November 1983
Vol 6 No 2
I've been on the road for the past month trying to find answers to that question. The conclusions I've drawn are varied indeed. It all depends upon where one is at the moment. It's a basic premise of map reading that a person first orient himself to a location before setting off toward an objective. And depending upon who you are, the direction you need to set off on toward success will vary.
A year ago, most of the stock market rise had already taken place. Despite warnings about $2000 gold, $100 silver – both markets have traded in a fairly narrow range over the same period except for a transient excursion of about 20% up and down around the first of the year. Single family houses reacted to lower interest rates as rebounding sales drove prices up. As I predicted, demand for mortgage money together with re-entry of consumers and government into the credit markets drove long term rates back to last year's levels, slowing sales and construction.
The media resemble the fable of the wise men and the elephant. Each had hold of a leg, tail or trunk which they could describe, but no one could describe the entire elephant. Similarly, some pundits focus on the money supply and predict inflation. On the other hand, rising credit needs of the Treasury which will be about $65 Billion the last quarter of this year could cause a collapse of our recovering economy and a bone cracking depression. If you're politically oriented, it's logical to assume that no one in power ants negative economic news. They'll do everything they can to maintain the status quo until November 1984 – and this probably includes no increase in taxes until then. But internationally, we've lost control over events. Russians shoot down a 747 and get away with it! We are losing Central America! American Marines are being killed in Lebanon! Mexico is only a step away from political upheaval which will infect all our border states. The Filipinos are rioting in the streets over a public assassination
I've had the good fortune to be a speaker at several international conferences where real estate is beginning to gain grudging acceptance as an investment vehicle by financial counselors because of its stability and predictability in a troubled world. For the past 5 years, millions of dollars have been invested by foreigners in farms, shopping centers, office and apartment projects, shopping centers. Yet rental houses have been left pretty much alone because of the management problems which major investors can't handle. Now, limited partnerships are springing up in many areas of the country to buy residential properties. Real Estate Investment Trusts (REIT) are heating up, allowing investors in securities to get a piece of the real estate pie. Off site constructed housing companies are being recommended as good buys in the stock market too as a way to participate in what could become a boom in affordable housing. Where do YOU fit in?
THERE'S PROFIT AND PERIL FOR SFH INVESTORS . . .
One of the reasons that this letter contains insights into the political and economic spectrum is because they impact upon SFH investments and our future well being. The inflation rate, long term interest rates, availability of credit, employment rate, income tax laws, government rent and profit controls, balance of payments, housing and income subsidies, military commitments all affect the desirability of SFH income rentals and future profits for investors as well as availability of housing for users. We must
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take these all into consideration as a part of our overall investment portfolio strategy.
Let's take a look at some of the negatives first. Bills have been proposed in the Congress to eliminate all interest deductions for investment property and to permit depreciation to be taken only on the actual cash invested in real estate. Other bills would require 40 year depreciation schedules, phase out the tax benefits of mortgage bond programs which effectively subsidize interest rates for new houses, decrease the amount of property which could be left tax-free to your heirs. None of these bills have much chance of passage prior to 1985 when a new – possibly Liberal-controlled – Congress and Administration could be making the rules, but what might be their result?
Almost all investors who bought SFH for tax write-offs would want to get out of the housing market and into something with higher after tax yields. Highly leveraged pyramiders would find themselves with horrendous after tax negative cash flows coupled with ruinous income tax liabilities. There might be wholesale dumping of properties back into the laps of the mortgagees. This would depress the housing markets together with the credit markets, ruining developers, builders, and thinly capitalized lenders. But it would bring the price of housing back down into more affordable ranges – and the political appeal of being able to rob the investor to give to the consumer/voter might be more than our elected officials could resist. Plus, taxes would increase on those who survived.
But there's more. As a percentage of households, housing is becoming more and more scarce everywhere. High interest rates have held down construction and capital investment in housing. In a 2 year survey of housing throughout the countries of Western Europe, North America, and the Far East its amazing how little single family housing is being built for families in the median income ranges and below. Check for yourself in your own communities. How many builders are building houses priced from $45,000 to $60,000? These would require incomes of about $30,000 to $40,000 for buyers to qualify for conventional financing. How many people earn incomes in those ranges? By and large, this problem isn't being solved by the public or private sectors.
This means that fewer people will live in owner-occupied SFH in the future. Investors and government will be the landlords for more people than ever before. That means rents at historically high levels and house prices which can go out of sight. It also invites more government meddling in the housing markets as the political pendulum continues to swing from the producers to the non-producers. It's not difficult to see lent controls and profit controls looming in the distance. And our children will either have to sacrifice more to own their home or plan to live in a multi-family setting in most of the areas of this country just as millions do all over the world.
BUT THERE'S GOOD NEWS TOO . . .
In an effort to enable its citizens to have an opportunity to prepare for an uncertain future, hearings are being conducted which would enable producers to put away even more savings into their own retirement accounts tax free. This infusion of capital will find its way into the real estate and securities markets to fuel activity. And the home Equity Loan Program is gaining ground. H.E.L.P. is a version of the reverse annuity mortgage program which allows elderly home owners to acquire loans over 5 – 10 year periods which pay THEM in monthly installments. FHA is planning to guarantee those loans which will bring many more lenders into that market and make them available over a wider geographic area. Serious consideration is being given to allowing oldsters to sell and to lease back their homes after taking the one time $125,000 tax exemption. Both of these approaches will offer security to home owners to offset the uncertainties of the Social Security and Pension Plan programs which prevail. And they'll increase liquidity.
