September 1979
Vol 1 No 12
INFLATION – GETTING WORSE, OR BETTER IF YOU OWN SOMETHING LEVERAGED THAT’S APPRECIATING. Finished goods prices up 1.1 percent in July for an annual rate of 13.2. A reassuring report from the JOINT ECONOMIC COMMITTEE OF CONGRESS PROJECTS A U.S. INFLATION RATE OF 140% OVER THE NEXT TEN YEARS. The report states that the rate could be halved should the Government take proper measures, which is highly unlikely in an election year.
ARGENTINA IS CREDITED WITH THE WORLD’S HIGHEST INFLATION – 170% last year – 140% give or take this year. To hedge, the SMART PEOPLE OF ARGENTINIAN BUY ANY KIND OF REAL ESTATE and bid daily for interest rates on their short term cash savings. Long term hoarding of cash is unthought-of. OFTEN, LOSING BUSINESSES ARE ACQUIRED AT HIGH PRICES TO ACQUIRE THE REAL ESTATE INTERESTS THAT GO WITH THEM. Their stock market has been going up because people would rather have anything other than cash and all the little people who could not afford real estate jumped into stocks.
AS MONEY BECOMES MORE DIFFICULT FOR BUYERS TO BORROW AND HIGH EQUITIES ARE PREVALENT IN THE MARKET PLACE, I FIND THE LEASE/OPTION METHOD OF PURCHASING INCREASINGLY MORE EFFECTIVE. For example, one house in a rapidly appreciating area was for sale at an asking price of $140,000 and a relative value of $125,000. The loan balance was $40,000. The owner refused an offer of $125,000 on terms, but was agreeable to lease the house for 3 years at $500 per month and give a purchase option at a price of $140,000 during the term of the lease. The incentive? I AGREED TO PREPAY A FULL YEAR’S RENT (I would have prepaid all 3 years if he had insisted). THE OBVIOUS BENEFIT IN THE ABOVE IS MY PAYMENTS WILL BE $500 PER MONTH INSTEAD OF OVER $1,000, plus property taxes, had I purchased. I agreed to take care of all maintenance of the property.
WHAT I LOSE, HOWEVER, IS THE RIGHT TO DEPRECIATE THE PROPERTY. SUPPOSE I WOULD ASSIGN MY INTEREST IN THE LEASE AND OPTION TO A THIRD PARTY, probably a corporation which deals in real estate. It now (the corporation) has the right to lease the house for 3 years and purchase it at any time during the lease for $140,000. As I wish to occupy the house as a personal residence and would like to be able to deduct my payments (which I could not do by leasing), I AGREE TO PURCHASE THE HOUSE FROM THE CORPORATION ON A CONTRACT FOR DEED. The price, $145,000, $500 per month interest only for 3 years, then balance due. The corporation agrees to deliver the title to me when and if I make good on the contract. THE CORPORATION WILL PURCHASE THE HOUSE FROM THE OLD OWNER AND SIMULTANEOUSLY TRANSFER TITLE TO ME OR MY ASSIGNS IN THREE YEARS SHOULD I MAKE THE BALLOON PAYMENT ON THE CONTRACT. The corporation can use my contract to purchase as collateral for a loan to borrow the money to prepay the lease as per the terms of the lease/option.
The corporation pays no taxes as the interest it collects will be offset by the rent it pays. The profit it makes on the resale will be nominal. Of course, this would have to be an arm’s length transaction. AS I NOW AM A PURCHASER RATHER THAN A TENANT, I CAN DEDUCT MY INTEREST PAYMENTS and would qualify for favorable property tax treatment as an owner in acquisition. Should the market for some reason be bad for houses in three years, I will probably default on my contract without further liability and the corporation would probably not exercise its option to purchase.
EXCHANGORS TAKE NOTICE! In a recent lecture, the well respected Charles Ray Considine, CPA from San Diego, warns that the IRS is scrutinizing and disallowing many exchanges. THE PROPERTY THAT YOU ARE RECEIVING IN THE EXCHANGE MUST BE IDENTIFIED AT THE TIME YOU DEED YOUR PROPERTY TO THE OTHER PARTY. At the time of the contract, it may remain unidentified. Secondly, the continued exchanging of one property for another, i.e., A for B for C for D with A SHORTER THAN TWO YEAR TIME LAPSE BETWEEN EACH EXCHANGE WILL PROBABLY BE CHALLENGED and the tax free aspect disallowed. However, there seems to be no limit on how many exchanges you can make as long as different properties are used, i.e., A for B, D for E, etc. Thirdly, SHOULD YOU IMMEDIATELY TRY TO SELL THE PROPERTY YOU RECEIVE IN THE EXCHANGE, THE EXCHANGE WILL PROBABLY BE DISALLOWED and the gain, if any, would be taxable in the year of the exchange.
