I’m all for government oversight of consumer protection, but I wish they’d put more thought into the impact of their regulations before they passed them.  Take California’s SB94 covering loan modification and its effect on California homeowners.  It’s one of those things that, as comedian Harry Anderson used to say, “sounded like a good idea at the time”.  But as with many laws, it has unintended consequences.

Loan modification is a big deal right now, because foreclosure notices are seeping up everywhere you look, from people who’ve been out of work for a long time and can no longer make huge mortgage payments. to people who probably shouldn’t have gotten loans in the first place (no money down, no income documentation).  In theory, banks are willing to do loan modifications because even though the homeowner gets a lower interest rate and the loan is worth less, they have one less foreclosed property to deal with.

Here in California, purportedly as a consumer-protection measure, the state Senate passed SB94.  But it was not thought out well, for several reasons.  One is that the consumer must go through an existing lender, which must be registered with the California Department of Real Estate.  The lender cannot charge any fees until the deal goes through.

The results are more than disappointing.  If someone wanting a loan modification goes through their lender, they have to get in line and deal with the general incompetence of an overwhelmed and understaffed mortgage division.  It’s not surprising, then, that if you research customer happiness with their loan modification, 95% of the results relate negative experiences.  Even the successes are more like horror stories.  I heard of one consumer whose loan modification process took 18 months. According to one Web site, Bank of America has approved just 7% of the load modification requests they’ve gotten to date.  It’s no wonder that so many people are looking for reputable companies to relieve them of the hassle and frustration of having to deal with their lender.

Now, though, if California consumers want to go somewhere else, well, it’s become much more difficult.  Because of the no-fee clause, companies in California have much less of an incentive to provide services to California residents (companies located outside of California are not bound by SB 94).

Meanwhile, California-based companies and private investors now have much less incentive to participate in the process.  Private investors with funding could be the release valve to offload the pressure from the banking system.  People would pay for this service if they could get a solution without getting cheated, but now they’re forced to work with out-of-state companies if they want to get help.

The result is that California consumers are protected all right — but they’re protected from getting their mortgages under control.

As the summer wears on, I’m seeing a whole lot more activity on our distressed properties. I’m not sure what to attribute this to: investors patiently waiting for the bottom of the market, or our desire to take less in the way of profit to get certain properties off the books. Either way, it’s gratifying.

But what’s causing this? I’m beginning to suspect that the supply of really cheap property is disappearing, or “being absorbed,” to use the industry term, for three reasons.

1)      Savvy investors have undoubtedly snapped up the really good foreclosed properties, the ones in good neighborhoods that were purchased originally by over-extended but well-meaning buyers.

2)      Firms like ours have been churning through the next level of foreclosed homes, the ones with bigger issues but lower price tags.

3)      Cities have become more assiduous about two kinds of homes: the ones they’ve acquired through tax forfeitures, and the ones that have been abandoned. They’re tearing them down in order to reduce blight in otherwise pleasant neighborhoods.

The result: less inventory at the bottom of the market. I’m seeing lists of distressed properties that used to have a selection of prices in the thousands; now they’re in the tens of thousands. That tells me that demand is up.

Sadly, this does not signal less inventory on the market. It only signals less distressed inventory. According to an article posted on the Foreclosure Data Bank Web site on August 2^nd:

“While latest information tracked by market leaders suggests that the rate of foreclosures in America decelerated in 9 out of 10 of the worst affected metros during the first 6 months of 2010, it also reveals that this was not the case as well in metros with over 200,000 residents. There, 3 out of 4 metros reported increased rates of foreclosures, with 17 out of 20 of the worst increased recorded regions in California and Florida.”

The article’s hypothesis (which will come as no surprise to anyone): we’ve cycled through the homes that were purchased at the height of the boom with 100% mortgages, and now the people who have been put out of work by the recession are beginning to lose their homes.

There will still be foreclosed homes available, but presumably they’ll be in better condition, simply because their owners struggled longer to keep themselves afloat. The only downside — if there are too many foreclosures for the market to absorb, we may find ourselves facing a second wave of blight.

A friend of mine showed me an interesting book recently. My friend told me this book had originally been given to him by a man who graduated from college in 1927, and had the bad timing to become a stockbroker. That man was working at a brokerage in San Francisco on Black Tuesday, October 29, 1929, the day investors traded a record 40 million shares of stock. On that day, people following a herd mentality helped trigger a massive loss of financial value.

Though the book didn’t have a fancy cover and it wasn’t more than a couple hundred pages, its first printing had been in 1954 and its eighth in 1980. When I checked Amazon.com, I discovered it was still in print. Its title: The Art of Contrary Thinking, by Humphrey B. Neill.

It didn’t surprise me that it was still in print, because its message is still accurate. We’re seeing it now. When stocks are down, the herd gets out. But when stocks begin to go up again, the herd wants back in. Investors put their money in what appears to be winning and avoid what most say is losing.

When real estate goes up in value, the herd gets in to profit. A few years ago, people scrambled for the opportunity to participate in lotteries for unbuilt houses in Las Vegas. Today, you can have as many of those houses as you want. When the bubble burst, the herd left town.

What Humphrey B. Neill and I both advise: don’t follow the herd. Be an independent thinker. Be ahead of the herd. Professionals study trends, and then take a risk. They commit to taking the uncommon path, and usually do well by doing so. Real profitability is only available when people are willing to do the opposite of what everybody else is doing. Following the masses won’t work, because once the masses have figured it out, the value is gone.

A long time ago, I fashioned the chart you see at the beginning of this article. When you look at the activity and the opportunity that’s available, if you do the opposite of what others are doing, it’s very obvious where you’re going to be successful.

Admittedly, it’s hard to do. It takes independent thinking. People follow the crowd because it’s safe. It stems from our earliest instincts, when, if we stayed with the crowd, we didn’t get mauled by the sabre-toothed tiger.

Right now, companies and investors of all sizes all over America are playing it safe by sitting on lots of cash. When interest rates start going up, as they inevitably will, real estate activity will pick up as well, because the herd won’t want to be left behind. I’m confident that DBNR is uniquely positioned to take advantage of what’s going to come in the future, and I submit that the time to be contrary is now. A rising tide lifts all boats, as they say, and those who wade in now will find themselves riding a tremendous wave later.

This is another in an occasional series of profiles of DBNR Investments customers. Click here for more.

Who knows why people end up living in the wrong part of town? Maybe they’ve just finished picking up the pieces of a long, financially debilitating family illness. Maybe a divorce diminished their resources. Maybe they were laid off and had to move to economize. It doesn’t matter. It happens.

I postulate this because I don’t know how DBNR prospect Kurt and his family ended up in the wrong part of Indianapolis. All I know is that he lives in a downtrodden apartment house there with his wife and two sons. It’s not a safe place. He’s called the police multiple times about drug dealing and prostitution he’s seen there. He’s almost been mugged a couple of times. And it seems to be getting worse. He’s installed deadbolts and other security devices, at his own expense.

