Will the Real Estate Investor Please Stand Up?

After the housing market crashed, we are now in a period of pointing fingers in order to assign blame. Was it the homeowner’s fault for overstretching his / her abilities? Was it the mortgage banker who made loans that he / she shouldn’t have? Was it the guy on Wall St. who repackaged the bad loans into derivatives that no one could understand? Or was it the investor who rushed into areas like Florida, Nevada and California, flipping houses, banking on price appreciation going up and up, while running up the prices and making real estate unaffordable for homeowners and other investors, and thus forcing them into these exotic loans? Methinks that all of these are the root cause. We all collectively did our part. And some are guiltier than others. But we needed to educated ourselves a bit more, and anticipate these results, including the homeowner.

What concerns me is that our media, which is always overzealous to skew public opinion, places the blame on some parties more than others. And lawmakers have to respond, as their constituents beat themselves into a frenzy. Yet the Wall Street guys get a bailout package, and homeowners don’t get a whole lot of anything. And some states are now passing laws that make it illegal for investors to rescue homeowners in default. For example, New Jersey is looking to pass such a law now. According to the proposed law, it is illegal for anyone other than a nonprofit organization to counsel a homeowner and negotiate for a short sale with a bank. This is just stupid. Homeowners need all the help they can get, in order to get up from under these loans and resetting ARMs. Banks are overwelmed with shortsales and other workouts, and things are slipping through the cracks. Investors who are skilled with foreclosures and short sales are in a unique position to help the homeowner and the bank to deal with this overwhelming situation. Not all investors are honorable, of course. While many investors craft a true win-win all around, some “investors” are true scammers (I put “investors” in quotations, because they are not investing, but rather conning people out of their mone). And now these bad apples, who are in a minority, are screwing it up for everyone els, because for an inexperienced homeowner, it’s hard to tell if the investor is a good guy or a bad one.

But the investors who will survive the real estate calamity of 2008-2009 are a creative bunch. They are setting up non-profits or aligning themselves with non-profits, to help them carry out these deals. Good for them! If an investor can craft a deal that gets the homeowner out of foreclosure without messing up their credit, while keeping the bank from having to take back the house that they don’t know what to do with, there is no reason why this investor shouldn’t profit. Remember, you will always get paid in accordance with the value that you produce.

It is difficult to find any humor in the subprime industry’s collapse. However, this cute cartoon slideshow “Subprime Primer” does inject some humor into the otherwise grim situation. I am not 100% of the source that sent this to me, it ended up in my bookmarks, and I only just got around to reviewing it.

If you would like to almost add some levity to the situation, check it out! http://www.slideshare.net/guesta9d12e/subprime-primer-277484/

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There has been quite a bit written in the blogosphere about the “bailout” of our crumbling financial system. I don’t much feel like rehashing what’s been written, but I would like to state my opinion and cite some of my favorite blogposts on the topic, as I have had some time to ponder the issues. And finally, I would like to explore how this affects the real estate market and real estate investing.

First off, when I first heard about the proposed “bailout”, my gut reaction was that a bailout of any sort goes against the notions of free markets and capitalism. You mess up, you pay the price. You do well, you get rewarded. Isn’t that why immigrants come to this country? It sure is why my parents and I came here when I was 14: the opportunity to make something of yourself and your life, regardless of your connections to the KGB. What kind of message are we sending to corporations and other entities? It’s OK to fail. Your job is safe, the taxpayer will bail you out. Corporate greed is OK too.

Then I thought about it, and perhaps some kind of action plan is necessary (well, it was necessary a while ago, but our leaders were too busy telling us that the fundamentals are strong). What we need is not a bailout. Something different. Not sure what, yet. If the financial markets keep spiraling down into this vortex, the impact on the country’s economic health could be catastrophic. But how catastrophic? Would it be more damaging than the $700 billion + bailout is to the taxpayer’s wallet? It’s hard to say. But what if this bailout still doesn’t solve the problem? That’s entirely possible too. To ensure that it works, there needs to be a stronger plan of action vs. a fuzzy “blank check” approach. I find Robert Reich’s blogpost the most illuminating writing on the topic in terms of a strong action plan and concrete rules and oversights to be put in place.

