The Money Tree: Real Estate Investment

So many things in life can be related to farming. Even as an amateur gardener, I see patterns in my garden that imitate other seemingly unrelated facets of life.

One of the most valued plants in our garden is the peach tree. My wife loves peaches and makes it a priority to tend to this tree. I believe that the real estate investment business is like this peach tree. The only difference is that instead of peaches, the fruit is money. For this reason I would like to share the analogy of the money tree.

The fruit of the money tree represents profit. The weather and soil that the money tree lives in is the economy. The leaves of the money tree represent property. They are where revenue is synthesized from the life giving nutrients of market exposure, people, and tenable property. The branches represent the direction of investment whether it be in high end homes, or low-income housing, or any niche or segment in between. The trunk represents business infrastructure and the day to day mechanics of operating a business. Finally, the roots represent equity in the real estate investment business. Over time the leaves feed the roots and the roots grow. In turn, the roots feed the leaves and allow them to flourish. A healthy tree has a good balance between branches, leaves, and roots.

In the real estate investment business, many of us are growing money trees. We work and toil now so that our tree will bear fruit. Over time, and with proper care, the harvest will be easier and allow for enjoyment in life's other pleasures. Some of us inherited money trees from our progenitors(i.e. Donald Trump), some of us started from seed (i.e. me).

Regardless of origin, all money trees require the same care and consideration in order to bear fruit. Lets review the basic needs of a money tree:

1. Regular Pruning - the market place is always evolving. Housing needs and their accompanying market niches vary as demographics change and the local economy ebbs and flows. Likewise, branches on a tree sometimes die. Without pruning these unprofitable branches, the tree becomes burdened and less healthy. The roots are unable to grow as quickly as they could without the dead branch.

2. Regular Water - the economy has seasons. Water is the TLC that keeps the money tree alive and operating. In some locations, the economy is so robust as not to require much effort to make business profitable. In this case, water is plentiful for the tree and requires little attention in this regard of its owner. However, in most places, and particularly with smaller money trees with small roots, regular attention and TLC is required.

3. Pest Control - inefficiency can occur in any business. Pest control is a big part of keeping a money tree healthy. Some parasites will burrow into the trunk and waste resources on needless trinkets and administrative things. Through neglect, some bugs attach themselves to the leaves and make it harder to generate a revenue for the money tree. Fighting off pests is a constant problem regardless of how old the money tree is. Sometimes, the larger the tree, the more pervasive and harder to treat bug problem becomes.

During this growing season, begin to think of your business like a money tree. What does your money tree need? What would make it healthier? How can you help it grow?

My professional job as a Realtor is to help people grow their money trees and prune them when necessary. I have my Miracle Grow and pruners in hand. Let me know how I can help.

Utah Market: Steady As She Goes

A colleague called me today looking for data on market fundamentals. He had a hunch that prices are not dropping as much as buyers think they are. His hunch is correct.

Lets take a look:

This first chart shows appreciation rates along the Wasatch Front. Data here comes from OFHEO (now FHFA) with Q1 2009 being the most recently reported statistics. What this chart shows you is DIRECTION of price, not price itself. This chart shows that after price increases for over 8 years on a row, we have given a little back.

How much have we given back? Lets take a look:


This composite chart shows you price movement. This is what most people are interested in seeing. As you can tell from our graph, prices have given up just a small fraction of thier maximum value that peaked in 2007. Keep in mind that this is an index for all properties, distressed (wholesale) and everyone else (retail).

This chart demonstrates that buying and holding is always a winning strategy in the long term in Utah. The last time we saw price depreciation was in 2000. If you bought at the peak in 1999, you would have had to wait till 2002 to break even again. So, if you are in the real estate game to win, which I am, then you need to follow this chart below.


This chart shows the Utah market cycle in general. We are on our way from phase 2 to phase 3. Wholesale prices (composed of REO, Short sale, and other distressed proprety) are in the red. Retail prices (everyone else) is in the black. We will likely see a troughing of wholesale prices sometime in 2010. Meanwhile, composite prices (retail and wholesale mixed together) have only softened slightly as scene in the above charts. It might be reasonable to suggest that the decrease in composite prices is due to the wholesale component declining rather than all of retail prices declining. You make money in the marketplace differently depending on which phase you are in. Fortunately, phase 3 is where the easiest and safest money can be made.

