October 1980
Vol 3 No 1
Our family of subscribers now is international with both Canada and Australia being added to our readership. While we continue to enjoy an extraordinary degree of loyalty as reflected in a high re-subscription rate, we are seeing more and more of the investing public among first-time subscribers. Single family houses appear to be gaining in popularity with all segments of those seeking an economic hedge against the uncertainties of the coming years. As the only investment newsletter being published specifically for the single family house investor, we are enjoying our position as THE definitive investment guide in our specialty.
During the second year of our existence we gained readers in all 50 states of the United States. That marked a milestone in our planning. Now we are going to make a real effort to provide a system of communications whereby each of you can get to know one another. Over the years we have found major investment opportunities that were simply too huge to handle without a lot of help. We were forced to pass them by for lack of brain-power or shortage of management/supervisory people competent to act on their own to generate profits. We think we are on the threshold of a quantum leap into an extremely exciting period for the single family house investor.
As an illustration, Don Kendall who is a Trustee of the CommonWealth Trust has located a lender with some 600 single family houses located in several areas of the Southwestern United States. There is a possibility that we might be able to negotiate a Master Lease with an Option to Purchase on this Lender’s entire inventory. By presenting a solid front to the institutional lender, we will be able to cooperatively acquire a sound investment position on outstanding terms. The key point in achieving this is our proven credibility as successful investors and property managers of substantial means.
While the above example involves a “big deal”, there are often opportunities for investors who would like to get their toes wet in a “little deal”. The problem lies in getting the various parties together to explore their needs. To this end, we want to inventory our readership by means of a survey. We hope to identify those who seek investment opportunities and put them in contact with others who have situations requiring investment. Without underwriting the activities of anyone, or endorsing any particular investment, we aim solely to enhance the prospects of all our readers simply by helping them to communicate more efficiently. We envision no cost for this service.
We are enclosing our survey as a separate item along with the CommonWealth Letter this month. It must serve two purposes. First, it will provide a missing link in our files to a better understanding of our readership’s needs regarding the orientation and level of our newsletter’s information. If we find that you are just starting out, we will be more basic in our approach. On the other hand, if we discover that you are more sophisticated, we will become more technical and treat a different range of subject matter commensurate with your interests.
The second reason we are questioning you is to qualify you for membership as a Trustee in the CommonWealth Trust. The CommonWealth Trust is a lot like a pro football team. Only the best make the first team. All others comprise the back-up and specialty teams. Yet they are all professional performers. ONLY 500 PEOPLE CAN QUALIFY AS TRUSTEES IN THE COMMONWEALTH TRUST AT ANY ONE TIME! Based upon the completeness and timeliness of your response to our questionnaire, we will select the most active people who are building their own estates with real estate investments. Next year we’ll select another group.
WHAT IS THE COMMONWEALTH TRUST?
It is a group of past students of the Miller/Schaub Seminars who have attended both the basic 3-day course on creative acquisition, financing, and management of single family houses as well as one of the Graduate courses including the Options, Survival, or Nitty-Gritty Clinic seminars. The 500 Trustees at last count controlled over $400,000,000 in real estate assets. We expect that figure to approach one Billion Dollars once our survey has been completed! Trustees represent the elite of the over 6,000 students who have completed our basic course.
It’s not difficult to see the wealth of experience and savvy as well as success embodied in the CommonWealth Trust. By organizing the “crème de la crème” of those who are actively engaged in reaping the bounty of the real estate markets all over the nation, we will have harnessed one of the most potent forces in the investment world. From that point on, we will seek ways in which we can all work together to optimize our financial situation as a group as well as individually.
The 1980’s will be eventful, of that there’s little doubt. Demographically we will see tremendous numbers of people moving into the Pacific, Mountain, Southwestern, and Southern States. They will bring political and economic power with them into areas which are presently considered to be conservative and economically backward. As producers of profit, we are most affected by liberal trends such as Rent Controls and high taxes. I’ve found a terrific bargain called ROBERT WHITE’S DUCK BOOK written by another successful entrepreneur. It compiles much of the best conservative thinking around to give us the unvarnished facts behind our “representative’s” moves. $10 will buy you a lifetime subscription (Robert White Inc., P.O. Box 1928, Cocoa, Fla. 32922).