The apartment owner is no help, but worse, neither are the police. They’re actually tired of him calling them. They’ve come right out and said that they can’t keep sending out patrol cars about threatening situations, rather than actual crimes. They’ve gone so far as suggested that he move.

As it happens, on his way to work as a scheduler for a construction company, Kurt passes by one of the properties we own. As it also happens, Kurt’s done more in construction than just work as a scheduler. He’s built houses from the ground up.

He’s also just the kind of person we like to work with. When he called, I asked him to send copies of a pay statement and his driver’s license so I could confirm he was who he said he was. I briefed him on how our process works, and it was clear that he’s an intelligent guy with a good income, but not a lot of savings. I told him to go by the house to see whether it suited him. Other people had gone to look at it and we’d never heard from them again, so I was interested to hear what someone with Kurt’s background would report.

He did indeed call back. As it turns out, while Kurt seems reliable, the house doesn’t. He could only get into the kitchen and one bedroom, because parts of the roof have fallen in, and some of the walls have disconnected from the ceiling. The house was buckled in the middle and the floors creaked with every step. He said it was in horrible shape, and it would take a year and at least $40,000 that he didn’t have to get it in shape.

We’d encountered problems like this before, so I got out a map. Sure enough, the property was within a half-mile of the Ohio River. I’m pretty confident that at some point in the past, the property flooded, and the foundation has rotted.

The only other property we have in the Indianapolis area was too far from Kurt’s work. (This is the downside to having properties spread randomly across the country; we’re not competing with ourselves by selling distressed properties, but we also don’t have a lot of inventory to offer an interested prospect.)

Is that the end of the story? No siree. DBNR’s goal is not just to make a profit; it’s to help people like Kurt who want to get out of bad neighborhoods and get into their own homes. I know several wholesalers who have properties in that area, and I’m going to see if I can find someone who can match him with a property. DBNR may not make any money off of Kurt, but he will help us fulfill part of our mission.

In a really good mystery, the author can spin a set of circumstances to look like one thing has happened, and then unravel them to reveal a completely different — but equally plausible — sequence of events. I find myself asking if that’s what’s going on in the current mortgage-delinquency market.

Simply put, there are two disturbing trends — the number of mortgages that are entering the phase known as delinquency is rising, and the amount of those mortgages is rising. That is, a greater number of owners in more-expensive homes are falling behind on their payments.

Just for context, let me walk you through the process. A mortgage becomes delinquent when the owners are 30 days late with a payment. At this point, the lender traditionally sends a notice of delinquency. From this point forward, which is required under law if it wants to proceed with the foreclosure process, the lender files a notice of default. This notice must be served to the owners or posted on the property, and informs the owners that they have 90 days to make up all past-due payments and late fees to stop the process.

After this 90 day period, they have just 30 days to pay the entire loan balance in full, plus charges, penalties, and anything else the lender can legally throw in. If you’re keeping track, we’re up to five months here.

At the height of the housing crisis, lenders were so bogged down in defaults and foreclosures that it could be months before some owners received a notice of default. They could live in the house for a year or more without making payments.

Back to the explanation of what’s happening. One possibility is that wealthier people with more-expensive houses had more resources to fall back on. Those who were hit first may have been reaching to get into the housing market, and over-extended themselves. Wealthier people who were laid off from high-paying jobs still had home-equity lines, credit cards, stocks (though not as valuable as they once had been) to see them through. But the economy isn’t improving fast enough. These people may have been expecting that new job to come through, but it hasn’t, and now they’ve burned through those resources. They are now facing the same kind of stomach-churning fear that poorer people have been feeling. Hence, an increase in delinquencies for high-end properties.

Or is there a different explanation? It’s also possible that the lenders finally worked through their backlog and started the potentially four to five-month-long process earlier? Do they finally have the resources to start sending notices of delinquency and default earlier? It’s a mystery.

Either way, I find myself torn. This rising delinquency rate is bad for homeowners, but good for DBNR. When we started this business a year ago, most of what was on the market was substandard. We originally bought 33 houses for an average of $6,200 each. Now, we’re beginning to see more high-end property worth significantly more. That gives us a bigger pool of potential buyers, people looking for bargains in nicer neighborhoods. That’s capitalism — a system designed to help those with capital, as well as healthy chunks of luck and patience. But as a devotee of idealism as well as capitalism, I still feel for those caught up in these difficult times.

When the housing crisis first hit, there was a chain reaction not unlike an actual train wreck. As foreclosures mounted, clogging up the tracks of lenders, homeowners in search of loan modifications started rolling in, hoping to avoid the debris up ahead but still piling up behind it. The homeowners’ requests were in many ways legitimate — they wanted to reduce the terms of their mortgage so that they would be less likely to become part of the overall wreckage.

I don’t want to express too much sympathy for banks, but they were completely unprepared for this. The same departments that traditionally handled foreclosures also handled loan mitigation, as loan modification is called in the industry. Load modification requires similar documents that an original loan does, such as income statements and credit statements, but also hardship letters. Homeowners would send these documents in, and they would disappear into a black hole. Three months later, they’d get a request that all the documents be resubmitted.

A catch-22 popped up in that, if homeowners lost their jobs in the meantime, they were no longer eligible for modification. Think about it — the people who needed it most were disqualified.

The situation got worse. As usually happens in such a crisis, third-party intermediaries step in and offer to guide dazed and confused homeowners through the process — for a fee. Now, some of these companies were legitimate. But as it happened, they were no more successful at navigating the rubble of the lenders’ loss mitigation departments than the homeowners were. Frequently, they just gave up — after they collected their fees, of course.

The situation has improved somewhat now, I’m happy to note. California has instituted some rather stringent guidelines regarding these loan modification agencies. The agency must be licensed by the California Department of Real Estate. It must comply with an 11-point checklist of items that must be taken care of before the agency is paid. Even better, the federal government is beginning to exert pressure on mortgage lenders regarding modification under the guise of consumer protection issues. To motivate the lenders, the federal government may allow the lenders to recover some of any losses attributable to the load modification. The government is also postponing for a year or two taxes that homeowners may owe as a result of obtaining debt relief.

We’ve recently come across a company called I’m Not Leaving, which has developed software that calculates figures showing bank officers how much they will benefit from load modification based on the Obama administrations’ tax credits. By doing a lot of the lenders’ own homework, it gets the process moving more quickly. According to I’m Not Leaving, it can generate a 97% approvable situation inside of 48 hours. You know what your costs are going to be before you sign a contract, and you don’t pay until the load modification goes through.

That’s what I call light at the end of the tunnel.

It’s never a good idea for someone in business to talk politics. But as I think about what’s going wrong with our mortgage system, it seems hard to avoid. I don’t mean to imply that banks and other financial services firms don’t deserve some of the blame for the housing crash. There’s really enough blame to go around. The federal government may not have been involved at the beginning, but it’s involved now.

