1. Increase Curb Appeal on Multifamily Property

Stand back and look at your multifamily property through the eyes of a tenant. When you consider the rental amount you will be charging, is it inviting? Going beyond curb appeal, periodically ask your tenants: “Other than reducing the rent, what is one thing you would you do to improve your living unit”? You will typically hear something like, “Get rid of Unit #3 because they are up all night and play loud music.” A good tenant will tell you something obnoxious that could be cured with better management practices.

2. Take Steps to Avoid Credit Loss

When a property is occupied by a tenant who simply doesn’t have money to pay or opts to use the money for something else, that is known as credit loss. In some instances, there is little you can do—the tenant has lost a job and simply does not have money and you cannot get rid of them quickly enough. In other instances, your poor decision-making allowed you to accept a tenant who really did not have enough money to pay the rent consistently. Be sure to screen tenants out who are notorious in slow-pay or no-pay rent habits. Verify that the tenant is gainfully employed. Do they make enough to pay the rent? Most owners use a multiple of 3x the rent to income as a calculation. If you accept tenants who cannot meet this income ratio, don’t be surprised when you don’t receive the rent.

3. Don’t Engage in Loss to Lease

When your property is rented for less than what it would command today on the open market, then you are experiencing loss to lease. Many owners say that they keep the rents in their multifamily properties 10 percent below the market to stay full, but this effectively means a 10 percent vacancy factor.

4. Don’t Surrender to Vacancy Loss

When a unit in your multifamily property is not occupied and consequently not producing rent income, that is known as vacancy loss. Look at it this way: There are 52 weeks in a year, which means each week equals roughly a 2 percent contribution to a year’s worth of income. If your unit comes vacant and you do not immediately clean it, prep it, and get it ready for leasing because you decided to go on vacation for a week, then you have just volunteered for a 2 percent vacancy for the entire year.

5. Screen Tenants Well

This is becoming more difficult because of federal and state laws. The laws require you to process the first rental application received until you either approve or reject the first tenant before you receive the next application. All of that takes time and you have no option about it. Nevertheless, be sure to use an appropriate income ratio to best ensure your potential tenants can pay the rent.

Vacancy means lost income. Call or email me today at (541) 912-6583 or rene@1031guru.com to discuss ways to avoid vacancy.

Don’t make assumptions. Prior to offering the investment real estate property for sale, it is imperative that a seller understands the property’s value. If it is an income-producing property, confer with a real estate investment broker and obtain a broker’s opinion of most probable sales price prior to listing a property for sale. They will probably provide it only if they are promised the listing.

2. Allowing the Property to Be in “Less Than Best Condition”

Ask a person who is an expert at marketing your type of properties to drive by and tell you what they see. Does the landscaping look inviting? Would tenants look forward to moving there? What might cause a tenant to stay away? Does the front entry area look appealing? Is there any visible trash? Junky vehicles are the first sign of poor quality tenants. Do something about it!

3. Being Unaware of Your Tax Consequence

Ask your CPA to calculate your tax bill if you sell at the most probable sales price suggested by a real estate investment broker (that is, if you are not completing a 1031 tax deferred exchange).

4. Neglecting to Have Pertinent Financial Information Ready

A buyer will request the last three years of an owner’s tax returns as well as the December operating statement from the property manager. Be prepared with the documents normally requested in the due diligence process: current rent roll with current rent and deposits, date tenant(s) moved in, date of last rent increase, three years of Schedule E’s or Form 8825’s from your federal tax return, property manager’s year-end report for past three years, and a year-to-date operating statement. Being prepared will eliminate delays.

5. Lack of a Good Marketing Plan

Listing the property on Craigslist may sound like a good idea, but if the property does not sell, it will become shopworn. Buyers will believe something is wrong and shy away from it. There are numerous ways to market real estate. Use a commercial real estate broker that understands the options and has the contacts to get the job done.

