Buy Real Estate Investments with Your IRA

If you have a retirement account with over $200,000 and are looking for cash flow, more stability, and a secure retirement portfolio you need to attend our upcoming free seminar.

Tuesday, November 15, 2011

7:00-9:00pm

Phoenix Inn, 850 Franklin Blvd, Eugene

To Register Call: (541) 987-2232

At Pacwest Real Estate Investments I receive calls from clients all the time asking “What is the Cap Rate for an Apartment Complex”.  A cap rate is the ratio between the net operating income that a property will generate and the capital costs (purchase price).  While cap rates vary from market to market, in the Willamette Valley we are seeing cap rates between 7 1/4% to 7.5%. 

 A key to buying commercial real estate successfully in this market is with low leverage.  The cap rate has to be about 2% in excess of the current interest rate that would be charged for the new loan on such property.  If you are obtaining a loan the lender’s require a Debt Coverage Ratio of about 1.3 so you need to be attentive to that too.

To ensure that you are buying a quality investment you should carefully study the past three years of:

1.  Year-End Property Manager’s Operating Statements; and,

2. Owner’s Schedule E’s for the same years

The operating expense should be about 40% to 44% of the actual rental income received. If it is less than that, then be cautious in using the resulting Net Operating Income for your valuation.

Good luck and let me know if you have any additional questions!

While housing starts are struggling and sputtering, multi family is still the preferred properties to buy among Investors.

Apartment demand continues to gain steam and strong demand is emerging. It’s a great time to buy!

Recently, Bob was asked about like kind exchanges:

“The more I think about it, it seems that ” like kind ” property is a very loose term. I guess the ” character” of the property more important than it’s use. I mean if you have a duplex and you exchange it for an apartment building then that is clearly “like kind” . But if you exchange that duplex for say a property with a restaurant then that would not seem to be “Like kind”. Mostly it seems like this is used for exchange of rental or timber property but it must also apply to other businesses and I suppose it doesn’t really matter what the business is. Can we just cover it with a blanket called ” Investment property”?

So do we categorize properties? Business, trade, rental, timber, vacant land… I can’t really think of any others, manufacturing maybe. Or do we just do what “feels” like it would be a reasonable argument for ” like kind”?

Nelsonian Theory has the answer:

Like Kind:

1. Property held for long term investment (not income generating, but held for appreciation in value): e.g..: a lot, ten acres etc.
2. Property held for
   1. Productive use in trade or business; or,
   2. Generation of long term passive income (rental property).

Not Like Kind:

1. Personal use assets (personal use, not business use)
   1. Personal residence
   2. Second residence
2. Property acquired for resale to others (dealer status)
3. Personal property (REIT’s, appliances, cars, etc.
4. Partnership interests
5. Stock and bonds (secured or unsecured by real estate)

The real test: What was the intent of use at time of acquisition, and then how was it used after acquisition.

The Purchase Decision: When considering the purchase of an apartment complex (or any income generating rental property), there are several critical features to consider.

1. “Attractive”:

a. general “curb appeal” (important to tenants and buyers)

b. overall security for tenants

c. income generating capacity that would support the asking price Why: Nelsonian Theory has it that “Before you buy, figure out how to get out of the property later”

Ask yourself this question: “If I were offering this property for sale today, will I get interested qualified buyers at this price?

2. “Strong pride of ownership”

a. Can it be made to reflect a “price of ownership” consistent with the level of rents that I target? Again: Think resale.

b. Long term tenants appreciate pride of occupancy, and will pay decent rent for a safe and clean place to call home.

3. “Well maintained property”

a. Did the prior owner do a good job in maintaining it?

b. If not, there will be a price penalty.

The Financing Decision: The lender will require certain information with the application. The most important information is the operating history of the property.

