December 1984
Vol 7 No 3
EVERY HEAP HAS A TOP AND A BOTTOM . . .
No matter what the politicians promise, there are still those who wind up at the top and those who occupy the bottom rung of the ladder. This remains true without regard to the particular form of government, economy, tax laws, domestic or foreign disorders. For those who want to succeed enough to sacrifice time, effort and capital, there's always a way. In this issue, I'd like to set some premises as to the future and see if there isn't a way to overcome the more obvious obstacles on your way to profit.
Let's look at some of the possibilities which could confront us over the next two years. Real estate could lose many tax advantages which enable it to compete for capital with the securities, money and commodity markets. Profit controls could be set up at the federal level to reduce “speculation“. So could rent controls at local, State or federal level. This would enable the government to inflate to pay the deficit. Interest rate controls are already in place now. Indexing is a fact of life with ARMs. It would be a simple matter to index all debt to the inflation rate. Of course, with all these governmental interventions into the markets, we could see a lot of inflation, a recession, or BOTH – stagflation. Each of these scenarios offer opportunity to those who can adapt!
How likely might any of the above be? Your guess is as good as mine. The economy is like a huge truck gathering momentum as it negotiates a narrow road down a hill. The brakes are having less and less effect. The driver is just barely able to maintain control. As the truck goes faster and faster he has to decide whether to lock the brakes and stop it entirely, try to continue to steer it even though the road ahead is more treacherous, or jump out and save himself. The future is uncertain at best, but it seems to me that SOMETHING is going to happen which will cause investors to have to make quick decisions just like the driver in that truck. I like to locate the fire escapes BEFORE the fire. We'll try to do this to some extent in this letter.
The first step is to acquire an aggressive attitude concerning opportunity. In sales we say one man's lemon is another man's lemonade. Any distress market offers myriad opportunities to make a huge profit! When you take a bath in the stock market you can still sell out for cash in moments at some price. That isn't true in real estate because we don't enjoy an ORDERLY MARKET and our use of LEVERAGE means that we need FINANCING to transact business. Thus, when an owner is in distress he's like a whale washed up on the beach. Helpless unless someone puts him back into the water. Distress buyers who can do that earn profits just like people in the stock market who capitalize on price drops. Here are some market segments which will he most affected by the above market changes I imagine.
LAND DEVELOPERS AND BUILDERS ARE VULNERABLE. . .
Both land development and building rely on the credit markets both to create a product and to sell it. They place their bets sometimes years ahead in order to be able to obtain undeveloped land at reasonable prices and to wait for new roads, zoning, population growth, favorable impact studies. Meanwhile they pay interest, taxes and principal out. When inflation increases their costs, unless they can increase their prices they lose money. Even without inflation, when interest rates rise and freeze a large number of buyers out of the market, they have to reduce prices or offer rebates at the expense of bottom line gains. And when the expenses of ownership or tax rates on their profits increase, their profit pays the price. A little innovation can go a long way whether you're buying or selling.
July 1st is the new deadline for imputed interest! You can still sell with 97 or more Trust Deeds without any problem with more interest being imputed by the IRS. Start at once to run year end sales with minimum down payments, 9% loans, maybe cash rebates or “decorating“, “pool“, “landscaping” allowances, etc. You want to create transactions now. Waiting until JULY will require you to charge/pay much higher interest rates or to make allowances for them. That's very difficult in mass marketing. Instead, close on a Land Contract. In areas where non-judicial foreclosures are prevalent, consider a lease option situation for houses or a pure option approach for building lots. Structure all of these to get the benefits of any tax rulings. In your contracts/Options you can place a clause which requires the buyer to obtain conventional financing at an appropriate point. You might say that ” the balance due hereunder will be due and payable in full at any time the buyer or assigns can make a bonafide application and qualify for conventional loans equivalent to 80% of the appraised value of the property”. Or the contract could be for one year, with the balance due at that time. However, you'd have the option to replace or extend the contract with an adjustment for inflation and interest rates in lieu of demanding full payment. This approach has several benefits.
