August 1983
Vol 5 No 11
One of the great mysteries of the past year has been the fantastic surge in the price of stocks. It's easy enough to rationalize why nervous foreigners might put their assets into American companies or why fund managers choose the equity markets in lieu of relatively mild performance in Money Market Funds or T-Bills. And the 1982 IRA accounts that flooded into the market certainly helped boost it along. But what about business fundamentals? Has anyone noticed increases in business bankruptcies this year? Haven't after tax profits remained flat even with massive concessions by labor? Aren't our exports down and likely to remain down? Is the chronic unemployment above 10% just a rumor? Didn't interest rates start up recently, along with the rate of inflation?
I wonder if investors are just turning to speculation in the absence of firm indications of solid economic recovery. With over $300,00,00,00 in estimate gains tabulated over the past 12 months, speculation is pretty hard to disparage, but markets tend to have downsides which are just about as steep as upsides. Remember Gold and Silver in 1979 and 80? A lot of people also thought those markets would never collapse. Anytime we let hope for profit take precedence over rational investment decisions, we run the risk of losing our investment nest egg. What might a logical scenario be for the rest of the year?
The new budget resolution promises no control over deficits. They'll continue to remain at historically high levels. Reagan seems to have won his tax battle for now, so government revenues will probably be generated from some borrowing and some inflation. From now until November 1984, election politics will dominate economic policy. When the voters lose jobs because of high interest rates which crowd both domestic and foreign consumers out of our markets, we can expect just enough inflation to bring them down. On the other hand, when inflation begins to drive up the costs of doing business and family budgets to the point of voter rebellion, we can expect interest rates to rise. Volker's re-appointment to the FED means that, at least, we'll have an experienced foot on the brakes and accelerator. How does all this affect single family house investors?
Anytime interest rates are down, housing construction and sales will prosper, but it will be more difficult to buy using creative financing techniques. Prices will rise. But the costs of financing will be lower. That's a good time to create relatively low yielding paper to use in the exchange markets. And refinancing bad loans should be fairly easy and inexpensive too. When interest rates rise, it will be time to reverse your tactics. Buy back your created paper at discount, or buy other people's well secured, seasoned paper at discount. The bond market will enable you to use discounted bonds to buy houses with large equities as was explained in our May 1980 letter. When interest rates lock other buyers out of the market, your free-form-finance techniques will find more seller acceptance. And you'll be able to sell properties you've financed profitably by using wrap around mortgages to capture higher interest rates.
Beware of starting big projects without enforceable guarantees of permanent financing. Whip-sawing of the interest rates could catch you off base. Even when rates sink lower, there will be long lines at the credit window. Lock in your terms in advance. If you need to raise cash, it might be better strategy to sell a high equity property for cash, replacing it on the next interest rate swing when sales turn down. By anticipating
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interest rate excursions, you can make money by selling in low interest rate seller's markets at high prices and replacing the properties in high interest rate buyer's markets at lower prices as well as at foreclosure sales. And when sales are slow, as a rule, rents can be increased. Thus, your SFH portfolio provides a double-edged hedge with which to create profits in any kind of market, provided you avoid interest rate traps.
HERE COME THE BABY-BOOMERS.
In a way, the housing market is like a form of food chain. Owner-occupied SFH comprise all but a small portion of the single family house market. As young couples buy their first home, this frees the seller to buy a larger one from someone else. At some point the process reverses itself. People who have passed their peak earning and family rearing years are concerned with turning equity into income. They move “down“, selling out to someone moving up the ladder and buying smaller houses or condos. But the entire process depends upon that first-time buyer being able to buy a house.
Builders who are able to construct attractive houses priced for the young married market are thriving. And even when the houses are more expensive, they will be purchased if loan and payment terms can be structured to be affordable to first-buyers. Builders are innovating as never before in meeting the needs of these buyers who are finding it difficult to buy inexpensive houses in the resale market. When economic uncertainty causes current owners to avoid selling, new buyers can't find houses that they can afford. Demand builds and builds. Recent mortgage rate reductions and some of the new type loans are releasing this demand, and first time buyers are entering the market in unprecedented numbers.
