February 1990
Vol 13 No 4
WHAT EVER HAPPENED TO THE $50,000 HOUSE?
I've just gone through over 9000 houses listed in multiple listing. These are arrayed in price and neighborhood sequence. I was trying to find out the listed price of houses comparable to the ones I own. They've almost disappeared! Very few houses in my area can be bought for less than $50,000. Those that can are by and large undesirable by virtue of their age, condition, location and/or functional obsolescence. What's happened?
Plenty! Despite claims by the investment media that 'housing prices are going to collapse', in my market sector, they appear to be steadily climbing. Florida's biggest open secret is that residential housing in this fastest growing state is cheap by comparison with almost every other area in the country. But this is going to change more and more rapidly as we move into this decade. There are several reasons. Most are being caused by growth.
Historically, Florida has been a non-union state. With maybe 5 exceptions, our cities are just small towns that grew up. We still retain 'small town values' in most areas. Floridians are 'square'. They're accustomed to hard work in agricultural areas and small towns. The fast lane may exist on the lower East coast, but rarely elsewhere. At least that's the way we like to think things are. But, with almost 1000 people per day moving in, a town the size of Orlando could be built and filled each year. All these new people bring new values. New opportunity. Jobs. Money. They fill up land. They strain municipal and county budgets as infrastructure is expanded to meet the need. We're running out of sewers, roads, schools, water, power and billions of additional dollars must be raised for capital investment. This same phenomenon is occurring in growth areas everywhere. We're going broke!
For years when we needed a new road, sewer plant, school, etc., we just phoned in our order to our Congressman. He slipped in a bill here and a bill there and, VOILA, we got a Federal grant. No problem. But the Feds are running out of money too. They can just print more when they need it, but cities and states have to make do with what they can raise. In Florida, it takes a Constitutional Amendment to inact a state Income Tax (which explains why many of those new people are coming in). That leaves the sales tax and Ad Valorem real estate tax as the principal source of revenue. And IMPACT FEES, Assessments, permits. A few years ago, the Governor almost got impeached for placing a tax on services.
That's what's happened to the $50K house. The combination of rapid growth in COST has killed it off. In 1970 I got my real estate license. My first house sold for $9500. It was about 1000 square feet. FHA financed it at 7%. It had been built for $4900 in 1955. That same house today would sell for $45,000 even though it's obsolete and in a declining neighborhood. In a better neighborhood, a house that cost $18,500 in 1970 would sell for about $70,000. Why? Because builders can't compete with newer houses. LAND isn't available in convenient locations except at unbelievable prices. Try to buy a building lot in a mature neighborhood with desirable amenities. When you find one, $25,000 is considered a bargain. But suppose Aunt Tilly leaves you a building lot, you still can't afford to build a cheap house. Local government has seized on the construction industry as a prime source of funds.
A hot item this year is WORKMAN'S COMP, FICA, FUTA. The independent CONTRACTOR is being scrutinized by everyone from the courthouse clerk to the CIA to prove that he/she is really an EMPLOYEE. Why? Because employees generate more tax money to feed bureaucrats than contractors do. EMPLOYEES file W2 forms, loved by the IRS because taxes are WITHHELD. CONTRACTORS use 1099s and don't withhold tax. Contractors are able to use 'tax planning'. So, a builder/developer/entrepreneur's costs are increased either by virtue of being taxed for every worker as an employee or maintaining volumes of records to prove they aren't.
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TO MAKE A FORTUNE, FIND A NEED AND FILL IT . . .
Think along with me a little. If builders can't afford to build a $50,000 house, older houses in that price range will become much more liquid. As families are formed and young people enter the housing markets, rents will turn up. As older people sell their appreciated houses, they too will enter the market for lower cost housing. The beneficiaries of this will be Mobile/Manufactured housing, condominiums, and attractive, well situated older homes near neighborhood amenities, jobs, transportation, These will be good, solid investments both as rentals and as re-sales. But with a shortage, caused by cost factors of land, labor, capital, regulations and liability, builders/developers will no longer compete with entrepreneurial investors. The question is then, how do we get a piece of the action?
First of all, we've got to approach the solution to the growing shortages of low and medium priced housing creatively. We've got to avoid all the costs that have driven builders and developers out of this market. For now, I'll stick to single family houses rather than to consider ways in which to work with condominiums and manufactured housing or apartments. Those lend themselves to other strategies which we'll consider another time. But for now, let's take it one step at a time, eliminating each layer of cost as we go.