Finally, Paulson’s connections to the Street make the whole thing appear just a bit too fishy for my taste. And the Section 8 is just the last straw. It reads exactly like this:

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Did that make anyone else’s hairs on the back of the neck stand up? Eeeekkk! We are headed towards something very very bad in this country. We are allowing an ex-Goldman guy to have unilateral control (without being reviewed by a court of law!!) to make decisions on the Wall St. bailout. That would make it very easy to cover stuff up, wouldn’t it? Hmmm…. And no one can investigate…

When did it become OK for the American public to give up all control of their lives and decision making to folks who supposedly should be acting in the interests of the public, but have way too much conflict of interest to actually do so? How did we allow ourselves to be scared into Patriot Act and the Iraq war? And now we are being scared into passing this piece of steaming shiitake? Are we still a democracy? Sure doesn’t feel like it. Feels like we are headed towards a dictatorship, a military state. I am exceedingly concerned for this country and the ease with which the American Dream and Democracy are being annihilated in front of our very own eyes. Our founding fathers must be rolling over in their graves.

So… I must somehow bring this back to real estate and real estate investing. How does this affect real estate investing? Well, in the same way as this whole mess has been affecting real estate for the past year or so (this mess started in real estate, if you remember). It is close to impossible to get a mortgage for an investor (and now, as of Dec 1, Fannie won’t allow to finance more than 4 properties per person, including primary residence). So forget about conventional channels. If you want to take advantage of good deals, you must learn and implement creative real estate investing (seller financing, subject-to, private lending, etc.)

Everyone is cautious, however; homeowners and investors are waiting for the market to hit bottom before moving. And now that the sky is falling, and we seem to be writing a blank check signed by the American Taxpayer, Joe Investor who is hoping to work the foreclosure market and get some cashflow properties is a bit more afraid of his future and is a bit more hesitant to act. Investing for cashflow, if you follow creative real estate strategies, remains a viable strategy. As far as other exit strategies, it’s a bit more dicey…  Jim Homeowner to whom Joe Investor hopes to sell his rehab is also more hesitant; he is more concerned about keeping his job than straddling himself with a new liability in the form of a new house. And now that Jim Homeowner is funding a bailout of epic proportions, well, there goes his saved up 20%+ downpayment that he now needs to buy a house.

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Happy Friday!

Perusing real estate blogs, found some interesting “Top 10″ lists on Real Estate Bloggers.  There are several lists, but as an investor, I find these most relevant:

Top 10 most stable real estate markets

Top 10 best cities for job and wage growth

Have readers of this blog had any experience with any of these markets? Please post your comments!

The credit markets biting the dust, the collapse of Indy Mac (and other smaller banks), as well as the Fannie / Freddie bailout are sending chills down the spines of many real estate investors. It was always tougher to get conventional financing for an investor than for a homeowner. After all, even though you show proof of rental income, the bank would still check your credit, and each mortgage loan would go on your credit. Only so many loans could be on your credit before you became a bad credit risk. But now, it’s hard even for a shiny-new first-time homeowner, reaching for that American Dream of homeownership. If you don’t have a 700+ score and 20% to put down, keep dreaming…

Even before the collapse of the mortgage market, savvy investors employed various creative strategies to pursue investments above and beyond what would “fit” into their credit report. Obtaining private funding is a central strategy (discussed below), as well as subject-to’s, seller financing and other such strategies (discussed in forthcoming posts). Needless to say, becoming fluent in these strategies in 2008 is no longer a “nice to have”, bit a requirement. Below is a discussion of some non-traditional financing approaches. (Traditional lenders are banks, and the loans they give are typically secured by your own credit score and credit history).