6. Neglecting to Pre-shop the Market for the Replacement Property

Buyers often like to look on their own, but you need an experienced real estate investment broker to assist you in buying the upleg or replacement property. Unassisted buyers frequently waste their precious 45-day identification period chasing something that will never sell.

7. Lack of Professional Property Inspection Prior to Marketing

Understand your property’s defects so you can anticipate what will come up in a normal buyer inspection. Fix health and safety issues prior to listing the property. Although you can price a property to reflect the cost to cure known defects, this frequently does not work as anticipated. Buyers often come back and ask for an additional discount on items that come up during their due diligence—even if they were identified up front and given a price adjustment for those items.

8. Not Knowing about the Prepayment Penalty

Most investment property loans have a yield maintenance penalty, or prepayment penalty, built into the loan agreement; this affects how much a seller will net from a property. Find out from your lender whether you have a prepayment penalty and how much it would be. Can it be reduced if the buyer financed through the same lender? That’s an option worth looking into.

9. Failing to Review a Preliminary Title Report

Title defects cause lengthy delays. If you have child support judgements, loans that were paid off but never removed from title, or owner of record issues, it’s critical to obtain a preliminary title report prior to marketing the property. This will provide time to remove the cloud on the title and avoid a delay in closing.

10. An Unrealistic Timeline

You may have heard the adage “Don’t jump at the first offer.” Understand that when you introduce your property to the market, there is usually a pool of pent up buyers ready to go. If they believe your property is consistent with the market, they will jump at it and make an offer quickly. If they make a low-ball offer, you can at least use that as a bumper offer to tell the next prospective buyer that you have an offer in hand and they shouldn’t bother with a low-ball offer.

Call or email me today to discuss how to get your property ready to market. (541) 912-6583 or rene@1031guru.com.

How to Get Started Investing in Commercial Real Estate

Many investors these days choose to invest in commercial real estate.  Their investment goals are twofold: appreciation or equity buildup, and return on investment.

What are the best properties to purchase? Which properties will yield the best return? Some investors choose to invest in single family homes while others invest in apartment buildings. Others opt for commercial, retail or office buildings.

The following is an analysis of each type of investment. As an investor, you need to determine your investment time horizon (how long you intend to hold the property), as well as your tolerance for risk.

Single tenant properties

Some investors choose to invest in commercial properties leased on a long-term basis to a single credit worthy tenant such as a national drugstore or supermarket. It is very important that the tenant be financially stable and have a long-term lease.

Lenders are very cautious when asked to finance properties that are occupied by local non-credit tenants or situations in which the lease matures shortly.

In the event the tenant does not renew the lease, or cannot afford to pay the lease, the landlord and/or lender could be left with a vacant building unable to cover the mortgage payments. On the other hand, lenders love to see tenants such as Walgreens, CVS drugstores, national chains, brand name supermarkets etc.

Apartment buildings

Most investors consider apartment buildings to be a prime investment choice. These properties contain many tenants, thereby limiting the credit risk of a major tenant vacating the premises. Apartment buildings are also easy to rent in most markets. This eliminates the fear of units being vacant for months at a time.

The combination of multiple tenants and ease of rental make apartments a very good choice for investors seeking to minimize their investment risk. New investors should seek apartment buildings in good rental neighborhoods and avoid properties in need of major renovations or restructuring.

Experienced investors, with good net worth and liquidity, may choose to purchase apartment buildings that require extensive repairs and maintenance.

Retail centers and office buildings

Many experienced investors choose to invest in these properties. Retail centers may be local strip centers containing local stores, shopping centers containing anchor tenants, or local and regional shopping malls. Office buildings may be single tenant properties or larger office buildings containing multiple tenants.

All of these properties require significantly more management than the properties discussed above. These properties should be considered by experienced commercial real estate investors only.

Purchasers without experience should only consider these properties if they will be managed with a professional property manager. This will be a requirement by all commercial mortgage lenders.

