Here are two fallacies that often strike new real estate investors.   The first one bugs me only a little – the second one bugs me a lot. 

The first fallacy is the one peddled by late-night infomercial stars.  It’s the idea that it’s really not that difficult to find an old house, buy it for much less than it’s worth with no money down, and sell it for big bucks.   It’s true that some deals of this sort do happen, but they’re very rare.  If you start your real estate career thinking you’re going to get 50 deals like this on the way to that new Bentley, you’re actually on a fast track to disappointment.  (And if you really have done 50 deals like this – and have documentation, and don’t charge $1 million for people to see it – call me!)

The second fallacy is much more insidious and hits people who are much too smart to be fooled by the first one.  I’ll call it the Every Dog has its Day fallacy.  This means that any property you buy, no matter how big a loser, will eventually make money for the owner.  This view is underscored by two other views, both also erroneous:

1. All real estate rises in value over time.
2. When you own rental property, your rents go up over time, while your expenses stay the same.

We know in our hearts that this assumption is wrong, but still fall for projections that show it.

It’s certainly true that most real estate rises in value over time.  However, that’s not true everywhere.  I’ll give you two examples: Detroit, Michigan, and Buffalo, New York.  Right now in Buffalo, there are almost 800 houses listed for sale for $50,000 or less.  45 of those are listed for less than $10,000. 

 Why do you think Buffalo might have these wonderful deals?  It’s because Buffalo has been one of America’s fastest shrinking cities over the last 50 years.  The population is less than half of what it was at Buffalo’s peak in 1950.  This, coupled with the reason for the decline (there are no jobs to be found), has resulted in a huge drop in real estate values over decades.  Almost anyone who put their money in Buffalo over that time lost much of it.  By the way, this also means Buffalo rents dropped over the past few decades, so those Buffalo investors lost money every year on their way to eventually selling at a loss.

Detroit is in a similar way, with 6,900 homes for sale for $50,000 or less; 3,200 for less than $10,000; and a population less than half what it was in 1950.  Detroit’s motto, translated from Latin, is “We Hope For Better Things; It Shall Rise From the Ashes.”  I sure hope they are right!

This extraordinary hovel can be yours for $100 in Detroit.  Make an offer!

Thankfully, there are few true disasters like Detroit and Buffalo around the United States, although there are many cities where prices have risen only a little, stagnated, or dropped even before the real estate and mortgage crashes.  Even elsewhere, however, you might lose money over time because of the “expenses never go up” assumption.

 Suppose you buy a property for $100,000, with rents of $1100 per month.  Your expenses are as follows:

·         Monthly mortgage payment: $480

·         Insurance: $75

·         Taxes: $200

·         Allowance for maintenance: $100 (0.1% of purchase price)

·         Allowance for vacancies: $55 (5% of rent – assumes a 5% vacancy rate)

·         Utilities: $100

·         Legal, accounting, mileage and so on: $50

Obviously these numbers are going to vary widely for different properties.  It’s worth noting, however, that poorer communities usually have relatively high property tax rates.  They have to provide the same services as wealthy towns but with smaller tax bases.

For this example, however, your monthly expenses are $1060, which means you’re making a profit!  Congratulations!  It’s a very small profit, but should be much higher a few years from now because according to the second assumption, your rents are going to rise, and your expenses will stay the same.  Five years from now, your rents will be more like $1300, which means you’ll be making $240 per month in positive cash flow, which is excellent.  And, of course, you’re building equity.

So many new investors fall for this.  The truth is that every one of those expenses is going to go up except for the mortgage payment (assuming a fixed rate loan).  If they go up by more than about 9% per year, your monthly profit will decrease, even with inflation in rents.  And that can certainly happen.  In particular, property taxes, utilities (mostly heat and water/sewer, the two utilities most often covered by landlords), and insurance have all risen by 10% or more in many communities over the last five years.

The pinch will be even greater in communities experiencing rent stagnation or deflation.  If your rents stay the same and expenses go up even a little, your profit will fade and disappear.

That equity growth that was going to save your bacon?  That won’t happen, either.  If your monthly cash flow stays the same or decreases over a five-year period, your property will be worth about the same, or even a little less, at the end of that time.  Yes, you’ll have added a bit of equity through the principal portion of your mortgage payment, but not enough to make a major difference.

