Debt
By John | June 16, 2011
Greeks are rioting. Banks, nations, governments at all levels are in trouble. Debt is stifling economic growth and threatening to plunge the world economy into chaos.
In my book, I advocate the judicial use of debt. If debt can be used safely to leverage reliable returns, debt can be beneficial to the investor. But that means that the debt incurred must be used to generate returns greater than the cost of the capital employed. Debt to support consumption is discouraged, as that debt does not generate a return, and only increases the cost of whatever is being consumed.
Now this may seem obvious. I know it seems obvious to me. However, it apparently is not obvious to government officials who advocate that government debt be used to support government expenditures (i.e., consumption) that cannot, or will not, be supported by government revenues.
Governments do not create wealth. They do not generate a return on invested capital. Therefore, in my opinion, governments should never borrow money.
Greece, Portugal, Spain, Ireland, California, Illinois, New York, the U.S. Government, etc. have incurred debt beyond what any reasonable person would expect to be repaid. Rather than recognize reality, all governments who find themselves in this position try to postpone the inevitable by borrowing even more to pay back old debts.
These governments are bankrupt, and the sooner that is officially recognized, the sooner we can return to a rational economy.
Greeks are rioting against austerity. To the extent that Greeks are objecting to the reduction in their “entitlements” (i.e., the money they did not earn), their objections are not legitimate. In a free market economy – one that respects private property rights – no one has the right to claim the fruits of another’s labor.
However, to the extent that Greeks are objecting to the failure to recognize that the Greek Government is bankrupt and needs to repudiate its debt, they are correct. Is it reasonable that the Greek population should experience a drastic reduction in standards of living in order to support debt owed to foreign banks? Isn’t that a form of involuntary servitude?
Greece will not recover until it is reorganized economically. That means defaulting on Greek Government debt. That means recognizing that Greek citizens must support themselves, and not rely on government handouts.
I know what you’re thinking. How is that going to happen? Probably not voluntarily. Probably not without a lot of further social unrest and economic upheaval.
Unfortunately, this outcome will not be confined to Greece, as most of the governments of the world are in the same situation. They have incurred debt inappropriately – debt they cannot possibly pay off. Their citizens, having become reliant upon government handouts, will resist the termination of their “entitlements.”
As we take this “big picture” look at the world, let’s not forget what those pieces of paper we carry around with us in our wallets truly represent. The entire world uses fiat currencies. Those currencies represent the debt of the issuing governments. This debt, too, will be defaulted upon.
What to do? Put your savings in true stores of value. Don’t trust governments to honor debts. They can’t, even if they wanted to.
I advocate gold, silver and land. As stores of value, these are not investments. They do not yield a return, in a true economic sense. So, do not borrow to purchase them. Own them free and clear of any encumbrances. If you will owe property taxes on land, make sure it is minimal, and make sure you have the funds to pay them.
Government defaults are coming. I just don’t know how long they can keep postponing the inevitable. I know that the longer the postponement, the more serious the outcome.
Be prepared. Mass amounts of wealth will be transferred as a consequence of massive debt defaults. Plan to come out of the debacle with a portfolio of solid assets. Gold and/or silver – coins or bullion – not paper backed by gold or silver. Land – a solid piece of the earth’s surface. They will still be there when the dust settles.
Topics: Commentary | No Comments »
Real Estate Bundle of Rights
By John | June 4, 2011
Real estate ownership constitutes a “bundle of rights.” Most real estate investors strive to own property in “fee simple.” That means they own all of the rights associated with that particular property. As an investor in vacant land, I typically strive to own in fee simple. However, sometimes that is not possible.
The “right” most often not available when purchasing vacant land is mineral rights – the right to extract minerals from that property. What does that mean? What it means can vary from state to state. In Michigan, where I live, it typically refers to the right to drill for hydrocarbons – oil and gas. However, it can also refer to surface minerals, such as sand and gravel. If you are acquiring land that does not include mineral rights, make sure you know what that means in your state.