THE OUTLOOK FOR CHANGES IN THE TAX LAW LOOKS FAVORABLE with most of Washington talking of tax cuts to spur the economy. An interesting fact is the 90% OF ALL TAX REVENUES COLLECTED ARE PRODUCED BY THE TWO LOWEST TAX BRACKETS. A ¼% increase in these brackets would produce approximately 5 ½ billion in additional revenues. All the propaganda you hear about taxing the rich is just that. The misinformed working class always has and always will bear the major burden of the tax load.
INDEPENDENT CONTRACTOR STATUS OF SALESMEN WILL CONTINUE TO BE A POINT OF CONTROVERSY AS THE GOVERNMENT SEARCHES FOR ADDITIONAL SOCIAL SECURITY INCOME. FLORIDA NOW ALLOWS SALESMEN TO INCORPORATE AND FOR THE BROKER TO HIRE THE CORPORATION. This sets up the proper structure which will insulate the broker from paying social security and unemployment taxes and allows the salesmen flexibility in how they take the income. A high income salesmen can pay himself a salary, set up retirement plans, medical plans, and retain earnings in the corporation at lower than personal tax rates. Check your state laws and encourage salesmen to incorporate if your statutes permit it.
WITH HOUSE SALES GRINDING TO A HALT IN MOST AREAS OF THE COUNTRY, FORECLOSURES ARE ON THE RISE. Watch for unkept houses and check small loan companies for defaulted consolidation and home improvement loans. KNOW YOUR STATE LAWS REGARDING THE RIGHTS OF REDEMPTION OF DISPOSSESSED OWNERS AFTER FORECLOSURE. Often, this right can be purchased, removing the threat that the owner will repurchase the house. Should another buyer outbid you at the foreclosure sale where the auction price was in excess of the foreclosed loan balance, have the owner exercise his right of redemption to repurchase the house for the old loan balance. You contract to purchase the house from him and co-sign a note at the bank arranging for the certification of title to be sent to the bank, who will then record a deed in your favor from the seller.
TO GENERATE CASH FLOW WHEN WORKING WITH INVESTORS, Denis Koelsch, White Belt Winner from St. Petersburg, Florida, makes this offer to his investors. WHEN HE ACQUIRES A PROPERTY, THE INVESTOR IN LIEU OF PAYING A COMMISSION, LOANS DENIS $2,000 PER HOUSE. The investor will receive his down payment along with the amount he loaned Denis when the property is sold or refinanced. At that point Denis and his investor will split the profits. In the interim, Denis manages the property without charge.
A SEVENTY THOUSAND DOLLAR VISA CARD! Steve Poletti of South Lake Tahoe reports certain CALIFORNIA SAVINGS & LOANS, SPECIFICALLY STATE S&L IN STOCKTON, ARE ISSUING CREDIT CARDS WITH LIMITS BASED ON THE EQUITY IN YOUR HOUSE. The credit limit is based on 80% of their appraisal and the interest rate will be either 12 or 16%, the lower in the event your first loan is theirs. The maximum credit line on the card is $100,000. This line of credit can be paid off at any time and then redrawn at will. There is a five year expiration date on the Visa card.
THIS TYPE OF LINE OF CREDIT WOULD ALLOW YOU TO TAKE ADVANTAGE OF FORECLOSURE SALES AND OTHER HIGH PROFIT OPPORTUNITIES WHEN HEAVY CASH WILL DRIVE DOWN THE PRICES. After purchasing these opportunities with cash, you can either refinance or bring in an investor to pay back the line. AS THIS CREDIT LINE IS GOOD FOR 5 YEARS, AS OPPOSED TO THE ONE YEAR THAT COMMERCIAL BANKS INSIST ON, THE PRESSURE OF REPAYMENT AND THE RISK OF DEFAULT WILL BE MUCH LOWER. Because the lenders are basing their loans on credit cards, they are able to charge higher rates than with a standard home loan. Beware of borrowing long term at these high rates. Use this line only for purchasing well below market.
MANY HOMEOWNERS ARE CERTAIN TO “CRANK” OUT MUCH OF THEIR EQUITY USING THESE CARDS. THIS WILL LEAD TO HIGH NOTE PAYMENTS AND POSSIBLY MANY DEFAULTS. Contact the loan servicing officer in charge of these accounts and mention that you could help people out of these large payments when they become a problem.
WHEN PURCHASING A HIGH EQUITY HOUSE, HAVE THE OWNER REFINANCE BY USING THE CARD AND THEN GIVE THEM A SINGLE PAYMENT NOTE FOR THE BALANCE (IF ANY) OF THEIR EQUITY. This type of financing would create huge negative cash flows, so be sure to buy appreciating properties at wholesale prices.
Tom Geizentanner, Chico, California, suggests that YOU MAY KEEP A LOWER PROFILE AND CUT COSTS WHEN TRANSFERRING TITLE BY HAVING THE TITLE COMPANY TAKING TITLE TO PROPERTY THAT YOU ACQUIRE. You execute a holding agreement with the title company in which they agree to hold title and you agree to indemnify them against any liability they may incur. ALL THE BENEFITS OF OWNERSHIP PASS ON TO YOU AS THE REAL OWNER. When the property is transferred, the new owner simply executes a new holding agreement with the title company and there is no need to record a new deed as the title remains in the name of the title company. This could possibly save some transfer tax and may confuse tax property tax assessors, and lending institutions that pick on you when property is transferred.