We can eliminate land cost per se by buying existing houses. We can eliminate impact fees (with a few exceptions) at the same time, since the property will already have been improved. If we take on an otherwise uninhabitable property, we'll most certainly be dealing with a distressed owner. We would surely expect to buy the property at prices and terms well below current market. If we do most of the work ourselves, we can eliminate the costs associated with employees. If we are careful to hold title in another entity, we can reduce our exposure to liability and taxation dramatically. For example, a corporation would only be in the 15% bracket up to $50,000 of NET PROFIT AFTER ALL EXPENSES each year. And those expenses could well include multiple FRINGE BENEFITS, Pension Plans, Tax shelters. Because we'll be buying older houses in older neighborhoods, assessments for roads, utilities schools, etc. should have been paid off. Property tax assessments should be too.
That leaves us with potentially much higher profit margins than a builder gets. But there's a catch. We have to have some skills and the willingness to use our time to do the necessary work, or to have it done by low-profile contractors. The easiest way to avoid having your contractor characterized as an employee by the government is to insist he must be INCORPORATED. Corporations can't be employees! It's cheap. Easy. And he'll get a lot more net income out of it. You'll have to sell them on it. Maybe help them get it going. But you'll avoid lots of potential problems if you do it correctly. It's a simple solution. And it provides for a multitude of family strategies when several incorporated family members joint venture on a project. This type of planning is discussed more in our seminar on corporations and in the new Dynasty series that Peter Fortunato and I are developing.
REHAB PROFITS ARE BUILT IN AS YOU GO . . .
Let me give you a couple of case studies. Once upon a time I was contacted by an owner of a house that had burned down. About 30% was missing, 30% was charred wood. It was well situated in a quiet, older low income neighborhood. This wasn't a blighted area or high crime area, but it was full of obsolete older houses, most of them in good repair. The owner had already been paid off by the insurance company. The house was free & clear. I bought it with $500 down, $4000 WHEN I SOLD THE HOUSE FOR CASH OR IT WAS FINANCED. It was a mess. Before I closed on it, I had the building bureau (government) list all the things I'd have to do to make it habitable according to code (government). In my area, they use electrical connections to enforce everything. No government sign off, no electricity. It's pretty effective. We had to do about $5000 in extra work because of squabbling among the various city inspectors, but ultimately sold the property for a $16,000 profit after about 8 months of rebuilding and marketing., In the interim, we re-negotiated the Note to $2500 for an early cash payoff. The moral of this story is that by buying the house that nobody else wanted at an non-competitive price ($3000) and terms (Zero interest, no payment), the cash flow and profit could be built in at the start.
PROFIT – NOT LOVE – MAKES THE WORLD GO 'ROUND . . .
Think about that for a moment. Take a long look around you and try to pick out a single thing that profit hasn't provided. Since the definition of fee simple real estate title includes everything from the center of the earth to the outer fringes of the universe, all natural elements in the environment are yours to enjoy because they were bought and sold! Or stolen and sold. Or confiscated by the government and sold. Or rented to you (when the government collects rent, they call it TAXES). Every stick of furniture, the car you drive, your fuel, electricity, food, even good health, birth and death are all traceable to PROFIT expected, lost, made or earned by someone somewhere. So is your basic shelter.
First our intrepid builder buys his lot out of tax-paid money which represents about 50% of his gross profits, then plugs in the cost of paying all the EMPLOYEE benefits the law requires for what used to be his sub-contractors. Next, he'd better buy a HUMONGOUS insurance policy to cover potential LIABILITY. With our law schools generating new Lawyers around the clock, LITIGATION has become a fact of life for every builder. Vicious courts are blaming him for Radon, seepage of pollutants into the soil, interruption of the sex life of the snail darter, broken marriages and failure to provide low-cost housing. So he has to build the cost of potential litigation into his price on top of his other costs.
Another growing cost involves IMPACT FEES. In my county, impact fees can run as high as $6500 on the most basic house. A new law is going to require the builder to pay for all sorts of problems that a housing project could generate. He's going to build not only schools, but roads, sewer plants, air-scrubbers, parking facilities, etc. or he's not going to be allowed to build. Zoning is driving the cost of land development sky high. Once upon a time I owned an acre of land which permitted me to build 33 units. That has now been reduced by two thirds. That means I'll have to build more expensive housing in order to be able to recapture the cost of the land, or convert the property to another use.
Now, let's talk financing. In the good old days, there were plenty of front end write offs, reasonably priced construction loans, 125% financing without personal recourse. No more! The bank/S&L crisis is drying up the financing fast. While interest rates seem to be coming down, so is LEVERAGE. Now, the builder has to have more money to start his project. The 'non-inflation' the government touts somehow is causing the affordability index for housing to drop. Fewer and fewer people can afford to buy a house. Their costs of living continue to rise inexplicably. There's an index called the 'nuisance index' which tracks the cost of things people really buy – Big Macs, Cars, Electricity, Waste Removal. According to it, the true rate of inflation is 4 times as great as the government admits.