There are many other separate rights associated with land ownership. I have purchased land without grazing rights – they had been sold off to another rancher. I have purchased land that had no right of ingress or egress. (In other words, you couldn’t get to the land without a helicopter.) I have purchased land in which the prior owner retained timber rights for a specified time period. I have purchased land in which the prior owner retained timber rights for a specified time period and for specified portions of the property (as shown on a timber map). I have purchased land on which neighboring owners held easements for ingress and egress, or for monitoring oil and gas wells.
The right to use property is, of course, part of that bundle of rights. However, if you are new to land investments, you might be surprised by how many limitations are placed on usage rights. Zoning laws in many areas are very restrictive. In fact, to me, land in an area with no zoning laws is more valuable than land that is zoned.
Development rights are being purchased by government agencies, preventing the land from ever being developed.
Many state and federal laws impact the right to use your land, such as wetlands laws, endangered species laws, and requirements to obtain permits for everything from building to mining to installing a water well.
Speaking of water, western states, in particular, have different laws regarding water rights. Just because you own surface rights does not mean you have the right to use either surface water or the right to extract water from underground aquifers. I backed out of the purchase of a western ranch one time after consulting with a water attorney, who discovered a recorded water usage plan associated with that land.
I am an owner of land in Utah that has a very exciting water development opportunity associated with it. This could make the land worth several times what we paid for it.
The bundle of rights issue is not all negative. You might want to specialize in investing in particular rights, such as mineral rights, timber rights, development rights, water rights, etc. This represents an opportunity to develop very specialized knowledge of these property rights and how you might capitalize on them. It might also be much more cost effective to only purchase those rights you are interested in, rather than buying a fee simple interest in land.
Investing in vacant land is much more complicated than many realize. That is why it contains investment opportunities you may not have thought of.
Topics: Rural Land Investment | No Comments »
Are You an Accidental Lender?
By John | May 13, 2011
Markets have been in turmoil recently. Turmoil creates confusion as to where one should be invested. Let’s take a step back and try to see the forest for the trees.
We know the Federal Reserve has announced they will discontinue QE2 at the end of June. Different opinions have been expressed regarding the implication for U.S. Treasuries – the primary beneficiary of the Fed’s QE2.
Some believe Treasuries could be a good investment now, even though the Fed is backing away from the market. I don’t agree.
In the short run, I don’t pretend to know what the market for U.S. Treasuries will do. What I do know is that the U.S. Government, the issuer of Treasuries, is essentially bankrupt. The U.S. cannot possibly fulfill its promises and pay back Treasuries with full purchasing power. In fact, it is not even pretending to do so, as the Federal Reserve has targeted an inflation rate of 2% per year.
Why would you want to loan money to a bankrupt entity? Just because everyone else is doing it? Does that make it a sound investment?
Even if you don’t own Treasury securities, you are still loaning money to the U.S. Government. How? Do you hold Federal Reserve Notes in your wallet or bank account? Are you aware that those are unsecured, promissory notes, backed only by the “full faith and credit” of the U.S. Government? Yes, that same U.S. Government that is bankrupt!
That is why I encourage everyone with savings – anything you don’t plan to spend anytime soon – to take those savings out of dollar denominated assets and put them into hard assets: Gold, silver, land.
You need to protect your savings from devaluation. Don’t be an accidental lender to the U.S. Government. Don’t exchange your hard-earned savings for worthless paper. Own something real.
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Be Prepared
By John | May 2, 2011
With the recent buzz regarding the Bernanke press conference and now the killing of Osama Bin Laden, we are witnessing an upbeat mood in U.S. financial markets. However, it is important to recognize that underlying fundamentals have not changed. The following remain in place:
1) The U.S. Government is committed to massive deficit spending. Even the most extreme proposals coming out of Washington expose huge deficits as far as the eye can see. It is clear there is not a mandate from the public to stop the spending. Only a minority see the danger posed by this spending binge. In one short generation we have gone from a production economy to a consumption economy. We have gone from a meritocracy to an entitlement society. The spending won’t stop until it is forced upon us by a crash.
2) The Federal Reserve Bank is committed to supporting the fiscal irresponsibility of the Federal Government. The Fed remains the purchaser of last resort of U.S. Treasury debt. Therefore, the creation of Federal Reserve Notes, unbacked with real assets or real production, continues. The supply of U.S. dollars remains on an unsustainable uptrend.
