July 1980
Vol 2 No 10
In the event that phrase sounds familiar, you probably read it in last November’s issue on solving the “Liquidity Crisis”. We who have cash in the bank are feeling like the only girl at a U.S.O. dance. Everyone is making us offers, and the secret is to take the best one without waiting too long.
Most economists are now predicting a “short, but steep recession”. Interestingly enough, if you read the predictions in 1974, they too predicted a short recession. My guess is that although different regions will be affected at different times, the recession will be with us much longer than many are predicting.
People in the real estate business are born optimists, and this will cost many the fortunes they have earned in the past four years. The smart money is cutting overhead and planning on a long dry winter. The temporary reduction in long term rates will sucker many into thinking that the worst is over, when in fact the storm is yet to come.
Last month Jack pointed out that builders across the country were targets of opportunities with much unsold inventory. Even a more vulnerable seller may be the real estate licensee who has recently purchased a large home and now finds himself without the cash flow to support his (or her) lifestyle. The builder may have the strength to hold off the bank and other creditors, but the poor salesman probably cannot borrow money when times are good, much less now.
These people are “lifestyle conscious” and are knowledgeable enough about the business to make a creative sale. I recently acquired a house from such a person who was in a cash flow bind. I purchased a house appraised at sixty four thousand for fifty six thousand, using a five year ten thousand dollar note for the down payment, and taking title subject to a forty six thousand dollar first with payments of five hundred and fifty dollars per month. The note has no payments until the due date, and as additional consideration he can lease the house back for four hundred dollars per month for three years. This is an apparent savings to him of one hundred and fifty dollars per month, or another fifty four hundred dollars over the first three years.
The kicker is that the house would only rent for four hundred anyway, no matter how I rented it to, so the apparent lost rent was “his gain”, but not my loss. In addition as the original owner will continue to live there at a “bargain” rent, I will have no rent up problems, and probably no management problems for a three year period. The salesman had purchased the house at a good price and had a profit on the sale, plus he did not have to relocate his family or go through the hassle of showing and selling.
Many industries are laying off workers across the country, and most of these will collect some type of unemployment benefits. Salesmen across the country are also seeing their incomes suffer, but will receive no help from the government or other relief funds. Look for the weak spots in your area and make propositions that will allow them to continue to live where and how they want to, and will at the same time allow you to make an acceptable profit. To implement this idea you will have to have some excess cash flow, most of which will be returned to you when you file your tax return in the event you are still paying taxes. Let’s examine another source of cash flow.
Dominant in our recommendations during the past six months was the theme of investing in “paper” for cash flow. The prime benefit of holding paper is cash flow as it gives you neither tax shelter nor growth. Paper, like any other investment can be purchased without cash when done properly. Many think of paper only as existing notes, mortgages or trust deeds, or leases. Often these instruments represent hard cash investments on the part of the current holder, and they are reluctant to sell without receiving at least part of their investment in cash.
The alternative to this is to create your own paper. In the example cited on the first page of this letter, I purchased a house without using any cash, but had to allow the owner to rent the house as part of the consideration. Had he agreed to move out in return for a larger, single payment note due in five years, I could have then resold the house to a user at a slightly higher price. Of course I would sell on terms which provided me with immediate cash flow. This would have created a piece of paper in my portfolio, with cash flow, for which I had paid no cash.
When you create an investment like this, the difficult part is to determine your yield, as you have no investment yourself. Suffice it to say it’s enough! Another way to create cash flow paper is to sell an interest in a property which you have acquired on a lease option. Many larger houses are in a financially distressed market due mainly to high interest rates. People who can afford to purchase these homes are waiting for the rates to adjust, or are refusing to pay the banks the points and closing costs they are demanding.
Last month Jack pointed out that the rent houses command does not raise in proportion with the prices of the houses. Therefore we may be able to rent a house worth one hundred and fifty thousand for seven hundred dollars per month. In the event that we could obtain a five year lease at that rate coupled with an option to acquire the property at today’s price, we could profit short term as follows.
Advertise to sell the house at a price of one hundred sixty thousand dollars, with one thousand dollars down and twelve percent interest only for four years, with the balance due in full at that time. You will then be collecting fifteen hundred and ninety dollars each month while paying out only seven hundred dollars, an eight hundred and ninety dollar monthly cash flow for four years. Plus at the end of the four years you will collect an additional nine thousand dollars over your option price, should they exercise their contract. You are purchasing on a lease option and selling on a contract for deed (land sale contract, agreement for sale, etc.).
The purchaser enjoys all the benefits of ownership and receives all the tax benefits of home ownership as he is buying a home. The original owner who is conveying to you on a lease option is out of the management business and rests peacefully knowing that you will probably exercise your option. You feel better because you have greatly increased your cash flow with a nominal effort.
