July 1982
Vol 4 No 9
Nationally, with a few exceptions, housing has been in a slump for what may soon be a record breaking length of time. Unlike almost every other investment medium, the single family house has performed exceptionally. Even the most skeptical of the hard money camp is beginning to advocate houses as a store of value in the face of the projected inflationary binge the Congress is going to foist on the American voter in this election year. Billions of dollars are poised to enter the market! Why? How?
In 1982 the Bond market could be wiped out if interest rates return to their expected levels. Leveraged positions in Gold, Silver, Commodities, and Stocks may soon become too expensive to maintain. Changes in the tax laws have measurably reduced the attractiveness of collectibles, gems, stamps, porcelain, carpets, books to pension plans. For many corporations, the value of their real estate holdings is the brightest spot on their financial reports. When reduced appeal of alternate investments is added to the special tax benefits of real estate – and when the need for inflation, hedging against the monster deficits generated by the Congress is fully apprehended by the public – a rush into improved, income-producing real estate is sure to follow. The single family house is the most accessible to the small investor. It is one of the safest and most predictable long term investments for the private, corporate, or institutional pension plans. Above all, it represents the best of all inflation hedges for users.
With Congress unable to act and the voters unwilling to “bite the bullet” to wring inflation out of the economy, resumption of a high inflation rate is a certainty. EVEN IN THE FACE OF A PERIOD OF HIGH UNEMPLOYMENT AND STAGNATION, cheap money can produce only high inflation. Dollar devaluation means expensive long term money and a long line at the credit window. The U.S. Treasury will be first in line. Credit will be in short supply. Lenders will be nervous and reluctant to underwrite inflation. Interest rates will have to rise. Terms will be set to insure the lender is protected, not the borrower! The more feverishly that Congress subsidizes industry, social programs, defense and low cost mortgage financing, the faster the inflation rate will rise. In this critical year they’ve cranked up the presses and house prices are again on the increase. Buy with care.
Options, Equity Financing, Structured Mortgages, Carved-Out Interests all offer opportunities without much risk for investors. However with so many special interest groups trooping through Washington today, the picture could change virtually overnight. Your strategy should be to CONTROL property without personal financial liability and at a cost that’s feasible. You can’t do this and still pay high interest rates on loans. An Option allows you to limit your risk solely to the money paid for the Option while it provides you with maximum leverage to take advantage of any inflationary growth. The Option booklet I wrote spells this out in more detail. You can have one for free if you extend your subscription for one year. You’ve probably already received one. Read it!
In the February 1981 CommonWealth Letter we devoted the entire letter to ways of freeing your houses of debt without using cash. Methods we explored included moving loans onto a single property off of several others, working with other investors, pension plans, or corporations to remove debt; tax-free exchanging, creatively structured paper, discounted Bonds, Gems, etc. for making your investment house portfolio free and clear. Re-reading that letter is a good idea now. (Send $3.00 for a copy if you’ve lost yours.) These same techniques can be used to buy houses in today’s market before it’s too late. If prices rise rapidly, those who delay could easily be left behind. It’s time to act!
EQUITY SHARING: LOOK BEFORE YOU LEAP!
A secret that everybody knows isn’t very valuable. Back in January 1979 we suggested using an Investor with deep pockets to provide the financing for a single family house acquisition. You’d lease it back with an Option which would divide the profits between you equitably. Several of the people who took this newsletter and/or who attended one of the seminars we presented have emerged full-blown into the seminar field as Equity-Sharing specialists. Somewhere in the process the concept has been modified. Not only has the technique been given wide dissemination, impairing its value somewhat, but it has been distorted. It could prove to be quite hazardous of done in an improper manner.
There are a variety of programs being presented to the public today. A few years ago, one firm in Dallas came up with the “Rich Uncle” program to enhance home sales. The TICKET Program started in California in 1979 to assist sales agents to sell houses. It is used in some 15 states now. Basically, an investor or a seller puts up a portion of the down payment in return for tax benefits and appreciation as agreed between the parties. An approved standard form contract is used by TICKET. In New Jersey they spell it ESP (Equity Sharing Plan) and it works in about the same way. In Florida, Tom Novak of RETEL has structured several variations of these plans and presents a seminar on it. Where before, this approach had been developed to help the owner occupant to buy a home, Tom also included ways for investors to buy rentals.
