Real Estate Investing in the Real World

How many houses do you have?

Christopher Smith (EquityScout.com) — Sun, 24 Aug 2008 14:16:17 -0500

The gaffe of the week goes to John McCain, when in an interview with Politico.com he was unable to remember how many houses he has.

Folks of all political stripes who read this blog will probably be willing to give Senator McCain a little slack on this one. We're real estate investors and we buy and sell properties. We might not have married a $100 million heiress like Senator McCain (or made $4 million off a lucrative book deal like Senator Obama, for that matter) but we can understand how LLC's and partnership purchases might turn a seemingly simple question into one that can be a little more tricky.

So my concern is not that Senator McCain was unable to rattle off the right answer. My concern was his startled, confused reaction. His rambling, mumbling response: "I think -- I'll have my staff get to you -- um -- its condominiums where -- I'll have them get to you." In today's complex world the ability to think on your feet and stay on message is an important prerequisite to being the President of the United States of America. The fact that Senator McCain was so visibly unhinged by this question will worry some voters.

I don't' think that the average American begrudges Senator McCain family their $100 million fortune; Americans don't resent wealth - we aspire to it. But folks who are struggling to make ends meet want to feel that the President understands their challenges, and those who have invested in the ownership society want a leader who will get the economy back on the rails. When Senator McCain facetiously quipped last week that $5 million per year is the cutoff for being wealthy, a lot of folks felt left out of the joke.

I feel that we facing an immediate future of complex economic challenges - one in which prudent real estate investors will be comparatively well positioned. But in the end the returns that we realize will be linked closely to the fortunes of our fragile economy, which in turn will be heavily impacted by gas prices and - ultimately - oil.

Oil is an international fungible commodity, and therefore oil prices - the single more important driver in our economy - will be largely outside of our control. The biggest factor in what will happen with oil prices lies in direction of international stability, or lack thereof. Neither party talks much about this particular elephant in the room - the reason being that both parties realize, rightly, that there isn't much that we can do about it. Our recent adventure to send our Armed Forces to the Middle East to spread freedom and democracy isn't entirely to blame, but it has been an exacerbating factor that has undoubtably made things worse and weakened our influence, both politically and militarily.

In the future there will be a link between what we do overseas and our economic fate here at home - and it's a new relationship that will be strikingly different from what we've seen in the past. As retired Army Colonel and Niebuhr scholar Andrew Bacevich writes in his excellent book The Limits of Power, our economy can no longer be sustained by expansion abroad enforced by our military. As a former military officer myself this is a new way of thinking. I now tend to put less of a premium on "experience" as traditionally defined; I want a leader who can see the new patterns as the world continuously rewrites the rules.

So while I can forgive Senator McCain the fact that he doesn't know how many houses he has, I am more concerned about the prospect that having spent decades as a fabulously wealthy United States Senator has dulled his ability to identify the shifting currents of the new world economy.

Smart investors are honest investors

Christopher Smith (EquityScout.com) — Thu, 27 Mar 2008 11:30:15 -0500

Ethics in investing is a topic that I’m interested in. This is one that I’ve written about before, both in the press and here in this blog . It’s one that I don’t think gets enough airplay – but the lessons of ethics and investing are the subplot to many of the other ideas and strategies that I write about on this blog.

Here are five discrete thoughts that have emerged from experiences that I’ve written about recently.

Honest investors are fearless investors: I have a lot of philosophical reasons for being honest, but I also have a practical one: I’m not clever enough to keep a web of deceptions straight in my head. That’s too much work. And as I tried to show in yesterday’s post, a deception which one commits doesn’t disappear. Ever. It sticks around; you can’t un-ring a bell. But honest men have no fear of such things.
Ethics is good business: Honesty, truly, is its own reward. Honesty is the foundation of relationships, and relationships are the foundation of business. Honest business people can at times feel that they’re at a disadvantage (how can you break even if you never screw anyone but others screw?) but it’s my observation that the world doesn’t work like this. The short term gain that one may achieve through some slimy deception or half truth rarely translates into a long term gain.

Race in America

Christopher Smith (EquityScout.com) — Tue, 18 Mar 2008 21:18:47 -0500

Regardless of who you support in this election - Senator Clinton, Senator McCain or Senator Obama - this is a speech that you should watch in its entirety. I have never before heard a politician speak this directly, or with such subtlety and complexity, about this important issue facing our nation.

The problem with the speech is that it will be blasted into a dozen Fox-news sized ten second snippets, and a truly honest discourse on race in America is not a topic that can be reduced into sound-bites.

If you're a supporter of Senator Obama's then listen critically. If you're not then listen with an open mind. Either way - listen.

Foundation problems might present an opportunity for Real Estate Investors

Christopher Smith (EquityScout.com) — Sun, 10 Feb 2008 08:44:13 -0600

Plumbing, Foundation. Roof. HVAC. These are the big ticket items when you're doing a physical inspection on a potential investment property.

Most investors are part timers. Most of us are somewhat good with our hands and know something about houses (we all live in houses, don't we?) So three of those items might not scare us too much when they arise. We've all replaced a faucet or two. We all do maintenance on our own AC systems. Most of us have had a roof replaced.

But sloping floors and crooked door frames will send us running for the hills. But consider this: all foundations are not created the same - so all foundation problems are not created equal.

You get below-market-value purchases by pursuing properties that have scared off other investors...[READ MORE]

Real Estate Investors :: Five approaches to today's soft market

Christopher Smith (EquityScout.com) — Thu, 07 Feb 2008 09:19:57 -0600

Here are some ideas to give your clients who investors wondering what they should do next. Hold 'em? Fold 'em? Walk away? Run? Or double down, maybe...

Well lots has been written on how our current soft market is hitting homeowners. But it’s not so easy to find anyone addressing the issue that looms largest in the minds of most real estate investors: what should I do now?

