April 2009
Vol 32 No 7
IT’S TIME FOR A REALITY CHECK . . .
If you were drowning 50 feet off shore, a Republican would throw you 25 feet of rope and manual on self-improvement. A Democrat would throw you 400 feet of rope, but forget to hang on to one end. A BILLION dollars seems like a lot of money, but it is only one thousandth of a TRILLION dollars. It’s like trying to pay a $100,000 bill with a $100 check sent to the wrong party. The Bank Bailout and Economic Stimulus Bills were 400’ ropes that won’t do much to solve our underlying economic problems or our trillion dollar credit problem. Consider that TARP money was used by bankers to build up cash reserves or to buy other banks; but not to help distressed homeowners or sellers. The new Stimulus Bill helps Unions and government employees at all levels, but not small businesses, investors, and entrepreneurs. The $billions that government is doling out rewards those who made bad financial decisions. Those who made good decisions will pay the tab. The auto bailout only made car companies into government wards who are already asking for more $billions.
The Mortgage Bailout Bill purports to help homeowners avoid foreclosure and restore house sales. If first mortgages are no more than 105% of current appraised value, home owners can refinance them with low interest fixed rate loans. If they continue to make payments on time for five years, they’ll get $1000 per year credited against their loan balance. Lenders will be compensated for cutting sub-prime interest rates and payments down to 31% of a debtor’s income. Fannie Mae and Freddie Mac will buy up to $729,750 in new home loans. First time home buyers get up to $8,000 tax credit so long as they don’t sell their homes for 3 years.
Despite all the clamor about protecting the sanctity of home ownership, foreclosures are proceeding apace and rising. Unemployment is also rising. None of the beneficiaries of these bills are going to create new industries and jobs that will make American businesses more competitive. Minimum opening bids at foreclosure sales and retail sales continue to free fall. The former head of the RTC has opined that between 500 and 800 banks will be forced to merge with stronger banks or forced to go out of business. Depending upon whether you are foreclosing or being foreclosed –- or whether you are trying to sell houses or buying houses — this is either going to create more distress or more opportunity for you. It certainly is going to change the way you do business until the housing market absorbs all of the distressed inventory being created by bankrupt builders and foreclosed borrowers.
The most often heard complaints come not from foreclosed home owners. They’re from retail home sellers whose prices can’t compete with comparable houses being acquired by buyers via Short Sales, HUD Auctions, or Foreclosures. These are priced as much as 40% below current appraisals based upon MLS sales in some areas. In the not too distant future, appraisals based upon discounted sales are going to dictate the loan-to-value limits on new financing. The only way sellers can compete is by matching discounted values, or by offering innovative seller financing. If a house is being bought for resale, in this falling market, it must be bought at a deeply discounted price. Houses that are selling fairly rapidly today are those that were bought at 1/3rd to ½ of 2006 price levels; then sold for 2/3rds of MLS prices. We’ve been able to buy these houses via foreclosures and REO sales.
Cash is the key to being able to buy bargains at foreclosures, via Short Sales or bank REO liquidations. Without access to bank loans, the two principal ways to get cash is to attract funds from private investors, or to create Notes that can be discounted to investors to raise cash. Investors, IRAs, pension plans, and Exchange Intermediaries are likely sources for funds, but today they want high yields. As a co-venturer, I want to divide net profit 50/50. Many Note buyers want between 10% and 15% return on reasonably short term transactions. When the cash is used to buy houses in today’s discount market, these arrangements still make sense.
IF YOU NEED CASH, DON’T BORROW IT, EARN IT!
Over the past decade, easy, low cost institutional financing has been the mainstay of fixers, flippers, landlords, and retail buyers. While low interest rates are being hailed everywhere, not everyone is going to be able to access low interest rate loans. Qualified buyers are going to be harder and harder to find as the economy continues to steal jobs and consumer confidence from the housing market. Loan underwriting criteria has tightened considerably. For many home buyers, low interest rate, low down-payment loans are going to be restricted to first time owner-occupants with high credit scores. When the money finally become available, owner-occupants with good mortgage payment records for the past 12 months will be first in line for low interest rate loans to support current loan payments or to refinance adjustable rate mortgages that are getting ready to catapult upward.
Non owner-occupants, including speculators, second home owners, and landlords aren’t going to get much relief. What recourse do they have? They must either refinance with private lenders or sell with seller financing on wrap-around terms or installment purchase contracts to buyers who can’t qualify for new low interest fixed rate loans. Subsequently, they can discount these loans to investors for cash. In order for a seller to reap the maximum cash, buyers must be willing, able, and ready (acronym WAR) to qualify for new financing. If they can’t qualify for new loans, desperate retail home buyers must expect to pay higher prices, higher payments, higher interest rates, or a combination of prices and terms that will alleviate the negative cash flow being endured by sellers.
