Getting Started in Real Estate Investing

Many people would like to invest in real estate.  Housing prices have plummeted; rates are at historic lows.  You can actually buy cash-flow investment property in California!  It’s a great time to buy real estate.  But how do you get started?

There are several ways to invest in real estate.  You can buy investment rental property, or purchase in an interest in an investment company.  You can buy single family homes, apartment buildings, REOs, fixer-uppers, or even raw land.  Or, you can purchase tax liens, options, or notes.  Thanks to the credit crunch, you can also invest by loaning money secured by real property.  There are several strategies, such as:  “buy and hold,” “leveraging,” “flipping,” “wholesaling.” for maximizing profit:  flipping, “buy and hold,” leveraging, wholesale contracts.    For the new investor, it’s like learning a new language.  There are literally dozens of books and articles in the library, the bookstore, and on the Internet – it can seem very overwhelming!

A word (or two) about risk.  All real estate investing involves risk.  There is no such thing as a “risk-free” investment.  You can learn to manage risk, and take steps to reduce risk – you cannot eliminate it.  Each individual has their own personal risk tolerance level.  While getting started, consider what would happen if you lost your entire investment.  As you gain experience and confidence, your tolerance for risk will probably increase, along with your ability to reduce the risks inherent in any investment.  An important element of risk management is to avoid problems, whether they are of an economic or legal nature.

There is not enough room here to explain everything you need to know about real estate investing, but a few pointers will help you get started.  I strongly recommend new investors should attend real estate investment seminars, talk to other investors, and read books and articles on real estate investing.  Learn the language.  Consider a low-risk, short-term investment and try it.  You will learn more “by doing” than anything else.

First Step:  Make a Plan.  The most important step is to consider both your personal and your financial goals, and develop a Plan.  A good Plan will focus on your goals.  Goals must be realistic.  Your plan should be flexible, and contain an exit strategy.  Be sure to have a Plan before you write your first check!

Your financial goals should support your personal goals, not the other way around!  Determine where you want to be in a few years down the road:  in a new home; retired; or not worrying about the kids’ college tuition.  Your financial goal should be to earn enough to help you reach your personal goals, plus a little extra for emergencies.  Remember, good investment plans take time – there is no single perfect investment, despite what some promotional ads try to make you believe!

Second Step:  Do your Research.  You don’t need to be a genius to make money in real estate investing, but you need to be smart.  And you can get smarter.  Again, I recommend that you attend real estate investment seminars (like SJREI) and talk to other investors.  Warning: Be wary of motivational seminars that try to sell you investment products, books, software programs, and CDs.  Listen.  Learn.   But don’t buy everything they sell -or say!   Invest in real estate – not gimmicks!

Remember, there are many different types of ways to invest in real estate.  Focus on those that you understand and are comfortable with.  When you are getting started, avoid complicated schemes, and stick to simple.  Achieving a level of comfort and success with one type of investment activity or another requires practice and patience.  Smart people learn from their mistakes.  Really smart people learn from other people’s mistakes!  (Hint:  everyone makes mistakes.  Try to make small ones, not big ones!)

As you learn more and gain confidence, you may choose to modify your Plan.  Make adjustments to keep your Plan realistic and achievable.  Establish a realistic timeline for your financial goals.  Modify your Plan to help ensure that your Plan will remain current and relevant.  For example, you might choose to modify your plan to invest out of state, or to team up with other investors.  The key to survival is adapting to a changing environment, and a smart investor must be prepared to adjust their investment strategy in response to changing economic conditions.  Remember: It is important that your Plan include an exit strategy.   In addition to doing Research on your strategy and a more specific investment proposal, you should develop a reliable “team” of professionals you can rely upon for timely, relevant advice.  Most successful investors have a team of tax specialists, real estate agents, attorneys and other professionals they work with on a regular basis.  They are often well-worth the cost of their services.  You can use the knowledge you gain from your professional advisors over and over.  The rate of return on your investment in professional advice is priceless!