25 – 34 year old buyers with dual income families averaging S30,000 per year are buying 50% – 65% of all new purchases in the USA. Pulte homes reports 90% of its new homes are being purchased by this group. In step with this trend is the secondary loan market which absorbs mortgages and provides permanent funding. It is expanding at a tremendous rate. Mortgage-backed bonds and securities enable lenders to spread their risk among non-real estate investors, hence more money is made available for long term loans. And housing is beginning to take different shapes to meet this market.
First of all, houses are being down-sized, down-priced, and made more simple. Off-site constructed homes are becoming more and more prevalent. Cardinal Industries is leading the pack with several housing tracts comprised of their factory-built houses. And accessory-apartment concepts are being designed whereby high density housing shares common area family rooms, patios, decks while retaining private dining and sleeping areas. Recently we saw tiny efficiency apartments containing about 500 square feet of living space for singles priced at $22,900 with payments of less than $250 per month. These were being sold as condos to students, however, 2 of them would still be affordable for a larger family. This young adult market will be able to buy homes up to about $59,000.
NEW HOUSE SALES ARE STAGNATING RE-SALE MARKETS.
When a first time buyer buys a new home, there isn't any ripple effect through the resale market. The next seller in line has lost some of his market. He can't move up unless he can use his equity to buy his next residence, and he's been reluctant to incur high interest rates and corresponding payments. By and large, he just stays out of the housing market. This slow down has been felt at all levels in the housing chain. It offers buying opportunities even in the midst of a housing resurgence.
Anytime you can find a way to enable a home owner to move in to his next house he'll be more willing to accept creative terms. Put yourself in his place and solve his problem – and you will be able to buy his house. When pondering the key to his buying, you'll also have the key to your on purchase of his house. Consider first financing of the property he wants. Don't overlook trade-ins. Rely on your own creative concepts.
Here are some approaches you might consider: Create a Note secured by his old house and offer it to the owner of the house he might want to buy. You agree to pay it off in return for his deeding his old house to you once it has been accepted in payment for his new house. You buy his house, he uses your note to buy his next house, and that owner receives the note payments – or uses it to buy his own replacement house Ad Nauseum.
You might structure your note to have instant cash value in the discounted paper market so that the final recipient would be able to convert it to cash. Or you might do the opposite, making it worth very little in the resale market, but with a high future value so that the seller could accept a low (9%) interest rate at a lower tax rate, and take his gain tax free into a replacement house.
If the seller wanted to buy a new home but was prevented by the lack of a sale for his present house, you might arrange with the builder for a trade-in after which you would agree to buy the trade-in house back from the builder for paper you might create. As a part of this arrangement, it might be a good idea to try to get an option on one or more of the builder's houses to be built at the end of the project, locking in prices and terms while interest rates are lower. Builders often lock in advantageous terms with interest rate buy-downs to facilitate sales. Adroit negotiating might enable you to get these too together with the traded-in house. Later you could offer your optioned houses in a trade-in program of your own.
By now, using lease-option techniques to buy control of houses is widely known and accepted. Consider offering to negotiate a lease/option for a seller to obtain the home he wants from either another seller or a builder. Remember, that home owner wants a new residence more suited to his family and economic circumstances. So long as you're able to obtain it, with a reasonable certainty that he'll be able to buy it upon the eventual sale of his old property, you should be successful in also lease/optioning his old residence. Voila! You're buying with nothing down and no debt. You may even get a positive cash flow while you await the appropriate selling season. Meanwhile, he'll be enjoying the house he wants and locking in the price against future increases.
Why wouldn't you merely option the house he wants and ignore the step of buying his old house? Because his old house might fit perfectly into the rental market whereas his new house might be too big or expensive to make sense. And this lease option method is impervious to any of the up-coming repressive tax legislation that's been proposed. You'll note that none of these techniques involve your going into an institutional lender and obtaining financing. Brains, energy and intestinal fortitude have always been a substitute for cash! Every day we either find people who will pay us for these attributes or we find ourselves paying someone for theirs. That's what the service industry is all about. So we shouldn't be surprised when we're able to work without banks and financing.
