April 1982
Vol 4 No 6
The Reagan Administration has left little room for doubt that it intends to stick to its guns – and planes, and aircraft carriers. Deficits during the next three years will zoom to $400,000,000,000 EVEN IF THE MOST OPTIMISTIC FORECASTERS ARE RIGHT. That’s almost half as much as the total of all deficits that have ever been run up since this country began. And to think that we almost impeached Eisenhower for a $100 billion budget and a 1% inflation rate. It’s not Reagan’s fault entirely, but it is his budget.
A Civil War has been ignited in America. This time it’s not between North and South, but between haves and have nots. Early skirmishes have started. Casualty figures include Bank failures (Metropolitan Bank in Tampa in February), record high numbers of bankruptcies in both the business and private sectors, wholesale blood letting in Bond Markets, massive unemployment figures in heavily unionized areas. We can expect to see even more of this in the coming months as Federal funding for housing projects, student loans, minority businesses, social programs dries up. Fifty years of government economic tinkering and mismanagement have culminated in an impending financial crisis which will accomplish what our enemies have never been able to do. It will set neighbor against neighbor, father against son, Easterner against Westerner as each struggles to survive economically. And like the man said, a house divided against itself cannot stand.
That doesn’t mean you should buy a gun, canned water, and head for the hills. It DOES mean that you should start seeking the financial high ground. In this issue we’re going to continue to suggest ways to start converting EQUITY into INCOME. If we’re set on walking a STAGFLATION tightrope between high inflation and unemployment, now’s a good time to add some cash to achieve better balance in our portfolios. Think of it as a good insurance policy which could cost some future profit, but save what you now own.
WHEN YOU CAN’T SELL, EXCHANGE!
Conventional borrowing is extremely costly and competitive in today’s market. When the government starts to fund the awesome deficits it projects, there will be precious little long term money left for borrowers. On the other hand, if the government can’t borrow at reasonable rates, it can always print the money it needs. This will create inflation and interest costs we can’t even imagine. Lenders will seek to charge interest that will yield at least as much as the inflation rate on equities which will be soaring to unheard of levels.
To the real estate markets which are always vulnerable to interest rates can’t survive in the conventional way. Sellers, facing high inflation rates, dare not sell on long term “paper” which inflation will rob of its value. Remember, Mortgages act just like Bonds. The higher the inflation/interest rate, the lower their value. Without any cash or mortgages, it’s still possible for investors to EXCHANGE their properties to improve their cash positions. Fortunately, the Exchange Market is reasonably well organized to provide this service, and single family houses usually command a premium.
Suppose you have a $40,000 equity in a house that just breaks even when it is rented. If you could exchange that property for an income property that is almost free of debt, you would have reduced your risk, increased your cash flow, and still maintained an inflation/deflation hedge. Who would exchange with you? A USER who wanted to move up. Or someone seeking higher depreciable basis for tax shelter. Or anybody who needed to move into your location with his or her investment provided you could move your equity out of the area into the location in which their smaller property was situated. The point it, that Exchanging is a viable way to seek safety until things quiet down a little.
LAND LEASES ARE COMING INTO THEIR OWN
When someone sells the land beneath their property then leases it back on an indexed long term lease, it generates a wide variety of benefits for all parties. Say you own a $75,000 house which is not generating any cash flow even though it has an equity of $20,000. You might sell the land beneath it, subject to any liens, for $15,000. To the Buyer, you’d guarantee to pay 10% per year on the land value PLUS you’d agree to adjust your rents each year by the CPI. Look at the results. You’d raise $15,000 with only 10% annual costs INTO PERPETUITY of as long as you owned the property. You could even sell the property and let the next owner have the same benefits. If inflation runs amuck, your costs would go up, but so would the value of the improvements you still own. If costs of money were to rise, you could structure a profit into your lease by selling the property and charging the buyer a 12% land lease cost with a wraparound lease.
The investor who bought your ground would have a very secure, indexed income producing investment. This would be ideal for a Corporate Pension Plan or a Trust where tax benefits wouldn’t be of primary concern. If the leasehold interest were for a term in excess of 30 years, counting all renewal periods; it could be EXCHANGED tax-free for other investment real estate if you wanted to own something else. Or, it also might be sold at a profit for capital gains. If the person who owned the house failed to make lease payments, he could be EVICTED, and the house would be forfeited to the investor. Land Leases can generate cash for an owner and income for an investor in troubled times. And of course, it is possible for someone with an improved property who doesn’t like management to exchange it for a land lease – and vice versa to get the benefits he wants.