A different range of hazards is presented when investment properties are bought, sold, or packaged in quantity using Equity Sharing techniques. This is a lot more hazardous when either Tenants or passive Investors are involved with a Broker. In all the enthusiasm for Equity Sharing, not enough has been said about the problems. Whether you’re a Tenant, Investor, Agent, or Packager it’s not a bad idea to take a long objective look at your position at some point in the future when someone wants out.
First of all, a lot more people are going to start co-venturing acquisitions using Equity Sharing to enjoy the same tax benefits as in other investments. Prior to that time they were not eligible for the usual tax shelter benefits. At almost the same time the Federal Home Loan Mortgage Corporation agreed to start buying Shared-Equity Mortgages in the secondary market. These changes could bring millions of buyers into the market – and into bed with investors for the first time. That means that economic problems which affect major segments of the public or investment community will affect both equity share partners. Let’s look at a couple of potential scenarios.
In some states, Equity Sharing might be termed an “ostensible partnership”. If so, then each “partner” would have unlimited liability. In one such instance that I heard about, one partner filed for relief under Bankruptcy statutes. This tied up the property, preventing the other partner’s getting long term mortgage financing to meet balloon mortgage payments. They’re both in court. No one is in the house. They haven’t heard from the IRS yet concerning failure to file a partnership tax return.
What about the SEC? Especially where a real estate licensee is involved, the sale of an investment property where income or gain is to be realized through the efforts of a third party without involvement on the part of the passive investor can be termed the sale of a security. Without a license or regard for regulations. Criminal penalties apply! Of course, who’ll know if all works out well? What could possibly go wrong?
The investor could go broke and stop making payments. The homeowner could lose his house because he couldn’t make his share of any payments. Or their positions could be reversed. Or needed maintenance might not be done by the occupant. Or either party could be divorced, go insane, be sued and a judgment attached. More likely, all could go well up until the final disposition of the property. Most plans call for the homeowner to buy out the investor for a stipulated percentage of the appraised value. He might not be able to raise the money, yet be unwilling to move out. It’s likely that the courts would be sympathetic to someone with a family being evicted by an investor. Because of the popularity of the 5-year time frame used in many Equity Sharing plans, literally billions of dollars of loan funds would be needed for all the people to be able to pay off the investors between 1985 and 1987. Courts could be clogged with those seeking relief.
What about the homeowner who loses his job and is unable to either move out or to pay his payments? The investor will certainly be faced with massive problems, especially if he or she owns several houses in an area like Seattle where a single cut back by Boeing could cause layoffs of thousands of people. Some of the plans in which the investor puts up little cash down payment because of high leverage, then leases the property with an option to the promoter who in turn subleases to a tenant, giving him an option to purchase in return for a high rental payment could be lethal in a downturn.
Picture how difficult it is to evict any tenant for nonpayment – then think of the difficulty in evicting the same person who has rent receipts totaling several thousands of dollars with a vested interest in an option to purchase. Like noted tax attorney, Marvin Starr says: “If you think it’s hard to evict a tenant, try evicting an OWNER sometime.” If you’re going to use equity sharing approaches, here are some ideas.
Avoid any form of partnership – and make certain your structure confirms this. Use some form of entity such as a Trust or Corporation to insulate the property from court actions, family squabbles, death, etc. Get good tax and legal counsel in setting up your arrangement and make certain the other parties are represented to avoid problems. Escrow all documents needed to carry out the complete program – especially the buy-out phase. Pre-agree on all foreseeable contingencies as discussed above to dispose of the property and to disburse the proceeds. Make sure your agreements will hold water. Last of all, if you’ll deal with responsible, intelligent, solvent people on an equitable basis, you’ll have far less problems with equity sharing. There may be better ways!
ARE YOU WASTING CASH-FLOW WITH YOUR INSURANCE PROGRAM?
If you’re like most of us, you’ve been buying houses one at a time with little thought of insurance. Usually, we’ll try to get the seller to let us keep the current policy as well as the impounded funds to be used to buy the next year’s insurance. Then we advise our Agent of the expiration date and get him to automatically switch it over to his company when it comes up for renewal. He takes care of the details and adds special component for loss of rents and personal liability to reflect our special needs. If the prior policy won’t cover the property because it is being converted to a rental, he automatically makes the appropriate adjustment so long as we aren’t “short rated”.