Take Freddie Mac and Fannie Mae. According to Investopedia, they are government-sponsored enterprises. GSEs are defined as privately held corporations with public purposes created by the U.S. Congress to reduce the cost of capital for certain borrowing sectors of the economy. But in September of 2008, the federal government took over Freddie Mac and Fannie Mae, which together accounted for 50% of the mortgages in existence.

The other 50% of mortgages are done by financial institutions who create mortgage-backed security pools. These institutions fund the mortgages on credit lines, and then pool them together on the secondary mortgage market, where pension funds and insurance companies buy them. These are some of the mortgage-backed securities that went south early on, trigging the downturn. The federal government is now trying to create new rules to govern these securities, so they will basically have their fingerprints all over most of the mortgages written in the U.S.

What concerns me is that when government gets involved, the engines of commerce tend to slow down. If the U.S. economy is going to generate a recovery, housing is going to be a key part of it. When people buy homes, it triggers a multiplier effect. They remodel. They paint. They buy new furniture. They throw housewarming parties.

Approximately 90% of the population is still working, but the housing market is still in the doldrums. We could already be in a spiral that will decrease the value of housing. In the rest of the world, the mortgage business is already quite different than in the U.S. It has higher interest rates, shorter term mortgages, bigger down payments … and less expensive housing.

Americans believe that owning a home is one of their sacred rights. The public may have to face that fact that that may be changing. If there is a transition going on in which the percentage of homeowners in the U.S. decreases, it will increase the number of renters and increase the number of investment properties. But those properties may not be as profitable as they have been, so that will make them less desirable.

I don’t have the solution to this problem but I do believe the government is going to have to start extricating itself from the mortgage business — it’s simply not its core competency. And the private sector is going to have to figure out a way to step in and take over.

Last week we pontificated about the economy, and the mixed messages it’s sending. The topic is still on our minds this week, because there’s no end of conflicting signals.

Item: San Francisco Chronicle business columnist Kathleen Pender noted on July 1^st that investors were turning to both gold and bonds, a confluence she’d never seen before.

Item: Interest rates are at historic lows, but according to my colleagues in that segment, there has not been a corresponding increase in mortgage inquiries. For my entire career in mortgage lending, when interest rates went down, the phones would ring like crazy.

Item: The stock market fell below 10,000 again, amid worries that the recession is going to be shaped like a W rather than a V. Unemployment remains high, so consumers are hanging onto their money.

I’m no more prescient than other investors. I see conflicting issues everywhere as well. On the one hand, I see the U.S. moving from a manufacturing economy to one based on technology. The latter not only needs fewer workers, but it can just as easily be replicated overseas with cheaper labor. Even if you factor in our superior intellectual property laws and transaction protections, that kind of paradigm shift always causes problems.

But on the other hand, I’ve also been talking to colleagues who are working with private hedge funds who need to invest somewhere in the neighborhood of $41 billion in order to fulfill their business plans. They want to get in, get out, and count their profits. It’s hard to do that these days (although my sense is that you could buy most of downtown San Francisco for $41 billion right about now).

That may be our current economic dilemma in a nutshell: People with money won’t do anything. People without money can’t do anything. We don’t have answers and we don’t know where to look for them.

I still believe the answer has to start with the housing market. I believe that low interest rates are going to do their part to entice buyers back in, and that may help trigger perhaps just the small avalanche necessary to get us rolling again. In the meantime, something I’m now considering is do we have a business un-friendly administration in power?

Economists like to use the term elasticity to refer to price sensitivity, but it’s equally appropriate now because the economy seems to be expanding and contracting like a rubber band held between a nervous child’s fingers.

Item: On June 16^th, the U.S. Department of Housing and Urban Development announced that privately-owned housing starts in May were at a seasonally adjusted annual rate of 593,000, below April but above May of 2009.

Item: On June 23^rd, the U.S. Department of Housing and Urban Development announced that sales of new single-family houses in May 2010 were at a seasonally adjusted annual rate of 300,000, below April and below May 2009.

Item: On June 16^th, BusinessWeek said that economists polled by Thomson Reuters expected the Conference Board’s index of leading economic indicators would fall 0.5 percent in May; it had slipped 0.1 percent in April, the first decline since March 2009.

Item: The following day, the Conference Board announced that its index of leading economic indicators had actually risen 0.4% in May, following no growth in April.

Item: On Monday of this week, CNBC reported that that day’s stock market drop came from concerns about consumer spending, which supplies some 70% of the country’s GDP.

Interest rates are at historic lows. And the latest jobs report isn’t due until Friday. No wonder everyone’s confused about the economy.

This makes me wonder if all this confusion will pass, or are we heading into a time when uncertainty is normal?

I of course look at the economy through the lens of housing. Mortgage underwriting guidelines have undergone tremendous changes thanks to regulatory intervention. Lenders are interpreting the guidelines to protect themselves from violating the new rules. But at the same time, they’re trying to find a way in those guidelines that lets them generate profitability. The government is trying to protect consumers, and the lenders are trying to protect themselves from a recurrence of what we’ve all been through.

The problem is that the economy and the housing market are inextricably linked. When I was in real estate financing, we used to say that the sale of a piece of property pays the salary of some 10,000 people, once the transaction closes. It’s no wonder that consumer spending is dropping — what’s the most logical time to buy new furniture, appliances, and electronics but when you move into a new house?

If this isn’t the “new normal,” then what will trigger a shift back to the familiar? I believe it will be the result of American ingenuity and innovation. It’ll come from the private sector and investors who have no other place to put their money. When the adjustable rate mortgage was invented in the late 1970s, it was in response to astronomically high interest rates. It was a godsend, and nobody questioned the impact. It was an opportunity to sell something.

As we get accustomed to these circumstances, and as distressed properties dissipate and get assimilated back in the mainstream, we will begin to see changes in the way people finance houses. The changes will be small at first, but more and more people will begin to get financing, and they’ll do it in creative ways that don’t look like anything we have now. I’m voting that the confusion will pass.

A few weeks ago, I wrote about a man I called NavyDaddy, a name I took from his e-mail address. He was a naval veteran in his 50s whose wife was expecting twins. Though they were living in Michigan, they were very interested in a property DBNR had in Gary, Indiana, where the wife had family. I wrote that I would continue to NavyDaddy’s story as it progressed.

Frequently in this venture, my initial interactions with a prospect are full of enthusiasm and potential. People who have been frozen out of the housing market for years, realizing an opportunity to finally get equity in a property (even a currently distressed one), are often exuberant in their fantasies. But then the realities of tax forms and income verification and such kick in, and the exuberance fade.

Not so with NavyDaddy. If anything, his enthusiasm grew, even as he struggled through mowing the overgrown lawn … and painting the bedrooms … and fixing the electrical receptacles because the junction boxes were missing. This is a 970-square-foot, 3BR, 1BA house. No garage. A freeway runs along the back fence (in the real estate business, we promote something like this as “no backyard neighbors”). But he loves it. He sent me before-and-after pictures. He sent me pictures of himself doing the work. His delight in creating a home for his family never flagged. A friend of theirs, who also survives on Social Security payments, is going to join them in Gary and help them take care of the twins.

