April 1985
Vol 7 No 7
INCOME PROPERTY – MAKING MONEY THE OLD FASHIONED WAY . . .
Last month I talked about some of the ways I'd lost money on “paper” investment. This month I'd like to reflect on ways I've made money on a different kind of paper. The paper that I prefer has some interesting features. First of all, it's indexed so that my income from it roughly rises in times of inflation. And oddly enough, it also rises when real estate markets are in a slump. My favorite kind of “paper“ is unsecured for the most part, yet it offers virtually unparalleled income in terms of quality and durability. It is rarely affected by bankruptcies. It can continue to pay year after year in increasing amounts. Best of all, I can, through my own efforts, increase the amount of yield without investing additional money. You see, my paper is a rental contract. My income is rent!
Managing single family income property isn't for everyone! It's not passive. At best, it's dull work. Landlords aren't usually thrill seekers. We don't like tenants who bring excitement into our lives. But it is challenging. Rewarding. It gives one an opportunity to use all one's talents. A Landlord is a Personnel Manager, a Financial Executive, a bookkeeper and an accountant, Chief Executive Officer, Maintenance Supervisor, Procurement Specialist, Foreman, Cost Estimator, Contractor, Collection Agency, Promoter, Diplomat and Counselor rolled into one. The job requires those skills with ideal tenants. With the other kind, it gets even more complex. I'm amazed at how easily people invest in rental property without any training and experience as a small business owner or supervisor.
In most areas, the owner of just 10 rental houses is responsible for a business with more assets than 75% of those listed in the Yellow Pages for the same area! If he's going to be successful, he's going to have to run his rental business with the same degree of determination and effort as any other small business operator. He has to know the law as it applies to his business. That means the health and safety regulations, minimum housing statutes, landlord and tenant laws, civil procedures for evictions, small claims courts, garnishment. He has to have a nodding acquaintance with state and federal income tax laws. He has to know the difference between hiring a contractor and employing someone, and why that's important. And he has to combine these talents to produce cash flow.
THE REWARDS CAN MAKE IT ALL WORTHWHILE!
Every time I see the stock market jumping by 20 points in a single day I'm overcome by envy. Until rational thinking resumes and I realize that 20 points in a 1300 point market amounts to little more than 1.5%. Of course, that could add up to serious money if it happened every day, but it doesn't. Over the past 20 years stock markets have run up and run down making millions for the speculators who won, and losing millions for the ones who guessed wrong. Today the Dow Jones Industrial Averages stand only about 300 points above where they stood in 1966. 30% over 20 years isn't too thrilling compared to a house I've owned for about the same amount of time. I paid $3000 down and took title to an existing assumable 5.25% loan. I lived in the house for 11 years and have rented it since. It is now worth about $70,000 and I owe about $6,000 on the mortgage. It pays me almost $400 per month after all expenses. And most of that income is sheltered by depreciation.
I'm not sure how to compute the yield without a lot of historical research, but based upon my original down payment, I think I'm getting 160% or so a year. Of course that's just cash flow. If I count the invisible benefits such as loan amortization, tax enhancements, appreciation; the figure would be bigger. And I imagine that I recovered all my original investment years ago. I can't seem to find other $3000 investments that will do as well for me. Remember, I'm not a speculator. Speculators take chances on things they can't control – like markets, inflation, tax laws, interest rates. They're usually in a hurry. In the stock market they're called “traders“. I'm an investor.
Copyright © Sunjon Trust All Rights Reserved, www.CashFlowDepot.com. (888) 282-1882
Quotation not permitted. Material may not be reproduced in whole or part in any form whatsoever.
An Investor is more like the turtle than the hare. I'm patient. I'd rather be safe than sorry. I'll take the slow, more certain profit than to take a chance on the larger gain. Fortunately, the economy and the tax laws favor Investors over Speculators. Here's how. Speculators take all the chances. When they win, they pay the highest taxes. They can't take long term capital gains on inventory they've bought just to resell at a profit. They can't make tax free exchanges under IRC 1031. They usually buy property without any cash flow – or with NEGATIVE CASH FLOW. They over-leverage; increasing their risk of failure. And they fail regularly. Bankruptcies are continuing to remain high.
If interest rates start back up again, or a new tax law changes. tax benefits, more will fail.