Private Lending is a form of a non-traditional approach and can take 2 basic forms: one-to-one lending and syndication (many-to-one lending).

Syndication is basically raising money from a group of investors, who pool their capital together.  The syndicate is the group of investors, and the person raising the funds / project manager is the syndicator. Typically, the SEC requires the syndicate to be in the same state as the investment. After the syndicate is put together, the legal entity is created at that point (typically an LLC).  Funny tidbit: as a wholesaler, you are also a syndicator by definition, because you are putting together two parties. This is just a small blurb about syndication; I intend to write a longer post dedicated just to syndication.

You can also raise money from one person, and not a group. This type of private lending can also take several forms: a private loan and a hard-money loan. A plain private loan tends to be a longer-term loan that you can get from any other individual (not a hard money lender). These are typically better than hard money loans (discussed below), because they are less costly. Think of your private lender as a bank / mortgage guy, but without the silly closing costs. The key here is knowing how to find folks who can invest in your project, and how to position your project to them. Mike Lautensack often writes articles on how to raise private funds and sells a program on his site. Check out his latest article. We will be welcoming Mike to our NYC Real Estate 2.0 Meetup on September 24th via teleconference.

A hard money loan is also a real estate loan received from a non-traditional lender, secured by the property. Why is it called hard money? It is not hard to get, but hard to pay back. Just kidding. But only a little. In all seriousness, hard money loans carry a much higher interest rate than a conventional mortgage; these rates are typically between 12% and 15%, and can go up to 20%. The lender also charges “points” (one point is one percent of the loan amount), which can range from 2 to 6. The amount of points, as well as the rate, are driven by the lender’s perceived risk. As you see, they are quite expensive, so it’s no wonder they are used for short term loans.

A hard money loan is typically used for rehabs, which are tough to finance with conventional loans. Because you typically get up to 65% - 70% of the ARV from a hard money lender, and don’t have to put any money down, this type of loan is perfect for a rehab. You get in with no money down, do the rehab, exit the deal via a conventional loan or via a retail sale, and pay off your hard money lender.

Check out this Wikipedia article for a pretty comprehensive definition of hard money loans. http://en.wikipedia.org/wiki/Hard_money_loan

We hope this is a good kick-off of a discussion of non-traditional lending. We will be exploring this in greater detail in future posts. Talk to us! Leave comments, leave questions on this blog or in our discussion section.

Every so often, we read headlines about housing prices (seems like every other headline is about housing prices these days), and they all seem to contradict each other. Why is it that while NAR numbers say we are flat-to-mildly-decreasing, the Case-Schiller index states that we are decreasing? Which numbers do we trust, and why are they so different?

To start, there are 3 major indeces:

1. OFHEO (Office of Federal Housing Enterprise Oversight - they regulate Fannie Mae and Freddie Mac)
2. S&P / Case-Shiller index
3. National Association of Realtors (NAR)

1) OFHEO looks at existing home sales and excludes new home purchases. In addition, it only looks at conforming loans, ignoring transactions that are not guaranteed by Fannie and Freddie. Homes with non-conforming mortgages are seeing larger price declines than the homes that OFHEO tracks. So this means that the numbers that OFHEO reports are not as volatile as the rest of the indeces. To make matters even more complicated, OFHEO also considers appraisals that are generated when people refinance their homes, which is almost always different from the purchase price, and is a truer indication of market value.