There is no single right answer to that questions – it all depends on your local market, your appetite for risk, your view of the future, and the length of your runway - how long you have before retirement. But in my opinion there are five basic courses of action for investors in 2008:

1: Rebalance equity in the same market. This is the path that I’ll be following this year. Investors who have been in the market and were well positioned during the run-up will be sitting on a pile of equity that probably isn't going to perform too well in 2008. So it’s time to re-leverage: sell and invest back into properties that will give you the right cap rate. Although it’s not a lot of fun selling in a soft market, when you’re both buying and selling at the same time then it’s a wash. Price your property right and it will sell – and at the same time look to buy a property at the same sort of discount.
2: Lift and shift. If you’re in a market like Florida, Las Vegas, Las Angeles or the San Francisco Bay Area then you might be concluding that your market has run it's course and the future might look a bit less rosy. Some might be tempted to try to hold on until the market turns around returns to the peaks that it enjoyed during the peak of the roller coaster ride, but a better idea might be to cash out now, take that equity and re-invest in a region that is less overvalued. Investors like Jeff Brown in San Diego are pushing this type of strategy, moving investors from CA to TX.
3: Bargain hunt (speculative version). Fifteen years from now they’ll be asking “what did you do during the market downturn?” Well unless you have your crystal ball up and working you don’t know now what the best answer to this question will be just yet, but investors with a speculative attitude are watching out for the bounce. Again, this is a speculative view. Not that there’s anything wrong with that (as they say on Seinfeld) – as long as you're aware of the risks you're shouldering. There’s nothing as dangerous as someone who thinks they’re an investor but in reality they’re acting like a speculator.
4: Bargain hunt (value version). Regardless of your view of what’s going to happen next, in many markets the current correction is creating some great value deals – properties that you can pluck straight form MLS that will generate a positive month-to-month cashlfow with only a 10% down payment. You won’t be seeing many of these in, say, Las Vegas. But you will in Fort Worth, Tulsa, and Kansas City. You’re not looking for the dip with this strategy – you’re just poking around in a relatively favorable market for positive cashflow investments. If the market bounces then great. If it doesn’t then you’re in good shape to weather the storm.
5: Ride it out (do nothing). Good traders acknowledge that sometimes their best trade was one that they didn’t do. Strategies 1 and 2 require you to have underperforming equity redy to re-deploy. Strategy 3 is for speculative high-rollers, and Strategy 4 only works if you’re currently living in the right kind of market. So what if you fall into the “none of the above” camp? Well...patience can be a virtue in investing, and I’m not in the “now is always the best time to buy” camp of real estate investors. Waitingn for the market to show it's hand might be the right thing to do.

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Real Estate Investsors :: Shop the two-for-one sales

Christopher Smith (EquityScout.com) — Wed, 06 Feb 2008 22:23:26 -0600

A reader who goes by the handle “Max” made a comment the other day that got me thinking. There’s a concept in pop business theory called the Peter Principle which states that managers tend to get promoted to their point of incompetence – taking on bigger and bigger responsibilities until they eventually get to the point where they’re over their head. And this, ironically, is the point where they tend to stick.

In discussing the concept of leverage, where an investor builds a profitable portfolio of investment properties over the year by occasionally executing a 1031 exchange, the Peter Principle might be relevant. As Max points out, you don’t want to get in over your head.

There’s something to this. There’s an implicit assumption that over the course of your investment career your ability to manage the complexities of larger properties and a greater number of tenants will increase. Additionally, you will also put yourself in a position to make judicious use of property management services. But at some point an investor needs to know how to say “enough”. Smart investors need to recognize when they’ve gotten to that point.

But often they don’t. And if you can find one who has gotten beyond his comfort level then you may be in a position to negotiate a great purchase. There’s a phenomenon I’ve noted which I call the “two-fer” sale – keep your eyes open for these. From time to time I’ll notice two similar properties which hit the market simultaneously. Sometimes they’re FSBO’s, and you’ll notice them if there are two identical FSBO signs on the same block. In my experience, this is a sure sign of an investor who paid for some expensive Rich Dad type motivational seminar, and in a wave of enthusiasm and empowerment hit the streets and bought the first two houses he could get a mortgage for. Essentially, this investor hit the Peter Principle very early in the game. He wants out.

Two-fer’s can be a great opportunity. If you can find a reluctant landlord who’s struggling with the negative cashflow drain of two vacant properties, you negotiate a great bargain by saying you’ll take both of the properties off his hands: I’ll take ‘em both for $XXX,XXX. And that should be a really low combined price. But the reason that this tactic works is that you’re making the seller’s problem disappear in its entirety. This can make the seller shift into “cut my losses” mode in one fell swoop.

This is a tactic that works. This is how I bought the two properties (FSBOs) a few years ago that I’ve recently vowed to sell as my New Year’s resolution. And on the buy side I’m looking at a couple of similar opportunities as we speak.

So the Peter Principle is a sword that cuts both ways – so make sure you’re on the right side of this trade.

Real Estate Investors :: What's next?

Christopher Smith (EquityScout.com) — Wed, 06 Feb 2008 21:57:52 -0600

As investors we’re not out there spinning the roulette wheel; we’re looking at the underlying fundamentals and taking measured risks. That said, investors do need to take a view of the future in order to make decisions in real time – and BusinessWeek’s recent cover story gives the housing market a timely and even-handed overview.

You’ll see some of the boilerplate that you’ve read before, but pay attention to a reference to an influential paper written by Harvard economist Gregory Mankiw which back in 1989 predicted a precipitous decline in housing prices. The premise was that a shrinking body of first-time buyers along with a glut of downsizing baby boomers will collectively pull lots of demand out of the market, leading to an excess of supply and a sticky plunge in prices.

