November 1990
Vol 14 No 1
SO FAR, IT'S A 'SARAH LEE' WAR! NOBODY (among the Politicians) DOESN'T LIKE IT . .
I just returned from Southern California – supposedly the site of massive layoffs as a result of cut-backs in Defense spending. The Peace Dividend has been steam roller'd in a rash of new government orders aimed at defense industries everywhere. Where the L.A. and Orange County investors were petrified at the prospect of some 27,000 highly paid wage earners being deprived of the funds they need to make payments on over-leveraged houses, they are now contemplating a resumption of price inflation fueled by new government orders and overtime pay.
This phenomenon is being repeated all across the country. In Tucson, the Hughes plant was predicting layoffs of 1800 workers. Now they're paying overtime. In North Carolina, orders for industrial pumps at a major manufacturer near Charlotte are surging. Manufacturers orders throughout the Northeast are being infused with new life. It's being seen in the South and Mid West as well. The Economic doldrums are being aided just in time for the off year Congressional elections as well as gubernatorial contests everywhere. Any student of modern history should be able to discern a pattern in all this activity that strongly suggests the presence of a lot of political manipulation of our current events.
American (and foreign) politicians have always used war to distract us from what might otherwise be deemed crucial domestic problems. When in this century, except in war time, have we seen such a confluence of opinion regarding the righteousness of our cause? Jesse Jackson & Jesse Helms, Teddy Kennedy and Bill Buckley, N.A.A.C.P and the K.K.K., WASPS and Chicanos – everyone is getting behind George Bush (and on the gravy train to political power) as we gird our loins to go into battle over MONEY! That's what this is all about. OIL and the flow of money around the globe. Skeptical? How much time would we spend on this if the dispute had been between New Guinea and Borneo? When it comes to money, everyone becomes a fan. When was the last time the world powers – USA, CANADA, ENGLAND, FRANCE, SPAIN, RUSSIA, ITALY, GERMANY, JAPAN, MEXICO were all on the same side. Even neighboring Arabian states too.
Herbert Hoover was our last peace time president over his entire term. FDR had his WWII. It saved the economy after all his alphabetical agencies and social spending had failed. Truman surrendered American control over the Korean War to UN diplomats and we wound up the losers. Eisenhower took on the Dominican Republic. JFK blew the Cuban Bay of Pigs invasion then had his Missile Crisis. LBJ's Tonkin Gulf Resolution put us into Viet Nam in a major way. Nixon got us out of it with appropriate political acclaim. Jerry Ford had the Mayaguez Incident (give him a break, he was only President 2 years). Carter had his killer rabbit and the Iranian Hostage situation. His handling of this cost him his job more than any other factor. Reagan had his Granada. No one bothered to wonder why 7000 American boys invaded this tiny island to fight Cubans when we had an active Naval Base in Cuba at the same time. Now George Bush has his Iraq. His popularity has never been higher.
MILO MINDERBINDER WOULD BE PROUD OF BUSH . .
So far, this is a purely FINANCIAL WAR. We've mobilized thousands of men in the Reserves and National Guard. It's caused the DOW to drop 500 points and anxiety to lenders who find themselves victimized by the prospects of having their interest rates and payments reduced as a result of the Soldiers and Sailors Relief Act of 1940. It has also reduced some unemployment, staved off a lot more joblessness and economic up heaval and allowed Bush to restore some defense appropriations despite Gramm-Rudman limitations. It's taken Congress off the hook too.
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If you'll browse through the book, 'Catch 22', you'll discover Milo Minderbinder. He was an enterprising young fellow who managed to contract out all combat bombing in such a way that nobody got hurt. In the meantime he made quite a profit for himself. None among the survivors minded at all. George is doing the same thing in his own way. When have any of his predecessors been able to mount a bloodless campaign where the objective of the war was not political supremacy or territory, but maintenance of deficit spending and avoidance of a recession. It's a game of 'Chicken' in which the stakes are high and in which just one mistake could result in a full scale conflagration. We can only pray he pulls it off.
IT'S BEGINNING TO LOOK A LOT LIKE 1973 . . .
I picked up a subscriber in Odessa, Texas today. At $40 per barrel, the Energy Belt is beginning to hum. Property values are starting up. He felt now was a good time to start updating his techniques to start buying before prices exploded. In Houston, we just got out of a special hearing to convince the tax authorities that our own property hadn't increased in value by a factor of 800% in a little over 2 years. We finally got them to agree on a mere 300% increase. And it's just started. Prices respond to PERCEPTIONS of inflation. Higher oil prices mean higher inflation rates. That means higher house prices as well as other kinds of real estate. That means that the real estate held by RTC and other lenders will begin to catch up with the loan balances it secures. Old George may be using oil price inflation to bail out the banks instead of tax payers' cash. Who knows?
