 I've watched Gold and Silver create billions in profits, but for some reason I've never met anyone who became wealthy and who kept his wealth in those markets. On the other hand, there are scores of real estate millionaires who came from zero assets to real wealth during that same period. I met with several of them in Acapulco last week and I was amazed to see how much wealth had been created by so many of them .
Not to overlook the small investor – it's still not too late to start buying Options on houses. These might be builder's inventory, bank repossessions, transferree homes, improperly financed negative cash-flow rentals, or even building lots where SFH or mobile homes might be parked. Buy these Options with cash, management services, loans, merchandise, automobiles, boats, airplanes, RVs, jewelry, even gold or silver. You might offer to do all the leg-work to get Mobile Home zoning in return for an Option on ½ the profit a subsequent sale to a developer might bring. There's a place for everyone who tries.
CREATIVE MANAGEMENT TECHNIQUES CONTINUE TO GENERATE CASH FLOW.
One of the truly significant trends which we've discussed before has been the merging of two households into a single rental. In some areas owners are making minor modifications to their houses to enable two rent payers to occupy a single family house. Let's take a three bedroom, 2 bath house which rents for $400 per month. It might be suitable for 2 childless couples who'd share kitchen accommodations and living/family room areas for a rental of $250 each. Ergo, their rent expense goes down while the owner's income goes up by $100. Naturally, this carries some risks, but profits are high. If you consider that the same house might require $375 in operating expenses and payments, what was formerly a $25 per month cash flow has increased to $125 or 500% PER MONTH!
The same approach has been used to install renters into RVs and trailers place. at the rear of a large residential lot, or to convert garages into separate apartments for rent, or to merely rent the garage to another party for storage thereby supplementing rents. In one instance we encountered a 1200 square foot house which had been especially constructed to house 5 single men as renters. Truckers, they need a place to store their possessions, but spent most of their time on the road. They didn't cook in their rooms. They paid $55 per week each for a sink, office type refrigerator, a bed, table and chair. Each had a separate outside entrance and a door giving access to a common living room for social events. They shared a common bathroom and shower. Each had his own parking spot. Look at the numbers: $1182.50 gross rents per month, $14,190/year for a building which cost $28 per square foot to build including the lot. The widow who owned it was getting a 30% return after expenses cash on cash.
Last year, my rental contract contained a limitation of 10% on any rent increase The Tenants paid me the equivalent of a month's rent for an Option to extend their contract for an additional year at “no more than“ 10% increase. This year, I sent 31 of them a note inquiring as to their intentions. I reminded them that they had already purchased an Option to renew and would forfeit the Option consideration if they chose not to. I offered them an extension of their Option for one more year if they paid the increased rent. Thus I avoided any “rent raise“ in a recession year. Then I offered to reduce their rent increase by $10 if they'd agree to paint, repair, bring lawns back to life, etc. I was inundated with acceptances. I lost 4 out of 31 and increased overall net cash flows by over $1000 per month. I also delivered over $500 in paint, had tile laid, fences built, and trees trimmed at no cost to me. Giving tenants a chance to work out costs really helps everyone.
Whether we know it or not, each of us has an organization we should use in our management efforts. Less an organization than a federation, it is comprised of other investors and owners or managers in our area. I make it a practice to share ideas, tools, advertising, market insights with others. I've watched their properties when they were on vacation and they've done the same for me. We lend each other appliances, share repair men. In short, we cooperate to hold down our expenses to remain competitive in the market.
Over and over I hear that one “just don't raise rents“ because the market is too soft. I challenge that unless there has been a major exodus of renters, house sales are on the increase, or depression is too severe in a particular area. Our rental contract ends the rental year for all tenants on the same date. When I send out the rent raise letters, I don't invite negotiation although rent increases are based upon costs and my own cash flow requirements. My rents are usually low market because my costs are low. When all tenants are thrown into the market looking for essentially similar housing, it CREATES A STRONG RENTAL MARKET as each perceives a shortage of that type of housing. They renew early as a rule to assure their own housing availability. I sent out my letters this year at a time when I had 5 vacancies. The market I had created immediately filled my vacancies at a time when I was increasing my rents. Soft markets are similarly created by owners who won't test the market. As a result they lose money and cash while others gain. In any business, increased profit margins allow one to pull ahead of competitors. As a landlord or landlady, you have to keep increasing your cash flows to become financially independent.
IN THE POTPOURRI DEPARTMENT . . .
Its still not too late to put $2000 into an IRA for 1982. If your spouse's only job is helping you, pay him/her $2000. You deduct it as a business expense. He/she also deducts it as an IRA contribution. VOILA, you reduce your taxes and simultaneously invest. Remember, April 15th is your last chance at 1982 tax trimming. Don't delay too long.
RentCheck is a National credit rating system for renters. By merging their records with Telecheck's list of hot check artists, they can tell you whether or not an applicant should be accepted as a Tenant. It costs about $3- $5 per call to check their 7 year data base by telephone. They recommend you use the tenant's driver's license to verify biographical data, spelling of names, prior addresses, etc. After July 1st, 10% is going to be withheld on most savings and dividend account earnings unless you write your Senator and Congressman to repeal that legislation. If we all pull our money out, interest rates will shoot up again! Appeal for repeal. Write today!
Beware of your tenants becoming your employees when they perform maintenance on their houses. That would make you eligible for workman's comp., FICA, withholding, etc. Put on your rental contract the fact that they will only perform tasks as independent contractors, be fully accountable for all costs, expenses, results of their sub-contractors and responsible for payment of all required fees, taxes, insurance bonds, and permits. If some specific job is to be done by the tenant, get him to execute a specific contract for that job with appropriate disclaimers. Pay him with a check which identifies him as a contractor and his services as contractor services.
Copyright Sunjon Trust All Rights Reserved
Quotation not permitted. Material may not be reproduced in whole or in part in any form whatsoever.
1-888-282-1882 www.CashFlowDepot.com
