A reality check on recent “good” news.

Human optimism has driven civilization to extremely challenging locations.

We humans are optimistic by nature. How else would civilization have spread to areas as extreme as the arctic north or the vast deserts of North Africa? Our optimism is in full force almost daily now as reporters and political figures claim recovery is here because fewer people are losing their jobs this month than last month. The billions in equity injections and commercial bridge loans by the government have so far only created a little friction in the fall. To be sure the situation has improved: inventories have been greatly reduced, housing price declines have more or less stabilized, and the all-important consumer seems to be more confident than before. And let’s not forget the eye-popping stock rally that’s come on the heels of all this “good news.” But before we break out the bubbly let’s be honest with ourselves.

In May the U.S. economy lost 345,000 jobs. That is well under the 504,000 jobs lost in April, but still not exactly something to celebrate. Imagine your personal investment manager came to you and said “Good news, I only lost 15% of your wealth this month, that’s less than the 25% of your money I lost last month. I’m doing much better.” I’ll guess the majority of us would not be overjoyed with that report. But somehow we’ve convinced ourselves less bad news is the same as good news. Human optimism at its best.

Unemployment continues to rise. Actual rates likely much higher than gov’t reports.

The fact is businesses are still shedding jobs; real estate prices are still falling; credit markets are still seriously locked up; GM, an icon of American industrialism, is in bankruptcy; and the federal government (as well as many state and local governments) are running major deficits. Some of the greatest optimists tend to be real estate professionals, most of whom have been calling the bottom of the market since before the market implosion of September 2008. As I previously outlined in Road to Recovery there is likely a lot more pain coming for the commercial real estate sector, albeit less so than the housing crash.

Commercial real estate will be somewhat protected since the industry has done a much better job this past decade of not over building. Nevertheless, with the economy in the doldrums and job growth not likely to return for a long time (perhaps a couple years) occupancy rates are going to remain under pressure and so will prices.

Our economy is tremendously resilient and we will recover from this mess, but let’s be realistic what that recovery looks like and how long it will take. For investors that do an honest assessment and take a patient approach the road to riches lay ahead. For those that don’t, the fate of sisyphus is a more likely outcome.

Trust deed investments offer a highly secure alternative to the traditional menu of stocks, bonds, and mutual funds.

After the stock market went into a tailspin last year a lot of money went into hiding in money market accounts and other cash equivalents. Why not? An annual yield of 1% is better than devastating loses, already at 40% or more. While the stock market has come back quite a bit from its March lows it is still extremely volatile and economic recovery uncertain. So what to do with all that cash sitting around earning next to nothing? Trust deed investments offer a highly secure alternative to the traditional menu of stocks, bonds, and mutual funds while providing returns far greater than money market or savings accounts.

A trust deed is essentially a mortgage. (The actual differences between the two I will leave for a later post, but for this discussion they are really negligible.) Investing in trust deeds means you are lending money against a piece of real estate – a mortgage in standard terms, but a private mortgage. You, or the mortgage investment sponsor, set the terms of the loan, and get paid regular interest at the rate agreed upon. When the loan term is up you get your capital back and can do it all over again. Most private mortgages pay you a much higher interest rate than the rate on a traditional bank loan; generally 10% or more in today’s market.

All investments entail a certain degree of risk, but a trust deed investment provides a level of security most other commonly available investments cannot: they are backed by tangible assets – equity in real estate. I know, you’re thinking “that didn’t seem to help the big banks much.” I said the security is equity in real estate. The big banks were lending 80%, 90%, sometimes 110% of the value of the property. Not much equity there. A key to successful trust deed investing is always making sure there is significant protective equity in the collateral property so if the worst case scenario occurs there is plenty of cushion and you can feel confident that you will get your capital back. If necessary you can even use more than one property owned by a borrower to backstop a single loan. These are often called a blanket loans.

Trust deed investments are available to everyone, not just the rich and famous. One of the best ways to invest is with your retirement funds, through a self-directed IRA. It’s a little known fact that you can invest your IRA in almost anything you want, not just the mutual fund pushed by the big brokerage houses. Imagine if you could consistently earn just a 10% compound annual return while paying no taxes on the earnings. A $100,000 dollar investment of this type over the last 10 years would have delivered almost 17x the return of the same investment in the S&P 500, with much less volatility!

Security, consistency, and great returns: if you follow the right formula with trust deed investments the recent mortgage crisis may be just the opportunity you’ve been waiting for.

A $100,000 dollar investment over the last 10 years would have delivered 17x the return of the S&P 500.