Special use properties

This category consists of properties that have one specific use, such as restaurants, gas stations, bowling alleys, theaters, etc.

These properties have many associated risks and should not be considered appropriate for new investors. They require extensive experience and have the potential to remain vacant for long periods of time in the event the business fails.

Vacant land and development deals

Again, these properties should be avoided by new investors. Without proper experience, borrowers should not consider these opportunities.

Lenders will only consider these opportunities from borrowers that have a positive track record, sufficient cash flow, net worth, liquidity, and history of development success.

Take-away

Prior to investing in any commercial property, an investor should determine if his investment will require active or passive management. He will need to determine whether he has the proper time, energy, and experience to manage the property properly.

A new investor should also limit his investment to properties that are close to home. Properties will require site visits and a significant amount of time at the property. This will be unattainable if an investor seeks to invest too far from home.

In addition, new investors need to realize that real estate investments are not readily liquid. This means that real estate is a longer term purchase then say, stocks or bonds, which may be sold easily. An investor needs to understand that a real estate purchase is a long term commitment.

Only after these items are addressed should a new investor decide to make a purchase.  A new investor should consult a competent mortgage broker for advice upfront.  He will be able to analyze the property and determine if the property meets the investor’s requirements.

The broker will also be able to determine which lenders are appropriate for the transaction.

Don’t misinterpret like-kind property

When completing a successful exchange, a taxpayer must relinquish and acquire like-kind property. However, many taxpayers misinterpret like-kind property. All too often I hear, “If I exchange a duplex, don’t I have to buy a duplex?” I always respond by clearly defining like-kind property.

Like-kind property refers to the intended use of the real property, not the type of real property, as investors often believe. Provided that the property is initially acquired and held for either business or investment purposes, it can qualify as a suitable replacement property under IRC Section 1031. Like-kind real property exchanges may, for example, include any of the following: bare land for a rental house, duplex for a fourplex, retail center for an apartment complex or an office building. And yes, you can also exchange from residential to commercial property (and vice-versa)!

Read the entire article.

College Town Apartments

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.

Bob Nelson

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.

Bob Nelson

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

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

I have several clients who have purchased buildings over the last three years who are retooling their businesses to use that model. One of them has had a 30 percent increase in business the last three years running.

The change in retail is driving the industrial building investment to a more desired property than small strip centers. Investors like the fact with a concrete tilt or concrete block building they can pressure wash it out and bring in a new tenant without costly tenant improvement (TI) work that the retail-commercial spaces require.

The functionally obsolete buildings in our area that have too low of ceilings, lack loading docs, or have unfriendly freight truck layouts are not the best buy. The best investment currently is a 23 foot high bay storage building with great freight truck accessibility, freight dock pit and lots of three-phase power. This building fits most users in the industrial leasing market.

At Pacwest Commercial Real Estate, Inc. we understand our changing market and can help guide you into a solid industrial building to either lease or be an own.

For Lease
5,000 Square Feet
Unit B 3825 West 11th Street
Great location on West 11th
$2,495 per month NNN
• 4,265 SF Warehouse
• 745 SF Office/Bathroom
• 12 foot Low Eave
• 14 foot High Eave
• 400 amps 3 phase

While Pacwest specializes in commercial real estate, we feel that it’s important to keep our clients informed of the activity in the residential arena. At October’s rate of sales, the current 1,939 active residential listings would last approximately 6 months. A truly healthy market likes to see that balance closer to 2-3 months of inventory.

In the month of October, closed sales were up 5.7% but pending sales were down 6.7%. We are still seeing a glut of pending sales that are waiting for bank approval due to short sale situations.

Check out the attached report, especially page 2. Notice the Average Sales Price % Change field. This is a comparison of the rolling average sales price for the last 12 months with the 12 month before. As you can see the figures are all over the board depending on what area of Lane County you are interested in.

If you would like more information on real estate trends in Lane County, don’t hesitate to call us at (541) 686-8246.