Bob Nelson

By Bob Nelson Written on 1/1/2010

Part Two: THE REAL ESTATE INVESTMENT MARKET

WHERE ARE WE NOW

As “Part One” summarized, the pre-2009 investment real estate was red hot, but starting to cool at a rapid rate. What had been “too many players with too much credit opportunity were driving prices ever higher. Now things started to change.

The Pre-2009 Real Estate Investment Model is summarized below.

1.The Buyer’s Mantra became “Ready, Fire, Aim”.

Restated: Buy any attractive property, and buy it quickly. The only perceived mistake was not getting involved in the feeding frenzy for good looking real estate.

Frankly, there was a lot of truth involved in that strategy in a run-away market.

The old and wise adage of “look before you leap” turned into “Ready, Fire, Aim”

• Offer quickly or lose the opportunity to buy.
• Once you have it under contract, there will be plenty of time to decide if you really wanted the property.
• If you didn’t like what you had roped, you could cut it loose to another investor who was waiting in line to buy it. Or, hold for a very short period and flip it for a profit.

Real estate brokers became familiar with the buying game.

• If three qualified buyers bid on an available property, there was the buyer would was able to get an accepted offer… he or she was referred to as “The Winner”.
• The person who came in second was referred to as “First Loser”, and the third buyer as “Second Loser”
• You only won as a “Winner”. Loser” didn’t count.

2.The Buyer’s Mantra became “Debt is Your Friend… borrow as much as possible.

The Logic: If you could come in with say 10% down and the property appreciated at 20% per annum, then you had a 200% equity rate of return from appreciation only.

WHAT HAS CHANGED?

The following notable changes have happened that have changed the tried and true Real Estate Investment Model

1.A national and world-wide recession that has continued to deepen at an alarming rate.

2.The US Congress led by President Obama has tried all kinds of stimulus efforts to correct the economic downturn.

• Most of the visible efforts involved throwing previously unimaginable amount of money at the banking industry… unfortunately with no visible results of correcting the primary element that will cure the recession… employment.
• The National Debt has increased greatly in recent months.
  • Someone in the future will have to shoulder the burden of dealing with and reducing that debt.
  • Hope that you don’t live long enough for your grandkids to understand exactly what we have allowed to happen. We have mortgaged their future.
  • Big Moral Question: Maybe we owe it to our heirs to accumulate enough wealth to pass to them so they have a running chance at dealing with the situation. Give them “enough to assist them, but not enough to ruin them” with the concept of “entitlement to wealth”.

3.Unemployment rates continue to rise.

• Consequence on the Real Estate Market:
  • Unemployed people soon lack the financial ability to pay rent or make their mortgage payment.
  • Increasing mortgage defaults mean increasing short sales or foreclosures for those who were not lucky enough to have sold prior to our current “short sale and foreclosure ridden market”.

4.Property values are spiraling downward in the face of competition by low priced short sales and lender resales of properties that they foreclosed upon.

• If you are looking to sell or refinance, then a real estate appraiser will be required by the lender who would make the new loan
• As always, real estate appraisers are required to use the most recent sales that have occurred in the market
• However, a number of the recent sales are short sales or resales of bank-owned property. One low sale influences future sales in the eyes of the lender. The lender is looking for Market Value today as well as the current value trend of the market.
• This adverse impact of short sales and foreclosure sales will continue until the bank-owned properties have mostly all been sold.

5.There is a clear and obvious federal move from capitalism toward socialism.

• The move toward much stronger federal regulation of all financial activities is one that causes great uncertainty concerning important financial relationships.
• The federal government takeovers of General Motors and increasing control of the banking industry causes concerns that additional regulation and new governmental agencies could substantially alter the business models that have caused past stability and long term economic trends.
• The recent success of a nationalized health care program is positive in concept. How can you argue that people should not have some minimum level of health insurance? That would seem un-American! However, the question remains: “At What Cost?” The cost of the plan stacked upon the financial failures of this recession will cause further stress on a system that is bulging at the seams to hold things together.
  • My friends in the insurance industry appear to be next for strong federal regulation. Anytime the government starts to dictate the “actuarial” statistics, something very strange is about to happen.
  • Who Will Pay The Bill? Guess what? You will be fine ….SO LONG AS YOU DON’T MAKE “TOO MUCH” MONEY!