The lenders know it. They're betting on Adjustable Rate Mortgages to help them capture the profits from any rise in real estate prices. So the family that was willing to sacrifice to buy a house in expectation of profits, will see their friendly lender taking most of their profit as their mortgage interest and/or principal is driven up along with house prices. In prior newsletters we've stressed that sellers who carry back mortgages should also index their loans for the same reason – to earn a higher profit. But this isn't good news for the person trying to buy a first house. He's priced out of the market.
Then, there's materials cost. Every supplier is confronted with approximately the same employee costs as the builder/developer. So are the people who transport materials to the site. So are the people who provide security at the site. They all pay taxes and licensing fees, buy insurance, pay rent. So their costs go up, driving their prices up. This happens at every stage from production of raw materials to delivery of finished product. Ask yourself how much of this cost would be eliminated if government were removed from the cost generators. Possibly as much as 75% of the cost is attributable to layer upon layer of bureaucracy, regulations, ordinances and the effect of populist court decisions. When house prices rise, OWNING is no longer an option for young starters and elderly retirees. They enter the rental markets, driving up rental demand and with it rental rates. This in turn prices many people out of housing entirely. This is where the HOMELESS come from.
Before entering into the transaction, we made a best guess effort to establish our final costs, including costs of marketing and got the appropriate officials to sign off on what they'd require to approve everything. We used 'day labor' to clean out all the unusable burned wood and to clean up the premises, then sub-contracted with licensed people to do the parts of the job which required inspection. We were able to use hourly paid part time help to do much of the rough work, and 'finish carpenters' for the final touches. The key to holding down our costs was to sketch the entire job out in sequence so that we were able to make maximum use of people we'd hired. In general, we didn't pay on an hourly basis, but on a completed job basis. The roof, dry-wall, plumbing, tile, kitchen cabinets, floor coverings, re-wiring, paving were all done that way. Only the general work and site clean-up was paid for by the hour. The finished house met FHA and VA requirements.
This same approach can be used anytime you have an insurance claim. Let the insurance adjuster first make an estimate and go out for bids. Once the winning bid has been selected and they're ready to settle, take the money, but do the job yourself. State Farm has a policy of subtracting 20% for 'overhead' that an owner doesn't have to pay when you do it yourself. At first I'd go to the state Insurance Commissioner to force them to pay me for doing the work. Later, after I'd obtained a legal fictitious name for my sole proprietorship, I'd let it have the job, after the claim had been approved, as a contractor. Then I'd do the job myself. I always was able to beat the contractor estimates.
In one instance, we had an exploding oil heater. The bid was $2800. We did all the repairs for $600 including installation of electric heat. We used the rest of the cash to put on a roof and to install central air conditioning. In another case, a car had driven into the front living room at about 80 mph. The claim was for $4600. We used the money to pay off the loan because the mortgage company began to impose all sorts of restrictions on us as to the way the work had to be done. Then we made a private loan and repaired the house for $1100 using tenant labor provided by the tenant who lived there and who didn't want to move out. He was a maintenance contractor who already carried workman's comp on himself.
Currently, we have a house that was vandalized by a tenant. Quite often, owners are intimidated by tenants who threaten to 'trash' their house if evicted. We carry a rider on our insurance policy to cover 'tenant mischief' and vandalism. We also have a 'loss of rents' clause which gives the insurance adjuster incentive to settle fast, since he's got to pay for all rents we lose while we haggle over the settlement. In this case, we are installing an entire new room out of the proceeds of the insurance policy plus central heat and air. We aren't defrauding them at all. We let them use their own estimators, but we've learned how to beat the high cost of contractors by doing it ourselves at minimum expense.
And, we've used our own labor to add rental space. This past summer I spent 60 days personally building a kitchen and bedroom onto an existing daylight basement family room which had its own bathroom. When I was stuck, I hired skilled carpenters and dry wall people to do specific jobs. But mostly I did the work myself. It cost $4800 including all appliances, cabinets, windows, heaters, and furnishings – most of which were used. The monthly rental is $450. Annualized, that means that I'm receiving over 100% return on my cash less the value of my labor. These are yields that I created out of my own imagination. And they are yields that you can duplicate over and over again. To the extent that you are willing to marshal your financial and family assets and to become involved in rehab work, you're going to find a whole new world of opportunity. And a whole lot of recreation to.
The key to finding the house that will work out lies in AVOIDING BLIGHTED AND HIGH CRIME AREAS, finding the 'UGLY DUCKLING' that you can turn into a swan, FOCUSING ON CURB APPEAL, landscaping, kitchen and bath treatment, doors, floor coverings and heating/cooling. Be sure to have financial plans supported by a low-cost source of funds, negotiate to get 'breathing space' on the seller financing – even if the seller is the lender. Orient your efforts to your purpose. You rehab rentals completely differently than you do resales.
