September 2008
Vol 31 No 12
They couldn’t adapt! I dredge this lead-line up every few years when the markets change to make the point that nature takes no prisoners; nor do financial markets. One of the primary reasons that humans are at the top of the food chain is that they are among nature’s most adaptable species. When the forests changed to grasslands, our ancestors climbed down from the trees and learned to walk erect so as to be better able to see their enemies and their prey. When he couldn’t find meat, homo sapiens learned to survive on vegetables, fruits, and nuts. When the ice age froze the North, survivors moved South. When their habitat became too limited, humans explored the earth to find new lands and opportunities. Those who adapted to the new realities prospered. Those who refused to adapt didn’t survive.
Four years ago the housing market was sitting pretty. House owners were enjoying very high real appreciation rates. Low income tax and interest rates made it possible for millions of people to enter the housing market, and/or to move up to bigger and better houses. They had a virtual guarantee that they would be able to build wealth simply by owning a house. All that is changing.
Today, the combination of credit woes, falling currency values, and collapsing equity values has radically changed our markets and our opportunities. Voters are now confronted with a Hobsen’s choice of two totally unqualified and untested Presidential candidates. Neither has run a business or been solely responsible for major decisions; yet one of them is going to be in charge of our country; with the power to appoint judges and to issue executive orders. You can bet the farm that huge financial mistakes are going to be made. Those who aim to survive the next four years must adapt to the new financial and political realities that emerge just as they’ve had to adapt to the changes in the past four years.
Some three decades ago, before the age of computers, a prescient book by Alvin Toffler exploded onto the best-seller lists. It was called “Future Shock”. It more or less forecast terrific acceleration in the rate of change the whole world would undergo from that point on. Toffler’s premise was that changes would be so rapid that the neither the public nor the government would be able to perceive, measure, or accommodate it. History has proven Toffler’s warning to be correct.
In 1975, Radio Shack offered the first home computer. Nobody could foresee the impact of computers priced within the reach of virtually every citizen. Since then we’ve seen the growth of the Internet with its infinite store of easily accessible information. FAXes, text-messaging, and email now by-pass snail mail. Personal privacy is long gone. Computer crime, identity theft, and government eavesdropping pose new threats. Millions of people have lost the ability to relate to each other; they substitute chat rooms, forums, and blogs for face to face contact. They select their mates on eharmony.com. Print media and television are being shoved aside by YouTube and MySpace. Traditional marketing of everything is being morphed into computer marketing via eBay, Craigslist, and email blasts. The communication systems giants of yesteryear have been replaced by satellite and cable TV and new hi-tech gadgets such as Apples 3G Iphone and the Blackberry Thunder.
True to Toffler’s predictions, most of the general public, and especially our government, don’t really grasp the enormity of change that is taking place; nor do they have they any plans for adapting to it. Despite what they say, the same political hacks are using the same old tricks to get into office and to stay in office by currying favor with PACs and making the same old promises. This time around they’re going to discover that the shady dealings of their past are going to be revealed to the by past emails. Alaska’s Senator Stevens has been indicted. The old political pros were startled to find that Obama found a way to use the Internet to reach more new voters and to raise more money than they could raise. He raised enough cash to reject taxpayer funding to get elected. Expect more changes to come.
THE MORE CHANGE IS PROMISED, THE MORE THINGS STAY THE SAME.
In this election year, as the day of destiny draws closer, do-nothing politicians are doing everything in their power to make the electorate forget how badly they have performed since the last election. In addition to promising everything to every person, they passed the $150 billion give away that was supposed to jump start the economy, then took months to deliver it. You may have noticed that the Dow responded by losing about 10% of the value of investors’ equities. Now, they’ve passed a $300 billion housing relief bill that is supposed to help homeowners keep their homes. Here are some of the salient provisions;
1. Homeowners who take the Standard Deduction can deduct $500 – $1000 from their 2008 Income Taxes. In the 15% tax bracket that boils down to about $75 -$150 less taxes per family. That ought to save a lot of homes.
2. First-time home-buyers who buy homes between August 9, 2008 and July 1, 2009 will receive $7500 in income tax credits. This sounds pretty good until you read the fine print: It says the credit must be repaid over the next 15 years, or by the time they sell their house.
3. Homeowners whose mortgage principal and interest payments (not including tax and insurance impounds) exceed 31% of their gross income can transform their loans into government-backed 30-year fixed rate mortgages. But only IF their lender wants to do it. How many banks are in position to do this today?
