Vol. 14 No. 2
December 1990
MAY YOU LIVE IN INTERESTING TIMES . . .
That's an old Chinese curse that seems particularly appropriate when we take a close look at the way 1990 has introduced us to the final decade of this century. No one can say it hasn't been interesting. 3000 on the Dow followed by an almost 600 point drop. 200,000 battle ready troops poised to enter what could turn into WW-III with nuclear weapons and a global conflict – or WW-I with poison gas and massive battlefield casualties – all in the name of oil and money. Deficits and accumulating interest that are compounding toward $3,000,000,000,000.00 at the rate of some $275,000,000,000. per year with no end in sight. A banking and credit calamity which could reach into the $trillion range once the unprotected insurance companies are counted and which will deprive millions of our elderly of their financial security and comfort. A vacillating President who refuses to lead and a Congress that seems incapable of placing the public good ahead of its members job security.
It's up to the voters to save themselves. In Massachusetts – a state particularly beset by a sea of troubles – they're sporting a bumper sticker that says -'INCUMBENTS OUT'. That's a pretty good idea. Anytime management in a business can't run a company, the share holders vote 'em out. Why shouldn't share holders in America do the same? Force them to leave the protected environment inside Washington's beltway – drive them from the Eden they've constructed for themselves secured by government pensions outside the Social Security system and royal privileges into this chaotic world they've forced the citizens to live in. This letter is being written and mailed early to remind you voters this is the time to do it. In Europe this year, East and West Germany have created a new nation by resolving political differences, merged their economies and currencies and held an election while we dithered over RTC ineptness, the plight of the Owl, crooked Senators and the President's son who got rich while the tax paying public paid off the debts of the S&Ls they were ransacking.
GOOD NEWS? BAD NEWS? IT DEPENDS ON YOU!
If you're going to be a bear, you might just as well be a Grizzly! Most of the fortunes made in real estate have been made during bad times. During the mid 70s recession in Florida, I was able to consistently buy houses with $100 down and taking title SUBJECT TO (no liability) the existing assumable loans. These houses invariably produced POSITIVE CASH FLOW from day #1 because I didn't make any payments on any owner's equity. Either there was no equity, or if there were any, I neither paid interest nor payments until I'd sold the property and made at least 10% clear profit over my purchase price. Here an example:
FHA ASSUMABLE LOAN BALANCE: $25,000.00 @ 7%, PITI payments of $226/mo, rents $250 OWNER'S EQUITY:12,500.00 @ 0%, NO PAYMENTS FOR FIVE YEARS OR UNTIL SOLD! CASH FLOW: $100 down paid back at $24/mo (Tenants absorbed maintenance costs) from net rents.
Talk about a feeling of nostalgia. But honestly folks, that was all a house cost in Florida back then. And we held off closing until I'd found a qualified tenant so that I didn't have to contend with rent-up losses. I actually TURNED DOWN a house in a lake front community which I could have bought for $1000 down because it had a $5.00/month negative cash flow. And any house I bought came with all the appliances, drapes and rods plus all the money in the Tax and Insurance escrow impound accounts – often in excess of $500. The owner was often motivated because he/she was leaving the area to find work and the drain of first mortgage payments was too big a burden. It was with considerable relief that most of the sellers accepted my $100 and/or my willingness to manage the property for income with which to pay their payments. As you can see, my own payments to them awaited my sale of the property at some point within the next 5 years. This is what I call FIRST STAGE DISTRESS.
Copyright © Sunjon Trust All Rights Reserved, www.CashFlowDepot.com. (888) 282-1882
Quotation not permitted. Material may not be reproduced in whole or part in any form whatsoever.
SECOND STAGE DISTRESS commences when the seller starts asking for an early payoff of the zero interest/ zero payment loan. At this point you can re-negotiate all the terms. Here are some variations on a theme: (we'll continue to work on the $12,500 equity Note)
1. Give him $2000 and stretch the balance out for 10 years.
2. Give him $5000 as full payoff.
3. Give him $3000 and pay the balance with a 'scrap' lot obtained at a tax sale at discount.
4. Give him $3000 and an ENCUMBERED property on which he must make small payments.
5. Tell him to borrow $2000 from a finance company, then agree to make the payments in return for a $4000 credit on the balance you owe him.
