Fasten Your Seat Belts, It’s Going To Be A Bumpy Ride

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Topics: Market Trends

From 1978 to 2009, Jack Miller wrote the Commonwealth Letters, the first newsletter devoted to the single family house investor. Jack Miller was a brilliant real estate investor with 45 years of experience. He created many of the creative techniques and strategies which are used today. He stayed on top of what was happening in the economy and with taxes because he knew they both affect business, consumer confidence, and real estate markets. His favorite past time was reading the Internal Revenue tax code to better understand how it affected investments and where the loop holes were.



Below is Jack's newsletter from December 2008, one month after Obama was elected the first time.. See how “spot on” Jack was about what would happen after the campaign promises fell to the way side. You can read Jack's advice about inflation and real estate strategies.



Soon, CashFlowDepot.com members will have access to all of Jack's Commonwealth Letters. I've posted 6 so far and hope to have the remainder posted within a month.



The advantage of reading Jack's Commonwealth Letters is looking back to time with similar economic conditions and seeing what Jack advised investors to do.  You can look back to previous times when high inflation and high unemployment were looming and see what Jack's advice was for real estate entrepreneurs. 



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CommonWealth Letters                        Vol. 32 No. 3
For Investors In Single Family Houses                December 2008
www.CashFlowDepot.com
                                                                                                                                      
GOING, GOING, GONE . . .

          Jimmy Walker once said that voters always get the politicians they deserve; and so we did.  Obama’s new programs create additional government bureaucracies staffed by thousands of employees that will initiate and supervise uncounted new regulations that will make doing business much more difficult and less profitable.  And you can bet that when he says “we’re all going to have to sacrifice”, he means we are going to pay higher taxes!  None of these changes will take place in 2008, but many new tax rate increases on both business and individuals will be put in place.  These could be made retroactive to January 1, 2009.  The point is, that if you want to take advantage of the current tax rates and benefits, you’d better do it before year’s end.  After that they could be gone forever.  

          When making decisions as to whether to demand payment or take deductions and to write off expenses, you should think in terms of the next two years.  The income, dividends, and capital gains you take in 2008 could be taxed lower than in 2009, and the expenses you take in 2008 could be more valuable to you in 2009, or vice versa; so you have to weigh which year in which to take what.  Bear in mind that if your AGI exceeds $159,950, itemized deductions are reduced by 1%, but this doesn’t affect medical expenses, casualty losses, or investment interest.  With that in mind, let me review some of the things you could be doing before the year ends:

          Depending upon your tax situation, if your total itemized deductions are about the same as your Standard Deduction, the Standard Deduction is going increased in 2009; so it may pay to take itemized deductions in 2008, and a Standard Deduction next year.  You can increase 2008 itemized deductions by paying State income taxes early this year along with the mortgage interest.  Get elective surgery done if it exceeds 7.5% of your gross income.  Add up all deductible charitable gifts you intend to make in 2009 and pay them in 2008.  

          You have the choice of deducting either State and local sales taxes or State income taxes.  If your State has no income tax, you should deduct either the actual sales taxes paid, or taxes from the IRS tables.  Car buyers can add sales taxes on cars on top of the taxes in the Sales tax tables.  This is a good deal.  Suppose you were to buy a new SUV with a loaded weight of over 6000 pounds used 100% for business; you could deduct $25,000 +$12,500 Bonus Depreciation, plus $3500 regular depreciation, or $40,000 the first year on a SUV you financed at 100%.
     
          There is a 50/50 chance that those over 70.5 years of age who are required to take a distribution from retirement plans may not have to take a distribution in 2008, but that could cause you to take two distributions in 2009 when tax rates could be higher.  If you would ordinarily be making gifts to charity out of taxable income, in 2008 and 2009 you and your spouse could each divert up to $100,000 to charity from separate IRAs and not have to pay taxes on it.  

