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

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.

I recently read this article in USA Today (10/15/09) that gave the top indicators of economic heath.
These are the indicators according to HSBC Consumer Survey of 1,000 households.

• 42% stated: People around me get jobs again
• 39% stated: Unemployment rate declines
• 22% stated: Home sales improve
• 16% stated: Retail sales increase
• 15% stated: Fewer empty store fronts.

Nelsonian Theory would state:

• Watch new job growth – there must be jobs to generate income that will allow and support consumer spending.
• Consumer spending leads to the spending cycle that generates consumer confidence and a return to the free flow of money. Nothing works unless people have money and borrowing capacity.
• Watch for the stable return of the commercial mortgage market – The “continual bad news” being emitted by the commercial lending sources is by itself squelching the desire to borrow on a long term basis. If there is a fear of availability of financing, there will be an absolute slow down in construction.
• Frankly, that can be an advantage, if you personally would purchase existing construction. The increase in user demand (tenants) will force a reduction in vacancy factor in the existing supply (apartment units to be rented to the folks that need safe and clean shelter).
• It is a great time to corner good quality property – The competition is sitting on their hands, and sellers will consider reasonable offers.

 Bob Nelson, CCIM

(541) 485-8100  bob@1031gur.com

Pacwest Real Estate Investments, LLC

Doug Moy is a consulting specialist in estate/gift taxation and planning that I have relied upon for key estate tax planning issues over the years. Doug’s contact information is contined at the end of each report.
With Doug’s permission, I am including his most recent Estate Wise Planning Newsletters.

Vol. V, No. 9. September 2009 “Estate Tax Return” and other topics
Vol. V, No. 5. May 2009  “State Estate Tax Misunderstandings”  “Lifetime Estate Management Plan” and other topics
Vol. V, No. 8. August 2009 “State Real Estate Transfers”, “Life Insurance Policies Sold At a  Profit: and other topics

David Moore of Equity Advantage  and IRA Advantage  has created a brief and concise article dealing with the “mortgage over basis” or debt over basis issue, and how it can be solved by using the IRC Section 1031 Tax Deferred Exchange.

With David’s permission, I have included that article below.

Debt Over Basis article by David Moore

The Cash Flow ARM

Several new loan programs are available for “residential” rental properties. A “residential” property is one that does not exceed four units in size. Thus, a house, duplex,triplex or fourplex would qualify.

Basic Concept: The Cash Flow ARM

The lender makes a loan that has four repayment options. With each monthly payment, you get to select the payment option that makes the most sense to you.

Payment Option One: Make a monthly payment that would amortize the loan over 15 years. If you consistently select this payment option, you will own the property free and clear of debt in 15 years. Own enough of these rental properties free and clear, and you are the cash flow master of your own destiny! People will call you the real estate guru!

Payment Option Two: Make a monthly payment that would amortize the loan over 30 years. The size of the monthly payment will be less than that of a 15 year loan repayment term, but is still paying off the loan (if that is important to you).

Payment Option Three: Make a monthly payment that only pays the interest that has accrued since the last payment. This repayment option will result in an even smaller monthly payment than the 30 year loan repayment option. If you consistently use this payment option, you will still owe as much money as the day you put the loan on the property.

Payment Option Four: Make a monthly payment that only covers part of the lender’s requiredyield. The remainder of the unpaid interest payment is added back to the loan balance. If you consistently use this payment option, the loan balance will increase with each passing month. If the loan grows to 115% of its original amount, then the lender will require that the loan be re-amortized to avoid a potential financial catastrophe. However, it does allow you to own the property with the lowest possible monthly payment, and either the highest possible cash flow or lowest possible negative cash flow.

The Thought For The Day…

With Payment Option Four (the one that causes the loan to increase over time), what happens if the property increased in value by 15% and the loan balance increased 1% this year? I think you are the big winner in this game of equity growth!

This is a great option for those who are looking to buy fixer properties, and then hold them vacant while they are up-grading the property. You are a winning with this program!!

WHAT DOES THIS ALL MEAN?