Darlene Jones from Merritt Island, Florida shares with us that she runs ad ad in the paper soliciting people who want to lease their homes on a long term situation with an option to purchase. She reports that the response has been delightful and profitable. I too am now running an ad to that effect, and find many people misinterpret the ad as a house for rent so that it is also a source of potential tenants. This approach will work successfully on properties which need work. In that case you can probably drive a harder bargain on the lease option, applying all money paid in against the purchase price, and resell on a “fix up for down payment ad” at a considerable gain.
From that bastion of liberalism, Massachusetts comes a new law to supplement their infamous Chapter 93 A. For those of you not familiar with Massachusetts law, 93A allows a homeowner to collect triple damages from a licensee who fails to warn the purchaser that his septic system will back up four years later, or his roof will leak, or his kids will not get along with their schoolmates. Yes, it even makes allowances for mental anguish. The new law allows the claimant to ask for triple the triple damages allowed under the current law. As the sellers in these cases are not in the “business” only the brokers are liable under the law.
The City Council of Boulder, Colorado recently passed an ordinance which limits the resale price on houses in the “moderate price range”. In the event you wish to resell a house purchased on today’s market for about fifty two thousand dollars, first you must offer it at a price tied to the median income in Denver. Then the city Housing authority gets the right to first refusal. This ordinance covers all sales for the next FIFTEEN YEARS.
It is unthinkable that the people of Boulder could be so asleep at the switch as to let such an ordinance be passed. Not only have they let the government regulate away their property rights, but they let them tie prices in Boulder to the income of a totally different city many miles to the East. Gary North’s topic in his last issue of Remnant Review was the four G’s of his investment strategy; Gold, Guns, Groceries, and God. I think he left out one important G, Guts. With all four of Gary’s G’s, unless you stand up for your rights, one by one you will lose them.
You that are parents, or property managers, know that given an inch either your children or your tenants (they act remarkably alike) will ask for mile after mile until you lay down the law. Politicians, left to their own devices will also take your rights away one at a time until you band together and threaten their jobs. There is a lot to be said for keeping a low profile, but don’t get so low that people walk all over you!
This month’s “Dear John” asks “We have a slow rental market and many landlords are advertising their properties for rent with option. Under what circumstances would you give a tenant an option to buy?”. My policy is never to give away anything without first receiving a corresponding gift, or promise of one. With that in mind when you “give” a tenant an option to buy a house you own, it should be at a price which is weighted in your favor. It is dangerous to try to out-guess inflation with Jimmy behind the eight ball this close to election time. Even if you pick a price well beyond what you think the house may be worth in a year or two, you may be fooled. Most of us tend to underestimate the value of our properties when selling, so place the burden on an unbiased third party, your friendly FHA appraiser.
State in the option that the price will be determined by FHA appraisal at the time of sale and that the buyer will be responsible for all contingencies. Any FHA appraisal includes the price of these repairs, so you will be protected against unexpected price inflation, plus have a built in cushion. Never record an option against a property you own, and be certain that the option refers to the lease and a default on the lease will automatically be considered a default on the option. Also state that in the event that the lease is renewed, that the option will expire unless exercised within the original negotiated period.
Whoops! My mistake is your potential gain. While cleaning out my garage last week, I uncovered an untouched case of 1979 vintage Miller/Schaub Workbooks. We have made revisions once since these were printed, so they are not identical to the new text, but do have many of the new formulas. They will be available to past students only while they last for twenty five dollars each. (They weigh nearly three pounds and that price includes the postage.) Mail your check, payable to Fortune Seminar, to “Workbook”, 1938 Ringling Blvd., Sarasota, FL 33577. Please state on your check when and where you attended the Seminar.
I have just finished Bill Tappan’s latest work titled, “The Real Estate Acquisition Handbook”, $7.95. (Prentice-Hall, Inc.) As in his previous book, “Real Estate Acquisition and Exchange Techniques”, Tappan gives detailed real-world ways to make money in the business. This is not a rehash of all the basic formulas many talk about and is well worth your time.
We are continually overwhelmed by the success of our students. Many are now teaching seminars of their own. (Fortunato & Turner’s “Profits in Paper”; Jimmy Napier & Don Tauscher’s “Money Maker Seminars”; Bruce Robinson’s “New Secrets of Acquiring Wealth & Keeping It”; Hal Askins’ “Basics of Exchanging”; Jim Warkentin’s “Representing the Buyer”; and now Bob Allen (Salt Lake City, Class July ’77) has taken some of our Ideas and incorporated them with his own experiences in a book, which hit the best seller list last week, titled “Nothing Down”. (Simon & Schuster, available at Waldenbooks.)
Writing and teaching are great ways to build your own self confidence and to make friends with other doers. In the event you are so inclined, begin by giving talks at a nominal cost to other investment groups (Lowrey Nickerson, Ruff Times, Miller/Schaub discussion groups, etc.) You will find that the quality of the audience will improve in direct proportion with the amount you charge for admission. Talk about your own buying and managing experiences to gain credibility and soon you will have more groups than you want soliciting you to speak and eventually even paying you.
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