This is the first in a series of discussions on Trust Deed Investing. In subsequent articles we will discuss how mortgage investments compare to other common investment vehicles, how to find investments, how they are structured, and what to watch out for.

REOs are attractive today but may be “fools” gold.

REO investing can be lucrative but requires specialized knowledge and skills as well as a solid capital base.

In the charred ashes of today’s economy there emerges incredible opportunities for investments, both long and short-term. Everyday I see great opportunities to lend money on real estate for great returns, acquire commercial properties for long-term cash flow, or acquire residential properties for either cash flow or quick profits. One of the seemingly most accessible opportunities is REO houses. These are properties that were taken back by banks through the foreclosure process, and they want to sell them quickly, sometimes for far below market value. As a hard money lender I get calls almost daily from people looking for financing on REO deals. 95% of the time I graciously end the call within a few minutes.

Why? REOs are not as easy as everybody thinks, and few of the optimists chasing them today really have the skills, knowledge, networks, or finances to turn it into a successful venture. There are three distinct phases of successful REO investing, each with its own complex and often specialized range of activities.

The whole process can take a lot of time and upfront money to do it right. This brings me back to all those phone calls. Most people who call, aside from not having adequate experience, seem to think a lender will give them most or all of the acquisition and the rehab money. This is simply not the case. A good rule of thumb is that a hard money lender may provide up to 65% of the ARV (After Repair Value) or 80% of acquisition price. Keep in mind that these are absolute maximums, and your deal may attract lower loan amounts. This means you need to be well capitalized and financially prepared. If you don’t have a solid balance sheet going into the process most lenders won’t provide you any funding at all.

New investment strategies don’t stray far from traditional products.

As I was catching up on my back issues of the Wall Street Journal I came across an article telling me that in this new economic environment investment advisers are embracing new tactics and turning their clients to alternative investments. (Advisers Ditch ‘Buy and Hold’ For New Tactics, WSJ 4/29) My first thought was “it’s about time.” As I read the article though I realized that when the investing establishment talks about alternative products they are mostly referring to new flavors of the same old menu of stocks and bonds.

The biggest disappointment here is that most money managers are simply becoming more active traders rather than just following the traditional buy and hold approach. In fairness, for the small percentage of investment advisers that truly know how to do this, it is probably a good thing for their clients. But what would really be much better for most investors is the recognition that there are other asset classes available to them, and that they offer significant portfolio enhancements in terms of diversification, returns, and security. Unfortunately it appears that the “new” investment tactics consist of exchange-traded funds, structured products such as derivatives, asset allocation funds and hedge funds, or taking a more quantitative approach to investment decisions. A very small number of advisers are looking for true alternative assets to expand their clients portfolios, but most shy away because their knowledge and experience doesn’t stray too far from the tried, and tired, world of stocks and bonds.  True alternatives include various real estate investments, currencies, commodities such as gold, and even oil and gas exploration.

Real estate, if approached the right way, is still one of the safest and best investments available to most investors today. There are dozens of great real estate investment approaches that vary by risk-return, time horizon, and level of investor involvement and control.

Trust deed investments offer one of the highest levels of security, quickest return, and least management hassles in the market today. On the opposite end of the spectrum is pre-developed land investments (which we previously discussed in Identifying High Growth Areas.) In the middle are direct commercial or residential income investments, or buying REO properties which we discuss in the next article.

What the investing establishment doesn’t want you to know is that these investment opportunities are accessible to most investors, including through IRAs or 401ks providing tax free or tax deferred growth, and offer viable alternatives to the volatile and unpredictable stock market.

On Monday April 13th UC Berkeley’s Fischer Center for Real Estate and Urban Economics held it’s 14th annual conference in San Francisco. Keynote speaker and well known real estate guru Ken Rosen did not paint a rosy picture for a short term recovery.

“The world is structurally changed and it’s going to take a long time to get back to a system that is sustainable,” Rosen said. “The underlying assets are still going down at accelerating rates.”

Rosen predicts that both residential and commercial real estate values will continue to get pressured from three key dynamics:

• Unemployment will continue to climb, likely topping 10% in the near future (meaning millions of new job losses)
• The credit markets will remain constrained for some time, and interest rates will begin to rise.
• The newly conservative consumer is not going to return to the debt-addicted lifestyle and spending will continue to be curtailed.

With residential values continuing to plummet and some office values down 35%-40% conservative investing is key. Private mortgage lenders can protect their trust deed investors through conservative underwriting and low Loan-to-value lending. For equity investors with money this is a great time to buy as values are highly compressed.