March 1990
Vol 13 No 9
TWENTY YEARS LATER, WILL THE MARKET DO A REPEAT?
This month marks my 20th anniversary as a licensed real estate professional. I was a jaded General Foreman in an electronic assembly factory when a good friend, Ray Flach, persuaded me to study for my real estate license. Lucky for me that he did, because within a year I'd been laid off and had been extruded out of the manufacturing business into residential real estate sales. This letter is for those in similar circumstances, who, whether because of age or lack of future opportunity in a dead end job, want to find out more about the transition from the insulated life of an employee to the roller-coaster ride we call entrepreneurship. The decisions I had to make, the risks I had to take all led to the icing on the cake. Maybe it will help you evaluate your own alternatives for the future.
In 1970 the economy had slowed considerably. There was little inflation. Nixon hadn't freed the dollar from gold yet. The house you bought just about returned your down payment and payments after 3 or 4 years if you sold it. Interest rates ranged from 7½ to 9 percent on 29 year mortgages. The market was slow. People were being forced to sell and move on to areas with more economic activity, so it was a buyer's market in which you could buy a house for less than $1000 down, or lease-option it, or buy it from the lender or a builder under very favorable terms. Many times, houses were listed for sale under terms and conditions which often only generated enough cash or 'paper' to pay the sales fee. I was able to buy several of these properties with nothing down. (Much later, one of my students named Robert Allen wrote his book about this.) But my usual down payment was $1000.
I think a comparable situation is emerging today. Apply a 20 year inflation rate of just 6% to $1000 down payment and you come up with $3200. Today, that's probably enough to buy a $75,000 house, which would have been priced at around $20,000 back then. Before you get too excited, remember, I'm discussing the Florida market. Check some of the old newspapers in your area for March of 1970 and see how prices then compare to prices in your area now. You may discover that you've had much more appreciation than we have had here in Florida. And you may understand why I think Florida residential real estate is under priced for the market, and due for a price explosion in the next few years. Suffice it to say that the use of prudent leverage, good management techniques, and a long term holding plan produced a net worth which compounded at a rate in EXCESS OF 20% PER YEAR FOR 20 YEARS, It can happen for you too, if you'll just get started. But starting can be the hardest part!
YOU HAVE TO BE FINANCIALLY AND PSYCHOLOGICALLY PREPARED WHEN YOU COMMENCE TO COMMENCE!
Some of our readers have good, secure careers with predictable income. Others have high incomes with less security, or predictable incomes which are lower. In some cases, readers have foregone high incomes and security in favor of careers that they truly enjoy. Or they're retired, looking for active outlets for their abilities. Regardless where you personally fit into this picture, starting up as an entrepreneur can be scary! The key is that YOU'VE GOT TO WANT THE BENEFITS OF ENTREPRENEURSHIP MORE THAN YOU WANT THE BENEFITS OF A REGULAR JOB. The word 'entrepreneur' translates into he/she who takes the risks. As an entrepreneur, you'll be investing MONEY, TIME, INITIATIVE, TALENT, EMOTION, CREATIVITY in hopes of achieving FULFILLMENT, SATISFACTION, SELF IMAGE, POWER, CONTROL, ACCLAIM and FINANCIAL INDEPENDENCE. Along the way, you'll sacrifice SECURITY AND COMFORT and no little sleep. Your social life and life style will be early victims. Financial safety margins will become a fond memory. So it's essential to plan carefully to succeed.
My transition began when I was laid off at the age of 40, unable to find a new job at my previous salary level. I knew I'd peaked out as an employee. I had to find a
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different approach to earning a living if I hoped to continue to support a family in the midst of the teenage years at anywhere the level we'd become accustomed to. In a single jump I went from 23 years of continuous salaried employment into COMMISSION SALES where my compensation was directly linked to my own personal level, of achievement on a day to day basis. I didn't go into this blindly. I set both personal and financial goals, enlisted the support and understanding of my family, established GO/NO-GO POINTS as to income over the next 6 months to determine whether or not I could AFFORD TO BE AN ENTREPRENEUR. Here's how:
YOUR FIRST FINANCIAL PLAN SHOULD BE A HOUSEHOLD BUDGET. This is definitely no way to win a popularity contest in the family. Each of us made a list of absolute ESSENTIALS without which we felt we couldn't survive based upon our spending patterns over the prior year. Next we refined these to see how much cost-cutting we could do to trim them further. Then we set up a chart with the essential expenses along the left margin and with weekly periods marked off on the top. Each week, we plugged in our budgeted dollars on the line with the appropriate expense item. Next to this we left a blank column to show our ACTUAL EXPENDITURES in each period. The next column showed the amounts by which we either spent more or less than the amount planned. The final column showed the reason WHY and CORRECTIVE ACTION TO BE TAKEN IN THE NEXT PERIOD TO BRING IT INTO PLAN.