In fact, NavyDaddy’s so excited that he’s getting ambitious. The houses on either side of this property are vacant. One of them has a garage; he’s begun to figure out how he can eventually buy that house too.

Many of us, especially here in Silicon Valley, would look on a 970-square-foot house as cramped and too small to bring up a family. For NavyDaddy and his family, it’s their dream come true.

As many of you know, one of the tenets on which I founded DBNR was to help people who may never have had homes become home owners. I admit it: I have an altruistic streak a mile wide.

But I’m not a philanthropist (not this year, anyway). I’m committed to taking care of my family too. Only a business that makes a profit can survive long enough to help those less fortunate. The two go hand in hand.

That’s why I’m always tickled when the two literally go hand in hand, as they have in what I call our “Chicago Project.” In Chicago, we own a unit in a 20-unit condominium brick building. A second unit is being foreclosed upon by a bank. The other 18 units are owned by an investor with whom I’ve been in contact. I’m not exactly sure what his story is, but I believe he was in the middle of arranging a deal to secure the assets of the entire building when his financing started getting wobbly.

I always say that you never know where your fortune is going to come from. Fortuitously, a second person in Chicago tracked me down when he found our unit on one of several Web sites where I’d posted it. He called our toll-free number and announced that he was looking to acquire all the units in the building: ours, the other guy’s, and the bank’s.

But what do you suppose he wants to do with it? It turns out that he works with an extremely well-connected non-profit organization in Chicago, one that understands the arcane mazes governing getting city and county money for grants. He wants to convert the building into a halfway house for women released from prison. Currently, thanks to urban unemployment rates and Obama’s stimulus plan, he has access to some extraordinarily skilled laborers who’ve signed up with his group to provide low-cost labor to renovate buildings like this one.

It’s a win-win-win. DBNR sells its unit; it gets a finder’s fee for linking the guy with 18 units to the guy who wants the building in toto. A cluster of underemployed people get to work. A stream of female parolees gets housing. An empty building gets revitalized.

I still have to figure out how to connect the guy from the non-profit with the bank that owns the foreclosed 19^th unit, but in the scheme of things, that’s pretty minor. The rest of it, and all those fulfilled motives, makes me smile.

All too often those of us here in Silicon Valley congratulate ourselves for living on the cutting edge of technology. We all have neighbors who work for either companies with household names or unfamiliar start-ups, around whose work there is a great deal of secrecy — until there’s a flashy story in the Wall Street Journal.

Sometimes it can be hard to keep up, which is why every year I attend the day-long technology “boot camp” sponsored by the Silicon Valley Small Business Development Center, part of the U.S. government’s Small Business Administration. For $49, it’s the most cost-effective resource I’ve run across, because I’m sure that it would cost thousands of dollars to learn the same thing at other seminars.

We learned about issues most likely to affect our businesses, such as cloud computing, how Skype works, and how those and other technologies are changing the economics of small business. But a couple of days later, I started having a nagging feeling that something was missing. Several years ago, I heard Scott McNealy, former chairman of Sun Microsystems (now a division of Oracle), say, “People don’t want computers. They just need them to get what they do want.” McNealy wanted to figure out a way to deliver the information and essentially make the computer invisible. (I hope he wasn’t thinking about human-chip implants.)

I don’t want to sound cynical, because the Internet has made it easier than ever before for entrepreneurs like me to start businesses. But it seems to me that the Internet has only provided about half of what the real estate industry needs. It’s revolutionized the ability to find and finance homes. Even at DBNR, we can now post a video about our houses at a single site and have it syndicated — that is, distributed automatically — to dozens of other sites. It’s an amazing time savings.

So what’s missing? Context. Context is one of the things we need most about DBNR property. Certainly, we can find out the basics about a property: who owns it, the property taxes, the water bill. But we can’t find out what the neighbors are like. We can’t find out what the traffic is like. We can’t find out whether businesses are coming into the neighborhood, or fleeing. We need context.

Technology does not yet have a way to deliver what I call human-centered research. If you walked into any neighborhood where DBNR owns a house, you’d be able to discern almost immediately the feeling of the neighborhood, whether there are kids running down the street, or elderly grandmothers rolling their groceries home from a local market. Even then, we would need a method to gauge the source of the contextual information, based on trust, an issue I have strong feelings about and have written about frequently.

Technology is great. But it’s not perfect.

Between wars, oil spills, and economic doldrums, the world seems pretty grim right now. That’s why I was especially interested when Ann Curry interviewed the Dalai Lama on The Today Show last week. This is a man who has had more interaction with the highs (spiritual enlightenment) and the lows (political oppression) of life than most of us ever will. But to my surprise, when Curry asked him about his vision of the next ten years, he was surprisingly optimistic.

He envisioned more peace and harmony for the human race, as well as a lot more people developing relationships in ways we haven’t done for decades — if at all. I also learned that he does not live in a technological vacuum — one of the reasons for his optimism was the reaction of people who rallied to the assistance of earthquake-ravaged Haiti simply by punching a series of numbers on their cell phones. Truly the intersection of the technological with charitable, even spiritual, urges.

To me, his reference was a clear example of people bypassing governments to do some good, to get something accomplished that needed to be done quickly. I sense, like the Dalai Lama does, that we are moving toward a time of greater personal connection. I believe this for two reasons. First, I see technology — whether Facebook or cell-phone contribution systems — bringing us closer together, binding us in ways we’ve never been bound before. But second, I also see us recognizing the need for greater personal connections. Technology is just a way to achieve it more easily.

Now, I’ll be the first to admit that my interest in, and devotion to, personal development makes me think about these issues more frequently than most people. But to me, personal development encapsulates these goals: it’s a commitment to look inside yourself and think more carefully about how you participate in the world outside. That may seem like a contradictory concept, but so too is the idea of using technology (which can be inherently impersonal) to increase personal connection to other people.

So how am I putting this insight into action? Coincidentally, it’s a situation close to home, one related to the story about Haiti I told above. Relatives of mine have experienced a financial, not seismic, earthquake, and they’re in need of help. In the past, they might have gone to a finance company or a sub-prime mortgage company for assistance with their housing situation, but government regulations have managed to create so many “protections” for consumers (and taxpayers) that companies are shying away from situations like theirs. They can’t get help.

This is where the human connection comes in. Though family members might not have done this twenty years ago, when we were all so independent and generations lived apart, I believe it’s time for me to step up and help them, whether to navigate the treacherous waters of the mortgage system, or financially if necessary.

My relationships with my family, my personal connection to them, compel me to help them. The injustice of how they’ve been abandoned by the system — especially a system that thinks it’s helping them — peeves me. It’s up to me to help.

If Michael Anthony gave you one million dollars of John Beresford Tipton’s money today, where would you spend it? I saw a trio of experts on CNBC last week talking about which of these three areas was currently the best investment: real estate, gold, or stocks. The experts agreed that stocks are too volatile, but the consensus was that gold (even though it’s expensive) and real estate were best.

