John Schaub's Strategies and Solutions - 
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#9807 

HOME VALUES STARTING TO HPYERINFLATE ACROSS THE NATION

That is the headline from last Sunday's paper. National real estate columnist Ken Harney listed areas where houses were increasing in value at rates higher than inflation. Naples, FL topped the list with a 21.7% increase. It was followed by Boulder, 20.2%, Jersey City 19.9%, San Francisco 19.8%, San Diego 16.3%, Colorado Springs 15.1%, Orange County, CA 13.0 %, San Jose 12.9%, Ann Arbor 11.9%, Seattle 9.6%, and Detroit 9.6%.

While not every market is increasing at this rate, this is a widespread phenomenon. Areas that have experienced depressed markets in the past, such as California and Colorado, have rebounded with revenge. If your town is not on the list, don't wait for values to take off. Buy today at great prices and borrow at interest rates your parents would love.

HOW YOU CAN BEAT THE AVERAGES AND REDUCE YOUR RISK

My town, like many of yours, is only appreciating at single digit rates. That does not mean all my houses will go up exactly 6.7%. An advantage of investing in houses is that you invest in different neighborhoods. By choosing neighborhoods in the best areas of town, and buying the right house, you can often beat the average. 

Buying in different neighborhoods can provide protection against a disaster, natural or otherwise. A long term road repair project can be as costly as a hurricane if you can't get good tenants because of the construction. If all of your houses were on one street and they tore it up, you could be in deep asphalt. I make it a rule not to own houses next to each other, and not to own more than a few on any one street. 

However, owning several houses in a strong neighborhood makes sense to me. You become an expert on the rental market and the value of properties in the neighborhood. This knowledge enables you to set your rents competitively and to make offers quickly when you spot an opportunity.

While it would be nice to have a 20% jump in prices, a more modest increase makes it easier to operate normally. At a 6.6% average increase, it will take about 10 years for a house in my town to double in value. While we do have a sellers market (more buyers than sellers), I am still able to buy properties that make sense. 
If you are new to this letter, I define properties that make sense as properties that give me a good return on my money today, without inflation. Low interest rates make this possible today, even though bargains are harder to come by.

WHY ARE PRICES INCREASING?

This upswing in values is no fluke. I predicted it in the September 1996 issue and have since been encouraging readers to buy and borrow aggressively. This increase in prices is a result of several factors. 

Low interest rates are making buying more attractive than renting. Every tenant who can, is trying to buy a house. The percentage of homeownership is growing. Many landlords will sell their rental houses to realize a large profit. This reduces the supply of rental houses available.

The short term effect is that landlords are experiencing higher than normal turnover. Good tenants are harder to find and harder to keep. Today, I will allow a good tenant to stay at the same rent rather than lose them. Properties are appreciating. If I can stay full, I am making a good profit without raising my rents.

Soon I will be able to raise my rents. The long term effect will be a reduction in the number of houses available for rent. As this happens, and eventually as interest rates begin to rise, fewer tenants will be able to buy. Then they will have to compete for fewer rental houses. The rents will rise as a growing group of tenants compete for a smaller pool of houses. 

Owners are now moving up into more expensive homes. They can afford a bigger loan because of the low interest rates and their increasing income. This turnover increases the supply of starter homes available for tenants to move into.

Another reason for hyperinflation is that lenders will make loans to those with less than perfect credit. Today I received a check from a closing with a borrower that had no job, and little income (she was a full time landlord). She would have never been able to qualify for a loan in a tighter credit market. In the last issue, I mentioned that many lenders are making loans for more than the value of the property. Many of these high risk loans will become foreclosures and opportunities for knowledgeable buyers.

A third factor is that rents have increased dramatically since the tax law change of 1986. This law penalized real estate investors who pulled out of the real estate markets, resulting in few new apartments and rental properties being constructed. This shortage of rental units available caused rents to increase. Now tenants are buying properties that have payments lower than their rents.

These factors combined with the strong job market, will insure strong growth until the next cycle. Nothing goes up forever. But our country's economy has six good years for every one bad one. It would be foolish to sit on the sidelines waiting for prices to come down.

SEVEN STRATEGIES FOR TAKING ADVANTAGE OF THIS BULL MARKET

#1 HOLD ON TO YOUR BEST HOUSES!

When the market gets going, you will be solicited by brokers looking for listings and buyers anxious to buy. Your tenants may approach you to buy the house they are in. They may offer you more than you think your property is worth. Never accept an offer without rechecking the market!

In the last hot market, we had a broker give us an opinion of value, not a formal appraisal, on an out of town property we owned. It came in at twice our purchase price. A few months later we received an offer for about 10% more than the broker's price. We accepted it, only to learn later that the market had jumped 20% in those few months. Now, when I receive an offer, I ask for a day to accept it. I take that time to recheck the market before I make a decision.

#2 GET RID OF YOUR DOGS

Now is the time to take a hard look at your portfolio and ask if you own any properties that you would like to get rid of. Look for properties that take too much time to manage, or that break too often, or that do not appreciate as much as your other properties.

You cannot always sell property at prices you like. Now may be the window of opportunity to sell your dogs. But remember to hang onto those good houses.

I occasionally run across someone who will tell me about all of the property they used to own. Twenty years ago they owned ten houses, but they sold them in the last hot market. These are some very disappointed people. After you have done all of the work to find, finance, and buy a good house, don't sell it just because you can. Have a long term plan to accumulate a certain net worth and cash flow from your properties and then stick with your plan.


#3 BEFORE YOU SELL, MAKE SURE THAT YOU CAN BUY A 
REPLACEMENT PROPERTY THAT YOU WILL LIKE BETTER

It's a common mistake to sell a property at what you think is a good price, only to find that you cannot buy another property that will produce the same amount of profit. Before you accept a contract to sell one of your houses, make an offer to buy a replacement house that you like better. If you cannot replace what you have with a better investment, keep what you have!

