May 1983
Vol 5 No 8
Three writers over the past 4 decades tried to deal with that question. Most recently, John Naisbitt wrote MEGATRENDS which dealt with demographics and fundamental changes in economic and political structures. Alvin Toffler wrote FUTURE SHOCK and THE THIRD WAVE which pointed out that things change much more rapidly than we expect or in ways that we didn't anticipate. In his classic book “1984“, George Orwell forecast a socio/political structure which we are more and more beginning to resemble which more or less reduced free people to the status of serfs who generated power for bureaucrats. Under any of their scenarios, survivors must learn to adapt in order to prosper.
The first lesson to learn is that history doesn't necessarily repeat itself. It could be a mistake to expect future investment performance to mirror the past. Things are changing – and at a rate far in excess of that reported by news media. The computer generated information explosion has compressed economic cycles into much shorter time frames. And technocrats are able to tinker with the economy using computer designed economic models. The problem is that, without clear comprehension of cause and effect, this manipulation of inaccurate data creates less rather than more control of events.
Look at the roller coaster ride of the past few years. Inflation, stagflation, depression, recession, inflation. Tax increases, tax cuts, tax increases. Bill Bradley proposed a flat tax of 10%. Now its climbing into a progressive tax and it hasn't even been debated yet. Social Security was going broke. Under the new law now wage earners will go broke supporting those receiving Social Security. Our automobile and steel industries, once the envy of the free world, can't even compete today. Five times as many jobs are being created in the information/computer/service industries as in the manufacturing industries. In only a couple of years we went from being the world's most efficient producers of agricultural products to paying farmers not to produce.
By confronting these changes and adapting new strategies, a tremendous array of opportunities will present themselves to serious investors and entrepreneurs alike. Venture capital is being made available in unprecedented amounts to those able to create new products and services. State and local governments are taking more power away from Federal agencies in determining who, where, why, when, how they'll spend their tax funds. As was demonstrated in the Chicago election, new political coalitions are being formed. And in housing, profound changes are taking place which will offer mega buck opportunities.
New financing tools are beginning to re-open the housing market. Under Section 203(b) FHA mortgages, interest rates are NEGOTIABLE, any one can pay points, and they're available to investors. A new entity, Residential Funding Corp (RFC) with 2000 estimated offices has $4 Billion for residential loans in price ranges ABOVE FNMA and Freddie Mac Limits of S108,300. This opens up higher priced housing to high leverage loans, making them more liquid. Federal, State, and Local subsidies and revenue bond programs combined with a myriad of less restrictive long term loan programs will boost sales.
The zig zagging economy has opened up distressed buying opportunities as never before in traditionally high growth markets such as California, Nevada, Florida, Texas. For those with cash, or the ability to raise cash, these properties can be purchased for 1980 prices. Coincidentally, holding properties will be less costly than ever before. For the first time in many years, RENTS ARE RISING FASTER THAN THE CPI while interest rates are falling. But beware! Over-leveraging purchases can be just as hazardous this year as before. They're still talking about dis-allowing many tax benefits where there isn't much economic justification (negative cash flow) for an investment.
AFFORDABLE HOUSING IS TAKING MANY FORMS
In Hawaii, OHANA ZONING permits an additional house on a lot zoned for only one. With land costing $10. plus per square foot, this makes a lot of sense to hold down costs. Off-site constructed housing is making major in-roads into the traditional housing market through zoning changes and up-grading of construction codes. HUD criteria allows these units to be located and financed virtually everywhere under FHA thirty year loans. With almost all of these homes falling within HUD financing limits, it opens the market to millions of potential buyers who can't afford traditional housing. Potential profit from Planned Unit Developments and sale of Condominium Mobile Home projects is awesome.
The Government's jumping into the act too. Permanently housed citizenry spells cash and political influence. Billions of dollars are allocated based upon accurate census information and this is rendered invalid when there are major shifts in population. Reduction of local housing regulation will remove 25% of the costs of house construction. In Lincoln, Nebraska a pilot project to reduce building restrictions enabled one builder to cut retail costs by $12,000 on a $51,000 house.
Senate Bill 3045 proposes to allow elderly citizens to sell their homes, take the $125,000 tax exemption, lease the property back for the remainder of their lives if they wished. The buyer could get full tax benefits including depreciation. This offers multiple opportunities for providing cash to the elderly as well as estate planning and estate building strategies for both buyer and seller. For instance, Mom and Pop could sell the old homestead to their high-bracket kids, lease it back break even, and lend the kids the money at any interest rate from zero to market yields. The house escapes from their estate. The loan could be forgiven at the rate of $10,000 per parent for each kid until it disappeared, and the kids would get the tax goodies plus appreciation. On the other hand, the parents could just keep the money if they needed it.
