February 1980
Vol 2 No 5
Depending upon your personal point of view, the year (and decade) that is coming up can be the source of unbridled optimism or extreme anxiety. From the standpoint of the single family house investor, the demographics can be fantastic. Never before in our history will so many people have entered income brackets which will afford them opportunities for investment and the “good life”. Our internal markets should see continuing expansion, which will continue to generate additional increased in income levels throughout the middle and upper segments of the economy.
In spite of this, there are clouds on the horizon. As the weaker elements in our competitive society fall farther and farther behind, there will be political advantage in pandering to the demands of those who are unable to cope at the expense of those who can. In this election year, we can expect to see many a straw cast into the wind by various political candidates. Some of these might possibly influence OUR well being, so a little educated guess-work on the coming year might be beneficial.
FIRST THE GOOD NEWS:
Tax-reform is on the Congressional agenda. Possibilities of advantageous changes include faster write-down of income property, some relief from taxes on interest income, a general tax-cut once the economy appears to have slowed down, more exclusions to certain types of income. The new Value-Added-Tax won’t pass in 1980.
Interest rates will taper off somewhat later in the year. We can anticipate a prime rate somewhere around 11% to 12% by year’s end. For savers, Federal law will allow interest bearing checking accounts to become commonplace. Even now, with usury rates being suspended until Spring, some of the lendable funds which have been flowing to “high-interest” States are returning to areas which have been hard pressed for mortgage money.
Aside from political interference with the markets and distribution system which could be caused by rationing or a Federal gasoline tax, the gasoline shortage is being eased by the action of the market itself. As the price continues to go up, people are conserving gasoline as a natural reaction to high prices. This resolve on the part of millions of individual consumers has done more to help the energy situation than all the rules and regulations put together.
Defense spending will be “in” in 1980. President Carter will ask for and get additional money for procurement. This means that housing around military bases, defense contracting and manufacturing facilities, R&D installations, Universities engaged in military research projects will be in demand. The tenants will have the money to pay increased rents as the local economies boom.
Gold, Silver, numismatic coins will still attract investor money, and some of the more stout hearted will buy deep-discount Bonds or special-situation stocks. In 1980 there will be huge profits for those who guess right and just as steep a slid to the bottom for the others. We continue to prefer SFH over all comers.
Energy shortages will cause consumers to look in new directions for their recreational interests. We like resort time-share condominiums when they can be bought at reasonable prices, and in popular locations with Summer and Winter seasons.
AND THE BAD NEWS IS . . .
1980 is an election year! That means that the economy is going to be put into some unusual attitudes during the year. On the Presidential level, the picture is still cloudy. It looks like a real donnybrook is shaping up unless something dramatic happens in the World situation. If the Iowa debates were any indication, it’s going to be a L-O-N-G year until November. We can expect a lot of pump-priming by Congress to get the voters into a positive frame of mind, so what does that mean to us as investors?
Inflation in 1980 will look a lot like inflation in 1979. Food, gasoline, medical services, property taxes, FICA, housing will continue to rise in price. We can expect a lot of lip service, but little real action to attempt to hold things down. An area of growing concern is CONTROLS! We are a little nervous about rent controls, taxes on speculative profits in housing, moratoriums on condo-conversion of existing apartments, and increasing environmental limitation of sea-shore development all over the country.
The international situation is heating up rapidly, and we have been caught in a weak position in the Persian Gulf in spite of repeated warnings. We can’t completely rule out the possibility of WAR in 1980. Our freezing of Iranian assets and bank reserves and our embargo on trade with Russia is causing many of our fair-weather friends to scurry for cover. Any time nations start protecting their own interests at the expense of loyalty to their allies, it creates uncertainty. We’ll keep a close watch on this.
How does this combination of good and bad prospects for 1980 affect our own individual plans and investment decisions? What should we be doing over the next 12 months? One of the primary attractions of the SFH as an investment vehicle is its built in resilience. Because it comprises basic shelter, it will continue to appreciate at the rate of its replacement value in good times and bad. As inflation drives wages, land, materials, and money upward in price, the SFH will be forced upward with them. We don’t see the threatened recession as being very serious at this time. We see inflation as the greater influence in the economy. Our strategies are based upon increased housing costs!