Buy a good property whenever you find one you can afford. My friend Jimmy Napier often quips that he's paid too much for every property he ever bought. On the other hand, he follows my advice and only buys property that makes him money, today! If you buy a property that makes money every day, you can afford to hold it forever. 

Buy property today on good enough terms that it has a little cash flow plus repays a part of the loan each month. Then even if the property doesn't go up, one day you will own a free and clear property that will make you look smart.

#4 GET RID OF A BAD LOAN BY SELLING THE HOUSE AND REPLACING IT 

Sometimes it's not the house or the tenants or the neighborhood that is the problem. It's the loan. With interest rates low and lenders eager to loan, you may be able to refinance without a large cost and keep the house. The drawback to this strategy is that when you refinance, you do not make a profit. In fact, you actually lose money. The closing costs you have to pay to refinance, even if they are built into your new loan, reduce the profit you will make when you sell.

The alternative of selling the house with the bad loan, and buying another with good financing in place gives you the opportunity to make two profits. One by selling at a retail price in a hot market. Another by buying a property on good terms.

You may be able to improve your cash flow significantly by using this technique. Suppose you own this house presently:

House value $140,000
Loans:
1st @ 9% 70,000 payable $809.75 monthly
2nd @ 10% 10,000 payable $212.47 monthly

You accept an offer to purchase your house for $140,000 with the buyer paying off your existing loans. You will receive $60,000 at closing (rounded for this example).

You buy a replacement house, in a new neighborhood at close to full market value, because the market is hot. After you close on the replacement house your position is this:

Value of replacement house $160,000
Purchase price 150,000
Loans new 30 year 1st @ 8% 90,000 $660.38

This move can increase your cash flow more than $360 a month on just one house. With the longer term loan you will have less amortization or reduction of your debt each month. But, the increase in cash flow would allow you to invest in another house that would double your profits in the long run.

#5 DOUBLE YOUR PROFITS - BUY OUT YOUR PARTNERS

I have long recommended bringing investors in on deals to provide the capital to get you started buying. It is a strategy that has worked well for me over the years. 

Once you have significant profits in properties you own with your partners, you may be at the point where you can buy out some of your partners. If you are doing all of the work for half of the profits, you can double your profits without increasing your work load by simply buying out your partners.

Some will accept a note for their interest as they are interested in cash flow, which you can provide with a note. You can secure the note by the interest you are buying in the property.

Others may need cash. If you own more than one property, you can simply sell one, and exchange your half interest in the property that you sell for their half interest in the property you want to keep. By completing the exchange, you pay no tax and end up with all of one property. They get their cash and can reinvest in another property or simply spend the money.

#6 KEEP YOUR GOOD TENANTS

A good tenant is one who stays forever, fixes everything, pays on time, and never calls. You may not be able to recognize your good tenants, because you should never see them.

Obviously, not all tenants qualify. I am amused by those people who think they are great tenants. After they finish explaining how good they are, I share with them my definition of a good tenant. Then I raise their rent 

I never mourn the loss of a tenant that doesn't fit the definition of good, because I know there are good ones out there. I know, because I have dozens of good tenants.

I won't attempt to teach the entire Positive Landlording course in this letter, although I highly recommend that you study and use that program to acquire good tenants. Call Dottie at 800-237-9222 to order your copy. Here are a couple of pointers for keeping your good tenants.

Rather than sending them a letter raising their rent, call them and talk over how things are going and ask them what amount of increase would be comfortable for them in the coming year. Whatever they say will work for me in a market where good tenants are hard to acquire. Even no increase is acceptable, I will ask them to do something in return for no increase so they value the fixed rent. 

A little thing tenants could do would be to plant a few small bushes or a small tree. If they plant them, they will water them. Specify the type of tree or bush. Not all trees and bushes are assets. Another small thing would be to fertilize the lawn (again they will water it), or to repaint the front door, or pressure clean the house. These things are really tokens, but are meaningful. They bond a tenant to the house, and get them to commit to another year.

Inertia works for the landlord. A tenant at rest is inclined to stay at rest. Nobody likes to move. Give them a reason to stay and they will. 
#7 KEEP BUYING

Stock market buyers call it averaging. They suggest that you continue to buy a set amount of investments regardless of the market.

The real estate market is quite different than the stock market, but they both have cycles. Buy a little every year is even sounder strategy in real estate, because every time you buy a house, you get a little smarter. Each purchase is a seminar. It would be foolish to try to buy ten houses at a time. You give up the advantage of learning something from every deal. You will become a better negotiator. You will become better structuring offers. You will make better and better deals..

I have learned, that even in strong seller's markets, some sellers get in a bind and have to sell quickly. Because there is no organized market for houses, like there is for stocks, when someone has to sell quickly, they must accept a lower than market price.

If you can keep your good tenants, and not spend a lot of time on management, you will have time to seek out these rare opportunities. It takes a lot more effort to find a really good deal in a seller's market, but it can be done.

Set a specific goal for the number of houses you will buy this year. Now, further refine that goal to include the type of debt you want to have on the houses that you buy. Write down how much you will use for down payments, and start making offers that will allow you to meet your goals. Do something! The sound you hear is opportunity knocking.

Note: The information offered in this letter is part of an ongoing series. This issue builds on the information given in previous issues. The author and publisher are not engaged in offering tax or legal advice. Laws are constantly changing and advice of a competent accountant and attorney should be obtained before implementing strategies suggested in this letter. 
Strategies and Solutions is published six times annually. Annual Subscription $47.00. To subscribe or for information on John Schaub Seminar and tape courses call Dottie at 800-237-9222
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