July 1987
Vol 10 No 9
Over the past 10 years investors have been whipsawed by everything imaginable. In 1977 we had 8½% 30 year fully assumable loans with 4% inflation under Gerald Ford. By 1979 the Carter inflation had begun taking interest rates and price appreciation into double digits. Suddenly, even at 17%, leverage was in. The 'Nothing Down' school was in full swing. With house prices appreciating in excess of 2% per month in some areas, interest costs became NEGATIVE compared to inflation. SPECULATORS WERE MAKING FORTUNES OFF THE SAVINGS OF INVESTORS which were being loaned out by mortgage companies.
Lenders weren't doing badly either. So long as they could borrow (pay interest on deposits) at a rate below the inflation rate, they too had negative costs and their profits were pure gravy. Reagan changed all that in 1981/82. Inflation dropped like a rock, wiping out real estate speculators with high interest rates. Not just single family house owners, but farmers, small businessmen, capital intensive industries – and LENDERS TOO. Banks shot themselves in the foot! By foreclosing aggressively, they scared others out of the market. They had to start carrying real estate inventory on their books. They effectively replaced income-generating mortgages with management-intensive real estate.
Even though interest rates began to drop, the REAL INTEREST RATES ROSE! Many people misunderstood the difference between NOMINAL interest rates and the true costs of interest over the current inflation rate. Thus, even at 10%, interest became too high to sustain with inflation at 4% where previously a 17% mortgage was feasible with 20% price appreciation. Foreclosures and Bankruptcies became a way of life in many areas where speculators could no longer sell or refinance to pay debt obligations. Real estate prices fell taking the borrowers and the lenders along with them. So did OIL. So did GOLD.
Despite the fact that we're enjoying the most remarkable, longest lived, economic recovery in history, both banks and borrowers continue to go broke at record rates in many areas. Meanwhile the stock market has been exploding, making millions for speculators. The consensus seems to be that the market still has a long way to go. That's the way the 'nothing-down' folks used to talk in 1980 too, but things change. In the stock market, things do change virtually instantaneously. At least in real estate, it's possible to predict the changes far enough ahead to get out when the time comes, or to get safe. But with 24 hour trading, you can go to sleep rich and wake up poor as a stock speculator.
Where does all this lead us? The whole market's jittery. Money is being switched between stocks, bonds, gold and silver in wholesale lots. And the markets reflect this. Bankers are jacking up interest rates to offset anticipated inflation. Both real estate and non-real estate markets, in reaction to sudden rate increases, are creating yet more uncertainty. What's the prudent investor to do? Even the cash saved against economic calamities is losing value as inflation begins to rise. Meanwhile, TRA-86 deprives the saver of more and more of his spending power by decreasing tax shelters on interest.
Now may be a good time to get back to sound real estate investments – and the old reliable single family house still remains at the top of the investment heap almost everywhere despite economic news. As stock market investors seek more stable investments, real estate is the logical choice for all the same old reasons it's always been the final repository for true wealth – tax preferences, income, appreciation, amortization of loans, and because it offers something for everyone from the smallest to the largest investor.
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YOU'VE GOT TO KNOW THE TERRITORY . . .
By definition, real estate is fixed in location. This is what creates much of the differences in value between what might seem to be identical properties. Locally, the variations in location might relate to neighborhoods, schools, crime prevention, organized recreational activities for kids, physical amenities, proximity to jobs, churches, shopping and major arterial routes or public transportation. These would be important for houses. Commercial locations would be valued on such factors as visibility, zoning, access to rail sidings or high volume traffic, future growth in markets, labor and consumers. While the appearance of houses and prestige commercial properties is important, there's much more to be considered when making an acquisition. Often, the differences between success and failure depend more on hidden benefits than on those which are visible to the untrained eye.
Evaluation of houses requires less expertise than virtually any other kind of real estate – I'm talking about moderately priced tract homes. Why? Because the vast majority of the field of organized real estate sales continuously gleans market knowledge about house prices through the Multiple Listing Service computers and sales reports. An investor can find out average prices and terms for houses virtually on a neighborhood and street by street basis in much the same way that a car dealer can consult his NADA book to find out average values for each type of car with its accessories. Furthermore a host of specialists in the field of Appraising, Finance, Inspection, Title Insurance and sales await the beck and call of the serious buyer. Thus it would seem that any person could go to any locale and make a wise purchase. But, there's a fly in the ointment. . .
MANAGEMENT! Even vacant land must be managed. Hazards must be removed. So must trash which has been dumped on lots. Some areas require lots to be mowed regularly and pests must not be allowed to breed. Forests, Orchards, Groves require even more special care to insure they produce at peak efficiency. Office buildings and retail centers need managers who can respond swiftly to occupant's problems. Multiple-Unit residential properties can create liability problems which only on-site, competent management can avoid. Houses offer management challenges too, but these are far easier to meet than most other types of income property under ordinary circumstances. Regardless of the kind of real estate you buy, the ultimate profit and/or loss will depend more on the management you use than virtually any other factor. When you invest out of your own area, FIRST FIND COMPETENT MANAGEMENT, then make your purchase based upon the manager's proven performance.