6. Let him use the $12,500 you owe him as a down payment to buy a lower priced house which he can finance out. This way, you eliminate the $12,500 debt while selling another house for a cash out.
7. Don't give him any money, but help him meet expenses by extending him credit at 18% and crediting the accrued, compounded interest against the $12,500 you owe.
8. Agree to co-sign a $3000 loan at the small loan company if he'll pledge the $12,500 as security.
9. Move him into a vacant house and give him a rent credit of $6000 in lieu of future payment. 10 Give him $1000 prepayment for each additional house he can find that you can buy 'right'.
Ask yourself if you fully understand all the above transactions. WHY would he do these things? WHY would you? WHERE is the profit/benefit on BOTH SIDES? WHAT are the tax ramifications? WHO would make these deals? WHEN? WHERE can you get the cash you'll need. HOW do you get the property rented up and under management control to avoid your own distress? In a distressed economy, buying at a profit is much more subtle and complex than it might seem. You've got to know how to compute PRESENT VALUE, YIELD, COST of a future income stream. So you'll need to be able to handle a financial calculator. There's a lot more involved than merely buying low and selling high if you're going to maximize all your opportunities.
CONTROL OF EQUITY AND THE INCOME IT PRODUCES IS THE KEY TO BUILDING WEALTH!
There are several definitions of EQUITY. 'That part of real estate that makes you feel good until the day you have to sell' is one of them. Another defines equity as the difference between Fair Market Value and the loan balance. Yet another subtracts CALLABLE loans from LIQUIDATION SALE VALUE (and that includes any loans with due-on-sale restrictions). I like to think of equity as that part of the property that produces NET INCOME AFTER TAXES. I used to buy property solely with APPRECIATION in mind, but I've found over almost 40 years of active investing that appreciation can be an ephemeral benefit. I've seen my equity wiped out by Zoning, Land use Restrictions, Highway By-Passes, Credit Crunches, Bankruptcies of Lenders, Title problems, Income Tax Law changes, Property Tax reassessments, Sewer and Water moratoriums, Economic and Social changes in my neighborhoods, War and Peace. That's why I like my definition best. If the property can't produce net income, I can't buy much with what's left. And, unfortunately, my living standards depend on my purchasing power.
Control of the equity gives me first shot at the income it will produce. And this can take many forms. It can be RENT, GAIN, HARVEST, USE, MORTGAGING, and EMPLOYMENT INCOME. Just as I can BUY equity that will provide me income from these things, so I can SELL, LEASE, MORTGAGE, the right to USE and/or HARVEST/or MANAGE income property to someone willing to buy the equity from me. And I can combine several of these in a single transaction. We've left out one of the most powerful of all tools in a down market: OPTIONS!
Everyone knows how to lease/option a single family house both as OPTIONOR and as OPTIONEE. Or do they? There are tangible reasons why people sell a CALL OPTION on their house. To raise tax free cash. To hedge against a down turn and falling values. To get a real pro involved in the sale of their property. To share in future appreciation in exchange for present income. To entice people with deep pockets to share RECESSION RISK with them. They rarely agree to selling a call Option when they think prices/economic opportunity will improve, so the best time to buy an Option is during a recession. We presented our OPTIONS STRATEGIES seminar in 1989 specifically to take advantage of the markets we're experiencing today. We'll present it again in 1992, and as usual, we'll give subscribers and Season Ticket holders first priority by private notification. In the meantime, if you'll look up Options in your comprehensive BACK ISSUE INDEX, now might be a good time to bone up on these techniques. But what about LEASE/OPTIONS?
People who need money, but who don't want to move, are excellent candidates for selling an Option. People who must move, but who don't need immediate cash are most likely to consent to a LEASE. Bear in mind that a lease without an Option is a valuable tool in itself. It captures (1) USE, (2) INCOME, (3) APPRECIATION and future value, (4) loans, (5) co-venturers, (6) Business Profits. It can be an inflation hedge, an estate planning tool, an efficient mechanism for dividing both profits and risk. When you lease a rental house, you're attempting to find a tenant who can (and will) buy the house for you while giving you a management income today – a source of cash and pyramding equity tomorrow with the least amount of investment of skill, energy or cash on your part. Here's what I mean:
If you rent your house to me on a long term lease with the right to sub-lease, I will control your equity legally for the term of that lease. If I sub-lease the property at a profit, I'll keep the income plus all rent increases while you pay the expenses that I've managed to negotiate for you to fund. On a long term lease, anytime you need to use the property for an Equity or Home Improvement Loan, or when you want to re-finance, you'll have to come to me (assuming I know enough to record the lease). The lender will require that I SUBORDINATE my lease interest to his loan (agree to give him superior rights to my own). If I refuse, you won't get your loan. You'll be in DISTRESS as to that particular funding requirement. The only way I'll agree to subordination is if you'll (a) agree to giving me a much more attractive lease rate/terms or, (b) give me an Option/partial equity in the property. Hence, I'll get part of the appreciation – maybe all of it. (c) I may ask you to lend me part of the loan money. Conversely, I may be able to borrow against my NET RENTAL INCOME and to pull a lump sum of cash out even without your help by virtue of my SPREAD between what I'm paying you on the lease and what my tenants are paying me.
