Tis the season to not buy a home…fa la la la

Today, the Chronicle reported that the home sales fell even more then expected, and that the percentage drop is the biggest since 1968. (The story). People in the industry are calling for Congress to subsidize more mortgages stating it would lead to over 500,000 home sales.   However pockets of areas are showing great sales figures, such as places like Nevada or California, where sales are up like 40%.

If the sales figures are so high, then this to me indicates that money is in the industry being hoarded by investors till they see the right price. The subsidized mortgages assume easy lending standards of the past. People will still have to go through underwriting, and with weak economic indicators; this is not a slam dunk. People will have to show stable job history, good credit, etc. In this economy, credit scores are plummeting as people cannot afford the places that they have, lost their jobs, or simply are over leveraged. Who will be getting all these subsidized mortgages if most people who want their own piece of dirt have red flag that will not pass the muster, then who will be getting all these homes? Investors will be the primary beneficiaries. At that point, it is an illogical proposition. The purpose of bailing out failed mortgages is to preserver the American dream that every American can buy a home. 

Investors are just sitting back to find homes at bargain rates, as everyone tries to predict the bottom. Obviously investor money is fueling the sales in Nevada and California as well credit worthy home owners (the minority group that they are).   The system is just cleaning out the fat from the over inflated prices that existed in many areas. It is just a natural correction, however painful it is. 

I am not saying that some liquidity in the market would not be good for everyone. However, I want the public to be honest with who will benefit during those periods. It will not be the father and mother working three jobs to support their three kids.  Those individual just are not good candidates for banks to take a chance on.

Any bailout will have to provide liquidity or guarantees to provide a market to buy mortgages, which allows banks to divest risks.  If the Government bought these mortgages and got private firms to assist with renegotiations and collections, then the predictions made by some pundits of potentially discounted portfolios growing in value could come to fruition.  Banks will also have to build stronger controls for underwriting, and as foreclosures epidemic bottoms out venture to take smart risk.

Why would you ever do a “stated” income loan? Why would you do a “no doc” loan? Why did they do “zero down” loans for so many people? Why did mortgage brokers not have some kind of charge back or cost for every failed mortgage that they did?  There should have been some incentive for mortgage brokers to not get greedy and make every loan for fear of consequences. 

There are good hardworking people who deserve to get mortgages even in these tough times. The banks will have to once again take calculated risk on those people other wise they will simply not make the return on their velocity of money to justify their business model.  Banks must make more money then the cost of their capital (interest paid out on savings, cd, etc). This means that there must be some risk to help them gain the better margins.  Banks will also have to embrace methods to encourage drive by banking or online banking, so they can reduce cost and overhead.   Bank of America has great new drive through ATM, where they make the person put each check in one by one, and this makes the person assist in the scanning and sorting of checks. Customers now get on their receipts scans of each item deposited, which is great.  Banks will have to continue to make efforts like this that helps cut out overhead and also provides customers benefits as well.

 Banks are no different then the Big 3 automakers in that they got full on the success they had. Automakers in the US over loaded their portfolios with SUV’s and Trucks. They were totally unprepared for the shift in customer preference to gas efficient cars. Their visit to Congress was blasted for their pompous manner that they traveled to Washington. However, banks were no different. They cut back on doing due diligence and created complicated products that average consumers had no business using. Complicated ARM’s, Balloon Payments, and other exotic products had no business being offered to non institutional or “sophisticated” investors (based on standard used by the SEC for securities). Average working class people did not fully appreciate the risk that was inherent in those complicated schemes.  This is why going to back to some more traditional fundamental and due diligence will help restore sanity to the system. After logic presides, banks will realize that they will not survive hoarding there money for people who have 750 and up credit scores. 

Investors can still act in this market, but they might have to put more of their money in the pot. The days of 5% down payment is over. It may stifle some deal flow, but it hopefully will provide enough skin in the game for them to be prudent with their investors. Also, investors during due dilligence will have to determine their worst case scenario planning to see if a deal makes sense. Investors with a better head on their shoulders will help keep the market in check as we recover. 

Investors should know there are deals to be had and investments to be made. The key is to not avoid doing their homework on deals. Out of state investors must build  trusted network in the markets that they choose to do business in, but they should actually visit their property if at all possible.  Additionally, they should do more homework on rental rates and not try to analogize with their home market.  Different real estate markets have different rental rates and dynamics. I have seen too many investors tell me they bought homes or property based on a agents reports and with no real independent due diligence. The agent is paid on commission so any analysis has a tilt towards closing the deal in some cases. It would be good to have do your own homework.  You want to make sure that the data you review is kept with a skeptical eye and it is not spiked with over inflated assumptions. These over inflated assumptions will will haunt you later like the ghost of past real estate deals gone bad.

Enjoy your holiday, and Happy Thanksgiving!

Is relief on the way with the bailout? I am not so sure.

Many people are divided on the idea of whether the government should support private business. However as many investors know, the recent crisis in real estate has frozen all liquidity and created a slew of foreclosures that only a select few investors are seeking.

