February 1984
Vol 6 No 5
SINGLE FAMILY HOUSES – A VANISHING AMERICAN DREAM?
Recently the U.S. League of Savings Institutions' Home Ownership Task Force warned of an impending crisis. “There isn't going to be enough long term mortgage money available from lenders at affordable rates to allow aspiring home owners to get a mortgage.“ One of the reasons is that Americans are only saving 3% of their income – a new low, down from the 5% reported during the Carter administration. Contributing to this is the record level of taxes and increasing deficits which promise to drive interest and inflation rates skyward. Inflation has driven land and construction costs upward at the same time as interest rates so that buyers can't earn enough to enter the housing market. And owners of older homes are not moving up into higher cost housing.
With average house prices reaching into the 80's – even higher in many areas – and with long term mortgage rates at around 13%, the effect is a moratorium on buyers. Last spring when interest rates were lowered, house prices were driven up by pent-up demand. Demand for loan money swiftly brought about a correction in interest rates so buyers were once again forced out of the market. Chronic deficits are going to maintain pressure on capital markets and mortgage money is going to remain tight. Americans are going to have to adjust to living in apartments and multi-family variations such as zero lot-line houses, town houses, duplexes, etc. But a few people will avoid this.
Already we're seeing owners of older homes start to remodel rather than moving up to newer houses. They treasure those low interest rate assumable mortgage loans and don't want the burden of double digit interest rates. I've been reading newspapers all over the country for the past 2½ years. The 1000 square foot, 3 bedroom house which was the mainstay of the 235 program in the early 70's has virtually disappeared from the market. It cost from about $15,000 to $19,000 to build. If it were available, it would cost about $55,000 – and more. People are keeping these houses for themselves or to rent. Check your own area. You'll find older houses dating from the 30's in this price range and newer houses in the $75,000 range with 12% – 15% mortgages. But the truly affordable house is growing more scarce every day. And its price will reflect its scarcity.
I've reported previously that single family houses are not available to first time buyers throughout the Western world – and indeed anywhere else – except through massive government subsidies. Where government priorities and revenues dictate other choices for their citizenry's life style, they uniformly choose drab multiple family projects which resemble cement silos for storing people. Bleak? Only for those who can't or won't take action to acquire their own home. For the SFH investor, the future appears to be golden. Millions of people are entering their highest earning years. They have the capacity to buy housing and to pay high payments. Once they perceive what's in store for them, they'll enter the market in droves, bidding up the prices. They'll do this even if it means sacrificing some of their toys. So will most affluent people too.
The paradox here is that the mass market will be denied to builders because of high costs of home ownership, so construction will slow. But those who can afford it will place home ownership of single family detached housing near the top of their priority lists, and they'll provide fortunes to those who have an inventory of houses to sell. It will generate untold windfalls that we can't even imagine. We've seen what has happened in Orange and San Diego county, California when the public senses a shortage of housing. Prices explode. Speculation in those areas eventually caused the bubble to burst, but
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(888) 282-1882 in the scenario I foresee, USERS will be buying these houses. They won't resell them! The bubble won't so much burst as have the air leak out of it as the inventory of SFH is consumed. At that point those who can offer decent single family houses for rent will reign supreme. And I believe this scenario will take place within this decade! Hasn't it already started?
1984 IS THE YEAR TO STRAIGHTEN OUT BAD FINANCING!
Interest rates are artificially LOW! Here's what's happening. Foreign money continually flows into American savings institutions. It is used to fund government and private credit needs. In combination with pension fund and institutional entry into the secondary mortgage markets, and FED policy in this Administration, the problem of crowding out has been avoided. But the murmuring on capitol hill portends difficulties in 1985. We hear of tax increases, dismantling of tax shelter legislation, import controls, a National Industrial Policy. The precarious balance thus far maintained is in jeopardy. It's quite likely that we'll see a stampede for credit. in 1985 which will catch unwary investors unprepared. Don't be one of them. Start getting liquid while you can.
