Is This The Year Of The Turtle?


        When you consider the yields that conventional investors earned on their invested capital compared to those earned by single family house investors over the past 5 years, it’s no wonder that investment in single family homes has been so popular.  Now that prices are softening, the prospect for making a fortune merely through equity appreciation without much work or know-how seems a much longer term proposition.  As a result, a lot of the enthusiasm of newbies for single family houses is slip sliding away.  Attendance at investment clubs is shrinking together with the numbers of eager investors willing to put up money for a share of quick turn profits.  Now they want more collateral and higher yields on their investments. 


          In many areas, the single family house paradigm is beginning to revert back to the norm that dominated the market between 1980 and 2000.  This was a period in which investment yield was created more by cash flow rents and loan amortization than by appreciation.  This isn’t necessarily bad news.  In so many words, the market that provided spectacular speculative investment returns is giving way to one of steady equity growth that increases with each amortizing loan payment


          If speculators who buy, fix up, and sell houses at a profit are the hare’s of the single family house business, landlords who collect monthly rents are the tortoises.  The hares get off to a quick start making a lot of money in a short period of time, but they give a lot of it back in the form of high interest and taxes.  Meanwhile, the tortoises plod along, sheltering their income with depreciation and using it to reduce debt.  When they up-grade their properties, they can do this tax-free by replacing one property with another.  When they finally liquidate their holdings, they get the benefit of long term capital gain tax rates.  Unlike the hares, they can also stretch out their tax liability and increase their profits by selling their properties on installment contracts.  Dealers in houses and land make a lot of money but they don’t wind up with much of it.  On the other hand, the truly rich people in real estate are almost always owners of income property.


          It’s always been pretty easy for average people without much education to become wealthy with income real estate so long as they’re patient.  It boils down to a purely mathematical proposition:  If properties are financed for thirty years with  $1,000,000 level payment fully amortizing loans, it’s axiomatic that at the end of thirty years, the owner will own $1,000,000 in free and clear properties without counting either tax sheltered payments or appreciation.  Getting tenants to pay rents with which to reduce debt is more or less how I made my first million; but I didn‘t wait 30 years for this; I found ways to speed up the process.  Here are some:


          To begin with, I didn’t buy free and clear houses; I bought houses that had existing loans on them.  Despite the Due-on-Sale clauses that frightens off many a would-be house buyer, I usually took title “subject to” existing financing with a low down payment and paid the balance with seller financing.  Sometimes this took the form of a “Wrap-Around” loan and sometimes I bought a house on an Installment Sale Contract.  My only criterion was that the house at least produce “break-even” cash flow from rents.  To get this, I had to convince the seller that it was in his best interests that his carry-back financing include terms that provided a margin of cash flow to protect both our interests.  I pointed out that there was no profit in setting payments so high that I had little prospect of being able to make them on time.


          It’s difficult to negotiate a discount from market value unless a house has significant equity.  This meant that my target house would have a loan that had been paid on for about half the original loan term.  I structured my own payments so as to be able to fully amortize my loan within the same period.  Hence, in fifteen years or so, all loans would have been completely paid off.  This built equity very fast, and as each house loan was paid off, my net worth and income rose accordingly.




     If the object of the exercise is to build equity quickly, ordinarily, over the life of a loan, some of the equity growth will be produced by appreciation; some by property improvement, and some by loan amortization.  There are all sorts of market factors that can influence how fast a house appreciates, but level pay amortization is based on a mathematical certainty that a loan will pay down at a predictable rate. With each payment, the equity increases a little; less in the early years of a loan, and more in the latter stages.  But, when unconventional financing is used, the rate of amortization can jump off the charts; especially when full credit is given for lease payments against an Option price, or when zero interest financing is carried back by a seller.  Let‘s explore this a little more:


           It’s easier to negotiate zero interest financing from motivate sellers who, for any number of personal reasons, are more interested in selling than in holding out for interest.  Sellers with free and clear property are rarely motivated to sell on zero interest terms except for special situations where an estate is being converted to income, or where property and its owners are separated from each other.  On the other hand, in a slowing market such as we’re now experiencing, owners who are confronting payments on vacant houses are often motivated to offer attractive terms:  Some of the negotiating points might be quick pay down of their existing loan; especially when they are offered any combination of a slightly higher price, larger down payment, bigger payments, a fast loan pay back, and/or a quick sale closing.  Using a $150,000 house, the following examples worked well for me: 


1.  With a free and clear house; half down and half in five years; with no payments or interest in between.  The seller would carry back his equity in second position behind a $75,000 first mortgage lien used to fund the down payment.  This provided fairly easy financing with net rental cash flow from day one that could be used to pay down the first lien.  At end of 5 years, the house could be sold and the balloon Note paid off; or if refinanced, rents would pay off the new $75,000 loan swiftly.


