AL LOWRY'S "WINNING WITH REAL ESTATE" NEWSLETTER Dear Investor: As promised, I'm devoting a major part of this issue to the implications of the Supreme Court's recent ruling effecting due-on-sale clauses. I've given you a number of creative strategies that will work in combating lenders and being able to construct a workable property transaction, even in this slow period. Because real estate law varies considerably from state to state, I continue to recommend seeking advice from competent legal counsel when completing a complicated transaction. DUE-ON-SALE DEAD END As most of you probably know by now, the Supreme Court recently ruled on due-on-sale clauses. The ruling said that federally chartered savings and loans can enforce the due-on-sale clause even when state laws say "no". This is a direct rejection of a recent California Supreme Court decision that said federally chartered lenders are bound by state law. This is what it means to lawyers, but what does it mean to the rest of us? How will it affect you? This depends on where you live and what types of loans you have against your property IT WILL NOT AFFECT EVERYBODY Many people -- probably the majority of property owners -- will not be affected by the decision - at least not directly. If you live in a state where local laws allow lenders to enforce due-on-sale provisions, there will be no change at all. If you live in a state that prohibits enforcement of due-on-sale clauses, there will be changes; but if your loan is with a state chartered bank or savings and loan association -- or is insured by either-the Veterans Administration (VA) or the Federal Housing Administration (FHA) -- then those changes will not affect you. Not immediately, anyway. You will be affected if you own property in one of the anti-due-on-sale states -- like California -- and the loan is held by a federally chartered savings and loan association.  Before the Supreme Court ruling, there was disagreement about whether these lenders were bound by state law. Now it is clear that they are not. But the Court's decision was actually quite narrow and specific in the points that it addressed NO DIRECT RULING ON DUE-ON-SALE The ruling said nothing about due-on-sale clauses themselves. It did not say that they were desirable and the lenders have a constitutional right to enforce them. Nor did the court comment on the California ruling which held that due-on-sale clauses are a restraint of trade. (The California Supreme Court, in the Wellenkamp decision named for Cynthia Wellenkamp who sued Bank of America for attempting to raise the interest rate when she assumed a loan-- said that due-on- sale clauses were unenforceable because they restricted people's ability to sell their property). All the Supreme Court decision said was that the Federal Home Loan  Bank, (which regulates federally chartered savings and loan associations) and not the individual states, had the right to set policy for Federally chartered S & L's. The Federal Home Loan Bank had already ruled that Federally charted savings and loan associations had the right to call loans due when a property was sold. The Supreme Court merely upheld the Federal Home Loan Bank's right to make this sort of decision without interference from the states. It did not rule on the wisdom and advisability of the decision, or the reasoning behind it. The court did not say anything about the ability of states to prohibit enforcement of due-on-sale clauses by state chartered lenders. It only said that the states could not overrule a direct policy of the Federal Home Loan Bank because that was exceeding their authority. A SHALLOW VICTORY FOR LENDERS This was a definite victory for lenders but not the victory that most of them had hoped for. First of all, it only applies to those lenders who are regulated by the Federal Home Loan Bank and excludes all others. State chartered savings and loans, banks and mortgage companies get absolutely no benefit from the ruling. They must still adhere to the local laws of any state in which they operate. Federally chartered national banks are waiting for a ruling from their regulatory agency. In the meantime, they are not affected by the Supreme Court decision. Even federally chartered S&L's should not be resting that easily, since the Supreme Court ruling so narrowly focussed. If the composition of the Federal Home Loan Bank changes in the future, the members could decide to prohibit enforcement of due-on-sale clauses. There is nothing in the recent Supreme Court ruling to stop them from doing so, CHANGE UNLIKELY BUT POSSIBLE Such a change is not very likely in the near future. But if and when it ever does happen, all Federally chartered S&L's will be bound ~ by the new rules; even those who do business in pro-due-on-sale states. More important, the ruling gives little comfort or encouragement to state chartered lenders who wish to see the due-on-sale clause reinstated for them too. Since the court did not rule on the right of lenders to enforce due-on-sale clauses on their own initiative, this ruling will not set any precedents in such cases. The state chartered lenders will either have to fight the battle in their own state legislatures and state courts and/or come up with a new argument to bring before the U.S. Supreme Court. S & L's CAN CHANGE CHARTERS Of course there is nothing to prevent a savings and loan association from changing its charter. A state chartered S & L can apply to become a Federally chartered S&L and many of them, particularly in California, have