          Many people would like to raise money but don’t want to pay taxes on gain on appreciated assets they sell on which the price has declined.  They would wind up paying more taxes while losing money.  For some, the Alternative Minimum Tax, with rates between 26% and 28%, could be added to income tax along with State tax.  Gain could thus be taxed more than 50%.  Because regular income taxes can be deducted from AMT, it might pay to take a larger salary, pay the maximum into your IRA or Corporate Pension Plan, and avoid AMT.  If in later years, if you incur a tax loss carry-back, you can recover income taxes, but not AMT.  If you formed a qualified  corporate pension plan, you could contribute appreciated Stocks and real estate to your corporation, sell them to capture the gains, then put up to $185,000 into a Defined Benefit Plan, or as much as $45,000 into a profit-sharing plan tax free.  The tax on your corporate salary will offset AMT.  Don’t delay in doing this.     

 
FASTEN YOUR SEAT BELTS, IT’S GOING TO BE A BUMPY RIDE. . .

          
          Obama will have just 77 days to assemble a cabinet, set critical priorities, and prepare a federal budget.  It must be submitted to Congress by February.  In addition to our multi-trillion dollar national debt, the Congressional Budget Office estimates that there will be a $450 billion shortfall this year, and $750 billion next year.  Most of the “change” by each new Administration occurs within its first 100 days during a Honeymoon period with the new Congress and the Media.  After all the new players in the game settle in, the sledding gets a little tougher.  Big business, unions, financial backers, and social agencies stake out their territories and start demanding a piece of the budget pie.  That’s when the rubber meets the road and reality sets in.  We can expect about the same in 2009.

          Obama will have to confront a host of challenges that will demand immediate attention.  The most pressing of these is rapidly falling housing prices, defaulted loans, and bank owned real estate.  A 90 day moratorium has been proposed for home owners who have demonstrated a conscious effort to pay their loans.  This will be coupled with new Bankruptcy laws that give Judges the power to cram down loans to make them more affordable.  You can expect long lines at court houses.  

          Nobody seems to question how already weak mortgage lenders can stay in business when they must pay interest to investors and depositors at a time when they can’t foreclose defaulted loans; and when the value of their loan portfolios can be changed with the stroke of a pen by a judge.  This can only result in fewer loans to fewer buyers, continuation of falling housing prices, rising defaults, and a much slower housing recovery.  This scenario is great for buyers, but bad for sellers.

          Obama’s first priority has been reported to be to dispense with the secret ballot so that unions will be able to identify who voted for and against them and their issues.  The net result will be to accrete power to labor that it hasn’t had for the past 50 years.  We’ve already seen what happened to the quality of public school education after unions gained control of teachers; wait until unions take over industries in other areas.  Let the strikes begin.  As union membership grows, so will there be more money for union lobbyists to pass laws that will restrict trade and make America even less competitive in world markets.  

          Coupled with increasing influence of organized labor will be higher taxes on employers and employees who make over $250,000 per year including higher payroll taxes and higher income tax rates.  This will take place at the same time that the economy is slumping and unemployment is increasing.  The net result ultimately will be loss of jobs and loss of savings in any 401K plans that are invested in stocks.      

          To ease the pain of unemployment, penalty-free withdrawals from retirement accounts up to the lesser of 15% of the account balance, or 10% would be tax-free.  To encourage hiring, a $3000 per employee tax credit would be given to employers in 2009 and 2010.  A refundable mortgage credit equal to the lesser of 10% of the current mortgage balance or $800 would be given to non-itemizers.  It is doubtful that any of these measures will have much effect on those who have lost their jobs.

          As health-care costs spiral out of control and Medicare faces increasing shortfalls, overhaul of the entire health-care system is urgent.  A refundable tax credit equal to 50% of the costs of health-care insurance premiums paid on behalf of employees by small employers has been proposed.  Note: Tax credits are only valuable when a company is making enough money to pay taxes, so this may not work very well.    
     