1. “Schedule E’s / Form 8824’s” and “Year-End Reports”:

a. The lender will require the last three years of the owner’s operating performance from filed tax returns, and manager’s Year-End Reports.

b. The lender and the lender’s appraiser will use this information to establish a baseline of rents and expenses.

c. The Target: a normalized Net Operating Income (“NOI”) which is the annual cash flow if owned free and clear of debt and before personal income tax considerations)

d. The lender’s allowed Debt Coverage Ratio (“DCR”) when divided into the normalized Net Operating Income (“NOI”) will define the lender’s opinion of the maximum annual principal and interest payment that the property can safely support.

i. Today’s DCR for apartment complexes: 1.25 to 1.30

ii. FYI: That has increased from 1.15 two years ago

e. The amount of annualized debt service (P&I) when divided by 12 will define the maximum allowed monthly debt service (P&I only) that the lender would permit for the property.

f. When the monthly maximum debt service is applied to the lender’s interest rate (6% to 7% today) and maximum allowed loan term (25 to 30 years today), this will define the maximum amount of loan that the lender will permit for the property.

g. There is no mystery involved. If you can define the normalized NOI and can obtain the Debt Coverage Ratio (DCR) that the lender will use, then you can determinate in advance the maximum available financing for the property. A good commercial – investment broker will do this prior to bringing a property onto the market.

SIDE-BAR COMMENTS  AND  STRATEGIC OPINIONS  FROM “THE GURU”….

1. DCR-based Calculations can be misleading.

a. Recently I made such a calculation for a 72 unit apartment complex that I was marketing. Using current lender standards (1.30 DCR, 6% interest rate, and a 30 year term), the calculation inferred that the lender should be willing to make an 84% Loan to Value Ratio (“LVR” or “LTV”) loan. My observation: Fat Chance!!

b. Lenders still feel edgy about going past a 75% LVR, even when the “financial moon and stars” are in perfect alignment. However, do not abandon the information presented above.

2. Interest Rates change quickly. Never trust old information

a. There are several really good and dependable lenders that I look to for current and accurate information. I may be able to help.

b. There is nothing that will ruin your day more than tying up a really good property, then finding out that something has changed, and you have to sheepishly step politely out of the “Winner’s Circle”. Again, maybe I can help IF I AM BROUGHT INTO THE GAME EARLY ENOUGH TO BE ABLE TO MAKE A SUBSTANTIAL IMPACT.

3. Use FIXED RATE LONG TERM Financing.

a. I will try to remain “Politically Neutral” here (I am a registered “Independent” and have been since 1964), but in my opinion what the current administration is doing will lead to super inflation in the fairly near future.

i. Super inflation leads to super interest rates.

ii. You can’t just leave the printing press on at the Treasury without having someone notice…Gee, maybe there is a downside to “too much money”.

b. Absolutely avoid a variable rate loan.

i. You will become the custodian of the apartment complex for the lender as the variable rate loan indices start to climb.

ii. With a variable rate loan, the lender would have passed the inflation risk through to you.

3. Use the LONGEST AMORTIZATION TERM AVAILABLE.

a. This would require the lowest monthly PI payment.

i. You can always add more to the payment if cash flow is available

ii. But you can back off to the lowest required payment if cash flow turns negative for a period.

4. These are times that build wealth and character!

a. Be cautious, but keep moving forward!

i. Interest rate are MEGA-CHEAP

1. The last “Great Recession” (1980-86) first mortgage price was 21.5%!!

2. Today’s “Mother of Recessions” has first mortgage prime at around 6%.

3. We have never seen a recession where prices are “right” and money rates at “right” too.

a. But borrow with an interest rate that can not be adjusted for at least 5 years and preferrabley10 years. You can thank me later.

ii. Prices and investment yields are getting “more right” every day.

1. If you can borrow at 6% and invest at 8%, you are making money on money you don’t even have. WHAT A COUNTRY WE LIVE IN!!!

Contact me if you:

1. have questions about this information; or,

2. are looking to purchase or sell an apartment complex.

I know my “stuff” and can buffer you from certain dangers.

Bob Nelson, CCIM

The 1031 Guru

41 years of commercial – investment brokerage expertise

(541) 485-8100

bob@1031guru.com

www.1031guru.com

As real estate prices continue to drop it may be a great time to buy another piece of real estate. However, it is always important to evaluate your current portfolio first to make sure it as recession proof as possible.