6.Interest rates have been maintained at very low levels. This is highly unusual in a recessive economic environment.

• The recession of 1980 – 1984 was led by increasing interest rates. First mortgage price hit 21% during the heart of that recession.
• Very low interest rates and the availability of mortgage funding so far has characterized the current recession. This is very unusual.
  • The recession of 1980-85 had first mortgage prime at 21%. You really needed to borrow money if you agreed to borrow it at that rate.
  • It was high interest rates that led to the recession of 1980-85.

7.A mantra of “tax the rich” is heard at the federal level and at the state of Oregon level. Oregon is known for being one of the “Top 10 Most Taxed State in the Nation”.

• This is a dangerous theme. New employment is required to lead us out of the recession. Oregon has lost much of its appeal to those companies who could help the quickest. Small business is the major source of jobs that will create local stability. However, a number of small businesses failed in 2008 and 2009.
• Interesting Issue: People with money have the capacity to maneuver their money to avoid taxation. The big problem with “soak the rich” is that sooner or later you run out of “rich companies” and “rich people” to tax. Then what do we do?

WHAT IS THE CURRENT REAL ESTATE INVESTMENT ENVIRONMENT?

- or –

WHAT DO WE HAVE TO WORK WITH?

Put the above in a blender and put it on “whirl” for about 30 seconds. Then, pour it out and evaluate what we have to work with.

1.Cheap Mortgage Money: At this time, there is an availability of “cheap” mortgage money for:

• Those who can afford to make a 30% to 40% down (depending upon the property type) and as little as 25% down on other asset types.
• Contact me for some hints of some that I have discovered.

2.Increasing Debt Coverage Ratios: The lender’s Debt Coverage Ratio (“DCR”) has replaced the Loan to Value Ratio (“LVR”) as the standard for gauging maximum loan amount for income producing properties.

• Range of DCR: As the recession started to develop, the DCR was increased from 1.10 to 1.25 and 1.30.
• Restated: The amount of a new loan has been reduced rather substantially as the recession continued to progress.
• How the DCR Works:
  • Start with the Net Operating Income of the property and divide it by the Debt Coverage Ratio. This will define the maximum allowed annual principal and interest (P&I) payment.
  • Next, divide that by 12 to identify the maximum allowed monthly P&I payment.
  • Using a “present value” calculator, input that maximum monthly P&I payment in with the lender’s allowed loan amortization term and the lender’s required interest rate.
  • The result is the maximum amount of loan that the lender will permit on that property using that DCR.

3. Uncertainty of the tenant’s ability to pay rent.

Here is where the real estate market has been shaken to the core.

• Retail: A number of national credit tenants (Linen & Things, etc. etc,) have failed during the recession.
  • Past Observation: The retail triple net lease has been valued highly on the pecking order of desirable “institutional quality” investments. Cap rates were relatively low to reflect the low risk faced with national credit tenants.
  • The Problem: As some of the “big names” started to fold, the risk rating sky rockets. It would be logical that the cap rates would also increase to recognize that increased risk
  • Conclusion: The retail triple net credit tenant lease has started to pick up a bad name. Flip on the Red Stop Light.

• Commercial Office: An interesting observation has been made about office tenants. They are starting to contract in amount of space needed. They are also attempting to renegotiate their leases for lower rents. Several of my commercial broker friends are starting to make a special practice in serving tenants as they negotiate against their landlord,

• Commercial Medical: I have had several conversations with skilled doctors concerning the potential impact upon their career and their ability to generate income. They have expressed a deep concern about their continued ability to make good money.
  • Some might say that they earn too much to begin with. Maybe so, but if they have less income, then they can’t pay as much rent for leased medical space. Medical building landlords… are you listening.
  • Lower rents would mean lower values for leased medical buildings

