June 1980
Vol 2 No 9
The credit crunch is creating terrific opportunities for buyers in distress markets everywhere. Speculators who traditionally rely upon institutional lines of credit are being squeezed by astronomical interest rates and the collapse of the long term mortgage market. For those who can continue to function in today’s real estate market the next few months will offer fantastic buys in both SFH and discounted paper.
BUILDERS OF NEW HOUSES ARE MOST VULNERABLE!
In the recent bull market in housing, they plunged ahead borrowing money at 2 to 3 percent over the prime rate to build more and more houses. Their customers, who needed to sell their old homes first before closing on the new houses, now can’t qualify for the new high interest loans. Thus, the builders have to meet monthly interest payments out of cash reserves. Buyers who would like to complete their purchases are also trapped in their old homes.
This situation is compounded by the lending institutions who are also being assaulted on all sides by depositors who are withdrawing funds to subsidize inflation, Presidential policy which restricts credit, the Federal Reserve’s reserve requirements. The adventurous SFH buyer, who is willing to hold houses for income over the long term, is insulated from these market fluctuations, and thus is in a perfect position to help builder, banker, and buyer while using innovative financial structures to help himself.
First, survey builders in your area who have finished houses they can’t sell. Try to find those who have had recent sales “fall through” because buyers couldn’t sell their own houses, or declined (or couldn’t qualify for) new loans at higher interest rates. Look for the builder who is truly motivated to get off the high negative construction loan interest payments he must make. Even though some builders will get relief through the new 14% interim financing the government is going to provide, most of them will be exempt from it because of their higher priced houses.
From the builder, get the names of the recent buyers he has lost, and contact them. Here’s a way to help both of them if they are motivated. Suppose the buyer has a $75,000 house with a $45,000 FHA loan (assumable) at 8 ½% with $346 monthly payments. Previously the builder might have offered to take it in trade at a wholesale value of $60,000 with the equity of $15,000 being applied to the down payment on a new $100,000 home. The balance to be carried in a new 13% loan with payments of $940 per month. When interest rates rose to 16%, the buyer’s payments climbed to $1143. He lost interest. Now you propose the following to the builder: you will put the transaction back together if he will agree to sell you the “trade-in” house for $10,000 payable at $100 per month principal only with you assuming the underlying loan. From the builder’s stand point, this relieves him from his monthly payments on his $80,000 (i.e.) construction loan which, at 22%, was costing him $1467 per month. He might lose everything soon, and by eliminating this cost, and adding the $100 per month, it will give him a little more time.
Now back to our buyer. You show him how he can save his dream home at the old payments. With the builder taking the buyer’s house in at full value ($75,000), $30,000 will be credited toward the down payment. The Buyer’s new loan at 16% on the remaining $70,000 will be $941 – almost the same as before. He agrees, but to protect yourself you contract with him to purchase his house for $10,000 over the loan with the payments you had arranged with the builder above. With this contract recorded, the buyer trades in the house which the builder sells to you. You rent it for enough to pay all payments.
Of course you can structure offers in other ways. . . (a) You can agree to allow the builder to buy your option for cash, terms, or other property such as lots, other houses, or options on other houses. (b) You can buy the builder’s interest in the house with “soft” paper. Your purchase money note might read “no payments”, “due in full in 5 years”, “ payable at 30% of face if prepaid in first 48 months”, “full substitution of collateral permitted at option of maker”, “no recourse”, etc. (c) if the builder is on firm financial footing with his sub-contractors (who are probably suffering too), you might offer to co-venture ownership of the house for a quick sale or a long term holding position as an investment, or even assume any mortgages he can get.
Remember, when negotiating with our friendly builder we have an advocate on our side: THE LENDER. During periods of housing slumps the construction lender is also very nervous. Let’s face it; Loan Officers look omnipotent when things are going great. They look exceedingly vulnerable when no one is making loans. One might even say they are SURPLUS to lender’s needs. We have seen Lenders dictate terms to builders in order for them to protect their assets (and their jobs). To better understand some of the opportunities available when dealing with builders we recommend John Schaub’s booklet: “Investing in New Homes”, available from us free with a year’s extension of your subscription.