I hope this information helps you understand the marketplace. You can make money in any part of the cycle, you just need to know WHAT to do. If you want to know what that is, give me a call and I will show you.

Laser-Guided Smart Weapon: The Collections Agency

For those of you who follow this blog, you might recall a post from a while ago titled The Perils of Landlording: Canine Catastrophes.

That was a heartbreaking experience for me. I had to clean up my tenants filth and I knew that better tenant screening would have saved me the money and the hassle. The whole experience cost me about $3,000 in damages. Not fun.

Part of my problem was trying to recover the damages. The tenants balked when I told them they needed to pay for the carpet. They grabbed any excuse they could (all very poor ones) to try to avoid payment. My concern as a landlord was the learning curve involved with taking a tenant to collections. I had never had a damage dispute with a tenant nor had a reason to have one before this.

Fortunately, one of my property management friends suggested I contact North American Recovery Services in Salt Lake City. As a collections agency, they do all the work in hunting down and getting funds from deadbeat tenants. They don't charge you unless they collect. If the collection is pre-judgement then the rate is about 30%. If the collection goes to court (which you don't have to personally appear at) then their rate goes to 50%. Either way, its been a valuable stress-relieveing tool in my landlord tool belt.

As of today when I called to get an update, they had recieved a judgement from a court and also recieved approval for thier garnishment to start in the fall. I know I will be paid and I know when. Beautiful. Justice is served.

If you have trouble with a tenant damaging property or skipping on rent contact North American Recovery at 801-364-0777.

500 Years of Deferred Maintenance

I see houses everyday that have been neglected for 10, 20, or even 40 years. However, since they have been lived in, most have had at least some sort of minimal attention paid to them. Broken window have been fixed or boarded over, leaky roofs get patched or at least a bucket on the floor.

Author Alex Weisman has written a book about how important we are to our surroundings and describes the results of our absence.

Want to see what happens to your house after 500 years? Click on the picture below for an animated version:



The shot is brief but did you notice that after 300 years the ceramic tile is still intact!

Multi-Unit Sales: Alternative Financing Dominates

We are halfway through the year and I wanted to see how sales of multi-unit homes were doing.

Here is our first chart:


Rather than be a prophet of doom, I'll speak euphemistically and just say that this chart describes "softer than usual" sales.

This phenomenon can almost exclusively be attributed to banks requiring 30% down payment on investment property. Not to mention the blood typing and pedigree charts they require to get a loan through underwriting these days.

Here is another very interesting chart:


This chart shows what kind of financing is getting multi-unit transactions done. As you can see, conventional financing is cliffdiving. However, cash sales are the highest they have been since the last market trough in 2002. FHA Sales are robust. And most interestingly, as if awoken from hibernation, seller financing now accounts for 20% of the market. That is a huge increase from just 2% in 2007.

There are indications that the bank's tight lending criteria may last several more years as we deal with high unemployment and recession. If that is the case, look for these other forms of financing to increase their share of the market.

If you want to learn more about how seller financing works, give me a call and I will walk you through it. Its heavy on details, but, when done right, it makes for a win-win situation for all involved. I have many happy clients who have used this tool to make things happen.

Oh PLEASE Help Me! Here Are My Demands....

I got a perplexing phone call this week from a person looking for housing. This person made $640 a month income (not a typo) and was desperate to find a place to live. Section 8 housing had been subsidizing them.

I informed them that I didn't have any place that they would qualify for but another landlord may have a property for them. Then came their punchline: "Oh, and I must have a place for my two big dogs. I won't get rid of them just because I have to move, you know."

Whatever happened to adapting to survive?

This is a crazy example but we all need to keep in mind what we bring to the table when we negotiate a housing transaction (or anything else for that matter). If we have a weak hand, we need to recognize that and accept the market's terms. Otherwise, we need to spend some time strengthening our hand. An entitlement attitude certainly won't carry us very far.

Economic Crisis Just A Symptom of Something Larger

David Goldman (a.k.a. Spengler) is a favorite essayist of mine. His insights have captivated me since I was first introduced to his writing several years ago. He is a devout Jew living in Tokyo that manages a hedge fund and used to work for the Reagan administration. If you have a spare 17 minutes, listen to the interview below. David describes how deteriorating demographics are driving our economics.