Other steps to take:  Research the market and local conditions.  Fact-check information you get at seminars.  Remember: If it sounds too good to be true, it probably is!  Don’t rely on obsolete  information.  A lot has changed in the past two years – check the dates.  Learn as much as you can about the local market, demographics, and conditions.  Get local information:  use the Internet, but don’t rely on what you see online.  Find local newspapers, churches, and realtors, and talk to someone “on the ground.”

Finally, as part of your research, don’t forget to make sure the investment is consistent with your financial and personal goals.  If not, STOP.  Ask yourself:  “Will this investment get me closer to my financial goals?”  If the answer is “No,” step back slowly from the checkbook!  If you don’t have enough information to answer the question, you need to do more Research, modify your Plan, or find a new investment.

Third step:  Action.  Invest, don’t spend, your money.  If your ultimate plan is to make money investing in real estate, invest in real estate – not in sales pitches.  Remember, there is no such thing as the “perfect” investment. When getting started, it is okay to proceed slowly and deliberately, but you need to proceed.  Take a deep breath, get going, and keep an eye on your exit strategy!

Getting started is important.  Getting started on the right foot is even more important!

Loan Mod Catastrophe Can Be Avoided

Is the glass half full or half empty?  Or is it the wrong glass?  On October 8, Treasury Secretary Geitner announced that the Administration’s loan modification program was on target to help 500,000 households avoid foreclosure.  On October 9, a Congressional TARP Oversight Panel released a crtical report that predicted the Administration’s program would, “in the best case,” prevent “fewer than half of the predicted foreclosures.” (NY Times 10/10/2009).  Who’s right?

The problem, of course, is that no one really knows.  The program, which requires completion of a three-month “trial” period for a homeowner to qualify for a “permanent” loan modification, is still in the infancy of the implementation period to provide any meaningful statistics.  According to the NY Times article, as of September 1st, only 1.26% of trial modifications had become permanent, and the plan had produced only 1,711 “permanent” loan modifications.   Many of these so-called modifications involve only a short-term reduction in rate with no reduction in principal, and leave the homeowner upside down with no hope of qualifying for a refinance.  With many Option ARM loans due to reset, and thousands of new homeowners who just entered the market to take advantage of the 3.5% FHA down payment and the $8,000 tax credit, the stage is set for a new wave of delinquencies if the job market continues its current trends.

Another problem is the so-called “shadow inventory” – the homes that should be on the market at a trustee or foreclosure sale, but are not.  The evidence is empirical but not necessarily reliable.  Stories abound of homeowners who have not made their mortgage payments for months, but who have yet to receive a Notice of Default fromt their lender.  Perhaps some lenders are waiting to see how their first round of “trial” modifications play out.  In some cases, the sheer volume of applications has overwhelmed the loan servicers, forcing delays stretching into months while the applications are “under review.”

Bruce Norris recently attempted to calculate more precisely the extent of this phenomenon, noting that the number of Trustee Sales had dropped despite the ever-increasing number of delinquencies.  In July, 2009, he reported the number of Trustee Sales in California had dropped to slightly more than 17,000, compared to almost 29,000 in July of 2008.  Based on the number of deficiencies, the number of Trustee Sales should have been almost threetimes as many – 52,700!  Running the numbers over the past year, comparing delinquencies vs. trustee sales, Bruce Norris calculates that there are approximately 306,329 additionalhomes that should have gone to trustee sale in California.  If the rumors about delinquent homeowners who haven’t even been added to the list are even partially true, the discrepancy would be even higher.  And if the best the Administration’s Plan can hope to achieve is “less than half” of the predicted foreclosures, the prospects for success are indeed dismal.  Any grade less than 50% would not be considered acceptable under any circumstances.

Rising unemployment, overwhelmed and untrained loan servicing agencies, and a continuing refusal to provide adjustment for actual market value, are all ingredients for failure.  Add a few scoops of Option ARM resets, continuing chaos in the appraisal system, and a whole new crop of FHA-backed minimum-down mortgages to the mix, and you have the classic recipe for a catastrophe.  On the national level, the conflicting statistics only generate fuel for debate over policies and programs.  But at street level, families and neighborhoods continue to suffer from the collapse of a complicated securitized mortgage marketing scheme that should not have been allowed to take over and replace a more fundamental but functioning system.