• Residential Income: You have heard the adage… “Everyone needs a place to live”. That is true, but watch the “trickle down effect” take an interesting gyration during a heavy recession.
  • Vacancy factors has started to increase.
    • However, in the Eugene-Springfield apartment market, the vacancy factor has increased from about 2% to about 4%. That is a rate that can very well be tolerated.
    • My friend Brian Miles, CCIM of SMI Commercial Real Estate in Salem has observed that vacancy factors for apartment units has doubled over the past six months in the greater Salem apartment market.
    • The commercial appraisers who appraise apartments are the best source of current vacancy rate and rent level information.
      • The problem is there are few that are generating published vacancy and rent reports any more. Rick Duncan MAI and owner of Duncan Brown Appraisers in Eugene stated that he grew tired of his competition using his reports in their appraisal reports.
      • Rick Duncan and several of the larger apartment complex property managers are the best source for vacancy factors in the Eugene-Springfield area. Rick is my “go to” guy when I need to get a quick and accurate temperature check of the apartment market in the Eugene-Springfield area.

My Caveat To You

Concerning “Real Estate Market Information”

Be very cautious when accepting information as “fact” concerning the “real estate market”.

The “real estate market” consists of a number of localized sub-markets based upon:

1.Type of property

2.Type of tenant;

3.Location; and,

4.Quality of the information source.

Often I real articles in the local newspaper claiming that “real estate is a total train wreck”. Then check the source. It is an article written in very generic terms about the “housing market” is some region far form the I-5 Corridor between The California border and the Canadian Border.

My Observation Concerning the I-5 Corridor (Oregon and Washington): to date

1.Property values for most types of tenant occupied real estate have held up rather nicely compared to other parts of the nation.

2.Mortgage funding is available to those qualified to purchase.

3.Occupancy levels are showing strains of a recession, but this is where the product types would be anticipated to have recessive problems

Read part three

Bob Nelson

By Bob Nelson

Part One: “Recession Real Estate 101”

What Should I Do Now?

As a real estate investment broker, “What Should I Do Now?” is a question that I hear with increasing frequency.

The Principles of a Winning Strategy: My response is substantially influenced by winning concepts of the great Vince Lombardi. He stated that if you master the basics and apply them with intensity, then you have what it takes to win the game.

• The key to a winning strategy is to execute the basics to the best of your capacity.
• As new influencing situations develop, improvise, adapt, and overcome.

Focus on a Real Estate Investment Strategy: By developing a strong understanding of the basics of the real estate and financial markets, you can develop a real estate investment strategy that would allow those less timid real estate investors to prosper from our current recessive market.

“What Should I Do Now?”….. Why That Question? With the deepening recession, and the national political shift from capitalism toward socialism, the “Investment and Ownership Model” for real estate has definitely changed, and may remain changed forever. What worked well in the past may not work so well in the future.

Real estate investor confusion will continue until a new effective real estate investment model is developed, and is then proven successful through application in a deep recession.

This presentation is divided into three parts:

Part One: Factors That Changed The Real Estate Investment Model

• How the train wreck began

Part Two: The Real Estate Investment Market in the Pacific Northwest

• Were are we now

Part Three: What Should I Do Now?

• A study of the Real Estate Investment Basics
• How to start to form a viable real estate investment strategy

Part One:

FACTORS THAT CHANGED

THE

REAL ESTATE INVESTMENT MODEL

Period: 2004 through 2007 – The Real Estate Boom and What Led to It.

1.Stock Market Lost Investor Reliability. The stock market took a dive, and continued to perform poorly. Many investors relied heavily upon stocks as the backbone of their retirement portfolio. Many stock-based retirement portfolios lost about 40% of their value during this period of time. This came as a real cold shower to a number of folks who were on the verge of a comfortable retirement.

2.Bond Market Lost Appeal. The bond market had lost much of its appeal to the stock market. While uncertainty was driving many away from the stock market, the bonds had very little appeal as bond yields continued to drop with falling interest rates on government securities.

3.Real Estate Market: “The Only Game in Town”. The real estate market became the “darling of the investment smorgasbord”. If investors have three tables from which to dine, real estate became the only attractive table which appeared safe to dine.

The walking-wounded stock investors flocked to the real estate market. They bought the duplex on the corner and the house next door. Buying pressure helped cause prices to soar.

