Do I Wait For the Bottom to Buy?

What are we, as real estate investors, supposed to do?

Everywhere we look, we get news that “The bottom hasn’t yet been reached” and that “Things will get worse before they get better” etc.

We cannot deny the outstanding bargains available in so many markets right at this moment. But.. shouldn’t we wait for even better bargains?

In the meantime, it is not even clear what to do with our money. Savings? A tiny interest return, surely less than the real inflation, may cause a loss of money in real terms.

Stocks? Very unclear. Real estate actually seems like a very decent place to invest in right now, what with buying properties at half the construction costs and getting very solid cash flows. But will it get even better?

Well of course we don’t know what the future will bring. However a few points can be made:

1) There are markets in the country that have gone down quite a bit. The statistics tell us that Phoenix, for example, went down 34% from the peak (it was in today’s newspapers actually). This seems like a major drop – If a house cost $300,000 at the peak, today’s news tell us it is now only worth $300,000x(100-34)% = $198,000. This is based on serious study data. The media also uses data such as this when predicting (very possibly correctly) that values will still continue to drop. But here’s the rub: the market value of the house may well be $198,000 and it is possible that it will indeed keep going down to a market value of $158,000 (that’s ANOTHER 20% drop – more than most negative-minded experts are predicting, incidentally). However the point missed is that the neighboring house, of identical value, may have been seized by a bank. The bank may behave quite irrationally and offer the neighboring house for a ridiculous price of $120,000. Why would the bank do that? Well, banks could never be accused of exercising too much logic. These properties are sold by a bank clerk who may even get a bonus if a certain number of properties are unloaded. Does the bank employee necessarily care about the exact price? Perhaps not. In addition, holding the house keeps costing the bank money and it is subject to vandalism and other potential expenses. The bank may have considerations which don’t necessarily mirror the current market values.

As a result, there are many anomalous cases such as the one I described here. Buying the neighbor’s house from the bank for $120,000 is actually buying it for quite a bit less than the future bottom predicted by most negative-minded experts. So in essence there is a situation now where we can, at this very moment, possibly pick up houses for much less than the projected bottom prices of the future.

2) In our recent lectures we discussed the sellers’ mentality and how it changes on the way down towards the bottom, at the bottom, and after the bottom had been reached. When properties are still going down towards the bottom, sellers’ mentality is negative. Sellers may feel that time is “not on their side” and as the days go by, their properties become less valuable. Sellers feel a pressure to sell as quickly as possible, for a good price, before the properties go down even more and get below the current low sales price. The general thinking is negative – like right now.

How do we know that the bottom had been reached? The only way to know is when prices actually start inching up. In other words – recognizing the bottom can actually only happen in hindsight.

Right after the bottom had been reached, the media starts reporting that happy fact, and also reporting how prices are now starting to go up again. What is likely to happen to sellers’ mentaility? Isn’t it obvious that sellers will think more along the lines of “Time is on my side?”  and “the longer I wait the more I can get for my property”? Why would sellers, after the bottom is reached, bend over backwards to accommodate buyers? In addition, before the bottom is reached, buyers are scarce and sellers don’t wish to lose them. After the bottom is reached, buyers start jumping in in ever-growing numbers (fueled by the media, no doubt).  Isn’t it clear that a buyer is far better served buying before the bottom than after the bottom? Yes everyone would love to be one of the 2.5 people who actually bought at the exact nano-second which was AT the bottom, but realistically most buyers will purchase either before or after the bottom.

3) As I mentioned before, there are many markets where houses can be bought for a lot less than the raw construction costs. These are prices that are already below the intrinsic value of the materials and labor, even if we consider the land cost as zero (and it’s not). Unlike an expensive home that used to sell for $8M and now can be had for $5M but actually only costs $2M to build, there are places where the construction costs may be $180,000 yet the house can be had for $110,000. Buying well below the basic intrinsic costs is also a signal of great future value.

When is the bottom going to be reached? People can only speculate. Most experts talk about either late in 2009 or sometime in 2010 (especially with trillions thrown around in stimulus money from the government).  I feel that no matter when the bottom is reached, there is a window of time, possibly of one year, maybe one to two years, when the “perfect storm” of buying at anomalous prices set by hysterical banks, that bear little relationship to any real values, will be possible. I believe that investors who can buy, will most likely benefit by buying now, during that window.

No doubt, financing are harder to come by (especially if the investor already owns more than 10 properties), down payments need to be higher, and in some cases buying for cash may be the best strategy. However it is hard to ignore what is going on around us. Buying during this current window may be possibly seen, from a future perspective, as the best time to buy in nearly a century.

