THIS IS MY 172ND BLOG ON UNDERSTANDING MONEY
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BLOG 172-B
Let’s look at demographics and making a living. Millennials are moving to the
socialistic Northwest. They will
find it harder than they thought to find a job, and more expensive. Let’s take Phoenix area where I
live. For the past few years,
after being eaten alive in 2007-10, it is one of the top areas in the
country. Sounds good except that
it is very difficult to make good money.
Service jobs are plentiful, at low hourly rates. Big money and corporations have moved
in for my areas of expertise like real estate and development. Unless you are a big corporation, or
have multiple millions of dollars you have been pushed out of the market. Sell real estate? Nope. Everyone has a license; about 90,000 licensed real estate
agents in Arizona. I have a friend
who was a homebuilder who went out of business in 2007-2010. He is now a professor of real estate
and does consulting in Nevada, Colorado and South Dakota where he has developed
a niche to make a living. Point
here is that what sometimes looks like a hot economy, will not let you in to
make a living.
When going to work for a company, plan with management where
you could go within the company, pay levels, type of retirement plans and benefits.
Somewhat similar if you start your own company. When planning and working on a pro-forma, also think about
your exit strategy; are you building a business for your children to run one
day, how many years you want to work, buy/sell agreements, keep the company
private or try to go public, etc.
Are you planning enough cash flow and asset reserves for normal business
cycles and downturns, which will occur?
Timing is all important for success, I don’t care if it is
real estate, stocks, gold, diamonds, precious minerals, or sex…timing the
markets is where you will make
money. Here is another situation
where timing moved away from me. I
put two farms together outside Milwaukee, Wisconsin, for a total of 200 acres
and worked closely with the Wisconsin Department of Transportation on the
western side of the city. The State purchased 65 acres from me for the 4 lane
highway and overpass. I did my
permitting and land work along with the State. I controlled all four sides to
the interchange and the 135 acres remaining. My law firm at the time had big developers in mind for this
land and wanted me to sell. Two
things stood in the way of this.
One, my law firm wanted 25% of the deal to sell it off at a very high
price. Two, I was a developer and
thought I could get an extra multiple in value if I completed much of the fill,
grade land work estimated to take 3 years. In 2007 the highway opened, a lot of my work and expenses
were out of the way, but The Great Recession hit and buyers disappeared. I still sit with the land wondering
what I could ever do with it.
Never saw the calamity coming.
Timing! Buy low, sell high
when times are good and before everyone else wants out. Strike while there are buyers who will
pay top dollar.
Here is another experience. In 2004 I joined a small group of people to form a
partnership to finance custom homebuilders in Arizona, mainly Phoenix
area. It was a 5 year limited
partnership formed with $7.5 million, lending money short term at 11%
interest. We encumbered each piece
of real estate with a “first” deed of trust. One would think nothing bad could happen, and the managing
partner had a solid 20 year track record.
What happened was The Great Recession in 2007. By 2008 builders were walking from homes partially built and
the lots we lent money on. What
made it worse was that the managing partner in 2005 borrowed an additional $1.5
million without the partners’ knowledge or voting approvals. Things happen! Our loan was called due and payable by
the bank therefore we needed to sell our lots that we foreclosed on at a great
reduction in price. Ouch! The partnership was to be terminated in
2009 (5 year term) and the US and banks were in terrible financial shape,
especially Arizona real estate.
The partners, including myself, voted to continue the partnership. The normal person thinks land and lots
without debt are cost free, wrong.
You have real estate taxes, regular maintenance of the lots to meet
city, county and regulatory standards like spraying of weeds, fill for erosion,
etc. Also, the managing partner
needs to pay his corporate rent and employees maintaining records. Move to 2019. The partnership is still going. The partners still get to vote each year to see if we want
to continue the lending of money, and the vote is always a majority “yes”. If you want to sell out, it is only
permitted to an existing partner with approval, and usually at a 50%
discount. Do I need to say “ouch”
more often?
Let’s talk encumbrances and collateralization of
assets. Take an example of being
on the other fence of lending money.
When borrowing money the first question a bank or private party will ask
is, “what do you own to collateralize this loan”? Bottom line, try not to over-encumber the loan up to its
value or up to 125% of value. If
you are improving a property and it goes up in value, have releases in writing
from the original collateralization to bring that amount down. Here is an example that happened to
me. I was a partner on a large
ranch acquisition for development in Arizona; paid $15.5 million cash for the
ranch. We collateralized the
operating loan with the entire property.
Over 7 years we did considerable work, and had major contracts in place
to close once our work was completed; 1800 quarter acre lots with major home
builders and a 39 acre parcel with Westin/Marriott Hotels. The project was approved for 6600 lots
plus custom lots, once 2 golf courses were laid out by Nick Faldo. The land
work was to take another 2 years, to meet contracts. 2007 rolled around and Citi Bank, our lender, called the
loan due and payable immediately.
We had two appraisals by outside companies and both came up with a net
asset value of $150 million…serious money! We requested Citi Bank to separate out some of the
land under contract, they would not.
Two passive partners bought out the loan, and then foreclosed on
us. (We had paid these two
partners 1% of loan amount at time of loan with Citi Bank to guarantee the
loan, for a lower rate of interest and limit our personal liabilities.) We went to court and lost. In hind site we should have hired our
planner first, as we had the financial capabilities, then taken the ranch and
divided it immediately into several parcels before borrowing money. In today’s world set up separate legal
entities for each subdivision.
Also, form a separate corporation for the land development and the
construction/builder group. In the
end everyone lost. Once our corporation went Chapter 7, the new land-owners
lost everything we had completed from planning to approvals for water and sewer
taps. City and county development
and building codes also change over time.
One last point to make. Try not to do business with family members, unless there is
no option. My brother came to me
for a loan in 2004 for $100,000.
What I did was permit him to borrow that amount on my home in Milwaukee
as a line for credit. The home was
worth three times that, and free and clear of debt. M&I Bank was willing to do this if I signed a letter
authorizing the loan and my brother holding an interest in the property they
could encumber. I thought safe
enough. As it turned out, once
M&I Bank was sold to Harris Bank in Chicago, and M&I loan documents
were no longer accepted by Harris Bank.
The loan of $100,000 was called immediately due and payable. I wasn’t informed a thing until I was
served foreclosure papers; no one kept me in the loop. Bottom line here is what starts out sounding
low risk can turn into something major.
In addition my brother had a large “judgment” loan against him by
another bank. In court Harris Bank
was permitted to “Piggy Back” the loans, and I lost my home and entire value.
I could write quite a bit more, but I hope you learned a few
things from this blog.
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