The real estate investor’s mantra was clearly either:

• Buy, buy, buy! Then, sell and do a tax deferred exchange into a bigger and better property; or,
• Buy, fix it up, then flip it to those with less “fixer ability”. Then, repeat the process as quickly as possible. There was profit in nearly every move. If you erred, just hold on, the market will make you well again.
• For either strategy, clearly “Borrow as if there’s no tomorrow”. Rates are low and yields are high. It’s an investor’s dream come true. The only mistake to be made was not getting into the game.

4.Mortgage Loans Were Plentiful. The availability of long term money in the capital market remained high and rates were low.

Newly created loans were immediately sold into the secondary mortgage market. The secondary mortgage market bundled loans and sold commercial mortgage backed securities (“CMBS”) to pension funds and institutional investors. They were attracted to the yield and safety of the underlying mortgage bundle. The mortgage default rate was extremely low. There seemed to be almost no risk at all.

The Mortgage Lender’s Process: Make a batch of loans as quickly as possible, and then sell them quickly for cash into the secondary mortgage market.

The secondary market had a strong appetite for CMBS offerings.

The secondary market (mainly Fannie Mae) would then slice the CMBS into pieces of the offering. They would then sell each slice or tranch with a priority in accordance with which slice would be paid off first in the event of a foreclosure. Some tranches were the most risky and would be sold to generate the highest yield for the investor. Those tranches of lesser risk sold for lower yields, and so on until the entire offering was fully sold out.

The players in the secondary market became rich with profits. Like Robert Zeckendorf had discovered in the 1950’s, a property could be sold in pieces with the cumulative value of the pieces exceeding the value of the whole. Sell pieces, and make abnormally high profits. Like Zeckendorf, they would discover the cost of failure, if any piece of the offering failed.

Huge Benefit to the Mortgage Lender: Using the Primary Mortgage Market and Secondary Mortgage Market scheme, the mortgage lender would never run out of money to lend so long as the secondary mortgage market remained eager to buy the newly created mortgage loans.

What a system was created!!! … Lend and never run out of money!

That is exactly what happened as mortgage market lenders raced to develop new mortgage loan programs. Their lending strategy was:

• Develop a new mortgage loan that was a bit more attractive than your competitors are offering.
• Make it easier and quicker to get a mortgage loan than your competitor.
• The Lender’s Mantra: “Pick me, pick me!”
• The lender was paid a loan fee, and a loan processing fee. The lender would often receive a “back-side” rebate as the loan was sold into the secondary market.
  • A loan servicer has the task of collecting the monthly payment and allocating it between property taxes and insurance, and then allocating the remainder to interest, and then to principal to amortize the loan.
  • For servicing the loan, they collected a “loan servicing fee” that was often as much as ½% of the loan.
  • It was like the nurse that married the undertaker: they got paid coming and going.

5.Mortgage Borrowing Standards Loosened. As part of the new loan program process, lending standards were loosened substantially.

• The “Credit Score” Became King. The lender came to rely heavily upon the Fair Isaac credit scoring model. The credit scoring system became the primary criteria in qualifying for a mortgage loan.
• What Is It? Your credit score is a three digit expression of how you had handled credit in the past.
• What Was the Premise? If you had performed well with credit in the past, so might you perform in the future.
  • If your credit score was high enough, loan terms were made so attractive that almost anything with a good credit score would be offered the most liberal loan terms.
  • You may recall TV commercials that boasted that they would lend 125% of the value of your property. Had the world gone mad? What safety could exist for the lender if there was no collateral behind at least 25% of the loan being made?

6.Real Estate Values Appreciated at a High Rate. Easy borrowing and a huge demand for investment real estate caused the illusion that you really couldn’t pay too much for real estate.

• If you over-paid, just wait. The market will catch up with you soon, and all will be well again.
• It was not uncommon to find appreciation rates of 15% to 30% per year. Areas like Las Vegas and Phoenix experienced even higher appreciation rates.
• Recent market evidence proves that the most over-heated markets that spiraled upward at the most rapid rates have tumbled at even faster rates.
• Examples: Bend – Redmond in Oregon, Las Vegas, Phoenix, and parts of California are primary examples of “fast up and fast down” markets.

