Greetings From “bubble” Territory

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May 2009
Vol 32 No 8

GREETINGS FROM “BUBBLE” TERRITORY

         By dividing my time between Florida and Nevada, I think I lead a charmed life.  Both areas were right in the middle of the housing boom as retail values doubled about every three years.  And now, both areas are leading the Nation in Foreclosures, Bankruptcies, and falling house values.  I can’t believe that I’ve been so lucky.  Of course, being lucky could mean that I’ve had more than my share of good luck, or of bad luck.  Over a long and checkered career, I can honestly lay claim to both camps; but not during the past housing boom, nor during the current recession.  How can that be?  

         When prices were going up, we sold the houses with the biggest equities and bought into the rising market; but we sold houses with big equities at retail and used the cash we got by unlocking equities to buy as many houses with low equities as we could at discounted prices; taking title “subject to” reasonable, fixed rate loans.  This way, we got the benefit of the leverage that the former owner had obtained with his owner-occupied institutional financing when he bought the house, then used the cash we’d generated by selling rentals at retail to buy the equity at wholesale prices.  With prices rising at high rates every day, we marked up the houses and sold them as swiftly as possible, using the cash from the sales to buy back in as swiftly as we could.  This was a lot of work, but it made a lot of money.  

          Admittedly, we could have hung on to the houses that we sold as long-term rentals and collected steady, tax-sheltered, net income.  This would have required us to divert our attention from buying and selling to management, which for the past 15 years has been a relatively low-paying proposition compared to the potential profit that was available to those who bought and sold houses during the period.  This same equity that took years to build disappeared in just months once the Sub-Prime fiasco surfaced and everybody started trying to bail out at the same time.

          All during this period I exhorted readers of this letter and attendees at my seminars to sell their rentals as house prices rose, and to wait on the sidelines until the bubble burst.  Today, house prices have corrected too vigorously, swinging as far beneath historic values as they rose during the price bubble.  When prices suddenly reversed themselves and started back down, we found ourselves in mid-stride in our race for riches and got caught with a lot of unsold inventory, as did a lot of people.  The difference was that our inventory was free and clear so we could afford to rent it and wait; but doing so would have made things worse rather than better.  

          After some soul searching and head banging, we realized that the longer we held on to the houses that we had thought were going to make us more money, the more we were going to lose. So we bit the bullet.  By cutting prices to the bone we lost a fair amount of accumulated equity, but got out without being mortally wounded.  We use the cash that sales had generated to buy far superior houses at foreclosure sales at prices that fell a little more with every sale.  

     Today, we find ourselves doing pretty much the same thing we were doing during the housing boom.  We’re able to buy far below replacement value at foreclosures, and are able to sell at a profit in about three months for significantly less than MLS comparables or Appraised values before values fall beneath the price we paid for them.  I’m startled by the house values that we are able to buy at such low prices; and startled even more by the thin profit margins that we’ve been able to coax out of all those cheap, opportunistic buyers.  Still, I have been able to continue to buy and sell even as the media have been proclaiming the end of the housing world.

         There’s got to be moral somewhere in all of this.  I think it is that no matter what is happening in the market, there is always something productive to do.       
The only real losers are those who refuse to adjust to changes in the market.
 
THE YEAR OF THE WHEELER-DEALER

          The Chinese have a special name for every year.  I have dubbed 2009 as the year of the wheeler-dealer.  After all economic, financial, and housing bailout funds are spread around; and Obama’s tax hikes become law, we’ll have to make big changes in what we do.  For now, in any area where prices are falling – especially in Bubble areas – this is the worst time to be a long term investor; and the best time to be buying and selling to raise cash with which to exploit this market.  
 
          Let me recite a parable:  In late August, we bought a 4 year-old house in a newer subdivision replete with a long-term tenant willing to pay top rent for about $70 per square foot.  We were radiant over our good fortune.  Last month we bought essentially the same house just a few blocks down the street for about $40,000 less.  The only mistake we made was to hang on to the first house because of the terrific tenant that came with it.  Had we sold it, we wouldn’t have lost all the equity value.  Even if we could net $1000 per month in rents, forty months must go by before we’ll be able to recover what we lost in equity.  By selling and replacing it with the house we just bought, we’d still own a good house, but be $40 thousand richer.  That should be an eye-opener to you landlords who are in love with houses that are losing equity with each passing day that you continue to hold them.    

