June 1986
Vol 9 No 8
Americans have found a new national pastime – going to court to settle their differences. And the trend is on the upswing. A generation ago a person could expect to live out his entire life without the need for a court appearance. Now the reverse is more the rule. It will be the exception in this generation for a person not to either sue or be sued at least once.
This phenomenon isn't limited to only disputes between private parties. Over the past few years we've seen increasing use of the court system by government agencies in their quest for redress against industry as well as private parties. Now the worm is turning as government at all levels has started to feel the sting of law suits filed by citizens for myriad claimed injustices ranging from the effects of Agent Orange and fall out to spurious claims by the IRS for unpaid taxes. One suit almost bankrupted an Arizona town.
Like so many other aspects of a complex society, this situation can't be traced to any one cause. Insurance companies blame trial lawyers and their contingent fee peers. They in turn argue that citizens can't expect justice from a system so weighted in favor of the rich. Judges maintain that irresponsible juries award excessive damages in order to compensate the aggrieved parties disproportionate to their true losses. Regardless of the root causes, this propensity of our society to use the court system as a source of profit ultimately poses a major threat to everyone – and especially to those with high visibility property investments.
Not the least of the problem stems from political expediency at all levels of government where those who are successful are blamed for all of the ills of the society in which voters must live. Administrative and regulatory red tape makes it more and more difficult for the small business man to function profitably without incurring liability in some form or another. And when that industrial accident, consumer suit, tenant injury does surface, it's usually accompanied by a long list of broken regulations which virtually assure that the entrepreneur will lose his business whether or not he wins his case because of the costs of mounting his defense.
REAL ESTATE CARRIES EXTRA RISKS . . .
Contrast two investors. One invests in a diversified portfolio of securities, collectables, commodities, annuities, bullion and numismatic coins. The other owns rental income properties. They become embroiled in a dispute over property rights with another party. He seeks out the services of a contingent fee attorney who checks out the property holdings of our two defendants. The real estate owner is a sitting duck when the tax rolls reveal him to be the owner of valuable income properties. The other investor's holding would be much more difficult to locate, appraise, assess and seize. But that's not all:
Suppose the plaintiff wins and a large judgement is awarded by the court. When this has been recorded, it automatically attaches to all the real estate and starts to earn interest until paid. In the meantime, the sale and/or refinance of the property is pretty effectively blocked until the winner has been satisfied. It's a different story with the diversified portfolio – especially when the assets are held out of state in Trust or in a Corporation. It's much more difficult for the claimant to lay his hands on them – indeed, it may be impossible before they're converted to cash and spirited out of his reach.
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This vulnerability is never more apparent than when one takes a look at some of the recent court rulings and ordinances affecting the plight of real estate investors. As was noted in a recent letter, federal agencies are deeming it a CRIMINAL offense when HUD and FNMA regulations are violated by investors when applying for new financing. At the governmental level, things are being tightened administratively by States and Cities too. Here are a few examples:
1. In New Hampshire, mobile home park residents must have 18 months notice before a park can be condemned or have its use changed by the owner. Tenants are given a 30 day grace period before they can be evicted for non-payment.
2. Landlords in Berkeley, California are officially PRESUMED guilty of rent gouging when they raise rents. Rent controls are even more virulent than in New York City. Even VACANT apartments and COMMERCIAL BUILDINGS are rent controlled.
3. The 'COSTA BILL'(A.B. 483) in California is struggling through the legislative process. It seeks to partially override local rent controls by allowing rents to rise to market levels. In the interim, some landlords in Santa Monica have discovered a loophole in the political system. By renting only to convicted felons and foreign nationals who can't vote, they hope to be able to have a voice in government proportionate to their financial tax contributions. Their tenants won't be able to vote themselves lower rents.
4. In Tampa, the Housing Assistance Office has 'red lined' neighborhoods in which owners can obtain tax supported ZERO INTEREST RATE LOANS up to $5000 for renovation of rental houses which will be earmarked for low income tenants. Too bad the middle class doesn't have anyone in its corner too – particularly since they're going to pay the taxes.
5. In Wisconsin, they've established a 'PROTECTED CLASS' which the state will defend in eviction cases. This includes families with children, the handicapped, students, and convicted criminals. That just raises the costs to all the others who aren't protected.
