“Buying Foreclosure Without the Exposure”

Start your retirement planning early

Real estate investing is exciting because we get the opportunity to use wealth pillars like leverage which allows ordinary people the ability to considerable wealth in a short time; I know because I’ve seen it happen. Another exciting aspect is there are always opportunities to make strong returns, regardless of how the market is doing and right now that is especially true as we bear witness to hundreds of thousands of foreclosure nationally per month. But like other forms of investments, real estate investing takes discipline, education and smart decision making to become successful. I’ve met with clients who made impulse purchases and the result is usually disaster.

There are fundamentally at least eleven reasons why real estate deals are always available no matter what the real estate market is doing. There is no magic here, just human circumstances that create opportunity if you know how to look for them.

1. Divorce
2. Job loss
3. Job relocation
4. Bankruptcy
5. Health problems
6. Incarceration
7. Reduced income – market conditions
8. Death
9. Failed business
10. Military duty or activation
11. Adjustable rate mortgages – on stated income that was unreal

Right now all eleven of these personal circumstances are widespread since American is in two military conflicts, unemployment expands monthly, record business failures and layoffs and numerous professional incomes reduced due to market conditions. In my own practice of modifying loans I see that there was a serious abuse of the stated income loan that has now come to boil and are popping left and right leaving folks unable to make the payments. The inability to make adjusted payments should be no surprise as there was no way for them to ever afford the home with their current income.

Enter the REO. An REO (real-estate-owned) is a form of distressed property and is similar to buying a short sale (sale of a home for less than the owner owed), except the property is already back in the possession of the lender or bank through the foreclosure process. In an REO situation the banks end up owning the property when no one bids to cover the amount owed against the property at a public auction. REO homes are often considered the best way to buy a distressed property because the seller is already out of the picture. It’s just the investor or their agent, the bank or the bank’s agent negotiating the transaction. Some REOs can be purchased directly from the lender for pennies on the dollar especially for those who can buy them in bulk. However, if you combine the purchase of an REO with a system for investing where you don’t have to do anything but collect your checks then you can leverage your time and resources to make and find more opportunities.

Normally REOs are purchased on what is referred to as tapes and the more money you have to spend the better the tape but on these large tapes there are the good, the bad and the ugly which are properties that you wouldn’t want because the fix up costs eat into the profits. Also, to get really good deals or the actual pennies on the dollar you have to come in with millions if not billions the way the hedge funds do who typically have purchased most of the good deals by the time the individual investors or small investor pools can get a hold of the REOs. Nevertheless, there is an old fashion way of acquiring these properties if you have the time to fly all over to numerous states and get into the underground or you can rely on a systematized approach to investing in this distressed market where you’re able to not only get all good properties (bedroom communities), the system operators actually cherry pick and buy properties that are livable, fix them up bring you not only positive monthly cash flow from your systematized property but also has built-in exit strategies that put a cash windfall on top of your positive cash flow.

All the most successful business in America follows a system. Once you have real estate you are in business in a sense, you’ve become a real estate entrepreneur and why wouldn’t you want a system to take care of your investing? To make sure we understand what a system is specifically here is a great definition: System (from Latin systma, in turn from Greek systma) is a set of interacting or interdependent relationships, real or abstract, forming an integrated whole. The concept of an ‘integrated whole’ can also be stated in terms of a system embodying a set of relationships which are differentiated from relationships of the set to other elements, and from relationships between an element of the set and elements not a part of the relational regime.[i] Now this is just a very technical way of saying things that work together or “special sauce” if we were to look at Kentucky Fried Chicken (KFC™).

The system works like this, you buy the property, management places a new buyer in the home that will pay you the going rate for rent is in the area as their new mortgage payment to you, and you’ve just become the bank. For example, say rents at the local apartment are $500 and you only make $1,000 to $1,500 net after taxes. If I came up to you and said hey, “how would you like to own a home for $500 down and $500 per month,” the same you’re paying right now in rent, what would the reasonable person do? They are going to want to own and you have them on a land contract, no landlord/tenant relationship here so you don’t fix sinks, toilets or anything else…it is their home. You just hold this contract like the bank and are akin to the note which is reverse engineered at $500 at 10% time 10 years amortized. Did you get a deal? Of course you did and until this person repairs their credit so did they because we made it affordable just like a car dealer would…it’s all about the payment.

