Milk from Unseemly Ilk: Slumlords

Someone asked me the other day: "Who is buying all these bank owned properties in these bidding wars that are going on?"

The answer is a mixed bag of optimistic flippers and cashflow investors.

For those of you who know me, I am interested in the transformative effect that well-planned and executed real estate investment can have on improving a community.  My personal investment model and experience follows along these lines.  So, when I observe cash-flow investors coming in and purchasing bottom-end property, it becomes a bur under my saddle.

The reason that I become so irked by this is that cashflow on these very low end properties is extremely high for the investor while at a terrible expense to the neighborhood.  These investors purchase a property, make little or no investment in improvements, and then market it for rent to the folks who are the most untenable.  These untenable tenants are typically freshly released felons, drug addicts, or other nefarious types.  However, since they still need a place to live like everyone else, they, unlike everyone else, tolerate the poor condition of the slumlord's house.  Also, wanting to stay under the radar, they arn't likely to complain much about their sour living conditions.

What a dreamy situation for an investor! He gets a cheap property that he is required to invest very little into and gains tenants who desperately need a place to live,who pay a premium because no respectable landlord will rent to them, and who don't complain about how crappy the property is.  Welcome to the slumlord business model.

Our good friend Adam Smith in The Wealth of Nations describes why slumlording is such a profitable trade with a story about the inn keeper:

Disagreeableness and disgrace affect the profits of stock in the same manner as the wages of labour.  The keeper of an inn or tavern, who is never master of his own house, and who is exposed to the brutality of every drunkard, exercises neither a very agreeable nor a very creditiable business. But there is scare any common trade in which a small stock yileds so great a profit.

If you doubt this, talk to the owners of the Budget Inn or the Ogden Lodge here in Ogden.

As an investor, I made the conscious decision not to be a slumlord.  First off, I value my equity and so I take too much pride in my properties to allow them to atrophy.  Secondly, I have chosen not to work with the unseemly demographic that gravitates toward slumlord properties.  I decided that if I am going to be an investor, I had better make the business palettable to my lifestyle.  I also wanted to lift the communities I invested in rather than detract from them.  Am I as profitable as many slumlords? No, I certainly am not. However, I am profitable enough for my business objectives and I sleep well at night.  I also survived the market crash intact.

If you are contemplating becoming a real estate investor, decide what kind of landlord you want to be before you make your first purchase.  Your forethought and preparation will go a long way toward your success.

From Houston to Ogden With Love

We arrived back from our yearly winter vacation to Texas.  Every time I travel to Texas, I always find myself being amazed at the the development going on there.  I am particularly fascinated by the quality and quantity of housing construction there.

For instance, my brother purchased a very cute 1400 SQFT home in the Eagle Springs subdivision of Humble, Texas for $127,000 new.  The home is a rambler with 3 beds and 2 bath.  If you do the math, it comes out to about $90/SQFT for a new house.  Wow!

Well, I learned some fascinating things about the Texas real estate market.  First off, I learned how taxes can oppress market prices.  In Texas they don't have income taxes.  However, they do have sales taxes and crazy property taxes.  Due to the forces of affordability, those taxes have had a tendency to suppress house prices.  For instance,  my brother's house payment is $1215/mo.  Principal and interest payment on his mortgage is about $800/mo.  His property taxes are $415/mo.!  (That doesn't include his $75/mo HOA fee or his expensive water bill.)  If you took a Utah scenario where taxes were only about $115 per month the higher principal and interest payment would equate to about $180K.  So, $130,000 homes in this part of Texas are about the equivalent of $180,000 homes in Webery County, Utah...based on affordability. 

Secondly, construction materials, superior ones for that matter, and extremely cheap labor, combine to make for excellent housing designs and subdivisions made for very little cost.  Construction costs there run around $60-$70/SQFT.  You can frequently find 15 year old homes there for $50/SQFT.  Pretty amazing. Timber is abundant.  Many developers clear their wooded building lots, send the trees to the mill, and bring it back as their construction material.  Land is cheap because its taxed heavily and there is so much of it available.  My brother's lot cost him $500.  Even bricks, which cost 75-cents a piece here in Utah, only cost 23-cents a piece there.  The soil in Texas is clay...perfect for brick making.  Hence, almost all of their homes are made with brick.

Here is a brief video on the ground:



One thing I did notice was that the Eagle Springs architecture would fit very will with urban infill ideas currently being implemented in Ogden.  For fun I have put together a map overlay:

This is a map of Ogden showing areas that might be right for infill and reuse.  The big round structure there is Dee Elementary School.

Here is a map of my brother's subdivision in Texas.  Its actually a small portion of a very large 40,000+ community.  I like this community layout because garages and driveways are in the back of the homes.  Unlike Ogden's abutters alley's, these are paved.  Also, there about about 110 homes in this yellow box.  That is dense use of space.  We could probably fit 50 homes of this type in the yellow boxes on the Ogden map.