MOTIVATED SELLERS ARE EVERYWHERE DURING A CREDIT CRUNCH
Once they begin to perceive a slowing housing market, they become much easier to deal with. We have used a simple device to survey markets in several areas lately. It’s a door hanger which offers quick cash to sellers or quick loans to those who don’t want to sell. These can be distributed by hand personally, or by mail, the paper-boy, or kids who want to earn money on weekends. Only when the Sellers themselves feel they have a problem in selling their homes will they respond to the door hanger, but when they call you, they’ll be ready to palaver.
Because the homes we want to purchase are in the most secure portion of the market, they remain the most difficult to purchase in good and bad times. For this reason we have been considering another portion of the market: the very expensive homes. As we illustrated in our first example with the builder, by acquiring the “trade-in” house at a lower interest rate, we would have a positive cash flow going in with nothing down. With formulas wherein we become involved with higher priced houses, we expect to have some negative cash flows, but the benefits are awesome.
In most areas, houses rent for reasonable fractions of their value until they pass the median point of their respective housing markets. From that point on, they fall rapidly behind. For example, a $60,000 house might rent for $500, but a house worth $100,000 will rent for only about $700. A $250,000 house will only rent for about $1,000 year around, yet these larger houses on several acres (or in desirable locations) appreciate very rapidly in inflationary times. The current tight money market makes sale of them extremely difficult, thus their owners are motivated.
We recently found the owner of a 3400 square foot house on 5 acres with barns and fenced pasture who had been unable to sell his home. He had already purchased a replacement house. He had two payments and an extra house. We responded to his “For Sale” advertisement with an offer to LEASE the property for 5 years with an option to purchase at the end of that time. Our Lease would call for a total of $75,000 payable at $1250 per month. This almost covered his original payment on his older low interest Trust Deed. It provided him quite a bit of financial and mental relief. The Option priced was at current value. This transaction is still pending, but we learned a lot.
Negotiation over this lease created several ways in which to structure options on higher priced residences. (a) One might offer a high monthly cash flow, but take the profit in the form of a lower purchase price at a point farther into the future – say 7 years instead of 5 years – to take advantage of the compounded appreciation rate over a longer period. (b) In lieu of a longer period and a lower price, one might get a high percentage of one’s lease payment credited toward the down payment and purchase price. (c) Or one might allow the owner to receive the appraised value of the property at the time the option is exercised provided however that the Optionee/buyer has the right to decline and to receive ALL PAYMENTS PAID IN OVER THE OPTION PERIOD IN CASH at that time.
The alternative listed in (c) is particularly provocative when one considers the full ramifications. We have stated over and over again the benefits of living in a leased house while owning investment rental houses. Basically, you can continue to take a standard deduction on your personal income tax since you aren’t paying any tax or insurance bills on the house you live in. At the same time RENT payments would be LESS than high-interest monthly loan payments. The excess of personal budget funds you save can be plowed into investment houses to fund needed cash flows which will enable you to handle more investment houses. They in turn will generate more depreciation and lower your tax bracket, ad nauseum.
Suppose you decided on an extremely expensive house as mentioned in our high priced example. The Owner agrees to allow you full credit for the $75,000 you pay in as rent if an Appraiser places too high a price on the house at the end of your 5 year lease term. Instead of renting the property at a negative cash flow to someone else, which you might do under the other alternatives, you decide to occupy the premises as your personal residence. Look at your position in 5 years when you agree to accept the $75,000 in lieu of exercising your option. You have had the experience of living in luxury (albeit at a high price) at a sum far less than a comparable house would cost if you purchased it. At the end of that time you have all your funds returned to you tax free, since they merely represent a return of your own invested funds. Of course, in the event you had an opportunity to either sell or sub-lease profitably, you could!
There’s a temptation to dismiss daring concepts as fanciful and impractical. Distressful times create unusual situations wherein the fanciful becomes reality because of financial duress. An economic shotgun is being pointed at all sellers who MUST sell and who know nothing of innovative financing techniques. Until money once again is made available for loans, new ways of doing business will be able to command premium profits simply because no conventional business will be possible without institutional financing.
We have already discussed using a “trade-in” program with builders, leases with Options with higher priced homes, door hangers to help locate the motivated owners; these and other techniques are covered in our supplemental booklets “Options – a better way to control houses” and “Free Form Finance – buying houses without bankers” (our latest effort which has just come out). These booklets are available as a free bonus to our subscribers when they extend their subscriptions one year. What are some other methods by which we might capture this once-in-a-decade distress market?