Bad News? Not for those who are prepared! After all, most of the major fortunes that exist in this country were made during times of turmoil. It is when the rules are being changed by runaway inflation, depression, war, government controls and opportunity really thrives for those who can recognize it and capitalize on it. For those, the “80’s” will offer unparalleled avenues to the peak of power and wealth. Already we see signs of tax reform that will aid the small business person. Let’s look at the tax picture.
Congress is throwing up more and more road blocks that the IRS must overcome. We will see more liberal depreciation allowances for houses, furnishings. Tax rulings will ease for installment sales limitations, small business corporation restrictions, “over 55 $100,000 exemption” on sale of personal residence, profit sharing and pension plans. All are under congressional review. The Government is finally beginning to realize that the only way they are going to get capital investment is by allowing the business person and the entrepreneur to make a profit AFTER TAXES.
Capital gains taxes will be reduced to 30%, and gradually eliminated for investors. With capital gains taxes being reduced, and the long range trend being toward gradual elimination of capital gains taxes, the real estate picture will change drastically. Consider all the billions of dollars invested in low basis property which has been “locked in” because of high tax ramifications. Think how the prospects of the 70% income tax bracket have influenced investors to keep their assets frozen in low yielding properties such as raw land rather than liquidating them. We could be looking at a market explosion.
It won’t happen overnight, but elimination of capital gains taxes and a lowering of the tax penalties for liquidation could bring millions of properties into the market. The resultant liquidity would drive prices higher and higher as investors competed for the income properties. We, as owners of single family houses, might enjoy fantastic increases in market price for our assets, since few other investments would benefit by price inflation as much as single family houses. Our secret advantage is that our product is priced in accord with its replacement value while income properties are priced in accordance with yield.
To illustrate this point, suppose the investor market is willing to accept a net cash-on-cash yield of 10% when inflation is equal to 10%. This provides a hedge that maintains purchasing power constant for the investor. Thus a building that provides a net income stream of $10,000 might be worth $100,000 cash investment. Now, if inflation goes to 20%, while operating costs offset any rent increases, that same investor would only be willing to invest $50,000 for the identical building, because he would still require his net cash-flow to yield the inflation rate. Thus, inflation tends to lower the value of income properties rather than to increase the value. This fact is often overlooked by amateur investors who seek income properties as a hedge against inflation, thus they have in effect created a commodity market. It is being priced on the basis of speculative profits rather than on predictable investment results. It could be extremely hazardous.
Meanwhile, the single family house construction costs are being driven up by the same inflation rate. Materials, labor, land, and money are all extremely responsive to inflationary movements in the economy. Builders can no longer afford to build houses that the public can afford to buy. We see evidence of this all over the country in the form of unsold housing subdivisions. Lenders, made nervous by overdue construction loans, react by tightening their qualifying requirements and increasing interest rates. New house sales slow down, and rental space becomes scarce. Landlords increase their rents to meet market demand. That’s the reason that single family houses tend to thrive in inflationary times.
For the individual who has never attempted to invest without using institutional lender financing, market opportunities remain in phase with tight money. Buying opportunities await availability of investor money. There are few bargains in good times, and none that can be purchased in bad times. On the other hand, the creative investor who shuns banks and who uses Seller financing, Exchanging, Leases, Options, etc. to control investments is in a good position to work against the market. As money becomes tight, he or she can step up purchases, since they are working in a non-competitive segment of the market. They buy in a buyer’s market and sell in a Seller’s market. They are able to increase profits no matter what the financial situation. By buying houses creatively, the investor has a perfect double edged hedge. He or she has a hedge product in the SFH and hedge financing in the creative formula and structures used to buy houses.
There are several ways to buy profits through the use of “interests” and “rights” in property rather than the property itself. These include the INVESTMENT OPTION, the LAND, LEASE, REMAINDER INTERESTS, and the PRIVATE ANNUITY. These offer great promise as creative real estate tools. Here are some illustrations of how they might be used in unorthodox ways to create wealth without great expense or risk.
