“Boring” Can Be Sexy When Investing in Real Estate

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Have you ever had an a-ha moment?  I mean one of those moments of clarity whereby in a feat of intellectual acrobatics you question and successfully defeat solid logic that you’ve come to except as truth…

I had one of those moments a few days back.  It doesn’t happen often to me since I try not to think too much (works out pretty well for a dumb landlord like me), but this time such a moment was triggered by a question from a fellow BiggerPockets member, Mehran Kamari, on another post of mine entitled A Controversial Look at Debt.

[By the way, this kid Mehran has some serious potential in my opinion. Although an opinion of a dumb landlord doesn’t mean much, Mehran seems to have it all together.  I mean, if I knew what he knows when I was his age…:)]

But the bigger point is this – you newbies out there have BiggerPockets; I did not.  When I was first figuring this stuff out, Josh Dorkin was a blimp on the corporate radar, and Brandon Turner was…never mind; we don’t really need to go there, trust me!  The point is this – use the collective knowledge on BP to cause action and positive change in your life, much as Mehran is doing!  But I’ve regressed…

The question Mehran asked me at the end of our exchange which triggered my chain of logic was the following: What do you like about Lima so much, besides the 10 CAP?

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The Intersection:

I’ve always believed and taught that successful real estate investing lives at the intersection of Desirability and Accessibility (affordability), which is to say that, on one hand, your product has to be something that people want, but simultaneously it also needs to be something that your potential audience can afford.

I could literally write 50 pages on this topic.  Suffice it to say that when I speak of Desirability, I mean reasons for which your product is desirable to you – the investor, your potential tenant, as well as your potential buyer when you are ready to sell.  And the same applies to Accessibility.

This balance is quite difficult to define and even more difficult to achieve, and considerations span the gamut of everything from location, to number of bedrooms, to ease of maintenance, to finance-ability and everything in-between.  Huge!  The ability to successfully negotiate this maze is, in fact, what sets the pros apart.

Read Between the Lines:

This brings me to Mehran’s “read between the lines” point – surely I could come up with one or two places in the country to invest in that would work better than the little relic of industrial age called Lima, Ohio…

Let’s Consider:

Firstly, I must say that having grown up in a city of 8 million (St. Petersburg, Russia), there is nothing in this world that would make me move into a large metropolis once more.  I don’t need the restaurants – done enough of that.  I don’t need the nightclubs – I never needed that; ever. And don’t talk to me about the culture and the arts.  99 people out of 100 living in Chicago, Miami, and Dallas wouldn’t know arts or culture if it hit ‘em in the freaking head.  And anyway – I can always get into my car any time I itch, and drive to Cincinnati, Detroit, or Chicago to listen to a great performance or visit a wonderful exhibition…and I do!

So, on the very personal level, I just don’t see any quantifiable upside to big city living.  In the meantime, I happen to enjoy living in a place where I can open my windows and breath-in something other than the pleasant mixture of sewer gases and car exhaust.  If you enjoy that – more power to you; personally…not so much.

So – no matter what opportunities they offer, I simply would not enjoy living in a big city.  However, this puts me at odds with very solid investment logic that propagates the need to buy property in vibrant economic areas.  Following this train of thought, many investors choose to invest long-distance…

And as you know, or you should know by now, I would never buy property out of my geographical proximity unless it was a very large proposition allowing me the additional spreads to be able to travel and be physically present on location to manage the managers.  But if I am not willing to invest long-distance, then I guess I loose…

Well – May be Not!

Investors tend to part ways with the laws of physics from time to time, one of the most applicable of which goes like this:

Whatever goes up must come down 

It’s true – one of the main drivers of growth in real estate is economic; more specifically JOBS.  When people have jobs, they feel good.  When people feel good, they spend money and take on debt – this is what drives up value of Real Estate in a low interest-rate economic environment.

However, this creates a dangerous environment for investors in my opinion.  If this growth cycle persists for long enough, people begin to get used to everything going up and up and up…forever.  You know this tune, don’t you?  Things are good until they are not; everything goes up until it does not!  Everything is cyclical in our consumer-driven economy.

