March 1985
Vol 7 No 6
YOU CAN'T BUILD A PYRAMID FROM THE TOP DOWN . . .
Ten years ago I wrote an article called 'HORIZONTAL APARTMENTS, A NEW INVESTMENT VEHICLE', it was published in what was then called The Real Estate News Observer. It was deemed a radical departure from conventional thinking on real estate income properties and as a result of this I was invited to address investor groups to defend my position. The National Association of Realtor's commercial investment division even denied me credit toward their CCIM designation for my experience with single family houses on the basis of their opinion that a house was not a commercial or investment income property. As a result of this article, I wrote a seminar which eventually became the only seminar on single family house investment anywhere in the country. Things have changed.
Now, ten years later, the woods are full of single family house seminars and experts who will guide the patient follower through the maze of financing tools and fancy footwork required to make quick millions virtually without work – almost automatically. My newspaper and TV screen regularly extol the wisdom of a transient guru who will devote a weekend toward converting some poor, tax-paying wage earner into an instant mogul. It seems almost a sacrilege to have made LESS than $1,000,000 if one is going to offer any kind of education. Any mention of effort/risk/failure/sacrifice is a definite no-no!
Tens of thousands of neophyte would-be investors all across America have joined investment groups which meet periodically and which offer additional education on all sorts of variations on the theme of making big money without work. Yet, in spite of their faithful attendance, it doesn't seem to be working for most of them. WHY? BECAUSE NO ONE TAKES THE TIME TO TEACH/LEARN THE FUNDAMENTALS! A long time ago in this letter I wrote that single family house investment is a game of inches. The difference between making a lot of money and losing a lot of money can boil down to just a few details that might have been overlooked.
Look around you at your peer investors; people who've bought the tapes and attended investment club meetings regularly over the past 5 years or so. How many of them have achieved financial success and independence? Is it just possible that all the things they've been learning have been the wrong things? Is there any chance that their teachers found their own way to the top by selling seminars and educational materials rather than by actually doing what they propose their advocates do? Or has the single family house as a viable investment vehicle become passe' as a stepping stone to wealth and leisure?
IN ANY GAME THERE ARE RULES FOR WINNING AND FOR LOSING!
A couple of days ago someone asked me what the best possible investment might be for the balance of this decade. What do you think? I told him INVEST IN YOURSELF FIRST! What does that mean? Simply stated, before you spend money on real estate make sure you know what you're doing! That goes for buying real estate paper too. Financial lessons are always a lot cheaper when you can learn from other's mistakes versus your own! Someday I'm going to sponsor a convention where the speakers speak only of their mistakes and the money they've LOST. A few years ago I offered a seminar with Pete Fortunato called PITFALL, and PROFITS. Nobody came, so we dropped it. Maybe some of its insights can be shared in this month's newsletter. Several years back I wrote a pamphlet called WINNING WITH JACK MILLER which contains over a hundred of these rules.
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LEARN TO MANAGE VERSUS MERELY COLLECTING RENT!
For creative financing people, OPM is the cornerstone of estate building and pyramiding of wealth. It's a magic concept; using other people's money to amplify our investment returns through leverage. Why can't we use the same concept in management? We can! First of all, we've got to divide our management job into various components which we'll call profit centers. Once we take a closer look at these, the opportunities for increased cash flows and profits will become more discernible.
What might logical management subdivisions be? Certainly Rent Collections, Deposit Policies, Penalties and Fees would qualify as income generators. What about Occupancy and Turnover, Maintenance, Appliance Policies and Insurance? These can go either way. They can be a source of expense or they can be leveraged to increase cash flow depending upon how they're handled. What about fences, pools and carpets? Pets? These too are potential sources of profit. The key to wringing profits out of what are normally expense items is to pass these costs along to the tenant -every chance you get. When rents tighten up in your area, you should consider implementing some of the policies which will reduce expenses or generate higher incomes. Consider these:
Start with rent collections: the easiest way to insure prompt collections is to rent to people who routinely pay their bills when due. You can verify this through the use of credit checks and references. And you can attract these people by offering a discount on their rents in much the same way that Safe Drive insurance companies attract the better drivers and commensurately higher profits. We go one step further and offer tenants access to our Credit Card Account so that they can authorize us to simply call in to our bank in the same way as any other merchant in order to collect their rents.