done just that. IS THE RULING RETROACTIVE? Once the change is approved, they are free of state regulation and interference in their future dealings. The Supreme Court made that clear. This in turn, puts pressure on the states. If they don't change their laws, all the state chartered S & L's will switch to Federal Charters. But, the question remains: what about their past dealings? Can lenders now go back and foreclose on old loans which were assumed while they were still chartered by the state and loans were assumable under state law? For example, let's say you bought a house two years ago with al $80,000 assumable loan at 9%, held by a state chartered Savings and Loan Association. Your payments are a nice comfortable $641 a month and you are quite happy. Then you get a letter saying that the lender is now Federally Chartered and wants to re- negotiate the terms of your loan. You have two basic choices: You can either agree to a new, higher interest rate or you can pay back the entire $80,000 at once. What should you do? FORMAL ASSUMPTIONS ARE SAFE If you formally assumed the loan, you should call the lender and inform them that they have made a mistake. The lender agreed to transfer the loan to your name and you paid an assumption fee. The lender obviously agreed to let you assume the loan even if your lender was Federally-chartered from the beginning or the loan and actively cooperated with you. It is too late for regrets. "SUBJECT TO'S" ON SHAKEY GROUND But many people never really assumed old loans. They took the property "subject to" the existing financing instead. This means that the loan technically stayed in the original borrower's name. The buyer was allowed to take over the loan, but only because state law said the lender could not stop him. The lender did not cooperate with the buyers or agree to the assumption. If you are one of those "subject to" buyers, then you may have problems. In theory, your "subject to" assumption was perfectly legal. The lender was state chartered at the time and you acted in accord with state law. But the lenders are saying that their federally chartered status-should be retroactive. They feel that they now have the right to foreclose on your loan. EXPERTS UNSURE Since the Supreme Court did not rule on this particular question, no one is really sure. Most legal experts seem reluctant to give a definite answer at this point, so everyone is speculating about which way it will go. Until someone tests it, we are not likely to find out. A newly Federally-chartered savings and loan will foreclose on a property owner with enough money and stubbornness to fight back. It will wind its way through the state and federal courts and eventually, the Supreme Court will rule. Until then, there's no reason for you to give in without a fight. DON'T CAPITULATE: NEGOTIATE Many new Federal Savings and Loans will try to get people to renegotiate old loans they took "subject to", but few of them will really go to court over the issue. FIGHTING BACK Even if your lender was federally chartered from the beginning or the laws in your state favour the due-on-sale-clause, don't give up hope yet. There are ways of getting around the due-on-sale clause even when it's clearly enforceable. These methods are not completely legal and I do not necessarily recommend any of them, but they do exist. Whether you feel comfortable using any of them, only you can decide. I present them for your information only. KEEPING IT SECRET The simplest way to get around a due-on-sale clause is simply not to report the sale. If the lender doesn't know that title has transferred, then it can't call the loan. In California, for instance, many federally chartered lenders have already said that they will not be actively seeking out people who illegally assumed loans. They will just act on the ones that come to their attention. For example: if a check comes in to their office with a new name on it, other than the original borrower's name, they will assume title has changed and they will call the loan. But if the original borrower keeps making the payments, then they will never know, right? THE INSURANCE TIP-OFF The insurance company sends the lender a copy of the fire insurance policy when it's cancelled. Unless the lender gets a new policy from another company, you could be in trouble. Many people get around this problem by continuing to pay the premium on the buyer's fire insurance policy. If you do this, be sure to get a new policy in your own name from another company. It will cost you more money but it's the only way to cover yourself. The seller's insurance company may not pay off if anything happens to the property and they find out that it was sold to you. The lender keeps getting checks from the original borrower and getting renewed insurance policies in the borrower's name. There is no reason for anyone to assume that the property has changed hands. BECOME A MANAGEMENT COMPANY Some people are a bit bolder than that. They contact the lender - either by phone or by letter and say they are a management company. They claim to have taken over the management of the property, but not the ownership. They inform the lender that the payments will now be made by their company, Secret Sale Management, on behalf of the owner. Since the insurance is still in the name of the "owner" (the original borrower) many lenders don't question the arrangement. LENDERS ON THE PROWL Some lenders do follow-up. They might even have employees search county records periodically to seek out any title