None of this is intended to turn you off real estate investing.  Many thousands of people have done very well with their property investments – yes, even some in Detroit and Buffalo.  They avoided losses by being very, very careful about where they bought.  They looked for towns and states that were growing, particularly in employment, a leading indicator for housing growth.  They avoided towns with a history of high property tax increases.  They looked for houses in neighborhoods where people wanted to live.  And, they sought out properties where they could reduce expenses by taking responsible steps to lower maintenance, utility and insurance costs.

Finally, they made sure they could sell on their terms by making sure they had enough cash to handle emergencies and daily living.

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Tags: equity, housing, inflation, landlord, rental-property, stagflation, tenant

I admit the title is a bit hokey and a play on words. However, it also is one great investment alternative. The reading audience is very well aware of the opportunity in real estate investing but may not be aware of the alternatives that actually produce as promised.

Most people know about CDs, annuities, life insurance, stocks, bonds and other investment alternatives. However, not eveybody is familiar with Treasury Inflation Protected Securities or TIPS. The complete dirty lowdown can be found here.

For this post I’ll concentrate on only the cursory details. Simply put, TIPS are simple, inflation-indexed, fixed-income investments that deliver a real rate of return that the U.S. government guarantees will keep pace with inflation. Their measuring stick is the Consumer Price Index (CPI).

TIPS generated interest is taxable only by the federal government. State and local taxing agencies are not allowed to dip their grubby meat hooks into this interest bearing animal. This feature alone alone gives you an advantage over CDs and savings account.

Since they are indexed to inflation -no matter what you think about the validity of the CPI- you get another benefit. Here are some numbers to put TIPS into perspective.

Money Example

Assuming a person buys a $1,000 TIPS security with a 4% coupon and inflation is at 10% during the first year we own it, the face value of the TIPS would rise to $1,100. Additionally, the coupon rate of 4% would generate $44 in income.

NOTE: In reality, the payments change to reflect shifts in the CPI, and the payments are semi-annual. However, even though the numbers in the above example are static, I think you can get the idea. Heck, if you can figure a CAP rate in your head just from the figures tossed out by the seller, you definitely can grasp the shifting CPI rate.

A point of interest is that since their inception in 1997, TIPS have actually outperformed the U.S. Standard & Poor’s 500 stock market index. Given our current economic debacle, they’re likely to do even better I say editorially speaking.

You can invest in TIPS through your local bank or broker or if not inclined to use either facility, visit the above website and invest directly through the U.S. Treasury.

Diversification Is Still The Name Of The Game

I posted this information because I am a strong believer in diversification. I would bet those of us in the real estate investment arena who lost everything we had (I personally know several as they contacted me to do a short sale on their properties) during this bubble burst would now agree with me.

What we learned is something the investment community has preached for years - don’t put all of your nest egg into one investment vehicle. Spread it around to protect yourself.

I’m not preaching to the choir nor am I recommending TIPS as an investment. Like everything else, give them a look over and make up your own mind. If they fit your portfolio, go for it. If not, you at least learned about an another type of investment vehicle.

Photo Credit: zzzack

Tags: inflation, investment, real estate investing, real estate tips, savings, Treasury Inflation Protected Securities

We all know both the US government and the Federal Reserve are going full bore with one tweak after another to “save” the banking system and supposedly, thereby the economy. At least, that’s their argument to Congress and the American people. Hank Paulson and Ben Bernanke on news talk shows or testifying in front of Congress are constantly using the tired refrain of “helping the American public”.

The real truth is all this government and central bank meddling will do very little to help the average American. And in all likelihood, the economy will actually suffer from it.

Let’s take a look at some trends since Hank and Ben have been hard at work.

1. Unemployment is up…and getting worse…hurting those looking for work.
2. The stock market is in the tank hurting pensioners and others who live off of equities or dividends.
3. The price of gold is steadily declining as of March this year hurting those who were counting on this safe haven instead of stocks to provide for retirement.
4. Real estate prices are still falling hurting anyone wanting to sell or refinance and draining government coffers which depend on property taxes.
5. Consumer confidence is at all-time lows meaning retailers are screwed in the coming Holiday shopping season and the economy in general since consumer spending is what drives it.
6. All of the above is getting replayed in Europe and around the world.

Great job guys!