But look at all the Investor has going for him. He gets to write off his SFH under ACRS, he gets long term capital gains on sale, he can exchange tax free and pyramid all his life without having to pay taxes. When interest rates rise, effectively shutting down the SFH market, he can raise his rents and cash flow while reducing his repair expense through the use of laid off construction workers. That's because he controls basic shelter which is essential to life. When people can't purchase shelter, they must compete to rent it. When lenders take back a lot of unfinished or unsold houses, they rarely rent them, so newly constructed housing is often not made available to the rental market. Rents rise.
Right now I think interest rates for 30 year mortgages have bottomed out. I see them rising. Many people disagree with me and only time will tell, but let's look at the possibilities from both sides. If I'm right and interest rises, construction will slow down. People will be laid off. There will be less purchasing power in the community and as laid off employees draw down their savings, lenders will begin to tighten up on loans. Let's face it, they're just lending out depositors' money. When it's drawn out for living expenses, they can't lend it. People will be forced to rent rather than to buy. As the lines form, I'll increase my rents to meet the demand. My cash flow will increase. That's exactly what happened in Florida in the mid-70's. My vacancy rate was 2% over 4 years of the worst depression to hit Florida since the 30's.
Suppose I'm wrong and mortgage rates fall off? Say to 10%? Millions of buyers will enter the housing market. They'll be like desert wanderers who've found an oasis. There's no way the construction industry can respond. There will be shortages of labor and materials, land and money. I know, I've been a real estate salesman in just such a market. Then, instead of rents going up, house values will climb. I'll experience a soft rental market in exchange for leveraged profits. Eventually, demand will level off as payments become too expensive due to the combination of prices and interest. Long term rates will be driven up by the quest for long term mortgage financing the land rush will bring about.
Either way the landlord wins. He can increase cash flows or capture capital gains. He starts having a problem when he must hold onto his appreciated property in a soft market because he prefers not to sell. On the one hand, various sooth sayers will be shooting from the hip with their calculators telling him that because his property is now more valuable, his cash flow rents are below the yield he could get if he were to sell. In terms of straight mathematics, they'll be right. If a $50,000 house becomes worth $75,000., a 10% return which formerly amounted to $5000 per year must now be $7500. It's doubtful the tenants would respond to a rent increase based upon the need to maintain an owner's yield.
Isn't it odd that non-income producing property doesn't fall under this logic. People who hold stock or gold aren't required to sell just because the price goes up. Nor are those who buy land. Nor are venture capitalists. They're allowed to just feel lucky and to keep their appreciated assets. Somehow, the rules for income property owners aren't applied the same way. They all come under pressure to sell. But the great fortunes of the world were amassed by those who bought and held – for generation after generation. They've found ways to hang on to their properties in good times and bad, rental markets hard or soft.
WHAT CAN YOU DO ABOUT A SOFT RENTAL MARKET?
COMPETE! Like any business man, you've got to be prepared to match your product to the market. And you've got to let the public know that you're able to satisfy their needs at a lower cost – or conversely – to give them something extra at a greater cost than your competitors. Of course the greatest tool for survival is to learn to cooperate.
For several years I've urged readers to get to know one another. To form local support groups. To help each other succeed. I've sponsored low cost conventions around the country to put people into contact with their peers, and my Hands Off Management course sets one evening aside for several hours of socializing. There is virtually no substitute for financial friends. In my own situation I've been fortunate enough to have found a half dozen people in my own area with whom to share troubles and opportunities. Here's how:
I use a tape recorder to handle responses to my rental advertisements. So do some of my friends. It saves lots of time and wasted conversation, but it does much more. When our houses are all rented up, and calls are still coming in; all we do is to place a message on our tape answering machine. It directs them to our friends' phone number. This costs nothing. It generates income at no expense to our own. It makes for firm friendships and reciprocal action. They do the same thing for me. There are other ways to help too.
My town sprawls out over 20 miles in each direction. I've worked out agreements with friends who live near my more remote rentals. They take care of emergencies on my houses located near them, and I do the same for them. It saves time and expense for both of us. I do the same thing with people in neighboring towns who have property in my area. In exchange they watch over my property. We don't charge each other. We make an effort to keep reciprocal services in balance. Friendship is a two way street. Each has to do his part to maintain the accord. Cooperation spills over into other areas.