We can then say that Options generally control APPRECIATION and Leases generally control INCOME/USE with lots of overlap between them, We can MORTGAGE both Options and Leases even when we don't own the property. When we can combine them, we get all benefits of ownership at the lowest possible cost. This is usually possible under circumstances in which the owner is in DISTRESS because of MANAGEMENT BURN OUT, LOSS OF INCOME, VACANCIES, NEED FOR CASH/CASH FLOW, or when he's got to relocate. Use of the Lease/Option alleviates the owner's distress while transferring multiple benefits and profits to the Lessee/Optionee. It's the ideal way for someone to buy/control equities without much capital. It efficiently converts KNOW-HOW into CASH FLOW and GAIN. But you've got to have the know-how to do it.
MANAGEMENT IS THE KEY TO ALL LEASE AND OPTION TECHNIQUES . . .
Many an erstwhile investor's ship has foundered on the Lorelei Rocks of property management. It seems too easy to compute cash flow based upon market rents and payments, but actual management of a house to make it produce net income is a whole different ball game. You've got to assure that the house meets applicable housing and health codes, you have to get occupancy licenses. You've got to make the house attractive and create curb appeal so people who respond to your ad will consider it. Of course, you've got to be smart about advertising expenses, picking the right way to present the property to the public at the right price. You've got to be able to select the best tenant without illegal discrimination or violating anyone's rights while keeping the wrong people out. And once you do accept a tenant, you've got to have a written rental agreement that contains your total agreement. Any duties, obligations, privileges, rights of either party must be spelled out including remedies for non-performance on both sides. Your contract can't be UNCONSCIONABLE or it will be thrown out of any court. It must conform to the law in your area.
Once you've got a tenant, you've got to be able to hold maintenance costs down while keeping collections up. You'll need firm collection and credit policies too. But if you do all these things, you'll find that management is your key to investment success. Most of the skills and knowledge associated with management can be learned in a reasonably short time. Property Managers can encounter more of life's drama in a year than most people experience in a life time. It only takes one bad tenant to make you embrace a firm policy of credit checks for everyone over 18, no more than 2 adults in a family who aren't blood relatives, no vicious dogs or kids, no checks, no rentals to anyone who isn't currently employed in a stable job, no tenants for whom at least two prior landlords can vouch – and this doesn't include any family members with whom he's lived or from whom he's rented. Lack of any credit history usually denotes fraudulent names and numbers. Photo I.D. has become an absolute minimum in the screening process. Rents should not exceed 25% of the family income – and probably less when income comes from retail sales commissions. Never work out a deposit. If a person hasn't saved enough to pay everything in cash up-front, then there's little likelyhood that they'll be able to make regular payments of rent and pay for extra repairs as needed. Enforce on-time rent payments with swift eviction consistently. This is a broad brush glimpse of what it takes to manage property. There's lots more to learn – but you'll do it if you expect to make money in a down market. And once you do learn it, it will continue to provide you cash flow and profits all your investment life.
YOU CAN NEVER LEARN TOO MUCH IF YOU'LL APPLY WHAT YOU'VE LEARNED!
One of our graduates manages 400 HUD vacancies. He gets $40 per empty house each month. He has 400 of them to watch over. NO TENANTS AT ALL. He got the job because of the MANAGEMENT CREDENTIALS he's acquired over 10 years of property ownership. That's almost $200,000 a year in a stagnant economy. Look around your area. Maybe you can do it too.
The key to getting ahead in any field is to thoroughly grasp the FUNDAMENTALS.