After months of governmet tweaks from Billion Dollar Stimulus Packages to Billion Dollar Bailouts to Billion Dollar War Spending…the economy is heading where it was always heading…south.

The cold, hard truth is government is not bigger than the economy. Government is not bigger than consumers. Yet those in power would have us all believing they are.

At the Fed meeting next week, Ben will lower rates again showing us just how much control over this economy he thinks he has. But this latest lowering of interest rates will do nothing to kick-start the economy…and in all likelihood is responsible for the stock market sell off this past week.

Every time Bernanke or some foreign central banker lowers rates he is signaling his disregard for future inflation. There is nothing more devastating to the real economy, the average worker, or the retiree than even modest inflation.

Be prepared. Many economists, pundits, and market watchers (including myself) believe a bigger stock market crash is coming since this massive inflation effect is already baked into the cake…it’s just a matter of time.

Of course, one silver lining of an inflation tsunami…real estate prices go up!

Photo Credit: hansol

Tags: bernanke, Central Bank, economist, Economy, housing, inflation, markets

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

The economic news seems dire, to say the least: home prices taking their steepest fall in May—ever! As in, ever!

The Standard & Poor’s /Case-Shiller index of 20 cities dropped 15.8 percent in May compared with last year, reports the Associated Press.

And, that is an average, of course.

Las Vegas, for example, had home prices drop 28.4 percent in May.

But the current and somewhat related energy crisis may help provide a sort of blueprint on how to lift ourselves out of this credit,mortgage,housing debacle.

Consumers strike back!

After week upon week of a steady drumbeat of seemingly perpetually rising oil and gas prices, oil has now actually dipped to a seven week low, down more than $2 a barrel! And gas prices at the pump are also moving in a downward direction.

What happened?

What happened is the American consumer got fed up and revolted.

According to the U.S. Transportation Department, drivers in the U.S. logged almost 7 billion fewer vehicle miles in May, the biggest drop ever recorded during the normally gas guzzling summer vacation season.

To be sure, there are other factors at play—a stronger dollar, for one thing, that are having an effect on the price of oil.

But, at the end of the day, it appears pretty simple–Americans are driving less and using less fuel and that is primarily what is responsible for the fall- off in the price of oil.

The mortgage/credit mess is admittedly a much tougher challenge. Having said that, what is happening with oil may be showing us the light at the end of the tunnel?

More and more foreclosed houses are now on the market–but fewer and fewer people can afford to buy them because credit is so damn tight. But there will come a point when banks (if any remain standing?) will have to lower their credit barriers or risk permanently losing potentially lucrative customers.

Can consumers, then, help turn this around for the good? Yes–we can!!

Tags: Economy, gas, housing, inflation, mortgage, oil

Everybody knows a recession is when your neighbor loses his job. A depression is when you lose your job. Apparently more of us are coming closer to depression than we would like to believe.

The data you are about to read is from the June 2008 edition of Collections & CREDIT RISK magazine. This particular magazine touts itself as the consumer & commercial credit authority. I’ve been a subscriber for several years and agree with their self assessment.

Some of the people and sources quoted in the article, Late with Their Mortgage Payments, Consumers Lose Faith in the Economy, have been quoted before so you might recognize their names.

RealtyTrac CEO James J. Saccacio is one of the people offering an opinion. On the topic of federal, state and local governments and community groups offering a helping hand to consumers he, in part, says, “stopgap measures could be simply deferring another flood of foreclosures which would mean extending the length of time required for the market to recover.”

My question would be does it really make a difference if these entities attempt to help. By their own admission (in this article) the industry says loan workouts are far and few between. If the industry says it isn’t willing to work with the borrowers, what difference, in actuality, does it make if stopgap measures are utilized to halt the flood of foreclosures?

Another quoted source is TransUnion. I would think they know a thing or two about delinquencies and can paint a picture of the nation as a whole, at least credit wise. They say the mortgage borrower delinquency rate – people 60 or more days late with their mortgage payment - is expected to rise throughout 2008 to 4.0% up from 2.9%.

If their quoted figures of 15 million adults getting calls from collectors is true, I would believe this information has relevance. After all, 1.1% is a staggering rise in a short of period of time.