Why? Because at some point, we’ll see inflation, and the two best hedges against inflation are gold and real estate.

Even better from our perspective here at DBNR, the experts also concurred on the fact that we’re bouncing along the bottom of the market in terms of real estate value. According to this column from the Bigger Pockets blog, the Commerce Department says the number of vacant homes eclipsed a record 19 million units in the first quarter of 2010. That’s a near-record 10.6% vacancy rate, where 8% is considered normal. At the same time, rental property vacancy rates are hovering around 11%, the highest they’ve been since 1956.

Hopefully, this is the point at which we’ll start to see some bounce back. The CNBC experts predict that both commercial rental and vacant vacancies will decline, which represents the beginning of a cycle where rents increase and property values start to escalate.

Except for one little glitch.

The banks — especially the ones flush with bailout money — don’t seem to be putting it back into the system. We’re hearing lots of anecdotal evidence of loans (especially jumbos) being hard to get, particularly if the applicant is self-employed. The banks are being particularly persnickety about loaning money to people whose income dropped last year — but that includes most of the people we know, whether they’re self-employed or had to take pay cuts.

That actually is good news for DBNR. If people with money can’t get loans, they rent in the interim. The more people who do that, the faster vacancy rates go down and rents go up. And because companies like ours that circumvent the traditional lending process, we can provide housing and rental property for those who want to buy or invest.

The handwriting on the wall is clear. Prices and interest rates are still low. When there’s a sincere recovery, it’s sure that higher interest rates and higher property values will follow. Anybody who can buy now should take advantage of real-estate’s long-term advantages, both as an investment vehicle and an inflation hedge.

Regular readers of this column know DBNR Investments’ goal: in response to this unprecedented housing crisis, we’re committed to putting people back into homes that need them, want them, can afford them, and who are willing to work to keep them.

But regular readers also know that it’s not as easy as it sounds. Not for us, and not for the people we’re trying to serve. It’s arguably difficult to help someone make the transformation from living paycheck to paycheck to a financial life that involves long-term commitments. It requires a stick-to-it-iveness that is not part of many people’s makeup.

But when I do run into that kind of person, it always makes me smile.

I’ll call this man NavyDaddy, not only because it’s his e-mail name, but also because it clearly represents two of the things he’s most proud of: his service to his country, and his kids. He and his wife live in a small town in Michigan, and she called our toll-free number about a house in Gary, Indiana, about an hour away from where they live.

Now, we make every attempt to return every phone call within 48 hours, but sometimes that doesn’t happen. People are usually okay with that, except that Mrs. NavyDaddy was so excited about this house that she called a second time. And she left a message on our Web site. I’ve been doing this long enough to know that this is someone committed to changing their situation.

I called them back and talked to NavyDaddy, a man with the wonderful lilting accent you only find in eastern Tennessee and South Carolina. I learned more about their situation. She’s pregnant with twins. They live in a 40-year-old trailer in a mobile home park. They have illness and disability issues, which means that they derive their income from social security, but the amount still qualifies them for this particular house. In fact, the amount they’re paying for rent in the trailer park is almost the same as they’d be paying for this house in Gary.

I also learned how much he wants to provide for his family. He wants to go see this house in Gary, he tells me. He wants to know if there’s a way to get it without having anyone else bid for it.

As much as I want to help him get this house, I tried to convey to him that it was not in move-in condition. The house and the roof are structurally sound, but the inside needs work. I was not about to have a pregnant woman move into a house in such condition. I told him that he could certainly see the house, but he had to take a notepad, write down everything that needed to be done, and provide a plan for how he was going to do it. Was he going to fix it, or was he going to hire someone, and on what time frame?

I also sent him an emergency contact form, which includes next of kin information. It’s not that I’m expecting anyone to die, but I want information about relatives in case I have to track anyone down later. I knew NavyDaddy was different when he sent me the name of his landlord instead. Nobody has ever volunteered landlord information. Having been burned before, I asked the landlord a lot of questions about the mobile home park just to make sure he wasn’t a shill. He wasn’t.

That made NavyDaddy one of those clients I live for. The story’s not over yet, but I’m eagerly anticipating a happy ending for NavyDaddy, his wife, and his kids.

It’s spring, and there are signs that the economy is blossoming along with the flowers. The stock market threw off the cloak of panic from what looks like a trader’s typo earlier this month and is back at its previous levels. Personal income, personal consumption expenditures, and personal income were all up in the latest figures from the Bureau of Economic Analysis.

However, there are some disturbing trends.

Item: While the Bureau of Labor Statistics reported multiple industries increasing their numbers, the overall unemployment rate edged up from 9.7% to 9.9% in the latest reports.

Item: We have heard of some clients with equity in their homes, secured assets, and dual six-figure incomes being turned down for refinancing requests because one of the parties is self-employed and (guess what!) their income decreased last year.

Item: The federal government is still working on legislation to “fix” the mortgage issue, but some experts feel these new laws may cause more trouble than they solve. As Robert E. Story Jr., chairman of the Mortgage Bankers Association, wrote in an editorial earlier this month:

“Enacting broad risk retention, requiring lenders to keep a portion of the original loan on their books, has the potential to eliminate a sizable percentage of the mortgage-lending capacity in this country. There is an entire segment of the residential mortgage-lending industry that only does mortgages and does not take deposits from customers. Those lenders make loans to borrowers, sell the loans into the secondary market (with representations and warranties) and then use the money they receive from the sales of the loans to make the next mortgage to another borrower.

Requiring these independent mortgage lenders – many of which are small businesses – to retain a portion of every mortgage they sell would render their business model unsustainable. Elimination of this critical segment of the market – often smaller lenders that serve underrepresented areas and borrowers -would limit capacity and choice for consumers, driving up borrowing costs or limiting access to mortgages altogether, which is the last thing we need in a real estate market that is just beginning to see signs of recovery.”

While these developments roil the traditional segments of the industry — including many of our friends and colleagues — we can’t help but feel that they will end up helping DBNR Investments’ business model to blossom along with the spring flowers. As we noted in last month’s column, The Road Ahead, we’re making a transition to a new phase of real estate investing.

Because lending institutions are still unable to deal with the massive number of abandoned mortgages and the distressed property left behind — whether because of their own inertia or governmental regulations — we feel we’re offering a valid alternative in the marketplace. With the government and in turn lenders turning back the clock fifteen-plus years on qualification criteria for getting new loans, they have effectively blocked a majority of the U.S. population from the ability to finance a home.

DBNR Investments is renewing its commitment to putting people back into homes that need them, want them, can afford them, and who are wiling to work to keep them, and we are doing this without forcing buyers to endure the expense, hassle, and frustration of the conventional real estate and lending communities. We believe we can return to a time when deals were based on performance and trust, and in doing so, contribute to the revitalization of property and local municipalities.