2) Similar to OFHEO, Case-Shiller looks at existing home sales and excludes new home purchases. Although there are actually three Case-Shiller indeces (monthly 10-city survey, monthly 20-city survey, and a quarterly report that looks at all nine U.S. Census regions), the one that makes it to headlines most often is the monthly 20-city survey. In addition to already being more volatile than OFHEO, this survey can be even more misleading as a proxy for the national situation, as it looks at only 20 metropolitan statistical areas. It just so happens that these areas include some of hardest-hit areas as far as price declines, such as Detroit, Las Vegas, Los Angeles, Miami, Phoenix, San Diego and Washington, D.C. Additionally, Case-Shiller can miss trends in micro-markets, as it doesn’t consider sales of condos and co-ops. So, next time that you are tempted to get worked up over Case-Schiller numbers, don’t. Especially if it’s the monthly survey.

3) NAR’s methodology is much more straightforward. It looks at sales of existing homes listed by MLSs, and reports median home prices. As we know, there can be a disconnect between a sales price and a home value. In addition, NAR considers median prices only, reducing the impact of price volatility in upper price ranges.

Case in point: Freddie Mac home-price index indicateed that housing in New York state fell just over 4 percent in value in the past year. Meanwhile, the Case-Shiller index tells a different story, indicating that New York’s home prices are down roughly 15 to 16 percent from their high.

Source: To make sense of the home price indeces, I used a very well written analysis written by Matt Carter for Inman News

found this fantastic video by reading this post in Noah Rosenblatt’s Urban Diggs blog (great blog about NYC real estate that I read quite a bit). Bill Ackman is proposing a new plan to solve the Freddy / Fannie problem and bring liquidity back to the market. This solution is not via a government bailout, but rather proposes a balance sheet restructuring (basically converting their debt to equity, in order to affect the crazy D/E ratio - currently at 129:1 - Yikes!!!). I am not going to rehash Noah’s post and the video - they both do a great job explaining it. Check it out!

Video: http://www.cnbc.com/id/15840232?video=793726867

Real Estate investing has historically been fraught with so-called late-night infomericial “gurus”. “If you only pay us $10,000, we will show you how to get rich in 1 month, and you will never have to work a day for the rest of your life.” Yeah, right! Few things in life are this easy, and there are no shortcuts to a solid real estate investing education. I came across this video today, and was appalled at the advice given to the poor woman in the video by Russ Whitney. He and his instructors recommended to flip the investment property. Well, anyone with half a brain can see that today’s market is fit for anything but flipping.

And yes, real estate conditions vary from state to state, city to city, and even neighborhood to neighborhood. Per my neighborhood real estate broker, my neighborhood in Jersey City only experienced a 5% drop in prices, while the less affluent parts of the city and Bayonne have dropped about 10% (of the new listings there about half are in foreclosure). But still… Even in Manhattan, the hotbed of real estate activity, unsold inventory is starting to build up, making a flipping decision tantamount to financial suicide.

Check out this video! (unfortunately, I am having technical issues embedding the video, so you will just have to click on this link)

Enjoy!

HomeVestors (the “We Buy Ugly Houses” folks) has named the top 10 cities for real estate investing and 10 junior markets for real estate investing in the first quarter of 2008 (Junior markets are cities with a population of 150,000 or more). They are as follows:

1. Dallas, TX
2. Houston, TX
3. Atlanta, Ga
4. Fort Worth, TX
5. St. Louis, MO
6. Philadelphia, PA
7. San Antonio, TX
8. Denver, CO
9. Minneapolis, MN
10. Phoenix, AZ

Top 10 Junior Markets

1. Columbus, GA
2. Panama City, FL
3. Springfield, MO
4. Brevard County, FL
5. Greensboro, NC
6. Lubbock, TX
7. Columbia, SC
8. Ft. Walton Beach, FL
9. Kent/Sussex Counties, DE
10. Michigan City, IN

These findings are based on the number of houses bought in each market by HomeVestors in Q1 of quarter of 2008 (source http://www.homevestors.com/inthenews)

As the Dallas-based franchise company specializes in buying, rehabbing and selling single-family houses and rescuing homeowners from ugly houses and ugly real estate situations, the current downturn in residential real estate makes for a fantastic acquisition environment. As I mentioned in a previous blogpost, this climate of falling prices, inventory oversupply, and resulting homeowner desperation to get rid of their houses, is a prime time for smart investors to go heavy on property acquisition. As long as your exit strategy is to buy and hold, and not to flip (which is going to be very very difficult in today’s climate), and as long as you can afford to hold the property for at least 5-7 years, you should definitely take advantage of these conditions.

