Finance Roll

In the foregoing illustrations, the presence of a passive investor was a key to being able to capture large portions of equity in a relatively short period of time. The investor provided all the cash but, in the end, the transaction generated yields far in excess of those available in any other competing investment opportunity of comparable ease and safety. The stock market has been moving up and down for months as investors wait to see how the inflation picture shapes up. None of these can produce investment yields like those in the foregoing examples.

For many years I've been more investor than entrepreneur, but I see myself as a sort of venture capitalist who takes a large profit in return for sharing some of the risk with an entrepreneur. The amount of profit depends upon the particular transaction. When I have financed those who buy houses to fix up and resell and others who have developed mobile home lots, I've been able to earn around 20% per year on my invested cash. I've also financed those who attend foreclosure sales to buy houses for resale with roughly similar yields. I do no work. My role is that merely of a lender who lends money on a shared appreciation mortgage (S.A.M.) loan.

A lender usually gives up the benefits of amortization, appreciation, tax-shelter, and leverage in exchange for high cash flow returns. By keeping money invested in relatively short-term propositions, he is able to roll funds over and over, and thereby generate high yields. Except for mobile homes, I've rarely seen a house that would produce net cash flow yields that compare with those that private financiers can command. This is particularly true when conventional financing dries up. Builders, fixers, land developers, dealers are heavily dependent upon the availability of financing to stay in business, and they're willing to pay high short-term interest rates to get it. When credit is tight, this is a fertile field of opportunity to those who followed my advice and sold some of their houses over the past few years and who are now looking for ways to invest their cash.

The big buggaboo of the lending business are those who become overextended and who file for bankruptcy protection. This can be a worrisome situation that robs the investor of a lot of time and money. There are several reasonable steps that a person can take to reduce credit default and bankruptcy risks.

1. Act like a banker. Lend only to those with high F.I.C.O. scores who have plenty of collateral that you would like to own. When you lend to them, don't let them borrow more than they can repay. You won't be able to get as high a yield, but if safety is a priority, this is a prudent way to get higher returns.

2. Don't make loans! Instead of lending money to those involved in risky ventures, buy something else that they own at a discounted price. Instead of receiving regular payments which could cripple their cash flow, let them buy their property back at some point in the future. If they go broke, you've avoided the need to foreclose; or the need to file a motion in a bankruptcy proceeding. On the other hand, if they're successful, the price at which they buy back their property can be increased in order to capture an agreed upon share of their profits.

3. Instead of buying another property as above, buy the property that a dealer wants to resell. Give him an Option to buy it from you at a price based upon risk factors and the time of repayment. This avoids potential usury problems, since you only deal with 3rd parties when buying, and they need not buy the property back from you. Obviously, you'll want to buy at a very attractive price which will enable you to sell out to someone else if the entrepreneur fails to buy the property from you. This is particularly wise when dealing with builders and developers.

4. Provide a secondary market for sellers' mortgage Notes. By buying them at a deep discount to value, you can build in a margin of safety and some liquidity, since you can re-sell them at a point in the future if need be. If State law allows it, give sellers an Option to buy back their notes to create a specified yield.