Read Part Two

Click to enlarge

2009 will go down as one of the toughest years for the Portland economy since the early 1980’s, with only the Great Depression causing noticeably more pain. While we all know how tough the second half of 2008 was, there was little to prepare us for the turbulent waters and gale forces winds which impacted the Portland economy and commercial real estate in 2009. So just what happened here in 2009?

Portland Economy: The big surprise of 2009 was just how weak the Portland economy was. Over the twelve months ending in October 2009, we have lost 53,200 wage and salary jobs, or over 5% our employment base. In addition, our unemployment rate rose from 6.8% in October 2008 to 11.6% in October 2009.

Read the full 2010 Winter Newsletter.

In recent weeks we’ve seen reports suggesting that real estate prices have begun to stabilize. What’s being said is not that prices are returning to the levels seen in 2007, but instead that declines in many communities have now slowed or stopped. Indeed, home prices are actually rising in some local markets. These reports are good news, but many people wonder: How is it possible for home values to stabilize while our vast “shadow inventory” of distressed and unsold real estate continues to grow? Read the entire December 2009 Market Trends Report

A flurry of recent apartment transactions and positive reports from the trenches by apartment owners is leading multifamily experts to say the sector is finally showing signs of improvement.

“The attitude towards multifamily has completely changed in the past year,” said Dave Doupé, managing director of Jones Lang LaSalle’s West Coast Capital Markets team. “Financing from Freddie Mac and Fannie Mae has certainly bolstered the viability of this sector, but we’re also seeing buyers and sellers begin to come closer to a common ground on pricing discovery in the multifamily product category.”  Read the full story

Potential Tax Savings Opportunities 

Nelsonian Fundamentals: There are two ways to increase “profits”.

Either: 1. increase your incomes; or,

        2. decrease your expenses.

Both will increase the “Bottom Line”.

Both of the following “opportunities” can improve your profit margin right now by decreasing your expenses… the expense of taxes paid to the government.

 Do I have your undivided attention? Read on.  

NOTICE: THIS IS NOT INTENDED TO BE “TAX COUNSEL”.

This is intended to be a “heads up” for those who own real estate.

 Item One: NEW FEDERAL LAW as of 11/6/09

 Great Tax Relief, if your business has LOST MONEY in 2008 and / or 2009.

 The “Worker, Homeownership, and Business Assistance Act of 2009″

Five Year “NOL” (Net Operating Loss) Carry-Back

Who Qualifies:

1. Owners of a small business with gross receipts of less than $15 million per annum in 2008 and/or 2009; or,

2. Tax Payers who do not qualify may use it in either 2008 or 2009 (but not both years)

Summary of Opportunity: If you own an eligible small business that:

• grosses less than $15,000,000 in 2008 or 2009, and
• had business losses

then, you may amend your tax return to carry those losses back for up to five (5) years and thus reduce your taxable income in those years by offsetting those more profitable (and more taxable) years with current business tax losses.

 How About the “Alternative Minimum Tax” (AMT) Tax payer? This new law suspends the 90% limitation on the use of a NOL for the AMT Tax Payer. Pretty interesting for once for us AMT tax payers!

 Nelsonian Theory: With Your CPA’s Blessing, Maximizing 2009 Expenditures:

1. One way to legally increase your 2009 “tax write-offs” is to increase your IRC Section 179 Expenditures (new computers, business oriented equipments, etc…. ask your real estate oriented or business oriented CPA to make sure that your perceived “expenditure” qualifies). This can really increase your qualified expenses while acquiring needed equipment to become more productive.
2. Another whopper of a legitimate tax shelter expense increase is to convert to the Cost Segregation depreciation method. Unfortunately, the conversion to this method is not quick. It takes a detailed Cost Segregation Study to get started, and that doesn’t happen over night or at a small expense…. See “Item Two” below for addition information on that topic.

 To Learn More: Consult your business oriented CPA. This could be a whopper for those who did very well before the Recession hit, and are now not having nearly as much fun with accumulating business losses.

 Item Two: Cost Segregation Depreciation

 Who Can Use It: Any owner of real estate who uses that real estate in a manner that qualifies for a depreciation allowance:

• an investment property owner who owns a property with building improvements; or,
• a business owner who occupies the building that they own as a productive asset in your trade or business.