What most homeowners facing default fail to grasp is that the investors who hold or control their mortgage have absolutely no incentive or interest in “saving” the homeowner from default.  All that matters is the value of the Note, and in any particular situation involving a portfolio consisting of hundreds or thousands of individual Notes, which in turn comprise security for an investment held by shareholders, the decisions whether or not to modify the terms are made — not for the benefit of the individual homeowner — but purely and simply on the basis of the impact on the value of the portfolio overall.  Complicating this process are multiple layers of IRS, SEC and similar regulations and restrictions that limit the extent to which the portfolio managers can make adjustments without putting the shareholders — or themselves — at risk.  As it is, the best a lender can tell a homeowner in distress is that they will do a “charge off,” effectively shifting the financial burden for the loss from the lender to the borrower.  While it sounds like a huge break if the lender “forgives” a $100,000 Note, the lender gets to write off the loss against other gains, while the homeowner faces the prospect of a $40,000 tax bill via a Form 1099.

There are solutions out there.  Modifying the tax codes and restructuring the securitized mortgage market dynamics would take too long and would offer little in the form of timely relief.  I like Bruce Norris’ concept of returning to the days when an investor could buy a property by assuming the existing loan.  It would be a simple transaction, and return control of the housing market to people willing to work to make it succeed, instead of faceless institutional speculators amassing unmanageable volumes of security instruments that bear little relation to the properties they represent.  Investors would be permitted to manage their risk more directly, and more importantly, homeowners would have the opportunity and the incentive to participate in the process for a successful outcome.  It provides the opportunity for a classic “win-win” that would save families, preserve neighborhoods, and restore communities.

Forecast: 100% Chance of Uncertainty

In a recent article published on September 18 in Forbes Magazine, “Where Home Prices are Hitting Bottom,” author Francesca Levy attempts to make sense out of recently compiled housing price data produced by a Mountain View research firm,, in effect trying to explain where and how different Metropolitan Statistical Areas (MSA) would be hitting “bottom.”  The data focused on whether the number of homes selling at a discount had declined or held steady.  Presumably, if the number of homes selling at a discount was declining, the argument could be made that the housing market in that specific MSA was close to the “bottom” — and a signal to investors to buy.

Four days previously, Ms. Levy had authored another article in Forbes, entitled “Where Home Prices are Likely to Rise.”   In that article, Ms. Levy reported on a housing price forecast produced by Moody’s  As reported, Moody’s calculations were based on long-term demographic and economic fundamentals, changes in income and population, and supply and demand.  Overall, the prediction was for a nationwide 16.08% decrease in prices by the end of the year, but by 2014, prices “will have nearly reverted to their pre-2009 state.”

For San Jose, the article says that the five-year forecast calls for a 23.04% jump in prices; however, that will follow another 25.14% decrease within the next year!  Housing markets in Texas will not see much of a climb, but then they also won’t experience much of a decrease.

As I’ve fondly quoted Yogi Berra:  “Making predictions is difficult, especially about the future.”  The Forbes articles make for interesting reading, and the online graphics are impressive.  But the “small print” caveats continue to provide the harsh reality check.  No one knows the full extent of the number of homes that will go into foreclosure, whether Congress will extend (or increase) the first-time homebuyer’s tax credit, scheduled to expire on November 30 of this year, and certainly no one knows if the banks will relax credit and start making loans again.  FHA, which has been providing a substantial number of loans, recently announced it has to tighten credit due to low reserves.

All of this makes for interesting reading, but one has to question where it takes us.  There are a number of unprecedented anomalies that makes me wonder if the forecast models are valid.  At least one real estate expert noted recently that there were over 2 million excess housing units in California — a shocking number given the number of programs designed to address housing shortages in this State.  California recently hit 12.2% unemployment.  Add to this a “shadow” inventory of properties that have not yet been foreclosed, due either to voluntary moratoriums or deliberate efforts to control inventory.   The Wall St. Journal reports there are approximately 1.2 million homes where the foreclosure process has not begun, even though the mortgages are more than 90 days past due.    The repercussions on local governments across the country have yet to be fully felt, let alone measured, yet are causing unprecedented cutbacks in services.   Ultimately, the entire process will come down to buyers’ ability to purchase homes, whether as first-time buyers taking advantage of tax credits and other incentives, or property owners selling their existing property and moving up.  Without jobs, this simply will not happen.