In dealing with the Soviet Union, Ronald Reagan had a favorite saying: trust, but verify. It was something the Russians understood innately, because as it turns out, when he said it, Reagan was quoting Felix Edmundovich Dzerzhinsky, one of the architects of the Soviet secret police.

Although Dzerzhinsky and Reagan used it in the context of politics, the concept has strong roots in business. There, it’s called due diligence. Just as with the U.S. and the U.S.S.R. in the old days, both sides in a business transaction have strong motivation to accept the word of the other. Common sense, however, dictates one take steps not only to confirm what you hear but to consider its validity.

I find myself thinking about trust and due diligence a lot these days. When I was watching U.S. senators questioning Goldman Sachs on CNBC recently, I was struck by how little seemingly rational and intelligent people relied too much on the first and too little on the second. The topic of discussion was stated-income loans — loans given based not on documentation, but on the borrowers’ word. Borrowers stated their income, and the figure was accepted.

The use of stated income began logically enough. It was used with high-net-worth individuals, people so well-entrenched that their companies paid most of their expenses. They really had no income per se; there was no need of it. But these people clearly had other assets, assets whose existence could be verified.

The meltdown that we just witnessed came when the banking industry realized that it could charge more money for loans with additional risk. So they adapted stated-income loans for a much larger pool of people for whom it was intended. Fold in derivatives, in which the risk was supposedly shared, and you have institutions buying into loan pools, thinking 1) that someone had performed due diligence on the original set of loans and 2) that real estate values were only going to go up.

Too much trust, not enough diligence, and a trillion dollars of value went poof.

As I’ve written about previously, in putting people who have never been homeowners before into distressed properties, I’ve had to reconfigure my thoughts about trust and due diligence. Trust has three components: sincerity, reliability, and confidence. If I can’t judge a buyer by their credit history (because they don’t have one), I have to come up with new ways to judge them. How much money is in their bank account? How much does what they say align with what I see and hear? How fast do they get back to me with information?

Interestingly, it has paid off financially. We had originally planned to sell properties in exchange for notes, and then sell the notes to regenerate cash flow. We initially planned to sell them in the first six months after the transaction, but because the risk is higher, we get less money; say, 60-70% of the note’s value. After a year, the discount goes way down to about 25 or 30%, because people have demonstrated that they can make their payments on time. More confidence, less risk, more value for us. It’s built-in evidence of due diligence.

It’s working great for DBNR. I wish the bigger financial companies were as committed to it as we are.

Last week I wrote about two different kinds of investors who contacted me about a multi-unit property DBNR is selling in Syracuse, New York. One was a couple who was dedicated to converting a recent inheritance into real estate, looking for quick returns and cascading profits after a series of purchases, flips, and new purchases. The other was a meticulous woman who spends a lot of time researching potential investment properties, asking a lot of questions, and making extensive calculations.

I asked the question, whom do you think I enjoy working with more? The answer may surprise you. I won’t keep you in suspense – I far prefer working with the meticulous woman.

You may think I’d prefer to work with the couple who has scads of cash and is looking at real-estate investing as an exhilarating rollercoaster that will only take them up. But the fact is, I don’t think these people should be buying real estate. Let me explain why.

There are only four things you can do with money: spend it, earn it, save it, or invest it. This couple knows about earning and spending, but they don’t know about saving or investing. You could argue that because they didn’t earn the money that was burning a hole in their pocket, they didn’t know how to deal with it. But the fact is, we just got through a period of history when too many people looked at real estate as a quick path to riches. You can’t look at it that way anymore.

Even more important, you need to have a plan. Clearly, they don’t have one (which is how they got to this point in their life where they had no savings). When I asked them when they thought they would want to take the money out of real estate, they didn’t know. When I asked them what they might do with their profits, they didn’t know. All they know is that they had a problem – no money for retirement – and now they have a solution – the inheritance. Everything else will take care of itself. They don’t know about cash flow. They don’t know about return on investment. They don’t even want to be landlords. They just want to flip real estate.

You might think that having a client like this is perfect for someone like me. They have no metrics for success, so no matter what happens, I can’t be held accountable for not meeting non-existent goals. But more likely, whatever happens, they’ll blame their advisors because their expectations are no match for reality.

I would much prefer the woman who does her homework, even when, as it turns out with this one, she didn’t buy the property. Why not? As part of her research, she talked to another investor who already had property in that neighborhood. That investor told her that the people who rented in that neighborhood were difficult to deal with; they’d pay rent when they could, skip it when they couldn’t, and work the system to stay in the property until they were evicted. Being a landlord in that situation would have either been too time-consuming for her or too expensive to have someone else manage it. She passed.

But I want to work with her again. Because she’s smart, patient, and conducts appropriate due diligence. That’s the kind of client I prefer, because in the long run, that’s the kind of person who’s going to appreciate the work that I do and have realistic expectations about the outcome.

You may think that dealing in real estate, I’m happy to see anybody come in the door (or over the Internet) as long as they have money. Nothing could be further from the truth. Imagine a house-painter – one who takes pride in his work – with a client who wanted a house painted mango orange. Do you think that house-painter would point to that house as an example of his or her best work? Probably not.

I’m the same way. Let me illustrate by telling the story of two investors. You pick whom you think I like working with best.

Let’s start with a couple who called me about a property in Syracuse, New York. She was a social worker and he was an Internet researcher. It was a classic bad news/good news situation. The bad news was that, though they had been married a while and had three kids, they hadn’t put much aside for their retirement. The good news was that one of their parents had passed away and left them a sizable inheritance with which to rectify their financial situation.

These people looked upon real estate investing as something akin to a trip to Disneyland. They are throwing money into it with abandon. They wanted to buy houses, fix them up, and sell ‘em for a profit, and then start over again. They look at real estate investing with an unalloyed optimism, thinking of it as a money machine. When I asked them how well they wanted to do, they said, “As well as we can.”

Does that sound like heaven? A couple with money, optimism, and time.

Let’s contrast them with someone working from a different perspective, a woman who called me about the same multi-unit property in Syracuse. She’s a very studious investor. When she called, she interrogated me about our business model. She spent a lot of time mulling over a potential investment, even though she is already familiar with that particular area. She visited the properties to see their condition in person. She sent a contractor over to get an estimate of how much it would cost to get the property in shape. She even took the time to research the title, making sure DBNR actually owned the property and that there weren’t any liens against it.

She spent a long time on the phone, explaining to me with her extremely meticulous strategy. She buys properties and holds them until they increase in value, unless she derives significant cash flow from them. She determines whether the cash flow is sufficient by looking at what she gets in tax deductions and her return over three years. No matter what, she says, she needs to see a realistic exit strategy within five years.

Whom do you think I enjoy working with more? The answer next week…

In The Shawshank Redemption, Morgan Freeman played a convict who could “get things for you.” Whether it was plum job assignments or pin-up posters, he was the go-to guy within the confines of that community.