1. Lower exposure to negative cash flow.

If you want to acquire a property using maximum leverage…. restated, if you wish to make your down payment buy as much property as possible, then this program may have high interest to you.

Buy a large property, but still have tolerable cash flows.

2. More property means more value appreciation.

Q: If property values increase at 10% to 15% or more per annum, then how much property would you like to own?

A: As much as possible…. if I can control my exposure to negative cash flow.

ARE THERE RISKS IN USING THIS PROGRAM? ABSOLUTELY!

If you select the lowest allowed monthly payment plan, then you are trading off cash flow against equity growth.  This may not be a big deal if you only plan to own the property to capture its high rate of value growth. However, what if the value appreciation rate in your area starts to flatten or even fall?

You can find that an increasing loan balance is gobbling up your invested equity.

But, as you see this start to happen, you can still either refinance into a more conventional program, or even sell the property to someone else. Market changes do not have to produce a terminal result. Just keep your head down and your eyes open as you go.

THINK THIS MAY FIT YOU?

If this loan program has intrigue for you, then contact Rene’ Nelson.

It pays to deal with the best… those who understand all available options.

Over the past several years, there has been a “feeding frenzy” for small income properties. The stock market has left seriously depleted a number of retirement accounts. Rental properties have become the obvious answer for those seeking to generate wealth.

First Problem: Prices have increased much more rapidly than have rents. Prices are increasing and investment returns have dropped.

Second Problem: It has become too easy to buy those small rental properties. First: Mortgage
interest rates for those small rental properties (houses, duplexes, three-plexes and four-plexes) are extremely attractive. Second: Residential lenders allow purchases to be made with very small cash down payments.

Result: Many small rental property investors have been lulled into a false security when buying smaller rental properties. They are attracted by big price increases, but they are not paying much
attention to the bottom line performance of the property.

Concern: Rents for smaller rental properties have not increased much in the past three years. First time homebuyers have moved out of rentals and into homes of their own. New apartment complexes have increased the supply of competing rental units. Consequently, vacancy rates increased substantially in that same period. Only recently have vacancy rates dropped to a point where rents can be increased without a fear of a move-out disaster.

Point: The extremely high available leverage generates the opportunity for even greater negative cash flow even in more normal times. However, the inability to increase rents has resulted in some serious negative cash flow for small property investors.

BIG QUESTION: How Do You Cope With Negative Cash Flow?

You have several choices:
1. Sell one or more of your properties. Then use the net equity as a cash flow reserve to cover other negative cash flow properties. While this will eliminate the negative cash flow, this is not very exciting. Without property, your net worth will not grow as quickly to a point of financial independence. Keep the properties, and you will need a second job to support your investing habit.

2. Increase your rents. This is only really possible when other landlords for similar properties are doing the same thing. If you move substantially ahead of the market, you will increase your probability for vacancy, and even more negative cash flow.

MORE REASONABLE SOLUTIONS

1. Set a cash flow reserve from the on-set. There are several options:

a. prepay several months of mortgage payments; and,
b. set a cash flow reserve equal to at least two months worth of PITI payments.

This strategy will give you at least a six month holding period, even if your income have been reduced to zero.

2. Seek out a trusted person to become your tenant-in-common “joint owner” in the negative cash flow property. In lieu of a cash down payment, your co-investor will be required to make a monthly payment equal to the negative cash flow.

This strategy will allow you to retain a large portion of the property, while eliminating the negative cash flow during the holding period.

3. Refinance your loan will more attractive repayment terms. Rene’ Nelson is our go-to source for residential mortgage loans for rental houses, duplexes, triplexes and fourplexes

FOR THE LATEST INVESTMENT PROPERTY LOAN PROGRAMS

Contact:

Rene’ Nelson, CMPS
Certified Mortgage Planner Specialist
Pacwest Mortgage Group, LLC
Direct: (541) 912-6583
rene@1031guru.com

BABY BOOMERS…..SET UP YOUR RETIREMENT INCOME

Sad Fact #1: It is a sad fact that very few Boomers nearing retirement have created and funded a
retirement plan that will provide dependable income through their retirement years.