Demographically, things are really looking up. Of the approximately 44 million owner occupied SFH in the United States, people aged 21 – 34 own 9 million, ages 35 – 54 own 17 million and ages 55 – 70 own 18 million. As the population ages, more people will move into the home buying market with rising incomes and both the ability and desire to own their own homes. The advent of high technology industries will permit many people to work out of their homes with computer terminals, hence their homes will become more important both as a place of refuge and as a place where they earn their living. The housing market will be affected by international and domestic economies as well.
Everyone is aware of the banking crisis brought on by inability of lesser developed nations to pay their debt. With a strong dollar and high interest rates, the probability of them ever being able to retire their debt becomes more remote. And about the only way our economy can survive is for the government to subsidize their economies. In order to do this, Americans must somehow generate more dollars for government's use. An expanding economy can do this, but it also will need credit to feed the recovery. Or an expanding tax base could do it, but the trend has been for the tax base to shrink as unemployment remains high and business bankruptcies continue to rise. Government can borrow from both domestic and foreign sources by selling bonds. But this takes money out of the credit markets and increases interest rates – making it even more difficult for foreigners to buy our products or to repay our debts. As interest rates rise, bond and mortgage yields must also. This reduces the value of existing debt instruments and slows down business expansion, construction and house sales.
The alternative is for government to borrow manufactured money from the Federal Reserve. With more money in the economy, wages can rise, businesses expand, interest rates drift lower. Everyone is happy for a time. Elections can be won. But all those foreign borrowers can move their money out of the country too. The dollar would be weakened so that foreign goods would become more expensive and domestic products less expensive to foreigners. Unemployment would decrease. The tax base expand. Sure, prices would go up, but maybe we'd be ready for it. Timing is critical so that we only perceive the benefits of inflation prior to the election. With lower interest rates and full employment, house prices will explode! 1983 will be “the good old days“.
YOU PAY YOUR MONEY AND YOU TAKE YOUR CHOICE!
I continue to place my bets on the side of inflation. Whether we get into a shooting war, banks see massive defaults pending on international debts, a credit crunch threatens the recovery, or the balance of payments shuts down foreign markets to our products increasing business failures and unemployment; inflation is the most likely scenario for the future. There's just no other way to fund the massive deficits. It's easy to make jokes about banana republics and Polish loans, but USA debt per citizen is many times as great as in those distressed South American countries. And our government is no different about borrowing money with which to pay merely the interest. We aren't retiring OUR debt either! So we don't have much room to talk about those who owe us.
If you intend to hedge against this inflation, the SFH is an excellent way to do it, providing you can leverage it with reasonable financing. That means that you must avoid excessive interest, personal liability on loans, and negative cash flows. You can achieve this through the foreclosure market and distress sales where the seller gives you the terms you need to preserve his credit rating and equity. Or you can put together syndicates of investors which will enable you to buy without debt and to avoid interest and negative cash flow problems. You can Lease/Option or acquire pure Options to maximize your leverage while minimizing your risk. But you must avoid any indexed loans, adjustable mortgages, variable rate mortgages, etc. and balloon payments which could trap you at a later date.
Remember, most cycles have two sides. Each rise has a parallel drop. As many people found out between 1981 and 1983, sometimes credit can't be obtained, rents can't be raised, and real estate can't be sold to raise cash to pay bills or taxes. So you have to prepare for that eventuality too. And if you are more successful than your peers, you must be prepared to contend with envy among private parties and government policy makers. When building construction slows, rents are vulnerable to controls. If you rely on tax shelters in making investment decisions, they can be eliminated without notice. If you invest in the wrong syndicate or limited partnership, you may find that the promoters aren't prepared to provide management. Indeed, this year syndicators have been paying above market prices for properties which generate poor returns and have little potential for appreciation because unwary investors have settled for sketchy promises of tax benefits and write-offs rather than examining the merits of the property critically.
When making the decision to invest with someone, whether you're the equity investor who puts up the cash or the sweat investor who puts up the expertise and effort, you should check out the other party thoroughly. Cash investors should start with those syndicators who already own their own property. Inspect it. Look at how it was acquired and financed. Check out the cash flows, maintenance and management. Does it measure up to the way you'd want YOUR money spent? Next, ask for bank references, professional references in the real estate and management fields. Get a credit report. Make sure the person your dealing with is competent and financially responsible.
If you're going to be the sweat equity investor, you also have a right to know with whom you're dealing. Check out the same financial references. Look at any weak spots in the financial statement such as balloon notes, unfunded obligations, contingent liabilities on other deals. You don't want to tie years of your life up owning property with someone who is subject to law suits, flaky business deals, bankruptcy, etc. And if you're going to be responsible for management, make certain there's a clear agreement as to the financial results each party experts to achieve, the holding period, and the remedy in the event either party fails to perform.
I prefer that title to jointly owned property be held in a Trust or Corporation. This skirts many of the problems associated with divorce, incompetence, bankruptcy, law suits, clouded title, abandonment, etc. If twp people are on title to a property and either one of them has legal problems, it could cloud the title in certain cases. With title in a neutral entity that can't die, divorce or self destruct, its a lot safer. And this approach also provides a low profile plus access to Trust or Corporate strategy. These and other techniques for acquisition and long term holding of investment property will be highlighted in the PORTFOLIO STRATEGIES course being offered in November.
THE PORTFOLIO STRATEGIES COURSE WILL GIVE YOU THE TOOLS YOU NEED.
In about one year we will have a national election. Now's the time to prepare. Tax laws will probably be biased against SFH investors. We could have rent controls. Interest rates could rise. We could be entering a long term inflationary period. Or war. That's why I'm presenting a course designed to deal with these contingencies and to give you time to get ready. We'll be considering an entire range of possibilities. There's a strategy for each. Regardless of the future, there will still be winners I intend to be among them, and at this course I'll show you how.
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Quotation not permitted. Material may not be reproduced in whole or in part in any form whatsoever.
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