The Current Poster-Child

A lot of investors at the moment have blind faith for Texas – deservingly so.  The extremely friendly corporate tax environment has been inducing a constant migration of businesses to Texas.  Texas is certainly booming, and will likely continue to boom for a while…until it stops.  Does anybody remember the 80’s?  Texas was booming and then it wasn’t; and when it crashed, the fundamental investors came-in at cents on the dollar.  This, if anything, is what I am looking for before I show-up in Texas.  In the mean time:

The A-ha moment!

My area, Lima, is not going up.  In fact, Lima has seen better days – this used to be a booming industrial town, but not any more.  However, the same big employers that were here 20 years ago are still here and will more than likely be here 20 years from now.  Even though it may be past it’s glory days, Lima just is…you know what I mean?

This is why while in a lot of parts of the country, real estate lost 40% – 50% of it’s value in the recent crash (more in some places), in Lima we lost 15% at the very top end of the market and 10% in the segment that “normal people” can afford.  Stable!

The reverse to the statement Whatever goes up must come down, is – If it don’t get too high, then it won’t fall too low.

Conclusion

Do you like roller-coasters?  I hate roller-coasters!!!  I don’t need any more excitement in my life above and beyond what I already have.  Relative to real estate, this means that I’ll take my stable Cash Flow at 10 CAP, and I’ll take appreciation if it comes, but I won’t chase it!  I also like the affordability of life in my smaller area, meaning that my money goes a lot further than most anywhere in the country.

A simple distinction to understand is the following:

Equity = Wealth; while Cash Flow = Financial Freedom

Cash Flow, as you know, is income minus expenses.  I am forever in search of financial freedom; I couldn’t care less about wealth.  Lima affords me higher income and lower expenses, therefore, I like Lima. 

Lima is a place I know and understand, and Lima will be here long enough for me to get done what I need to get done – without the lights and glamour of the roller-coaster that most people now-days think defines investing…

So, what do ya say guys? 

How do you view your local area?

Photo: sonjalovas

About Author

Ben Leybovich

Ben Leybovich has been investing in multifamily residential real estate since 2006. His area of expertise is creative finance. Ben works extensively with private as well as institutional financing. Ben is a licensed Realtor with YOCUM Realty in Lima, Ohio. He is also the author of Cash Flow Freedom University and creator of a cash flow analysis software CFFU Cash Flow Analyzer.

52 Comments

  1. “When I was first figuring this stuff out, Josh Dorkin was a blimp on the corporate radar..”

    Geesh, Ben, not nice calling Josh fat, lol 🙂 Seriously, your post overall points out that as long as each individual is comfortable with their investing strategy, is aware of the pros and cons of the area they have chosen to invest in, and doesn’t enter an area with rose-colored glasses, then it’s ok. The beauty of REI is no two investors need to have the same criteria.

    Mehran probably was asking the question more to see if it’s an area he would like to invest in (since we all know he does out-of-state investing) and not so much to make you defend Lima, but being the smart guy you are, you turned it into an exercise to take another look at your current situation – we should all do that from time to time.

    As you know, I’m heading to Texas (Houston, specifically) soon to restart my investing career. I chose Houston primarily because that’s where my family lives, and after residing out of the country for 3 years, I really, really miss them. But after looking at the macro and micro economics of Texas, what’s not to like,and I’ve decided it’s the place I want to focus on for now.

    Texas’ downfall in the ’80’s was due to the failure of the energy segment (mostly oil). Texas has now diversified its industries, so there’s not likely to be a repeat on that front. In addition, Texas never did have the tremendous run up in real estate prices that many other areas in the nation did before the housing market collapsed. That meant recovery wasn’t that difficult – Houston was all but completed recovered by November of 2011.

    Still, the past has taught us we should never forget, and so I’m with you – unless your investments give you Freedom (cash flow), then you shouldn’t be buying them. That will be my plan. And if Houston doesn’t work out, well I’ve been an out-of-state investor before, I can do it again.

    • Sharon – thanks so much for your comment!

      If you are living there, then it’s your “Home Market”. All bets are off. Why – because you know the micro, you know the political landscape, etc. This is very different from investing long-distance in a market only because the market is hot 🙂

      Perhaps I should have made this clearer…

      Thanks so much for leaving a comment 🙂

  2. Douglas Dowell on

    Excellent post as always Ben! I love it when the conventional wisdom is called into question. Texas is great….but for how long? I don’t want to be the last one to the party that’s for sure.