2.  Combine a 5-year lease/Option at the retail price.  Negotiate a full credit for on-time above-market rent payments to build equity fast. $1000 per month lease payments supplied by sub-tenants translates to $60,000 equity in 5 years.


3.  Setting loan payments at 1% per month of the original loan balance. With $20,000 down, suppose a seller would carry back $130,000 for 100 months on a wrap-around mortgage with payments of $1300 per month. If the house averaged about $1000 in net monthly rent over the period, you might sell it to an investor who would pay the $20,000 plus monthly payments for the house.  You‘d net lease it back for $1000 per month with an Option to buy half of it for $10,000 plus $150 for each month when sold.  You’d invest your management effort and he‘d invest $20,000 plus $300 per month for 100 months.  At the end of 8.5 years, you’d each have a $75,000 equity plus any appreciation.  After that point cash flow would be divided equally.   


          If the house and rents appreciated at only 3% per year, each of you would have almost $96,500 in equity with a monthly gross cash flow of just over $640.  Do this just ten times and you’d each be able to enjoy a $64,000 per year inflation-hedged income and $965,000 in appreciating equity.  At that point, if you wanted to hire a manager, you’d have less income, but you’d be free to come and go as you pleased.  How many people do you know who have done as well in only 8.5 years?


4.  Why not switch horses and become the investor?  In these troubled financial times for debt-ridden consumers, those who don’t like management can share future profits with an owner.  You’d make monthly payments for an Option to subsidize loan payments while the owner continued to occupy the house.  I first did this by providing $100 per month toward a $300 loan payment for half of the $25,000 equity.    


5.  Buy a Remainder Estate behind a Life Estate from an elderly person on lay away.  You can do this by making the payments on any existing loan, thereby eliminating his payments.  At time of death, the entire equity value will transfer to you.




          In the foregoing illustrations, the presence of a passive investor was a key to being able to capture large portions of equity in a relatively short period of time.  The investor provided all the cash but, in the end, the transaction generated yields far in excess of those available in any other competing investment opportunity of comparable ease and safety.  The stock market has been moving up and down for months as investors wait to see how the inflation picture shapes up.  None of these can produce investment yields like those in the foregoing examples.


          For many years I’ve been more investor than entrepreneur, but I see myself as a sort of venture capitalist who takes a large profit in return for sharing some of the risk with an entrepreneur.  The amount of profit depends upon the particular transaction.  When I have financed those who buy houses to fix up and resell and others who have developed mobile home lots, I’ve been able to earn around 20% per year on my invested cash.  I’ve also financed those who attend foreclosure sales to buy houses for resale with roughly similar yields.  I do no work.  My role is that merely of a lender who lends money on a shared appreciation mortgage (S.A.M.)loan.    


          A lender usually gives up the benefits of amortization, appreciation, tax-shelter, and leverage in exchange for high cash flow returns.  By keeping money invested in relatively short-term propositions, he is able to roll funds over and over, and thereby generate high yields.  Except for mobile homes, I’ve rarely seen a house that would produce net cash flow yields that compare with those that private financiers can command.  This is particularly true when conventional financing dries up.  Builders, fixers, land developers, dealers are heavily dependent upon the availability of financing to stay in business, and they’re willing to pay high short-term interest rates to get it.  When credit is tight, this is a fertile field of opportunity to those who followed my advice and sold some of their houses over the past few years and who are now looking for ways to invest their cash.


          The big buggaboo of the lending business are those who become overextended and who file for bankruptcy protection.  This can be a worrisome situation that robs the investor of a lot of time and money.  There are several reasonable steps that a person can take to reduce credit default and bankruptcy risks. 


1.  Act like a banker.  Lend only to those with high F.I.C.O. scores who have plenty of collateral that you would like to own.  When you lend to them, don’t let them borrow more than they can repay.  You won’t be able to get as high a yield, but if safety is a priority, this is a prudent way to get higher returns.