The Houston Chronicle today had an analysis by the AP about why the Obama team could help calm the markets, but it also discussed how the confidence has collapsed in the past few weeks (AP article). The article highlighted how the nature of the bailout changed from its initial scope of buying out the failed assets of banks to investing in banks that provide loans to credit for student, credit cards, and auto loans.  By changing the scope of the assets, the Federal government is trying to encourage spending and consumerism.  The unfortunate thing is that those policies do not encourage middle class and lower income individuals to learn how to save and promote fiscal responsibility. The belief that easy credit was available has created an economy where people lived beyond their means.

As a property manager, I have often talked to prospective tenants who are looking for homes. The thing is that most people have a distorted view of home ownership. I have seen people who are afraid of background checks for rental due to their credit issues, but they some how believe that they plan to fix their credit within a year or two and buy a home. Most of these people do not understand how difficult that the process of homeownership will be as we emerge from these difficult economic times. 

I have had prospective tenants who call for homes request “owner financing or lease to own” deals, but those types of deals are no longer an easy thing to get. Due to some changes in regulation, the rules of providing these kinds of deals are much more convoluted.  In fact, standard realtor leases have built in clauses that state that you should not write lease options in your standard lease. You have to go out and get a legal document (hopefully reviewed by a lawyer), if you want to pursue those types of deals.  People have to provide statements showing how much money is being applied to equity versus interest.  Additionally, you cannot provide contract for deed deals (where the purchaser gets no equity till all payments are made) here in Texas due to abuse by others in the past.  These reforms have definitely made those kinds of arrangements much more difficult to come by.

Moreover, with the scope of the bailout changing from saving failed assets to provide more liquidity, these assets will remain on the books of these banks. Banks do not provide upkeep or repair these properties. In certain areas with high concentrations, this could create a downward slide towards creating slums. I have a few investors who own condos in communities with high foreclosures, and this has created a very slum like atmosphere which has made it difficult to attract good tenants. The foreclosed units are often in very bad conditions with broken windows or often vandalized.  In fact, the units are often havens for squatters, and this only creates a spiral downward for the other units.  As tenants flee and owners sell, the prices for the properties start a downward spiral.

Now other threat looms, the city of Houston is working to close down complexes with high crime and other issues. The city puts the responsibility on the owners of these complexes to improve conditions, but many cannot afford to put in the high levels of security that are required to remove these elements, which then leads the city to foreclose those properties. In Houston, we have heard and witnessed several complexes that the city has held meeting with owners or threatened to close the complex.

What are the solutions? It is not an easy answer. The truth is that these large complexes will need to be bought by consolidated investor groups and then with consolidation of units create the appropriate tenant mix.  This is done by screening tenants (criminal, proof of income, rental history), enforcing eviction policy, and being willing to slowly fill up property to get that appropriate mix of tenants.  It is not an easy solution or quick fix. 

However while these assets remain in the hands of banks and liquidity is difficult to achieve, there will be for the foreseeable future difficulties for condo complexes.  Sometimes the best medicine is time, but not many people are willing to take the medicine because it is bitter.

Who do you rent to?

I run a property management firm, and the firm has the hardest time predicting good tenants. We have had to evict people of the clergy, old friends of the family, nice students. Predicting who will be good tenants is such a art that it is more like tarot card reading then painting. It is difficult to predict who will be good tenants.

What compounds the difficulty in predicting the tenant’s future is that at this point many people have blemishes on their records. On average, many people who rent often have credit issues, which is why they rented during periods of easy financing in the past.  I have learned from experience that finding a credit worthy tenant is extremely difficult.

Therefore, how long can you go before you have to compromise your ideals of the perfect tenant? This is especially difficult if you are seeking to rent out a property and use those cash flows to pay off mortgages.  How long can a investor hold out for the Holy Grail of tenants?

Many people often try to blame their realtors or property managers for a tenant who ends up being evicted. If the realtor or property manager does their due dilligence by searching for rental history, verifying application, criminal history, and verifying pay; then this is all that we can do. There are no psychological test that we can run to determine if someone is going to honor their lease. If big companies like Enron, GM, and others can possibly go out of business; then how can any person truly feel comfortable that their tenant will keep their word?  As my dad says about contracts, “a contract is only as good the word of the person who writes it.”

Today, in this financial environment; the difficulty in predicting only increases. Whose jobs are really going to be safe? Economist even in the local Houston market are expecting a slow down. With Real Estate slowing down and energy slowing down, the economy is descending (maybe more slowly than other areas). This only creates a environment where job security is not a sure thing.

I am not hear to state that screening is not a preventative. The more time that you do spend up front will decrease the percentage for issues later then those people who do not. To me it is similar to a medical check up, you may never see anything that worries on those visits, but that ounce of prevention may prevent you from developing a far gone case of heart disease later on in life.  Along that same analogy, just because you get a check up does not mean you will not develop heart disease.  This is the same issue that people face when selecting tenants. Screening may not prevent bad things from occuring, but it can definitely protect you from obvious red flag type tenants (multiple evictions, not enough money to afford the place).

Sell…no..dont sell… rent instead!