  3. Great Topic!
    It’s funny, I live in a town of about 100k people and my friend has moved from Denver to come work with me and learn Real estate and investing. He went from 1 mil plus to lest than 10% of that and so far loves it. He thought moving to a smaller town would be the biggest downside to this huge change, but so far he has a nicer house(my old house), friendlier neighbors, everything is closer and less traffic.

  4. Matt DeVincenzo on

    Great post Ben. As another one of the expensive CA market investors, and one that due to circumstances beyond my control will be staying here for a quite a while longer I got a lot out of this.

    One thing I really liked in the original discussion with Mehran that you touched on in the comments, was his point that CA CAPs are in the 5’s and just don’t cashflow well enough. But while the market dictates what things trade at, it’s not about what the market CAP is it’s about the CAPs you achieve through situations. In Lima it sounds like you can just go buy something at an 8-10 CAP, but you got in at almost a 11 CAP with only $5K out of pocket.

    If your 10-plex was here in CA, buying the same situation and getting it at a 7 CAP you’re doing 30% better than the rest of the market. Coupling that with the fact that flipping out here works better, stabilizing your 10 plex and getting it’s performance up will allow it to be flipped in 18-24 months at the 5 CAP rate.

    Obviously as you said the “higher the high the lower the low” needs to be watched, but there is always a situation that provides an opportunity whether in OH or CA it’s just figuring out if you can fix the problem and make money and which ones you can’t. (I liked your video last week as well it was a great explanation of problem solving)

    • Exactly Matt – CAP Rate is a representation of market behavior and market expectation. You can do better- and that’s the point! You can do that in any market. However, in terms of CF it may not be good enough to beat the market by a couple of point, which makes it necessary to utilize different strategies 🙂

      Thanks for commenting Matt!

  5. Mike McKinzie on

    Sharon, I think Ben meant “blip”, not “blimp” on the corporate radar

    Ben, I visited your hometown of St. Petersburg this summer. It was quite the cultural experience. We even got to preview a “Russian Flip” of a flat, over by the St. Petersburg Yacht Club and the St. Petersburg Tennis Club. In the parking garage of the complex was a Maserati and Ferrari (owned by a professional NHL player, who has a vacation home in St. Petersburg.)

    Having been born and raised in a suburb of Los Angeles, I know what you mean about big city living. I moved to Colorado for a dozen years but had to move back to care for my dying father (he passed last year). There are MORE people living within 500 yards of me now, than in my entire town in Colorado (Bayfield). I miss the Rocky Mountains.

    Anyway, great article. Cash flowing property is very BORING when it comes to investing. But it is “sexy” to be able to retire at age 50 and travel.

    I think you might want to expand your thinking. I have bought 7 houses in the past two years, in Tennessee, Texas, Oklahoma and California. I did not ever look at the houses, I never even set foot in the town they are in. With the internet, I can research an area until the “cows come home.” I can get an appraisal, home inspection and additional Broker opinion’s, and never leave my house. I got my Tennessee Broker and PM right here on Bigger Pockets. I know many Real Estate Investors just HAVE to see the property they are buying, and if that is their style and it works for them, EXCELLENT. But my idea of investing is that I want to be able to go on ‘vacation’ for months at a time and not worry about anything. That means property management. And if the property has good management, it doesn’t matter where it is located.

    On a lighter note, you state the physics law, “what ever goes up must come down,” referring to gravitational pull. My age keeps going up and it looks like it is never going to come down. I guess that is because it is tied to the “space/time” law that states, “Time marches on.”

    • Haha, Mike, I knew what Ben meant, hence the smiley face. I was just teasing him.

      I’ve done out-of-state investing too. I’m from Cali originally. Where there are you investing, if you don’t mind my asking? I know some areas in very Northern Calif or Central Valley can still cash flow. Thanks!

    • Mike – thanks so much for taking the time to comment!

      Let me start out by expressing my condolences to you for the los of your father. I am blessed not to know what that is like thus far…

      As to the real estate, I think there is a conceptual difference in the way that we see RE and it is this – there is a big difference between being in the business of real estate, and investing in RE. You are an investor, and to accomplish your goals you outsource the necessary systems. On the other hand, I am in the business of building these systems and plugging people into the systems to run them. I also want to phase myself out, but growing as much as is required to accomplish my goals makes it impractical to outsource systems.

