Will the Real Estate Investor Please Stand Up?

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.