6. In Austin, Texas, a proposed tax would levy a per foot tax on developers to raise funds for low income housing. Of course this just increases the price to the consumer.
7. In Schenectady, NY, the city imposes a $25 fee for a re-inspection of the premises any time a new tenant wants to move in.
8. Boulder, Colorado's housing authority is building houses for tax-payer-subsidized sale to low income occupants in direct competition with local builders and brokers. This way they're managing to shrink the tax base at a time when there's a 13% vacancy rate and a glut of resale housing on the market.
9. Reflecting the rebirth of the New England market, Vermont voters recently defeated an 'anti speculation' tax which would have levied extra taxes on entrepreneurial profits.
10. And Boston's real estate board is suing to challenge an ordinance requiring that the RENT EQUITY BOARD issue a permit before apartments can be converted to condominiums.
Investors will require more management skills than ever if they're to stay abreast of new regulations and court interpretations of their responsibilities to their tenants. In response to this, I've been making some fundamental changes in my rental system and I'm clearing out potentially hazardous properties in the current selling environment. With my more critical properties where tenants may be exposed to risk – e.g. swimming pools, water front or frontage on busy streets – I don't rent to families with small children. I get a written inspection report on which the tenant affirms that no hazardous condition exists. In extreme cases, I make the tenant the owner by selling the property on an installment sale contract which includes liability insurance in the payments together with larger deposits in the form of a down payment. The contract carries no recourse in the event the occupant chooses NOT to complete the purchase. Whether I'm doing business on my new Rental Contract or via an instalment sale, the resident can earn a significant bonus by returning the house to me clean and ready to be re-occupied.
And my 8 month experiment with REBATES rather than DISCOUNTS has proven these to be much more efficient in today's rental markets. My problem was that the 'cream of the tenant crop' could buy instead of renting. As a result, the new tenants were less desirable and required more motivation to meet their obligations. Each month I mail out a special Rental Credit which must be endorsed and returned prior to 5 PM the last day of the month together with the rent in order to be used. My new rental contract carries language which explains the rebate program. It also authorizes me to enter the residents' rental records into the local credit data base for future access by other landlords as well as placing more responsibility on the tenants instead of on me for the discovery, reporting and/or removal of any hazards on the premises.
The rental rebate ties into my maintenance program too. Anytime there are any maintenance calls at all, I withhold the rental credit for that month, thereby assuring my tenants will be charged l minimum 'management fee' of $50 – $75 for any repairs without any collection effort. Finally, I'm in the process of installing a maintenance coordinator who can respond to any tenant call and follow up to see the work has been done. By using a professional process server, a separate collection and eviction contractor my new hands-off system is doing a better job with even less effort on my part. I've held off presenting any HANDS OFF MANAGEMENT classes since last fall until this system has had a chance to prove itself. Commencing with the class in San Jose, and for the other two classes in Philadelphia and Ft. Lauderdale, this will become part of the revised seminar. Employing professional techniques in management goes a long way toward reducing exposure to liability law suits.
EVEN THE INSURANCE COMPANIES ARE RUNNING SCARED . . .
Success has never before been so perilous! Investors are now able to join with doctors, dentists, manufacturers as preferred targets for liability awards. State Farm just cancelled a policy which they'd carried for 12 years on my office building. Even though there had never been a claim filed, the presence of trash on an adjoining lot owned by the city created too much threat of liability for their underwriting standards. This incident reflects merely the tip of the iceberg of what looms as a major problem for owners. The California Supreme Court in BECKER/vs/IRM CORP held the owner STRICTLY LIABLE for a concealed defect in a shower door even where there had been no negligence established. A distressed landlord advertised a discount to 'Yuppies' on his 255 vacant Miami Beach units and was sued for age discrimination by a 57 year old lady. It cost him $50,000. In High Point, NC the management company was sued and found liable for the theft of property even though the lease relieved the owner from any liability. He got away free. They paid!
Cities are losing their insurance too. And they're reacting. Sleds are now outlawed in Denver's parks. Yellowstone's bears are now off limits. Bar owners in Washington DC are being held liable when inebriated customers harm 3rd parties after departing the premises. Lafayette County, MO closed its jail when their insurance was cancelled. Physicians are refusing to deliver babies and many are leaving medicine because of insurance premiums. In Coleville, PA they've shut down the police force for lack of insurance. From Day-care centers to Nursing Homes, Americans at every level are under legal attack.