The key to successful transactions is to comprehend the needs of all parties and to meet them at the lowest possible cost. Regardless of the market, there will always be individuals with problems. You can ease them and make a profit by so doing if you'll bear in mind the relationship between rents/interest, repairs/depreciation allowances, appreciation/costs of credit. By using your wits rather than institutional financing you control your risks, costs, and investment decisions. While others sit around lamenting high interest rates, you'll be creating low interest paper to buy with in a buyer's market. And by structuring your seller carry back loans to be fully assumable, self amortizing, level payment, with full sustainability of collateral; you'll be poised to sell in any market regardless of the interest rates.
The original terms and conditions of your purchase set the range of opportunity for subsequent profit taking. When you can buy a house on 'soft” terms, you can either re-sell it for a profit to someone who can't structure them for himself. Or you might choose to “wrap“ your terms, taking a cash-flow “spread” after selling on conventional terns. Conversely, you could pass on your acquisition price to someone else for cash and continue to make your soft payments, if you have given yourself the privilege of moving the loan off onto another property for collateral. If you could substitute collateral on a $25,000 purchase money Note, then sell the property to a user for cash, you'd be able to pocket the cash and continue to pay off the low interest rate Note. If the note called for only 9%, that's what you'd effectively be borrowing the cash at, under your own terms.
IN THE POTPOURRI DEPARTMENT:
July 1st saw the last of the loopholes close for assumable loans except for those “window period“ loans which are bound by state law. From here on in assumable loans are going to command premiums. I hope you took my advice about putting your non-assumable FNMA and Freddie Mac loans into corporations, partnerships, and trusts to make them more maneuverable in the future. If you did, you'll see big profits in the coming years. Bear in mind that, when you structure seller carry-back terms, all your loans will be assumable. FHLB recognizes 18 states in the window period: Arizona, Arkansas, California, Colorado, Florida, Georgia, Illinois, Iowa, Michigan, Minnesota, Mississippi, New Mexico, New York, North Dakota, Ohio, Pennsylvania, Utah, and Washington. But the Senate Banking Committee EXCLUDES Florida, New York, North Dakota, Ohio, Pennsylvania, and Washington. However, it does INCLUDE Wisconsin. From here on in, proceed with caution.
I've just read a good book: Foreclosure Investing by Peter R. Blaser, Tennco Press, 3705 West 73rd Avenue, Westminster, CO 80030. For you folks in Colorado, this is a good reference book on the laws and strategies of foreclosure buying. In our recent seminars we've been mentioning an emerging brokerage trend called “Single Agency“ wherein real estate brokers will represent only one party in a transaction. It clears up a lot of the confusion regarding who is representing and being paid for by whom. For a free brochure on the subject, contact William R. Broadbent, 1380 Broad St., San Luis Obispo, CA 93401.
Rent Controls are receiving some set backs. The Senate has attached a condition to its subsidized housing package making funds available only in areas WITHOUT RENT CONTROL. Even in Santa Monica, they've dispatched their former mayor plus two city council running mates to the pasture in favor of candidates who affirm landlord rights and looser controls. We keep getting good ideas from readers. Start mailing tenants reminders to change air conditioner filters this summer. Or to clean rain gutters in the fall. Or to keep sidewalks free of ice in the winters, or to water and fertilize grass in summer. If you make the language positive and cooperative (free fertilizer?), it should work O.K.
One re-hab specialist, bothered by vandalism, has put temporary flood lights on his houses which are activated by audio switches (Radio Shack), Lights turn on at the slightest sound. California Civil Code Section 2943 requires beneficiaries of Trust Deeds to give true and complete copies of Notes and Trust Deeds to entitled persons upon written demand. Included are the Trustor, assignees, successors, escrow agents. Beneficiaries who refuse to comply face $300 fines, but they can charge $50 for providing the documents.
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