 How to Get On Board: It takes a Cost Segregation Study to start to receive the benefits. There are a number of firms who specialize in preparing the necessary Cost Segregation Report.  Those firms typically consist of engineers and CPA’s. For a not-very-small fee, they perform a Cost Segregation evaluation of the buildings. The study identifies the structural components and their relative “cost”.

 How It Is Used: Once the study is completed, each identified component is evaluated to identify its specific value and a specific depreciation schedule. Each year, the CPA will calculate the annual depreciation allowance that the owner is allowed to claim.  

 The Result: The owner/tax payer can claim a substantially larger amount of depreciation allowance each year…. thus offsetting a like amount of otherwise taxable income generated by that property or that business (in the case of an owner-occupant).

 Heard on the Street: A broker friend of mine stated that it saved one of his clients $100,000 of real money in the first year of application. That tax savings came in a refund from IRS on taxes paid in former years on income generated by that property.

 Is It For Everyone?  I don’t know. However, the initial cost of establishing the Cost Segregation Study is probably not “cost effective” unless your property improvements exceed $1,000,000 in value.

 How Much of This Should I Rely Upon?  Very little. I am just trying to give you a “heads-up” that might save you big bucks.

 How Can I Get Good Advice? Talk to your real estate oriented CPA.

 Don’t Have A Real Estate Oriented CPA? If you own real estate and are not using a good real estate oriented CPA, then that could be very costly! You need to correct that defect RIGHT NOW!

 Our new President has ideas for tax increases to fund the new socialized medicine and other programs that will require new tax law changes. Guess what…they will not favor additional wealth accumulation by investors and business owners.

 Get ahead of the curve… even then, it will not be easy or safe. Don’t go to a proctologist for a tooth ache, and don’t trust your financial future to tax counsel to a person who is not an expert in real estate taxation and real estate investment concepts.  

 Get informed counsel for your specific needs! If you need assistance in finding a “real estate oriented CPA”, then call me Bob Nelson (541) 485-8100.  I have some ideas.

The credit crisis, which is fallout from the subprime housing debacle, essentially shut down mortgage lending and other loans critical for real estate sales and refinancing in 2009. Commercial banks are watching delinquencies increase and vacancies continue to rise, and are tightening their credit requirements.

Most lenders use a measurement called Debt Coverage Ratio (DCR) to determine how much money they will lend on a property. Debt coverage ratio measures the property’s ability to generate enough cash to cover the monthly debt payments. In the past lenders requirements were around 1:1 but now are being increased to closer to 1:3 to 1:35 coverage. This means if the income from the property is not sufficient enough to cover the DCR; the borrower will have to put down a larger down payment upfront when purchasing the property.

Mark Cusick, a Commercial Loan Officer with Commercial Lending Group, is seeing lender’s require the following items from individuals:

1. Net worth equal to or greater than the loan amount requested
2. Cash after closing equal to or greater than one year of principal and interest payments
3. Borrower’s personal cash flow must carry their own debt load. Lenders want to know that the borrower will not need to supplement their personal cash flow from the properties cash flow
4. Strong ownership and management experience will help offset potential weakness in Items 1-3

Now more than ever a knowledgeable Real Estate Broker can make the difference in your real estate transaction. You need a trusted advisor on your side guiding you along the way!

Market Trends for October 2009

While Pacwest specializes in commercial real estate, we feel that it’s important to keep our clients informed of the activity in the residential arena. At October’s rate of sales, the current 1,939 active residential listings would last approximately 6 months. A truly healthy market likes to see that balance closer to 2-3 months of inventory.

In the month of October, closed sales were up 5.7% but pending sales were down 6.7%. We are still seeing a glut of pending sales that are waiting for bank approval due to short sale situations.

Check out the attached report, especially page 2. Notice the Average Sales Price % Change field. This is a comparison of the rolling average sales price for the last 12 months with the 12 month before. As you can see the figures are all over the board depending on what area of Lane County you are interested in.

If you would like more information on real estate trends in Lane County, don’t hesitate to call us at (541) 686-8246.