      Besides, I do not buy SFR – strictly multi. The due-diligence process can get quite a bit more involved, which is why I wouldn’t think to buy sight unseen 🙂

      St. Petersburg is a different place now – very different indeed; not a place I would want to live! Though, the culture scene is truly unparalleled…

      Thanks so much for your comment Mike!

  6. In terms of Desirability (Demand) and Affordability, my market sees a lot of buyers relocating from larger, more expensive cities. We’ve worked with buyers from New York, London, Munich, San Francisco, and everywhere in between. As people get tired of long commutes, high housing prices, and small living quarters, it’s no wonder that they venture to smaller cities like Charleston, SC (where I live and work) to get more home for the money.

    • Thanks for commenting Lee, and you are right – some people, like me, run away from the hustle and bustle. This may or may not reflect positively on the investment environment – obviously in your case it does. But, the general “truth” that investing is best done in a highly populated area is thrown into question here.

      Obviously, people have to have jobs to be able to pay rent. But, as you mentioned, Charleston has jobs even though Charleston is not Chicago…

      Good for you and thanks for your comment!

  7. Mehran Kamari on

    What’s funny Ben, is that in my question, I was more probing for reasons regarding lifestyle that you’ve chosen to make Lima your home 🙂 I’m glad that you shared that as well in this post. In planning ahead, I’m seriously considering a move outside of California for many of the same reasons you like your town. Lower cost of living (my passive cash flow will go further!) and less population density (I’m always going hiking to get away from the hustle & bustle) would be nice. I have a good feeling I’ll migrate to a place that’s a little bit more laid back than Los Angeles some day.

    However! I’m glad though that the question sparked some deep thought that led to you write this article as it has made me think more deeply about my own investment philosophies. Heavy market swings with big highs and very low bottoms are too unpredictable for me. There is fortunes to be made with great timing but It’s just stressful to me! Before I really thought about it, I naturally gravitated towards higher cash flow areas where the values “don’t get too high or fall too low.” I enjoy the thrill of roller-coasters in theme parks, but not when it comes to my portfolio! I think this is why most of your articles/posts resonate so much with me!

    Maybe when I have a steady, hefty base of cash flow that replaces my w2-income, I’ll feel more comfortable making plays at bigger paydays like flipping on the side (especially with more free time to devote to investing). There is something so enticing about adding to the snowballing pile of truly passive cash flow though.

  8. Right now my W2 gross is about $6500/mo. I’d need around that if I plan on keeping my current primary residence and lifestyle. Maybe a bit less would be alright since I’ll have depreciation etc and will probably be taxed much less than my earned income.

    If I sell my house and move that’s a whole different story!

    • Mehran – there is such a thing as Effective Tax rate. With income like yours and living in Cali, you are likely spending 50% on income, social security, state, and local taxes, which leaves you with about $3,500 to live on. You could do the same with $4,500 of property income -likely less. And in a lot of places this would be enough to live on. Thoughts?

      • This is true and is why REI is so awesome! I’m real interested to see what my effective tax rate is on my rental income this year. I’m even more pumped up about leaving the JOB sooner than I originally planned. Now I just need to hustle and make the right moves to increase my cashflow.

  9. Ben:

    I share your philosophy of local: to-date, all my properties can be reached “à vélo”! However our boring little government and university town has had a very stable rental market (2-3.5% vacancy rate for the past 8-10 years). This situation has lead to the {slow} ratcheting-up of prices on small {2-8 unit} properties and a couple of big players trying to secure all larger (20+ unit) properties and a few in the middle driving the expectations into the range of $100K/unit.

    While rent is good (2 bdrm/1bath rents for $800 – $1000/mth w/o utilities), deals are becoming like hen’s teeth. I’ve started educating myself about the rental environment in a far-more cyclical, blue-collar city about an hour away. While I have found a few potential 5-10 unit properties that look promising, but an hour still seems a long way … especially in winter.

    As a consequence we have not purchased a property this year and have instead been rehabbing to improve energy efficiency and make existing properties more attractive and affordable while being able to ask increased rent.

    We have plans for X-units in 5-years, but we may have to extend that timeline until a little air is let out of the local market.

    • wow 100k / unit – that needs to gross around $1,200 – $1,300/month to look attractive. I love you saying that you have not purchased a property this year – there wasn’t a good enough deal 🙂

      Wait for the market to cool off, or move lol

      Thanks so much for reading and commenting Roy!