We try to use bulk buying power to get wholesale services. This year I've been putting down carpeting. By buying it directly from the mill, it only costs about half as much, but I have to buy lots of it. That's no problem when other landlords can share the expense and use the carpets in their own properties. We all save money. We share equipment and materials from time to time too. I'm delighted to let someone use a spare stove or refrigerator when I don't need it. It saves me the trouble and expense of storage and of moving it around. I use a simple I.O.U. which I let them repay at a later time. There are differences in value sometimes between what I give and what I get, but over the years, it evens out. It's to everyone's advantage We do the same with labor and specialists such as air conditioning repairmen, plumbers, electricians whom we've found to be reliable.
Several years ago I bought a motor home. I needed someone to watch over my property while I wandered. In return I agreed to watch over his while he was on vacation. This way, each of us got the chance to enjoy the benefits of rental income without any of the duties associated with it. Because we'd each tuned our systems up to the same rental agreement and had used about the same criteria for selecting tenants, the additional effort required was minimal – the rewards maximal. You can do the same.
You've got to be just as creative as a landlord as you've been as a buyer. If rentals are soft in your area, remember, it's a temporary condition. You can weather the storm by cooperating to fill vacancies and to hold down costs as has been discussed. You need to compete with non-cooperative landlords for tenants. My first source of tenants is an apartment house, a duplex, a condo. Surveys have shown that people with pets, extra cars, boats on trailers, kids, large families or a need for quiet or privacy prefer single family detached houses to any other form of habitation. Two thirds of all Americans live in them. All you have to do is to deliver/mail a description of your vacant house with a list of amenities (closets, double garage, fenced yard for gardening, family room, etc.) to occupants of apartments and offer to rent to them at comparable rents. You'll fill up.
LANDLORDS HAVE TO STAY ON TOP OF THINGS . . .
On the legal news front:
(1) A California court has ruled that any money given to a landlord that isn't used for rent is a deposit. In Granberry v. Islay Investments, the first month's rent roughly equaled normal rent plus the deposit. Following rents were much lower. In a dispute over the deposit, the landlord said there was no deposit, but the judge said the excess first month's rent contained the deposit. It's important that you who use my 'First Right of Refusal Option to Renew' document that the tenant agreed that this was a purchase of a right rather than a concealed deposit. I recommend you use a separate document rather than the Rental Contract itself in California.
(2) A Garden Grove landlord was recently defeated in court when his illegal alien tenants went on a rent strike to have his rents rolled back to about one third of the contract price. They didn't like the maintenance, but he couldn't get required permits to do the necessary work due to red tape. The judge instructed him NOT TO CONTACT THE IMMIGRATION AND NATURALIZATION SERVICE to have the aliens deported. How fair can you get?
(3) In a landlord and tenant dispute over maintenance, the tenant threatened to withhold rent until repair was completed. The landlord sued for eviction and the tenant used 'retaliatory eviction' as a defense in the Louisiana court. The court ruled for the landlord. It said he had the right to evict the tenant for the tenant's safety. When the premises are in such a state of repair that the tenant's safety is in jeopardy, safety considerations override retaliatory eviction statutes.
(4) In Georgia a new Code Section 44-7-19 prohibits rent controls by statute. It allows county and municipal governments to regulate their own rents or to contract for negotiated rents but leaves rents on single/multiple family residential units unregulated.
(5) In Alameda, CA a jury awarded tenants $100,000 for emotional stress because their roof leaked. The trial lasted 17 days, the verdict took 6 hours.
(6) Other California courts have established landlord duties: Landlords must make residences safe for occupancy (Kwaitkowski v. Superior Trading Company), but need not take precautions against attacks by unknown assailants he has no reason to anticipate (Totten v. More Oakland Residential Housing, Inc.). But, if the landlord has taken extra precautions to provide increased security, he may be presumed to have anticipated a danger to tenants and be held responsible (Olar v. Schroit). These may extend to a guard for the parking area to prevent acts of theft and/or vandalism which might be required to eliminate a potentially dangerous condition (Gomez v. Ticor). All you Condo owners could be in jeopardy whether or not you rent your units if the California Supreme Court rules that the condo association is liable for all the normal landlord duties to protect residents against crime. Liability assessments would be added to your normal association fees. Punitive damages are likely where the condition remained uncorrected for a long time(Penner v. Falk).
Before you panic, bear in mind that the key to eliminating costly litigation is to avoid using the courts to settle disputes. The secret is in TENANT SELECTION. It pays to be choosy. Don't rent to argumentative, crafty, assertive tenant applicants who spout tenant and landlord law to you. Be fair, be firm, be friendly once you rent. Understand your landlord and tenant laws and make certain both you and your tenants each do your part.