changes, recorded contracts of sale or lease options. If the lender you are dealing with is this thorough, there is not much you can do. You are going to get caught sooner or later so you may as well resign yourself to it. Try to deal with the lender and see if you can work out a compromise on interest rates and terms. Most of them do not want to go through foreclosure if they don't have to. It is an annoying, costly and time- consuming ordeal and, in this market, they have no guarantee that they will get a buyer. Therefore, they may be willing, even anxious, to deal with you. YOU CAN'T FORCE PEOPLE TO BUY Besides, in this market the problem by continuing to pay the ruling will have little beneficial effect as far as the savings and loans are concerned. It is a moral victory more than a practical one. The savings and loans can now prevent people from assuming old loans but they can't force them to take out new loans at the current interest rates. If they can't get financing at affordable rates, many people just won't buy. They will simply sit it out until the rates come down and this benefits no one. The savings and loan associations want to get the old low-interest loans off their property and replace them with new higher-yielding loans. If they have to compromise to do this, many of them will. For example, let's say you have an old 9% loan for $40,000. The going rate for new loans is 16½%, but you can't find anyone willing to pay that much and neither can the S&L that holds your loan. Therefore, you can t sell your house and the S&L can't clear your 9% loan Nobody is happy with this situation. The buyer wants to buy, but can't afford -- or qualify for -- 16½ % interest. You want to sell, but have no way of paying off that $40,000 loan unless you get a cash buyer. The S & L wants that $40,000 paid off so that they can re-loan it at a higher rate, but the loan has another 26 years to go. It's a classic stalemate. BLENDED INTEREST RATES Faced with this situation, many S& L's will negotiate and offer the buyer a new loan at less than 16 1/2%--say 12% to 14%--on the theory that a partial rise in the interest rate is better than none. VARIABLE RATE LOANS STILL ASSUMABLE Or, you may not have to compromise at all because your loan may be fully assumable. Not all loans have due-on-sale clauses. Many lenders, particularly in California thought they had a smart way to keep ahead of inflation. A few years ago, they came out with variable interest rate (VIR) loans which could go up or down with the cost of money. One of the selling points of these loans was that they were automatically assumable. As long as the interest rate at the time of the assumption was at least 1/4% higher than the original rate and the buyer was a good credit risk, the loan could be transferred. At the time, the lenders probably thought that they had covered all the angles but they didn't. According to Federal law, the interest rate on these loans could only go up ¼% every six months and a maximum of 2 ½% over the life of the loan. That seemed like a lot at the time, but then no one was expecting interest rates to hit 16 1/2% to 17%. Today, an 11 1/2% (9% original interest rate plus 2 ½%) or even 13% or 14 ½ % assumable loan looks awfully good, but there's nothing the lenders can do. The recent Supreme Court decision will not affect these old variable loans at all. If you are the original borrower on a low interest loan and you want to sell your property and the loan with it -- don't despair yet, there are ways you can at least try to pass the loan on to the buyer. First of all, you can lease option the property, instead of selling it. Many due-on-sale clauses specifically prohibit this, but as long as nothing is recorded, how is the lender to know? Have an appropriate document drawn up and have one copy held by your attorney and one held by the buyer's attorney for everyone's protection. Then, when and if interest rates come down to a mutually agreed upon level, the buyer can refinance the property and take formal title. This can also be done with a land contract of sale. PROTECTING YOURSELF AND THE BUYER Of course there are drawbacks and pitfalls. Buyers are usually reluctant to put up much down- payment money if they won't get formal title. This means the seller has to make do with little or no cash up front. Most sellers don't like this idea. They want at least some cash when they sell. Instead of giving him title to the property, give him a lien against it. If he gives you a $20,000 down payment, give him a $20,000 note and a second (or third or whatever) deed of trust or mort- gage against the property. Or give him a lien against other property you own. PASS ALONG THE TAX WRITE-OFFS You can give the buyer all the tax write-offs, just as if-he had-- taken formal title. This should make him feel happier and more secure. As long as he is not losing anything by not taking formal title he-should be happy. This way you can accomplish everything you both want without asking the lender's permission. This is probably the easiest and most common way of getting around the due-on-sale problem but by no means the only way. THE CORPORATE ESCAPE ROUTE Form a Corporation and have it buy the property from you. Then, when the lender threatens to foreclose the corporation -- which has no other assets besides the one piece of property--threaten to file bankruptcy. This has nothing to do with you or your personal credit rating, so it will not leave any stains on your record. Faced with a difficult situation, the