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/

Related articles by Zemanta

• Playing Truth or Dare with Alan Greenspan
• Karen Dalton-Beninato: Tales of the Subprime: Troubled Asset on a Bender
• U.S.-style meltdown won’t happen here: Harper
• 10 of the World’s Most Dramatic Financial Crises, and Their Lessons
• What Does the Better Business Bureau Have Against Magic Johnson?
• Subprime

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.

Related articles by Zemanta

• Marshall Grossman: Hey Congress, Tell Mr. Paulson: No Public Investment without Public Equity
• Bush-Pelosi bailout plan
• Cliff Asness on the Current Crisis
• Off Topic: Fallout from the Bailout
• Dealbreaker Editor: “Wall Street Is Broken”

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.

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

I bet it would be impossible to find a real estate blog that didn’t post anything about the mortgage mess today / over the weekend. It’s not that the credit crunch / mortgage industry collapse hasn’t been on everyone’s mind since a year ago. But a new wave of panic is sweeping us today, after IndyMac failed on Friday, and Freddy and Fannie are so unstable (after a precipitous slide in their stock price) that they need to be propped up by the government. So naturally, I ponder what that means for the real estate investor.

First of all, let’s take a step back. Why did IndyMac fail? Well, because like other banks in a similar situation, a large portion of their business was subprime loans. If you make loans to people who can’t afford the house, as long as they say they can and state that they make enough money to buy it, which part of this approach is sound strategy, exactly? Unfortunately, the mortgage markets weren’t too concerned with the future.

So as the market started crumbling and the bottom fell out from under, why did the banks still refuse to do short sales? (A short sale, for those who don’t know, is a deal that a buyer (retail buyer / investor / etc) negotiates with the bank, for a sale of the property for less than what’s owed on the property). This was a very necessary step, in my opinion, as values had dipped under the amounts that were owed. If only banks worked with these buyers to do these short sales, along with mortgage workouts, it would have largely mitigated the mess, and banks would be straddled with a lesser inventory of houses. And as we all know, banks need liquidity, not houses, to exist. The idiotic thing is that these same properties, if no one buys them, get foreclosed on (huge expense for the bank), get seized and get auctioned off for less money than the proposed short sale. If I have an outstanding loan of $10, wouldn’t I rather take $7 from a buyer today, than sell it for $5 tomorrow? Duh! Instead the banks made it so difficult for an investor to do these short sales, with the process dragging on for months. With such an abundance of foreclosures and deals to be had, no wonder so many properties end up going to auction. From my personal interaction with real estate investors, the frustration with the banks’ loss mitigation departments (those who end up working out the short sale deals) has been palpable. I spent some time perusing blogs and blog comments written by investors, who lamented that IndyMac exhibited many of the same behaviors. IndyMac had a chance to recoup some of the money they ended up losing due to the bad paper, and they squandered it. I am not, in any way, suggesting that short sales are a cure-all. I believe that it was important to pursue all avenues, one of which is short sales, one is mortgage workouts / loan modifications, and other steps. Hopefully, the next bank straddled with foreclosing properties, will be a bit better at short sales.

So now that IndyMac failed, and other banks with similar patterns are likely to fail, for the same reasons as stated above, the credit problem is only going to get worse, and the panic is going to get out of control. Which concerns me as an investor and as a technology entrepreneur building a web-based resource for investors. If there are no funds available for investors to buy investment properties, the investment industry is going to go the way of the mortgage industry. But not so fast! Investors, the good ones at least, are extremely creative, nimble and entrepreneurial ; they find opportunities at times when everyone runs and screams that the sky is falling. The deals are abundant. And yes, prices will likely keep decreasing, especially as the mortgage mess shrinks demand (many homebuyers who were in the market for a house, now will have to go back to renting, because they can’t get a loan). However, an investor who is good at doing the short sales, and other such strategies, can max out the deal anyway by getting it at very low prices. To finance these properties, a creative investor will look to non-traditional avenues, such as seller financing and private money. As far as my business, MeetMOJ,O is concerned, we are going to do just fine, as we extend our matching model to private money lenders and other alternative sources of capital.

So next time someone asks me what I am doing, and I answer “I am building a web-based community for real estate investors”, and that person looks at me like I am insane, I am going to insist that this is a great time to be an investor. If you know what you are doing, of course.

Senate Democrats are attempting to push through a controversial plan to allow bankruptcy judges to modify the terms of troubled borrowers’ mortgages as part of a larger package of foreclosure prevention programs. Allowing judges to “cram down” loan modifications over the objections of lenders could raise interest rates on mortgage loans by 1.5 percent or more, industry groups fighting the proposed changes to the bankruptcy code say. If the bill caused interest rates to go up by 1.5 percent, payments on a $300,000 30-year fixed-rate loan would increase by $300 a month. The bill would also mean higher down payments for home purchases and increased equity requirements for refinancing existing home loans.

The above is certainly likely to make the real estate investing climate slightly worse off than conditions are now (low mortgage rates, depressed housing prices). On the flip side, there are some positive points that the new bill (S2636) is going to bring to the table, which hopefully can curb the foreclosure frenzy.

Some of these positive points include: $200 million for pre-foreclosure counseling, and giving the authority to the state housing finance authorities to issue $10 billion in additional mortgage revenue bonds to refinance subprime loans and provide mortgages for first-time home buyers.