The Option can be a potent device for controlling real estate. The problem is that it is difficult to obtain in quantity. But suppose we bought a house, then sold it after we had created an Option interest and retained it for ourselves. We could price the house in such a way as to entice a buyer with full knowledge that he or she would have no chance of making a profit other than to enjoy the use of the property, giving him a bargain. Thus, we have the same benefit as if we had purchased an option, and we will have divided any gain between the sale date and the date we in turn sell the option for additional profit. We have a form for tax-shelter and we also hold our investment as PERSONAL rather than as real property. When one holds real property, it must be probated according to the laws of the State in which it is located. However, when one holds personal property it may be probated under the laws of the State in which the deceased is domiciled without regard to the location of the real estate it represents. Thus Options avoid probate problems too.
To illustrate, suppose a $100,000 gain was realized by selling a property for $50,000 and retaining an option to repurchase it for $50,000 in 7 years. $50,000 of the gain would be realized at sale, with the remaining $50,000 held in the form of the repurchase option. If the option interest appreciated at the rate of $10,000 per year (not unusual with single family houses), it could be harvested again and again over the years by allowing the property to appreciate another $50,000 and then repurchasing it and reselling it under the same terms and conditions as nauseum. Note, there would be no need for management under this strategy, or for rent collections. Furthermore, your control over the property would be maintained the entire period by your option interests.
The above illustration divides the property through the use of an Option. A Land-Lease also can be used to divide a property. It can be created in the same manner as above, since it too is difficult to purchase in the market. Rather than providing a capital gain periodically, it provides income which is related to the value of the property and the prevailing costs of capital. Unlike a Mortgage or Trust Deed, a land-lease does not lose value over the term it is in effect. In fact, as its termination date draws high, it begins to increase in value, since at that point ALL THE IMPROVEMENTS ON THE PROPERTY REVERT TO THE HOLDER OF THE LAND LEASE! Of course land leases should carry escalators to maintain their value in the face of inflation – something that Notes and Mortgages rarely do. They are also eligible for a tax-free exchange under Section 1031 when they are over 30 years in length.
By purchasing un-zoned land, then having it re-zoned to increase its value, and then agreeing to permit someone else to erect an improvement on the land in return for a lease based upon the appraised value of the property, one can gain awesome returns from land leases. It isn’t outside the pale of human experience to see an acre of land which costs the investor $10,000 to be rezoned commercial (thereby increasing its value to $25,000) and to finally be appraised at $50,000 with an appropriate structure on it. The lease payment might be based upon 10% of value, or $5,000. This would be 50% of the original cost NET per year over a long term holding period with utter safety, if drawn properly.
Remainder Interests offer yet another approach to profit. In effect, one buys a property today to use at a point in the future. Here, the key point is that the price paid is only the DISCOUNTED VALUE OF THE FUTURE PRICE. For example, if you buy a remainder interest 15 years into the future from an elderly person who will have no need of it then, you would expect to pay the fair market value (i.e. $100,000 appraised value) DISCOUNTED by the prime rate (i.e. 12%) for 15 years. This amounts to $18,269.63. Shocking isn’t it? Yet that amount, if allowed to earn 15% interest for 15 years will equal $100,000. Since you won’t have access to the property until that date, it isn’t fair to pay any more than that. Of course, when you sell the property, you can sell an option based upon the future APPRECIATION based upon the growth rate. If this was 10%, the property would be worth about $417,725 after 15 years. You should be able to sell an option for more than you paid for the property. Better yet, sell a ½ interest and hold your investment for free.
Private annuities offer fantastic variations on a theme. In this case the U.S. Treasury tables control everything except the valuation which must be done by appraisal. In effect, the owner is offered an unsecured promise to pay a series of payments based upon Treasury Regulations. He or she is taxed in much the same manner as on an Installment Sale, with a portion being allocated to basis, gain, and interest. The Basis of the Buyer is the purchase or appraised price, so an immediate cash sale at the same price yields no taxable gain but plenty of cash. This is a terrific estate planning tool, since there is no “gift in contemplation of death” problem. It works great for families or close friends.
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