As time goes by and our business becomes more important to our agent, we feel entitled to special handling. Our policies are all turned over to a single staff member with whom we do business. All claims are handled with her. WE DON’T NEGOTIATE WITH ANY ADJUSTERS. We submit our bills and they are paid. Conversely, we don’t abuse this. We avoid chiseling our insurance company and we don’t allow them to chisel us. As a result, we get lower rates and better service. We buy insurance to cover big losses, not to earn us a profit or to cover small items which we can handle ourselves.
Last month we reported that Gregg Adams had found an independent underwriter who could save a high percentage of insurance costs and we urged you to contact him direct. You should certainly get your own agent to bid your total package every so often just to keep him honest. Insurance appraisers tend to be ambitious about the increase in value of your houses, and they’ll insure the ground beneath your houses if you allow them to. Keep your insurance down to the minimum and use a high deductible. It may only save a few dollars per month per house, but that adds up with several houses.
A few months ago one of our readers lost several thousands of dollars because he had failed to insure adequately. In an effort to get around a due-on-sale clause, he had himself added as “additionally named insured”. When the original owner moved out, it cancelled the policy automatically unknown to anyone but the agent. The claim was disallowed on the basis of his not having an insured interest. There are many strategies to dupe lenders into not accelerating their loans, but whichever decision you make be sure to confer with the insurance agent to make certain your interests are protected. If you hold property in Trust or in a Corporation you might have yourself listed as Agent for the Owner. This could give you an insured interest as well as concealing the real ownership. Of course this strategy must be one which will pass muster with the particular insurance company with whom you carry your property and liability insurance.
IN THE POTPOURRI DEPARTMENT. . .
Jim Harris informs us that the house market in Sacramento is rapidly turning into a distress market EXCEPT FOR OUR RECOMMENDED HOUSE located at the mid-point of the market. These houses either sell at retail or the owners won’t part with them. In spite of all the bad reports, SFH in a non-speculative segment of the market continue to defy the predictions of the impending crash. People are sacrificing to hold on.
Congress is letting a sleeping dog lie – until after elections. Due-on-Sale Legislation has been shelved for 1982. The Supreme Court will expedite a ruling on the Fidelity Federal S&L of Glendale case, due out sometime this summer. The options outlined in our May letter may become activated sooner than we realized. (Vol. 4, No. 8)
Under a recent ruling of the 6th Circuit Court the IRS now has the right to names of people doing business in organized barter clubs. Under Rev Ruling 80-52 the IRS has ruled that “credits” received in barter are taxable as ordinary income. . .
This year’s crop of bankruptcies, the highest numbers in 50 years, has had repercussions. The IRS has a special task force researching tax returns of those who have borrowed against property, then walked away from it. To the extent that their mortgages exceeded their basis in the property, they’ve had recognized gain on which they owe taxes. And this year unpaid taxes will carry interest at 20% per annum. It has almost become a cliché to borrow out “equity” to meet current expenses. When it has become impossible to pay accumulated bills many people have taken what appears to be a hassle-free way out by surrendering their assets. The IRS can change all that now. Whether we like it or not, 1982 is going to be the year when many of us returned to the old fashioned values of hard work, thrift, and layaway plans. That may not be all bad!
There’s another retreat to yesteryear emerging in the housing market: the ACCESSORY APARTMENT. That’s a nice phrase for couples doubling up. Now they’ve started doing it wholesale. I’ve been solicited several times by people willing to pay more money if we’d permit two families to occupy a single family house. Zoning boards are being inundated with complaints – more than they can handle. The impact is interesting. With very little multi-family construction, housing pressures will continue to build where the population can’t afford to buy a house. If owners can find ways to make their single family houses livable for two couples, they can charge higher prices with very little increase in expenses. Of course management and turnover problems will increase but perhaps the increased cash-flow would be worth it. Take a look at your properties to identify those with two baths, perhaps a convertible garage or family room and a floor plan amenable to erection of temporary partitions, entrances, etc. which would lend themselves to this concept. You might specify no children or pets to keep it simpler.
Speaking of doubling up, JOHN AND VALARIE SCHAUB HAVE A NEW BABY BOY. You guessed it, he’s long. Just the right size to start painting ceilings early. Some people will do practically anything for tax shelter – even if it eats income!
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