Therefore, I question what it means to say that housing prices in any specific MSA will rise or fall over any projected time period, given the current turmoil in the market, particularly the inability of the typical person to borrow money.  At the special Norris Group event held on September 11, 2009, “I Survived Real Estate 2009,” the various speakers were remarkably eloquent if not cautious.  David Kittle, 2009 Chairman of the Mortgage Banker’s Association, and John Young, Vice President of the California Builders Industry Association, along with other panelists, were quick to point out that for every new home purchase would result in anadditional expenditure of $7,500 for furnishings and supplies, and noted that Congress is considering a $15,000 tax credit.  They claim that if enacted, this would result in over 400,000 home purchases, significantly reducing the backlog of troubled inventory.  Interesting concepts, and worthy of consideration as a means to jump start the economy.  But such a move by Congress, if enacted, would definitely throw another wrench in to the forecasting models.

It’s easy to be a skeptic, and I won’t claim to know of a better methodology or model.  But I would caution investors to adopt a healthy dose of skepticism when reviewing the ubiquitous “Top Ten Cities” lists as a basis for making an investment decision.  Concentrate on cash flow, a strong and diverse job market, and local conditions.  A good cash flow investment in a bad market will be a better investment than a negative cash flow investment in a good market.  An outdoor enthusiast once told me, “there’s no such thing as bad weather – only bad clothing.”  A corollary maxim would probably be that “there’s no such thing as a bad market — only a bad deal.”  Good gear can get you through the worst of storms.  A good deal will beat a bad market.

Investors need to look deeper into the background information provided by these articles, and REALLY understand the dynamics and demongraphics.  Communities with diverse economies and industries will fare better than those without.

Foreclosure Crisis: More Info but Less Knowledge

Yet another study — this one released last month by the Federal Reserve Bank of Boston — serves only to reinforce what we already know:  lenders were reluctant to modify existing loans during 2007 and 2008.  (Wash Post, 7/27/2009).  Although some 1.5 million borrowers were subject to some form of foreclosure filings during the first half of this year (2009), only around 200,000 loan modifications have been issued since March, when the Administration launched the new Making Home Affordable Guidelines.   Part of the difficulty in evaluating the data is that many lenders have only very recently begun to apply the new Guidelines, while study after study focuses on statistics from 2007 and 2008.  Part of the reason for the sweeping new Guidelines was to remedy the shortcomines of the previous programs.

The Washington Post reports that “Modification makes economic sense … only if the borrower can’t sustain payments without it” and the modified terms will allow the borrower to keep up.  Duh.  Another brilliant conclusion:  Borrowers who are likely to fall behind even if the loan is modified are not a good candidate for loan modification.   Double-Duh.  And this:  Lenders have little financial incentive to help delinquent borrowers, who with extra effort and a little luck, can catch up without a modification.  Well, you get the gist of it.  I hope they didn’t spend a lot of money on that study!  If we only had solid information like this back in 2006, we might have been able to avoid the whole problem, don’t you think?

Compounding the issue is a fundamental lack of critical knowledge:  is it more economically advantageous for lenders to foreclose or modify?  Even the Washington Post can’t make up its mind:  the headline says “Foreclosures are Often in Lender’s Best Interest.”  Then, they quote Laurie Goodman, senior managing director at Amherst Securities, saying “In some cases, lenders lose twice as much foreclosing on a home as they did two years ago.”  Apparently, falling housing prices — often a direct consequence of foreclosures — cause lenders to lose money in foreclosure sales.  Go figure.

So, did we learn anything from the Boston Fed study?  Well, we learned that only a small percentage of loan mod applications are actually being approved, as lenders are only just now starting to apply the new Guidelines.  The study seems to confirm what we suspected — lenders are focused on their bottom line, not the borrower’s.  Lenders are working on finding the right balance of when would be the most optimum time to proceed to foreclosure based on the projected price bid they can get.  If the loan mod will only delay foreclosure and housing prices continue to drop, it only makes sense to deny the loan mod and proceed to foreclosure.

