May 1995
Vol 18 No 9
Recently I was reminiscing with one of my original investor clients about how kindly fate had treated us over the past two decades. His daughter, a suckling infant at the time his investment program was initiated, is now attending MIT. Her tuition was paid in full out of her investment portfolio which was started with $5000 the day she was born. Moreover, she still has $80,000 in equity left in her investment account. I wonder how many parents in the United States with kids in college (or college kids themselves, or their teachers) might envy this position. What was the secret to her success? Her parents had simply made profitable long term investments, and then left them alone so they could produce and compound her yield. Come to think of it, that’s also how Warren Buffet, American’s riches investor with a $10 Billion net worth, built his own fortune.
In general, true capital gain is created by the increase in value of capital assets measured in terms of after-inflation net purchasing power compared to the total costs of acquiring and holding an investment. To arrive at this figure, one must take into account not only the purchase price, but net yield after paying all interest, operating or holding costs. The eventual sale price must be reduced by selling costs and capital gains taxes. The period of time over which any net investment yield is allowed to multiply and compound without interruption prior to disposition completes the equation.
Since both time and yield are factors which produce gain, it’s tempting to try to cut down the time it takes to produce wealth by increasing investment yields. There are a lot of hidden risks and costs associated with trying to substitute yield for time to produce profits. Investors too often focus solely on an income stream’s quantity, ignoring its quality and durability – and profitability. That’s why so few of the people who flocked to California in 1849 found fortunes in their search of gold, or today’s investor has much better luck buying questionable discounted notes, or speculating in land. Circumventing the time factor of investments is difficult at best.
The power of compounding can make and break profit. For instance, we all know how profits can be made and lost by discounting notes, but how often do we apply these same principles to the costs of foregoing income while holding idle assets over the long term? A speculator who holds property for the long term without income or with negative cash flow in an attempt to get rich ‘quick’ can wind up realizing far lower yields in real terms than with a comparable property which produces income. A speculative profit is wonderful, but by its very nature, it can’t be repeated with any consistency. While a hare is waiting for the next ‘killer deal of the century’, the tortoise is methodically compounding his yield every day, adding to his capital.
Typically, speculators don’t accumulate large estates. There’s a reason for this. A wheeler-dealer who buys low and sells high pays the highest taxes and usually has the highest expenses in terms of time and effort, credit, advertising, insurance, etc. He not only incurs higher market risks, but essentially bets everything on his own physical and mental capacities and the state of the economy. Another intangible is the invisible consumption tax. This comes into play when the speculator spends a portion of his profits rather than re-investing them right away. Then he borrows to fund his next venture, and repeats the process. Is there any way to overcome all these problems, and to create wealth without waiting 20 years for time alone to do the work? Read on . . .
The secret to achieving financial success over a shorter period of time is in beginning to think in terms of possibilities rather than in terms of obstacles and barriers. If Capital X Yields X Times = Gains, then more capital producing the same yield would increase our gain in less time. Last month we discussed using other people’s capital without debt via Options. This month, we’ll focus on producing our own capital.
CAPITAL IS MORE THAN JUST MONEY – EVERYONE HAS SOME
Younger people often use the lack of capital and experience as an excuse for failing to make investments. While capital is no doubt needed to get started in real estate, it can take many forms that beginners fail to perceive. Money is what most people think of when the term ‘capital’ is used. Unfortunately, this limited concept of capital deprives many of financial success later on in life because it discourages initiative and optimism when they’re young. It doesn’t begin to describe capital in all its various forms and manifestations. How might capital be perceived in such a way that relatively impoverished fledgling investors might use it to start building an estate?
In addition to money, our definition of capital assets might include such tangible assets as real and personal property of all shapes, sizes and descriptions. Intangible property such as stock, bonds, bailment receipts, and Options, are certainly capital. Credit is just borrowed capital. Some of the more familiar forms credit might take are Leases, installment purchase contracts and various types of secured and unsecured promissory notes whether issued by individuals or legal entities such as trusts, partnerships, limited liability companies or corporations. And of course TIME – to let profits compound. Let’s not overlook one’s motivation, willingness to risk, dedication and chutzpah.
Over a long and checkered career in real estate I’ve seen some fairly arcane ways in which people have used imagination and innovation to create capital out of thin air. Here are a couple of examples: I once spent a weekend at Lake Tahoe in a condominium that had been bought free and clear from an estate for $70,000. The buyer had paid for it with a promissory note that was secured by a legally sufficient collateral assignment of all right, title and interest in his irrevocable trust share of a wealthy elderly aunt’s estate. Within a few months, he’d sold the condominium for $105,000, pocketing his profit, and paying off his loan. Using his profits to buy other property, he’s now comfortably retired and living a life of leisure in the sun in Arizona.
Let’s face it, he was a speculator, right? Suppose he hadn’t been able to sell the condo for a profit, and had been forced to keep it instead? Today, a decade later, that same condominium would sell for about $160,000. Over the intervening years, he’d have been able to rent it for tax sheltered income which would have increased each year, thereby reducing his investment with each payment paid for by rental tenants. At the end of 10 years, he could elect to defer taxes by investing the sale proceeds from his growing equity into other properties, repeating the process. Not as glamorous as a quick sale, but certainly profitable.
In a second instance, a subscriber wanted to get into the business, but had no cash at all. He raised $12,000 by creating a chattel mortgage on everything of value that he owned, including home and office furnishings, vehicles, insurance policies, etc. With this, he bought a house at a foreclosure sale on an abandoned, run-down property, subject to an existing first deed of trust. During the next 4 or 5 weekends, the whole family pitched in and ‘spruced’ the property up. Using the borrowed funds and family energy ‘resources’, they created a $40,000 equity in the home. Within 6 months, the property had been sold and the profits plowed into a similar foreclosure situation. Because the financing had been done via a chattel mortgage, the entire proceeds from the house sale were usable. The loan on their otherwise idle personal-use assets was paid off with monthly amortizing payments. They thus created ‘Sweat equity’ capital free and clear of debt through the combination of creative collateral and the productive use of free time.