  10. Jeff Brown

    No offense to anyone, but comparing 80s Texas to today is like comparing 1930s Harvard football teams to today’s NFL teams. No need to pile on here, but the difference is fundamentals. In the 80s, Texas was nothin’ but oil. Today? Their job base is impressively diversified. You want evidence? You bet.

    About five years ago do you remember oil goin’ from just under $40/barrel to just over $140/barrel faster than we could watch it happen in real time. Remember how shortly thereafter it crashed back down to $40 at the same speed? Normally, as Ben implies, that woulda crushed the entire Texas economy. However, due to it’s new hugely improved employer diversification, it experienced about a six week hiccup and went about it’s business of showing the rest of the country how it’s done.

    Jobs? Again, fundamentals. Unlike some other states that can’t stand investment capital and business, while taxing/regulating into a death spiral, Texas has no income tax, loves investment capital of every kind, and has created more jobs, net/net the last couple years or more than the other 49 states combined.

    Yes, graphs and charts go up n’ down, that’s axiomatic. But if in our current state of affairs the Texas economy goes down? The rest of the states will have already preceded them.

    • For clarification, Texas does not have a personal income tax. Business income tax (Franchise Tax) does exist in Texas.

      I will echo your comment. Texas was all oil in the 80’s and earlier. Now, we are much more diversified. I wonder if the shale energy boom will transform the state back into a commodity economy…

      • Jeff Brown

        Any energy boom, in my opinion, will only serve to further boost a very healthy and growing economy. It won’t have any affect, at least negatively, on all the industries now comprising the states employment base. Your observation that there’s a business tax is, of course, true. Whenever I say ‘no income’ tax I’m referring to personal, but should of said just that. Thanks for the clarification.

  11. Texas seems promising and being that I am an AR resident it’s right next door. My question to anyone who actively invests in Texas is, what are the more favorable cities venture in? I’ve heard that Austin is pretty good. What’s the (investment) climate like for some of the cities in Texas you invest in?

  12. Ben I agree on the roller-coaster, not a fan.

    Generally I look at the list of “hottest” markets to invest in as the places that are no longer good markets to invest in since the main stream media has figured it out.

    Now I’m not saying that investors in Phoenix, Las Vegas, Atlanta or Austin etc. don’t know what they are doing. Far from it if they are established there, since they were investing when the deals were really good and now have assets that have much higher value then when they acquired them. So they have the options of:
    – Selling/trading places for big profits
    – Holding the places for much better cash flow than the new investors will have a difficult time getting

    When I see a market has gone up 40% in the last 8 months and that “investors” are flocking to the area, that doesn’t say to me it is a good place to invest in now. It tells me that it was a great place to speculate last year.
    (Stupid crystal ball being on the fritz again!!!!)

    • Shaun – I concur with you by and large. I have to say that of all of the hot markets, Texas does make a lot more sense than the rest because of the economic base, taxation, and population trends.

      Still – like you, it makes me nervous to come-in from out of town, not having the “big picture”, not understanding the government intricacies and tendencies, and knowing only the macro-economics.

      Furthermore, as you mentioned, I can get much better cash flow elsewhere. Sure – I will not get appreciation the compares, but I am willing to trade that for lower risk…

      Thank you so much for your comment!

      • Hey Ben,

        The thing is in the hot markets that have already run up a lot of quick appreciation there is a good chance you will NOT get a lot of appreciation. If there are good fundamentals (as have been presented for Texas) you might still see a steady incline for some time but if the only reasons are supply and demand because of:
        – Low building the last few years (Builders are going to go to hot markets)
        – Lack of REO inventory (Banks WILL eventually clear up issues and start taking places back again and will release more if they can get more for them)
        – Or Institutional buyers have been gobbling up properties (They will sell off in the strong market or at least move to new areas as many have already announced)
        Then you are possibly buying into a bubble.
        Be weary of his unless you believe the market is so hot that there is no chance prices could ever go down.

        Oh excuse me the doorbell is ringing…
        HEY 2004 how are you doing!!! Dude long time no see, it is like nobody even remembers you are around! 🙂

        • LOL You are a funny guy Shaun. I agree – my point is that if I lived there and had the inside track then perhaps I would feel more secure buying into the run-up. Otherwise, looks to good for this dumb land lord 🙂

      • BTW even when talking about a place with strong fundamentals you still don’t want to get caught up in the hype.

