Is The Sky Really Beginning To Fall After All?

Vol. 5 No. 4 January 1983

IS THE SKY REALLY BEGINNING TO FALL AFTER ALL?

Two years ago the new decade was heralded with some of the most optimistic forecasts in memory. Demographically, our population was on the threshold of exploding prosperity. A new President had been elected by an overwhelming majority and handed a blank check with which to reverse inflation, reduce government interference and costs, restore fiscal sanity, and usher in the decade of the golden eighties.  In this first issue of the year, it might he wise to do a little summing up.

Government has grown both larger and more expensive. The statesmanship needed to effect real change has never surfaced. Instead we've gotten the same old line up of excuses. Two years ago, in this letter; we predicted a higher tax load, threat of war, and an administration hamstrung by inter-party squabbling.  It's even worse than that! America has lost control over it^'s own future.Our ship of state seems to have lost its wind, sails, rudder, and helmsman.  More than ever, citizens are going to have to plan on shifting for themselves.  As entrepreneurs and investors in SFH you area head of the pack.

 It isn't going to be easy. At best you should hope for non-interference from those who gained your vote with promises of support.There^'s no doubt that you^'ll pay the highest taxes in history for Americans. And you'll get less for them unless you work for the government. Look at the run down: The Social Security Commission appointed by the Congress to come up with are commendation to solve the impending insolvency problem doesn't have any solution. Here's what you can expect. Higher FICA taxes every year. Delay of the date when YOU^'LL be eligible to start receiving benefits. Adjustment to the indexing so that inflation takes bigger and bigger bites after you finally start getting checks. Currently, almost one third of the budget is going to those 65 or over. In 30 years it will take 30% of every wage earner's gross pay just to support the retirees.

Unemployment in heavy industries and among unskilled workers is approaching the levels of the 30^'s. To the extent that this has wrung inflation out of the economy, it is to be tolerated, but many of these jobs will never come back. Tax incentives necessary for inducing business men to make the capital investment in new plant and equipment aren't available. The industrial unions still are striking or considering striking in the auto and steel industry. New jobs in manufacturing aren't being created except in high-tech industries. Our school systems have been so busy staying equal that they've forgotten how to set standards and to impart education. Even the vaunted California system hasn't been able to prepare graduates for the demands of the bio-medical and silicon chip industries. Unemployment there is at historic highs. The state economy is in the red and sinking. And state and local social programs are being cutback everywhere. Even government payrolls.

 We've tied our economy to credit, and we^'ve tied credit to bad loans all over the world. The government has guaranteed to support the banks both here and abroad to avert a financial panic. Consequently, American workers who still have their jobs are being taxed to support anti-American nations in which our banks have interests.We've turned our international friends into paid consorts who remain loyal so long as we pay. Nobody has been left out. If you don't pay income taxes, then you'll pay highway, excise, import, sales taxes. Or you^'ll be taxed through inflation which is going to soar. Despite all the lip service, the Federal Reserve is in high gear. Mid-summer will see the results.  Many Americans have given up. We^'re now going to give farmers wheat to sell so they won^'t have to take the risks of growing their own. And they^'ll sell it to Russia! For credit we supply!  We won^'t pay soldiers or give them modern weapons to defend ourselves.

AND THE GOOD NEWS IS . . . YOU!

Just as in the valley of the blind the one eyed man is king; so in a country where the majority of the people will settle for bad promises and brain deadening T.V. can someone with energy and initiative achieve unlimited success. The very fact that you subscribed to this newsletter and probably attended one of our seminars is a good sign that you aren't among those who will become the victims of this decade. But you must work.  Now^'s the time to be aggressive in securing your future. And Option techniques probably offer the safest way to pyramid assets at the lowest possible cost. The problem is that few people really understand what an Option really is. Do you? Would you be comfortable if your future were tied up in something called an Option? How do they work? Briefly, let^'s review property ownership. Real estate means land granted citizens by the state – not merely land, but all the rights which pertain to ownership of the land. That means the minerals, water, air, flora and fauna,development rights, improvements, etc.