What about those who have been trying to sell for months with no takers?
Just as changing times require changes for buyers, so too must sellers update their techniques to attract credit-qualified buyers. First of all, rather than merely listing a property for sale with a broker and sitting back to await buyers, take control over your marketing effort. Your first job is to find a broker who will put your property into MLS for a flat fee. This usually costs about $500 until sold.
Next, if you don’t want to pay retail for advertising, get the broker to commit a certain amount of ad space under his existing contract at his bulk-space rates for you to place your ads. This usually costs another $500 or so. Then, if you don’t have time to deal with inquiries and want someone with experience to screen potential buyers as to credit worthiness and motivation, pay the broker to do this. You always run the risk that callers will be diverted to buy the broker’s own listings, but when brokers receive 5% vs 3% sales commission, they have a real incentive to sell your house. Few of their other listings will pay them as much as yours will. If you’re nervous, put your cell phone number on the For Sale signs.
To find potential buyers, rather than relying upon print advertising, advertise on Craigslist.com and on other internet sites that are relevant to your area. To stage houses, rotate attractive furnishings from other houses, or even from your own home. (Do I hear write-offs?) Take lots of digital exterior and interior pictures of the house and landscaping and post them on the internet. Change photos frequently to keep the listing from going stale. One innovative person collects pictures of occupants’ attractive furnishings and uses them on subsequent ads when the same house is to be sold or rented. Take advantage of “highest bidder sales” whereupon buyers post bids for listed houses for 10 days or so, and the highest acceptable offer is converted to a purchase contract. Collect cell phone numbers and email addresses from low bidders and sell them other houses.
Prospect for buyers in the same way you prospect for sellers by direct mail and cold calling on apartments. Where not prohibited by law, include a “buyer’s wanted “Dead or Alive” and reward bird dogs who produce buyers who actual buy or rent the target house, or any other house you might want to sell or rent. If you want to use Lease/Options to sell houses, screen applicants carefully to assure that they will be able to get loans under current loan approval criteria. Offer 1-year deals with reverse rental and home improvement credits to help them get loans.
TO SURVIVE, LEARN NEW WAYS TO MANAGE RENTAL HOUSES . . .
I got caught flat-footed in the last recession with houses that I had expected to sell swiftly. I bought them “subject to” existing loans with very low down payments. When I couldn’t sell them, I had to either rent them or give them back to the people from whom I had bought them. There weren’t books or seminars that would teach me how to manage single family houses, but I did the best I could. I took a resident apartment manager course offered by the Home Builders Association where I made some valuable contacts. I was encouraged to join the Apartment Owners Association where I not only found wholesale prices for materials and appliances, but also access to professional referral and rent collection agencies, process servers who would serve late notices and attorneys who specialized in evictions.
For a year I volunteered to work for free for a single family house landlord to gain as much experience as I could by managing his houses. I figured that I’d rather make my management mistakes on his property instead of my own. It was there that I learned that rigorous screening of tenants prior to renting to them
paid big dividends in terms of turnover, vacancies, and maintenance; the big-3 of management expenses. Today, FICO scores serve as the basis for a lot of credit screening, but a number of factors go into them that don’t necessarily predict the performance of tenants. I discovered that job and wage stability, the absence of pets, and rents that didn’t exceed 30% of a tenant’s disposable income led to multi-year tenants who were happy to renew their leases year after year.
I formed a cooperative among a number of landlords who managed more than 400 apartment units, mobile homes, duplexes and houses to form a cooperative under the name of “Realty Management of Tampa”. We shared information on tenant scams aimed at shaking down landlords with fraudulent claims to get free rent. We passed along good tenant prospects when we were “full up”. We also leveraged discounted fees from materials suppliers, roofers, floor covering contractors, heating and air conditioning contractors, plumbers, electricians, attorneys, etc. to give us discounts. We set up a “black list” to avoid passing troublesome tenants from one of us to another. We paid cash for our purchases to avoid credit problems.
We got an entrepreneur to form a corporation called “Tenant Check” that screened tenants on a number of data bases and guaranteed the rents for 6 months on tenants they approved. The tenants paid for this check in advance in cash. This start-up business was subsequently sold to subscribers in Miamisburg, OH where it continued to operate profitably for many years. Even when it disqualified a tenant, if we needed to lower our standards, we could charge extra rents or deposits to offset the risks we ran. The disqualification was a reality check for weak tenants.