In the early part of the 70s, higher OPEC prices caught everyone by surprise. We saw a sharply depressed economy. In Florida, this recession lasted for almost 4 years. Remember, the Government even gave new home buyers a 5% credit against their taxes if they bought a home just to get construction moving. Then the effects of the built in inflation hit. The public realized that their only hope of hedging their savings and future costs of living lay in investing in TANGIBLE ASSETS. So they bought Gold, Silver, Art, Collectibles, and HOUSES. In the hottest areas, we saw several years of house prices growing at 2% – 3% PER MONTH! Fortunes were made by those who could find ways to buy and hold single family houses. In those heady years we presented the first seminar ever on the merits of single family house investments. And we started this newsletter. I think it will happen again!
With this letter, we're including our complete seminar schedule for the balance of 1990 and 1991. We're planning to work harder in the next 14 months than we have at any time during the 80's to give you the tools you'll need to cash in on this last big real estate market of this century. And we're making it easier and less expensive for you to come. For the first time in several years, we're going into the Northwest. Seattle has enjoyed one of our hottest markets for the past couple of years. But Spokane and Portland may be poised to be next. We'll do a seminar there. We'll also go to Louisville and to Phoenix to try to find ways to capture future profits in those areas where prices are low. We'll make presentations for the first time in Albany, NY. We'll be in Oakland, Cleveland, Atlanta, Houston, Las Vegas, Reno, Orlando, Los Angeles – even Tampa so subscribers can visit these areas and get an on site perspective as to how they compare/contrast with their own areas. This is your year of preparation while you ready yourself for new opportunity.
BRAINS, GUTS AND IMAGINATION . . .
Everyone can find an excuse for not accomplishing something. The thing that sets a winner apart from a loser is that he/she refuses to acknowledge an obstacle as an excuse for failing to achieve his/her goals. Among the all time favorites of losers is the 'lack of capital' excuse that prevents them from buying a property. But winners have repeatedly discovered that real know-how combined with perception of all the possibilities generates a level of confidence that makes it possible for them to succeed. Guts alone aren't enough. Nor is mere possession of facts. Nor creativity. But all these in combination can work miracles. Boiled down to its essence, capital is a SUBSTITUTE for the three factors above. In fact, everyday we can find employers who must raise capital in order to hire those with brains, guts and creativity. If we can generate these within ourselves, we can by-pass the need for capital. In today's markets we can find an astonishing array of opportunities if we look for them. Single family homes remain my favorite investment in good times or bad, but when they're not available at the right price, several other kinds of real estate will still make money. But you've got to buy them under conditions that will generate a profit. That means you'll have to know real property values in TODAY'S markets as well as be able to make fairly accurate projections as to profits at the time you either sell or rent your real estate. In short, you've got to know the territory.
There's one way to offset lack of market know-how: make it a practice of always buying in the distress markets. That's what I've been doing for the past 10 years. When 3-mile Island almost blew up, I was nearby in York, Pa. buying houses from panicky owners. During Florida's 4 year recession in the mid 70's, I bought almost one house a month and still never had any negative cash flow. I bought in the Riverside/San Bernardino corridor, in Massachusetts, in Nevada when things were slow and rode the gravy train as the economy improved. In 1988, we invited subscribers to Houston to survey the distress market there. As mentioned earlier, the property bought as a result of that visit has skyrocketed. Phoenix may be next on our shopping list. By buying way below normal retail, we assured ourselves of a modest profit even if things didn't improve. But reaped tremendous gains when things got better. How did we do this? We took a calculated risk, then hedged our bet by never signing personally on a loan and always requiring the seller to share some of the risk.
Here's how you might do this. Suppose a distressed party swore by all that's holy that his property is truly worth $100,000. For you only, he'll sell it for $80,000. The underlying loan is NON-ASSUMABLE and could be called at any time, so here's what you do. You give the seller enough money to meet his immediate needs which would enable him to move out. Then you get him to wrap the underlying loan at a negotiated – but attractive interest rate which might be LESS than the rate on the underlying loan with payments equal to those required to service the underlying debt. Now, you set up a COLLECTION ACCOUNT with a local banker who'll accept your payments on the 'wrap loan', transmit them to the lender in first position, and credit your account with the seller on the wrap. This way you can be certain that all your payments will be credited and sent to pay the first mortgagee.