        For example my gut tells me that Austin itself is probably not the best place to invest.
        I will GUESS that there is some smaller city 20-40 miles away with good highway access and maybe a bus and/or train that goes right to downtown Austin where you can buy at 50-60% of Austin and the immediately adjacent municipalities and get rents for 80%+ of what you get in those areas.
        THAT is where people should invest right now.

        • Shaun, all due respect my friend, but I just don’t get this fear of a new bubble mentality, let alone trying to compare this market to the last market crash. First, we’re still nationally about 15-20% below the highs of that market. The places where the biggest run ups are occurring are in the areas hardest hit by all the foreclosures (Phoenix, Vegas, Calif, etc.), and even those increases seem to be more of a market correction towards normalized prices, not the hugely unrealistic ones of that era.

          Besides that, the main cause of that bubble was reckless actions on the part of the mortgage industry. Now, the criteria for getting a loan is much, much harder. And, with Bernanke’s QE plan, it is putting a damper on demand in many areas, which has already started to slow down the pace of escalating prices in the last month or so (coupled with the fact that we are nearing the end of the traditional summer buying season, which almost always logs higher sales than other times of year).

          And last, there is still an inventory issue. With prices not being close to back to what they were in the peak, there’s still many sellers underwater, who cannot or will not put their homes on the market. Even though I’m not a SFH investor (any more), I’ve been keeping an eye on that segment for a while now in Houston, and I see price decreases there every day – that was unheard of in the last bubble.

          In any case, I do agree with you in theory that investors should not go where the herds are (there’s lots of great outlying areas in Houston, for example, so you’re on the money there), which is one reason why I’m going to follow Ben’s lead and look at multi-families using creative financing – these two strategies alone should cut down on competition, which can lend itself to finding better deals.

          Again, dude, no offense, but if I hear one more person calling this the next bubble, I’m gonna scream 🙂 Just my 2 cents…..

  13. Sharon – if I may chime-in:

    The historical average rate of home ownership is something right around 63% – 64%. At the top of the bubble in 2008 we were at 69%. The argument is simple – are we or are we not going to return to the historical average in this country. If the answer is yes, then sorry to disappoint but we are not there yet by a long shot, which is why we are reading on CNBC the delinquency rates are sharply up once again – this thing is not over…

    Now – why are the prices up double digits year over year. Answer – hedge funds. Yes, things are trying to return to normality but we are not there yet and won’t be in my opinion, at least not in the SFR market. These funds are taking on market-setting activities by buying up entire subdivisions at a time. They hope that having pushed the valuation up, they will then begin unloading their inventory. With this we are talking about Vegas, Arizona, Portland, etc.
    You will not see me in those markets – ever.

    Also, let us not look back at 2008/09 and discuss the movement in the market relative to those highs. Those highs were unsustainable; people were being qualified for loans for whom a viable alternative was to sleep in the car – literally. Population demographics are 10 years away if not more from being able to fundamentally support those types of numbers. If it looks like we are heading there, it is a bubble – artificially driven growth in SFR space.

    Things are not any different in the multi space. A report linked below by Cassidy Turley concludes that CAP rates are at a miserable 5.3%, so if your game is Cash Flow – it is too late in the hot markets, which is Shaun’s point. Why would I want to pay 200-240k for a duplex bringing-in 2k/month if I can pay 40k/unit bringing in 600-650/month in Lima? It’s nice that the job market can support rents of $1,000/month, but the prices are outside of the basic fundamentals of Fundamental Investing in my view…

    You are right Sharon – the value-add essence of creative financing in multi-family space is the only way to substantiate buying property for cash flow in Texas today. 10 years ago was different…thoughts?

  14. Hey Ben! No, I do not think we will return to those homeownership levels any time soon (another good reason why this isn’t a bubble, I agree). First, because again, financing is much, much tighter, which won’t allow as many people to purchase a home. And second, because frankly, I think more people do remember the last bubble, more so than people are giving them credit for, and they are now preferring to rent.

    In regards to hedge funds, this is my opinion, and I may be wrong, but if they unload too quickly, they will be faced with devaluing all their assets, as over supply will cause more normalized demand. Banks have faced this same proposition, which is why we still have rampant speculation about how much shadow inventory exists. But if either group starts unloading their portfolios too quickly, then in the areas you mention, yes, we could have a mini-bubble, but I don’t think it will be anywhere near the scale of the last one.