3) Foreign governments and other entities are moving away from using the U.S. dollar as their medium of exchange and as their primary reserve currency as soon as practical. The U.S. is flooding the world with dollars, and others see it and recognize it as unsustainable. They are reverting to the use of other currencies and are purchasing precious metals and other assets with their dollars as fast as they can, trying to maintain an orderly currency market without causing a crash of the dollar.
4) The dollar is collapsing. The higher perceived price of gasoline, higher food prices, escalating stock prices, etc. are all an illusion. Stop measuring value against the dollar. It is an unreliable, elastic ruler. Measure prices against precious metal – gold and silver. Doing so reveals that many assets are at historic lows, not highs. As the dollar trends lower at an escalating pace, holders of dollars worldwide will treat them like hot potatoes, spending them before they become even lower in value. This will be the beginning of hyperinflation.
What should this mean to you? Get out of dollar denominated assets and into hard assets. Buy gold, silver, and real estate.
If you buy precious metals, take physical possession. Don’t buy “paper” assets, and don’t trust others to safeguard your assets.
If you buy real estate, don’t assume the revenue from it will continue uninterrupted. Buy without leverage, or keep reserves to cover debt service.
How about the stock market? I believe it is too risky, as a collapsing dollar will cause the economy to collapse, also, causing the stock market to crash.
Keep a minimal amount of cash available. Remember that currency serves three functions – medium of exchange, measure of value, and store of value. The dollar is fine as a medium of exchange (at least until no one will accept it). But if you need to store value for any time, you need to get out of dollars and into something that will retain value over time. You can keep gold or silver coins until you need to spend them. Then, either spend them directly (after the dollar crashes), or convert them to dollars when you are ready to spend.
Another thought: If the dollar crashes and the economy is disrupted, you may find some real bargains out there as others are in desperate need for cash to live on. Having a stash of gold and silver might enable you to get into real estate at bargain prices.
The world is changing. Be aware. Be prepared – don’t be scared.
Topics: Commentary | No Comments »
Land Valuation II
By John | April 22, 2011
I received an interesting call regarding land valuation recently. It went something like this:
Eight acres of multi-family development land had been assessed for tax purposes based upon its imminent development potential. Annual taxes are $11,000. The land was foreclosed on by the lender, and the property is now owned by the FDIC. The FDIC would like it appraised. What is its value?
This parcel was expected to be next to a successful residential development, which didn’t happen. Utilities were expected to be extended to this parcel, which didn’t happen. Local Realtors now expect this parcel to be developable in about ten years.
The first thing I am going to do is estimate the value of this property as if it were immediately ready for development. Let’s suppose that value is $500,000.
Secondly, I am going to assign an expected rate of return on a ten year, speculative investment in this development land. Due to its speculative nature, and the risk I am taking that it may never be developable, I am going to assign a 15% annual rate of return.
Now, I must calculate the net present value of an outflow of $11,000 per year for ten years, followed by a $500,000 receipt, say at the end of eleven years, using a 15% required return on my invested capital.
Using these assumptions, I can afford to pay about $52,000 now for this property. If I require a 20% rate of return, I can justify paying about $21,000 for this property.
Now suppose I only expect the property to be worth $200,000 when I go to sell it in year eleven. If I still require a 15% return, the present value to me is ($12,000). In other words you would have to pay an investor $12,000 to take this property under these circumstances.
If I expect the property to be worth $200,000, but I only require a 10% annual return on my investment, I can pay $2,500 for this property.
Of course, the real problem here is that the property taxes are excessive, given the current economic circumstances and the circumstances of the property. In many instances, local municipalities are taking properties without using eminent domain – they are just taxing the value out of the property.
If you are considering investing in development property for a long-term hold, please be aware of holding costs, and don’t be overly optimistic about future values.
Topics: Commentary | No Comments »
Land Valuation
By John | April 17, 2011
For those considering investing in vacant land, you want to know what land is worth. You want to know if you should pay the asking price for land that is for sale, or you want to know how much you should offer for land you are interested in buying. Let me make several comments regarding this issue. Some you may already know, some you may not want to hear, but need to.