SALE – LEASE BACKS CAN SOLVE CASH FLOW PROBLEMS
Seven or Eight years ago we helped a widow who needed income and whose only asset was her free and clear home. An investor bought her property and leased it back to her on terms that netted her more CASH-FLOW. Her house had a value of about $40,000. She needed $250 per month extra income for living expenses to supplement Social Security. The investor paid her $5000 down, and $500 per month on a first mortgage. He also gave her a long term lease on the house at $250 per month including maintenance and yard care. She got income. He got a trouble free property. You don’t have to be a widow to do this. If you’ve got a large equity in your own home, a lease back could work for you too.
Fouratt Corporation of Carmel, California has refined the sale – leaseback formula in an innovative way. They would buy the widow’s property above, but would give her a LIFE-TIME LEASEHOLD INTEREST. Here’s how they do this. Suppose she were 78 years old and would be expected to live 14 more years. Fouratt would work out a loan and a leaseback whereby she would receive a stated amount of money over the 14 years. If she died during that period, they would continue to send the payments to her estate until the loan had been paid off. If she lived beyond the loan repayment period, she would start to receive payments from an annuity program for the remainder of her life. For example, if she had been receiving $500 per month and paying rent of $250, she would continue to receive the $500 and paying the $250 as long as she lived. Fouratt’s investor, as a part of the purchase, would buy an annuity. In return he would get a below market price and interest rates to make the transaction appealing to him. We can all see the benefits.
REMAINDERS AND ESTATES-FOR-YEARS OFFER A DIFFERENT APPROACH TO CASH FLOW
In the above illustration, the widow could have sold a REMAINDER INTEREST in her property, and reserved unto herself a LIFE ESTATE. This means that the investor would only have an interest in her property after she had died. The transfer would be automatic and it wouldn’t involve probate proceedings. The property wouldn’t be in her estate. This works well when more expensive properties are involved. Suppose our widow owned a large estate worth $1,000,000. Taxes and repairs would be costly. Her income would be assaulted by inflation. She could easily lose her property and her lifestyle because of inflated expenses. An investor might offer to buy the property for cash, paying the DISCOUNTED PRESENT VALUE based upon the current interest rates. Here’s how it would work.
If she would be expected to live for 14 more years according to a standard annuity table, and if the current interest rate were 16%, then her house’s discounted present value would only be a little over $125,000. Here’s why. If she were to sell her house and put that amount of money into T-Bills at 16% for 14 years, they would add up to $1,000,000 counting accumulated and compounded interest. So if she’s going to continue to deprive the buyer of the use of the property for 14 years that she’ll be using it herself, without any rents being paid, HE is, in effect, lending her the money without any repayment for that period, and he deserves the equity that it is earning.
Why would she sell at such a ridiculous price? Because she doesn’t want to give up her right to continue living in her house just to raise cash. Perhaps making a $1,000,000 isn’t as important to her as maintaining her lifestyle. Or maybe she has no heirs to leave the money to. Or better yet, WHY NOT SELL TO HER HEIRS? Look what they’d be getting.
First of all, they’d be able to help their parent or aunt or grandmother in a financially meaningful way without it being charity in any form. Second, they’d be able to save many dollars in estate taxes. Third, they would have a virtually management free investment for the entire period she lived there. Fourth, they’d reap millions of dollars in profits in the event there was a runaway inflation. Fifth, this house would not be foreclose-able since it would not be mortgage. Where might they find the $125,000?
Suppose you were an investor with a spare $125,000 lying around. You’ve heard about the single family house market, but don’t like management. If you could buy a house TODAY for $125,000 which was worth $1,000,000 and share the equity 50/50 with the heirs, wouldn’t that be attractive? In 14 years, at 10% appreciation, it would be worth about between 3 ½ and 4 million dollars. And if you were an heir, couldn’t you find the money?
PRIVATE ANNUITIES CAN PROVIDE CASH-FLOW FOR ALL PARTIES
Unlike a funded annuity from an insurance company, a private annuity is based upon mutual trust between the donor and the recipient. It is ideally suited for families who work together. As a variation on the above theme, suppose Aunt Tillie agreed to sell her big house on an unsecured contract whereby she would be paid the full value of her property over her 14 years of remaining life. This private annuity has special Treasury Regulations which govern it, but in so many words, Aunt Tillie will receive payments of interest, principal, and long term capital gains over her remaining life based upon the Treasury tables. The buyers will have a basis of (i.e.) $1,000,000 in a free and clear property. IF they are unrelated to Aunt Tillie, they could then sell the property for $1,000,000 CASH, TAX-FREE, since it would be at their basis without any profit. If they were related to her, they’d have to wait for 2 years before selling, but they could borrow against the equity to raise the cash with which to pay her.
