The Tycoon Report
Are We Trading In Our Future for Quick Cash Today?
Friday, September 12, 2008 | Ethan Roberts

A friend emailed me this past week, and relayed an interesting story about his granddaughter's upcoming first birthday party.  Apparently, his daughter, son-in-law, and the son-in-law's parents had decided to throw a big, lavish party, with over 75 people invited. The parents had sent my friend a menu from a very fancy restaurant where the party was to take place. The menu items included Marinated Sirloin, Orange Salmon Fillet, Balsamic Chicken, Chicken Sorrentino, and other high-priced items. Needless to say, this party was going to cost quite a lot of money, and the parents were looking for my friend, the grandfather, to foot the bill.

However, my friend balked at this idea, feeling that it was quite extravagant for a baby's first birthday party, and instead offered to fund his granddaughter's college fund with the same amount of money for which he was being asked. 

It's not that my friend is cheap, he just feels that the money is far better spent on his granddaughter's educational future than on a one day event the baby will never remember, except from videos and photos that get passed around once in a blue moon. Unfortunately, his desire for pragmatism was met with disdain from the relatives, and now there is a cold war threatening to alienate him from his daughter and grandchild.

This incident reinforced in my mind a concern that with every passing year, a growing number of Americans are trading off their economic futures and opportunity to build wealth for tomorrow, for the immediate gratification of fulfilling present day needs.  Today I want to highlight several ways, both large and small, that I see this occurring. 

Let's begin with the sub-prime mortgage loans that have recently rocked Fannie Mae and Freddie Mac, and beget a government takeover this week. Say what you will about predatory lenders being unethical, but the fact is these loans were very appealing to borrowers because it allowed them to trade off a zero-down payment today, for a higher monthly payment tomorrow. The rationalization was: "This is a great way for me to afford more home than I ever dreamed possible, and I'm going to take advantage of it while I can. I'll just deal with tomorrow's higher payments, when tomorrow comes. " 

I actually heard this statement from several customers who told me they wanted to buy a home with a no-money-down loan.  Well, tomorrow has now come, and so we have 2,500,000 foreclosures and an ongoing financial nightmare, as we pay the piper for yesterday's short sightedness.

Next, let's consider the growing deluge of Payday Advance storefronts. Take a loan today on tomorrow's pay check. Deal with the interest later. You need money now! So what if the two-week loan you are taking has an annualized interest rate of 400%?! 


 
Hey Ethan, don't bother me with the small details while I'm counting

Stephens Inc. analyst Dennis Telzrow, who follows payday lenders, was recently quoted as saying that these companies developed, "because there was a great need for it from the customer. And that exists because, whether you like it or not, there's a lot of people who live paycheck to paycheck. And they don't save money."

While I don't disagree with his analysis, the sad irony is that the people whose needs are served will never be able to save money and get off the paycheck to paycheck merry go round, unless they quit making bad financial decisions, such as taking payday advance loans! 

I'm embarrassed to say that even in the real estate industry, we have commission advance companies that will pay 90% of an expected commission to a realtor up to 180 days before the scheduled closing. According to the website of eCommission, a leading advance company, the cost for receiving a $3,000 commission less than 40 days before closing is $286, plus a "refundable" reserve (with some fine print that makes me wonder). 

That's a 9.5% fee for not being able to wait less than six weeks for one's check. I completely understand that recent times are difficult for some realtors, but by having no savings to fall back on, it creates a situation in which one ends up giving up almost 10% of their income.  

Immediate gratification is expensive!

So one day not too long ago, I'm flipping the remote around the cable channels, and I see a commercial along the lines of "Cash now for your legal settlement!" All these happy people are dancing around with fist fulls of cash, because instead of waiting for their lawsuit settlement, they signed up to get the instant cash today. Nice to know that despite their severe injuries, head, neck, and shoulder traumas serious enough to warrant a lawsuit settlement, they are still able to dance so well!


 
Dancing for Quick Cash. 
Gives new meaning to that old disco tune, "Do the Hustle"

I did a little research to see what all that dancing costs, and while most of the companies would not reveal their fees (I wonder why), I did find one that said the cost is anywhere from 3% to 5% per month, compounded monthly, of the amount advanced, with a three-month minimum. And oh yes, there is also a small administrative fee to cover the cost of document preparations, filing, monitoring, etc. These "cash now" businesses don't even deduct their routine office expenses from the normal fees they charge.

So if a person is sitting on a $500,000 settlement, after the advance, the cash settlement companies would charge them anywhere from $15,000 to $25,000 per month. Now in fairness to these companies, I must add that if the lawsuit victim doesn't win his case, the money advanced to them is still his to keep without having to repay any of it. So these companies are no doubt pricing the risk into their fees, and probably only accepting the cases they feel have an excellent chance of winning.
 
The real estate world is far from immune from this game of roulette. In July, the government passed the controversial Housing Relief Bill. One of the provisions of the bill allows delinquent borrowers to refinance their existing loan onto an FHA loan.  The lender is required to forgive enough of the principal so that the homeowner can refinance at 90 percent of the home's value.  But the trade off is that from then on, the FHA is going to share in the home's price appreciation. If you sell the home in less than five years, FHA gets anywhere from 60-100% of the appreciation! If you sell the home after five years or more, FHA still gets half of the appreciation from the sale. It is a well-known fact that people move every five to seven years, and don't think your government isn't aware of those statistics.

Some may call this a quid pro quo for the bailout that is being provided. I have no quarrel with that idea. But there's a certain image I can't seem to get out of my mind when I ponder this. Doesn't this smack of the local street hood "helping" a struggling small Mom and Pop in exchange for 50% of all future business? Let's face it, there's just no such thing as a free lunch!



Yous guys want I should refinance da mawguj?

Well that brings me to the latest "trade your future in for today" deal, an article I was reading the other day about something called the "REX Agreement", with REX being an abbreviation for Real Estate Equity Exchange. This is an agreement between the homeowner and the San Francisco-based REX & Company, in which the homeowner receives a cash payment now in exchange for giving REX a share of the future appreciation of the home when it's sold. The only stipulation is you must have at least 20% equity in your home to qualify.

It's similar to a home equity loan, except there are no monthly payments or interest to be paid back. Also, should the value of your home decline in the future, REX will share in the loss when the home is sold, unless the sale is within the first five years.  REX also charges an "exit fee" if you do sell within the first five years, anywhere from 5-25%. 

The homeowner decides how much cash they want from REX, versus how much of their future equity they are willing to give away. Now here's the deal. For a chance to gain 12.5% to 15% of the current value, they only have to give away 50% of their total future equity!

With all of these things, it's not hard to imagine a future in which millions of senior citizens are living at or below the poverty level because they exchanged retirement assets in 2008 for immediate monies to pay off credit cards, car loans, or homes they couldn't really afford. Furthermore, with all of the recent bailouts and hand outs, we run the risk of generations learning to depend on the "cash now for your future" addiction as a legitimate solution to all their needs. 

Tycoon readers, I hate to predict doom and gloom, but if we don't get a handle on society's adolescent need for immediate gratification, eventually you are going to see the core of our economic system going up in smoke! I know we as Americans can do better than that!



 
(For illustrative purposes only kids, don't try this at home)....


See you next week!

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Ethan Roberts
Chief Investment Officer
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