First, and I know this will not come as a shock to you, land values are local. So, you need to know the local market in which this land is located. The traditional way of determining this is to have an appraisal done. Although appraisals can be valuable, I advise against relying on them for investment purposes.
Second, “fair market value” for a particular property is not a precise number, it is a range. That range will vary by location, type of land, the time period of the valuation, and the purpose of the valuation. It is because of these variables that I do not recommend relying on appraisals, which tend not to take these variables into consideration.
For example, an appraisal might tell you that a 40-acre parcel is worth $80,000, or $2,000 per acre. What it won’t tell you is how marketable that parcel is – how likely a seller is to find a buyer at that price. In this economic environment, in which many property owners are trying to raise cash, you might find that the owner of that 40 acres would be tickled to death to receive $40,000 for it, even though it appraises at $80,000.
So you must develop knowledge of the market in which you propose to invest. That means going beyond the superficial. That means developing that “feel” for the market and its values.
Third, if you are purchasing land as an investment, that is different than purchasing land for personal use. That means you must value it differently. After developing that feel for the market and the range of values within that market, strive to only buy if you can buy at what you know to be a real bargain price. i.e., buy at the bottom of that value range.
Fourth, the value of a particular parcel of land is not determined by some huge “market.” Land markets are local, and are determined by the participants in that market. If you are interested in purchasing a particular parcel, “value” will be primarily determined by you (the buyer) and the current owner (the seller). So you will want to be focused on finding a motivated seller, as that, more than any other factor, will determine if you will be able to buy at a bargain price.
Land values are subjectively arrived at, though you will encounter public opinion as to what is the “fair market value” of land of a certain type in a particular area. This public opinion is frequently wrong. It is often dated, reflecting what land was worth a couple of years ago. If land prices are declining, the public will have an inflated opinion of value. If land prices are rising, the public will have a low opinion of value.
So, as a vacant land investor seeking to buy land:
1) Develop your own, independent opinion of value.
2) Only buy at bargain prices.
3) Buy from a motivated seller.
Now, a few more general comments about land values:
1) In most communities, there is a surplus of development land. Most of it will not be developed for a long time. If you are going to buy it, only buy at an extreme discount.
2) I still favor rural, vacant land that is not in the path of progress, so the price reflects that fact. It is priced for its current use, which might be for animal grazing, timber, cropland, recreation, etc. If you can buy it at a bargain price, do it! If you can find a way to add value to it, you can make some serious profits.
3) watch out for farmland values. Some recent sales have been for $10,000 per acre plus. That is too much for farmland. It rarely can generate the kind of income that will justify that price. In most areas, you need to be in the $3,000 to $5,000 per acre range or lower to justify an investment.
4) Grazing land is typically not suitable for farming, as it is too infertile, too dry, too rocky, too steep, etc. for farming purposes. Grazing land typically can’t generate much income, so this land must be inexpensive. We have land of this type for sale for $200 per acre in Utah. If you buy right, you will typically have low carrying costs and limited downside risk.
5) Speaking of carrying costs, you need to be aware of what your expenses will be to own land. Watch out for land with high property taxes. Some taxes are so high I wouldn’t take the land if it were given to me.
6) Timber land can be a good, long-term investment, especially if it has some harvestable timber on it now. Ideally, you would like to buy the land, have it timbered, and then have a very low cost basis in the land. Before you buy, have a forester give you an estimate of timber value. (A word of caution – some unscrupulous foresters will tell you the timber isn’t worth much, then will buy the property themselves and make the profit for themselves.)
One more thing. This is a good time to buy. There are motivated sellers out there. Go find them.
Topics: Rural Land Investment | 1 Comment »
I Can’t Sell It!
By John | April 7, 2011
You bought vacant land as an investment. Now, you want to sell it. There are no buyers. What do you do?
This scenario is not unusual in this economic environment. You would be amazed how many people are out there trying to sell something – anything – to raise cash. Everyone wants to convert their assets to cash to meet expenses, service debt, you name it. Banks aren’t lending. Lenders are calling in loans. There is a shortage of cash.
You may have purchased vacant land as a long term investment, but now you need the cash. You may have purchased land with the objective of adding value and selling it, but now there are no buyers. What is the solution?