Management collects your $500 per month minus a 10% servicing fee for collecting and disbursing your money and making a website available to you on line where you can manage your property and check on it and see pictures both interior and exterior.

The lynchpin in this type of investing is the land contract. A land contract (sometimes known as a “contract for deed” or an “installment sale agreement”) is an agreement between the owner of a property and a person who wants to buy the property for an agreed-upon purchase price.

What are the Benefits of using the land contract you might ask? Well, there are plenty but they include, not having to fix anything, you don’t pay taxes or insurance, payments are predetermined and there are minimal liabilities (asset protection).

Finally, for the first time you have multiple exit-strategies inherent in your real property investment. I usually ask real estate investors that come in to my office two questions – #1 what is the exit strategy? And #2 did you buy retail, wholesale or discount? In both cases they give me a look like I spoke a foreign language at them. In this system these two threshold concerns are integrated because you have the exit strategies and you are definitely buying discount.

You or your new buyer could choose to refinance as it behooves them to get conventional financing which may be lower than structured in your land contract. For example, if you had an investment entry point of $23,900 and a $37,900 sales price fixed in your land contract. After a year of timely and seasoned payments the land contract Buyer’s credit is restored. Buyer can refinance property to lower interest rate and cashes out your $37,900 note which creates a high return on investment (ROI).

Alternatively, since you own this note you might choose to sell it to a note buyer. For example if you have an investment of $29,900 which you sold for $90,000 ($500 down@ $500 per month @ 12% interest) and after the loan seasons for 12 to 18 months you have the option of selling your note in a marketplace that is a trillion dollar industry. So you sell your note for $67,500 (25% discount). But you’ve also received the $5,400 in monthly income for the past year. The combined profit is in Excess of $40,000 or more with the monthly payments and the note sale even though it is discounted. That’s another hard to find ROI particularly if you’re accustomed to market returns from mutual funds and the like.

You can always just hold because you have an investment of $29,900 with a documented sales price of $60,000 via the land contract.

This system has been a huge success with waiting lists of approved applicants nationwide just waiting for properties to come available as the secondary buyers. We are watching this program transform families, neighborhoods and communities. In addition to the socially redeeming value of this program, it provides investors with massive advantages. Some of those include:

1.       Triple Net – Your buyer is responsible for taxes, insurance and maintenance

2.       Pride of ownership – Your buyer typically improves home and maintains well

3.       Lower Default – Owners paying the same amount as they would for rent rarely default

4.       Socially redeeming – You can help a hard working family become home owners

5.       Cash flow between $450 – $650 – for properties purchased all under $30,000.

The next five to ten years will be defining and you have the power to change your financial future if you only get off the sidelines and in the game. I played football in college and whether you were at a real game or a practice scrimmage, while you were on the bench at the sidelines you were helpless to change the outcome of the game. It was only when you got in the game and you knew you placed your entire being into the game that you hand control to change an outcome and in effect, you can only take control of your own personal destiny by getting in the game.

To prove the point that you can be more victorious in a down market you’ll want to take a lesson from the playbook of Floyd Bostwick Odlum. He has been described as “possibly the only man in the United States who made a great fortune out of the Depression.”

After struggling as a corporate attorney in Salt Lake City, Odlum received an offer to a law clerk at a New York firm, and in 1921 became Vice-President of his primary client, Electric Bond and Share Corporation.

About 1923, Floyd Odlum and friends along with their wives pooled together a total of $39,600 and formed the United States Company to speculate in purchases of utilities and general securities. Within two years, the company’s net assets had increased 17 fold to nearly $700,000. If Mr. Odlum got started with $39,600 during the Great Depression, can’t you get a few friends or family together and pool funds to get in on this once in a lifetime historical opportunity to purchase discounted REOs at a modern price-point of $29,900? We only see great declines once or twice in our lifetimes and who can predict the next one as this one came without warning; will you have done something by then?

“Opportunity is missed by most people because it is dressed in overalls and looks like work.” — Thomas Edison, Inventor

Success Driver,

James Burns, Esq.