    Frankly, I think the hedge funds need to stabilize their assets (get them rehabbed, put proper property management teams in place, rent them out) so that they can try to give their investors a return from cash flow and tax advantages. If they dump them now, that won’t happen.

    Thanks for the multi stats and report-can’t wait to read it! I always cringe when I see people making purchases, like the duplex you stated. Not the space I plan to play in.

    • I won’t rehash a lot of what Ben already said since he said a lot of what I would have responded to you above.

      What I would like to add (and not totally new from what Bed said) was that just because lots of areas have not returned to the highs they had pre-bubble (and may still be 20% or more off from that) does NOT mean there is no bubble. If the things were a 100% overvalued before that just means they are only 80% now…

      In my opinion places that are near or even above the pre-bubble pricing are the ones least likely to go down, not the ones that are being run back up and haven’t gotten as high yet.
      Why? Because these would be areas that didn’t fall as hard because there was at least SOME fundamental reason for the prices being strong.

      We can agree to disagree on this point.
      I hope those investing in the hot markets do great. I would like to be wrong and for you to be right.

      • Haha – Sharon, here’s the point: There are no hedge funds in Lima. Why? Cause Lima is too small, not a large enough economic base for these guys. And they are not wrong, conventional wisdom dictates that they go some place other than Lima.

        Conventional wisdom is not always right, which was the point of the article. Lima will not die in the next 20 years, which is long enough for me to get my 12 Cap to do what it’s got to do, and then what do I care?

        This argument is a slippery slope because nobody is wrong or right – it’s a mater of perspective! But, again, I would feel nervous going into a place that has already swung 20% – that’s just me. Furthermore, I just don’t want to care what the values do – value game is unpredictable and inherently dangerous. I play Cash Flow 🙂

        • Hmmm, Ben, I never argued that people should go into places that have swung 20% up. In fact, I agreed with Shaun that it’s not a good idea to follow the herds. And as the last paragraph of my first comment on this thread said, I invest for cash flow, and cash flow only (always have, even in the SFR segment), so not sure how my comments got so misunderstood.

          My recent comments have only been in response to some of Shaun’s assertions that another bubble is looming. I just don’t agree with that.

          I thought your response about hedge funds was in support of a bubble being possible. I didn’t know you were relating it back to the original point of the blog, which again, I 100% agree with.

          Anyway, as Shaun said, we may have to agree to disagree on some of this stuff 🙂

    • Great points Sharon! I agree completely. I personally don’t think hedge funds have pushed up the market, except in very specific markets. The hedge funds don’t have enough money or man power to move the entire housing market.

      We are also seeing low inventory and appreciation in many areas where there is not hedge fund activity like my market. I think the cause is no building in 7-10 years. Everyone counted on Reo and short sales to provide all the inventory. Now that Reo is decreasing there are no houses to buy. In my area, new builds are starting at $200k and the average price is $170k. There is no way new building can meet low and middle demand due to price points of new construction. The only way prices will drop is if we are flooded with reo(won’t happen, maybe a steady stream). Or all the low end owners decide to sell.

        • I think their is inventory being held, but almost all I it is in certain geographical locations. Mostly states that are hard to foreclose in, Indiana, Florida, New Jersey. Last I saw 50% of the shadow inventory was held be three states( not necessarily the states I listed). I talk to a lot of agents around the country in my Reo organizations and at conferences. Everyone says there is not enough inventory for buyers. Even if the banks are holding inventory, I don’t think there is enough to cause a bubble.

          I think the prices went down to far due to lots if inventory, bad economy, scared buyers and very tight lending policies. Once economy got a little better, buyers came back and banks loosened up slightly. The private sector has really loosened up with 5% and less down payments available with conventional now.

          I agree some areas with the most shadow inventory could see a mini bubble. From what I have heard that is the Midwest and Florida. Most of the reports are that banks are not going igloos the market for multiple reasons. 1. They don’t have the inventory too. 2. They like selling houses at higher values and making more Money. 2. They are selling more and more to hedge funds so they don’t have to worry about regulations. Every time they sell a pool it prolongs the process about a year. That is, if the hedge funds want to sell actual houses. They may turn around and sell loans to investors which prolongs the process even more(npl). Those end buyers may hold the notes, modify, repair or short sell.