Experian Consumer Direct did a survey and found “the number of severely delinquent mortgage accounts grew 15% between February 2007 and February 2008.” They did not define severely but I have to believe it is people who are a minimum of 90 days late and are about to receive a Notice of Defualt.

Maybe the most telling remark made in this article is by Theodore Iacobuzio, managing director and practice leader for TowerGroup. He said, “No one doubts the seriousness of the current credit crisis, but it’s noteworthy that the largest financial institutions are more likely than others to characterize its impact as severe or worse.”

Compare that quoted remark with what we’ve been hearing from some of TV’s talking heads and the White House. Maybe, just maybe, the most relevant information sits with those inside the industry who have the capacity to look at the macro credit picture.

Maybe, just maybe, we should be hearing more from them and less from the bleached blond bauble heads masquerading as “news” reporters. Then, maybe not…

Tags: consumers, Credit, default, Economy, Foreclosures, housing, inflation, loans, realtytrac

It is no secret that inflation has reared its ugly head in the US and around the world. And it is easy to see its effects whenever you go to the gas station to fill up your car or to the grocery store to buy a loaf of bread. You can read the statistics: gas prices are above $4.00 while corn and wheat prices are touching record high in the futures markets. However, for the individual investor it can be difficult to gauge the devastating impact of inflation on his or her investment portfolio.

Most investors have the bulk of their money invested in paper assets such as stocks, bonds and mutual funds. Paper assets as opposed to hard assets like gold or real estate usually fair the worst during inflationary periods. The reason for this is because while goods and services are rising in price there is a simultaneous drop in the value of the US Dollar and the price of securities or common stocks.

Public companies tend to trim operations during inflationary and recessionary economies because they find it difficult to pass on higher production costs to consumers who are spending less. This usually means that stock prices decline along with corporate growth. This is especially dire for the individual investor’s stock portfolio because as the price of stocks decline so does the value of his or her portfolio. This situation is only exacerbated by the fact that while stock prices are dropping there is also a decline in the value of the US Dollar. The overall value of an investment portfolio is eroded by two factors, the falling currency value and the falling stock values.

Many savvy investors, during inflationary periods, chose to invest their capital in hard assets like commercial real estate to counteract and hedge against the forces of inflation. A commercial real estate investment such as the purchase of an apartment building offers distinct advantages over paper assets.

The apartment building investor is directly benefiting from inflation because as prices for goods and services rise, so do rents. The most popular method for the valuation of an apartment building investment involves calculating the building’s Net Operating Income. Rising rents and net operating incomes can increase the overall value of an apartment building investment. In addition to increasing the market value of the apartment building rising rents can also help to defer the increasing operating costs.

The US dollar can be viewed as any other commodity such as wheat or soybeans because its value is primarily driven by supply and demand. Banks and lending institutions have cut back their lending on most residential and some high risk commercial construction projects around the country. Therefore money supply for new apartment building construction projects is very difficult to obtain. Also, there are fewer commercial construction companies willing to risk the development of a new apartment building complex while the costs of raw materials are rising. What this means for the apartment building owner is that there will be fewer vacancies on the rental market and a tightening supply situation in many metropolitan markets. The tightening supply of new apartment units combined with an inflationary economy should continue to cause rent prices to rise.

The demand for rental housing in most metropolitan markets around the country is forecast to increase in the next five years. The new demand for rental housing is being driven by two major factors. The first factor effecting apartment unit demand is the rise of residential real estate foreclosure rates around the country. Many thousands of homeowners have been forced to vacate their homes due to an inability to pay their mortgages and subsequent bank foreclosure. In addition, many first time home buyers are finding it impossible to qualify for a mortgage to purchase a new home because banks have tightened their underwriting guidelines for new home loans. Home buyers with no or poor credit are finding it especially difficult to find loans because there is no demand in the secondary market for packages of sub prime mortgages. All of the above mentioned people are going to need a place to live and most likely they will be looking for an apartment. These new additions to the rental market should help to buoy demand for rental units all over the United States.

Simple economics dictate that as the supply of rental units remains steady and demand is increasing then the price or rents for those should increase as well. In my opinion many real estate analysts are underestimating the potential demand for rental units and therefore I believe that sale prices for apartment building should rise well above most people’s expectations.

Tags: apartment building investing, apartment building investments, apartment buildings, buy an apartment building, buying apartments, inflation, landlord, rent, rent inflation