(949) 440-3243

TAX REDUCTION AND ASSET PROTECTION FOR REAL PROPERTY

The most intimidating concern of real estate investors is how do I protect my property, reduce taxes and what entity if any should I use? First, you must have a very good tax and legal team who understands real estate and investors.

If you are an investor who does rehabs, fixer uppers, option contracts, developments, consulting and services or you are a real estate agent or broker you are facing self-employment tax which is upsetting. The rate is 15.3% which is the difference of the 7.65% that an employer withholds for social security and Medicare and then matches. As a self-employed individual, you receive no match and pay the entire 15.3%.

If you’re paying elevated self-employment tax, you are a sole proprietor. Often a client can optimize their situation by using an entity but which one will do the trick? By now you’ve probably been racking your brains on this very question and heard of the C-corp., S-corp., Limited Liability Company (LLC), and Family Limited Partnership (FLP). The C-corporation is sometimes effective by typically not a good fit for most because it creates a double taxation. The S-corp is generally best for a company raising capital or going public. However, sometimes a C Corporation may be appropriate for other operations because its initial tax brackets of 15% and 25%.  For example, if you’re in an individual tax bracket of 25% or higher, then there could be an opportunity to eliminate taxes by shifting some of your income to a C Corporation. This has a nice application because of the shifting of income to a taxpayer (your C Corporation for instance) in a lower tax bracket than you personally.

The S-corporation makes great sense for those who are doing consulting, rehabbing, fix & flips, developments and services because it is a flow through entity. Because of this flow-through capability there is no capital gains tax and no dividend tax but you have to take a “reasonable salary” and create a payroll which is probably the biggest intricacy. There are no hard and fast rules on the salary and is a subjective analysis. My team and I have devised a spit that is prudent, yet reduces tax. This salary/dividend split is the number one strategy for ordinary income. Remember when dealing with real estate investing we may have passive or ordinary income and for each type of income there will be a different strategy that in combination, slays some of the tax and provides protection.

Some of the difficulties with the S-corp. if you want to really nitpick are, it is inflexible in moving long-term real estate in and out and you have to do a quarterly payroll. The payroll is simple to deploy but you need to find a cost-effective tax preparer who will do it or use a payroll company and it should not cost an arm and a leg to get done but the savings will substantially offset this expense. A good rule of thumb on when it makes sense to have an S-corp is around $50,000 or more of ordinary income.

If you’re not doing anything but buying and holding then you’ll want to consider a limited liability company (LLC). You will not get the abatement in self-employment tax but you have liability protection and an opportunity to do some creative estate planning to avoid future estate taxes. Owning a small business for rental real estate is an excellent strategy since it may convert personal expenses to business expenses that will offset income even if you are currently an employee receiving a W-2 from an employer. The LLC also limits a creditor to a charging order which is an assignment of income and many LLCs do not distribute or can elect to not distribute thereby making this a hopeless remedy for the creditor. Contrariwise, a limited partnership can be foreclosed upon by statute in California.

Sometimes clients are told to use an LLC and have their S-corporation be the general partner of their family limited partnership (FLP) and this can create vulnerabilities to the stock of that S-corporation by a lawsuit that occurs outside of the LLC activities. The strongest portfolios seem to be those that have a combination of active real estate investing e.g., fix & flips, rehab, and passive in the form of rental real estate which can then be used to offset income of the active investing, however, this requires use of two entities.

In closing, clients are often confused where the best place is to set up there entity because they hear all the radio ads about Nevada. If you are a resident of California, you will not save any taxes by forming your entity out of the state. There other states that have stronger protection (e.g. Delaware) and under the Supreme Court Doctrine of the Internal Affairs, a corporation will be governed by the state of incorporation but any disputes arising will have the law of the jurisdiction where the dispute occurs applied. For example, if you are incorporated in Delaware and hold Texas property and encounter a challenge in Texas, Texas law will be applied but how the corporation is run and its structure should be preserved under the state of incorporation which would be Delaware.

If you have any questions about setting up your real estate investing business you need to find a great team for the tax and legal strategies. The best is usually an attorney and CPA who are also investors and understand the merits of owning real estate. This is only a broad brush stoke on the possibilities and each persons circumstances are different so you would need to be evaluated, as one size does not fit all.

Happy investing,

James Burns, Esq.