Land prices in many areas have softened, as lending dried up, and as declining land prices caused buyers to shy away from purchasing land – the reverse of what was happening a few years ago, when credit was readily available and prices were rising.
Well, my first advice is, if you don’t have to sell, don’t. Land is real. It will be there long after the paper assets that have become so popular lately have become worthless. Land is especially illiquid now, but it will not always be so.
OK, that doesn’t fit your circumstances. You need to sell. You have debt secured by land and you need to pay it off, or you need cash for other reasons, but you must convert your equity in land to cash or you are in danger of losing it.
The primary problem with land today is not just that it may have declined in value. The problem is its illiquidity. You know what it is worth, but no one is buying.
Your problem may be that you are trying to sell into a very small market – the cash market. Expand your horizons.
Be willing to be a buyer.
For example, suppose you have an empty lot you want to sell. You have advertised it, but it is one of many empty lots on the market, and your chances of finding a buyer for that lot anytime soon are not good.
What else do you have to offer? What can you offer someone to induce him to buy your lot, even if he has no use for the lot? Maybe your prospective buyer has problems of his own that you can solve. You take on his problem, he takes on yours. We all have different skill sets, different assets, different circumstances. His problem may not be a problem for you, and vice versa.
Maybe the other guy has a property with a management problem he can’t handle, but you can. You acquire his property, with its income, and he takes your lot. Maybe he takes over the payments on your lot in exchange for services you offer him.
Take personal property, such as a car or boat, in exchange for your lot. This works well if the property you acquire is more liquid – more easily converted to cash – than the lot.
If you need to get rid of your property, expand your market by combining your property with something else you control that might be of value to others.
Focus on making your situation better. Yes, selling for cash makes your situation better, but is that the only way? Don’t focus on the ideal, and don’t think only of a traditional cash sale. Sometimes it takes multiple steps to get where you want to be. I have done many exchanges, but I never exchanged for something I specifically wanted. I just exchanged for something that moved me one step closer to my goal.
If you would like to explore exchanging, a couple of web sites that might be helpful are REE.com and reexchange.com.
Be creative. There is a solution out there.
Topics: Rural Land Investment | 3 Comments »
Inter-Generational Assets
By John | April 6, 2011
The Robinson family owns 103,000 acres in Hawaii – an entire island! Can you imagine what that is worth today?
Well, I frankly don’t know what it is worth today, but if it is worth $1,000 per acre, which seems low, it would be worth over $100 million.
Does your family own 103,000 acres? Why not? How did the Robinson family come to own this valuable property?
It seems the Robinsons had an ancestor who purchased this island in 1864. How much did he pay? $10,000!
Now, $10,000 in 1864 was a lot of money. But I’ll bet there were a lot of people with $10,000 in 1864 whose descendants don’t have real estate valued in the tens of millions of dollars today. What did they do with their money?
Probably most with that kind of money invested it for a high rate of return. They put it in the stock market. They lent it out for interest. They were striving to maximize short-term results.
Today, most investors still focus on maximizing short-term results. But many might be better off thinking of the long-term well being of their families.
Buying large tracts of remote land today, with the objective of passing that land on to your family, might be better for your heirs than focusing on short-term gains.
The U.S. Government is financing current expenditures with debt – debt that is expected to be passed on to future generations. The best way to protect those future generations from this inter-generational debt is with inter-generational assets.
Can you think of a better asset to pass on to your family than a big piece of the planet?
Topics: Rural Land Investment | No Comments »
Vacant Land Lenders
By John | April 4, 2011
Buying land on credit is different than buying your home. Many people get discouraged when trying to find a lender that will finance vacant land.
Since I wrote my book, the lending environment has changed drastically. Lenders, in general, have become very conservative. Under pressure from regulators, they are turning down loans they may have made a few years ago. So, if you want to buy land, but don’t have the money to pay all cash, what do you do?
My first piece of advice is to explore several options – don’t give up easily.