Regardless of whether or not you pay any attention to the experts’ predictions it’s important to have a view on what’s next; you can’t invest without having an opinion about the future. Personally, as prices slide and interest rates drop I’m actively pursuing multi-family opportunities. I don’t know that prices won’t continue to drop, but locally I’m also seeing strong demand for rentals and, in some cases, higher rental rates. According to the National Housing Council , rental rates are up 3.36% in Houston. Combine that with the fact that housing prices have slipped by 2.38% over the last year and you have a market in which an already competitive rent-to-value ratio has gotten even better. That, for me, is an acceptable risk.

Rental rates in some major markets are up even more: 8.87% in Dallas (accompanied by a big 6.18% slide in property values). Notably, some higher value markets like San Diego and Miami are showing strong double digit increases in market rents, but even with a little help you’re unlikely to find buying opportunities that will yield breakeven cashflow in those areas.

I’ll talk a bit more about the Center for Housing Policy’s recent press release on housing affordability in a post tomorrow.

Immigration and Real Estate

Christopher Smith (EquityScout.com) — Wed, 26 Dec 2007 13:34:22 -0600

We're so accustomed to having our intelligence insulted by politicians that we rarely complain about the dumbed down worldview that we’re spoon-fed by both sides of the political aisle. The partisan mudslinging that we’re subjected to these days makes it hard to imagine a world in which candidates might campaign by voicing nuanced, well articulated views on the complex issues facing our country. That’s too much to ask for, but at least we get to watch the primaries, which offer up the entertaining spectacle of Democrats savaging fellow Democrats and Republicans bashing Republicans as they fight for their respective nominations.

But there are a couple of issues that I think we should all hold our candidates to a higher standard. One of these is immigration reform.

Even the language of immigration reform is fraught with semantic landmines. Do you talk about “illegal aliens” or “undocumented workers”? Do you open the discussion with allusions to Ellis Island or by invoking 9-11. Is this about security or fairness. Economics or the American way?

But it's safe to say that we're all interested in the state of our economy and national security – these are two tides that lift all boats. And as real estate investors – we’re more interested than most in how the housing market weathers the current storm, not to mention how we operate as landlords and as consumers of labor intensive services like roofing, landscaping and construction.

More specifically – as politicians target employment, benefits, and housing as keys to the illegal immigration question, some municipalities have proposed legislation which would hold landlords accountable for policing the residency status of their tenants. These are bad laws.

The reality of the situation is that it is difficult to take a complex issue like immigration reform and turn it into an effective sound bite, so it’s rare that we see a candidate discuss immigration with any subtlety or insight. But when I hear anyone address immigration I’m listening for a couple of key things…

Does the candidate acknowledge the complexity of the issue, and our society’s complicity in creating it? George W. Bush has lately become fond of invoking our society’s dependence on foreign oil. This is a step in the right direction (although the solutions proposed are all wrong – that’s another post) but as a society we’ve yet to confront the fact that we’re also addicted to imported labor – especially when it comes to difficult, physically intensive, cheap, dangerous work. When I walk into a construction site, a rehab project, a house that’s being cleaned for showing, or a landscaping job I without fail see a group of workers made up almost exclusively of immigrants. Always. Granted, this fact is exacerbated by the fact that I’m in Houston, but many readers will find this to be a familiar observation.

I live in a suburb where the residents, generally speaking, are more inclined to lean towards the Tom Tancredo school of immigration reform than the Hillary Clinton view. But if you walk this neighborhood on any weekday you’ll see the streets dotted with landscaping and housekeeping crews made up of employees who are in the country illegally. It's interesting that the "Assault on America" philosophy of immigration reform is so successfully sold to those socially conservative families who every week enjoy a beautifully manicured lawn for $35 a pop - courtesy of the invaders.

Does the candidate appeal primarily to fear? In recent years folks who live in my neighborhood here in Houston have been subjected to some of the foulest, ugliest campaigning I can remember as Hubert Vo (D) and Talmadge Heflin (R) squared off for a seat in the Texas State House of Representatives. They both took the low road on numerous occasions on various issues; one of them was immigration. This ad to the right (actual scan of a flier which landed in my mailbox) won the prize for the crassest. According to Heflin, his opponent was so uninterested in the general public safety that if he won then Osama himself would eventually stroll into a local Texas Department of Motor Vehicles and get a drivers’ license.

Heflin lost the election in a very tight race, and I like to think that there were at least a few voters, like me, who were pushed into the opponent’s camp because they were angry about having their intelligence insulted.

Does the candidate talk about people? Immigration is a human issue. Immigration is about people. I think most of us would agree on how we should treat an illegal alien who slips into the country to sell drugs. But how do we treat an undocumented worker who has spent the past twenty years toiling in a Tyson chicken processing plant, paying social security, contributing to his community, and raising his kids who were born here and are now in high school?

If we were to wave a magic wand and magically deport all 12 million people residing in our country illegally, every restaurant in Houston, San Antonio, Los Angeles, Las Vegas, Miami, and San Diego would immediately close. Our crops would rot on the vine. Poultry and meat would disappear from our supermarkets. Hotels would shut down. Residential level construction work will grind to a halt.

Some of these industries would eventally recover – but at a great increase in cost to the consumer.

So ask youself: is the candidate presenting the issue to me in all its complexity?

Related Posts:

Big Oil and Real Estate

Christopher Smith (EquityScout.com) — Wed, 19 Dec 2007 20:59:19 -0600

An economic indicator that I consider occasionally is one from the Global Insight quarterly study on housing prices in America. Here’s an interesting tidbit from the most recent report: of the 330 markets surveyed, Houston is the most undervalued.

The study uses many factors in determining the theoretical price equilibrium level for each regional market, including taxes, income, population density, and a somewhat ambiguous “desirability factor”. So, as with most all economic studies there is an element of art mixed in with the science. Nonetheless I think this study is an insightful data point when thinking about the relative valuation of varioius markets.

