Personal responsibility in the mortgage debacle

Since the 1950s there have been warning labels on cigarettes making it clear that smoking is bad for us. There have been ad campaigns, public service announcements, educational films, not to mention a lot of high profile law suits against the tobacco companies. Yet as the first decade of the 21st century nears an end, there are still octogenarians filing lawsuits claiming they didn’t know that puffing down a daily pack or more for sixty-five years might cause a health problem or two. I have no great love for the tobacco companies, but gimme a break! How about a little personal responsibility!

So what do cigarettes have to do with personal finance? Everything! Today in the US we’re facing one of the worst financial meltdowns since, arguably, the crash of 1929. Liquidity has all but disappeared; paragons of the financial world are going up in smoke – no pun intended; and politicians are creating all manner of knight-in-shining-armor plans to protect the American debtor from…from what? From their own irresponsible behavior.

I ask you, where is the personal responsibility? If I buy a house I can’t afford, and take out a loan I can never pay back, why should I expect the government or corporate America to bail me out? Yes, it’s true, the mortgage industry and Wall Street carry plenty of blame for being blinded by greed and creating all sorts of mortgage backed products that even they don’t seem to understand, (the Frankenstein monster gone wrong) but is there anybody surprised by that today? The average American consumer invests 400%-500% more time planning a vacation than evaluating their financial decisions, and a mortgage is by far the largest financial transaction most Americans will ever make. I’ve been working in real estate finance for over ten years and shockingly few residential borrowers, even the most educated and business savvy, have any real interest in understanding the full implications of the loan they are taking. Their only real concern is “what’s my payment next month?” We got addicted to easy money, and when a meth lab blows up nobody should feel sorry for the cook – he knew the risks he was taking.

Anybody with children knows all too well that if you don’t teach them to be responsible for their own decisions you’re going to end up with some pretty messed up kids. If there are no real consequences for bad behavior that behavior will never change. This is equivalent to American consumers expecting a paternalistic government to step in save them from their own bad financial decisions. Yes, losing your home or filing bankruptcy is tough duty, but certainly not life threatening. Besides, what the press rarely talks about is that all these foreclosures are not resulting in legions of new homeless people across the nation. They lost their homes because they made very bad financial decisions, not because they lost their job. So now they’ll go rent a home for a while, and when they’re ready to buy a house again maybe they’ll think beyond next month’s payment before signing on the dotted line.

The Real Estate Mortgage Crisis is the Perfect Investment Opportunity.

New Years is coming, and on January 1st there will be a lot of bleary-eyed people downing Alka-Seltzer, holding their head in their hands and swearing they’ll never drink again. (Right!) But for those that kept their wits about them this is the perfect opportunity to get a jump on the New Year while the rest of the world is too hung over to pay attention.

The same is true in real estate. For the past five years or so real estate markets have been binge drinking on free flowing credit. But the party has ended, the tap shut off, and the financial hang over is a doozey! Should we swear off real estate forever? Absolutely not! In fact, now is the perfect time to get a jump on good real estate investments while the rest of the world is nursing that hangover. Here are four key reasons why.

A basic principle in the real estate profession is that you make your money on the buy. What this means is that if you pay too much for a property it’s unlikely the market will make it up to the point that you achieve a reasonable return on your investment. Property prices across the country have been dropping steadily for the past year, and this trend is likely to continue for at least another one to two years. With property prices down and investors nervous about real estate we’re entering a buyer’s market that makes it much easier to find a strong value investment.

You’re probably wondering: “why should I invest now if you’re telling me prices might continue dropping for another year or two?” Simple: because precise market timing never works. If we knew exactly when the bubble was peaking millions of people wouldn’t be in such dire straights now. (And if New Years partiers knew exactly when to stop drinking they wouldn’t have such a hangover.) When the absolute bottom becomes clear to the market as a whole, it will turn into a feeding frenzy and the odds of overbidding for low quality assets increases. Besides, real estate is a long-term asset. You should have at least a five year time horizon – which brings me to point number three.

Over the past few years the cheap debt available for real estate made a lot of lower quality properties seem like they were performing well. It didn’t matter as much if rents were not keeping up with the market or if operating costs were running a little high. Today real estate valuations have shifted back to the fundamentals: can the property attract and keep good tenants who’ll pay good rents, and still keep operating expenses low? The property needs to stand on its own, without excessive debt. So now you can look for fundamentally good real estate to hold for the long-term without the irrational bidding wars of recent years.