Anyway, I like traveling and seeing how other people are doing things.  I was impressed by what I saw on this trip. Ogden area developers would do well to initiate some higher quality infill projects.  I will certainly be on the lookout for these types of opportunities.    

Hurray! HUD Waives 90-Day Rule

Great news from HUD today regarding FHA rules about investment properties being purchased and resold for profit.  Starting February 1st of this year, FHA will effectively waive the mandatory 90-day waiting period required by HUD in order for investors to purchase and resell specific foreclosed property.  The rule will be on hold for 12 months.

This is excellent news.  The 90-day rule was supposed to stamp out fraud but the reality of the situation was that it just frustrated buyers wanting to purchase quality rehabilitated property.

The rule change comes with a couple caveats:

1.  All transactions must be arms-length between buyer and seller.
2.  Transactions with resale prices of 20% above previous purchase price must have the value increase justified by rehab or market conditions.

Click here for the press release.  

This will lubricate the marketplace mechanisms and help move quality property.  Hurray!

Video of the Day: Truth In Advertising

I am currently on vacation visiting my family in the Republic of Texas.  Today, my father made me aware of a youtube video that I thought you would enjoy.



I always appreciate folks who call 'em like they see 'em.

Y'all enjoy.  I'm fixin' to be back next week.

Going Green: Kandovan, Iran

The Green Movement may have found its flagship community.  With a nearly zero carbon footprint in construction, this forward looking community has harmonized the human need for shelter and the needs of mother nature.

Welcome to Kandovan, Iran:

Located in the volcanic hills, this community has been around for over 700 years.

Each home is carved into the rock and augmented with traditional windows and doors.

The community was originally founded by refugees from Mongol invation in the 1200's.

This is just proof that you can make any house into a home.  It is what you make of it.

Lessons from Adam Smith: Botched Lingo and Paying Yourself Your Due

I have immersed myself in Adam Smith's book The Wealth of Nations recently.  Compared to other books I have read from the 18th century, this is an easy read.  I highly recommend you pick up a copy.  The lessons in it are timeless.

One of the points that he makes in Chapter VI of Book I is about accounting for four components of price.  The components being:

1.  Rent - rent for land or space to produce a good
2.  Wages - money paid for labour
3.  Stock - money used to purchase goods or materials
4.  Profit - money returned to the overseer of the operation as compensation for the undertaking.

He then goes on to address accounts of wild profits being had by farmers in America and the West Indies who farmed their own land:

A gentleman who farms part of his own estate, after paying the expense of cultivation, should gain both the rent of the landlord and the profit of the farmer.  He is apt to denominate, however, his whole gain, [as] profit, and thus confound rent with profit, at least in common language. 

This quote got me thinking.  I suppose the reason Mr. Smith brings up this story is that rumors of wild profit were circulating around England at the time.  Obviously, rumors of riches can cause huge migrations of society (i.e. California gold rush).  He attempts to rebut the excitement created by these stories by saying "What those guys say is profit really isn't profit and here is why."  It's like stories today we hear about homes "cashflowing" when the actual term the unwitting storyteller should be using is "revenue".  There is a huge difference between the two words.   

This quote also got me thinking about the analogy of the farmer of 1776 to today's real estate investor. Lets replace a couple words in the above quote and see if we can get something more out of it:

"An investor who manages his own real estate, after paying the expense of mortgages and upkeep, should gain both the profit of the investor and the property manager."  

So as investors, we need to take into account management of our property as either a profit center or an expense. Since the market rate for property management is 10% of gross rents, investors can find themselves significantly more profitable when managing the property themselves.  However, if we wish to grow our wealth in a way that is scalable, property management becomes unwieldy quite quickly and must, in most cases, become an expense as we pay someone else to do it for us.  It becomes the cost of growth.

Let us learn form Mr. Smith's sagely ways.  Always be accurate in what you speak to others and always be honest with yourself in your accounting books.

REO Phenomena From Another Perspective

The Washington Post has an interesting article about the REO market there.  I thought the story sounded oddly familiar Cash-Rich Real Estate Investors Trigger Bidding Wars, Frustrate Other Buyers.


Here are some excerpts:

Investors have reemerged with brute force in the Washington region's real estate market over the past few months, triggering bidding wars in some neighborhoods teeming with foreclosed properties and hindering traditional home buyers...

Does this sound familiar?

With interest rates low and home prices way down from their peaks, all-cash investors are snapping up the cheapest properties and helping clear out the excess supply of homes on the market. They're betting that the market has hit bottom or will soon.