          On the other hand, consider house Wheeler-Dealers.  They are in the market every day either buying or selling, so aren’t concerned with whether houses are going up or down over the long term.  All they have to do is to buy for less than they sell for, whether the market is going up or down.  They do this primarily by turning their inventory over as fast as they can.  Unlike car dealers who pay high interest to carry car inventories that people can defer buying for several years, house dealers sell a survival necessity that people have to have.  Like it or not, people must either rent or buy their shelter; and pay market prices for it.  For basic shelter there is virtually no elasticity of demand.  Buyers and Renters will pay what they must and do without discretionary purchases such as new cars.  So long as population and net income are growing together in any area, house prices and rents will be driven by rising demand.  That’s what happened during the past boom.  The rental market should continue to tighten up where people are losing their homes.  

         Credit scores damaged by foreclosures or Short Sales will lock millions of  people out of the market unless they take title subject to existing loans through the use of seller financing.  At the same time, government programs are enabling defaulting owners to remain in their homes as tenants for relatively short periods.  This is going to create bulges in rental demand when thousands of former homeowners and tenants who are living in foreclosed houses have to seek lodging elsewhere.  It is only a matter of time before the landlord business will come roaring back; but it’s a little too early just yet.  In the meantime, we dare not wait for this when there is so much money to be made in the current market via buying and selling.  We should do this until we find we can’t replace houses we sell for less than we make.   

      The foundations for the next housing bubble are being created by the current Administration today by myriad short-sighted financial rescue packages combined with free money in the form of Grants.  Congress is mandating that banks lend out the new bailout money at low interest rates, and that FNMA buys the loans that are thus created.  City, County, State, and Federal governments are rushing housing assistance programs through their governing bodies as fast as they can.  It will take a year or so before the rubber finally meets the road, but the fun has started.  

     The new $8000 tax credit, plus other housing Grants, will bring new buyers into the market who will pay higher retail prices for houses they’ll be able to buy under the new programs.  Because foreclosure and REO sales require cash, active dealers will still be able to buy far below the retail cash prices we’ll be able to sell for in the retail housing market.  HUD has a 91-day seasoning period on foreclosed houses before they can be financed with FHA loans, but other programs waive seasoning, so we’ll be able to recycle houses faster.  The track is fast, and it’s going to get faster, but by aggressively selling and buying back in, you’ll do fine.
 
DON’T LET FEAR HOLD YOU BACK

         I rarely dwell upon possible dire consequences of my actions and decisions when something doesn’t work out.  Someone once said that “Ninety percent of all the things that might happen never do.”  Y2K pretty much demonstrated this.  I wasted a lot time preparing for an event that never occurred.  What I did wrong was to allow myself to be influenced by learned and respected leaders who were teaching me about something that I didn’t understand.  Today, the media and Internet are full of every kind of negative news, the result of which is to scare a lot people even though it might never directly affect them.  They seem to think that standing still and doing nothing is somehow preferable to continuing to do what they’ve been doing until it no longer works at their level.  I’ve learned from Y2K.  Now, I try keep my focus upon matters within my immediate view in my micro-economy.  I try to ignore those dire predictions that affect the macro-economy; about which I can do nothing.  

         I’ve always been more driven by what I think I can personally accomplish than by what somebody else thinks I can or can't do.  In 1972, I abandoned my promising career as a top salesman and opened my own residential Brokerage office at the worst possible time.  Richard Nixon had just reneged on America’s promise to redeem dollars with gold at $35 per ounce.  He also devalued the almighty American dollar by 10%, and instituted wage and price controls that triggered a very short, sharp recession.  In response OPEC was formed and gasoline prices doubled, so Nixon also started rationing gas to $1 worth every other day.  To make sure that the housing market would come to a standstill, he also froze both FHA and VA financing.  Conventional mortgage companies did not recognize the earnings of a spouse, nor could gifts exceed $3000 without triggering a gift tax, so buyers couldn’t buy. When credit finally unlocked, points on FHA and VA loans were as high as 11%.  That’s the propitious period in which I chose to open my own brokerage office.

          Without affordable institutional financing, I quickly discovered that I had to change the ways that I listed and sold houses.  Instead of offering them for sale, I sold houses on “Lease/Purchase” contracts for the full amount of the purchase price, which was divided between the existing loan which title was conveyed “subject to” and the equity.  Buyers only had to come up with a token down payment that just about covered the costs of settlement and title insurance.  

          The terms of the Lease/Purchase contract required buyers to apply for loans any time mortgage credit became available.  In the interim, I had to service the loans and to extract my 10% commission ratably out of the payments as they were made.  You can be certain that I was a very persistent collector during this period.   
I also stayed on the lookout for any kind of financing that I could round up that would enable the buyers to get a loan that would pay the seller and me off.  