A lot of balloons are going to pop in the next 18 months. 300,000 will come due in California alone in the next 2 years. $4 Billion will come due this year, and $32 Billion in the next 5 years – just when government deficits will be most severe. Start doing something about these now. Here are some thoughts:
a. Offer private mortgage holders an incentive to permit you to convert a balloon to an amortized loan. You might offer to start making payments early. Or to raise the interest rate (to a point which is more advantageous than merely refinancing the loan). One person threw in a free Time Share Condominium as “points“ in which he had a low basis. Another debtor leased a Mercedes and loaned it to his cooperative lender.
b. Explore all the options with new loans which would be more advantageous than facing a balloon payment. Beware of another short term balloon situation which would take you out of the frying pan and put you into the fire. Refinance or use 2nds or FNMA wraps which produce the optimum cash flows versus costs and future risks. Try to negotiate one-time assumability. Or take the loans in the name of a corporation, trust, etc.
c. Sell then buy back. Find someone who'd like lower payments for a couple of years and co-sign a loan with them so they can buy your house from you as a user. To the extent permitted by law, subsidize their down payment and/or payments to make it attractive while they live in the property, but arrange to recover possession and title at a point in the future when it is advantageous to both of you. By co-signing the loan and structuring the agreement properly, any due-on-sale clause problem might be avoided.
d. Use the new Equity Access credit card loans as a last resort to avoid default on your balloon payment. Remember that some of these are callable and others are not, so look into it carefully. These simply give you a line of credit equal to a percentage of your equity. If they won't lend on investment houses, perhaps they'd lend on your
own home.
e. Co-venture your property with someone who can pledge C.D.s or T-Bills to get a loan
which would either pay off your balloon or encourage your lender to stretch out the payments. Your co-venturer might easily be the original seller who might prefer to resume ownership of a partial interest in the house rather than being paid.
In any event, start using your imagination and initiative now to solve future refinancing problems. Don't delay until you get caught in a credit squeeze. I'd rather get a new loan a year too early than a day too late! With any new financing, remember, make it assumable, long term, level payment, self-amortizing so that your property will retain its market appeal should you be forced to sell sometime in the future.
SFH ARE BECOMING EVEN MORE ATTRACTIVE AS A SOURCE OF RETIREMENT FUNDS.
For years Pension and Trust funds meandered along the byways of investment with little regard to maximizing yields. Unschooled in the ways of double digit inflation, fund managers thought that safety lay in certainty rather than in compounding of yields. That's all changed. As public funds become tighter and Social Security more dubious, the rush to high yields is on. And Real Estate has historically offered the most benefits to those who want high yields with reasonable safety. But there's more. Recent tax law changes have permitted private pension plan funds to invest in leveraged real estate and mortgages. Literally hundreds of billions of dollars are awaiting placement once a suitable property can be obtained. But there's the rub. Suitable properties are in short supply, so funds are turning to single family houses.
Syndicators who can assemble and manage sufficient numbers of houses are-going to find a market ready, willing and able to perform. It won't be easy for reasons stated in prior paragraphs, but the opportunity is there. Think about it for a moment. If fund managers think participation in real estate preferable to merely lending mortgage money, maybe they too are betting on increased inflation over the next decade or so. A few years ago a study concluded that only 5% of American would own their own homes by 1990. Entry of institutional investors into this area tends to re-enforce this point of view.
Recent events in the Reverse Annuity Mortgage program are opening the gates wider for elderly home owners – and eventually for all of us. In New Jersey, American Homestead Inc. ( call 609-866-0800 for details) has announced its “Century Plan“. This is a plan which requires NO REPAYMENT until the borrower dies, sells the home, or lives 40 years beyond age 65 when the loan may first be taken out. There are many variables based upon the age, value of the property, desired monthly payment rate, etc. but this method of funding retirement offers much more advantage than the empty promises of the Social Security Administration. Consider that there is no need for government funding, charitable gifts, massive credit commitment. There's no drain on the tax rolls or the average citizen's pocketbook. Oldsters can remain financially independent all their lives and still leave an estate to their children once they no longer need it. The RAM program also includes variations on sale/lease-backs to provide the same benefits plus some tax benefits. We'll continue to update your information as developments occur.