Here is the Nelsonian Theory on things to do RIGHT NOW….

1.  Evaluate your investment portfolio

a.  What is your ANNUAL YIELD:

i.  for each property

ii.   for the entire portfolio

b.  What is each property doing for you?

Restated: Why own it?

c.  Would performance be enhanced by refinancing it?

Restated: Do you have any interest only loans or variable rates loans that will adjust soon and have an impact on cash flow

d.  What is the “runt of the litter”?

i.  Should you hold it or trade it off?

ii. Can use it as a “down payment”

2.  Evaluate your LIQUIDITY (“staying power”)

a.  Make sure you can survive

b.  3-6 months of “survival number” or an extremely safe life of credit

3. Consider buying “foreclosures” and “the walking wounded”

Fannie Mae (FNMA) has a special program called Home Paths which allows an Investor to purchase a FNMA repossessed property and finance it with as little as 10% down payment. Special restrictions apply so check with you a knowledgeable lender regarding the financing options.

These special financing programs will not last forever!!

Many investors ask us our opinion of the market, when do we feel we will be out of the recession, and what is the right kind of property to buy right now.

First off, if we could predict when we will be out of this recession then we would be sitting on a beach on our own island having waiters bring us fruity drinks with pink umbrellas.  No one can really predict when the recession will end because it is job and employment driven.  Until people go back to work our financial woes nationally will continue.

With that being said, there are some ways to look at real estate to determine what will be the least likely real estate asset to be hurt in this recession.  Here is the Nelsonian Theory:

1. Class B and C Apartments in college towns
2. Modest priced rental houses in strong neighborhoods
3. Small medical office buildings with well established doctors
4. Key: Retain some LIQUIDITY!!!

Retaining liquidity is critical in a tough market like this.  If you have a leaking roof or the HVAC of the property fails having the cash to fix it quickly can make the difference of keeping your tenants happy or having them move out.

Liquidity is also important when you have a vacancy.  It is always painful when you have to dip into your own pocket to cover a mortgage payment if your space is vacant and there is no rent coming in.  Set a goal today of accumulating 1-2 months of operating expenses in a reserve account.

Class B and C Apartments are becoming very attractive to investors.  The tenant mix in these types of properties are hard working blue collar individuals who usually become long time renters.  They work hard and pay their rent on time.  They are looking for a clean, safe place to live and don’t expect granite, stainless steel appliances, etc. They are also not the type of tenant who is renting your place just long enough so they can save up a down payment and then vacate to go and buy a house which is a trend in Class A apartments.

The most popular Class B and C Apartment complexes can usually be found in college towns.  Right now with unemployment high the local universities and colleges are busting at the seams with people wanting to get an education.  College towns are great for apartments because there is a healthy mix of the working sector in addition to the student sector for possible tenants.

Read our next blog about things you can do right now to get yourself in a better financial position to weather the storm.

In CB-United we feel it’s important to help other people gain awareness in all avenues of life, for this reason let me forward some very helpful lines about identity theft right here:
A close friend of mine has a corporate attorney friend who sent the following out to the employees in his company. It’s worth reading and doing.

1. The next time you order checks have only your initials (instead of first name) and last name put on them. If someone takes your checkbook, they will not know if you sign your checks with just your initials or your first name, but your bank will know how you sign your checks.

2. Do not sign the back of your credit cards. Instead, put “PHOTO ID REQUIRED.”

3. When you are writing checks to pay on your credit card accounts, DO NOT put the complete account number on the “For” line. Instead, just put the last four numbers. The credit card company knows the rest of the number, and anyone who might be handling your check as it passes through all the check-processing channels will not have access to it.

4. Put your work phone # on your checks instead of your home phone. If you have a PO Box, use that instead of your home address. If you do not have a PO Box, use your work address. Never have your SS# printed on your checks, (DUH!). You can add it if it is necessary. However, if you have it printed, anyone can get it.