It is quite important to use realtors who will sift through the garbage and get only the houses that are worthy. Getting quality real estate and sitting on it for a few year while getting cash-flow,  may end up being  one of the best investment strategy for 2009.

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Missing Note Forestalls Foreclosure in Florida

Here is an interesting article sent to me by Liam Gillen from Orlando. It is from the Orlando Sentinel and is written by Mitch Stacy from Associated Press with a copyright to the Orlando Sentinel.

This is again a reminder of an issue that has been discussed a lot – that many banks have lost the original note. It is interesting to see that the mere request by the owner of the property to see the note, has stopped foreclosure proceedings in their tracks. While, as one expert quoted in the article, this may only end up being a “delay tactic”, it is still notable to see that banks are not as well-equipped to foreclose as they may appear to be. I believe issues like the one told in the article will play out more effectively in judicial foreclosure states such as Florida, where a judge has a determination of how the foreclosure proceeds. It would be interesting to get comments from experts in non-judicial foreclosure states such as California.

Sliced, diced mortgages buy owners time
Mitch Stacy | The Associated Press , February 18, 2009

Kathy Lovelace lost her job and was about to lose her house, too. But then she made a seemingly simple request of the bank: Show me the original mortgage paperwork.

And just like that, the foreclosure proceedings came to a standstill.

Lovelace and other homeowners across the country are managing to stave off foreclosure by employing a strategy that goes to the heart of the whole nationwide mess.

During the real-estate frenzy of the past decade, mortgages were sold and resold, bundled into securities and peddled to investors. In many cases, the original note signed by the homeowner was lost, stored away in a distant warehouse or destroyed.

Read full article on Orlando Sentinel

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Citi, J.P Morgan Agree to Foreclosure Moratorium

This is all over the news today. This particular report comes from  MEENA THIRUVENGADAM of the Wall Street Journal. Please see the article below.

I suspect all this wonderful stuff is for homeowners only. It will be interesting to see if there is a specific program for investment properties (my guess is no). The other point is if the lenders will automatically not foreclose on ANYTHING without bothering to check what is an investment property and what is not. Of course even if that were to happen (and it’s likely given the general chaos), the fact that a property is not a primary home will surface later, during the loan modification process. At that point there may be nothing available to the investor – at least not an official program.)

Citi, J.P. Morgan Chase Agree to Foreclosure Moratorium
 
By MEENA THIRUVENGADAM
WASHINGTON — J.P. Morgan Chase and Citigroup Inc. have agreed to weeks-long moratoriums on foreclosures as the government works on a financial stability plan slated to include billions of dollars aimed at keeping people in their homes.

“We will not add to the foreclosure process any new owner-occupied residential loans that are owned and serviced by J.P. Morgan Chase,” the company’s Chief Executive Jamie Dimon said in a Feb. 12 letter to Rep. Barney Frank (D., Mass.), chairman of the House Financial Services Committee. The moratorium on new foreclosure actions would remain in effect through March 6 and is similar to a 90-day foreclosure freeze J.P.Morgan announced Oct. 31.

“We believe three weeks is adequate time for the Treasury to announce — and for us to implement — a new plan,” Mr. Dimon said.

Citigroup in a statement said it would place a moratorium on foreclosures for all Citi-owned first mortgage loans that are on principal residences and on loans for which understandings with investors have been reached. The moratorium is scheduled to last until March 12 unless the government finalizes a loan-modification program before that date.

Lawmakers in a congressional hearing earlier this week asked the executives of some of the nation’s largest banks to institute a moratorium on foreclosures until the details of a revamped government bailout effort are announced.

U.S. Treasury Secretary Timothy Geithner on Tuesday unveiled the outlines of that effort and said details would be released later. Mr. Geithner has been meeting with other members of President Barack Obama’s economic team and the Secretary of Housing and Urban Development to discuss foreclosure prevention.

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Is a 25-30% Down Payment Acceptable for New Fannie Mae Backed Loans for Investors with over 4 mortgages?

