Current Market: May 2006 Archives

People looking for a place to live for several years: The market is unstable right now, and is likely to fall further. It may not, however. But you still need a place to live, and if you're going to be in the property a few years, you will quite likely be able to sell for more money than you would get in the stock market. Here's an ten year analysis (including selling costs) of how well you'd likely do versus an idealized investment in the stock market - Assuming the place loses $50,000 in value the minute you buy it, and only recovers 5% per year. Values may or may not go down further, and historically California has averaged about 7% per year.

Year 0 1 2 3 4 5 6 7 8 9 10

Value $450,000.00 $420,000.00 $441,000.00 $463,050.00 $486,202.50 $510,512.63 $536,038.26 $562,840.17 $590,982.18 $620,531.29 $651,557.85

Monthly Rent $2,200.00 $2,288.00 $2,379.52 $2,474.70 $2,573.69 $2,676.64 $2,783.70 $2,895.05 $3,010.85 $3,131.29 $3,256.54

Equity 0.00 -25,570.39 179.98 27,324.92 55,942.58 86,115.68 117,931.86 151,483.93 186,870.25 224,195.02 263,568.72

Net Benefit -31,500.00 -64,726.15 -50,417.66 -34,996.85 -18,380.23 -478.02 18,806.31 39,576.60 61,944.50 86,030.16 111,962.80

As you can see, you start out negative, but within a very few years, you end up better than even a tax free 10 percent per year from the stock market - and both the equity column and net benefits column take into account the likely cost of selling the property at that point!



People who can fix up run down properties: These hardworking folks can always find a project home that they will be able to fix up and sell for a profit. Unlike most speculators and flippers, these folks really do add value, and they are paid handsomely for it. When speculators and flippers are always looking for the next hot market and are S.O.L. if they can't find one that's appreciating twenty percent per year, these folks can always find estate sales, older properties, and stuff that just wasn't taken care of to turn from eyesores into very attractive properties that they can sell at a handsome profit. Plus they have a place to live while they do it.



People who can work the distressed situations market There are always people who have bad things happen to them. They lose their job, get transferred, or whatever, and have to sell right now so more bad things don't happen to them. What happened to them is not your fault, and most of them are very grateful to people who rescue them from the situation. There's also a good opportunity to make money at it. Distress Sales, Foreclosures, Real Estate Owned by the lender. Particularly if you can hold on to it for a couple years, you can do very well even in the current market. Doing this requires a certain amount of ready cash, but not as much as you might think.



Anybody with a stable positive cash flow You have a five year or longer fixed term remaining on your loan, and the cash flow from renting the property covers all expenses. Your payment isn't changing. You've got money coming in every month. You're sitting pretty no matter what the market does, and you have the luxury of dictating the terms of any transaction. You don't have to sell, because you're making money every month. So you make money if you sell, and you make money if you don't. I love these kinds of choices. Don't you?



Commercial Commercial and Industrial real estate are always more expensive, and require a bigger down payment. But they're not overheated the way the residential market is, and these lots are always more scarce than residential ones. Somebody looking to open a business in a particular area are often faced with one property to choose from, or even none at all! Depending upon the exact zoning, there can be immediate demand, either for tenant landlord or for people looking to open their own business or people looking to buy a building for their existing business. This ties in well with the stable positive cash flow, and also with the fixer-upper buyers. Unattractive properties that no one wants can be fixed up into turnkey condition and sold for a tasty profit to merchants who just want a great looking place for their clients to come.



Apartment buildings. If you have twelve or sixteen units on one plot of land, bought for a million or so, it's sometimes kind of hard not to make a monthly profit. The catch here is the down payment (and the ongoing work of having tenants), but if you've got that, it can be extremely lucrative.



Dan Melson

Riverside County Foreclosure Rates Rise 64%



Riverside County is the exurban bedroom community not only for San Diego, but for Orange County and Los Angeles County as well. It's where people head for affordable housing, despite commutes that vary from one to two hours each way. Entry level people were buying there, just to get their foot in the door of being homeowners. And people being people and real estate agents and loan officers being what they are, of course the people were encouraged to stretch too much so that the alleged professionals could get a bigger commission, and now the chickens are starting to come home to roost. A couple years ago you could still get a decent house in Hemet for $100,000, but part of the price for most folks was an 80 plus mile commute, the first twenty of which were to get to the freeway. The same thing today is around $300,000 or so. Temecula and Murrietta are as expensive as suburban San Diego county. Market overheats, people pay too much and secure it with unstable short term loans that they know they're going to have to refinance. Then Wile E. Coyote looked down, and now the folks are upside down on their mortgage and they can't refinance, not to mention rates are up (At least a full quarter of a percent on 30 year fixed in the last week or so, over half a percent since the start of the year).



The lenders are going to be in trouble soon. Bet they're regretting pushing all the garbage loans, and I'm betting underwriting and program standards are going to get tightened in a hurry, particularly in the subprime market.



I've gotten compliance alerts that were non-news to me from at least four lenders in the last week. This was stuff like "Don't commit fraud" and "We're watching for excessive fees". The lenders normally send out this kind of thing when they've been sued, as evidence to show they're supposedly on top of it, or that they're closing the barn door after this particular horse has escaped, so that, to quote Leo Bloom "We're very sorry and we'll never do it again!" But the real hazard to the lender's health is going to be defaults, foreclosures, and REO's where they don't recover their investment. We are likely looking at subprime lenders failing in the same numbers as Savings and Loans did in the early nineties.



I do not believe the A paper lenders are going to have that level of problem, as the Fannie Mae and Freddie Mac guidelines are probably going to turn out to have saved their bacon in retrospect. They'll have some increase in the default rate, of course, but nothing like what the subprimers are likely to see. They'll also probably lose some refinance business because Loan to Value ratios won't be there to meet guidelines.



Taxpayer bailouts are likely to be limited, however, as most subprime lenders are packaging houses that work with Wall Street money rather than depositors' funds, but look for some real trouble in the bond market, particularly mortgage bonds, but bleeding through to corporate in some instances. Now would not be a good time to be in residential REITs, either.



Now if your current lender fails, it really doesn't make much of a difference to you. The right to receive payments is going to be sold off somewhere, so just keep making those payments on time. Nor are they going to alter the terms of the contract you signed. But when you go to refinance, it could be a lot harder to find a loan if large numbers of subprimes go out of business and the survivors tighten up their policies. The ones who survive are also going to raise prices, aka rates, because they will be able to. Furthermore, with market deflation, a lot of folks that are A paper now could find themselves stuck in a subprime lending situation. Say you bought the property with an A paper 3/1 ARM two years ago, but you can't afford what it adjusts to and when you go to refinance you find that you're now in a subprime situation because you've lost some equity. This may well be a horns of the dilemma situation as you can't afford your current A paper loan and you can't afford the rate on a subprime refinance.



This is why ignorance of financial principles among other things, can be deadly to your financial health. These folks were encouraged to stretch too far by unethical people who pretended to be their friends in that they promised to get them into property they should not have been able to afford. Now the people are going to lose their home, their investment, have their credit rating ruined (because nothing hurts credit like a mortgage default), and likely owe thousands of dollars in taxes from debt forgiveness. I sincerely hope that those agents and loan officers who made this their practice face some severe consequences. If there's some lawyers out there looking for class action work that actually benefits the public, I know where you can start looking. Ditto district attorneys looking for some high profile public feel-good cases.



Caveat Emptor