Accessory Apartments ($10 – American Planning Association, 1313 East 60th St., Chicago, IL 60637) refers to modifying existing housing to provide for extra rent-able space. Includes model zoning language where changes are needed. The Three-In-One House ($9 – Home Care Research, 30 East Patric, Frederick, MD 21701) gives practical pointers for setting up shared living arrangements for elderly. As we pointed out in an earlier letter, shared rentals can produce amazing cash flow yields from single family houses, but they've got to be selected carefully, priced feasibly, and located in growth areas.
FLORIDA IS ON THE THRESHOLD OF FANTASTIC OPPORTUNITY
The book, Megatrends, identifies California, Texas, and Florida as being major recipients of massive population shifts from the North to the South in this decade. As the only one of these situated in the East, Florida will see explosive growth in almost all areas. I recommend Florida Trend (P.O. Box 611, St. Petersburg, FL 33731 $18) for keeping abreast of developments. Here's a synopsis of the foundation of my optimism:
1982 saw Florida's population grow by 230,000… enough to create a city the size of Tampa. More are coming! And not just for the sunshine. Florida's zero state income and inheritance taxes, 5% sales and corporate taxes; relatively inexpensive land located near good transportation links on air, sea, highway, and rail attract businesses as well as consumers from all 50 states. Its broad based economy is founded on citrus, insurance, shipping, cattle, light manufacturing, tourism, construction, space programs, and high tech industry. Florida's economy is stabilized by massive Federal funds which flow in to support social security recipients, military pay rolls, customs offices, marine patrols, coastal wet lands, oil leases. Banking interests are fighting to gain a foothold in the lucrative local and international markets, taking a piece of Florida's action as the financial gateway to the Caribbean and South America.
But the quality of the citizens and their life style is also a key ingredient. Florida is reversing crime statistics through neighborhood watch programs and budgetary commitments to law and order. Floridians elect pro-business governors who promote growth. Women, grey panthers, Hispanics, blacks divide political power with main stream citizens cooperative effort to move the state forward. Over the next decade 2 and 1/2 MILLION new citizens will join the 10,300,000 who already live in Florida.
One primary reason for this influx is a relaxed life-style which typically centers around water-recreational activities. Boasting of more shore line than any other state except Alaska, and a sub-tropical climate which compares favorably with that of any ether state in summer, and is incomparable in winter, Florida also offers plenty of real opportunity for the entrepreneur. This unique combination of broad based economic potential, enjoyable working and playing environment, low taxes, improving educational programs has created a situation in which businesses, relocating to Florida, can staff their facilities with the cream of the crop from all across the country. Thus, Florida's growth will be fueled by motivated, skilled non-union labor and progressive businesses.
While each region of the state will benefit as a result of projected growth, the Southwest counties will grow fastest as a percentage of their current population. On the other hand, a greater number of newcomers will move into the area adjacent to the lower East Coast and the “Golden Girdle“ extending roughly along Interstate 4 and extending to the coastal counties East of Orlando and West of Tampa. Miami will become an international financial center ranking with London, Hong Kong, New York, and Singapore. Tampa continues to astound the planners by the strength of the local economy. Its ports, air and water, continue to attract businesses. 34 relocated to there in 1982. It will host the 1984 Super Bowl. Oddly enough, few Florida counties will be left out of the boom.
As land prices rise; small companies, retirees, builders are moving into the central counties. They seek to avoid the problems too much growth can bring. Orlando's tourist centered growth revolving around Disney World and now EPCOT is causing crowding that will be aggravated by movement of high-tech industry into the area to support space programs and electronic manufacturing. Prices are beginning to rise even now. In the North East, Jacksonville is just beginning to augment its already strong insurance, military, and tourist industries with additional construction. Neighboring Clay county grew by 30% over the past 15 years while its median income grew by 140% – the second highest in the state. Florida's North West is a nugget waiting to be discovered. I-10 leads tourists into Pensacola and along the nation's whitest beaches to Panama City. For years Canadians have known about this area which is thriving on condominium construction, tourism, and military payrolls. For you who are looking for a new place to invest, you may find that Florida has more to offer than most – and there's still profit to be made.