Many investors are certainly rejoicing in the fact that they can now go in and purchase some ludicrously-priced houses and get good Fannie Mae-backed loans.
However for investors with between 5 and 10 mortgages, the down-payment requirement is 25-30%. Is that acceptable?
We have all been spoiled rotten when credit was flowing like wine and even investors with many dozens, if not hundreds of properties, got used to paying only 10% down.
Clearly those days are gone and every investor knows that 20% down is now the norm. This holds for people with under 4 loans as well.
That means that if an investor has 5-10 loans, the ADDITIONAL down payment is really only 5-10%.
One item to keep in mind is this:
When credit was easy and prices were high, such as in 2005, investors wouldn’t blink at buying a house for $275,000 and putting 10% down. This means the down payment was $27,500 (plus closing costs, of course). PMI was also part of the equation as an extra.
Today that same house, in the right markets, after cratering in price to perhaps $180,000, can sometimes be bought from a desperate bank for the absurd price of perhaps $115,000. 25% of $115,000 is $28,750. There is NO PMI and interest rates (for Fannie Mae backed loans) will surely be better than they used to be with 10% down (no PMI also helps the payments).
Thus despite the fact that the percentage of the down-payment is higher, the actual cash amount is virtually the same for the same property.
If you add to that the fact that in a few years, one can refinance the property for most likely 60-70% of the value at that time, it may be quite possible that after such a refinance one would actually get every penny they had put into the down-payment back. This is because the absurd lender-fueled prices are unlikely to persist for too many years. A property such as the one discussed here may very well be worth $200,000 in a few years (no one knows for sure, of course, but in this example $200,000 is not much more than the raw construction costs and thus is a likely value to be achieved once the bank panic subsides). If the house is indeed worth $200,000 in a few years, then even a 60% refinance will yield $120,000 - enough to pay off the existing loan and get back every penny that had been put as a down payment.
The new Fannie Mae guidelines are not perfect but they sure open the door wide to investors with over 4 properties. The down-payment requirement is not as onerous as some may reflexively think.
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Fannie Mae to the Rescue! Fannie Mae to Up Limit on Multiple Mortgages to Same Investor

This is hot off the presses: directly from Fannie Mae’s website.

Apparently Fannie Mae has reconsidered the loan limit for investors. I wonder if everyone’s efforts made a difference.

Fannie Mae will allow investors to hold 5-10 mortgages and still get Fannie Mae backed loans. This apparently will start as of 3/1/2009 and will be announced on Monday 2/9/2009.

The reserve and qualifying criteria for the 5-10 loan range will be more stringent, as well as the down payment requirements. Still – a major improvement over 4 properties. This should make a real dent in the uptake of the excellent deals available in some markets by experienced investors. 2009 is shaping up to be better already – at least for real estate buyers.

Announcement 09-02, Updates to Multiple Mortgages to the Same Borrower Policy, Reserve Requirements, Reserves Definition, and Form 3170 .

Read full announcement

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Sale of Tenant-In-Common Interests Must Comply With Securities Laws

Here is information that came from my friend Jeffrey Lerman, an attorney in San Rafael, CA. It is very relevant to sponsors considering setting up a TIC and for investors considering moving all or part of a 1031 exchange into a TIC share:

The Securities and Exchange Commission (SEC) recently issued a no-action letter taking the definitive position that Tenant in Common (TIC) transactions, structured either as a master lease or property management, are considered securities. Since the SEC has now stated, in no uncertain times, that these TIC interests are securities, prudent sponsors (any person or entity offering or selling TIC interests) will have to comply with securities laws, particularly with regards to disclosure and investor suitability. This is newsworthy because there has been much debate in the TIC industry over the last seven years as to whether a syndication involving TIC interests could be sold just as real estate or must comply with applicable federal and state securities laws.

TICs have been popular among investors as a way to own their investments. It allows two or more persons to own undivided interests in a single piece of real property. One of the primary benefits of using the TIC ownership structure is that it enables joint venture investors to each make their own decision whether they want to take advantage of the tax free exchange rules under IRC Section 1031 by exchanging currently held real estate for their TIC interests.

This ruling only applies to TICs involving “passive” investors (a passive investor just invests their dollars and are not actively involved in the investment; this is a complicated area and you should consult an attorney before taking any action). This ruling does not apply where all TIC investors are actively involved.

For all TICs involving at least one passive investor, it is now essential to get a solid, clear understanding of how to make sure your deals comply with applicable securities laws.

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Fannie Mae to the Rescue?

In light of recent efforts by Fannie Mae which include re-opening the discussions of the 4-property limit for investor financing (see post: Kenneth Harney on Rethinking Controversial Limits), and the short-sale speed-up pilot in Orlando (see post: Jerry Jackson of the Orlando Sentinel on Fannie Mae Short Sale Pilot ), there may be some hope that this agency is starting to wake up to its power to alleviate the housing market trouble in many markets. If cooler heads prevail at the higher level, we may see an easier time for real estate investor as well as reflief for people who truly need to dispose of properties. Both will be welcome developments during the current environment. Stay tuned.

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