The credit markets have been so frozen that the Government felt that they had to step in with the recently enacted $700 Billion bailout. The freeze that started with subprime mortgage loans had spread to prime mortgages, auto loans, credit cards and other consumer loans. The entire economy was teetering on the brink of collapse. This situation was so serious that they felt compelled to act a mere five weeks before a major election. This bailout is going to fix all of that, right? Wrong!

The idea of the bailout is to help large lenders and investment firms in danger of being crushed by the weight of the bad loans on their books. The fear is that there would be a domino effect throughout the economy that would cause it to come to a screeching halt. As these companies are relieved of the burden they would, in theory, be able to lend again. The initial benefit of the bailout legislation will be felt by these large institutions. The hope is that the benefit will trickle down in time and the economy will improve. The key phrase here is “in time,” this is not an instant solution.

What’s An Investor To Do?

Real estate investors need to get creative. The days of easy credit and no money down loans are gone for good. The so-called “liar loans” are as extinct as the dinosaurs and investors will actually have to (gasp) qualify for the loans they want. In terms of the long-term health of the real estate market, this is a good thing.

Investors who are challenged with poor credit or lack cash for down payments will have to look for alternatives. They will need to seek out sellers willing to provide financing, find money and credit partners and learn to acquire property subject-to the existing financing. All of this was done before the housing bubble and easy credit days and it can be done again.

What’s A Consumer To Do?

The primary thing that a consumer needs to do is forgo the need for instant gratification. The recent economic expansion was fueled, primarily, by credit. The bill has certainly come due. If you want something you should do the unthinkable: save for it. So many people are burdened by debt that they acquired to buy things that they could have done without. It’s time to pay as you go and stop maxing out the plastic.

If people learn a lesson from all of this we may actually come out ahead. It’s time to stop spending money that we do not have. This is also true of our Government, the wasteful spending and pork has to stop. We can’t keep throwing money away, we need to establish priorities and stick to them. We’ve had tough times before and we have managed to get through them and I believe that we will get through this as well. Will it be easy? Absolutely not.

The government solution to a problem is usually as bad as the problem.
Milton Friedman

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Tags: bailout, credit crunch, Economy

As a little boy I used to ask my grandmother to tell me stories of her life as a young girl in Germany. She was always reluctant to talk about it, but I was usually able to coax something out of her. I didn’t understand until I was much older, but her reluctance was a result of the pain those memories caused.

One of the stories that she would tell took place after the First World War. Germany lost and, in so doing, agreed to the Treaty of Versailles. In addition to the loss of geographical territory, the German Weimar Republic was forced to pay enormous sums in reparations. In essence, the Germans had to pay for all of the damage done in the war. Germany did not have the financial means to pay these damages and their solution was to just print money.

Catastrophic Consequences

As this new money moved into circulation the impact was devastating to the German economy. The inflation rate was absolutely staggering. A few years after the end of the war the German economy had an inflation rate in excess of 300% per month! The economy had essentially collapsed and the country was experiencing a depression of enormous proportions. This set the stage for the rise of the Nazi party several years later.

Which brings us back to my grandmother’s story. She would tell me how her father and brothers, all coal miners, would get paid twice a day. The currency was devaluing so fast that it needed to be spent as fast as it was earned. My grandmother told of collecting the money and going shopping for food. The grocers didn’t even bother counting it, they just estimated the amount by how large the stack was. A loaf of bread could be purchased for two bags of money in the morning, by the afternoon the price might be three bags. The currency had so little value that people would burn it in their stoves for heat because wood had more value than the money.

We Are Getting $700 Billion From Where?

The US dollar is a fiat currency. That means that it is not backed by gold or any other asset but instead is backed by “the full faith and credit” of the United States Government. As we increase the national debt we are destroying faith that the rest of the world has in our economy. As that faith erodes the dollar will fall further, and imported goods (read oil) will cost more and more. The inflation that we are already experiencing can quickly turn to hyper-inflation if we keep spending money that we don’t have.

Hyper-inflation is an end-stage terminal cancer to any fiat currency. However that inflation does not immediately follow the event that caused it. In Germany the Weimar republic began printing excess money in 1919, but the hyper-inflation didn’t take hold until a few years later. It may be several years before we see the real effects of the proposed bailout that we have before us.

No Simple Solution

There is little doubt that something needs to be done. My initial reaction is to let these businesses fail and have the chips fall where they may. Capitalism follows the law of the jungle in that it is truly survival of the fittest. However, it is not so cut and dried in this case. This crisis touches everyone whether they realize it or not. We are now faced with choosing the lesser of two evils, let the economy collapse or get this bailout deal done and hope it doesn’t collapse anyway.