Each week we had a budget review meeting to revise the budget and to discuss ways in which each family member could contribute to our overall savings. In a few weeks we'd found out the true state of family finances and the ABSOLUTE MINIMUM NEEDED TO SUSTAIN THE LIFE STYLE WE FELT WE NEEDED. That became our bottom line income goal that I had to meet. Within the budget process we set up allowable CREDIT LIMITS to tide us over in the event of a true emergency such as medical expenses, automobile failure, etc. Then I put into place my own financial plan for production of income. Without income, the expense budget would have been useless. While the entire family helped cut costs, the burden of producing income fell on me. In another time and place, it would have been shared by both parents. And in many instances, every family member contributes to the overall family income. Each family group will vary as to those who can contribute to income, and must plan accordingly.
Finally, I set up a schedule of drawing down our savings each week to meet the budget. I allocated one third of our total savings over the next 6 months to augment the income I expected to earn. At the earliest of either 6 months, or when the allocated draw down amount had been spent, we all agreed I'd have to find another salaried position and do the best I could to earn a steady income full time while continuing to be a salesperson part time. Income was paired to expenses in each period so I could keep myself informed as to my progress. On the other hand, if I were able to duplicate the income from my last salaried position while being a full-time entrepreneur, my plan allowed me to continue on.
The whole family pitched in, controlling expenses and assisting where possible in sales activities. They answered the phone, placed signs on properties, ran errands. My wife took over 100% of the domestic responsibilities while I worked 18 hour days trying to learn my new job. As a result, we survived the first 6 months, exceeding our goal by 50%. By the end of the first year, I'd doubled my last salary, and I was off and running. Now, I'd never go back to being safe and salaried. Then, only being fired got me started. It's a tough transition that begins in your head – in your dissatisfaction with your present job. It's contagious. No one in my family works at a salaried job. We're all entrepreneurs today.
YOU'VE GOT TO LEARN HOW TO BEAT THE CREDIT CYCLE AND TO USE THE BUSINESS CYCLE . . .
In the process of seeking ways to beat my competition, I discovered they all shared one vulnerability. Without institutional credit, residential and commercial sales volume suffered severe drop offs. Commission salespeople's personal income and lifestyles reflected the credit cycle. Oddly enough, many people don't spend the time necessary to forecast credit movements which are part and parcel of the business cycle. It's a 'chicken and egg' phenomenon. International credit movements can trigger a tightening/loosening of credit by the Federal Reserve Board – which directly affects the stock, bond and mortgage markets, and business profitability. From this, one can predict what real estate will do.
When banks are 'loaned out', they raise the price of money – interest. When the deposits they carry are withdrawn, the amount of money they have to loan-and are permitted to loan – reduces credit while increasing interest rates. So when business and the economy contracts, real estate commissions and sales also contract UNLESS YOU CAN BEAT THE CREDIT CYCLE. Seller carry-back financing does this. Lease-Options do this. Pure Options do it too. So do long term leases. And sandwich lease positions. Installment sales contracts held by the sellers. By learning to use these NON-INSTITUTIONAL SOURCES OF FINANCE and by finding individual INVESTORS WHO WOULD BUY MORTGAGE PAPER FROM THE SELLER, I was able to keep my income at satisfactory levels because I could find ways for people to buy and sell houses that the ordinary brokers didn't know. Along the way I became adept at EXCHANGING.
A natural by-product of being in the non-competitive area of the market was that people approached me and sold me their houses with prices and terms that guaranteed me a profit. I was picky. I actually refused to buy a lake front house with $1000 down and no personal liability on the loan because it would have cost $5 per month negative cash flow. In the past 20 years through thick and thin, I've never had negative cash flow overall from my real estate portfolio. The 'good' houses have always been able to pay for the others. This ability to create financing without the use of the credit markets enabled me to both earn a good living and to acquire properties at bargain rates. When the credit markets loosened, I'd sell the properties I acquired to generate operating funds in a SELLER'S MARKET. Thus I always bought in a Buyer's market and sold in a Seller's market. Few, if any, investors and brokers truly comprehend the power of private financing in estate building.
GOOD MANAGEMENT IS THE KEY TO GOOD PROPERTIES . . .