Sad Fact #2: Those that have funded an IRA or 401k will find that the fund is not large enough to
provide adequate income to support their pre-retirement life style. They will die in poverty in the
strongest national economy that they helped build and support.

IRA Fact: Few are aware that of all the income tax that you saved while funding an IRA over a
30 year period will be paid back to the government in income taxes in the first THREE years of
your retirement. Further, if you live to life expectancy, you will pay SIX times more in income
tax than you had saved by making a pre-tax contribution to the IRA or 401k.

Please do not misunderstand the message. In my opinion, if the government did not allow for an
IRA or 401k, most Americans would do NOTHING at all. We do not save… we carry credit cards.

“Credit Card Logic”: Who needs a savings account when you can carry five to seven credit cards
with cash advance limits.

Maybe this explains why the typical American family has over $9,000 of credit card debt, and that debt is at an interest rate that is over twice the interest rate on their home mortgage. By making the minimum monthly payment, it will take you 30 years to pay off the credit card balance, and that is IF you STOP charging one more dollar in additional charges.

What Is The Answer?

As I jokingly state in my “Real Estate Investments” evening class at Lane Community College, there are three ways of becoming wealthy.

1. Select wealthy parents, then hope that they don’t go through it all before it is your turn to take
over;

2. Marry someone who selected wealthy parents that did not go through it all before it was handed off to your spouse; or

3. Accumulate it the hard way – earn it, invest it, and manage your portfolio.

What Is The Real Answer?

Invest is income producing property and build a strong equity in well located and well maintained rental property. Your equity increases whether you opt to get up and go to work, or opt to stay home and play with the kids and grandkids.

I do not suggest playing too soon with this plan… work your rear off so you can afford to buy more and more property. There will be time to play later. But, the point is still a sound one …. your real estate equity grows independent of your personal involement. It is not tied to the number of hours that you work, or the stability of your job.

What Really Happens?

If we can just cover the down payment (and that is not a very big number) then the tenant will make all of the payments necessary to pay:

1. the property taxes;
2. casualty insurance premium;
3. cost of keeping it in good repair;
4. pay the cost for good quality professional property management (so you don’t even have any contact with the tenant); and,
5. also pay enough rent that you can make the mortgage payment each month.

Again, if you can cover the down payment, the tenant will cover the rest of it (or most of the rest of it) for you. If you own it long enough, your tenant will even pay off the entire mortgage loan.

Own enough property free and clear of debt and you become financially independent. Your passive investment income will completely pay for your living expense.

It Gets Even Better…. THE “END GAME”

For Those Who Played The Real Estate Equity Game….. TAX-FREE RETIREMENT INCOME

Concept: Harvest part of your equity, then invest it in an asset that will generate tax-free retirement income for the REST OF YOUR LIFE.
How: Harvest a portion of the equity in your home or rental property, and invest it in an asset that will generate sufficent tax-free retirement income.

Prerequisite

To play the end game to full advantage, you need

1. at least $100,000 in equity in your personal residence or in a rental property; or,
2. at least $100,000 in an IRA or accessible 401k; and
3. at least 10 years to allow the investment to compound and grow to generate the necessary tax
free retirement income.

IF YOU QUALIFY, THEN THERE IS A ONE EVENING SEMINAR FOR YOU

If you have $100,000 in equity or in a IRA or 401k, and have 10 or more years to wait before you
will need to start receiving retirement income ….. there is a great investment plan for you.

Equity Harvesting Seminar

To learn how the system works, contact Judy at 206-9026 to reserve a seat for you and your spouse / life mate at the next “Equity Harvesting Seminar”.

Date: First Wednesday evening of each month
Place: Find out from Judy, 206-8306
What Will Happen: Come with an open mind, and be prepare to be amazed. What you will learn
will knock your socks off!

Thank you,
Bob Nelson, CCIM
Real Estate Investment Broker
Pacwest Real Estate Investments, LLC