Sadly, this often comes as a bitter blow to the hard working borrower who is just trying to get a temporary reduction in their monthly mortgage payment, either through a rate adjustment or an extended term, so they can meet expenses and catch up.  Where home values have dropped significantly below the amount of the loan, and the lender refuses to make a meaningful modification, the borrower has little incentive to keep the house.  The result — absent any intervening factors — will be more foreclosures, further reducing prices, and causing lenders to prematurely panic and sell before the prices drop further.

Obviously, this will not work.  The Treasury and HUD have summoned industry executives to a meeting to discuss how increase the pace of loan relief.  It would seem that if more loans could be modified, even if only temporarily, there would be fewer foreclosures and less downward pressure on housing prices overall, not just for foreclosure properties.  Achieving stability would be a good objective, but we still have not seen any studies of the application of the new Guidelines.  Maybe if we had some relevant information, we might gain some relevant knowledge.

Foreclosure Crisis — Too Early to Define the Solution?

Another day — another study.  Stan Liebowitz, professor of economics and director of the Center for the Analysis of Property Rights and Innovation at the University of Texas, writes in an op-ed piece that “the most important factor related to foreclosures is the extent to which the homeowner how has or ever had positive equity in a home.”  He says that his analysis of foreclosure data shows that subprime loans, upward resets, and so-called “liar loans” were not the primary cause of the current foreclosure crisis, and hence current government programs are “misdirected.”

It is interesting to note that Professor Liebowitz’ analysis concludes that 51% of all foreclosed homes had prime loans.  He reports that his analysis of foreclosures during the second half of 2008 shows that while 12% of the homes had negative equity, they accounted for 47% of all foreclosures.  Professor Liebowitz’ reasons that negative equity, by itself, is not an indicator of a foreclosure, but it implies that the borrower is more likely to walk away from the loan.  He argues that current government programs (i.e., Making Home Affordable), and federal efforts to keep interest rate low, are misdirected.  Driving mortgate payments down to 31% of income will not have much of an effect, since his study showed that those with higher (38%) ratios were not more likely to face foreclosure.  Reducing interest rates induce refinancing, not home purchases.  Professor Liebowitz calls for stronger underwriting standards, higher down payments, and clarifying the consequences for homeowners who simply choose to “walk away.” The good news, according to Professor Liebowitz, is that housing prices are approaching a long-term, pre-bubble levels and equilibrium.  He singles out Barney Frank for criticism for efforts to artificially increase homeownership levels, which would delay the return to equilibrium levels.

Professor Liebowitz’ analysis is one of many that will be conducted as the data becomes available, and it will be interesting to see more precisely what will actually work.  Empirical evidence suggests that while we’re still headed downhill, and the forecasts for continuing foreclosures are dramatic, it is probably too soon to know more precisely what the actual causes of the crisis were, thus too premature to fashion a realistic solution.  We know that many of the investors currently holding the notes are largely unwilling to make significant concessions in terms of rates or payments, let alone reduce principal.  We know that rising unemployment will continue to threaten the pace of recovery — if we’re even in the recovery phase at this stage.  We know that lenders aren’t lending, despite billions of dollars already spent by the Federal Government.  And, we’re starting to see the first real wave of the crisis hitting the commercial property markets, where it will be difficult to scapegoat any single demographic factor as a cause.

Professor Liebowitz is correct when he says that “Understanding the causes of the foreclosure explosion is required if we wish to avoid a replay of recent painful events.”  That goes without saying.  But we just finished the first half of 2009, and studies of what happened during the last half of 2008 may — or may not — tell us all that we need to know.  We really need more analysis, more action, and less knee-jerk legislation.  Private lending has the potential to fill the gap left by the credit crunch, but there is room for mischief and abuse, and the banking industry lobby is fighting hard to protect its grip on the supply.  Ultimately, Americans have proven to be resourceful, creative and most importantly, survivors.  The current rush of legislation at the Federal and State levels are based on old data, driven by special interests, and may cause more harm than help.  We need to be a bit more patient and get better data before we inadvertently make the situation worse.