The States are fighting back with proposed legislation to limit damage claims as well as the fees that contingent fee lawyers can earn. Meanwhile, if your insurance should be cancelled, first see if your old agent can line up a replacement for you at once. Ask your fellow landlords whom they use. Try to get group coverage for your investment club if you are a member. Most importantly, STOP ADVERTISING YOUR SUCCESS! When the barrage starts, take cover. Portfolio protection is a must.
IF YOU CAN KEEP YOUR HEAD WHEN ALL ABOUT YOU ARE LOSING THEIRS . . .
This is more a time for cool, rational thinking than for panic. Your first job is to reduce your visibility if it's too high. An alter ego is just the ticket, and the process of obtaining it is relatively simple. Go to your local legal notices newspaper and inquire about the procedure. Usually, you go down to the Court House and check a machine listing to find a suitable name which hasn't been taken yet. I like things that don't say much. Like 'Allied Investments'. The newspaper will run a small ad saying that you will be 'doing business as' 'ALLIED INVESTMENTS'. Then, for a small fee – about $25 – they'll send in a notarized statement saying you've met the local public notice requirements and you can proceed to open bank accounts, get signs made, letterheads and billheads printed, etc. I've found a rubber stamp to be quite useful in endorsing checks, etc. too.
Interestingly enough, a corporation can also have an alter ego in the form of a legal alias or a fictitious name as the above is referred to. Bear in mind that you're not changing the FORM of your business, merely the NAME. You still keep your books the same as before and file taxes as you have in the past. You're just lowering your corporate profile a little. A sharp attorney can easily penetrate your new identity, but the man-on-the-street won't take the time. You can't use your new name on Deeds without also placing your real name on it too. But you can use it on Rental Contracts, bills, etc.
The spate of Equity Sharing arrangements can prove to be especially unrewarding when the court decides you were general partners, sharing all liability. I'd recommend you resolve any such division of property interests and convert them to Trusts with only one property in each Trust. This way NEITHER of you holds title in the event of a judgment. The law currently allows damages to be assessed disproportionately against the one with the most assets regardless of guilt. It can be extremely hazardous to be a partner today.
In an Illinois type Land Trust, an innocent 3rd party holds title while you do the landlord duties, collect the rents for your own benefit, and stay out of the limelight. When a tenant suit ensues, you're out of the direct line of fire because, in most states, a judgement doesn't attach to a Beneficial Interest in a Trust. That's what you hold in lieu of the Title. So you're one step away from the clutches of the court. It's important to understand that Trusts can't be used to defraud the public. But they're excellent as a shield for landlords who are in day-to-day contact with litigious tenants and biased courts.
In most areas of the world the CORPORATION rules the business roost. They're widely respected and enjoy a considerable body of law to support their uses. Corporations can be partners. They can be Trustees. They can be Beneficiaries. They enjoy a different tax year. They can be residents of another State. They can provide superlative tax and title holding strategies IF they are operated in accordance with the applicable statutes. That means meticulous record keeping and accounting practices must be observed. When all of the above forms of organization are melded into a working system, they can form the foundation for the ultimate in estate building and estate planning strategies.
In 1986 PORTFOLIO STRATEGIES will delve into ways to implement this as well as ways to capture the huge profits this surging real estate market is offering. We've got some tax and trust specialists together with some surprises scheduled for this year's class in ORLANDO on June 6 – 8th. We've also put together a 3 day seminar in Reno for July 11th, 12th, 13th just on CORPORATIONS. It costs only $75 for subscribers and $25 for immediate family members. If you attend both these seminars, we'll give you a couple of special books dealing with some of these strategic approaches as a bonus. I think you'll need both of them if you're to stay healthy, wealthy and wise. When you read this, I'll be overseas exploring some of the opportunities to discuss in Orlando. Hope to see you there.
Copyright Sunjon Trust All Rights Reserved
Quotation not permitted. Material may not be reproduced in whole or in part in any form whatsoever.
1-888-282-1882 www.CashFlowDepot.com