The fact that Houston is scored as the single most undervalued market is interesting when viewed in light of the underlying economic factors and the stark difference between the market’s reactions now with the past. When we think about real estate bubbles most of us immediately focus on California, Las Vegas, Florida, and other markets that have grabbed newspaper headlines with their flying prices over the past several years. But we forget that the poster child for real estate market corrections was Houston in the mid-to-late 80's.

Texans hip to irrational exuberance long before Greenspan poopularized the term. When the Gulf States kicked off the Arab oil embargo in reaction to the West's support for Israel in the Yom Kippur war, the resulting rise in oil prices fueled oil investments. This, in turn, pushed property values to unsustainable heights. Everyone wanted their own Southfork Ranch.

Fast forward to current day. Two rounds of war in the Gulf, rocketing demand and decreasing supply have again sent oil prices into the stratosphere; and this time around the increases have more fundamental sustainability than before. Cash is flowing into operational oil centers like Texas and Oklahoma. But, the property market hasn’t responded. Yet.

The graph below shows the Department of Energy refiner acquisition cost of imported oil.

Will property values in Houston and other oil centers go up? In the short term, perhaps not. Economic storm clouds and a jittery credit market will help to continue to keep a lid on the prices ... READ MORE ...

How passive real estate investors leave money on the table

Christopher Smith (EquityScout.com) — Sun, 09 Dec 2007 21:37:32 -0600

In A Brief History of Time, Stephen Hawking refers to a publisher’s rule of thumb that states that every formula that a writer includes in a publications will cut his readership in half. Well real estate investing is based on relatively simple principles - especially next to the stuff that Hawking researches- but there are some RE investing concepts that can be communicated a bit more effectively aided by a few equations and numerical examples. So bear with me - with this post I'm going to crawl through some numbers and risk turning off a few readers...

I mentioned in a recent column that when real estate investment starts “getting good” – when it starts generating some cash and putting some dollars in your pocket on a monthly basis – then that’s when it's time to sell. This might sound counter-intuitive, but let me give some examples that show why it is true.

Based on simple price appreciation, the stock market beats real estate hands down. Over the past twenty years or so the S&P 500 has gone up at an average rate of almost 10 percent per annum. The NASDAQ has appreciated at over over 11 percent per anum. Over the same period the average single family home in America has appreciated at around 5.6 percent. So why do we get so excited about real estate? Because it allows investors to prudently use leverage to increase her returns. And why should we consider selling a property just when it starts kicking off cash? Well, that's because this is a good sign that your leverage is running out of steam.

Consider a simple example. An investor puts 20% down on a $100,000 property. The investor starts out with $20,000 equity on a $100,000 house, giving him 5-to-1 leverage. Meaning: if the house appreciates by 5% that's $5,000 - a 25% return on the initial $20,000 investment. This is a basic concept you’re probably familiar with.

As time passes by two things will probably (hopefully) happen: a) the property will go up in value (a good thing) and b) your loan balance will decrease (also a good thing). But there’s an unintended by-product: a decrease in your leverage.

The diagram assumes an 8% fixed rate mortgage and an annual appreciation rate of 4.5%. Note that this isn’t a bad investment – in 15 years the initial $20,000 produces over $120,000 in equity. That’s an annualized rate of return of about 14%, which is considerably better than you'd expect out of the stock market over the same duration. But consider what happens to leverage (right axis). By year 5 around $4,000 will be paid off of the loan. And assuming that 4.5% appreciation rate, the property will have increased in value by around $24,000. That adds a total of $28,000 to the equity in the property – so now there is $48,000 tied up in the house.

In summary:

Initial leverage: $100,000 property ÷ $20,000 equity = 5 to 1 leverage
Five years later: $124,000 property ÷ $48,000 equity = 2.6 to 1 leverage

But, there is another strategy that will allow investors to considerably increase their returns over the long run wil acceptable risk. Read more to find out how...

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Real Estate Fraud :: a Case Study

Christopher Smith (EquityScout.com) — Thu, 25 Oct 2007 17:22:04 -0500

I got some interesting emails from readers responding to my recent posts on real estate fraud. Here’s one of them (posted w/ permission from the author, with names and minor details changed):

Chris,
I was approached by an acquaintance, Phil, to invest into a get rich quick scheme. I was to be the buyer and mortgage holder for two houses, but all documents and paperwork would be mailed to Phil’s residence and Phil would be responsible for all mortgage payments and monthly maintenance fees. I was promised a gift of cash in exchange for using my good credit. All was good for several months, and then I started receiving calls from American Servicing Company for non-payment.
Unfortunately, being very trusting of Phil, I did not ask for copies of any documents that I originally signed. Phil kept everything. At this time, I don’t know what to do. Phil does not return any phone calls. As of today, the two residences are unoccupied. Please, any advice is welcome.

___________________________

First of all, I'm not a lawyer and laws/property codes vary from state to state. This shouldn't be considered legal advice. You need to contact a lawyer.

A couple of things that I would do were I in your situation.

1) Don't ignore the mortgage company. Regardless of what happened between you and Phil it appears you’re currently on the hook for these mortgages. Call the lender.

2) Get ready to go to trial. I understand that you don’t have the paperwork, but you must have some documentation that a deal was done...receipts for cash payment, etc. Get these together, along with a written narrative of what occurred, and discuss these with a lawyer.

Now I'm guessing that one of two things might have happened here....

Non-evil Phil case: Phil got all fired up from attending one of those Rich Dad Poor Dad seminars or some other such motivational pep rally. Then, realizing he had no credit, talked you into backing one of his deals. Phil overpaid for the houses, realized he couldn't lease them out, ran out of money, and buried his head in the sand. Now your phone is ringing off the hook as the bankers are looking for their money, which you owe. It's possible that Phil didn't set out to rip you off, but he abused your trust and, in the end, skipped town.
Evil Phil case: Then again there are lots of ways to rip someone off in a case like this. Example...Phil found a seller selling his house for $100k. Phil offered $110k on the condition that the seller kicked back $10k at closing. The seller got his price, Phil pocketed $10k, and you’re stuck with a $110k mortgage on a house that's only worth $100k. There are many, many other schemes. It's possible that Phil is a genuine scumball.