An Interview With David Goldman on "Demographics & Depression" from First Things on Vimeo.

One of the topics David speaks about is the number of traditional households in the U.S. (i.e. mom and dad married with children) has held steady since 1960. Traditional households now only account for only 25% of all U.S households as compared to 40 years ago when they were the majority. He discusses this impact on the way people use housing.

He also describes the global problem of an aging baby boomer population with money to lend and the lack of young people to work and pay interest on loans that support those boomers. He foresees dramatic lifestyle changes ahead for all of us as this imbalance in demographics continues.

It will be interesting to see how these things affect Utah's housing market down the road since it has a demographic more reminiscent of 1950's America. On a macro scale, the financial implications (interest rate volatility, lending guidelines, inflation, ect.) will affect Utah, the difference however will be Utah's unique economic profile. Utah will be subject to macro-economic effects that are unrelated to its own local economy.

In a way, we are living through that right now in relation to the housing meltdown. Utah missed the big bubble. Yet we are paying the price via tight lending. More to come....

Conventional Lending: Gov't Siege Engines Attack

Although this is not a political blog, there are a few issues economically speaking that are becoming political in nature. Currently, government's hand in private sector business is growing. The ultimate effects of this will be inefficiency on a broad scale.

The reason I mention this is because more evidence of this government hand showed up in Freddie Mac's appraisal guidelines recently. You can read their new Home Valuation Code of Conduct here. This code applies to all financing EXCEPT FHA/VA, Native American Loans, and 502 Rural Loan. Those exceptions are already government sponsored and heavily regulated. These guidelines can be seen as cutting conventional lending down to FHA/VA restrictive standards.

The new requirements are significant. One provision is to essentially prevent contact between loan officers and appraisers. This barrier impedes business and prevents professionals from problem solving. Often, material information that will help an appraiser in his assessment of property is had by loan officers and realtors. This window of communication is now closed so appraisers must make "best guesses" based on hard market data. What this translates into is fewer appraisals satisfying the needs of the loan conditions and therefore less business being transacted.

One may suggest this is reaction to fraud and abuse that was found in the appraisal arena. Or, it might be just another sign of government's growing hand of control over our economic system and our ultimate dependence on that hand for subsistence. My guess is it's likely both.

*****UPDATE*******

Shawn Watkins called me this afternoon to tell me about an appraisal he just got back today on one of his investment properties. He was doing a refi and the lender was connected with the next appraiser in queue in "the rotation". Here is the break down on Shawn's property:

1. It has a current CMA of about $105K.
2. Shawn paid $77k for it as a short sale 18 months ago.
3. Shawn spent $17K in rehab and upgrades.

So what did this appraiser do? He used three BANK OWNED comparables (WHOA!?) to establish value for the property. There were plenty of other non-distressed homes available to look at. For some reason, this appraiser chose to grab his comps from the slimy bottom of the trough. His opinion of value? $70,000!

This appraiser is from out of the area. This rediculous HVCC rule just cost Shawn $450 and will cost him another $450 to play Apprasier Roulette again so he get his loan done . Lets keep our fingers crossed.

Screening Tenants: Keys to Success

To many people, being a landlord seems daunting. Of all the factors that deter people from investing in real estate, tenants, or the obligation to work with them, is the largest.

I hear people tell me all the time "I just don't want to deal with tenants" or "I had a really bad experience once, I just don't like tenants".

Its important to understand that landlording is part art but mostly science. Its definitely not something that you do shooting from the hip. That type of behavior will hasten your exit from the real estate business. So, lets take a look at the fundamentals of landlording and see if we can lay a solid foundation for everyone.

There are three things you are concerned about as a landlord:

1. Timely payments of rent
2. Preservation of the condition of your asset
3. Neighborly behavior of your tenant

The application is the means we use to determine the likelihood that these three things will happen. By taking an application AND verifying the information on it, you will eliminate most of your problems up front and be on your way to running a successful business.

The next question is: How do you know your tenant fits these three criteria?

Disclamer: What I am about to share is how my business model works. Depending on your model (i.e. slumlord model, resort property model, absentee owner model) you will handle things a bit differently.