One method we are using is to offer homeowners relief from high payments by subsidizing their income. Some householders become obligated to pay loans which strain family budgets. As inflation eats away on purchasing power, or jobs, or financial reserves; the effective burdens of high interest or high loan payment terms become more worrisome. We offer to “freeze” the fair market equity of homeowners at today’s appraised value, and to supplement their incomes with monthly payments of (i.e.) $100 in return for all future appreciation of the property. An Option contract protects us.
In effect, we are providing high cost inflation/depression insurance against loss of present equity values and relief from deprivation of lifestyle amenities. By taking on the risks of an uncertain future, we are able to command the assets of the owner which are increasing rapidly in value in this runaway economy. In a $75,000 house (and this formula works on the most expensive houses too) which is appreciating at a rate of 15% (conservative by today’s standards), we are acquiring yields of about 7% PER MONTH which will ultimately be taxed at capital gains rates.
It isn’t hard to see how this formula can be applied to new purchases as well as to existing homes. When the new purchaser can sell an option which will enable him to buy a better house in which to live with effectively lower payments, it opens the door to all sorts of creative negotiation with the Seller also, who might help fund the payments for just a part of the option in order to make a sale. We can see many ways in which ownership can be structured including Trusts, Corporations, Co-Tenancies, Leases, and Options depending upon the needs of the parties to secure their interests.
THERE ARE A FEW CAVEATS TO OBSERVE IN DISTRESS BUYING!
Make certain that all the parties to the transaction understand what they are doing. Courts are sympathetic to those who, at a later date, seek to reverse a transaction based upon their lack of comprehension as to the effects of their actions. In California, the Unruh law changes many of the old methods of buying distressed property. Be sure to seek legal counsel in any situation where the law is not clearly spelled out. Distress buying formulas are discussed in more detail in the Miller/Schaub Nitty-Gritty Clinics open to graduates of Fortune Building Fundamentals 3-day seminars.
IN THE POTPOURRI DEPARTMENT . . .
Beware of Santa Barbara’s new rent control charter amendment being proposed. It goes farther than most we’ve seen to deprive investors of their capital. It even forces the owner to pay the tenant in the event he or she wants to sell the SFH. Our June 1979 newsletter contains 5 or 6 basic strategies which will circumvent this ordinance. Read it.
We’ve beat the energy crunch with a technique which is about 50 years old. We converted our car to L.P. Gas (Propane). Now we have 800 miles of range, and unlimited supplies of fuel which costs us 71 ½ cents per gallon. Because only about 1% of L.P. gas is used for motor vehicles, there are no controls envisioned in the future. Check with your local gas company to find those who can convert your automobiles/motor homes.
Last month Gary Mansfield of Denver gave us a formula for buying houses with AAA bonds. This month Karen Brown of Chicago told us about her area where bad renters can be reported to the local retail merchants credit bureau. Now landlords can check out tenants by telephone, and record the names of those who don’t meet their obligations. Why not see if this will work in your area too. With all the growing tenant militancy, it’s about time that the people who provide the basic housing get organized too.
We still don’t like to leave money in banks and S&Ls. Now, on Gary North’s advice, we have borrowed out the last dollar of our insurance. Most is in “T” bills and money market funds, but we are getting into high yield first mortgages which we can buy at discounts of up to 50% of face value. The paper business is a terrific complement to your SFH program. Max Hollis and Carlos Royal have written a book: “Basic Steps of Using Private Money Financing” (Nat’l Mortgage Exchange, 7806 Madison Ave. #150, Fair Oaks, CA, 95628, $16.50) They’ve been in the paper business successfully for a long time and this is a good basic book to get started on along with Dave Glubetich’s “How to Grow a Money Tree” available in Walden Bookstores.
If you’ve given up on liberal politicians, do-gooders, labor unions as they invade your assets; give Texas a little thought. You can write for Kiplingers special free report (Mr. Golden, The Kiplinger Washington Editors Inc., 1729 H St. N.W., Washington D.C. 20006). It’s only one page filled with facts. Texas should be a solid choice for the next decade for a number of political, economic, geographic, and demographic reasons.
Charles Ray Considine has offered an interesting insight: with inflation driving incomes and housing costs through the roof, our modest rents may have fallen sufficiently below the median to qualify our property as “Low income” under HUD guidelines. If so, we can elect to write off all ReHab of $3,000 – $20,000 per unit done between now and 1982 over the next 60 months. Check with your own tax counsel for details. Includes Apartments.
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