Just as uncertainty drives the costs of Gold and Silver ever higher, so it also makes the single family house more attractive. Except for isolated, economically depressed areas, the SFH should remain a good strong investment vehicle. Implementation of controls on condos and apartments will only enhance the SFH as a store of value, and rental increases will keep pace with inflation as vacancy rates are eliminated by the demands of the marketplace.
We keep reading about the “real estate collapse” which is reportedly just around the corner. Experts who predict real estate’s doom are usually also defending the securities markets. Our interests are focused very narrowly on the single family house rather than on the “real estate market” per se, or even housing construction. Most of the data on which predictions are based relate to something other than existing houses. Thus, when we read that “housing is off”, that really means that OUR rental investments are appreciating faster as a result of the increasing demand for shelter which is not being built by the builders. We can draw the same conclusions from news items reporting “tight mortgage money”, “restricted land use”, condo-conversion moratoriums”, etc.
In spite of all the machinations of the politicians and “green panthers” to “protect” the public, ultimately, we the owners of rental houses benefit. Rent controls actually drive up our income as apartments fall into dis-repair and are abandoned to the tax collectors. Ownership of one’s home is an American dream not soon abandoned, and the public will sacrifice much more than we suspect to live in a decent house surrounded by a private yard. When he can’t buy this, he will rent from us at fair market rents we set. On the few occasions when rent controls invade the territory of the SFH, we can easily sell it for inflated prices to the same tenant who is prevented by law from paying a high rent. Later we can buy it back through the use of options at a profit.
In inflation or depression the concept of SFH investment has stood the test of time provided the financial terms at point of acquisition are structured safely and with an eye to the future. The lease/option technique is particularly suited to our times now, so here are a couple of variations of this theme to take advantage of current high rates of interest and tight money. See if they won’t work in your area.
In almost every area there are firms which specialize in either managing or listing houses for rent. They are a virtual mother lode of leads to owners who, at any particular time might be disposed to sell their property. There are two basic approaches to these owners. Let’s consider each.
First of all, it is essential that one cultivate close working relationships with rental companies, since they will be helpful in filling vacancies of houses once purchase has been completed. Bear in mind that they too have the problem of finding house owners who will list their vacancies with them. This creates a natural spirit of cooperation which can benefit both investor and rental agent.
The rental agents record and store valuable information concerning rental histories of properties throughout their areas. They know the names and addresses of various owners, vacancy rates of specific houses, maintenance and replacement schedules etc. They have insights into the attitudes of the owners, and will be the first to know when any particular owner is discontented with being a Landlord.
From the start it is important to convince the rental agent that you will be listing all houses you purchase or lease with his or her firm. Then ask him to send each owner a form letter any time that the rental agent must contact him or her to report a vacancy or a repair expense. This form letter will state that you, an investor, are interested in leasing the property for a period of 5 years (or 3 or 2) on a net basis slightly below prevailing market rates. Further, it should offer an alternative to the owner that you will improve the property and take care of ALL maintenance and vacancy expense in return for a credit of a portion of the rental to be applied toward the purchase price in the event you decide to buy the property at a later time during the lease period. Your interests would be protected with an Option.
In the event the absentee owner elects to lease you the property with an Option, you will have gained control over all future appreciation above the Option price. Sometimes, as an inducement to the owner to give you the Option, you may have to divide the future growth with him. This can be done by offering a price which reflects the appreciated value a year or so into the future. The increased price can be offset completely simply by adding a year or two to the lease period.
Now, suppose the owner is perfectly happy with the Lease, but is unhappy with the Option and refuses to grant it? There are still benefits to be obtained for the investor. Most of us need cash-flow from time to time. By negotiating a pure lease for 5 years which is discounted from fair market rents by enough to offset the projected vacancy rate and maintenance costs, the investor can structure in a positive cash flow from the start. This cash flow will grow as the investor increases his or her rents while holding his or her own costs constant under the provisions of the lease. Over a period of 5 years, this net cash flow can grow to over $100 per month. Of course, both Option or Lease should be recorded to protect the investor.