The idea of a go-to guy in a community is a common prospect, especially in real estate — without the criminal aspect, of course. There’s somebody (or multiple somebody’s) in every metropolitan area who knows the best contractors, the richest investors, the savviest real estate agents, the smartest mortgage brokers, and are even on a first-name basis with the folks in the municipal permits department. And as a result of knowing all these people, they have a keen insight of what’s happening in real estate in that community.

We’ve recently met a guy named Charles who fills this role in Chicago, Atlanta, & Dallas. He’s been doing it for fifteen years and he’s well-connected. He not only knows what properties are undervalued, he also understands financing. Best of all he has a database of local investors with cash on hand. He is a one-stop shop for anybody who wants to do business in Chicago.

What Charles doesn’t have is that same capability in other communities.

As DBNR expands its focus to include “light rehab” properties, we see a strong value in connecting with people like Charles. It dovetails with the trend we’ve been seeing (and writing about) of a trend away from regional real estate expertise toward national real estate expertise, in which professionals can take advantage of investment opportunities beyond a particular area. Imagine Charles’ counterpart in highly depressed Las Vegas want to share insight — and risk — with people in other parts of the country, as opposed to betting on the revival of his overbuilt city.

I’m working toward becoming a different type of valuable resource like Charles in Silicon Valley. We want to be his partner and the partner of his counterparts elsewhere. The problem — as always when people first come together through electronic and other impersonal methods — is trust. Establishing trust within the confines of a any community is easy. You say what you’re going to do and you do it, on time, and everybody in the neighborhood knows you stand behind your word. That’s not so easy when someone isn’t from the neighborhood.

The problem comes when someone’s stock-in-trade (who they know) are also their references. People are cagey about sharing that kind of information. We’re working through that. We’re still doing due diligence to confirm that Charles and others like him are who they say they are. We’re using social networking tools, like national real estate forums, to find people who know them or know of them. The tools are there. The process may take a little longer. But the ability to go to one person and spread your real estate investments nationally rather than locally is becoming a viable reality.

Even Bill Gates would tell you that some of the hardest — and most necessary — moments in the life of a business are the ones when you stop, take a breath, and ask yourself some questions: is this strategy working properly, just as he did in 1996 when he “redirected Microsoft to become an Internet-focused company”.  Can I make adjustments to be more profitable?

It’s almost an antithetical move for entrepreneurs, who are supposed to be confident in their strategies even in the face of setbacks. But once you’ve been speeding down the road for a while, it makes a great deal of sense to pull over to the side and recheck your roadmap. After all, if you headed off to a ski vacation in Tahoe, but you hear the highway is snowed in, you’ll have to find a different route to get there.

That’s what we’re doing here at DBNR right now.  We knew there would be challenges like these:

Speed. Cities and municipalities are razing dilapidated properties more quickly than in the past. We had one property in Indianapolis that we had no illusions about — in the initial photographs we received, there were tarps on the roof — but it was demolished last week without us being notified.  As the economy improves, cities are moving faster than in the past to rehabilitate “blighted” neighborhoods.

Lack of motivation. We were highly altruistic going into this project, hoping to put people who hadn’t had the opportunity to have homes previously into properties that they themselves would fix up. We’ve spent hours on the phone talking to people who are supposed to call back, but they didn’t because they were apparently wrapped up in March Madness.  On one property in Detroit, I’ve talked to 15 people and we still don’t have anybody who is willing to do what it takes — small though that might be — to get in there. Why is that?

So what do we do?  Every entrepreneur knows that out of challenge comes opportunity and we have found one we like a lot.  Over the last several months we’ve built relationships with other bulk REO investors and told them our story.  Turns out we’re not the only ones encountering these issues.  What a surprise!  One investor even told us how he’s changed his business to adapt.

Mike from Pleasanton, CA told us that now, instead of purchasing “C” class property, he purchases property that doesn’t need nearly as much rehab.  He then hires a local contractor to rehab and then sell on a land contract just as we are doing.  He’s found that using this method his hassles have gone way down.  He has a greater number of sales, his default rate is lower and since he “cherry picks” the properties he buys he gets to weed out the nightmares.  Yes, his properties cost more, but overall he says it’s worth it.

How do we take advantage of this?  We think we’re no more than 30-60 days away from getting additional investors on board.  In addition to being able to purchase more property, we’ll be able to test various adjustments to our model to improve performance, including Mike’s.  We’re building relationships with real estate professionals and contractors in Chicago to be able to test this “light rehab” model as soon as we’re funded, and possibly on property we now own.

Every entrepreneur likes to hear and act on new ideas.  We’re excited to evolve and adapt to challenges we face and we don’t have a problem adjusting our business when an opportunity presents itself.  After all, there are many roads ahead you can take to get to your destination.

Alfred Lord Tennyson thought spring was for love, but it’s appears to be different this year. To be sure, spring is a time for change. After being cooped up for the winter (yes, even in California), we emerge into the sunlight, ready to absorb its healthy Vitamin D. Polls show that spring traditionally brings better moods and positive expectations for most of the population.

Certainly, for many years this elation has been channeled into real estate-related activities. In all my years in the business, I’ve seen activity pick up around mid-February and continue through April. Sellers list property, prospects start looking for property. Even the activity around home improvement increases, whether in anticipation of selling or just because the weather’s better. Maybe it’s the culmination of projects you notice must get done when you’re stuck inside.

Of course, people focus on real estate in the spring because they want to make moves before summer vacation, and they want to make sure deals are finalized before the kids go back to school.

This year, however, there seems to be even more of a hubbub in real estate as spring begins. I’m seeing lots of reasons for this.

Low interest rates. Last week the Federal Reserve voted to keep interest rates at their historically low rates. This is giving people incentive to think about entering or investing in the real estate market again.

Number of properties available. No secret here. With lots of foreclosures and short sales out there, the market has never been better.

Number of sources for properties. More than ever before, properties are available both through traditional real-estate transactions and non-traditional seller-to-buyer transactions. Going the latter route requires a trusted advisor, but the traditional 6% commission structure is under fire as never before.

This silver lining has a cloud, of course — one that we’ve talked about before. The delays involved in appraisals, financing, and mortgage approvals are worse than they’ve ever been, stretching out to months instead of weeks. Even people whose credit histories are stellar and who have equity in their homes are seeing delays in simple refinancing deals. If you really want to either buy or invest in property — no matter what the source — before summer vacation or the autumn school year, the time to start your efforts is now.

Earlier this month, I wrote about the challenges of obtaining what’s known as an abstract of title for a property in Des Moines. It’s a legal document unique to Iowa that requires the services not of a title company, but of a real estate lawyer. If you never owned real estate in Iowa, you’d never know such a document existed.

But now that DBNR is investing in real estate across the country, I’m beginning to realize that not only are there many arcane, regionally specific rules, but also that municipalities are grasping on out-of-town investors as a faceless source of income. Some of our properties have been abandoned, which means that no one is there to see legal notices posted on the door regarding issues such as weed abatement. When the city receives no response to an order, penalties, fines and interest begin to mount up. Out-of-towners, after all, can’t vote, and so are frequently powerless to effectively argue liens and other orders.