          To help get the economy moving again, Obama has proposed a second economic stimulous package of $175 billion.  This will be parceled out to States to prevent more cuts in State budgets, for road maintenance and school repair, extension of unemployment benefits, tax moratoriums and credits, and for the purchase of troubled banks.  It’s not clear where this new money is coming from.  If it’s borrowed, it could drive up interest rates.  If merely printed, it could drive up inflation.  If it comes from new, retroactive taxes, it could deepen the recession.  Read on:              
 
WHERE DO WE GO FROM HERE?

          It may have escaped the attention of all the Presidential candidates but Ron Paul that America is broke.  We’ve over-extended our credit cards with all those who eagerly loaned us money when we were booming.  We’re waging a war that is costing us $10 Billion each month that we don’t have.  Our tax revenues are dropping in lock step with the incomes of individual and corporate taxpayers.  The costs of all those social safety nets are rising and are scheduled to rise much higher.  The only reason that the dollar isn’t dropping against the Euro and Yen is that the economies of Europe and Japan are in even worse shape than ours.  One normally doesn’t think of a country going bankrupt, but a couple of months ago Iceland did.

          There’s little chance America will go Bankrupt, but investors want higher yields to compensate for our weak economy and the fact that we never repay the national debt; we just roll it over and over at higher and higher interest rates.  If America were a person, we’d be a loan shark’s best customer.  If America were a huge corporation, it could issue Bonds; but Moody’s would rate them as “Junk Bonds”.  These are not investment grade.  U.S. Bonds aren’t quite that bad, but a month or so ago when the Treasury offered Bonds for sale, only about 20% of the issue was subscribed to.  As Treasury Bonds rates rise, higher interest is passed down the line to borrowers.  This robs consumers of buying power and stalls the economy.    

          If we can’t borrow money, then we’ll have to increase taxes to raise more money than we expect to spend.  This is what Hoover and FDR did and the result was the Great Depression.  If you’d like to read exactly how this came about, read “The Forgotten Man” by Amity Shlaes.  In so many words, taxes rob the real producers in a country of any incentive to risk their money to expand businesses, to increase production capacity and jobs, or to extend credit to customers and clients.  The result is a jump in unemployment claims that the country can’t afford to pay.

          If we can’t borrow or tax, the only choice we have is to create more money.  This is done by the simple device of the Federal Reserve printing currency and using it to buy U.S. Bonds that were printed up for sale.  This way, we owe it all to ourselves.  That may fool the American public, but it doesn’t fool the international community.  Nixon tried this and wound up having to decouple the U.S. dollar from the world price of gold.  This caused the dollar to devaluate by 10% virtually overnight and oil prices to double.  That’s the same as robbing 10% from the savings of every American, investor, and securities-based retirement plan.

          After Jerry Ford tried to pick up the pieces with his “Whip Inflation Now” (WIN) drive, Jimmy Carter inherited the shattered economy that Nixon created and decided if you can’t beat ‘em, join ‘em.  His inflation set new records, driving housing, gold, and silver prices through the roof.  Those that owned real estate made fortunes while the rest of America steadily became poorer.  

          That’s about where we are today.  Our new President is going to have to create money to pay for programs that he can’t pay for with growth, taxes, or credit.  Those who buy houses at today’s steeply discounted prices are going to reap fortunes as inflation takes hold; even though rents will probably remain soft as taxpayers are squeezed even more.  Those with fixed rate debt will make money at the expense of lenders, and those with adjustable debt are going to be wiped out.

          As inflation rises, so will interest rates.  Fewer people will be able to afford to buy and will have to rent.  Rental demand will eliminate vacancies and push rents upward while the highly leveraged profit locked up inside the Option will soar.  A long term lease coupled with an Option to buy real estate at a fixed price is going to create instant income for entrepreneurs.  The trick is to lease unsold houses from builders, lenders, investors, and individuals at prices far enough below fair market value to create a profit-spread.  Jimmy Carter’s inflation coupled with Options enabled me to retire early and the time is ripe for the Obama’s inflation to do the same for you.  The only thing you have to do is to go out and find houses in good neighborhoods that will attract desirable tenants and lease or Option them.