In the event the owner should find it necessary to sell the property at a point during the term of the lease, the investor’s recorded interest would cloud the title. He or she might need to be bought out by the owner prior to sale. In effect, this still provides an excellent opportunity to buy the property later without the formality of an Option. Increases in taxes, insurance, etc. similarly motivate owners.
As the Lessee, the investor has no right to depreciation under normal arrangements (but see The CommonWealth Letters, Sept. 1979 for alternative ways to depreciate leased property). Looked at objectively, depreciation amounts to no more than after-tax cash flow or profit. Control over appreciation and use of the owner’s equity without paying any interest at all during the lease period have a countervailing effect which offsets missing depreciation. Meanwhile the owner pays for major repairs and property taxes, insurance coverage, etc.
In order to capture ALL owner benefits, one must OWN the property. Here again we can turn to our trusty rental agent for help. Where it isn’t prohibited by law, one might offer to pay a $500 finder’s fee for every house purchased as a result of the rental agent’s assistance. The agent provides leads to disconsolate owners whom the investor contacts. Each $500 paid to the agent is equivalent to fees from management of 20 or so houses. It’s not hard to see why he likes this plan.
IN THE POTPOURRI DEPARTMENT:
For those of you interested in a more detailed study of economic forecasts for the coming year, U.S. News and World Report’s October 15, 1979 issue has a comprehensive study. The Kiplinger Magazine also publishes a booklet “The Exciting 80s” for about $5. Business Week in December and January has had several issues devoted to forecasts of specific segments of the economy. You might try your neighborhood library for these publications. An evening there could be well worth it.
Here’s a round-up of the Due-On-Sale Clause cases so far: Colorado, Illinois, Maryland, Nevada, New Jersey, New York, North Carolina, Ohio, Tennessee, Texas, Utah, Washington, Wisconsin are generally supporting them in their court cases. Alabama, Arizona, Arkansas, California, Florida, Michigan, Mississippi, and Oklahoma are opposing due-on-sale clauses. Also, Iowa, Arizona, and New Mexico are passing laws which will limit the lender’s right to apply due-on-sale clauses indiscriminately. Each case is decided on its own merits, but this indicates legal sentiment to date.
We’ve a nifty idea given us by Paul Olson of Brandon, Florida. He has a kit which makes it possible for him to key his own locks. It is the KWIKSET 400 SERIES LOCK TUMBLER SET, sold by Kwikset Sales and Service Co., 516 E. Santa Ana St., Anaheim, Ca. 92803. With this kit, in about 10 minutes, a person can change the lock in a house to fit another key. It is even possible to key all your locks so a single master key can be used by maintenance/management people. Try local dealers for one.
Tax-wise, if you’d like to know where you stand, a national average of those in the $25,000 per year income bracket, computed on adjusted gross income, take about $5400 in itemized deductions. This leaves them with a tax bill of $3130 plus a Social Security tax of $1404. They contribute $930 toward defense; $345 to interest on the national debt; $105 to Federal employee retirement; $410 to the unemployed; $91 to the EPA; $158 to VA; $240 to Medicare; and $15 to the Post Office.
Bill Greene (author of “TWO YEARS FOR FREEDOM” – $16 Hardcover, 307 pages, P.O. Box 408, Mill Valley, CA 94941) has sent us a quick summary of the latest (and hopefully final) court decision on tax free exchanging in the Starker vs. United States, 602F 2d 1341 (1979) case. Essentially it means that you may sell of your investment houses under controlled circumstances for profit tax-free. In combination with impending legislation which will enable you to pass on your real estate holdings to your heirs without paying income taxes on them, it means that taxes might NEVER need to be paid. This is a technical subject which we will deal more with in the Nitty-Gritty Clinics scheduled for 1980. In the meantime, find a competent Exchanger to help you structure your transactions to take advantage of the Starker decision.
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