My grandmother was a simple woman

who was never more than a blue-collar worker. Yet somehow she managed to buy her own house and live a decent life. She had a great work ethic and believed that people should earn the things that they want, not have them handed to them. One of the most difficult things that I ever had to do was to give the eulogy at her funeral, yet it was also one of my proudest moments. I can’t help but wonder what she would think of this mess if she were still here among us. I’m sure she would want to know how we let this happen.

A weak currency is the sign of a weak economy, and a weak economy leads to a weak nation. -Ross Perot

Tags: $700 billion bailout, economic crisis, hyper-inflation, inflation

First some background. The Great Depression that followed the stock market crash of 1929 saw an unprecedented wave of bank failures. At the time we didn’t have the banking giants that we see today, most banks were of the small, neighborhood variety. There was no such thing as deposit insurance, Federal or otherwise and when these banks failed the depositors lost their money. A failure at one would lead to a panic at another, which, in turn, caused that one to fail as well. As the panic spread more and more banks failed. It became an epidemic that led to financial ruin for many.

The panic in the banking and financial markets caused the Government to step in (sound familiar). In 1933 the Federal Deposit Insurance Corporation (FDIC) was created to insure deposits and stop the panic. The law that created the FDIC was the Glass-Steagall Act. Lesser-known provisions of this act actually played a much greater role in the economic recovery that followed. Some of these provisions were designed to control excess speculation and clearly delineated the roles of banks, insurance companies and investment firms.

For decades the banking, insurance and brokerage industry clamored for the repeal of this act. The brokerage firms wanted to enter the banking and insurance industry and banks and insurance companies wanted to be able to offer stocks, bonds and other investment instruments to their customers. All sides said the competition would benefit the consumer. Various administrations, both Democrat and Republican, had rejected this call for repeal since the 1960s.

Unintended Consequences

There were many that said that the Glass-Steagall provisions were no longer needed and competition would regulate the marketplace. We see now how that has worked out. The increased competition and the thirst for profits ultimately had a lot to do with the housing bubble, foreclosure crisis, failures of major brokerage and insurance giants as well as the current wave of bank failures. The banks, insurance companies and brokerage firms all got what they wished for with the repeal of Glass-Steagall, now they are paying the price.  Ultimately we will all foot the bill for this in some way, shape or form.

There are many in this country that pine for the days of the Clinton administration. They talk of their beloved Bubba as a great multi-tasker who could balance the budget while, at the same time, chasing interns around the Oval Office. They blame the current administration, whose mistakes are too numerous to list, for everything from a hangnail to the current financial mess. But with one stroke of the pen President Clinton repealed the Glass-Steagall Act on November 12, 1999 and may have planted the seeds for a financial crisis of epic proportions. Do you remember where you were?

Leaders are responsible not for running public opinion polls but for the consequences of their actions. -Henry A. Kissinger

By now everyone understands that the insane run up in real estate prices was fueled by easy credit. Buying a house with little or no money down was child’s play. Every novice investor that entered the market only exacerbated the phenomenon. Even those who weren’t looking for an investment, just a primary residence, got caught up I the frenzy. It was either buy now or rent forever, or so it seemed.

We now realize that this “irrational exuberance” could not last. Like a roller coaster that reaches the top of its climb, it came crashing down with a vengeance. Prices collapsed and refinancing was no longer an option. Left with no equity, there was no reason for someone to hold on to an investment that they didn’t have their own money in anyway. The housing boom led to a foreclosure boom. But what about those who are trying to hang on? Or those who are trying to invest in this mess of a market?

The Seller

Many people are familiar with the term “upside down”, it means owing more on an asset than the value of that asset. It was often heard in relation to automobiles. You would try to trade in a three-year-old car only to find that it was worth less than remaining balance on the loan. Your options would be to make up the difference in cash or to roll the balance into the new loan. Unfortunately that isn’t an option with real estate.

In this case the buyer only has one option other than foreclosure if he must sell. That would be getting the lender to agree to settle the loan for less than the balance owed. That is known as a “short sale.” The main problem here is that the banks aren’t equipped to handle the volume of short sale requests. The process can drag on for months with foreclosure looming ever closer. Many buyers will back out because of the lengthy delays leaving the sellers in a situation that is even worse than before.

The Buyer

Many buyers are unwilling to deal with the headaches of a short sale and choose to look elsewhere. All of the foreclosures have resulted in a tremendous number of opportunities if the buyer has cash or the ability to obtain financing. But what about the investors who don’t have access to capital? They will pursue deals involving seller financing or try to acquire the property “subject to” the existing financing. There are huge problems here as well.

