May 1986
Vol 9 No 7
Almost 10 years ago this month I held a little 2 hour symposium for a handful of Realtors. I'd been working on an idea for a seminar which would show ways to invest in single family houses and I wanted to try it out. I'd previously written an article on the same subject and this seemed a logical extension of that article. My premise was so simple that it seemed odd that everyone hadn't already recognized it. In a few words, I wanted to teach people that they could buy houses with less skill, knowledge and cash than any other investment. In order to find true financial independence, all they had to do was to make sure that the houses they bought could be rented for at least enough to pay for the mortgage payments, taxes and insurance on a regular basis and eventually they could have an estate valued in the millions.
To my knowledge this little meeting of the minds a decade ago was the genesis for every seminar currently being presented on the subject of single family investments. From it sprang the Miller/Schaub 'Making It Big On Little Deals' course, Robert Allen's 'Nothing Down' book and the various spin offs that his instructors and students began to offer. Way back in 1976 interest rates were hovering at 8% – 8½% for FHA and VA loans and the market was lively to say the least. Those were the good old days when buyers in San Diego and Orange counties would camp out for a week or so just to get their names put into a hat for a drawing to see who the developers would sell to. Markets were HOT all over the USA. The opportunities presented then will never be seen again, right? Read on!
In late February FHA and VA loans fell below 10% for the first time since 1979. They're still going down. 9% money's available in some areas. The Buyers are out in droves. Prices are on the move again. Single family houses are becoming extremely liquid as easy financing and affordability improve. The Northeast, New York and New Jersey are enjoying leap-frogging advances in prices. San Diego and Orange County house markets are beginning to evoke images of ten years ago. Florida's resales are booming. The Midwestern areas are seeing activity in housing which is revitalizing rents and sales for the first time in years. The Mid-Atlantic states and the Washington, D.C. area are hot spots. With only a few exceptions, those who invested in single family houses in accordance with my original concept are in position to reap huge cash fortunes today.
THE FEDS GIVETH AND THE FEDS TAKETH AWAY . . .
The first couple of times I went broke in the real estate business was because I thought I was smart instead of lucky. Which is it this time? I've been inundated with investment letter promos in which the writers point with pride to their predictions that interest rates would fall. And continue to fall. On the other hand, I still think they're TOO HIGH FOR PRUDENT INVESTMENT at the current inflation rate! Let's resolve this to see why each of the above positions carries some truth and some error. We'll begin by looking at INVESTMENT interest rates and CONSUMER interest rates.
As an investor, one must consider interest as a cost of doing business and a risk factor. When 30 year, level payment, fixed rate, assumable loans can be obtained at 9% that might seem terrific in comparison with the mortgage terms offered over the past five years. But over the past 30 years, they could have been ruinous. My point is, that long term investors should look at things over the span of their entire holding period, not just at relative comparisons over short terms. Sure, the past 5 years saw interest rates in the high 'teens on variable rate loans. Compared to these, today's financing is a godsend. But one must be able to predict the performance of property against costs over the future too.
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The paradox is that, while today's financing is a boon to the consumer, allowing millions of people to enter the housing market and to buy their own homes, mortgage interest is hovering near its all time high when compared to inflation. Official inflation figures are at a 32 year low. Those who are expecting inflation to make them a fortune with their real estate investments could he in for a surprise. Of course the long term could present an entirely different scenario, but the fundamentals still aren't in place to make it possible for the forecaster to make specific projections as to WHEN inflation will return, or at what level. Unfortunately, once you sign the loan papers, the lender knows precisely when you'll be paying your payments and at what level. Hence, the risk component of financing must never be far from your mind when the temptation to refinance properties arises. My original premise still holds true, RENTS MUST SUPPORT PAYMENTS IF YOU'RE TO SUCCEED.
Ask yourself: Why have interest rates gone down when consumer, corporate and government debt is at an all-time high? I'm talking about CONSUMER DEBT /vs/ investment debt. Let's plug in some more facts. UNEMPLOYMENT IS ON THE RISE AGAIN. WE'RE BECOMING MORE MILITANT IN OUR FOREIGN POLICY. WE CONTINUE TO LOSE GROUND TO FOREIGN MARKETS. OUR RATE OF GROWTH HAS SLOWED. WE'VE BECOME INDEBTED TO CITIZENS OF OTHER COUNTRIES BEYOND OUR CAPACITY TO REPAY. INTERNAL DEFICITS CONTINUE TO SOAR. WE DON'T EVEN HAVE A BUDGET. TAX REFORM HAS BECOME A JOKE. WE'RE LOSING OUR MANUFACTURING BASE. CAREER OPPORTUNITIES FOR COLLEGE GRADUATES ARE RAPIDLY WANING, OUR BANKS ARE AT THE BRINK OF DISASTER. How Le it that miraculously, money has suddenly become cheaper? Is this an election year? Hmmm.