Opponents of the plan say allowing bankruptcy judges to change the terms of mortgages after the fact will raise the cost of borrowing, in part because investors who purchase securities backed by mortgages will have less confidence in their ability to collect payments or foreclose on properties.

Well, project Lifeline was formally announced today by Treasury Department and the Department of Housing and Urban Development. As mentioned before, it halts for 30 days foreclosure proceedings for homeowners in default for over 90 days. The idea is to give homeowners and lenders some additional time to work out better loan terms.

It looks like so far it’s a pilot involving 6 of the largest players in the mortgage industry: Bank of America, Citigroup, Countrywide, JP Morgan, Washington Mutual and Wells Fargo. The hope here is that the rest of the lenders will follow suit. These 6 lenders have already been involved in the Hope Now alliance, an effort organized by the Bush administration, to keep subprime ARMs from resetting. The Hope Now alliance states that it helped 7.7% of 7.1 million subprime borrowers (or 545,000 borrowers) during the back half of 2007. This was done through permanent loan modifications (such as lower interest rates) and negotiation of repayment plans.

Unlike Hope Now, Project Lifeline addresses all mortgages, not only subprime. Project Lifeline does not apply to vacant properties, investment properties, or homeowners in bankruptcy proceedings or facing a foreclosure date within 30 days.

So the whole thing makes me wonder: If this actually a viable solution or is this a “photo op” for our politicians? After all, perception is everything, especially in this election season. And we are, after all, headed towards a recession… So it’s important to at least look like we are doing something.

Project Lifeline just may be a logistical nightmare for the lenders. How will they handle all these homeowners calling them over the next 30 days? And how will anything actually get resolved in 30 days? Borrowers and investors negotiating on their behalf have already been having a difficult time getting lenders to respond; short sales take “forever and a day” to negotiate. There are just too many foreclosures. And there will only be more.

And will homeowners actually take action? The real issue here is that there is limited incentive for those in foreclosure to do anything about it. Now that home values have plunged, many homeowners are “upside down” on their mortgages, owing more than their homes are worth, and having withdrawn all equity during the “boom times”. It’s becoming easier and more rewarding for the homeowner to just walk away. The proverbial ATM is empty.

As we all know, “what goes up, must come down”. By some accounts, home values are down for the first time since the Great Depression. Home values had skyrocketed over the past number of years, growing at a rate far exceeding average salary growth. So to afford the American Dream, citizens of America had to get into mortgages that overextended them, often getting into ARMs with low initial rates that were scheduled to reset, only delaying the inevitable. All for a chance at the American Dream! Can we blame them? And can we blame the lenders for trying to help (not saying that all lenders are selfless).

Even more disturbing is the natural propensity of our culture to use home equity as an ATM, forsaking all reason. It is not all lenders’ fault, even though it has become popular to point fingers at these “unscrupulous” bankers. These are just some of the reasons why we are in this mess. Call me cynical, but I really doubt that a 30-day time-out will do a whole lot.

Last week, Congress changed the conforming loan limit to as high as $729,750, as part of its Stimulus plan. This was part of the economic stimulus package signed by Congress and passed on to President Bush for signature on 2.7.08. This change raises the limit from $417,000 on maximum size of mortgages that Fannie Mae and Freddie Mac can purchase and market as securities. Same increases apply to loans backed by the Federal Housing Administration, a government agency that insures loans to borrowers with poor credit. So some loans that were considered jumbo are now considered conforming, which means lower mortgage rates.

The spread between conforming and jumbo loans had reached as much as 1% in recent weeks, because jumbo loans are considered riskier. Due to increase in mortgage defaults and nationwide credit crunch, banks have become more hesitant to create loans that couldn’t be later sold to Fannie and Freddie. Thus, higher interest rates were extended for these loans.

This new law affects investors and homeowners in 2 ways:

1) Firstly, it is designed to sell homes easier in higher priced areas, by making the mortgages more attractive to buyers.

2) Secondly, the lower rate will save homeowners money on their mortgage payments. Owners of existing mortgages can now refinance to a lower rate. What does this mean for investors? An opportunity to make some monthly cash flow! If you have a property that was bought at a jumbo rate, this is the time to refinance and perhaps see some cash appear in your pocket.

According, to AP, “Fannie Mae CEO Daniel Mudd said last week that over the past few years home prices rose so high in parts of the Northeast and West Coast, hiking the loan limits became necessary.”

The new increased limits, however, are temporary and are set to expire at the end of the year. It also excludes Fannie and Freddie from buying loans over the $417,000 limit made before July 1, 2007. However, old loans that are refinanced are considered new loans and thus can be sold to Fannie and Freddie.

It remains to be seen what impact this new law will have on home sales, as it applies to only 20 of the 160 metro areas in the U.S. Expensive real estate areas like New York and California stand to benefit the most from this plan. I suspect that reducing conforming limits simply brings mortgage rates closer to reality, to coincide with property values that had grown for years before coming to a screeching halt in 2007. I don’t believe that it will be easier to sell a house in excess of $417,000 than to sell a house under that amount: there is no shortage of either type of property out on the market. This is most definitely NOT a seller’s market. However, I do believe that allowing owners and investors to refinance will provide somewhat of a relief, and perhaps even save a couple of folks from foreclosure. I would be curious to see if it produces any positive cash flow for investors in my network.