Of course some of these rights may have been withheld by the previous owner or the state or local government. And they could be restricted by zoning or lack of building permits. Or a myriad of government agencies may have placed requirements on development to prevent any harm to the environment or adjoining property owner's rights. It all boils down to a piece of paper that you own which says you have certain rights. Unless that paper is recognized by the state through the courts, you have nothing.   An Option is a contract giving you the right to buy or sell something-in this case real estate.  If it has been acquired as the result of a bonafide transaction, it has the same protection under the law as any other contract.  So it must be structured as a contract, except, that it can contain provisions so that you need not complete the transaction. This in effect gives you a period of time in which to assure yourself that you can make a profit before you commit any large amount of money. And when you've settled the price and terms of the eventual transaction, you also realize the benefit of any change.

 For instance, suppose you paid me $5,000 for an Option to purchase a house from me in 1985 for today's value of $70,000. At that time you might agree to refinance the property, or to sell it to someone else who would generate enough cash to pay me the balance remaining unpaid of $65,000.  If the inflation rate returns to double digit levels, then the property would appreciate at that rate over the 2 year period. At 12% compound rate, this would make the property appreciate to $87,808. Your $5000 investment would have grown to $17,808.   That equals a yield of over 88% per year. Your risk would have been limited to $5000. If the property had gone down because of a depression, you could have declined to buy it and $5000 would have been the limit of your liability.

 Why would I be so willing to take your $5000 knowing this would happen?  Today, I might have a balloon note payment coming due in that amount. Or I might think houses had stopped going up in value.   Or I might have an impending transfer and want to know my house had been sold in case of a market down turn.   Or I might have a $65,000 payment due in 1985.  This year, I might have been in the 50% tax bracket, but I might plan to take a year off in 1985, reducing my bracket to zero. Hence the gain from my rental house would be taxed at minimum rates.  Or I might be 53 years old, and the option would extend the sale until I could get the $125,000 exemption for sale of my residence if I lived there. In any event, the $5000 would be tax free to me until 1985. This would give me the use of the money without any interest or taxes during the two years of the Option period.

 There are many advantages for both parties in working with Options. Once you are comfortable with them, and know enough to explain them to sellers, they become easier to acquire. And when you take the pains to structure and document them correctly, they can become just as real an asset in your portfolio as the property itself.  And they^'re a lot easier to manage and maintain – or to take across the border if things get too rough. With the potential for high, continuing inflation rates combined with unemployment and loss of income and a generally flat housing market, this seems to be the best of all times to get into Options in your house buying program. And new tax rulings may make it possible.

COMBINING MANAGEMENT WITH OPTIONS CREATES BOTH WEALTH AND INCOME

“Problem Solving^“is a term which is used in professional real estate quite a bit. It is associated with uncomfortable situations in which people find themselves, and relates to their degree of motivation in accepting less-than-palatable solutions. In a way, its like taking a spoonfull of sugar to make the medicine go down. Perhaps they^'d prefer hard cash, but in its absence,they accept “paper”, an exchange, or an Option.  For the average investor^“management^“ affords that uncomfortable situation. It doesn^'t necessarily have to include a negative cash flow. It could be that the investor just doesn^'t like the day to day demands or the inter action with the property and people. On the other hand, for the person who understands management, especially ^“hands off^“ management; this degree of uncomfortability relates directly to gross profits and income completely disproportionate to the work involved. Many people wouldn't consider giving up an Option to you without a significant amount of cash. But when you can offer to get them out of management, they readily agree to share future appreciation and income.