First of all, by CLOSING your sale on a contract, you'd beat the July imputed interest rate deadline. By using a low interest rate, this would give the property a boost in the market where everything else had 14% plus interest rate loans. If the person who was buying the property were buying in “bulk” at wholesale prices his contract might have a subordination clause which would enable him to resell to another person who would place a conventional mortgage on it. For example, suppose a builder were buying lots from a land developer. With the purchase of 25 lots, he'd be able to offer his completed houses to the market to buyers who could (a) get a new loan and pay him off in cash which he'd divide with the land developer according to their negotiated split, (b) sell the property on a wrap-around land contract with an interest rate spread as part of his profit, (c) sell only the improvements and retain the land. The buyer would pay less for the house since he'd only be buying it, not the land. He'd pay the builder land-rent on the ground at a rate which would make sense. Later on he could purchase the ground if he wanted to.
Of course, there would be installment sale benefits which could be carefully structured into this arrangement as well as marketing advantages. The “paper“ generated by the land sales might be offered to the lender to reduce the payments of either builder or developer. The lender might like this because his debt would be divided among many other creditors who would be far less likely to declare bankruptcy. You could be any of the players in this scenario. You could co venture marketing of product for either builder or developer. Or you could be either one! Or you could negotiate with lenders to accept the paper as security for a building loan or permanent financing. Or you could buy out defunct builders and developers and do all this as a “DISTRESS BUYER”. Or you could buy the paper at discount – or buy the land leases at discount for your own investment or for someone elses who might be paying you a fee. Or you go into business and re-discount either for a profit. All these opportunities are created by distress. Isn't that odd?
NEW APPROACHES WILL CONTROL REAL ESTATE PROFITS.
In many areas of the country, new house subdivisions are including DAY CARE CENTERS as a part of the association fees. That's a great idea for young families in which both parents must work to support new house payments. What's being overlooked is the same type of recreational facility for RETIREES and aging parents. Whether for young or old, builders who can recognize the need for specialized amenities will capture a larger share of the market. It's just possible that tennis courts, pools and saunas can be replaced by on-site paramedics and health maintenance organizations, legal services, notary and accounting services, tour and recreational programs, golf/yacht club membership, remedial education and adult study programs. Each of these could be a profit center in subdivisions located in the suburbs at some distance from the city center. It would seem that sponsorship of scout groups, little theater, teen programs and youth job programs would make sales of homes much more competitive with little increase in cost per unit.
In the alphabet soup of new loans, a return to the basics has proven to be a consistent winner in good times as well as bad for Jim Walter Corporation. Jim Walter Homes started offering unfinished shell homes to the mass market to capitalize on the incredible demand for housing created at the end of WWII. Right now, a person can buy a 3/1 960 sq ft single family house with NOTHING DOWN, NO POINTS or closing costs at the full price of $37,555. Your payments will be $362.40 at 10% for 20 years FIXED RATE which is assumable at that rate by a new buyer. This is a basic house. Any extras will have to be added. But it is complete. If you want to do some of the work yourself, it can even be less expensive. The catch: YOU HAVE TO OWN THE LOT FREE AND CLEAR! That's the security for the loan with nothing down. Jim Walter markets his homes nationwide.
Getting a lot free and clear is easier than you think. Suppose you owned a rental in an attractive setting on which you had a loan of $50,000 at 12% FHA which was fully assumable. You're concerned that there might be a major “sell off“ of properties in that price range because of economic upheaval in 1985 or 86. You run an advertisement which says: I HAVE: 3/2 HOME, ASSUMABLE LOAN. I WANT: F&C BUILDING LOT $20,000 RANGE. LET'S TRADE! You'll find this a fairly easy proposition to put together. Why? Because current interest rates have frozen many people out of the market who had planned to build but who now can't afford it. I should know, I was one when interest rates soared to 6% in the early 50's I couldn't qualify for a building loan. I found that ownership of a lot with no home wasn't as desirable as owning a home with a low loan already in place on it that I didn't have to qualify for and with payments that I could afford.
Of course, you could also create a mortgage against your property and use it to buy the lot free and clear from our distressed builder on the preceding page if you didn't want to sell your house or were just trying to pyramid an existing equity. That's why I've been presenting the ANYTHING DOWN course for investors this past year. The next course will be in Tampa at the Westshore Inn on January 12th and 13th. Call (813) 961-2148 for details. With the free and clear lot, you're off and running to get your next rental at a modest price which you could either sell or rent for a-profit. Better yet, wouldn't this be an excellent house for either youngsters or oldsters who wanted moderate payments?
FACTORY BUILT HOUSING IS THE WAY OF THE FUTURE.