5. Place the contents of your wallet on a photocopy machine. Do both sides of each license, credit card, etc. You will know what you had in your wallet and all of the account numbers and phone numbers to call and
cancel. Keep the photocopy in a safe place. Also carry a photocopy of your passport when traveling either here or abroad. We have all heard horror stories about fraud that is committed on us in stealing a name, address, Social Security number, credit cards.

6. When you check out of a hotel that uses cards for keys (and they all seem to do that now), do not turn the “keys” in. Take them with you and destroy them. Those little cards have on them all of the information you gave the hotel, including address and credit card numbers and expiration dates. Someone with a card reader, or employee of the hotel, can access all that information with no problem whatsoever.

Unfortunately, as an attorney, I have first hand knowledge because my wallet was stolen last month. Within a week, the thieve(s) ordered an expensive monthly cell phone package, applied for a VISA credit card, had a credit line approved to buy a Gateway computer and received a PIN number from DMV to change my driving record information online. Here is some critical information to limit the damage in case this happens to you or someone you know:

1. We have been told we should cancel our credit cards immediately. The key is having the toll free numbers and your card numbers handy so you know whom to call. Keep those where you can find them.

2. File a police report immediately in the jurisdiction where your credit cards, etc., were stolen. This proves to credit providers you were diligent, and this is a first step toward an investigation (if there ever is one). However, here is what is perhaps most important of all (I never even thought to do this.)

3. Call the three national credit reporting organizations immediately to place a fraud alert on your name and Social Security number. I had never heard of doing that until advised by a bank that called to tell me an application for credit was made over the Internet in my name. The alert means any company that checks your credit knows your information was stolen, and they have to contact you by phone to authorize new credit. By the time I was advised to do this, almost two weeks after the theft, all the damage had been done. There are records of all the credit checks initiated by the thieves’ purchases, none of which I knew about before placing the alert. Since then, no additional damage has been done, and the thieves threw my wallet away this weekend (someone turned it in). It seems to have stopped them dead in their tracks.

Now, here are the numbers you always need to contact about your wallet and contents being stolen:

1.) Equifax: 1-800-525-6285

2.) Experian (formerly TRW): 1-888-397-3742

3.) TransUnion: 1-800-680-7289

4.) Social Security Administration (fraud line): 1-800-269-0271

We pass along jokes on the Internet; we pass along just about everything. So don’t stop now. Pass this on or share it on facebook and twitter.

By Bob Nelson

Part Three: WHAT SHOULD I DO NOW?

FORMING A VIABLE REAL ESTATE INVESTMENT STRATEGY

A STUDY OF “THE BASICS”

My Background: My business opinions have been molded by my substantial professional education and by my 41 years of real estate brokerage expertise in the commercial-investment real estate market.

I have been a student of the real estate market even longer than that. My father Roy Nelson was a commercial real estate broker and real estate appraiser for 17 years before I became involved and followed in his footsteps. He taught me much of what I know about negotiation and client care.

A Bit of Valuable Theory First: Vince Lombardi Would Approve!!

Cause and Effect Relationships

We are familiar with “cause and effect” relationships. A particular “cause” or action will result in a predictable “effect”, reaction or response.

• “Laws of Physics” tell us that if you throw a tennis ball at a wall, you can accurately predict the direction that it will bounce off the wall.

That is an example of a “cause and effect” relationship within earth’s gravitational fields.

Further, if you change the “angle of incidence” (the angle at which a thrown ball hits the wall) then, you can accurately predict the direction that the ball will take as it bounces off of the wall.

The angle of incidence equals the angle of reflection, and predictability exists.

• “Laws of Human Response” tell us that if I use hurtful words or actions toward you, then I can anticipate that I will probably receive a predictable response in retribution from you.

If I don’t wish to receive that type of negative response, then I should be careful not to use hurtful words and actions toward you. We call that human nature.

While Laws of Human Response may be less predictable than the Laws of Physics (people can develop good acting skills), a good real estate negotiator learns to control his or her emotions in order to guide the negotiations to a desired result.