4. First-time homeowners with sub-prime mortgage loans can qualify for low-interest loans or refinancing under a provision that allows States to offer an additional $11 billion in tax-free municipal bonds; but this program will vary among the States. Each State has to pass legislation allowing this, then find a way to fund it. Do I hear higher sales, income and property taxes?
5. A new fund, paid for with profits from Fannie Mae and Freddie Mac, will help build affordable rental housing and make a market for mortgage loans of up to $625,000 for buyers in expensive areas. You remember Fannie Mae and Freddie Mac. Their most famous achievement was to cook their books to the tune of over a Billion dollars while paying their chief execs multi million dollar bonuses. They’re only staying alive today with taxpayer support.
Did you find yourself anywhere in this mix? The housing relief act says very little about helping entrepreneurs who have been investing in houses or who have been bailing out banks at foreclosure sales. When it addresses low income housing, it fails to recognize that, regardless of federal funding, constructing new affordable housing requires affordable land and infrastructure, labor, materials, and take-out financing; all of which are already becoming un-affordable.
The best part of this little $300,000,000,000 “re-elect me program” is that America will have to either print the money to pay for it, or borrow it from countries willing to lend it at rates that reflect the falling value of the dollar. With each dollar we borrow or print, the purchasing power of the dollar drops further. Nowhere does any office seeker or their pet media mention that this is laying the groundwork for very high inflation. It has already started. If the entire economy were inflating as fast as medical costs, pills, energy, insurance, and food, we’d already be inflating at a much higher level than in Carter’s time. Nobody in government is talking about inflation now, but wait until after the election and see how fast the truth will be told by the incoming Administration.
How long has it been since you sold a house without paying part of the down payment? Effective October 1st, the housing act prohibits seller-assisted financing; which presumably would include the Nehemiah program. This little provision is going to lock millions of would-be homebuyers out of the market and prolong the housing melt down. It will herald the return of seller financing.
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IT’S TIME FOR THE TOUGH TO GET GOING . . .
Nothing is more dangerous to the citizens than to have an election year coincide with an economic downturn. Office-holders who are also office-seekers like nothing more than to announce dramatic cure-alls aimed at solving our problems. Somehow, although they spend billions of dollars of taxpayers’ money, they always seem to make matters worse. In the process of shoring up weak banks so they can continue to lend money to weak borrowers, Congress is merely re-arranging the chairs on the deck of the Titanic. When this widely acclaimed emergency bailout is coupled with declining consumer purchasing power, a contraction of computer credit, and rising energy prices, it sets the stage for future financial disasters.
This is bad news for the American wage earner and those on fixed incomes, but it has the potential for making fortunes for entrepreneurs in the housing market. Why? How? First of all, the housing relief act boils down to “too little, too late” for most of the people in financial trouble today. It is estimated that it will only benefit 15% of them. When you consider that Fannie Mae and Freddie Mac are already holding Trillions of mortgage debt, the entire $300 billion in the housing bill amounts to bailing out a sinking ship with a teaspoon. Furthermore, Congress can pass all the Acts they want, but until specific regulations are written, adopted, and issued, very little relief will be felt by hard-pressed debtors who are caught between rising prices and falling incomes.
Lenders are ill prepared to implement the portions of the bill that apply to them. They are reeling from record mortgage defaults, inventory liquidation, short sales, foreclosure sales, borrower bankruptcies, falling bank-stock prices, takeovers, and mergers. Every bank merger requires a complete set of books to be created to describe the merged bank’s new financial position with respect to performing assets, non-performing assets, and present and future liabilities. Personnel have to be trained to be able to work in changing corporate cultures, new work environments, different computer programs, etc. All this means that the election will have come and gone long before the impact of the relief act will be seen in the housing market to any great degree.
Against this backdrop, the housing market is creating greater opportunities than ever before for opportunists who buy at mere fractions of the existing loan balance by using Short-Sale techniques, pre-fore-closures, bank liquidation sales, foreclosures, etc. In many areas, it is now possible to buy fairly new houses at price levels not seen since 2001. Sometimes that is as low as 30% of the defaulted debt, and as low as $80 per square foot for the house with the lot thrown in for free. Those who followed the advice given in this letter in 2005 and 2006 to sell out, accumulate cash, and wait are in position to reap fortunes from here on in.