In hindsight (not helpful, perhaps) there are lots of problems that led to this. The most important are a) you got into a deal that you didn't really understand, and b) you can't rely on trust; you need a contract.

This probably isn't much help, but at this point the horse is out of the barn. Call a lawyer, deal with the mortgage companies, and good luck.

Real estate shell game - part 2

Christopher Smith (EquityScout.com) — Wed, 24 Oct 2007 21:49:11 -0500

I've written a lot recently on real estaet fraud, to include posting a schematic of a popular investment collusion fraud that is plaguing many communities.

Unfortunately there are many variations on this theme. Here's another scheme that real estate con men are using to bilk investors:

Whether you're an investor or a real estate professional it pays to know the basic mechanisms of these schemes so you can identify them when they start popping up in your community. Check out this YouTube video which profiles some victims of the scheme.

Recognizing Fraud :: Real Estate Shell Game

Christopher Smith (EquityScout.com) — Sun, 14 Oct 2007 12:58:24 -0500

Volatile markets create opportunities for entrepreneurial investors. Today's housing market is a good example. Subprime problems, foreclosures, sliding prices - all of these factors are generating opportunities for investors who have an eye on the long term.

On the flip side, however, the smell of money will bring unscrupulous con artists out of the woodwork and into your neighborhood. These characters prey primarily on unsophisticated new investors who are looking for a quick buck, but they can target more expereinced real estate professionals as well.

Do you know the warning signs?

Most professionals have a general idea of how the basic collusion scam works, but here it is laid out in its five basic steps. There are a lot of varriations on this general setup, but this is the basic plot:

It's not just the buyer who gets bitten, it's the whole community. Bogus appraisals and sales drive tax values up, burdeoning nieghbors. Boarded houses start popping up as properties fall into foreclosure. And it gets harder and harder for the residents of the community to sell their properties as hones buyers are driven away.

Are you a Landlord or an Immigration Agent?

Christopher Smith (EquityScout.com) — Sun, 30 Sep 2007 16:37:49 -0500

As the presidential election approaches, the issue of immigration - primarily illegal immigration - will shift further into the spotlight. This has implications for all of us, but it may have a particular relevance for buy-and-hold real estate investors.

Across the nation local municipalities are attempting to enact legislation which would hold landlords responsible for verifying the legal status of their tenants, and would impose heavy penalites on any landlord found to be providing housing to an illegal immigrant. From the landlord's point of view, this is a tough issue. I live in a border state. Regardless of your political affiliation it's clear that illegal immigrants are woven into the economic and social fabric of our society. I'm trying to envision operating under laws which require me to evaluate an applicant's legal status. Is that SSN bogus or real? How about that ID card? Or the driver's license?

There is an unfortunate solution that many landlords will resort to: just don't rent to applicant who seems "suspicious". Meaning...minorities with accents need not apply. This, obviously, is a law that invites investors to turn to discriminatory practices.

I'm not a policeman and I'm not an Immigration Service agent. That's not what I do. I'm a real estate investor, and part of being an investor is to offer safe, affordable housing - places where families want to create homes - and to do so profitably. Landlords should strongly oppose laws which seek to turn us into government enforcement agents. This is not something I'm trained to do, and I have neither the tools nor the resources to do it properly and fairly.

These laws are bad. As landlords we should be vocal in our disapproval when they pop up in our states and towns.

Are you a landlord or an INS agent?

Real Estate Investors :: Managing the Eviction Maze

Christopher Smith (EquityScout.com) — Mon, 17 Sep 2007 10:17:42 -0500

Generally speaking, our housing laws were designed primarily to protect individuals and to regulate powerful interests. That sounds like a reasonable proposition, but one day most long-term investors wake up and realize "hey...in the eyes of the government I'm the powerful interest!"

So, Mr. Landlord, when you run into a problem with a tenant who doesn't pay or who trashes your property you might feel like the deck is stacked against you. But if you're familiar with your local housing laws (which vary from state to state) and play by the rules you'll find that you can get through the eviction process in as little as three weeks.

The procedure as local variations, but here's what it looks like in Texas:

In my opinion the key step in this process is the first one: filing the Pay or Quit notice or the Cure or Quit notice. If done right this can be just the nudge (or kick in the backside, as the case may be) that can help your tenant realize that the first check he pays every month needs to be the one that keeps a roof over his head. A clear, well worded letter with just the right threatening tone, followed up with a phone call, can work wonders. And, it's a required step if you want to proceed with a full eviction later.

Related Links

Investors get fingered for their role in shaking the market...

Christopher Smith (EquityScout.com) — Thu, 30 Aug 2007 13:46:21 -0500

There's an element of the American psyche dictates that for any event a specific cause has to be identified – and even better if that cause can be pinned on particular actor. Accountability is a important, but unfortunately it often segues into a “who’s to blame?” attitude.

Case in point: as the sub-prime market melts down and prices slip sideways (or worse) who's to blame? How about real estate investors and speculators? Read more...

Investors :: historic drop in the national median house price, what does it mean to you?

Christopher Smith (EquityScout.com) — Sun, 26 Aug 2007 19:51:27 -0500

I have previously written how there has never been a national correction in the U.S. real estate market. Well what we’re looking at now is not exactly a national correction, but it is a noteworthy occurrence nonetheless: we’re marking the first year-on-year national decline in median home prices since governmental housing agencies started keeping statistics on pricing.

The reason that this doesn’t necessarily represent a national correction is that even though the national median is down, there remain some regional markets that have continued to rise. As investors we know this and we’re watching our local markets.

The New York Times comments about the housing number, and two things pop out at me from this article. The Times does refer to the current market as a national decline, stating that the statistic contradicts “widely held notion that there is no such thing as a nationwide housing slump.” This clearly is a statement that was written by a journalist, not by an investor. As I've stated above, it simply isn't true.