What if Aunt Tillie lives to be 100? She will continue to receive the payments all her life. On the other hand, if she dies next year, they will stop, and neither the house nor the remaining payments will be included in her estate. The basis of the property to the buyer will be adjusted to reflect the actual money paid in to Aunt Tillie. This offers benefits to everyone in an age of dangerous economic fluctuations and taxes. It behooves everyone to get sound tax counsel when structuring private annuities.
REVERSE ANNUITY MORTGAGES – THE R.A.M. PROGRAM THAT REALLY WORKS
In the February letter I opened a can of worms when I punched the wrong button on my calculator. I had the lenders paying interest to the borrowers. When a couple hundred of you readers called me, I decided to straighten out my act and bring you some additional facts. Bronwn Belling, Deputy Director of the R.A.M. Program, 645 Tamaipais Drive, Corte Madera, CA 94925 has been most kind in helping me round up some specifics about reverse annuity mortgages. Write to her for additional information. Here’s how they work for people who are over 62 years old , have moderate incomes with few real estate assets, own their own homes with little or no mortgages in Marin County, Calif.:
Suppose you were 70 years old and needed to raise income. Your house is worth $150,000. You would apply for a loan at Bank of America, Crocker National Bank, Wells Fargo Bank, or Citizens Savings & Loan. It could currently be a 14% fixed rate, 10 year level payment, fully amortized loan. Each month you would receive $463 for 10 years. If you needed $5000 to pay off an existing loan, you could have that in a lump sum and then you’d only receive $386 each month. What if you only needed the money for 5 years? Then you’d receive $1276 after the $5000 lump sum payment or $1392 if you just settled for level monthly payments for 5 years.
A Graduated Payment R.A.M. is also available under which you might have a fixed interest rate and term, but monthly payments which increased 6% each year to fight the effects of inflation. In the above case they might start at $375 increasing to $632 by the 10th year. On a 5 year plan, they’d start at $1255 and wind up at %1584 for year 5. Lump sum payment plans are also available. And a Renegotiable rate R.A.M. is being readied which would offer you options to increase the term, raise the payments, etc. to reflect changes in the financial markets and the values of the property.
This isn’t an entirely new program. Over the past 10 years or so there have been. R.A.M. programs in Buffalo, Essex County, N.J., Washington, D.C. The Home Equity Conversion Project in Wisconsin serves as a clearing house across the country where three R.A.M. plans are due to come on stream shortly. You can call Ken Scholen, (608) 266-8103 to obtain current information on availability of R.A.M. plans in your area. Remember, these plans are to solve problems of older citizens who need income rather than equity. They aren’t designed to help out younger speculators who’ve been caught short by economic problems. But it isn’t difficult to see how helping our older family members and clients might generate cash flow which would relive strains on our own budgets, especially if we were to guarantee repayment at the end of the term in return for an equity interest. And with the larger 5 year cash flows, this could be meaningful as an income supplement.
EQUITY SHARING PITFALLS ARE BECOMING MORE APPARENT – BEWARE!
Equity Sharing has become a buzz word. Unfortunately the concept as originally taught by MILLER/SCHAUB seminars has become distorted. Investors are being trained to buy houses with negative cash flows, then to offer TENANTS equity interests in return for their agreeing to pay sufficient rents to offset the negative cash flows to some extent. It’s hazardous to go into business with someone with less assets than you have! In this time of easy bankruptcies, your property can become involved in costly and lengthy law suits even when only an Option interest is owned by the Tenant. When that tenant is a former owner who you dealt with in a distress situation, his buy-back option could be called a device to defraud creditors. In other situations, should he not be able to make his rent payments, you might be prevented by the courts from removing him and YOU’D be stuck with both the payments and a law suit to dispossess him. WE CONTINUE TO URGE YOU TO OWN PROPERTY INTERESTS ONLY WITH YOUR FINANCIAL PEERS to avoid future problems.
There’s an old adage which states that there’s plenty of money REGARDLESS OF THE ECONOMIC SITUATION for a good deal! When you can’t find investor money, maybe your transaction just isn’t sound enough. Then it might be wise for you to stay out of it too.
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