      • Hey Mark! Great points – I agree 100%. I don’t see banks wanting a reversal of fortune at all. I mean, if a bank has four loans in one neighborhood that are good, and they are sitting on four that have been foreclosed in the same neighborhood, it does not benefit the bank to unload all of the houses and drop the value of their other houses putting their clients further under water and risking that those people also walk away from their houses.

        I believe REO’s and hedge funds will use a more measured approach. Only time will tell though. Thanks!

        • Guys – this is very, very, very flawed and dangerous logic. The banks don’t care – look into loss-share agreements they worked out with Sheila Bair and the FDIC. In fact, it is border line more advantageous for them to foreclose lol

          Think about it. If a loan was made at 4%, and 3 years from now the rates are 7%, wouldn’t it be advantageous for the bank to foreclose and re-sell the asset…especially of the FDIC will reimburse the bank 95% of the loss. hahaha I should start a bank…

          Check it out. That’s why the banks are not entirely to blame for this fiasco Sharon – the politicians are…

        • Yeah, you’re right, politicians are always to blame for everything 🙂

          It was my understanding that LSA’s were only applicable for assets “acquired” from a failed bank, not for all future assets. I don’t know of many 4% loans that were originate several years ago, so I assume your example is directed towards those getting loans today at 4% being foreclosed on in a few years at 7% because the bank could take advantage of the LSA. I don’t think that’s how it works, but correct me if I’m wrong.

          Also,” those LSA’s were instituted about 5 years ago. Under the LSA’s, the FDIC absorbs a portion of loan losses (80% to 95%) for a stated period of time — typically 10 years for single-family mortgages and five years for commercial assets.

          Such agreements on commercial assets are now close to expiration, however they also comprise a small % of a bank’s portfolio (11%)”,per Reuters.

          Now, if this shadow inventory does exist, and the banks choose to release it, even taking the LSA’s into account, they have another 5 years on SF mortgages to do so. So even if they don’t care (which I agree – giving banks credit for thinking logically may be overly generous on my part), there doesn’t seem to be any sense of urgency for them to do so.

          In a nut shell, however, I think Mark and I were referring to what banks will do today, that could cause a bubble, not what they may do a few years out. Either way, only time will tell. Care to make a wager? Lol!

  15. Keith Weinhold on

    Ben,

    I enjoy your contributions here. Thanks.

    My home market of Anchorage, Alaska is a good one to invest in. I have an 11-unit and an 8-unit building here and do out-of-area turnkeys too. Anchorage benefits from population in-migration, a transient population, and resource-based jobs.

    Your best line from this column is the concise:
    Equity = Wealth; while Cash Flow = Financial Freedom

  16. Ben – for someone who “grew up in St Petersburg” – you should be congratulated on your command of the English language! Have you ever rented to any Russians?

    I invested a large chunk of time about ten years ago, learning Spanish. It comes in very handy. The phone rings, my wife answers it, then yells “ESPANOL!”. I market apartments in Spanish, negotiate rental agreements in Spanish, interface with vendors in Spanish.

    At the time, I had a job in a town about 45 minutes away. The commute time was a waste. So I got a set of disks and spent about 500 hours listening and repeating in the pauses whilst
    crawling through traffic.

    – Jerry Kaidor

    ?? ??????? ? ??-??????, ?? ???? ?? ???? ??????…..

    • LOL Jerry,

      You know, up until today I was likely the funniest guy on BP (my good friend Brandon Turner, God Bless him, tries really hard, but … 🙂

      As of this moment I have some serious competition indeed lol
      Thanks so much for reading and for the complement and for complement. To answer your question – no, I’ve never rented to Russians. Although this may change shortly. Up to now I’ve done all of my investing within 30 of Lima – I am the one and only Russian here… But, at the moment I am looking at bigger projects in Cinci and Columbus OH both of which have significant Russian immigrant population – wish me patience hahaha

      I love the bit at the end – “useless” – good for you. Keep in touch Jerry; it’s a pleasure!

  17. John D.

    I would disagree with Ben. San Francisco has surpassed the previous “bubble peak”.
    Plus it is always better investing in a growing economy rather than one which has seen the best days behind it. Else you soon find out that you would be investing in the next Detroit

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