2.  Don’t make loans!  Instead of lending money to those involved in risky ventures, buy something else that they own at a discounted price.  Instead of receiving regular payments which could cripple their cash flow, let them buy their property back at some point in the future.  If they go broke, you’ve avoided the need to foreclose; or the need to file a motion in a bankruptcy proceeding.  On the other hand, if they’re successful, the price at which they buy back their property can be increased in order to capture an agreed upon share of their profits.


3.  Instead of buying another property as above, buy the property that a dealer wants to resell.  Give him an Option to buy it from you at a price based upon risk factors and the time of repayment.  This avoids potential usury problems, since you only deal with 3rd parties when buying, and they need not buy the property back from you.  Obviously, you’ll want to buy at a very attractive price which will enable you to sell out to someone else if the entrepreneur fails to buy the property from you.  This is particularly wise when dealing with builders and developers.


4.  Provide a secondary market for sellers’ mortgage Notes.  By buying them at a deep discount to value, you can build in a margin of safety and some liquidity, since you can re-sell them at a point in the future if need be.  If State law allows it, give sellers an Option to buy back their notes to create a specified yield.




          High volume house buyer and seller Walter Wofford of Jackson, Mississippi  has been a principal speaker at several of our seminars.  He has averaged buying and selling more than 5 houses per month for over ten years.  Walter teaches an advanced boot camp that deals with many related private financing subjects and techniques including the concepts in this section of the newsletter.  


          Walter has brought financing of entrepreneurs to new levels of sophistication.  By combining the sale of a fixer-upper property with short term financing, he has integrated private money lending with sales enhancements in a way I’ve never seen before.  He is thus able to create more profit when he sells, and to get additional profit from the financing.  Most importantly, he uses funds provided by other investors to accomplish this.


          Walter is one of the most innovative people that I’ve encountered in this business.  He reincarnates himself almost every year with new ways to do business that I’ve never seen before.  One year he rented seats on a Saturday morning bus ride for $1000 each.  He took his passengers through neighborhoods in which he’d placed houses under contract, and invited them to bid at wholesale prices that would generate a few thousand dollars profit on each house.  His riders could use any or all of their $1000 admission fee to bid on a house, and Walter would guarantee financing for up to 45 days while they fixed up and resold a house.  This made it possible for any of them to bid up the prices and to buy the houses.


          In his next reincarnation, by providing a market for high-volume wholesalers to sell their houses into; he didn’t have to spend the time to locate houses on his own; he just market theirs up.  Let me give you some figures.  Suppose a wholesaler could buy a derelict foreclosed house for about 40% of their retail fixed up value — we’ll say $40,000 — from a distressed lender that was overloaded.  Walter would agree to pay him $43,000, then resell it for $46,000, netting $3000 profit for himself.  To induce the sale, he’d finance the buyer for all but $1000 of the purchase price for 45 days in return for $500 total financing cost.  The money would be provided by an assortment of investors willing to lend Walter money at 9% per year; so everyone was 100% leveraged in this transaction.  All transactions were documented correctly, secured with recorded first liens, with titles insured.  No investor loan exceeded 60% loan to fixed up retail value.   


          Let’s look at some of the reasons why everyone was willing to do this:


1.  If Walter can sell 60 houses per year and make $3500 per transaction, his gross annual income amounts to $210,000 per year without investing any of his own money.


2.  The wholesaler who sells 60 houses to Walter can make $3000 per house, his annual income comes to $180,000 per year without investing any of his own money.


3.  If an individual entrepreneur can pay $46,500 for 5 houses per year, add $20,000 each in personal or borrowed funds to fix them up plus $10,000 in selling costs, then retail them for $100,000; he’ll gross $117,500 a year working for himself.


4.  If an investor can earn 9% on his money by lending it to Walter, that’s twice the going rate for a T-Bill.  As inflation creeps in, everyone’s prices will rise, and the investor can expect to see his investment yield increase commensurately.


          By setting up this financial daisy chain which he calls “Turn and Burn“, Walter has created tremendous incomes and financial opportunity for many fixer-upper  entrepreneurs and bird-dogs who find houses to wholesale.  Best of all, they need to have only minimal amounts of capital invested.  The thing that holds it all together is the prospect for extraordinary profits made by everyone in the financial food chain with only a reasonable mark-up in price on a lot of houses.  Even with some softening in the market which might slow down the turn-over time, or reduce margins, there’s enough profit all around for everyone to lower prices and still do well. 


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