Finally, what’s often lost among all the headlines lately is that the basic character of real estate hasn’t changed. People still need a place to live, and a place to work; businesses need to manufacture and store their products, and retailers need a place to sell them. Most importantly, this country continues to grow. The U.S. population grows by about 1% every year, or over 3 million people. That’s like a new city the size of Chicago popping up out of nowhere every single year, with all the corresponding roads, houses, jobs, schools, factories, and commerce. Wouldn’t you like to get in on the ground floor of that growth? And that’s before any productivity growth which only increases your opportunity for building wealth. Of course this growth is spread across our vast nation but with the right knowledge and a little work you can find the properties that will bring you great financial rewards in the coming years.

The opportunity to invest in real estate has never been better, but with such a wide variety of investment options, how do you choose? What’s the best way to evaluate a real estate investment? Evaluating a real estate investment starts with evaluating yourself. So this New Year make your resolution to truly evaluate your investment objectives and see how real estate can benefit you – and of course to come back and read my discussions about how to perform these assessments and what types of real estate you should consider.

HAVE A VERY HAPPY NEW YEAR

How To Identify High-Growth Regions for Land Investments

So you want to take a vacation to some place new and exciting. I’ll bet you’ll spend quite a bit of time researching the area: where to stay, where to eat, how to get around, what’s going on in the area. Would you spend the same amount of time investigating an investment opportunity that could provide you with a comfortable retirement years down the road?
The key – well, one key anyway – to successful pre-developed land investing is identifying high growth areas before the growth arrives. As discussed in Money Doesn’t Grow on Trees, this land banking strategy is known as being in the path of growth.
But this is a big country, with a lot of open land. How do you know where the path of growth is? Of course you can never know with 100% certainty, but there are a series of fundamental characteristics you should look for in any land banking area. These are the qualities that keep the growth moving down a path toward your land.

1. Population centers. The best place to start looking for growth is, quite simply, where the people are now. These are dense population centers that, in order to keep growing, need to expand beyond their current boundaries.
2. Affordable housing. When people can’t afford to buy a home inside the population center they move to the more affordable outskirts. Ideally you’d like to find an outlying area with housing prices roughly half of average housing costs closer in.
3. Level, usable land. This is the land that gets developed first. Hilly, mountainous terrain, or land with other natural barriers to building, is usually the last to be developed, if at all.
4. Available water supply. It’s been said that water is the oil of the 21st century. You need water to support a growing population and, if it’s not there, the people won’t be either.
5. Transportation accessibility: freeway, train, air. Look for existing transportation infrastructure and serious plans for expansion. You may find a good deal in the middle of nowhere, and your great grandchildren will thank you for it.
6. Adequate utilities. In addition to water a growing population needs electricity, gas, telephones, cable, etc. The cost of developing this infrastructure is tremendous so utility companies forecast their budgets well into the future.
7. Educational system. New growth is generally led by families, and families won’t go where they can’t educate their children. Look for well supported primary education system as well as advanced education and training opportunities. Also, look for plans to build new schools over the next 5 to 10 years.
8. Proximity to large, metropolitan areas. New population centers don’t just spring up in the desert. (Las Vegas aside.) They radiate out from existing metropolitan areas. Ideally you should be within commuting distance – say 100 miles or so.
9. Existing and planned industrial and commercial base. Jobs. Jobs attract people, simple as that.
10. Existing and planned residential and commercial development. In real estate we say that retail follows rooftops. Builders won’t go into an area unless their research tells them there is demand.
11. Master plans for community. While we live in a free economy, it is ultimately the local government agencies that decide what will be built, when and where. Most communities are required to have a master plan for growth looking out at least ten to twenty years.
12. Authoritative population projections. There are actually people who spend their lives studying population growth. They’re called demographers and you can find their work at the census bureau, which provides population and economic data on the state and local levels as well. In addition, many local government agencies and economic associations produce well researched growth projections.

These are the principal characteristics to consider in land banking. If a region is missing the mark on a number of these points I would put it in the “not in my lifetime” category. Making sure these fundamentals are in place will definitely help you get into the right ballpark. A closer look at the actual stadium (i.e., which land parcels to consider) will be addressed in our next land banking discussion.

Pre-developed land is a powerful long-term investment vehicle.