Think about it this way: What makes a house cost so much? Land, Labor, Material and fixtures, Financing, Marketing, Time. Suppose we could reduce these drastically? It would have a dramatic impact on price. On a recent tour of several modular house and mobile home factories, this was emphatically brought home to me. In my area homes which are built to Southern Building Code specifications can literally be trucked to the site and placed on simple parallel foundation walls by a crane. Wiring and plumbing runs under the property in crawl space. Builders can control quality, delivery schedules, all the various elements of production without losing money to pilferage, union holdups, shortages, had weather and local inspectors who fail to show up. On one project I saw an 8 unit condo “installed“ in a single working day – ready for occupancy that night.
US Homes, Cardinal Industries, Southern Structures and literally thousands of independent home builders are racing into this market. As the housing affordability index (that % of the population who can qualify for loans on the median priced house) worsens because of rising interest rates, inflation, lower incomes caused by taxes or recession, these properties will become about the only alternative. The person who can work with either land owners, sales teams, financiers and lenders, local zoning departments to set the stage for this type of activity will prosper. Of course, the easiest way to get in on the action would he to merely buy stock options on the major companies and wait it out.
Don't forget our old friend, the MOBILE. HOME. How much do you think you'd have to pay for a 1400 square foot 3/2 home with cathedral ceilings, screened porch, central heat and air, plaster ceilings and walls, fully insulated for energy efficiency? I was quoted $17,800 with a $1000 rebate to cover my costs for delivery and set up charges. Of course these were “dealer“ prices. What does it take to become a dealer? INTENT! If I'd been willing to complete an application I could have taken delivery on the spot. My costs would have stayed the same whether I bought one or 10 units. I could have arranged 15 year financing through GE or had I owned a lot, I could have had FHA or VA financing for 30 years. It doesn't take a genius to see that there might be a little profit in buying this unit, placing it on a $7000 lot with some landscaping, then financing the entire property or selling it at retail for about $45,000. That's exactly what people are doing all over the United States. Some of this money is turning 4 times a year for CASH. For the person willing to carry “paper“, the lot need not be free and clear. (Remember our builder who is thinking about carrying back his available lots on 9% land contracts?) And the entire package could be carried on a wrap around land contract.
That's the trouble with newsletters. Too much theory and fantasy right? About 8 years ago I and another erstwhile speculator bought 2½ acres for $5,000 cash. We had it rezoned to permit 2 mobile homes. We sold both the lot and a used trailer for $22,500 at 9% with payments first toward the mobile home at $375 and the remainder toward the land once the MH was paid off. We accepted a house with a $3000 equity as a down payment. I don't know what that yield was, but the loan has been fully paid off now. We did this at a time when MR living was not nearly so popular. Today that package could easily be sold again for nearly $60,000. Don't overlook this segment of the market if you want to succeed.
Americans are in the process of repudiating the CONDO market except in special situations such as resort areas and inner-city locations where housing is extremely high. Almost everywhere else the desire to own one's own home and land at the expense of many of the amenities is becoming evident. The condo market is a shambles. The prudent investor would be well advised to look elsewhere for low cost vehicles with attractive financing. Negative cash flow properties are becoming extremely hazardous in the view of tax and financial advisers, particularly if the flat tax acts we've seen become law. This might be an excellent time to take stock and to start moving equities into proven vehicles such as single family houses – and perhaps modular or mobile homes on individual lots.
THE ELECTION WON'T BRING MANY CHANGES WE DIDN'T ANTICIPATE . .
The Reagan landslide represented less an endorsement of Republican philosophy than a repudiation of Mondale's divisive appeal to special interest groups and minority 'voting blocks. Americans voted for the American Dream of a single nation, UNITED, whose national policy promotes the concept that the individual can succeed or fail according to his or her unique talents and capabilities without governmental interference. Reagan's mandate is to continue to promote economic recovery – to make the pie bigger so that each of us will have an opportunity to partake of it rather than to simply cut more pieces out of it as Mondale would have done, leaving the biggest slice for the non-productive sector.
We can look for TAX SIMPLIFICATION, DEFICIT REDUCTION as priority objectives in the new administration. The legislative process will be stormy as each special interest group seeks to preserve its own territory. In the process real estate will take some buffeting and interest rates together with inflation rates will rise several points. We have about 6 months before any meaningful legislation can be passed on the new taxes. I'll keep you informed as the future of SFH investment begins to emerge from the smoke and fumes.
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