lender is likely to back down or, at least, compromise on the interest rate and terms. Then, once the corporation has successfully assumed the loan, you put the property up for sale. If the lender will let the loan be assumed a second time, well and good. If not, you just keep the property in the corporation's name and then sell the corporation. (This is, of course, an over simplification and you should not attempt to do this without consulting an attorney) THE FORECLOSURE GAME One more avenue is also open to those who want to pass on their existing loans. Again, it requires bending the law and I do not personally recommend it. I present it here only for your information. Due-on-sale clauses have one loop-hole: they only cover voluntary transfers or alienation of title. If a junior lien holder is forced to foreclose on a property and take it over, he takes it subject to any senior loans. He can pay off the senior loans if he wants to, but he is not obligated to do so. Does this put any ideas in your l head? Instead of selling your property, you can just take out a loan against it and then walk away. For example, you have an $80,000 house with a $40,000 loan at 9%. You get a $20,000 second mortgage and pocket the cash. Then the buyer gives you another $20,000 cash and, in exchange, you give him a third mortgage (or deed of trust) against the property. When you don't make the payments on this third, the buyer files a Notice of Default. Rather than go into foreclosure and hurt your credit rating, you just sign the property over to him. He contacts the first and second lenders, explains the situation and takes over their loans. Everybody's happy, right? TIME SOLVES ALL PROBLEMS Wrong. In a situation like this, it would be too obvious what you are doing, since you have no equity left in the property after taking out the third loan. But, you would wait a year or so, before transferring title and then you might just get away with it. As I stated before, I do not necessarily recommend any of these ways of getting around due-on-sale clauses, as I do not use them myself. But as long as there are creative people in the world, they will always find ways around the "rules", due-on-sale included. WHY WE WON'T ADOPT A FLAT, NO DEDUCTIONS TAX RATE Many people these days seem to be concerned that our country may adopt a flat across-the-board tax rate, with no loopholes or deductions. President Reagan recently announced that he is considering the idea and so people assume that it is a serious possibility. Needless to say, this is all the real estate business would need. Coming on the heels of the Supreme Court's due-on-sale ruling, it would be the final blow. Without the tax benefits, real estate would no longer be a very good investment. Even homebuyers would think twice and three times, if they could no longer deduct all their mortgage interest and property taxes. Prices would drop. The bottom would fallout of the market. Personally, I don't worry about it and I certainly don't intend to stop buying real estate. If other people drop out of the market that will just leave more for me to buy. I am convinced that we never will have a flat-tax rate, because it would create havoc with the whole economy--not just the real estate market.  Our whole economic and social system is built around the present tax structure. It depends on it. TAXATION AND SOCIAL POLICY Taxation is not just a way of raising money. It is a means of advancing certain policies, pushing people in certain directions. Tax incentives--deductions, write-offs, whatever you want to call them - stimulate the economy and keep it moving. People buy real estate because they can get tax benefits. They invest in cattle, oil wells and municipal bonds for the same reason. Businesses get tax credits any time they buy new equipment. Money- losing businesses can even sell a portion of their unneeded tax breaks to other businesses which are more profitable. TAX DEDUCTIBLE DONATIONS Charities depend on tax-deductible donations from wealthy benefactors. Non-profit companies often count on their tax-exempt status to give them the extra edge they need to survive. Educational institutions get students who want to take tax-deductible courses related to their professions. The list goes on and on. PLANNING YOUR LIFE AROUND TAXES Can you imagine what would happen to our society if all this suddenly changed? Symphonies, operas, theater companies and museums might have to close their doors or at least cut back their programs. Factories would layoff workers. People would lose their life's savings as the value of their houses went down. If all this sounds a bit exaggerated, just think about it for a minute. Put yourself in the place of someone like me. I make a lot of money, but I don't like to pay a lot of taxes. Therefore, I structure my business dealings with this in mind. I look for ways to shelter my income legally and get the maximum amount of deductions and write-offs. I do what the government wants me to do, what it will reward me for doing, like buying real estate. TAX WRITE-OFFS INCREASE PROFITS I buy real estate to make money, but the depreciation is a nice bonus. It also helps determine what properties I buy. It allows me to buy proper ties that wouldn't be profitable otherwise. If I rehab certain types of property, I can even write them off in only five years. That gives me a powerful incentive to invest in those types of property. Why? Because the government will reward me by cutting my taxes. If the special tax benefits were