S.E.C. Real Estate Observer

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In my opinion, depositing all of your money into a bank is tantamount to burying it. In fact, it may sometimes make more sense to bury it in your backyard — especially when you factor in the risks, inflation, and opportunity loss of the depreciating cash locked up in CDs or other long-term and low-interest investments. Let’s just take a minute so that I can explain what I have just said.

Did you know that if you removed the government insurance safety factor from even the best-run banks, their financial statement would not get most of them a fifty-cent loan? A bank’s net worth or capital base seldom exceeds 10% of total assets (a combination of its cash and other assets PLUS that which depositors, such as yourself, lend to them). This would be equivalent to your financial statement showing $1 million in total assets with $900,000 in debt that was due and payable in full at the end of the year (average). Remember, 90% of the bank’s assets are deposits from businesses or people like you, all of which are a liability to the bank. The bank is actually borrowing your money in hopes of making a profit on the spread between what it pays you in interest and what it earns from investing it. In addition to the profit, it must be concerned about having enough liquidity for when you or other depositors come into the bank and want to draw out cash. Can you imagine your banker or anybody with any fiscal responsibility giving you a loan if your financial statement looked like the bank’s financial statement? I seriously doubt you could ever secure a loan with a statement that looked like that of the bank (without government guarantees backing it).

In essence, every time we make a deposit in the bank, we must consider the possibility that we may be making a loan to a financially handicapped corporation. The only safety net we might have is that the US government has “in some cases” agreed to insure “some of those deposits” only IF the bank is FDIC-insured.

What you need to understand is that not all deposits are insured—even if the bank is FDIC-insured. Be sure to ask your banker which deposits are insured and which deposits are not insured should the bank fail. It is a certainty that all accounts, especially those over $250,000 in size, are often NOT insured. These laws are always subject to change as well as minimums/maximums insured.

Another important question to ask your banker is whether you will get your money back if your accounts are insured and the bank fails. Your money could be locked up for days, months, or even years before you regain access to it. How will you pay your bills in the meantime?

Regardless of whether a bank is a good risk or not, it is really beside the point. Banks are poor investment vehicles today. With interest rates barely over 1% and inflation higher than that, we are actually losing capital every day we leave money siting in the bank long term. I am not suggesting that you should not have a percentage of your assets in the bank in case of an emergency and for current payables. But I am saying that we are not being very good stewards of the money we have been consigned with if we put more than a minimal amount in the bank as a long-term investment. If you would like to see a recommendation from “Somebody” in a much higher station than I, read the parable of the talents (a biblical measure of money and gold). There, we are encouraged to be frugal with what He has entrusted us with. Burying all of your money in the backyard or depositing it in the bank (where it may be depreciated away) is not always frugal.

Now, you are probably asking yourself, “What is Langel suggesting we do with our money?”

One answer is: Do exactly what the banks do with your money when you entrust it to them: invest it! I would venture a guess that you might even do a better job than the bank. Why allow the bank to use your hard-earned dollars to profit when you have the same opportunity to reap all the rewards? There are many smart and qualified loan, investment, and real estate brokers who can help you achieve this if you don’t feel qualified to do so yourself.

A. Invest in notes and mortgages. You can purchase safe one- to four-family notes and mortgages at a yield exceeding 8%. These notes can be as safe as buying a new home in your hometown for perhaps $60,000, whereas the current market price may be $180,000! How safe would you feel about that investment when the market value for the home is perhaps $180,000? Even if you had to foreclose on the loan, you could get between $700 and $1,000 per month in rent. Not bad for your $60,000 investment. With rental income of even $750 per month, it beats interest by about 14% per year.

B. Make loans. I will give you examples of loans that I get requests for on a regular basis. I consider these loans to be much safer than loans made by banks, provided that you do your due diligence properly. The main reason is that I would not make the loan unless I would be excited to own the collateral and security in case of default. I do not believe anyone should ever make a loan to anybody for anything unless the loan giver would be happy owning the collateral. This rule applies unless you are simply trying to help a family member or friend (different rules apply in those cases). Naturally, to feel this comfortable, we must factor in every conceivable risk, holding, and foreclosure cost before making the loan. In many cases, banks do not do this. As you know, they sometimes make loans that exceed a 90% loan to value. I would never suggest that anybody make a loan with that kind of risk. It would be a rare case for us ever to exceed a 70% loan to value. Most of our loans are under 60% loan to value.

Let me give you an example of a loan that a borrower recently requested. He had a fourplex here in Gallatin Valley, Montana. It was recently appraised at $160,000, and he had zero debt against it. Because his credit had been scarred and the banks are as conservative as they are, he was not able to get a loan from any bank to generate capital for his business. He even tried appealing to the finance companies and other secondary lenders. Our investor client offered him a $40,000 first loan on the fourplex and took an assignment of the leases and rents. This loan was offered at 14% interest. The rents were projected at $2,000 per month, and the tenants paid all their own utilities.

Let’s face it. Is this guy going to let the lender foreclose him out? No, he has a $120,000 equity in this property, and he will make sure that the lender is the first one paid every month. Worst case, he will sell the property at 50% of its value, pay the loan off, and put $20,000 in his pocket.

(When making loans, check with your legal counsel about certain licensing requirements and usury laws that may apply in some cases.)

P.S. There are many great banks, owners, officers, and employees who have helped many others and me through some tough financial times. For this, I am grateful, and I respect them and what they do. And when we need the funds, the bank is usually the least costly place to get it when you can! I just do not believe that banks are the places to “invest” cash that you do not need in the short term.