          I soon came to the conclusion that the Brokerage community only seems to function effectively when things are looking up.  As in the current stock and housing debacles, Brokers were despondent.  Even today, they don’t seem willing to make the extra effort this market requires to represent buyers at Foreclosure sales, or to learn all of the “back channel” telephone and FAX number, or email addresses of those who work for mortgage lenders who can approve Short Sales or REO purchases swiftly.  The same held true in the 1970s in my area, so I got a Mortgage Broker’s license and began looking for money on my own.  

          I wasn’t trying to originate mortgages; instead, I spent my time looking for private investors who wanted safe, reasonable returns on their money. To get the word out to as many potential investors as possible, I contacted all the radio and TV stations in my area and offered to fill in on any panel where any kind of single-family house market insight would be acceptable.  I also contacted all the social and service clubs in my area and regularly made luncheon presentations about investing in houses and mortgages.  In addition to trying to find mortgage lenders, I started making the rounds of every small business to explain how owners could make more money letting me buy and sell houses for cash for our mutual benefit.

WHO WOULD INVEST IN HOUSES TODAY?
 

         Why aren’t more investors putting money into buy/sell house transactions?  It’s really a failure of wheeler-dealer public relations, of which there appears to be none.  Because of the intense competition in the house business, players tend to hold their cards pretty close to their vests. Nobody seems willing to find potential investors and to show them what they are doing, and could do with more money.  About the only source of information comes from trade publications and the Brokerage community; none of which is at all relevant to buying and selling houses for profit.  

         Millions of people use the news media as their sole source of information as to what is going on, and actually believe what they read.  Others rely upon the Internet (cashflowdepot.com) for their informational needs.  Learned writers of thoughtful economic articles that predict the direction and timing of markets are more prone to use graduate students’ sampling techniques to derive their data and rarely actually go out into the field to get their information.  But, those who have piled up enough money to be willing, able, and ready to invest in real estate today would have gone broke if they’d been willing to let others handle their investments.  Thus, their wealth wasn’t stolen or lost by incompetent financial advisers who didn’t have enough sense, at the least, to put stop-loss orders on their stocks or 401K accounts.  Despite all of the bad news, some investors were astute enough to get out at the top of the market with their cash.  They still have most of it.

         Those who were prudent enough to make money and keep it are confronted with a Hobson’s Choice:  They can either put their cash into one of those exotic CD schemes that purport to spread it around multiple banks so it will be covered by a broke FDIC, or to try to figure out a hedging technique to invest in the schizophrenic stock market; both choices would wipe out the purchasing power of their money when inflation starts back up.  They are looking for alternatives:

         About the only real choice for investors today is to buy into a business that can thrive in almost any scenario.  That is the wheeler-dealer house business can fill a need.  Profits can generate interest returns of around 12% secured by first mortgage liens on heavily discounted existing houses.  Or, investors can earn significantly higher low-taxed, or no-taxed, yields created by financing those who know how to buy and sell in today’s market.  If competition at foreclosure sales is any indication, there are a lot of people who know how to do this.

          The main problem for investors who have bought houses out of their area through other people is that they may be paying way too much; and once they’ve paid their money, the promoter disappears.  They’re pretty much cut adrift on their own; left to the mercies of the local vultures.  When they try to bail out, they discover that they paid too much.  When they sue, the hustler files for bankruptcy and they lose more money.  One such California Hot Shot just pulled this caper and left hundreds of investors high and dry.  Then he tried to attract more suckers after filing for Chapter 11.  Treatment such as this drives away many investors who would otherwise be willing to invest over and over if they were treated fairly.  

          Buying at deeply discounted prices through an agent at Foreclosure sales and immediately selling the house eliminates both overpayment and management problems; especially when those who represent your interests get well paid for doing so.  One Broker I know makes a pretty good living buying foreclosed houses for investors, fixing them up, and reselling them.  The investor takes all of the risk, and keeps all of the profit.  Our hero gets paid a flat fee when he buys a house with the investor’s money.  He gets an over-ride on all repair expenses paid to get the house in resale condition, he earns another fee when he puts it into MLS, and yet another fee if he sells it himself.  I would think that anybody in any area could do work this way with investors.  If you’re not a Broker, the investor can open an escrow with a third party who can lend it to you at sale when you buy a house, secured by the foreclosed house, then you can proceed as above.

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