A source that has worked well for me in the past is the local bank. I have found that a bank with local decision makers is a much better prospect than the larger national or regional banks. If they know you and know the local economy, they will feel comfortable making that loan, even if it is beyond their normal lending policies. As I buy and sell land on an ongoing basis, I have found it valuable to establish relationships with those local lenders. The one disadvantage they have is a very limited lending area. They may only serve one or two counties. So the next time I go to them for a loan they may say no, as the property is outside their area, even though they are comfortable working with me.
Local credit unions are also good sources of credit for vacant land purchases, and many of them are in better financial condition than the banks.
On a national scale, Greenstone Farm Credit Services is a good source of vacant land lending. That is true for several reasons. First, they are in great financial condition, as they lend primarily to farmers, and farmers are doing well. Second, because of their farm background, they are very comfortable with vacant land as collateral. Third, they now have lending programs designed for the non-farm vacant land buyer.
Suppose you have tried the above sources and have struck out. Is it time to give up? No, you have only just begun.
Turn the seller into a lender. Would he rather own his land, or would he prefer to own an interest-bearing note secured by that same land? Sellers of improved property or businesses tend to be concerned about getting back the property they are selling on a contract, because the property or business may have been damaged. However, vacant land is much more immune to damages. If the seller gets a substantial down payment, he may not object to getting the property back.
Don’t have a substantial down payment? OK, what do you have? Think of something that will make the seller comfortable. How about a lien on another property you own? If you are in a profession, you might offer to provide services to the seller as a down payment.
Another possibility is to buy the property on a contract from the seller, and simultaneously sell the contract to an investor. That is all cash to the seller, but the buyer is buying on credit. The seller may have to take a discount, as most investors won’t pay full price for these contracts, but some will. And the seller might be willing to take that discount in exchange for a cash sale.
If you think you might be in a better position to pay for the land in the near future, but you want to buy the land now, while it is available, consider leasing the land with an option to buy. The lease payments could apply to the purchase price, or at least a portion of them could. That way you lock in the price and take possession now, while avoiding committing to a purchase until some later date. This works well with land you plan to improve and re-sell.
There are bargains out there right now, due to the condition of the economy. Some of those bargains are bank owned. Banks won’t typically lend money against property they have foreclosed on. However, if you have other unencumbered property, you might take a loan against it and use the proceeds to buy the bank owned land.
There are many possibilities. If you have other ideas, or if you know of sources of vacant land lending, please comment……
Topics: Rural Land Investment | No Comments »
Worthless land
By John | April 1, 2011
When I mention that I invest in vacant land, most people assume I buy development land. I rarely buy development land. Why? Because it rarely meets my investment criteria.
As a contrarian investor, I like to buy property that is out of favor among the investing public. That is why I have always been drawn to rural land that is not in the proverbial path of progress. If most people question why anyone would want to own this land, I feel comfortable that I am investing in the right arena.
Another key to investing is the risk/reward ratio. Admittedly, that is subjectively arrived at. However, that does not make it any less important in an investment decision. If land is already out of favor, and the price reflects that, my downside risk tends to be limited. If this is “hot” investment property, the kind everyone wants, it is subject to price declines if expectations for this property don’t materialize.
And, if there are no expectations for future price appreciation built into the purchase price of this property, future surprises tend to be on the upside. For example, several years ago, I bought 40 acres that bordered on an expressway just outside a sizable city. However, it was land-locked. Why did I buy it? Because it was cheap. I believed the downside risk to be limited, as the disadvantages of this property were already built into the price. I thought it could only go up in value, especially if I were willing to add value to the property. I later sold it to a Fortune 500 company, who bought it with the adjacent property.
I like “worthless” land. It makes an excellent long-term store of value. It tends to have limited carrying costs, such as property taxes. There is limited downside risk, but good potential upside. It makes an excellent hedge against currency devaluation. In many cases, it can be leased out or even used for personal recreation.
We own considerable acreage in Northwest Utah that we have for sale for $200 per acre. The taxes are minimal, and can be covered with grazing leases. Is this land in the path of progress? No. It is remote, but accessible. What are the chances of this land being worth $300 per acre in a few years? $400? $1,000? I believe this is land with very favorable risk/reward potential, and an excellent inflation hedge. I would recommend this land over well-located development land any day of the week.
Topics: Rural Land Investment | 2 Comments »
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