Here again, we’ve got an example in which a speculative venture paid off, but the house could just as easily been converted into a long term rental that would have paid for itself while producing tax-free cash flow to help retire the mortgage debt. There was an additional dividend that paid off handsomely for the family. Their three kids grew up practicing to become entrepreneurs. They, in turn, are building their own estates with real estate investments. The long term success of the entire family unit can be traced to their refusal to accept lack of cash as being tantamount to lack of capital. It all boils down to their ‘can-do’ attitude and refusal to let any obstacles stop them.
I GOT BY WITH A LITTLE HELP FROM MY FRIENDS . . .
Every time that I see a real estate for “sale sign”, I marvel that somehow I escaped from the Brokerage business, with enough income from rents to retire, in less than 5 years, during a real estate recession. I didn’t make money because prices were going up. My profits had to be negotiated at the point of purchase. I never had access to bank credit because none of the institutional lenders recognized rents from single family houses as being reliable enough to repay mortgage loans. My principal source of money with which to buy houses came from brokerage commissions and short-term profits that I earned by Optioning houses at a negotiated discount which I later sold. For 153 straight weeks without a break I bought, sold or exchanged a house.
You might say that everyone in the family stayed pretty busy. Perseverance and optimism are real keys to getting out of the dead-end career rut and into the fast track, especially today’s fast-paced world in which so few people can truly count on financial security from a career. I did have several advantages that aren’t generally available today. I enjoyed a virtual monopoly. Because I was the only person in my area who set out deliberately to acquire houses to hold as rentals. Most importantly, I had the good health and energy required to put in 90-hour weeks.
Another critical source of ‘capital’ to invest in my own success was a family that supported me in all my endeavors, even though it meant some real sacrifices on their parts. My wife matched my long hours; in the office, answering the phones, keeping accounts, and at home, being a mom to two teenagers. They were pressed into service to hold ‘open houses’ to attract potential tenants; paint, clean and mow lawns; collect rents, etc. While they were still in their teens, after high-school, they each moved out, and into houses that needed repair. They repaired them in lieu of paying me rent.
Somewhere along the line I was taught that people see what you do, whether for good or evil, and they treat you accordingly. Because there were no books or seminars showing me what to do, I made it a practice to seek advice and counsel from successful property owners who had acquired enough real estate income to retire. This paid off handsomely. Not only because of the value of the information I received (and which, blended with my own experiences, I in turn try to pass on to readers and seminar attendees), but because of the personal relationships this engendered. One of them, single and without any heirs, began to sell me his properties as fast as I could absorb them. He crafted mortgage terms on loans he carried back that made my highly leveraged ownership with net positive cash flow of the rental properties financially feasible.
There’s a lesson here. When it becomes evident that you are intent on achieving financial success, and are willing to commit a major portion of your time and assets to that end, you start getting help from a lot of different quarters. A long time ago I read a book by a man named Bockl in which he said that successful real estate ‘elders’ should seek out young people with vision and commitment to encourage and support. Bockl opined that a perfect union can be accomplished when the wisdom, insights, connections and real estate assets of one generation can be combined with the fresh ideas, energy, creativity, enthusiasm of the next. The combination can be dy-no-mite.
Gradually, over the years, history has repeated itself, albeit with a certain amount of role reversal. More and more, I’ve begun joining forces with the next generation of capable entrepreneurs. In the capacities of both the lender holding a shared appreciation note, and as a member of a Limited Liability Company, I get the benefits of their inventiveness and new approaches while they get access to my financial capital and experience. We are each better off than we would have been alone. A word of warning: These relationships don’t work when they’re based upon exploitation of the other party in any way. But, as surely as nature replaces the older with the younger, there are successful people among us who would be most receptive to joining forces with highly motivated, bright, knowledgeable, capable, energetic straight-shooters willing to build their own financial fortress through dedicated effort. Do you qualify? Can you? The reason I’ve spent so much time getting this point across in this letter is to encourage you to seek out similar capital-sharing arrangements once you’re prepared to move up.
MY MOST SUCCESSFUL BUSINESS SPRANG FROM A JOINT VENTURE
Twenty years ago, income from rents had enabled me to quit working. I found myself rattling around the country in a motor home looking for something to do. A nationally published article I’d written called ‘Horizontal Apartments – A New Vehicle’ had given me a certain amount of notoriety because of the (then) revolutionary concept that single family houses should be bought and held for the long term for cash flow as well as appreciation. Based upon the reception I’d received as a speaker across the country, I decided to try my luck promoting a new seminar on the subject.
For the past few years John Schaub and I had been working as professional Exchange Moderators, putting complex real estate exchanges together. His quick mind and ability to concoct intricate solutions to complex problems made John the perfect choice to join me in designing a seminar around single family house investment. The results of both of us combining our respective talents and experiences together were a real phenomenon. After a slow start, the Miller/Schaub seminar, the first ever on investing in single family houses, took the country by storm. It spawned the single family investment house movement across America which, prior to that time, only a handful of people had participated in. Out of this seminar came most of the people you’ve seen peddling books and tapes on cable TV. As a practical matter, no matter where you turn, whether in follow-on books, tapes or seminars, all the information concerning single family house investment in American ultimately will trace its origins to the Miller/Schaub seminars.
After 8 years, we mutually decided to part friends, going our own ways with our own 1-man seminars and the epoch of the Miller/Schaub seminars was over. Now, we’re back.
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