Even under the best of circumstances, things can still go very wrong! Anyone who has ever visited Houston would probably agree that this is a world-class city. Real estate can be purchased at bargain prices and terms unavailable elsewhere. And for some, fortunes will accrue at breathtaking rates once Houston starts moving again. For others, disaster awaits just around the corner. The same might be said of many cities and towns in the Oil Patch and the Rust Belt. In order to capture these fantastic future profits, you have to know WHY the economy is currently down and WHY/HOW/WHEN/WHERE it will turn up. That entails knowing a lot more about the markets than merely the real estate aspects. Those who do their homework well will reap fantastic rewards, those who buy merely because prices are down will more certainly lose money than make it. There's a reason.
Real estate must compete with other investments in terms of what it does for the owner. When it falls behind, he'll sell it and buy something else. This happened in the years between 1982 and 1987 with a few exceptions such as Washington DC, the Northeast, areas of California and a few others. Land values rise when the products taken from the land also rise in price or when development can create value. This relates to consumption in the markets. Income properties rise when after tax income rises. Tax rates have a huge effect on after tax income. So, where house prices are down, it's likely that income is down too. Where land prices are down, the products of the land are down too. From time to time the government intervenes in the markets with special tax incentives, welfare payments in the form of subsidies or low interest loans such as are now being offered for low income housing investors. These offer POLITICAL rewards quite apart from ECONOMIC benefits, so should be considered carefully if they're allowed to intrude as a factor in your investment decision. You won't have to look far to see what happened to farmers and business people who had the government pull the rug out from under them in the farm belt. The bottom line to investing out of your own area is to select investments based upon the ECONOMIC return /vs/ the POLITICAL at prices and terms which will compete in the market.
YOU DON'T HAVE TO PICK ON THE HALT, LAME AND BLIND TO MAKE A GOOD DEAL . . .
I've been saying much the same thing about single family houses since my first nationally published article came out in 1975. That was before anyone had started to teach SFH investing. In that article I stressed that investment houses should be selected at just below the mid-point of the local market. Yet, over and over I find struggling owner/operators with 'junkers' – houses located at about the 25 percentile or below. After interviewing a number of these unhappy-but-cash-flow-adequate owners, I've started to realize that they bought these properties from people who were drawn from the same strata as the houses. From the bottom of the heap. Consequently, these landlords have been able to acquire large numbers of properties, but at the cost of litigation, tenant problems, high repair bills and hassle. In short, they're not investors so much as moonlighters with a second or third job. Most of them aren't much further along in their estate building program than they would have been if they'd just saved their money instead of investing it!
There's a fundamental reason for this, in my opinion. Out of the morass of tapes and booklets on buying houses, few facts are presented on delving into the NON-FINANCIAL MOTIVATION of the sellers, and meeting these needs as a part of the overall plan. Now, the new tax act has simplified this to some extent. Under TRA-86 we know that those who invest in encumbered land won't be able to deduct all their interest costs. And those who bought negative cash flow rentals will have similar problems. People with charge cards and credit accounts will lose consumer credit deductions. People in high sales tax states will lose these deductions. People with large portfolios of mortgage paper will pay much higher taxes as will those who sell stocks and get out of the market with large gains. What do these people have in common? They're members of the MIDDLE CLASS. They're largely capable of prospering in our society – thus are being victimized because of higher incomes rather than lower. And in many instances, they're more mobile than ever before. Hence, their needs relate to selling and buying shelter, disposing of assets, lifestyle needs.
With the recent rise in interest rates, many buyers have been shut out of the market. That means the middle class owner who depended upon a young 'starter' to buy his house won't be able to sell as quickly for cash. And he won't be able to buy without the cash from the sale of his house. This will affect every level in the market that depends on institutional loans to create sales. Developers, Builders, Dealers, Brokers, Salesmen. Under TRA-86, dealers and sellers of properties with a value in excess of $150,000 will be penalized when they use installment sales. Here's where the truly creative buyer will find unparalleled opportunity without much competition from the 'nothing down' guys. He or she will be able to buy middle class properties for middle class tenants at favorable prices and terms because of the ability to really solve problems that the owner perceives.
There are several schools of thought regarding this market. Some people think that both property and income taxes will be higher in coming years. Others believe that rates will come back down, causing the Stock and Bond markets to take off again. Some say that any decrease in interest rates will cause the dollar to drop and the Japanese to start buying EQUITIES in real estate and to STOP buying government bonds. They predict the specter of this 'pull-out' will cause the FED to hold interest rates up, causing the costs of servicing the US Debt to rise as deficits grow bigger. This cycle perpetuates the need for more taxes and more foreign capital, further complicating investor's lives. But regardless of what happens, the same numbers of people will need decent housing and will want to maintain their middle class life styles. So here we have a fresh opportunity to acquire investment houses from sellers with recognizable reasons to sell at prices we can afford to pay. Now all we have to do is to learn ways to structure acceptable purchases.
JUST SUPPOSE YOU WERE 'HOME FREE', WHAT WOULD YOU DO?
Under our preferred subscriber program, you've just been awarded $250,000 in credits to be used for your long-term security. What would you invest in? Houses? Cash? Tree Farms? Elder-care facilities? Tax-free Municipal Bonds? Single premium insurance? Retail/Office centers? Trailer Parks? Developments? As you might surmise, money brings more problems than it solves if you're looking for time off. If you're looking for brand new challenges, it can turn you into a kid in a candy store – wanting everything but only being able to afford a limited selection. If you're young with years of productive life ahead of you, you might want to start a business, or buy into one. But which one? On the other hand, if you're past the age of consent, you might be far more interested in the present, and want current income, indexed to inflation. As you can see, each individual has special needs and objectives, tolerances to risk and to hassle, abilities and limits.
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