MANAGEMENT IS STILL THE KEY TO CASH FLOW.
Assuming that you've avoided the traps of institutional financing and have bought your investment house, knowing what to do next is critical if you're going to enjoy peace and quiet and an indexed income from rentals. There's little joy in having enough income to be able to quit your job just so you can become a low paid handy man or rent collector. The solution is to plan your management system and to implement it from the start. The property you buy for your long term investment portfolio needs to be selected in an area which will remain attractive to residents for several years. It must be financed in such a way that you'll be able to hold it comfortably in good times and in bad. And it shouldn't impose maintenance problems which will limit its appeal to the rental market.
One of the really rude awakenings for new buyers are expensive repairs on what appeared to be attractive investment houses. Some of the more critical problems include cracked foundations, termite damage, leaking roofs and/or leaking plumbing. When inspecting the property PRIOR TO PURCHASE pay particular attention to cracks in masonry walls, sticking doors or a roof line which seems to have a bend in it. Look for any sign of water stains which might bleed through recent paint jobs in ceilings and beneath window sills. Turn on all faucets and operate all plumbing fixtures – don't forget the showers – to insure they aren't defective. With all faucets turned off, listen to see if you can hear the sound of water running. That may signify a leak in the walls or slab. When in doubt, specify in the contract that “all operating systems must be in good working order”. Or you might make the contract “subject to an acceptable report from a licensed roof (or plumbing or structural) inspector“. And to eliminate another round of negotiation, you could add that necessary repairs will be paid for by the seller prior to closing or their costs will be deducted from the down payment and purchase price.
Of course, another approach to maintenance problems is to actively seek out the “ugly ducklings“ – houses with relatively minor cosmetic problems which might require a few hundred dollars to remedy. When these can be purchased at below market rates and terms, they can be a profitable venture. One person I know who does this has a standard approach. He says that replacement of doors (where needed) and door hardware, ceiling fixtures, kitchen counters and cupboards; painting of appliances, exteriors and interiors and installing carpeting works wonders in both value and appeal. He buys his carpets direct from the mills in Georgia and North Carolina and has regular contractors who do the work for him. Usually, he can get improvement loans under FHA or from his local bank.
If this becomes a technique you find profitable, you might consider “selling your service“ to others. One company advertises a standard cleaning fee for rentals on a per bedroom basis. In another case, home warranty programs are offered to the public on an annual basis to guarantee them emergency repair services on small jobs. Depending upon licensing requirements, you might consider maintenance a source of cash flow for maintaining not only the physical premises-but also your financial reserves.
NETWORKING – A POTENT KEY TO FINANCIAL HEALTH
A few years ago John Schaub and I started up a confederation of prior grads of our seminar. Our idea was that they'd learn to cooperate and support each other in their individual quests for financial security. Since then investor groups under many names have sprung up all over the country. On the surface, this would appear to be a good omen. The danger is that members of a group start substituting real progress for endless rounds of education and shared experiences at the conversational level. Conversely, groups that share opportunities and knowledge can be powerful indeed.
If you aren't a member of a group, you should consider joining one. But if you are already a member, your group will benefit you most if it uses its economic power to negotiate for wholesale prices for materials and labor, advertising, financing and acquisition. Consider a group with 100 members, each owning 3 houses. They should be able to command wholesale prices and extra services from lenders, lawyers, insurance agencies, brokers, title companies, appliance and carpet dealers, etc. And when money is needed to make a purchase, what better people to co-venture a purchase with or to borrow from than your own peers who understand the situation.
In our classes we demonstrate how to buy houses by having groups cooperate in locating and negotiating for opportunities. Your group should be doing that all the time. Recently we had a member of our graduate group develop a computer management program designed around our unique needs as single family house investors. She was able to sell it to some 50 people in the group, thereby rendering a service to us and earning a profit for herself. There are myriad opportunities for those who can offer true value to members of their group in the form of services or opportunities. The message here is that your group will only be beneficial to the extent it becomes active in helping all of its members reach their fullest potential – and vice versa.
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