Buying Real Estate in the Aftermath of the 'Perfect Storm'

by Dr. Mark Skousen

Buying real estate? Are you nuts?

Investment U Chairman Alex Green thinks so, what with foreclosures skyrocketing and prices in some places falling more than half from their peak. He says the market is “dead” for now.

But dead doesn’t mean unprofitable. And as Baron Rothschild often said, “Buy when blood is running in the streets.”

Despite all the bad news making the front pages, real estate-related stocks and funds have been making a comeback; some are up more than 25%, suggesting light at the end of a very dark tunnel.

Equity Residential Properties (EQR), one of my favorite REITs, is up 20%. Toll Brothers (TOL) - builder of high-end homes - has been volatile, but appears to be bottoming.

My basic argument for a turnaround is that the federal government has essentially put a floor under the current real estate market, buying up the bad mortgages, offering incredible incentives including tax credits, and with prices down sharply, the bargains are everywhere.

Buying Real Estate At Bargain Prices

I just completed a survey of property and real estate experts in the hardest hit markets in the country - California, Nevada, Arizona and Florida - and, surprisingly, most experts expressed cautious optimism about rental properties and bargain real estate opportunities.

None were bold enough to announce that the bottom had been reached in housing prices. Most predicted lower prices in the next six months. However, aggressive speculators are finding profitable investments.

I spoke with a vulture capitalist who has put together a syndicate to buy up foreclosed single-family homes in Southern California. Another one is involved in condo developments, which have been hard hit in the region.

His group is going to market with a condo project in North Hollywood:

“We have started to see some serious pickup in home and condo purchase activity all around us,” he told me. The tax credits for first time homebuyers and the dramatic drop in interest rates seem to have caused a positive reaction. His gut feeling is that prices are not going to be dropping further in the urban areas.

Prices of homes and rents are declining in Las Vegas - home values are down 40% to 50% from a year ago, and the majority of housing and condo sales are foreclosures. Real estate sales are picking up, but almost all below market prices.

In fact, some speculators are getting back to “flipping houses” - they buy way below the appraised value, add several thousand dollars in fixing up the house with new carpet and paint, and sell for $10,000 to $15,000 more - still below appraised value.

In Utah, a friend of mine is negotiating on a foreclosed house that has a $2.8 million defaulted loan. He expects to pay close to $500,000 for that property.

It’s the aftermath of the “Perfect Storm” of the real estate bubble:

• Super low prices
• A locked-in 4.75% fixed 30-year mortgage rate
• An $8,000 (refundable) tax credit that can be applied to a 2008 return and never needs to be repaid. (It applies to first time buyers or those who haven’t owned a home for three years.)

Buying Real Estate Around the Country

These events are all lining up for real estate investors interested in buying real estate around the country: .

• In Arizona, a friend is looking at a dozen homes in the Anthem Country Club near Scottsdale that used to sell for $400,000 or more two years ago. Now they are for sale or held by the bank for under $200,000 and one three-bedroom/two-bath home is going for $129,000.
• In Florida, longtime real estate expert and investor John Schaub has bought six rental houses in the last six months. According to John, he can get better than an 8% net cash flow even with today’s lower rents. These houses are typically bank owned. Not every bank will sell at a bargain price, but a number who are in trouble will - and today they are.

For example, he just bought a house that sold for $190,000 two years ago and had a $150,000 loan balance. John paid $62,000 and it will rent for $895 a month. The net rent after all expenses would be more than $6,000 a year, or nearly 10% on cash return.

To get a great price, Schaub pays in cash and takes properties in “as is” condition. Banks don’t want to warrant anything so a buyer must carefully inspect any purchase. “All cash” offers will often trump higher offers from buyers who require financing.

John has a great book called “Building Wealth Buying Foreclosures.” I’ve found it an invaluable resource.

He believes this super buying real estate opportunity will last through the next couple of quarters:

• New inventory is shrinking fast and many banks are now renegotiating existing loans, rather than foreclosing.
• Buyers are recognizing that we are near a bottom, and incentives like the tax credit are beginning to enter the market.
• We’re going to see rentals increasing as profitable and attractive investments. A wave of homebuyers who can’t qualify for loans or who’ve been foreclosed upon will begin to put pressure on the rental market by year’s end.
• Rising rents will be a further inducement for fence sitters to begin buying.