A second annoyance is that the NYTimes article is chock full of predictions, from the likes of Moody's and Global Insights. Predictions by economists are notoriously un-useful.

But a decline in the national median might be significant if it contributes additional confusion and fear to an already volatile lending market. Liquidity has already started to dry up in some areas which pulls competition out of the market. This is bad for sellers, but it's good for buyers. You bargain hunters out there looking for a quick flip better have better confidence in your crystal ball than I have in mine, but buy-and-hold investors in undervalued markets should be on the lookout for solid positive cashflow investments that will weather the current storm with some upside once the market turns - whenever that may be.

After all, real estate investing is all about money...

Christopher Smith (EquityScout.com) — Fri, 10 Aug 2007 11:14:45 -0500

As an investor I spend a lot of time thinking about money, and I've found that my my ideas about the topic have shifted over time. Money, in my opinion, isn't the key to happiness. However, being overwhelmed by it (or the lack of it, as the case may be) can very well be a key to unhappiness.

In terms of importance you can compare money to oxygen: having lots and lots of it won’t necessarily make you happy, but when you don’t have enough it’s hard to think about anything else.

The concept of hedonism, in modern usage, is often associated with vice and amoral excess. Even the term Epicurean has this connotation, even though Epicurus, the thinker for whom the term is named envisioned pleasure primarily as the absence of suffering. So actually the idea of hedonism originally had an air of responsiblity to it. Meaning: indulgent times today leads to less fun things tomorrow – be it lots of credit card debt, a root canal, an unwanted pregnancy, acid indigestion, or that extra twenty pounds that’s magically materialized.

Two things brought these thoughts to mind today. First, I’m reading Milan Kundera’s excellent novel Slowness, which discusses the topic. And second: I just ran across an excellent photo essay about money at SavingAdvice.com. I found it insightful and funny.

Related links:

Real Estate Investors :: Time to buy? Ask yourself this question...

Christopher Smith (EquityScout.com) — Thu, 02 Aug 2007 14:07:10 -0500

So, what do we do now…?

I've written posts on the folly of forecasting. A current case in point is the diverse buffet of predictions for the housing market, each one served up by an highly qualified expert running a complicated economic model. Try Peter Schiff of Euro Pacific Capital who is predicting a fifty percent collapse in some overpriced markets. A bit more optimistic? Try out David Wyss from Standard and Poor’s who is predicting for a more modest 8% drop. Or if you’re really in the market to buy then the expert you want to listen to is Lawrence Yun, senior economist from the always-sunny National Association of Realtors, who tells us that “…further declines, if any, are likely to be modest given the accumulating pent-up demand.” The only thing this forecast is missing is a smiley face emoticon.

So if the experts aren’t helpful in giving us a heads up on the market’s immediate future then what’s a real estate investor to do? Perhaps it is the right time to sit on your hands and wait it out, but it is possible that it is the time for action.

In these cases I look out my own window at the local market and ask myself one question: am I waiting for the bottom or am I waiting for affordability?

If you’re waiting for the bottom them it might be the right time to start searching for deals. If you’re waiting for affordability then you might want to hold off for a while.

I’ll explain:

Bottom fishing: I had the opportunity to see Pete Sampras play at Wimbledon back in 1997. Of all the incredible things that I remember about that match one thing stands out: Pete always knew when a ball coming his way was out of reach and he didn’t try for a shot that he couldn’t get to. There’s an analogy here for real estate investors. When you’re aiming to buy at the bottom the only thing that you know is that you won’t ; you’ll buy too early or too late but either way you’ll never hit the bottom of the price trough. So why try?

If you’re bottom fishing then you’ve already reached the conclusion that a recovery is looming. So don’t try to time it. If market conditions are such that you can get a good price from a motivated seller, and bag an investment that yields positive cashflow then it might be the time to go for it.

Waiting for affordability: You might find yourself thinking gosh, prices have risen so fast in the past few years it’s just natural that we're finally getting a bit of a correction. If they just dip a little more then it will be a great time to get in.

If this is your view you’re probably betting on the good old days coming back again; this is a a highly speculative postion. Investors with this viewpoint often live in markets where it is impossible to find a real estate investment that produces positive cashflow – and in this type of situation a property must experience booming appreciation rates in order to yield a decent return. These markets, in my book, get the yellow light.

Don’t fit into either of the camps above? Then what signposts do you look for…?

Will Short Selling be the "new Flipping"?

Christopher Smith (EquityScout.com) — Fri, 20 Jul 2007 16:23:20 -0500

Well it seems like it was just yesterday that the TLC Channel was launching Flip That House while A&E TV was premiering Flip This House. Note that these were different shows – I suppose targeting unique target audiences who were interested in either that house or this house. Capitalism and free enterprise brings choice to the public, ain’t America grand?

Now that the housing market is off its tear in most regions flipping has lost some of its shine. Maybe one of the most telling indicators that the pendulum has started to swing is that accusations of fraud are popping up even in the sanitized world of reality TV. One Flip This House participant evidently didn’t even own the properties that he allegedly was flipping for big bucks. If you can’t trust what you see on reality TV then whom can you believe these days?

All of this submitted as evidence of a fact that we already knew: flipping isn’t investing, it’s speculating. Not that there’s anything wrong with that (s they say on Seinfeld) but it’s important to acknowledge that flipping is a speculative technique that works if the market is zooming and the buyer has a healthy risk appetite.

But that’s all so 2006, so what trend are they going to selling us next?

Well one person's pain is another one's profit, so expect the focus to shift to short sellers and pre-foreclosure investors. Not as groovy as the high rolling world of the flippers since it requires the investor to deal with the unpleasant task of negotiating with folks who are having their home foreclosed, but in an environment of flattening prices and embattled mortgage holders short selling can work.