First, you will have your tenant fill out the application. The Utah Apartment Association is an excellent resource for landlord documents. You will find out if your tenant has a job. If he does, how long has he been there? Does he bounce around from job to job? What does he do between jobs? Is his income steady? You want steady income from rents so income needs to be steady for your tenant. If not, a higher deposit is in order to compensate for the risk. Also, how much does your tenant make? Is it twice as much as rent? If so, beware. How will he pay rent if his car breaks down? How will he pay rent if he has to pay a speeding ticket? The safety zone for income-to-rent is usually three times rent. In a few of my rentals I require income to be four times rent. Again, if the tenant doesn't fit in this mold, I increase the deposit to compensate for the risk.

Note: Per Fair Housing law, you cannot discriminate WHERE income comes from. For instance, if your tenant is on disability income or receives all their rent from a church, you cannot discriminate against them for that. However, you can screen them for not making enough money based on your written renting criteria. That is a legitimate reason to decline an application. Just be sure you apply the rules equally to everyone who is applying. If you are "playing favorites" with applications, you run a serious risk of getting fined for violating the law.

Looking at your clients credit report is going to tell you a lot about your tenants track record paying his obligations. Is he late on his car payment? Did he stiff his last landlord? Or the one before that? It will show up on his report.

Now lets talk about protecting our asset. The first thing I do is make sure my tenants pass the smell test. If I can smell them (i.e. body odor, cat urine, smoke, alcohol, ect.) its an instant DQ. If they smell like that, what do you think their living environment smells like? Bad smells translate into repainting and re-carpeting when a tenant leaves. That mean you will spend a lot of money fixing the problem. Of course, most folks who don't take good care of thier hygiene typically don't take good care of thier credit either. There is a tight correlation there.

Pets are a touchy subject. You need to read Perils of Landlording: Canine Catastrophes to see how destructive pets are. I no longer allow dogs in any of my properties. I am 1 for 2 on dogs. I have had two trashed houses. Thats two too many. If you want to guarantee a property returned in good shape, avoid pets in general.

Smoking is another interesting and sometimes sensitive subject. Many tenants smoke. The risk associated with smokers is when they smoke inside or chain smoke. If they smoke inside, plan on stainblocking, re-painting, and re-carpeting when they leave. Smoke will ruin a house the same way that a house fire causes "smoke damage". For this reason, I am trending away from renting to smokers. They also happen to be higher risk for late rent as well. Smoking represses the immune system and so smokers are sick more often and therefore work less and earn less. Since they are tired most of the time, they usually do not do normal cleanup around the property. I have had a couple exceptions to this but not many.

Finally, its important, especially in larger complexes and in multi-unit situations, that your tenants behave neighborly. I had two tenants in one of my buildings who were at each others throat all the time. They both suffered from maturity issues and they each called me constantly to tattle on the other. It was a big headache. Unfortunately, there wasn't any one specific thing on the application or my conversations with them that would have clued me in to this type of behavior.

MAKING SURE GOOD THINGS HAPPEN

You need to be compensated for taking risks with tenants. Tenants need to compensate you for taking a risk on them. How does a tenant compensate you? They give you collateral.

If they have good credit, that credit and a small deposit is offered to compensate you in case of damages. If they trash your home, you trash their credit via a judgement and collections. A trashed credit report makes life much more expensive for that tenant in the future, plus you can collect from them via the courts if they have a job.

If they have bad credit to start with, a large deposit stands by their name. If they trash your home you keep their deposit. Most tenants I know want their deposit back so it acts as a huge incentive to behave well while in the property. So far, yet unfortunately, I have only had to keep one tenant's entire deposit.

Hopefully this is a good refresher for some of you and a good start for others. Practice makes perfect. Keep the three criteria in mind and balance risk with appropriate deposits and you will headed down the right path.

May Sales Volume Stats: Living In An Oil Press

Sales volume is continuing its slow march upward this season. For May, Weber County is down 25% YoY while Davis County is down 20%.

Just more pressure on the unnaturally large population of Realtors out there trying to make ends meet.

Trendline volume is back to 2002-2003 levels. The market is over-correcting at this point.

An interesting point is that, for a while, tightened lending guidelines created pent up demand as people who wanted homes were forced instead to rent. That pent up demand is now eroding somewhat as jobs are lost and people who were forced to rent are now forced into their parent's basement.