And in a few short years we may look back upon the incredibly beat up real estate sector and see it as one of the greatest buying opportunities of the century.

Comments

[User241885/...:]

The comparison between a possible turnaround in residential real estate with the recent price movement of several REITs does not provide good authority for the writer's proposition that "the federal government has put a floor under the current real estate market.." for three distinct reasons.

First, the resurgence in REIT prices on the exchanges is not about property values moving back up but rather about the REIT's ability to refinance their upcoming prinicipal debt payments, which payments were in doubt several months ago. Now with several recent IPO's paying off those "bullet loans". some REITS seem to be out of dangerso the prices on the market have risen. This is not true in all cases as we have already seen two REIT foreclosures this month based on their inability to meet those obligations.

Second, the writer used as his survey the most over heated, speculative markets in the US: Arizona, California, Florida. Nevada, where the swing of the pendulum cleaned out not only the individual speculators and their banks but also entire communities as well. The net result has been to see valuations at near-apocolyptic levels which is not reflective of the valuations for the rest (and entire) US real estate market.

Third and finally, how is the example with its pro-forma calculation any different from the wreckless speculation of the last five years where instead of annual double digit cash flow assumptions, the speculatiors were attracted to the promise of annual double digit appreciation assumptions.

Interested readers should review that paragraph and identify the risks behind the proposed mode. First, the investor citred in the article is a "long time real estate'. Are you? How familiar are you with markets outside your neighborhood. How good are you at finding accurate market valuations at a time when comporables are completely skewed by foreclosures and fire-sale pricing? Buying at the right price determines the success or failure of the deal,. Do you feel confident you know what that right price is?

Second, when banks do not provide a warranty on a foreclosed property, (which is not a blanket condition in the industry by any means,) you should be wary as you are now the transferee of risk for any liabilities associated with the property. Costs associated with any kind of remediation are prohibitive and could substantially affect the "ten percent return on cash".

Third, the statement he makes that "a super real estate buying opportunity will last through the next couple of quarters" may well be true. It could also true for the next couple of years. At that point, if you have bought real esate to rent, you may spend some time looking for a tenant while the jobless numbers continue to climb, perhaps also into that magical annual double digit rate. In which case, you had better have financial resources in the form of either extra earnings power or significant savings to carry that additional debt service.

Under this proposed investment thesis, the risks are more tanglible and much more visible than the ones that caught the real estate investor by surprise in late 2007. You need to understand the risks before you attempt this plan. It certainly is not difficult to look around and see what happens when people fail to do so.

Apr 23 09:58 AM

[Augustus:]

Being able to lock in the financing at less than 5% for 30 years is a critiacl point. Financing costs are in the range of 75% of total costs on an operating basis. Is there another business where the owner can lock in their costs at historically low levels for the next 30 years - maybe 20 if one looks at the paydown curve and does some sort of re-fi.

Sure, sales prices could go a bit lower. Who knows? It is pretty unlikely that the total payment will decline much as rates are almost certain to increase. Being a bit careful to match the property to the possible rental market is a key consideration. However, all of these "walk away" borrowers will be renters for a long time. Who will give them a mortgage again with nothing down? That mode of operation will be a thing of the past, particularly with the comming of the cram down bills.

Apr 23 10:54 AM

[vreporter:]

All I can say is...
Ummmm - NO CHANCE!

Deleveraging just doesn't work this way.

Apr 24 08:47 AM

[31October:]

TOL and EQR are risky while layoffs are occurring, while expensive infill lots are stuck, and while we are waiting for the collapse of commercial real estate markets.

After commercial real estate collapses, residential will get dragged down farther. Once blood runs deep on every street in every direction of realtyville, then it might be time to float your boat.

Local distressed real estate requires more esoteric research than could be relevant to Seeking Alpha, and is far more dangerous than seminar & book salesmen would have you understand.

Jul 19 11:11 AM