Quick primer: The bank doesn’t want to get stuck with a foreclosure. I’m always irritated when I read these exposés about banks licking their chops to kick old ladies out of their houses and sell it on the auction block the minute she gets behind on her payments. The truth is that a foreclosure is a black eye to a bank. Banks don’t want to own houses, especially one that has been trashed by a foreclosed owner.

If the owner is getting foreclosed on a house with no equity then there isn't a lot he can do. Say the house has a current value of $150 thousand and he owes $160 thousand on the mortgage; he can't bail himself out by putting it on the market.

Enter the short seller. He makes a deal w/ the owner to give him the house (and the debt) and at the same time cuts a deal with the bank that he’ll pay, say, $125 thousand for them to release the lien. Voila, everyone is happy: the investor bags a quick $25 thousand in equity, the owner avoids the indignity of being foreclosed, and the bank avoids the cost, time and bother of trying to sell the property –which probably would have cost them more than the $35 thousand it just wrote off.

Note that this is nothing new. Investors have been doing it for years. But it about to be the new thing which will be promoted online and in the media.

If the flipping phenomenon was vulnerable to fraud, this one will be as well. Two reasons:

It’s difficult: Making profits flipping houses in a rising market is as easy as falling off a log. All you need is the right level of risk appetite and lots of guts and initiative. Making profits off of short sales and pre-foreclosures is hard. There are a lot of details to these deals and pulling them off requires knowledge, negotiating skill and patience.
I'm just here to help: Short selling means dealing with vulnerable, distressed sellers. Short sellers promote themselves as investors who help people - and indeed many of them are good, decent people. But investing isn’t an altruistic pastime, and when a dishonest investor comes into contact with a troubled owner who is looking for a lifeline there is a potential for bad things to happen.

I’m trying to look into the crystal ball on this one. I’ll revisit in a couple of months…

The current glut of real estate agents is bad for the industry

Christopher Smith (EquityScout.com) — Tue, 10 Jul 2007 15:33:27 -0500

I wrote in a recent post that real estate investors who sell via Realtor will end up overpaying. If you pay a $12 thousand commission check selling a $200 thousand property it's highly unlikely that you've actually gotten $12 grand worth of time or effort out of the agent. And the idea that "the buyer doesn't pay a commission" is a myth since the seller will have to pass on a healthy portion of this expense.

This isn't to imply that agents are raking in the big bucks or that they're greedy. To the contrary - I've worked with a lot of agents and many of them are supremely competent and professional. But agents, as a rule, don't spend their time selling and buying houses - they spend their time trying to build a business and trolling for leads, which is time consuming and expensive. All this gets bundled into the 6% commission which the customer has to shoulder.

So the customer pays too much, and many agents still struggle. What gives? The answer, simply put, is too many agents.

But there is a strange phenomenon at work here. Normally a glut of supply for a particular service will cause the price of that service to drop accordingly. The price should reset to a new equilibrium point, offering better value for the consumer. But in this case the NAR leadership has done everything in its power to resist market forces: from monopolizing MLS data to aggressively defending the current commission structure to encouraging legislative hurdles to keep the banks out of the real estate game.

This is a self-defeating strategy.

I spent three years living in Bogota Colombia - a beautiful city with wonderful people. But...the traffic is terrible, and the main cause is the fact that there are too many taxi cabs. But because there are too many taxis and not enough riders the drivers have to work morning, noon, and night to make a living. And the fact that they're all working so much just perpetuates the cycle of oversupply of taxi cabs - made even worse because the long hours looking for riders causes them to use even more gas individually, which in turn puts upward pressure on gas prices due to supply and demand. And so on, and so on. It's a downward spiral.

Same thing's going on here in real estate. Market booms lure more and more agents into the field, all fighting to sell the same number of houses. No one wins. And the industry's leadership has bet the farm on defending the status quo instead of encouraging new models.

::So...what's next?

A new business model will show up eventually. The consumer will demand it. Will it be Zillow or Redfin? This question reminds me of a now forgotten company that I bought stock in back during the dot com boom. This company was working on a groundbreaking new technology for recording and storing music called MP3. I knew that this technology was going to be big, but unfortunately I bet on the wrong horse. Apple applied their marketing savvy and design expertise and created the iPod. The stock I bought tanked.

So...I got the general idea right but picked the wrong company. Will Redfin or Zillow win. Maybe. But the odds are against it, in my book. If I were the betting type I'd wager on someone from left field. Citibank? Or Google?

Related Posts ::

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Update 12 July: I've gotten some feedback, both via email and via comments , that this post might be encouraging ActiveRain members to engage in inappropriate behavior with regards to discussing commissions.

To be clear: my statements refer specifically to structural inefficiencies in the Real Estate market which make it difficult for Realtors to economically price their services below a certain level. While I do believe that the current level of market inefficiency is bad for the consumer, I want to specifically state that I do not believe that Realtors are engaging in any unethical activity with regards to pricing - nor would I encourage them to do so.

Agents should be sensitive to FTC guidelines and steer clear of any statements that could be construed as colluding with fellow agents to establish commission levels. If you have any questions about the issues please refer to Caleb Mardini's post on the subject. --Chris

Three principles to remember when negotiating real estate deals

Christopher Smith (EquityScout.com) — Mon, 09 Jul 2007 17:01:48 -0500

Investing in real estate is all about dealing with people - so developing your people skills is a critical and often overlooked component of investing. With all of thet talk about cap rates, foreclosures, flipping and mortgage options there's a real dearth of material out there about negotiating.

Good negotiators are students of human nature, and they learn from every interaction. I've mentioned in previous entreis that I'm a fan of the book Getting to Yes, the most famous product of the Harvard Negotiation Project. As I've negotiated various deals - both in real estate and in other fields - I've found it to be a useful practice to make a conscious note of how the guy on the other side of the table reacts to various situations. In the end, a key to being a successful negotiator is initiative, backed by a fearless, transparent honesty.