Normally, this newsletter is intended for single family house investors. But when it comes to Options and Management, almost any kind of property can become profitable.  For example, I own an option for 20% of the profits in an office building just for being the local manager. I arrange for maintenance. I pay the utilities,mortgage payment, utilities, taxes, and insurance out of rents I collect and render an annual statement. For this I have an inflation hedge until the property is sold and I'm paid off. I retained this arrangement when I sold the property.That's a key to ways you can do the same.

 
Today, when money is tight, the investor market in single family houses is one of the most active market segments. But investors want management.  Without it, they rarely buy. The last couple of letters have recommended you sell to raise cash rather than to borrow. You might offer your houses to investors for cash at WHOLESALE and take back a management contract together with an option to share future appreciation.

Here^'s how it might work. Suppose you had $100,000 equity in 5 houses worth $500,000 on the retail market. You might offer them for $475,000 with $50,000 in cash and $25,000 in a blanket 2nd mortgage. You^'d make it part of your agreement that you'd lease the properties back at the current rents for 10 years and prior to deeding him the property, you could convey a purchase Option for ¼ undivided interest as tenant in common to a member of your family, your corporation, or a trust, etc. for 15 years. During the interim you^'d get the benefit of any cash flow increases over the years. The Optionee would share in the appreciation to the extent of 1/4th interest. The investor would have the depreciation and 75% of the appreciation as well as a wholesale price when he bought. And the Optionee might realize long term capital gains in a lower income tax bracket too.

I've purchased apartment houses with lease options simply by taking over the management until I verified the true net income stream. My option terms were pegged to a 10 times multiple of net income so I got the chance to verify that income and to adjust the price prior to committing any money.  By that time the owner was so relieved not to have to manage it, I was able to negotiate full credit for my lease payments as the down payment with no other cash being needed. The profit upon my sale was over $50,000. Again,the combination of lease with option produced outstanding results without much risk.

 This year I changed my discount rental contract to include an option. In so many words, I^'m giving my tenants an option, but it^'s for 2 years from now and it includes a 10% rent increase after one year. Terms are all cash in January 1985 at appraised market value THEN. It^'s a ^“first right of refusal^“ Option. If I don^'t want to sell, they can^'t buy. Why am I doing this? The rental market is turning a little soft. We may be facing serious inflation as well as depression. My costs could go up and rents down. By giving tenants an inducement to stay at least 2 years, I stabilize my rents while providing for automatic increases which could place them above the market. The increase will phase in when there^'s only a year to go on the option.  I'm hoping this will provide just enough incentive for tenants to renew. And let^'s face it, in 2 years I may be willing to sell a few houses to raise cash. If interest rates subside, houses will appreciate swiftly.  By taking long term capital gains profits in January,  I'll be able to buy replacements. With access to new basis and ACRS, my depreciation over that year should offset any gains. At the same time, my tenants will also achieve some stability for two years.  With an Option, they will prevent my selling to someone else and evicting them.

 IN THE POTPOURRI DEPARTMENT:

FNMA is entering the secondary market with a vengeance. They are committing billions of dollars to financing mortgages. In addition to this, there are other Federal and local programs all over the country aimed at getting housing back on its feet. New construction has increased by over 25%. This could all be illusory unless the economy gets moving sufficiently for buyers to feel confident about buying. Watch this carefully in your own area.  Builders might overbuild. Lenders might become over extended. Or, indeed, maybe things are going to improve.

 
It all depends upon interest rates. Currently, long term rates are moving in the 12-14% range. They need to get to single digit before the great rush starts to housing. In the meantime, factory built housing, mobile homes, etc. will get a lot of action. You might take a hard look at this in your markets.  Mobile Home subdivisions that can be deeded separately are going to make a lot of money in the next couple of years. If you see an opportunity in them, consider it carefully.

Learn more about OPTIONS with Jack Miller's OPTIONS HOME STUDY COURSES.  

 

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GOOD LUCK ON THECOMING YEAR AND THE BEST OF WISHES TO YOU AND YOURS FOR THIS HOLIDAY SEASON