In December of 1989 the country experienced a severe freeze for a few days. in the South, this was devastating because people weren't accustomed to wrapping and heating pipes to protect them from freezing. Even in occupied and heated homes, pipes burst. This caused ceilings and walls to fall in. There was lots of damage to repair and prices rose to meet the emergency. Many times managers forgot to claim the owner's insurance, but mine didn't. I received almost $8000 in insurance proceeds to help pay for freeze damaged pipes. This is just one example of the difference between good managers and 'rent collectors' who call themselves managers. There's infinitely more to the job of managing property.
Ask most people, and they'll tell you the manager's job is to fill rental space, collect rent, repair damage, and generate the highest possible monthly revenue. Doing this can make an owner's life miserable because the manager is given incentives to get the highest rent – usually paid by people who wouldn't be allowed into a place at a lower rent because of their instability, income level, family composition and tenant performance record. They create 90% of the management problems in the country. Then the manager is usually given high marks for deferring needed repairs which would detract from net operating income except for those of an emergency nature – which are paid for at premium rates because of overtime. In other words, short term management goals oriented toward production of income at any cost arc the cause of much of the financial distress of 'amateur' owners who don't set their long term goals properly. They're perpetually confronted with tenant law suits, crime, code violations and bureaucratic harassment. There's a better way to handle management: I had to learn it.
First of all, the goal of any manager should be the increase in total return of a real estate investment. This ideally balances current rental income against maintenance, turn-over and vacancy expenses as well as the overall appreciation of the property based upon total after-tax net yield on investment, inflation adjusted net-income, and gain. So the manager has to know something about the income tax laws, HOW and when to EXPENSE items as opposed to CAPITALIZING them. When it's better NOT TO RAISE RENTS to keep proven tenant performers rather than to incurr higher MANAGEMENT COSTS because of lower quality tenants. Section 8 and other subsidized managers fail to realize that, by letting bureaucrats set rental rates and maintenance standards, they've lost the power to control overall yield of the property. A recent ruling in Connecticut now makes it illegal NOT TO RENT TO SEC. 8 people, thus, owners are being deprived of control of return on their own investments there.
IT'S HARD TO BE BOTH RICH AND FAMOUS AT THE SAME TIME . . .
Maybe the reason that 'Lifestyles of the Rich and Famous' is such a hit on T.V. is that we're all fascinated by those who appear to have seized the brass ring and have been able to acquire wealth and power. But they're rare indeed. When it comes to ownership of property, there are no easier pickings in many areas than the rental real estate owner. In an economic and political environment in which the rule of envy is rapidly replacing the rule of law, it doesn't pay to acquire a high profile as a property owner, Thus the use of TRUSTS and CORPORATIONS is becoming a foundation block in the asset protection planning of those acquiring real estate.
Trusts originated in this country out of several hundred years of BRITISH COMMON LAW in Massachusetts but swiftly spread to Illinois where they became known as ILLINOIS LAND TRUSTS when used in conjunctions with the holding of real estate and real estate oriented rights such as mortgages, options, easements, etc. Florida has the most complete Land Trust LAW, but Illinois continues to be cited when case law precedents are looked to in legal proceedings. Recently, Chicago Title and Trust Company – the company which almost 100 years ago initiated the wide spread use of Trusts to hold title to real estate in the United States – opened a subsidiary in California called Security Trust Company. They've conformed the language in their Trusts to California Law. The use of Trusts in most of the other states is cited in various statutes. By using Trusts, you can conceal ownership and to some extent protect your title against general judgement liens lodged against your name.
YOU'VE GOT TO BE ABLE TO ROLL WITH THE ECONOMIC PUNCHES TOO . . .
We had a recession in 1970, 72-75 (in Florida), 81/82. In successive waves, we've had recessions all during the 80s. The Farm, Rust, Energy Belts, Silicon Valleys in San Jose and New England, Northwest and Southeast have all taken their turn in recessions. But in all these, some people survived intact. Others found the seeds to their fortunes. As an active investor and businessman, I learned that a solid foundation of rents, financial privacy, intelligent private financing and a program of selling into a rising market, buying into falling markets using private financing stood me in good stead. But strategies must be flexible, risks assessed and managed objectively, losses taken as early as possible to limit damages. Acquiring the skills and insights to do all these things is a never ending task. But the rewards are high for those who can pull it off. Cheerleaders never win a game. Only those who are in the trenches slugging it out bring in victory. I've had to do it over the past generation and so have millions of others. You can too. We'll show you how in these letters and in our conventions.