From a landlord's perspective, it's a lot simpler to lift the receiver and to dial a local number, get a credit authorization, deposit the credit telephone order slip into his bank account for INSTANTANEOUS CLEARANCE AND CREDITING TO THE RENTAL ACCOUNT than it would be to collect rents the conventional way. And from the tenant's point of view, in a cash shortage situation, he avoids late charges, stress, evictions, and having to deliver his rents in return for a small credit card charge.
Of course, this doesn't replace the need to keep tabs on all collections to be certain that penalties are charged when the credit card fails to be credited because your tenant has exceeded his limit. Credit cards can be used for deposits too. I've found that people are much less sensitive to making higher payments when they can be charged. There are a couple of variations in this approach. Let's say that you've found a good tenant applicant who's having a problem coming up with his deposit plus his advance rents. Say he needs $1000 to move in, but he only has $750 plus a credit card. You could offer him your “credit card plan“ for 10% more rents, enabling him to pay his deposit and rents by credit card. If you could (a) qualify a desirable tenant by this means, (b) make your collections easier, (c) increase your cash flows, (d) reduce the clearing time for your receipts, (e) and get the tenant to pay for the entire thing while reducing your risk of vacancy due to temporary cash shortages which cause the tenant to be delinquent and to be evicted for non-payment of rent; doesn't that seem like a better way to do business?
This leads us directly into deposit policies. Probably 90% of all litigation between landlord and tenant stem from disputes over deposits. For 5 years I've been ducking this issue by ELIMINATING ALL DEPOSITS. Instead, the prospective tenant BUYS an Option TO RENEW HIS RENTAL CONTRACT after it's normal term with a 10% MA MUM increase in rents. This gives the tenant 2 years with rents which won't vary more than 10%, and it gives me access to the money immediately, since it isn't being held in trust for the tenant or as a 'security deposit against potential damages. These will be charged as they occur after the tenant has vacated. Instead, funds collected on the renewal option are PAID! They're not being deposited! They belong to me from day-1 for my own use. Over the term of the rental contract, I build in incentives to keep the tenant motivated to perform his obligations as called for in the Rental Contract. I go into this in considerable detail in my EASY STREET – HANDS OFF MANAGEMENT seminar. But suffice it to say, from the standpoint of collections, I effectively double the first month's rent collection and get the use of these funds over the entire life of the rental contract interest-free. Plus, I totally avoid disputes over deposits and regulation of what would have ordinarily been deposits by the regulatory agencies. This saves time and expense and generates cash flow.
Repairs and maintenance are the nemesis of the investor! During the first few years I did it all myself. I finally realized that my “investment“ was beginning to look like a job that I'd bought for myself – a very low paying job at that. Let's face facts, if you're going to have to work to make your investments produce profits, you have to subtract the value of your labor from the profit before you compute your yield. If you don't know how much to pay yourself, find out what someone else would pay to get your services or how much you'd charge for them. Then deduct that from your year end cash flow. The balance is your investment return. Here again, the trick is to get the tenant to do as much as possible of any work required on the premises.
My rental program starts with a tenant inspection. He is actually inspecting the prior occupant. Between tenants I do only absolutely minimal clean up. This way I not only save time, I save expense. By getting an in-coming inspection, I've put the expense and trouble of this job onto the person who I'm going to have to please. I only need to fix what he sees needs fixing. And his objective inspection is the basis for my charging the preceding occupant for costs of fixing up the property if any dispute arises. Once the premises meet the standards of the new tenant, he becomes responsible for keeping them up to snuff. Built into his discount for paying the rent promptly is a “deductible“ fee which he must pay for all repairs. For instance, if he gets a $50 discount each month for paying on time, then he also must pay for the first $50 of repairs needed each month.