• “Laws of Financial Markets” tell us about the “cause and effect relationships” between “Supply and Demand”.

If demand for a scare commodity increases, but the supply or availability of that commodity decreases, you can anticipate an increase in it market price.

Qualifying Demand Factors:

1.Demand is influenced by purchasing capacity. When dealing with “demand”, only those with purchasing capacity should be considered. Point: If I would love to own one, but can not afford to buy one, my vote does not count as part of “effective demand”.

2.Demand is influenced by availability of financing. If I could afford to buy one with a loan with an interest rate at 5%, but interest rates just increased to 6%, then my “desire to own” remains strong, but only at a lower price that would allow me to finance its purchase within my capacity to service debt. Restated: My “demand” no longer counts at the previous price.

3.Demand for real estate is influenced by the attractiveness of the stock and bond markets. A large part of demand for real estate that caused the “Real Estate Boom of 2004 through 2007” was due to the wholesale rejection of the stock market and the bond market.

Point: Many people lost 40% or more of their retirement account that was invested in the stock market. Many flocked to real estate for fear of continued losses in those other markets. A “feeding frenzy” pushed prices up rapidly. Too many dollars were blindly chasing too few attractive properties.

Qualifying Supply Factors:

1. Supply Responds Slowly. It takes a while for supply for real estate to respond to an increase in demand. You can’t just leave the printing press going over the weekend at the US Mint to create more money . That is an option that is only available to the federal government.

Point One: Observation: To create a new apartment complex, it takes a year or so to acquire the right property, get plans approved as a building permit, build the complex, then rent it out until it’s full. It does not happen over night. This can cause a substantial increase in market price for an existing good looking apartment complex.

Point Two: My prediction: When the market finally stabilizes for apartment complexes, we will see a horrendous increase in “cost” of generating that new complex. Systems development charges, cost of building materials, and financing costs will boost the “finished price” of that property.

Suggestion: Consider buying existing “pre-owned” apartment complexes right now. You will look like a hero later!

2.Political Considerations Influence Financing. The federal government has the capacity to regulate interest rates. The easier it is to finance the acquisition of an income property, the more appeal it will have.

Question: Why isn’t this a “supply-side” factor?

Answer: It is. The easier it becomes to buy a property, the more available property becomes to buy.

However, it is also a demand-side issue in that it is now possible to obtain a new mortgage with ten year fixed interest rate.

Observation: Ten year fixed rate financing allows the investor to neutralize the “cost of capital” issue during a recession.

Suggestion: Take advantage of available new financing.

Source: Steve Wiltshire of Marcus & Millichap Capital Group (503) 802-2000 in Portland told me of a Fannie Mae apartment loan package that features a 30 year amortization with a ten year fixed interest rate.

Rates change, so I will not mention the rate that he quoted me. However, the point is A FIXED RATE FOR A TEN YEAR PERIOD eliminates the risk of having an interest rate increase in the middle of a recession. That is a whopper of a demand-side benefit.

3.Tax Law Changes Influence Appeal. Recently the federal government provided real estate investors with the opportunity to increase their tax shelter from real estate. Cost Segregation depreciation allows such an opportunity. See by blog on that subject.

Understanding Changes in the Real Estate Financial Markets

These “Laws” or financial cause and effect relationships have recently become substantially altered, and thus have become far less predictable.