But this only works if you can manage to put yourself in the other guy's shoes and understand what's really motivating. Not the surface stuff...what's really underneath.

In my experience there are a few constants that tend to run through any negotiation. This tends to form my starting assumptions when I'm trying to reach an agreement.

People are motivated primarily by fear. Greed plays a role, as does ego - but fear is the thing that really drives peoples decisions and actions.
While price is important, it's usually not the most important thing. More times than not the guy on the other side of the table can live with 10% more or less on the price - what he's really terrified abou tis looking foolish or being taken advantage of.
The guy on the other side of the table isn't evil or dumb. And he's not out to get you. If you find yourself thinking that he's evil or dumb then you need to look under the surface and figure out what's really driving his behavior. Get into his head and use this to your advantage.

The devil is in the details, though: I've also written about some specific real estate negotiating examples.

Two roads to wealth :: which one will you pick?

Christopher Smith (EquityScout.com) — Mon, 02 Jul 2007 11:59:25 -0500

I'm not a big fan of "get rich" tomes, something I discussed recently in my post on Kiyosaki's Rich Dad Poor Dad series. But an exception is Stanley and Danko's excellent survey on wealthy Americans: The Millionaire Next Door.

This isn't a new book but it reamins relevant as it has a lot of messages that Americans need to hear and internalize. As a society we do a great job of consuming, but not such a great job of saving and investing - as our reliance on social security shows us.

Stanley and Danko take a very different apporach to Kiyosaki on almost every issue related to wealth: material things, work, education, motivation and more.

Why I don't like Kiyosaki's Rich Dad, Poor Dad

Christopher Smith (EquityScout.com) — Tue, 26 Jun 2007 17:10:14 -0500

It’s impossible to deny Robert Kiyoski’s success with his famous Rich Dad series. Go to Amazon.com and you’ll find almost fifty books, tapes and related paraphernalia on offer; Rich Dad in English and Spanish, Rich Dad for women and for kids. Even Rich Dad in Chinese. But it’s hard to beat the DVD Rich Dad’s 60 Minutes to Getting Rich. Kind of expensive at $79.99…but hey that’s a small price for wealth in 60 minutes, right? Boardgame anyone? Only $149.99. Plus tax.

Kiyosaki has a lot of enthusiastic supporters – and a lot of them are Active Rainers – so I might not win a lot of fans with a post like this. But...in case you haven’t guessed...I’m not a Rich Dad fan. Clearly he’s been wildly successful selling books and tapes, but I’d argue that the wisdom that he dispenses him his folksy tomes isn’t what the vast majority of Americans needs.

These books feel good, and that’s their allure. But I compare them to the weight loss industry. Take a look at Hoodia, Anatrim, Slim-fast...pick your poison. A seductive sales pitch is great – but what these customers really need is to change their lifestyle, not a pill.

But changing your lifestyle is a bummer. It’s hard. And that applies to getting your credit in shape and changing your spending habits just like it applies to getting more exercise and indulging in your favorite culinary vice in moderation (mine’s ice cream).

There’s a genius to the series, though. Kiyosaki does a great job of making an emotional connection to the reader – a requirement for any serial writer (have to keep the readers coming back). To his credit he is going to have a positive impact on some people – if he gets folks off their backsides and gets them to thinking about their financial futures then that’s a good thing.

But the problem is that there isn’t much substance here. Kiyosaki’s mane premise is that you get to be wealthy by buying assets. But the truth of the matter is that you can go broke in a hurry by buying assets – you can only get to be wealthy by buying the right assets. And that’s not splitting hairs…selecting the right assets involves skill, discipline, knowledge, hard work, etc. Education helps. So does a bit of luck. This is change-your-lifestyle stuff – not the stuff of best sellers.

However, Kiyosaki dismisses a formal education – the best education that a young person can make - as a waste of time and commences to dispense chapter after chapter of truisms and folksy anecdotes. That’s fine if you’re looking for motivational prose, but if you want nuts and bolts practical advice then go for Mclean and Eldred’s Investing in Real Estate. Boring stuff for the most part, but it's excellent, solid advice.

read more on Kiyosaki and Rich Dad .......

Should "speculator" be a dirty word for real estate investors?

Christopher Smith (EquityScout.com) — Sat, 23 Jun 2007 18:40:04 -0500

A while ago I wrote an entry here on active rain and on my real estate investing blog about the difference between a real estate investor and a real estate speculator. My view is that either approach may be right for you, but the danger comes when you think you're doing one and you're actually doing the other.

Some of the comments I got prompted me two write a few lines in defense of the real estate speculator. Great investors from Warren Buffett to T. Boone Pickens have always focused on fundamentals, but they've also shown a willingness to take a view on the future. In my view, that's ok.

Here are a few things I keep in the back of my mind:

Buy what you know: Raise your hand if during the .dot com boom you bought stock in a company that you weren't quite sure exactly what they did. If you sold all your shares of webvan and pets.com at the pre-cash peak then you walked away with some fat capital gains...but if you're like most of us then you rode it up then rode it all the way down. If you're going to take a view on something make sure it's a market that you know intimately. I recently made such a purchase - a foreplex in a hot area w/ marginal economics - but which will turn out great for me if the city puts in a proposed light rail line that will pass within a few blocks.

Be ready to lose: Speculators win big and they lose big. Don't bet more than you're willing to lose. Did you read about the Florida couple - an administrative assistant and a carpenter w/ a combined $90k salary - who took out $750,000 in financing to buy three investment properties? You don't want to be like these guys.

Flippers are speculators: Flippers are made by rising markets and broken by falling ones. This is a bet on a factor that is outside of your control as an investor.

Buying in an overheated market? You're a speculator. If you're buying in a region where $400k buys you a starter home that rents out for $2,500 per month then the only thing that will allow you to get a decent return on your money is rocketing price appreciation. If you catch the market right then you'll be in great shape, but almost all purchases in these regions are purely speculative.