Suppose you were confronted with the multiplicity of problems that the government must contend with, what would you do? In ancient Rome, they built the Colosseum and gave the plebeians free entertainment while they inflated their way to ruin. Today, we'll give them HOMES. How? Via low cost loans. Look at how many of the above problems this solves. The construction industry can put millions of people to work even when they possess limited skills. Employment rises. Low taxed raw land is converted to high taxed housing. This builds the tax base for cities and counties. Housing is one of the major components of the Gross National Product. Ergo, growth picks up. Long term mortgages at low interest rates stimulate sales and profits. Income tax revenues surge. And the inventory of resale housing is reduced. With each new loan, an old low-interest-rate-loan is paid off. This increases lender earnings without putting too much more money into circulation. We're helping to shore up the bankers. The public is distracted from fundamental economic problems while they scurry to buy homes or scurry to put their new found cash profits into the banks until it's time to pay taxes on it. And the FEDS get to pay less interest too.
I believe we're seeing 100% government manipulated phenomena! Housing is booming. But have you seen the stock market lately? It too is reacting to low inflation and lowered interest rates. Billions of dollars change hands every day, and with each change, taxes will be paid. Under the proposed tax bill, these taxes will be higher for this type of activity. Anytime things get tough, or inflation starts to move, all they have to do is to raise interest rates to suppress that portion of the market they want to control. Or raise taxes selectively. Meanwhile, John Q. Voter is happily adding up his paper profits or cash (the same thing, considering they're planning to change the currency too) and feeling good about the Administration. And they said Ronald Reagan was just a pretty face . . .
THE TIME HAS COME, THE TURTLE SAID, TO SPEAK OF MANY THINGS . . .
If what I've said thus far seems plausible, there are some things that you should be doing to enhance your position. Let's resolve the paradox of high investment interest and low consumer interest existing at the same time/rate. If it's too high for you and just right for them, WHY DON'T YOU SELL YOUR HOUSES? I am! I no longer have vacancies, I have INVENTORY. I've found that my practice of rigorously selecting my tenants has proven to be a mixed blessing. They've got the earning capacity and credit history to enable them to qualify for new mortgage loans. After I'd lost several excellent tenants who purchased their own homes, I decided to join the fray. Before getting into some specific strategies, take a look at the overall plan.
HUD estimates that some $70 BILLION in loans will be applied for by September. That's based upon 1.3 MILLION new home loans. VA will guarantee $18 BILLION more. GNMA is requesting increases in its ceilings to allow the secondary market to absorb these. Most of the new loans will be fixed rate, 30 year, level payment, fully amortizing loans – THE MOST ADVANTAGEOUS FORM OF INSTITUTIONAL FINANCING. Think of it this way, that means there will be vast opportunities for buyers for the next decade who can find ways to assume these low interest rate loans. Folks, I think we'll be able to do it all over again just as we did it in the early 70s. And the potential for profit will be comparable.
Suppose you were an early student who only went to one seminar, the MILLER/SCHAUB model being presented in 1979. That means you'd never heard about Equity Sharing, Negative cash flow benefits, 'pulling your equity out tax free via refinancing', syndicating a lot of thinly financed investors. All you knew was to buy a house, rent it to the right people who would pay the rent and do the repairs, stay away from non-assumable loans and personal liability, pick a house that would qualify for FHA/VA financing in an attractive setting. In 1979 that house might have cost you between $35,000 and $75,000 depending upon where you bought it. If you did what you were taught, you negotiated a price somewhere between 10% and 20% below the market on terms which might have ranged from ZERO interest with no payments for 7 years to 8% payable monthly out of rents. And that would mean that you'd have about $20,000 to $50,000 in gross equity in the house today.
Take a moment to think about this. If you failed to negotiate the proper terms, or picked a house that won't meet FHA/VA criteria, or is unattractive to the market, or has had the equity 'pulled out via tax free loans' and been spent; you won't be able to harvest the fruits of your labor. But if you've played the game the way you were taught, you're sitting on relatively large sums of money which you can capture in cash by SELLING to consumers in this hyper active market. Even if you did a lot of things wrong, there's still plenty of benefits to be had by selling now.