"What's happening in this area reflects what's happening in other parts of the country," said Sam Khater, senior economist at First American CoreLogic, which plans to release a report soon on all-cash deals. "In markets where price declines have been steep, we've seen quite a bit of competition between the low-end, first-time home buyers and investors."

It seems like this very phenomena is happening in the starter neighborhoods across Utah.  The below anecdote is very insightful and I believe explains one strategy being used in purchasing distressed property right now:

To successfully compete with this investor class, real estate agent Jennifer Bridges recently advised one of her clients to offer $275,000 on a Woodbridge townhouse listed for $219,000. After reviewing the prices of similar homes in the area, Bridges concluded that the home (a foreclosure) was listed well below its value to induce a bidding war.

"When the agent called the following day to say they'd accepted our offer, I was screaming a the top of my lungs," said Bridges, who is with ERA Blue Diamond Realty. "They had 14 offers, including some cash offers, but the agent said he felt ours was better. He didn't specify why."

Robert Bauman, the buyer, was downright ecstatic when he ended up paying $13,000 less than he'd offered because the appraisal came in that much lower. "It was so rewarding after having lost so many bidding wars," Bauman said. (emphasis added)

I think we saw this strategy on the bidding war for 2176 Jefferson Ave. a couple weeks ago.  And to sum up...

"There's a big difference between [the all-cash] investor and the flipper of the housing bubble, who put no money down," said Mark Zandi, chief economist at Moody's Economy.com. "This person has all the skin in the game, and that's encouraging. It suggests that housing in the area is now appropriately valued or maybe even undervalued."

I think Mark Zandi hits the nail on the head.  The market is telling us that prices are at or below "appropriate" value.  I still believe that while prices may have bottomed, they arn't going to be shooting sky high in the near future.  Investing for cash flow or a rehab flip are still viable options.  However, cash flow investors will beat out rehab flippers most of the time due to the lack of capital improvements they make to property. Rehab flippers will always need more room to compensate for resale risk and capital improvement risk.

*****EXCITING NEWS!*****

Hello Everyone.  Some of you are aware of a change which has been coming down the line for the last little while.  Now it's official: I am now the Broker for the Ogden office of Mountain Luxury Real Estate and Developement. 

For the folks at Terra Venture, including Sue Wilkerson, Dave Willis and Shannon Williams, that I have worked with for the last year and a half, thank you for treating me so well.  It was a pleasure to work with you.

My new office is located at 119 Historic 25th Street between Wall Ave. and Lincoln Ave.  Come and visit  me anytime.

I am excited for this opportunity to grow my business and expertise.  For those of you who I have served or hope to serve in the future, you can continue expect the same level of superior service you have come to expect from me.   

Let's look forward to an exciting and prosperous 2010! 

High Rise of Doom II: Made In China

It sounds like China may need to send its engineers back to school.  You may recall High Rise of Doom: Made In China.

From China today, we have a story of engineers trying to bring a building down to make room for a new one.  In the U.S. we are used to seeing these buildings engineered to implode on themselves into a nice neat pile of rubble.  Well here is how things are going down in China:

CLICK HERE TO VIEW VIDEO

Whoops!

Mind Over Matter: Removing My Antique Boiler

Well New Year's was fun. We went sledding with the kids and warmed our selves up with hot chocolate afterward. Then we sat around the house for a few minutes and I got bored.  I wandered into our basement and started organizing my tools.  Thats when I started getting an irrestible itch to demolish our vintage 1909 cast iron boiler.

The boiler scared us when we moved into our home five years ago so we just ignored it and installed a forced air furnace assuming that the boiler was dead.  Today I finally explored the boiler's innards while putting my demolition gameplan together.  If you ever wanted to see the bowels of a 101 year old boiler, here they are.

This is the chamber that would be filled with coal and heat the water into steam.  Sometime in the 1950's it was converted to gas.  That big plate would site over the hole in the floor of the chamber and was used to even out the heat from the flame.  Apparently, something malfunctioned and burned a hole right through the plate.  Thats not good.  Notice all the charred iron sitting in piles on each side of the chamber.

Here is a look inside the fire hole.  Lots of debris.

This is a photo of the upper chamber of the boiler.  I am unsure what the purpose of this chamber was.  Lots of corrosion.

I heard that people often destroy claw foot tubs with a sledge hammer to break them into managable pieces.  (If you ever are going to do that, call me first and I will remove it from your property for free.) So I got my sledge hammer out and started whacking away.  I didn't do anything except give a portion of the boiler a nice hammered finish. Puzzled, I got my drill out to see how thick the metal is.  I need to size up my opponent.  I discovered that this monster is made of 3/8th-inch iron or more.  That is some really strong stuff...stronger than me that is.  Unless someone can suggest some really good ideas for do-it-yourself boiler removal, I have decided that I will need to hire a welder to cut the thing out of our basement.  Score: Jeremy - 0   Boiler - 1.