Real estate is changing rapidly. Today it is no longer the realm of a select few wealthy investors, but has become an accepted asset class with a variety of solutions to meet the individual needs of each investor. These needs vary depending on the investor’s risk profile, time horizon, yield requirements, knowledge and experience, and available capital, among other factors. The investment options range from office towers, to the mortgages secured by that tower, to the land it sits on (or will eventually sit on.)

I’ll start my musings from the ground up (and ask your forgiveness for the bad pun.) Land goes through four basic phases in the development life cycle, and there are investment opportunities in every phase, each with its own risks and return potential. For the long-term investor, particularly if you’re investing with your self-directed IRA, strategically chosen pre-developed land (phase I) can be one of the best ways to diversify your portfolio and improve returns.

Pre-developed land in the path of growth can provide some of the highest potential returns. For the long-term or retirement investor there can be additional benefits to a pre-developed land investment:

• No tenants to deal with.
• No ongoing maintenance requirements.
• Little to no insurance requirements.
• Limited supply (can’t make more land.)

This investment strategy is often referred to as land banking – buying land and holding it for future development. Immeasurable wealth has been created by people who had the vision and the patience to execute this strategy. The exploding population in already crowded regions places continued demand for land development, and presents the owners of that land with an enviable profit-making opportunity that will never again exist. Once the land is built out the original opportunity is gone.

Land in the path of growth is a common phrase in the industry today, but the operative piece is “path of growth.” Defining and identifying path of growth is the key to profitable land banking as that’s where the largest asset appreciation resides. (Unless your investing for your great great grandchildren.) In my next article I’ll discuss my top-down approach to identifying quality land banking opportunities.

Hang a Garlic Wreath | Use Real Estate to Protect Your Portfolio and Improve Performance
Every October the many retailer displays in black and orange remind us that Halloween is upon us. The ultimate origin of Halloween is a topic for debate but nowadays we celebrate it by honoring the ghoulish and the dead. Today we are also celebrating another ghoulish black death: Black Monday, the second largest one-day drop in recorded stock market history. On October 19, 1987 the Dow Jones Industrial Average dropped 22.6% in one day! This was followed by equally enormous drops in stock markets around the world. (Coincidentally, we also celebrate Black Monday, Tuesday and Thursday associated with the stock market crash of 1929 which led to the Great Depression.)

Every stock market tragedy initiates a host of analysis and tools to prevent it from happening again, and the 1987 fiasco was no different. Computerized trading programs exacerbated the panic and pandemonium, creating massive order backlogs and accelerating the markets free fall. Following this crash new rules were put in place, known as circuit breakers, to put the brakes on trading and give panicked markets a chance to regain their composure before resuming business. Generally these circuit breaker rules are: if the market drops 10% early in the day trading is halted for up to an hour. If the drop is 20% later in the day or 30% anytime during the day, trading is suspended indefinitely.Like a time-out for a child throwing a temper tantrum, these programmed trading suspensions make very good sense given the snowball effect of a stock market in emotional meltdown. But what is most significant is that this troubled child has to destroy 10%, 20%, even 30% of the market’s value – in a single day – before we do anything about it! We may have learned to take news of stock market ups and downs in stride; but when it comes to your own investment portfolio are you really prepared to absorb those kinds of losses? You’ve diversified your holdings so you’re not overexposed to any single stock, but what do you do when the entire market drops 30%?

Most investment experts will tell you that you can diversify away your company risk, you can even diversify away your sector risk, but you can’t diversify away your market risk (also known as systematic risk.) Most investment experts, however, only deal with the stock market. In fact you can drastically reduce all these risks, including market risk, by diversifying beyond the volatile stock market. By adding real estate to your long-term investment portfolio you can significantly improve performance while hedging against the unpredictable volatility of the stock market. As discussed in Take the High Ground real estate is a non-correlated asset, transactions are complex, each property is highly unique, markets are very local in nature, and information flows are decidedly inefficient. The real estate market does have its cycles but they are long-term in nature and property values simply do not drop 20% in a day! Adding real estate to your portfolio will help ensure this never happens to you.

If you invest in the right real estate, in the right place, and with the right time horizon, the irrational ups and downs of the stock market will leave you undaunted and confident that you will achieve your investing objectives. Of course investing right comes in many flavors. Next we’ll discuss one of those flavors, a powerful but often misunderstood real estate asset class: pre-developed land in the path of growth.