And now a word about contrarian theory of investing. Contrarians say that you can make a profit where others say you can't. For example, rents have gone up most over the past 15 years in San Francisco, Los Angeles, Boston, San Diego, and Seattle. Dallas, New York, and Washington weren't far behind. However, West Virginia, Oklahoma, South Carolina, North Carolina, Alabama, Idaho, Kansas and Kentucky have more renters for the amount of housing available and Riverside/San Bernardino, San Antonio, Portland, Phoenix, and Dallas have a higher percentage of renter occupied SFH than other-cities. Did you notice that Florida was not mentioned? Gold is still pretty much where you find it!
For example, one of the most consistent complaints we receive from popular areas is that seller's aren't motivated. Prices and financing costs are too high to allow positive income cash flows. Yet in Ohio recently, one of our readers bought a property for $32,000, raised $49,000 on it at the bank to modernize it and now gets a positive cash flow even after financing. I suppose the message is that negotiation and perseverance can still win the day even in areas that don't make demographic headlines.
There's more good news for landlords. HUD has proposed a new Housing Payment Certificate Program which will allow tenants under subsidized rental programs to get the subsidy directly and to choose their housing, using the certificates for payment. These will be redeemed by the landlords. By cutting through a lot of the red tape, more SFH will be available for these rents, creating more competition among the non-subsidized house-hunting tenants. As houses are soaked up by subsidized renters, fewer will remain for non-subsidized tenants. Rents will be driven up that much more – by government.
Despite all the proclamations to the contrary, inflation will persist as it has over the past 10 years simply because government will continue to spend more than it can raise through taxation. Your SFH portfolio will still be one of the best places to hold long term investment capital. Once the general public becomes aware of rising costs or otherwise perceives the effect of inflation and rushes to buy tangibles; gold, silver, and houses will rise once again to counter inflation. Of course, if we don't have any inflation, then the pent up demand for affordable housing will cause affordable houses to rise in value as soon as interest rates subside. The rise will take place one way or the other. It remains but to buy at below market rates with feasible financing.
SYNDICATORS WILL LEAD THE WAY IN INVESTOR HOUSING MARKETS
When a person mortgages a house with a “nothing down“ financing arrangement, he is actually buying no equity with 100% financing. His equity rises proportionately with his down payment and negotiating ability. The problem is that fancy financing is usually done at the expense of negotiating position in the most competitive sector of the market. Usually, non-cash buyers are frozen out of the foreclosure market too. Suppose, instead of leveraging a 95% acquisition, you merely joined 19 other investors and bought a house for cash? You'd still have a 5% interest, but NO DEBT and NO RISK. You'd have a positive cash flow, albeit a small one. You'd give up some appreciation, but not all.
One fellow we know works with 25 investors. He convinces both spouses to make $2000 tax-deductible IRA contributions. With $4000 from 25 couples, he has $100,000 cash to work with. He haunts distress sales and makes low offers aiming at buying $160,000 worth of houses for each $100,000. Say he buys two $80,000 houses, paying $50,000 each. He can do this because he's using CASH in a non-cash market! He has no competition. At point of purchase, he picks up a 37% profit. He divides this with the investors by performing all the services associated with finding, negotiating for, buying, closing, managing, and manipulating the investment for maximum yield. He gets only the profit he's negotiated and they get the cash flow. If he averages a net of $1000 from both houses, each family gets $40 per month positive cash flow. This is indexed, roughly, to grow as rents rise with the CPI. $480 per year represents 12% cash on cash return to them. Not bad. And each year they can repeat the process. So can he! His perfectly safe investment hedges the inflation too. And by properly structuring his transaction, his $60,000 interest is tax free. Every year. And he has more than one group. And he has no debt to concern him.
You can participate in similar arrangements either as the investor or the entrepreneur safely and reasonably. If you did this for 10 years and retired, assuming a 10% compound increase in the property, you'd have a nest egg worth almost $75,000 once the cash flow had been re-invested. It would be paying you over $1200 per month in cash flow. How many companies would pay you that for 10 years service? Of course, if you had 20 years to go, you'd have over a quarter of a million dollars and $3200 per month. But look, the entrepreneur would have around $3.4 MILLION in his account!
You can appreciate that those kinds of returns would attract some pretty sharp characters, so before you start giving your money to ANYONE, find out plenty about him! Ask for references from recent and old customers – PERSONAL REFERENCES! Check the credit bureau and better business bureau. Check professional associations. Check his actual, provable track record. Insist on doing business in a business-like manner. I've heard some horror stories about people who both give and attend seminars solely to pick off the innocent lambs. Don't become one of them. Be prudent. Be cautious. Then invest.
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