A SUBMARINE IN A HURRICANE

          Today there’s an economic storm raging in a sea of mistrust and pessimism.  Big business, employers, investors, corporations, high incomers, retirees, and Johnny Lunchbucket are going to see some hard times despite all the promises to the contrary.  Those in the house business who are willing to adapt to the market are like a submarine lying deep below a hurricane.  No matter how stormy the seas above, it waits patiently in still water waiting for a target in the midst of the havoc.

          Put all of this into perspective:  At the height of the Great Depression, 75% of all the people still had jobs.  Today, even in a worst case scenario, about 90% of the workers will still have jobs.  About half of the owner occupied single family houses in America are free and clear of debt.  Those who are losing houses are speculators who bet that highly leveraged houses and condos would go up in value; or foolish homeowners who mortgaged perfectly good houses to the point that these loans could not be repaid out of rents or personal funds.  Many of those who supposedly are losing money on houses are really losing money on their expectations of profit, or on money that they borrowed and aren’t going to pay back.  How many of those who owned free and clear houses lost money?  Very few.  Why?  Because they weren’t forced to sell and could continue to occupy them or rent them for cash flow.

          Take another close look at all those tax changes and note how they will affect you and your investments.  As a reader of this letter, I presume that your main interest is in buying, selling, mortgaging, Optioning, leasing, and holding single family houses.  Almost everything that is on the docket to be passed under the new Administration plays right into the hands of the real estate opportunist.  Houses in the most distressed areas have dropped to 2000 levels, and rents are beginning to rise.  Under proposed tax changes, our tax benefits are still intact.  

          Consider the following:  The stock market has lost $trillions since July.  Many Banks and Mortgage Companies are on the brink of failure and insolvency.  FDIC doesn’t have the money to protect depositors.  Inflation is rising.  None of the new laws are going to help lenders liquidate foreclosed inventory.  As lenders auction their REO houses at rock bottom prices, you’ll be able to buy them for cash supplied by investors who have been sitting on the sidelines holding cash waiting for a safe, secure, tangible place to store it.  Why would they invest in real estate now?

          Investors are frantically searching for safe havens for their money where it won’t be wiped out by political manipulation of credit, higher interest rates, currency devaluation, inflation, higher taxes, etc.  If YOU had a $million, where would you put it?  What better place to stash it than in free and clear houses that can be bought at mere fractions of original cost or replacement value; then managed for tax-sheltered cash flow?  I’m one of those investors.  I’ve taken my money out of shaky banks and the collapsing stock market and am buying every foreclosed inflation-proof up-scale house I can afford.  That’s where you come in.
                  
          If you cultivate the skill to buy foreclosures, bank REOs, and houses from pre-foreclosed speculators who aren’t protected by anti-pre-foreclosure laws; the bad news really can be good news for you.  For the next few years or so, as all of the foregoing changes cause the economy to sink further, you’ll be able to buy houses at lower and lower prices while renting them at higher and higher rents.  How can this be when the economy is slumping and incomes are falling?
 
          The houses that I am buying are in a price range in the upper third of my housing market.  The rental market that I am aiming for is comprised of all those in the same market who can no longer afford to own their house, but can afford to rent my comparable house in the same neighborhood at a much lower price.  A typical house that was bought at foreclosure was rented to a person who lived just a few doors down the same street.  He lost his home because he couldn’t make the $2800/mo payments.  The house he rented was bought for about one third of the price he paid for his, so can be rented to him for $1500 per month.  At that price it will earn 7% net rental profit after taxes.  He’ll never move out because he can’t afford to.

Copyright © All Rights Reserved, Sunjon Trust (888) 282-1882
Quotation not permitted.  Material may not be reproduced in whole or part in any form whatsoever.

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