• Change One: Artificial Supply-Side Pricing. Real estate prices are being adversely impacted by a large number of “forced sales” caused by defaulting borrowers being forced to sell under pressure to sell, and foreclosure sales by lenders in need of a quick sale.
  • Situation: A borrower is unable to make the mortgage payment, and has attempted to sell the property.
  • He discovers that it will not sell for enough to pay off the existing loan. He then notifies the lender of the situation.
  • The lender must then decide which course of action to take.
  • If the borrower has not been declared to be in default, the lender frequently ignores the borrower’s plea for relief.
  • If the borrower has been declared to be in default, then the lender will either:1. agree to accept less than the full loan balance in satisfying the loan (a “short sale”); or,2. take steps to foreclose on the property, then resell it quickly to recoup the amount of the loan.
  • Result: Discounted sale prices resulting from “short sales” and “foreclosure sales” impact all property values and force prices down. You will have difficulty attracting a buyer who would pay more for yours than they could pay to acquire a very similar property offered through a short sale or foreclosure priced property.
    Even if you are successful in seemingly avoiding the impact of “forced sale” discounts, the appraiser who the buyer’s lender will use to value the property for loan purposes will include those low priced forced sale. The buyer will not be allowed to borrow as much, and your sale may be in jeopardy of closing.
  • Observation: Until the lenders sell off all of their REO and the number of short sales is substantially reduced, the value of real estate will continue to be adversely impacted.

“Real Estate Foreclosures 101”

What is a “Short Sale”? A “short sale” occurs when the lender agrees to accept less than the full loan balance as repayment of the existing debt.

Why Would The Lender Agree To Accept Less? Once a borrower defaults on a loan, the lender must form a course of action that would result in the least loss to the lender.

Would the short sale be less costly than a foreclosure resale of the property on the open market? If so, agree to the short sale and be done with it.

Observation Concerning Short Sales: As a buyer offering on what will be a “short sale”, there is never a quick decision to allow the deal by the lender.

The lender’s decision making process causes the potential transaction to travel through several departments of the lending entity before a decision to accept the short sale is reached.

It has been known to take months for the lender to finally agree to a short sale. By that time, the buyer lost interest in the property, and has walked away by the time that the lender approves the short sale.

Lenders are slow to agree to lose money, even if money is being lost with each passing day.

What Happens to the Lender When the Lender Forecloses? The lender’s financial statement will be immediately and substantially altered. The previously performing loan (an asset held as a “Loan Receivable”) is converted to a less liquid asset known as “Real Estate Owned” or “REO”.

Lender’s Financial Consequence of the Foreclosure: The lender will experience several negative consequences as a result of the foreclosure.

• The lender is often the only bidder to show up at the foreclosure sale.
  • At the foreclosure sale, the lender makes a bid equal to the balance of the debt. If no other bidders bid higher, then the lender receives title to the property.
  • If the lender receives title to the property, then the dollar amount of the previously performing loan is subtracted from “Loans Receivable” and the value of the property acquired through foreclosure is added to a category known as “Real Estate Owned” or “REO”.
  • The lender is well equipped to make loans, but much less equipped to hold real estate in lieu of a Loan Receivable.

• In order for the lender to get out of real estate ownership and back into the lending business, the lender must resell the foreclosed property on the open market.

• Probable Result: If the prior borrower could not escape foreclosure by selling the property, then the lender probably can’t do any better. This is where the lender’s bigger problems begin.

• 1. “Mark to Market” While the previous “Loan Receivable” and the “Real Estate Owned” are both “assets” owned by the lender, the bank auditors will soon require the lender to periodically mark down or reduce the reported value of the REO to reflect what it would sell for in a quick cash sale. Any action that reduces the value of the bank’s assets will directly reduce the lender’s “Shareholder’s Equity” (the bank’s net worth).
• 2. “REO Reserves”. In addition, the auditor will require the bank to create a “Reserve for REO” or a cash fund set aside to cover the performance of the REO asset.

This reduces the amount of available funds that could be used to create new loans and generate more revenue for the bank.

Summary: Both of the above actions will reduce the bank’s ability to generate more revenue and increase Shareholders Equity.

Lender’s Decision Point: Consequently, the lender may conclude that it is less expensive to avoid a foreclosure and to accept less than the full repayment of the loan balance by taking a short sale, and being done with it.

Foreclosure Sales: What Happens

Nature of Sale: An All Cash Auction: The trust deed foreclosure sale is an all cash auction conducted by the trustee at a published date and time at a specified public place. Typically, the only all cash buyer to show up at the foreclosure sale is the lender who brought about the foreclosure. The lender bids in the amount of the loan, and receives title to the property.