The Wall Street Journal reports that the average price of a new house has increased from $61,900 to $74,300 in the past year. That’s OVER 20% ON THE AVERAGE. We try to get a better than average buy on a better than average house.
The late billionaire and owner of Bankers Life & Casualty, John D. MacArthur, owned among many things six cars and two planes WHICH HE NEVER INSURED. Asked why, he snapped, “BECAUSE THE INSURANCE COMPANIES ARE THIEVES!” When you reach the position where the loss of an asset such as a car or boat would not be significant, it is costly, often up to 5% to insure a depreciating asset for replacement. Often the collision insurance for these toys is not even deductible. CONSIDER SELF INSURING. When is the last time you collected on a collision policy, and how much have you paid in premiums? Liability insurance is necessary and $1,000,000 worth of coverage cost less than $120+.
MANY RENT CONTROL ORDINANCES REFER TO “5 UNITS OR MORE OWNED BY THE SAME PERSON.” This is easy to avoid by titling five in your wife’s name and five in yours without losing depreciation, etc. BEWARE OF TITLING IN CHILDREN’S NAMES as you may create a problem in transferring title, refinancing, or evicting tenants.
WE’RE MOVING UP! A recent public opinion survey conducted by Coast Equities found that real estate salesmen were rated a high eight on a scale of 1 to 9. The question, “Ethics in Business.” The bad news is that nine was the worst (car dealers are still on top).
This month “Dear John” is asked many times each month, “WHICH AREAS OF THE COUTNRY ARE THE HOTTEST FOR INVESTING IN HOUSES?” HOT SPOTS ARE HERE TODAY AND GONE TOMORROW. They are caused by short term demand/supply imbalances which are often the result of arbitrary Government interference. A temporary moratorium on sewer hookup/or building permits will create a supply shortage and drive up prices. HOWEVER, WHEN THE MORATORIUM IS LIFTED, BUILDERS AND DEVELOPERS WILL JUMP TO TAKE ADVANTAGE OF THE ARTIFICIALLY HIGH PRICES AND TEND TO OVER BUILD THE MARKET. This will result in a soft market and will either depress prices or make it hard to sell at retail prices.
A GOOD EXAMPLE OF THIS PHENOMENA IS RENO, NEVADA, where a large demand for new jobs was created by the construction and operation of several large hotels. This created one of the hottest housing markets in the country for the past two years. Today, Reno is rapidly becoming overbuilt which will result in softer prices.
When you chase about the country searching for the hot markets, hoping to ride to big profits on artificial price increases, you are speculating. That always means higher risk. KEEP IN MIND, YOU MAKE YOUR PROFITS WHEN YOU BUY. Therefore, you would fare far better in the long run if you would search not for the “hot” markets, but instead seek out depressed markets where you could purchase well below market.
Last month, Jim Harris of Sacramento, rounded up a group of past students who were actively investing for a one day “Nitty Gritty Clinic.” THE GROUP WAS LIMITED, AND EACH PARTICIPANT RECEIVED PERSONAL ATTENTION IN AN INFORMAL ATMOSPHERE DESIGNED TO SOLVE SPECIFIC PROBLEMS AND STRUCTURE TRANSACTIONS. The results were extremely positive with each participant gleaning new ideas with which they could make larger profits. OTHER “NITTY GRITTY CLINICSW” WILL BE SCHEDULED AS REQUESTED in conjunction with the MILLER/SCHAUB seminars across the country. Should you have an interest in coordinating or attending one, please drop us a note.
Several who attended the Sacramento Clinic were involved in syndicating investors to invest in SFH’s. THESE SYNDICATES OFTEN MAKE THE FOLLOWING ERRORS: (1) In their eagerness to acquire properties, THEY OFTEN PAID NEAR RETAIL PRICES WITH CASH. (2) THEY COLLECTED COMMISSIONS FROM THE SELLERS, setting up a taxable event to the general partner and a conflict of interest with the sellers. (3) THEY RAPIDLY ACQUIRED SEVERAL PROPERTIES WITHOUT HAVING A GOOD MANAGEMENT SYSTEM IN PLACE, and often carry many vacancies which cost them precious cash flow. This negative cash flow seems insignificant at the inception, but will seriously cut into profits when allowed to run. One such syndicate had 17 vacancies due to a rapid acquisition program. That was costing them in excess of $6,000 per month with no immediate relief in sight.
SHOULD YOU BE BUYING LARGE NUMBERS OF HOUSES FOR INVESTORS, BE CERTAIN THAT YOU HAVE YOUR MANAGEMENT SYSTEM IN PLACE AND OPERATIONAL AND THAT YOU HAVE CONSERVATIVELY PROJECTED ANY NEGATIVE CASH FLOWS, Limited Partner investors often balk at continuing demands for cash contributions to feed properties, no matter how profitable the long term may appear.
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