If the seller is upside down, there is no equity. If there is no equity, there is no deal without a short sale. When hunting for a deal a buyer may find a property that the seller has owned for a long time and thinks that a deal may be possible. The buyer then learns that the seller refinanced and pulled out cash at the height of the market and there is no equity.  Frustrated once again.

Perseverance

As frustrating as things are, this too will pass. Eventually some sense of normalcy will return to the markets. We all have to adjust to a new set of rules and learn to adapt to ways of doing business. All we can do is hang in there and keep trying.

Patience and perseverance have a magical affect before which difficulties disappear and obstacles vanish. - John Quincy Adams

Imagine that you are on an African Safari. As you are working your way through the jungle in search of big game, suddenly you are confronted by a lion with a bad attitude. If you were armed like Rambo with a huge gun and lots of ammunition, you would probably come out of the encounter in pretty good shape. But what if you only had a small caliber peashooter with one bullet? The results might be quite different and you would certainly be very careful about using your lone bullet.

These days real estate investing can seem very much like that safari. There is plenty of game to be had, but bullets are scarce. In the days of easy money it was almost like walking into a fast-food restaurant. You could get your happy meal complete with burgers, fries, drink, and a no income verification mortgage on the side. With today’s tightened lending standards in can feel very much like hunting without any ammunition.

Afraid to Shoot

With the virtual extinction of 100% financing and lenders freezing or drastically reducing credit lines, many investors have little or no ammo left to hunt for investment properties. With investor loans, if you can get them, requiring a 20% down payment, many investors are reluctant to pull the trigger on a deal. What if they commit their capital only to have a better deal come along? This fear can be paralyzing.

Alternative Weapons

Many seasoned investors started out with little or no capital, yet they found ways to get deals done. I started in the days of assumable FHA mortgages (I know, I’m showing my age) that didn’t require qualifying. If you could convince a seller to take is equity in the form of a note you could do a deal with little or no money down. Although today’s mortgages are not assumable, you can accomplish pretty much the same thing by acquiring properties “subject to” the existing mortgage. While you are violating the due on sale clause of the mortgage, it is becoming a fairly common way of doing business. You may have some headaches if the lender finds out, but if the payments are kept current they probably won’t. The biggest problem is that so many homes do not have enough equity to allow these deals to make sense.

There are other methods that can be used such as seller financing and lease options. It certainly requires a lot more effort to uncover these deals. Being a successful investor is hard work but extremely rewarding. While you need to exercise due care and caution, you also need to avoid freezing up.

Develop success from failures. Discouragement and failure are two of the surest stepping stones to success. - Dale Carnegie
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Very early on in my investing career I received a great lesson in rental property ownership.  In the early 1990s I saw the potential for the Las Vegas market and decided that it would be a good idea to have long-term investments in the area.  At the time there were about 5,000 people moving there each month and builders were adding new housing at a furious pace.  There was a good supply of resale homes and the rental market was strong.  I was looking for future appreciation as opposed to immediate cash flow.

I lived in New York at the time and I would be investing long-distance.  I did have connections in the area and I received recommendations for real estate agents and a property manager.  I knew that investing outside of my local area would have some challenges and I was prepared to accept that.  Further complicating matters was the fact that I was taking on investment partners.  I did have partnership papers drawn up and everything was clearly spelled out. 

One of the major advantages of investing in the area was that there were an abundance of newer homes with FHA mortgages, at the time these mortgages were fully assumable.  With partners putting in cash, I was able to acquire properties fairly easily.  My plan was to acquire two properties and see how things worked out.  If it went well I would look to acquire additional properties.

The Good House

After several trips to the area and looking at dozens of houses, I located a property that met my criteria.  It was a 3 bedroom, 2 bath house in an excellent neighborhood.  The only work it needed was to have the carpets cleaned.  The purchase was smooth as could be due to the assumable mortgage and there were absolutely no complications with the closing.  My property manager began looking for tenants right away and had located and qualified a young family that would be ready to move in almost immediately after we closed escrow.

I had purchased the house for just over $100,000, including all closing costs.  The rent was enough to cover the mortgage, taxes, insurance, management fee and an allowance for repairs and maintenance.  After everything I was left with about $150 per month which was added to the maintenance fund as well.  The tenants were absolutely perfect.  There was never a problem, they paid the rent on time, and the house was always immaculate.  They stayed there for five years until a job transfer caused them to move. 