Suppose you had payments of $500 per month on the first loan balance of $45,000. You might have paid the seller $5000 to move out, and let him carry the $30,000 balance of his equity in a wrap @ 8% in the amount of $75,000. This could be any amount, but to the extent that it were less than the underlying loan, the seller would be paying part of your carrying costs. Now, assume that the first lien holder calls the loan. You'll have to step in and protect your $5000 down payment, but the seller would have to protect his equity in the 'wrap' – $35,000 – or be foreclosed out of his position. There are several ways you could look at this. If your payments to the seller were less than the rents you received, you might easily have recovered your entire investment without any risk at all prior to the loan being called. Then you could either walk away or negotiate to avoid foreclosure.
But there's another way to play this. You might find an investor who'd either buy the first mortgage or help you refinance that much of the loan. All that might be required would be for him to qualify for and assume the original loan without any cash at all. Or you might do it by yourself if you're financially strong enough. Or you could call the banker's bluff. Challenge him to go to sale. Recent cases have required lenders to prove their loan security has been reduced. By having the original borrower plus you now working to pay the loan, the lender might be deemed to actually be MORE secure. Courts can be tricky.
Let's assume the lender goes to foreclosure. There's nothing to prevent your renegotiating the wrap with your original seller to a lower figure in the face of his losing it all, then stepping in and buying the property yourself. Suppose some eager lad bids on the property against you. Your loans total $75,000. If you'd been able to buy the distressed wrap loan for $10,000. cash; your total investment might be $5000 + $10,000 + $45,000 on the loan being foreclosed. Remember, the fair market value of the property is $100,000. So, if the bidding goes to $80,000, you'll make $20,000 profit and be cashed out. If it goes above that, you'll make even more. But you can bid up to $80,000 without spending any more cash.
IT'S NOT WHAT YOU DO, IT'S THE WAY THAT YOU DO IT . . .
When you set out to make money in real estate, you only have a couple of basic ways to make it. You can buy low and sell high (Once you boil down all the fancy ways to structure things with paper, exchanging, Options, tax strategies, it still amounts to making a profit on gain) or you can make the property produce wealth either by renting it, mining it, fishing it, harvesting it or modifying it in some way. That's the BASICS. When you start considering all the para-mutations of these processes, you'll find virtually infinite approaches to achieving one or other of the above. Or, you might just get lucky!
The trouble with luck is that you don't control it. And you never know whether you'll have good luck or bad luck. But you can acquire skill and expertise through study and experience in combination. A lot more money has been made without luck than with it! Thus, it behooves you to see what you can accomplish with your own ability rather than to wait for fortune to smile on you. That's why we introduce new subjects from time to time.
Mobile homes are the future of entry level housing in my opinion. Look at the housing picture as essentially a food chain. Without the entry level buyer entering the market via FHA and VA financing, the person he buys from can't move up. Each person moves into larger quarters because someone else has bought his old house – or will buy it. Unless we have the young family building equity, they can't move. And they can't build equity by RENTING an apartment or Condo. They can do it with Mobile Homes. In the past decade, well situated Mobile Homes have appreciated just as fast as houses. When it comes to cash flow yields from rents, nothing in real estate can perform with them. Here's what I mean.
Comparing apples to apples, suppose you had a chance to buy a 1000 sq ft dwelling. On the average, you'd expect to pay anywhere from $50,000 to $150,000 for a conventional house with a low down payment. It would rent at about .75% per month for the low end, and about .66% per month for the high end. Interest rates would run at about .83% in both cases. With 90% financing, you'd have negative cash flow. Let's switch horses and buy a used Mobile Home for $2000 to $8000. We could rent the ground it sits on for about $150 per month and borrow money at about 1% per month. Rents would average about $350 in the same areas. Bear in mind that I'm speaking in generalities. Where lots and units cost more, rents run more too. In this illustration, you'd be making $80 or more each month cash flow. And if you don't like tenants who rent trailers, just start buying the lots. They run about $5000 and will rent for about $150 per month. That a gross rent yield of 36%. Try it , you'll like it.
So far, we've stayed away from all the variables that accompany creative financing. But with a firm grounding in ways to put financing packages together, it's possible to beat the above yields all hollow. In our Free-Form Finance classes, we start by pricing all the benefits once they've been identified. We charge the seller for those we leave with him and we pay for those we get. That's essentially what's happening in our various financing structures. Of course, we have to know which financial instruments to use to separate out the various benefits. Deeds, Options, Leases, Easements, Contrasts and Estates can be used to capture USE and GAIN. Leases and licenses capture income. So do permits in some cases. So do Notes. All these can be mixed and mingled to do multiple tasks when needed.
We've been using convertible debt to capture both income and appreciation in a benign tax environment while avoiding any possible liability that an owner might encounter from EPA or as a result of a tenant law suit. This is how we are holding our high risk distressed property interests in Houston.