We discovered that many qualified tenants couldn’t afford first and last month’s rent plus a security deposit. So for exceptionally well qualified long term tenants who signed a two year lease, we “bonded them” in lieu of a deposit. This took the form of a $100 “add on” to the regular rent that was paid monthly until such time as their deposit could be paid. Where a rental deposit would have been refundable, the “bond” payment was not. This gave us more net rental income and encouraged tenants to renew leases without the need for a deposit that other landlords would require of them. This reduced vacancies and turnover dramatically.
We turned our tenants into “bird dogs” who could earn rental credits for several months by finding other tenants and qualified buyers for our houses. For example, suppose the rent were $1000 per month; if they brought us a qualified renter, we would either waive the old tenant’s security deposit if on the “bond” program, or refund it to them if they’d already paid it. If they brought us a buyer, or bought one of our houses, we’d give them a rental credit equal to $1000 for every buyer we sold a house to. This was particularly beneficial to good long term tenants who had lost their jobs and who would have otherwise been evicted.
To keep houses filled with good tenants who would take care of them, we gave rental credits to those who’d lost their jobs in return for painting, etc.
BRAINS, GUTS, TALENT, AND ENTERPRISE CAN BE CASH SUBSTITUTES
Who do you pay out money to without a qualm? Those whose services or products you need that you can’t provide yourself. Among them you find Doctors, Dentists, Lenders, Managers, Sales people, Title Agents, Attorneys, etc. You also pay finders fees, repair bills, lawn and pest control services, mechanics, bird dogs, stock, real estate, and loan brokerage fees. In short, you pay for needed talent, skills and services that you can’t provide for yourself. Doesn’t it make sense that you can earn fees by providing services in today’s economy that are urgently needed by others who have no choice but to pay you for them?
You may not be qualified to provide professional services, but if you can find really good deals, you can tie them up with a recorded Option Contract and sell your contract for a profit to those who can’t find good deals. I earned fees both as a house salesman and a “Buyers’ Broker” until I discovered that I could make a lot more money with less liability selling Options that I’d obtained for a $100 bill. How? I figured out that those who couldn’t sell their house by themselves were happy to list it with a Broker and pay him a fee for selling it. The broker didn’t always get them as much money as they wanted, and the money they did get was reduced by unforeseen settlement costs and fees. When I offered to buy or sell their house for a guaranteed fixed dollar amount net to them, many of them were willing to accept my non-refundable $100 in return for a 6 month Option contract.
Of course, I had to know how much I could pay them and still make a profit after all expenses; so I had to be able to figure out their loan balance and be able to subtract it from the amount I could sell their house for before I’d even found a buyer. By setting my Option price at 80% of current fair market appraised value, I had a 20% cushion before I had to abandon all my effort plus my $100 and walk away. You’d think that competition for these deals would have been intense, but competing buyers and brokers wouldn’t bet on their own market savvy and pricing. I made about 7 times as much profit as a broker’s selling fee because I was willing to risk $100.
Today, all the prices have changed by tens of thousands of dollars; but the amount needed to tie up a house on a recorded Option contract might be less than $1000. That’s because today’s sellers are less sensitive to earnest money deposits.
The American value system is heavily skewed toward “style” vs substance. In many cases, people value the cars they drive more than their home equity. The evidence of this is all around us. Drive by an upscale apartment complex and look at all the expensive cars. Clearly, the residents rank cars ahead of home ownership on their personal priority scales. Many times debtors keep car payments current by missing home payments. I once Optioned a house by agreeing to make payments on a truck that the owner didn’t want to lose. Each payment counted toward the equity on the house. As the truck declined in value, my Option equity increased in value.
Focus on foreclosed owners. Every house that is foreclosed generates potential buyers and tenants. Whether or not a sale is postponed, the occupant of the house being foreclosed is soon going to need another home. To the extent it can be obtained at an affordable price in the same neighborhood, there is a high probability that your vacancies can be filled with foreclosed owners who have learned the hard way that government promises won’t help and that payments must be made on time. Offer to pay moving costs to relocate them from their foreclosed house to your rental. Make the same deal with a buyer to get him to buy your house with creative seller financing. If he can afford the payments, there should be very little sales resistance. Best of all, nobody else in the market is willing, able, and ready to offer this deal; especially the foreclosing lender or a broker who is focused only on fees. By being creative, you can create a selling monopoly.
Reagan’s recession of the early 1980s gave birth to dozens of ways to make money without access to credit.
The Subprime Meltdown Online Seminar will show you some of the creative ways Jack Miller, John Schaub and Peter Fortunato made money then when everyone else was going broke. Ask yourself how many of today’s gurus can do this, and how many have survived. They did!
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