The House of Horrors

We all know of parents who have a child that is so good that they can’t wait to have another, then Damian arrives with his Omen.  House number two was like that for me, if it had been house number one there would not have been a number two.  The second house was located in a different part of Las Vegas, but still in a good area.  The owners were desperate to sell and I was able to make a fantastic deal.  I was expecting to get even better cash flow than house number one.  It was also going to be a mortgage assumption so I expected a quick close.  My property manager began looking for tenants and had a family ready to go fairly quickly.

Then the fun began.  There were problems with the assumption because of missing paperwork and there were some title issues as well.  It took several weeks longer to close escrow than anticipated.  The tenants that were going to move in couldn’t wait and rented a different house.  We had to return their deposit because we couldn’t deliver the house when promised.  My property manager started looking for new tenants but was having a hard time finding anyone who qualified.  We eventually settled on someone who was looking for a six-month lease.  Big mistake.

The rent was constantly late and we had to file a notice to evict more than once, but they always paid before we could throw them out.  They left at the end of the six month term but left the house a shambles.  The carpets were ruined, holes in the walls, banister torn off the stairs and numerous other problems.  We kept the security deposit but that wasn’t enough.  They also moved without any forwarding address and we decided it wasn’t worth it to track them down.

After making several thousand dollars in repairs we rented the house again.  The next set of tenants were a problem as well.  They were constantly calling with one problem or another, rent was always late and rent checks bounced.  They left at the end of the lease and we rented again.  Problems again even though all of these tenants went through a screening process.  Because of extended vacancies, excessive repairs, eviction costs and other expenses this house was always losing money.

Lessons Learned

My partners were so fed up with that second house that they insisted on selling.  I can’t say I blamed them, but my preference was to hold on.  We did wind up selling house number two at a minimal profit after five years.  After taking into account all of our costs over the years, we made a profit of about $5,000, that amounted for about a 1% annual return.  Certainly not worth all of the headaches.

We also sold house number one at this point, a better result but not a home run by any means.  That first house netted a profit of just over $30,000 plus five years of positive cash flow.  When we calculated everything it amounted to about a 6% annualized rate of return. 

The end result was that I learned an incredible amount about owning rental properties and about long-distance investing.  It was also a lesson in working with partners.  I have invested with partners since then, but I am never eager to do so.  The rental property business is not an easy one but I have applied what I learned and my expectations are much more realistic now and the results have been much better.  These were not lessons that I could have learned any other way.  No book, course, guru or mentor could teach me as much as owning these rentals did.

Sometimes adversity is what you need to face in order to become successful - Zig Ziglar

 

Tags: las vegas, real estate investing, rental-property

Is it worth $300-$500 to have a professional home inspection prior to making a purchase? This is a question that I ask myself frequently. For most people the answer is absolutely! The average homebuyer does not have the experience or the knowledge to effectively evaluate a home prior to purchase. Experienced real estate investors, and especially rehabbers, probably have enough of a background to make a decent evaluation. However, that doesn’t mean that they shouldn’t have an inspection done.

That First Rehab

My first rehab project was a bank REO that I purchased in New York about 15 years ago. The price seemed right, but it was an as-is purchase. I had some construction experience but I was not an experienced rehabber. The house was in a great area but needed to be completely redone, I naively assumed that it would be a piece of cake. (see article: That First Rehab )

Since the house needed everything I thought that an inspection wouldn’t be necessary. If I had done one I would have learned about many problems that I had missed. I didn’t see the termite damage to many parts of the house; I missed the carpenter ants that had devoured a large part of the roof deck. I also didn’t find the pipes that had frozen and burst and I certainly would have liked to know that the furnace needed to be replaced. Had I spent the $300 for an inspection I would have known about the unexpected repairs that cost almost $10,000.

I probably would have gone ahead with the purchase anyway, but I would have done so with a better understanding of the problems that I faced.

A Negotiating Tool

Today I have a much better idea of what to look for prior to making a purchase. And while a home inspector may not find anything that I can’t find myself, the inspection report can be used as a negotiating tool. If the inspection uncovers anything significant I can seek a price reduction or additional concessions from the seller. If you use a home inspection contingency (and you always should) in your purchase contract you will have the option of walking away without a penalty should something significant turn up.

One thing to remember is that a home inspection is only as good as the home inspector. If you are using a knowledgeable and experienced inspector it almost certainly pays to have it done. If the inspector is not thorough it is probably going to be a waste of money. Seek referrals from experienced investors when choosing an inspector and you should be able to find a good one. The bottom line is that a home inspection will either save you from making a huge mistake or give you peace of mind when making a purchase.

A man who carries a cat by the tail learns something he can learn in no other way.
-Mark Twain

Tags: certified inspector, home inspection, house inspector, inspector, real estate, real estate investing, real estate investor