With every disruption in the market new opportunities emerge for investors and for entrepreneurs who can help them exploit the market. One Title Company has opened a subsidiary LLC that has specialized in Short Sales. It by-passes the mortgage service company to reach the actual investor that owns the loan; then negotiates acceptance of an offer that drastically discounts the mortgage payoff value. It will prepare all required documentation plus insure title, and close the transaction. This has drawn business away from competitors who don’t offer this service. Thus, at settlement, the company earns fees for closing the transaction in addition to the Short Sale fee; which amounts to 2% of the purchase price.
In another area, a Broker rather than a Title Company has specialized in Short Sales. Anybody can take advantage of these services by emailing or FAXing an offer to be relayed on to the mortgage holders of the defaulted loan. Time becomes very important to institutions that must report on foreclosed inventory that they hold, so closings are swift. The buyer either must have unqualified loan approval, or sufficient personal funds to close the transaction swiftly. For this the mortgage holder pays a fee of 6% that is collected from the sale proceeds at closing. Every Broker should consider providing these services where they live.
MANUFACTURING THE DOWN PAYMENT
Not so long ago, it was common for homeowners to have to come up with a 5% down payment in order to get a conventional loan. FHA loans required 3%. Only VA loans could be obtained with a zero down-payment. No seller assisted financing was permitted, however, borrowers could borrow the down payment if it were secured by collateral other than the home being purchased; but total loan payments impacted the amount of loan they could get. They could be gifted the down payment. They could sell something to raise the down payment; which included selling an Option on the house they were buying to an investor for enough money to provide the down payment.
In 1981, in an effort to halt the Carter inflation that he had inherited, Reagan imposed much higher interest rates and much more stringent loan underwriting criteria. This brought house sales to a screeching halt. For investors, this created a new opportunity back then that will be renewed after October 1st when sellers are prohibited from assisting in home financing. This scenario required three parties: The first was a Broker or entrepreneur who was trying to create a sale for a better home. The second was a credit-qualified, pre-approved buyer who needed to buy an affordable house, but who had no money for the down payment. The third party was an investor that wanted a safe, management-free investment.
First the seller had to get the buyer motivated to give up all future gain in return for a better lifestyle for his family today. The seller first showed the buyer unattractive FHA houses in lower priced neighborhoods that he could afford. Then he showed him houses in a better neighborhood that he couldn’t qualify for. Finally, he showed him the better target house that he wanted to sell. He explained that the buyer’s family could enjoy all the benefits of a better house in a better neighborhood, with better schools if he’d be willing to give up any gain to an investor who’d provide the down payment. They all wound up with what they needed.
That was the old technique. Now, let’s update this technique for today’s market: Joe wants to buy a great deal on a “Short Sale” house for his personal residence. It was mortgaged for $275,000 just two years ago, but the lender wants to get the defaulted loan off his books. It is willing to reduce the loan payoff to $200,000 to a new owner/occupant buyer who has been approved for a 95% loan from a new lender. The old lender who is being paid off will even pay the real estate commission. The catch is that Joe has to come up with a $10,000 down payment. The deal maker who has set this transaction up finds a Roth IRA that will pay $10,000 for an Option to buy the house from Joe for the lesser of $190,000 or the loan balance at any time after 2 years and prior to 20 years following the sale.
With this down payment paid into escrow, the deal closes and all the parties wind up with what they want: The original bank gets paid off. The financing bank gets a safe loan with a $10,000 cash down payment on a house that is clearly worth a lot more than their loan. The Broker/deal-maker gets paid. Joe gets into a house that he couldn’t otherwise have been able to afford. The long term Option gives him ample time to raise his family in a better environment without having to move. The Option is secured by a Note and recorded mortgage. This protects the interests of the investor and the property against judgment liens.
Suppose after a few years the investor wanted to get his cash out of the transaction? Joe could refinance the house and in the process buy the Option. Or the investor could sell the Option to another investor. If he had held it for a year, any tax on the investor’s gain could be deferred by structuring the Option purchase as a Section 1031 exchange. On the other hand, if later on when Joe were able to qualify for a loan to buy another house, he would have the choice of selling the house for cash at fair market value and paying off the investor; or he could sell the house very quickly, “Subject To” the existing loan and the Option, at a bargain price; and let the next occupant get all the benefits of a Champaign lifestyle on a beer budget. Or he could offer the house to the Optionee who would simply take over the loan and capture any equity that had been created by appreciation and loan amortization.
Copyright © Sunjon Trust All Rights Reserved, www.CashFlowDepot.com. (888) 282-1882
Quotation not permitted. Material may not be reproduced in whole or part in any form whatsoever.