Let's say that you've got a variable rate, high interest, non-assumable loan on the house buttressed by a 2nd and 3rd lien which you placed on it when you bought or when you needed cash. Even though you might not see a dime of cash profit on sale, you'd be able to DEFINANCE those loans, removing them from your statement together with any full recourse liability you might have incurred. The key is to have your buyer put a new loan on the house so your old loans would be paid off. Selling on a Wrap around or an all inclusive trust deed is probably not the way to do business in this market IF you can get your buyer qualified on new loans which yield CASH.
Remember, this is a CONSUMER market. Unless you're able to receive RETAIL prices for your houses from investors or syndicators, it's better to sell them one at a time to USERS who can obtain OWNER OCCUPIED financing. Investors aren't being welcomed into this market as enthusiastically as users, and they aren't finding loans as easy to obtain either. Here are some ways you might dispose of several houses which either have unfavorable loans, don't have much future potential profits, are hard to manage or which will require lots of maintenance over the next few years.
1. Sell to your better tenants. If they don't want to buy the house they're in, sell one of the others. If you don't have another, find another landlord and let his preferred tenants buy your tenant's house and let them buy his tenant's house. Here's one way.
2. Offer his tenants a 'contract to meet FHA repair contingencies' with a guaranteed payment sufficient to defray closing costs and down payments pending completion of the job and approval by the FHA inspectors. This would normally include painting, clean up, and light maintenance which he could do. Pre-pay the contract and place it into escrow as earnest money on a contract for purchase of HIS property. He does the same for your tenant. Voila! Each tenant qualifies for a new loan on his own home and each owner sells for cash without losing days to vacancies.
3. One person I know sells a new home to his existing tenants. The builder pays him a fee which is built into the sales price. Once the tenant has signed the contract, the closing is held off until the tenant has been able to help the landlord sell his prior residence. The tenant shows the property and keeps it presentable until a buyer for it is obtained. This way, no rent days are lost holding the house empty for showing. And the tenant is motivated to actively assist in the sale as a prior condition to his buying his own house. Of course, the owner makes more profit once the builder's fee is added to his sale proceeds.
I GET BUYS WITH A LITTLE HELP FROM MY FRIENDS . . .
There are any number of ways to cash out property in this market. Let's assume you've been successful at doing this. What's the next item on the agenda? TAX SAVINGS! There's such a thing as an ALTERNATE MINIMUM TAX which will affect sellers with big profits. But, fortunately, there's also a provision for tax deferral under IRC SECTION 1031. This will allow you to get rid of pesky properties or financing with a cash sale and re-invest the cash in more desirable properties which you should be able to buy at wholesale – all without paying taxes. The Exchange game is no place for amateurs. You'll need competent tax advice and real estate Exchanger services to do this, but it's worth the trouble.
In a liquid market, there's a unique opportunity for 'PAPER'. First, consider the plight of the person with a balloon note coming due on a property that's hard to finance in the conventional mortgage market. He can sell one of his FHA/VA houses and use the cash to pay off the balloon. Or he can give you an equitable interest in his property if you'll sell one of YOUR houses for cash and pay off his balloon. It's only a short leap to considering the short term gains one might realize by advertising quick cash for those facing balloons, and using your saleable properties to create cash to buy interests in larger properties which don't qualify for FHA/VA loans. This way you continue to leverage your estate pyramid with EQUITY in USER PROPERTIES with little or no management effort. The next possibility is for you to buy discounted liens on properties which have been listed for sale in hot markets. Remember, the lien holder isn't aware that the property is being offered for sale. His loan may have years left to pay off. When the house sells and is refinanced, the liens are paid off. Present value soars.
Here's an example. The second mortgage was 12% with 17 more years to go. It paid 72.48 per month. The balance was $6,295.95. Discounted to yield 15% (below current market yields), it had a present value of $5,338.44. When the house sold, $957.51 profit was made. Big deal! That's less than a thousand dollars. But this lender had lots of these loans. The strategy is to settle for a lower profit and to turn over your investment many times. Where do you find these loans? Try the multiple listing book which shows houses for sale and the liens which must be paid off. Then go to the court house and look up the lender's address on the mortgage or Trust Deed. Or check the telephone book. He's often listed.
There's a natural reluctance to sell houses you've worked long and hard to buy and to keep. On the other hand, if you've been running cash-short or if you've been taking chances on the due-on-sale loans or signing with full recourse, here's a rare opportunity for you to clean up your act, get liquid, get safe and to dump your losers. With millions of brand new, low equity, FHA/VA loans in place, you'll be able to re-enter the market as a cash buyer and to re-leverage correctly – and profitably for the long haul. Don't blow it.
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Quotation not permitted. Material may not be reproduced in whole or in part in any form whatsoever.
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