As compared to a year ago prices have fallen 1.6%, however this is a blessing compared to other markets which are dealing with prices falling in the range of 40%. Additionally, the Houston Association of realtors has stated that there has been also a decrease in the number of listings. This is creating some stability in prices of homes here, since that is helping us level out our prices with decreased demand.

I think that prices are holding stable as people are pulling off sales and turning them to the rental market. When many people are renting one home, they will shun using realtors and rent it out themselves. It is easy to manage a portfolio of one home for many people unless they travel frequently. 

However, it is difficult in this market to find good renters because of the uncertainty in the market.  The economy is uncertain and people are begining to lose jobs. If a person has a job today, there is no guarantee that they will have a job tommorow.   In addition, the last 10 years have created a easy credit environment, and today, many people are paying the piper.  Bankruptcy laws have become much tougher on individuals, so they are unable to shed bad decisions.  Additionally, now with banks and creditors suffering massive liquidity issues, people are unable to get easy transfers so they must pay back these incredible rates.

People must now deal with the fact that they have poor credit ratings , which will further limit the risk that banks will take on them in the future in regards to providing mortgages. This is only further limits the American ideal of every man owning their land to a more select few.

Even if prices fall, how many people can afford $100,000 homes? Who can afford to pay $3000 for property taxes on January 31st, 2009 in one payment? In the movie, “Its a Wonderful life”, Jimmy Stewart ran a small savings and loan that provided lots of loans to various people in his community.  However, we can’t trust a savings and loan to save us today because we bailed those guys out in the 80’s.

When does common sense prevail?

Yesterday, I was commenting how there is anecodotal evidence of the difficulty of getting mortgages.  On November 13th, Citigroup announced it was placing a moratorium on most new mortgages and was working on saving its current portfolio of loans. Forbes who reported this article that what has stimulated many foreclosures was a a negative equity position.

How does negative equity happen? It comes down to people violating the basic tenet of paying what a property what it is worth. The entire market was based on this one sided assumption of a always liquid and ever increasing market. In many markets, the price of a property often far exceeds its rental value. Often, when we deal with investors who request our property management, we find out that their break even point is often in excess of the rent that they can obtain. 

Often, the expected price is often far in excess of what market demands dictate. In certain markets, where there was a expectation of commuting and space to build outwards; people could find substitute homes which keeps the price of rentals down.  These dynamics were often overlooked by California or New York investors whose expectations were different then those of local Texas investors.  By not realizing the different assumptions, they often bought property in excess of our local rental market expectations.

One of the most common indicators of price of a property is to determine it is based on a multiple of income derived. This analysis is often a crude method, but if this ratio is skewed way beyond market prices, then this should cause some measure of reflection by investors. If the income does not justify the property, then what does? Most investors do not have the capacity to absorb cash flow losses for very long, so it is something that I wondering about when investors bring in these kind of deals for me to manage.

Hopefully, the investors learning in this environment try to find properties that they can afford and the price as a multiple of income ratio is not as dramatically skewed as it has been in past few years. Hopefully, common sense will prevail, and people will buy properties that they can afford.

Who can make money in this real estate environment?

In this current environment, we have banks that are struggling to stay afloat and homes being foreclosed on. For some savvy investors, this could signal a strong buy sign. As they often say in business, “Bulls make money, bears make money, and pigs get slaughtered”.

However, this environment will be different than previous ones experienced by veteran investors, especially those who gained their experience in more recent times. Traditionally, real estate is bought with debt, but with this credit crunch, this kind of leverage is proving difficult to get. There are many stories of creditor with good credit (above 650) now being denied the loans. For people seeking to buy their first homes or condos especially in the lower tier price ranges, this is proving to be mission impossible. 

For example, I have had a few condo listings that are in large complexes with a strong percentage of rental owners, and the condos cannot find a willing buyer. The thing is that the condos have a strong rental history and are cash flowing, but investors are finding it difficult to get loans to close on condos.

 At this point, investors have to come up with cash for the entire deal. 100% cash deals take some of the advantages that real estate provides in terms of effectively making money on other peoples cash. However, for those investors who have serious cash reserves this could create interesting buying opportunities since fewer people can close deals.  Since many sellers will be facing tighter pools, they may have to take steeper discounts to sell properties. Prices paid only a few years ago may not truly reflect market values in these austere times.

This may create situations where other investors may have to deal with the risk and issues inherent in partnerships or larger conglomeration of individuals to make deals happen.  It is going to be curious how this credit crisis will play itself out.

For some investors though, this could mean working to improve your credit scores while you wait out this crisis. Paying off debts, avoiding unnecessary expenditures, and improving how much money you could put down will all probably be words that many potential investors will hear over the near future.

Often as property managers, we have experienced investors who believe that the key to profitability arises when we take over the project. Unfortunately, some investors had already sealed their fate because they were over leveraged and did not have the finances to deal with issues that arise with getting property (make ready, deferred maintenance, etc). Maybe for investors buying in this period, they will have better grasp on what kind of deals they can truly take on.  Sometimes in the heat of the frying pan (that we all are facing), everyone can melt the fat off their bacons and come out a little healthier in the long run.