I have to admit that I don’t completely trust this data. I mean, I do not doubt that these are the areas where some of the best bargains can be had: HomeVestors does enough volume to observe significant trends. But there are so many other factors that make a city a hot investment market, which can not be ignored; the HomeVestors press release doesn’t address those factors explicitly. For example, the city’s economic development plans, jobs growth outlook, and other macroeconomic factors must be considered. Also, the rental outlook must be considered. As you buy a property, the low acquisition price is only one factor that determines whether you will see positive cash flow (or at least break even). Rents must also be strong and in demand. Overall, there is strong rental demand right now across the nation, as many homeowners lose their homes to foreclosure and many other hopeful homeowners can’t get a mortgage due to tougher standards. But some cities are definitely hotter rental markets than others. If people are fleeting a city due to lack of jobs, rental market will suffer. The HomeVestor list seems to be very TX-centric. By a sheer coincidence, the company is based in Dallas. Hmmm….. I would be very interested in hearing from our readers what they consider to be the top cities for investing.

Another question for the readers: would you consider investing away from home? What are some factors that you consider whether or not you feel comfortable with investing away from home? What resources do you use? Do you work with another local investor to show you the ropes? We are working on a tool that can connect investors to each other, based on area of interest, as well as other investing goals. As various areas of the country may become attractive to investors than their own home turf (Gulf Region GO Zone, for example), we see more and more people venturing outside of their own backyard. And we would love to help investors make the process a smooth one.

Last weekend, I attended a networking event in DC, at which Neil O. Albert spoke about the city’s urban development projects coming down the pike. Mr. Albert is the Deputy Mayor for Planning and Economic Development (DMPED). The event was held at Hotel Monaco in the MCI Center / Chinatown area of the District (the hotel itself if gorgeous; a visit to the website reveals that it’s an historic all-marble building that is a Registered National Landmark). I came into the area via New York Ave from the north. I hadn’t been to this area of the District in a little over a year, and I was blown away by all the new construction that was happening. Huge office and residential complexes, shiny and new. As I found out later at the talk, this is part of the NoMA (North of Massachusetts) revitalization plan, which is one of the key initiatives of the DMPED. There is a whole lot more development planned in that part of the NE, making it a mixed-use community, with office, residential and retail assets (check out this blog entry and this release from the DMPED).

At the heart of the DMPED revitalization strategy is the utilization of existing transportation assets, i.e. existing Metro stations. This is an approach that makes a whole lot of intuitive sense, as the underlying infrastructure is already established. In addition to NoMA, DMPED plans to invest in revitalization of Anacostia (including Anacostia Metro station and Ballpark District, which will revolve around a new baseball complex for the Washington Nationals). Bringing this huge project to Anacostia (SE) is a great initiative, as it will bring jobs to the area which has been economically depressed for decades. All in all, $10 billion will be spent on this area over the next two decades! However, my concern (and I am sure a lot of others are concerned about it as well) is whether or not there will remain affordable housing for the area’s current residents. Also, knowing from living in the DC Metro area, how saturated the DC Metro area is with condos, I hope that this new development doesn’t stick the city with a lot of unsold inventory. On the other hand, by the time this construction is finished, we will probably be in an “up” real estate cycle. Having spoken to several real estate folks at the networking session afterwards, there seems to be a lot of exciting development and investment in the area, and most of it doesn’t seem to be hit by the real estate meltdown (at least not as much as the suburbs). Their view is that the demand for real estate within city limits of DC is still strong. We will have to see if this remains true, as the down cycle progresses.