• As the lender starts to convert more of its performing asset base (performing “mortgages receivable” on the asset side of the balance sheet) to “REO” or real estate owned, the bank auditors will force the bank to set aside available cash (that could have been used to make another loan), and hold it as a reserve to cover the REO portion of the bank portfolio.
• A double hit has just occurred:
  • 1. The bank’s Operating Statement no longer has a performing mortgage loan, and now has instead a piece of real estate “REO”(Hint: banks are good at making loans and collecting monthly payments, but are not very good at holding real estate that must be managed and tenanted to prevent damage and further loss of value to the property); and,
  • 2. The bank has to use a portion of their available cash to set up a cash reserve to cover the REO.
    • Too much of that action, and bank auditors will write down the value of the REO property and increase the size of the REO reserve…both actions will reduce the “Stockholder’s Equity” (net worth of the bank). If it gets too thin, the Federal Reserve could close the bank.

• Example Two: The bank-owned foreclosed properties are soon sold at substantially reduced prices compared to other “non-foreclosure” properties in the same neighborhood.
  • The reduced sale price creates lower neighborhood values. Those most recent low sale prices form the “comparable sales” data base that the appraiser will use when appraising your “for sale” property for a buyer’s lender.
  • Your appraised value is reduced, and the entire process will continue to spiral so long as there is a bank-owned REO that is there to compete for the limited number of buyers for your property.
  • SOLUTION: Only when the last REO is finally sold will the artificial reduced prices cease to exist. Buyers may love this environment, but everyone else is perplexed by artificially lowered prices.

FINALLY… Part Three

THE QUESTION: WHAT SHOULD I DO NOW?

THE ANSWER: If you can complete the following steps, then I may be able to help you sort out a course of action that you should take.

Part One: Where Am I Now?

Define your current position in terms of money

1.Complete a detailed “Financial Statement” of your current position.

a.The Asset Side:

i.What assets do you own?

ii.What is the current value of each of those assets? (ignore debts owed on each asset, since they will appear on the Liability Side of the financial statement)

Note: Organize the Asset Side of the financial statement in the sequence of “most liquid or cash-like assets” at the top of the list, and “lease liquid or hard to liquidate assets” at the bottom of the list.

Now total the value of assets listed on the Asset Side.

b.The Liability Side:

i.To whom do you owe money?

ii.How much do you owe each creditor?

Note: Organize the Liability Side of the financial statement is sequence of “shortest term debt” like short credit lines at the top and “longest term debts” like mortgages at the bottom.

c.Your Net Worth – The difference between what you own and what you owe is your Net Worth.

2.Complete a current “Income Statement”

a.List all incomes that you receive

Note: Separate various incomes by category: Vocational Incomes, Investment Incomes, other incomes

b.List all expenses that you incur

Note: Separate various expenses by category: Vocational expenses, Investment Expenses, and Living Expenses

c.The difference between Total Incomes per Year and Total Expenses per Year is the Surplus Available For Investment

Part Two: Where Do I Need to Be? (a retirement goal)

Project your living expenses to your desired date of Financial Independence

1.What will be your Survival Number?

This is the minimum monthly income required to cover all living expenses. ALWAYS KNOW YOUR SURVIVAL NUMBER!!!

2.How much of that Survival Number will be covered with “other Retirement Funds”? (e.g.: Social Security, pension fund distributions, etc.)

3.How much of a Short Fall appears to exist?

a.This is the amount that your real estate portfolio much cover on a dependable monthly basis.

Part Three: How Long Will I Be Willing to Work to Get There?

1.How long am I willing to work to amass my retirement portfolio?

2.Does it appear that my vocational employment will continue that long?

3.What happens if it doesn’t?

Part Four: What is My Surest Course to the Goal Line?

THIS WILL BECOME YOUR REAL ESTATE INVESTMENT STRATEGY

SUGGESTION: Contact me once you have completed the above steps, and I may be able to answer questions that have occurred and assist you in refining your Real Estate Investment Strategy. Email Bob Nelson or Call Bob Nelson 541-485-8100.

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