taken away, I would probably put my money into something else that offered a quicker, easier profit. Rehabbing is hard work. TAXES AND BUSINESS When I buy anything for business and use, I always think about the tax write-offs involved. They lower the effective cost of whatever I'm buying and make it more cost effective. For instance, let's say I need a typewriter for the office or fifty or one hundred typewriters. Times are hard and I might decide to make the old one(s) do for another year, if the cost of new ones is too high. Or, I might decide to buy some, but not as many as I would like to buy. Here is where the tax benefits come in. They are an added incentive. If the base price of each typewriter is $500, then 100 of them will cost my business $50,000. But I can deduct 10% of this, or $5,000 directly from my company's tax bill for the year. That cuts the total cost down to $45,000. Then I also get to depreciate the machines over a three year period. This is another $15,000 a year off my company's taxable income. These write- offs make it possible for my company to buy all one hundred type-writers instead of cutting back and buying only fifty or seventy-five, to save money. If the tax credits are taken away and I buy fewer typewriters, the manufacturer will be hurting. His suppliers will be hurting and on and on down the line. TAXES AND SPECIAL INTERESTS And then there are the lobbyists.  If tax deductions are eliminated, some of the biggest, most powerful groups in the country will be affected. If people can no longer deduct their medical expenses, they might visit the doctor less often. The Medical Association would not like that idea. The National Association of Realtors would not be very friendly to any idea guaranteed to kill the housing industry. Neither would the National Association of Builders or the construction unions. The Savings and Loan industry would also be destroyed. Its only purpose is to loan money for housing. If housing ceases to be a good investment, the savings and loans will be out of business. Banks will not be very far behind. Many people will just walk away from their properties--especially the ones with negative cash flow. The foreclosure rate would soar. Rents will go way up as people decide that without the tax break, being a landlord doesn't pay well enough. Tenant and consumer groups won't like that. Tax lawyers and tax accountants would be out of business. They are not exactly helpless or politically naive and they would fight back. So would all the IRS auditors and agents who would lose their jobs and all their friends and relatives. PIE IN THE SKY A flat tax rate with no deductions may sound good, but in practice, it just won't work. It is a utopian idea, not a practical one for our society. If we were starting from scratch with no traditions or expectations to maintain, it would be different. Under those conditions, a flat tax rate might work. But we are not in that position. Switching to a flat tax rate would mean undoing our whore complex socio economic system and putting it back together in a different way. It would not be the easy transition some people expect. WRITE-OFFS AND CONGRESS Especially since members of Congress are so fond of write-offs for themselves, most of them are well off, if not wealthy, and they like to take advantage of the tax laws just like anyone else with money to protect. Most of them would be quite reluctant to give up their benefits in favor of a flat tax on all their income. So my advice is to keep buying real estate. First of all, it is the best investment I know. Secondly, it is an excellent tax shelter and will be for quite some time to come. One builder I know bought a lot in Piedmont, California, a wealthy community across the Bay from San Francisco. He intended to build a house on it, but he discovered the lot was too small. Piedmont requires a minimum of 10,000 square feet~-as opposed to a 5,000 square foot minimum in all the surrounding communities--and his lot was only 6,000 square feet. He went to the city planning department, and the planning commission, and the city council. He tried to get some sort of variance. It was one of the last buildable lots in Piedmont and he knew he could make a lot of money even on a small house. The next door neighbor objected and the city turned him down. Two years after he bought the lot for $30,000, he wound up selling it to the neighbor for $75,000. Even after expenses, he made over $35,000 profit--at least as much as he expected to net on any house he built. The neighbor was willing and able to pay for his privacy. Now he knows that no one will ever build a house right at next to his. My builder friend has found a new low- risk way to invest. Once again, everybody wins. Albert J. Lowry's WINNING WITH REAL ESTATE, is published monthly by New Capital Publications, Inc. No more than 250 words of this newsletter may be extracted or reproduced in context without permission of the publisher. It is a violation of the United States Copyright laws to duplicate or reprint this publication without permission of the publisher. @ New Capital Publications Inc., 1982. PRESIDENT: Thomas H. Lipscomb; MARKETING DIRECTOR: Leonard M. Wright, Jr. MANAGING EDITOR: Shelli Wolis; EDITOR: Calvin E. Wheelock; ASSISTANT EDITOR/ WRITER: David A. Chodack,  Sales offices of New Capital Publications, Inc. at 468 Park Ave. So., suite 1405, New York, NY 10016. Customer Services at P.O. Box 869, Mahopac, NY 10541, 914-628-4203. 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