I've discovered that one of the keys to low turnover and vacancy rates is to get the tenant involved in the property as soon as possible. His inspection, and perhaps letting him earn rental credits by doing painting, clean up, etc. engenders in the tenant a proprietary interest in the property from the very start. Coupled with the Option to renew mentioned earlier, and stabilized rents, he tends to stay longer prior to moving out. And he has an investment in the property in terms of his labor which he is reluctant to jeopardize by being evicted for not paying rent. Furthermore, when he has to pay the first $50 toward any repairs, it's amazing how much better he treats the property.
As a standard policy included in my rental program, I specifically exclude any appliances! This gives me the chance to (a) sell used appliances to tenants, (b) rent appliances, (c) buy appliances from tenants who won't need them in their next home when they move out at the expiration of the rental contract, (d) avoid having money tied up in CAPITAL improvements rather than in EXPENSES, (e) avoid tenant complaints and repairs normally associated with appliances, (f) save time which might otherwise have to be spent in buying and negotiating terms on appliances. When I really want a tenant, and the lack of appliances is a stumbling block, I can usually negotiate a slightly higher rent (5%) in return for putting in used appliances. I get him to find something he wants, within a stated budget amount, then I install it. Here again I avoid the time spent looking for a suitable stove or refrigerator which the tenant must like, and if it fails, I can always maintain that he picked it out, so he can't blame me if he isn't satisfied. And usually, the amount I've agreed to pay is less than he wants to spend, so he spends his own money to make up the difference, and I own the appliance. He understands my costs, and he takes better care of the appliance. Either way, my costs are reduced in terms of time and money.
Another often overlooked savings comes when your tenant pays for his own costs of insurance. I encourage his taking out a renter's insurance policy. This protects him from claims of others injured on the property, protects his property from accidental loss, theft or damage, and it also protects me from his claims to a certain extent. I give him address of MY AGENT so that any claims can be handled between us by the same company.
TENANTS ARE CONSUMERS TOO . . .
Most of us respond to the chance to buy something at wholesale prices. When you can offer tenants a chance to participate in buying something which will make their home more desirable at something less than retail prices, they too respond. I've already mentioned insurance policies which you can negotiate premiums on for your mutual benefit. We've recently gone into the carpet business with tenants. Here's how that works:
I can buy carpet from the mills at about 50% of the retail costs. I recently rented a house which needed a carpet. I offered to sell my carpet to the tenant and to have it installed at about 75% of the costs for comparable carpeting. I do the same for other landlords in my area from time to time. Each time I make a small profit for doing something I'd be doing anyway. The difference in the tenants is noticeable. They've paid for carpeting. In order to get their money's worth, they must stay in the house for years. To be fair, I don't increase their rent aggressively each year and they have the incentive to remain as tenants. They're happier in their homes and I get any residual value in the carpeting after they've departed. I offer to install carpeting in houses with tile or terrazzo floors if the tenant will pay $25 more per month. I do the same thing with new air conditioning. This makes the property more marketable as a rental, offsets my costs, and motivates my tenants to renew their rental contracts year after year.
PRACTICAL KNOW-HOW IS THE BEST DEFENSE AGAINST AN UNCERTAIN FUTURE.
Packard Motor Car Company had a slogan: 'ASK THE MAN WHO OWNS ONE'. As the economy has gyrated over these past few years I find myself counseling more and more with those who took the advice of people with little practical experience in the single family house field and who subsequently have had to endure massive financial reverses. Your only sure defense against adversity is to learn from those who have actually preceded you along the road to single family house investment. That's why I continue to teach seminars and why I'm leery about recommending courses taught by people who's experience I'm not certain of. There are those whom I can recommend and who's courses are a valid valuable source of practical know how. First among these is John Schaub's MAKING IT BIG ON LITTLE DEALS. John and I originated this seminar based upon our own experiences. It's the only one that I know of that dares test its material in real buying expeditions during the class itself. If you intend to acquire SFH and want to do it properly to make real progress up your financial ladder, it should be one you take at your earliest opportunity.