We have one property on Logan Street in Minneapolis. It’s a stately, 4BR/2BA two-story house on a good size lot. We’ve gotten more call volume on this property than any other. But even before we obtained it, because of its deteriorated condition, the city had imposed a tear-down order.

We talked to city officials, who told us we had two options: raze it or bring it up to code, at a cost the city estimated: $80,000. If the city razes it, it’ll send us the bill. Interestingly, when we talked to contractors in Minneapolis about this situation, we learned that if you have a local person who knows how to deal with the city, the costs come down considerably. It just requires someone local who knows how to deal in person with the system. One contractor told me, “We do this a lot because there are lots of old properties in the city that have been abandoned. It’s a fairly generic process.”

As it happens, the bank that foreclosed on the property had filed an injunction against the tear-down order, so we have some buffer in terms of figuring out how to deal with this.

We face a similar, but more optimistic situation, with a house on Bonar Street in Indianapolis. This house is in pretty bad shape, and it has $36,000 in back taxes and fines on it to boot (the city had done weed abatement on it, and assessed a fee for doing so). We found a buyer for the house, someone who knew and loved the area because she’d lived there as a child. We told her about the back taxes, warning her that she’d have to deal with the city about them. We don’t know the end of the story, but she thinks she can get the figure whittled down to around $7,000. Why? Because she’s going to be a tax-paying, voting citizen there.

Nobody likes foreclosed homes, and to be fair, municipalities are dealing with severe financial issues because of the loss of property tax revenue from abandoned properties. But it seems like they’re using this opportunity to soak absentee landlords for fees they can’t get from locals. Large out-of-state banks may be bureaucratic molasses to the rest of us, but to municipalities, they’re a godsend. Their slow-moving characteristics mean that fines and penalties can pile up quickly without someone paying attention to them, and corporations are more likely to pay the fines and write them off. The problem is that small companies like DBNR are being caught up in these nets too.

Want to know the current state of home ownership? Consider this February 2010 report from a real estate analytics firm, a division of First American Insurance:

First American CoreLogic reported today that more than 11.3 million, or 24 percent, of all residential properties with mortgages, were in negative equity at the end of the fourth quarter of 2009, up from 10.7 million and 23 percent at the end of the third quarter of 2009. An additional 2.3 million mortgages were approaching negative equity at the end of last year, meaning they had less than five percent equity. Together, negative equity and near‐negative equity mortgages accounted for nearly 29 percent of all residential properties with a mortgage nationwide.

That’s a lot of people with negative equity or, to use the colloquialism, whose mortgages are “upside-down” or “underwater.” What happens when you owe more on something than it’s worth? Your pride of ownership is diminished, certainly. And we’re really only talking about two things where this applies: houses and cars. We can buy stock and have it lose value, but stocks have more liquidity, so we can sell them quickly. We expect cars to depreciate, so that’s no big deal (if you feel that way, lease them).

But homes — that’s a different story. We expect homes to appreciate, whether they’re our primary residence or an investment. So what happens when almost a third of mortgaged properties stop meeting their owners’ expectations? The First American CoreLogic report cites an interesting observation: when negative equity reaches 25% or $70,000, people begin to behave not like homeowners but like investors who don’t want to pay for a declining asset any longer. They stop making payments and walk away.

That’s a lot of people potentially giving up on the American Dream of a safe harbor, a place to raise a family, a place tightly woven into the concept of controlling one’s own destiny. If you own your home, you can’t be evicted, and your lives and those of your children disrupted. Your rent can’t be raised exorbitantly. You get a mortgage deduction (this year, anyway). You get equity (usually) over the long term.

That’s really the key phrase: over the long term. People who walk away from a mortgage clearly have no appreciation of the long term. Not only do they not believe in it relating to the value of their property, but they also ignore the long-term ramifications of their actions on other facets of their life.

They forfeit their down payment and any other payments they’ve made. They forfeit any opportunity to see the value rise. But there’s more. You want underwater? Walking away from a payment commitment is like drowning your credit rating for seven to ten years. Your credit rating isn’t just something people look at when you want to buy another house when the economy turns around in the future; it’s something they look at when you buy a car, an appliance, apply for a credit card, or even rent an apartment.

There’s more: with the easy accessibility of credit reports, employers are using them more frequently to make hiring decisions. It doesn’t even matter if you’re going to be handling money; employers look at credit ratings and payment histories as a reflection of trustworthiness and stability.

In a country nurtured on instant gratification, patience is not a virtue highly valued. But in this scenario, people must begin to value it, at the risk of devaluing — no, crippling — their future opportunities.

A California-born colleague of mine tells the story of being completely befuddled in a North Carolina ice cream parlor many years ago. The girl behind the counter was asking him a simple question. But because of both her thick accent and the words she was using, it took him a while to realize she was asking, “One dip or two?” A “dip” to her was a “scoop” to him.

I had the same reaction this week dealing with a Realtor in Des Moines, Iowa, where DBNR has a distressed property on 11^th St. that we’re selling. The Realtor is representing us on the 5BR, 1BA (believe it or not) 1,400-square-foot gabled house with porch and basement. It was a bank foreclosure that was transferred first to the middlemen from whom we purchased our cluster of distressed properties and then to DBNR.

We’ve gone through several rounds of negotiations around commission and closing costs because the price is so low, and I thought those would be the most of our aggravations on this property. I was wrong. In a phone conversation last week, the Realtor asked me where the abstract to the house was. That was my “one dip or two” moment, because I had no idea what an abstract was.

I’ve learned working with distressed properties across the U.S. that I’ve grown remarkably comfortable in the bubble of local Silicon Valley real estate. Whatever vagaries we have to deal with out there, I’ve long since grown used to them. I’d forgotten that lots of other places of vagaries too. In Iowa, it’s the concept of an “abstract of title.”

Apparently, a long time ago, the lawyers in Iowa pushed through legislation that forbid the use of title insurance, substituting a regulation in which real-estate lawyers draw up abstracts confirming the transfer of ownership. Whenever the title to a house is transferred, another page is added to the abstract, which is a physical sheaf of papers that stays with the house and is handed from owner to owner. The older the house, the thicker the stack of papers. It’s up to the homeowner to figure out whether to keep them in a binder, or a manila folder, or a box. Technically, if you don’t have the abstract, you can’t own the house.

But as you know, the bank foreclosed on the owners. This wasn’t a friendly transaction where one happy home seller handed off the keys to the house to another happy home buyer with their real estate agents beaming in the background, a scene where the abstract would presumably handed off as well. And DBNR was three owners later. Where was the abstract, indeed?

As it turns out, we did a little research and discovered that just because the state doesn’t have title insurance doesn’t mean it doesn’t have title companies. It’s not so antediluvian that the state doesn’t require copies of the abstract to be filed with the state. A title search — though expensive — can be done and a copy of the abstract ordered. (And yes, we would have expected a Realtor in Iowa to know that.)

But for a while there, we were wondering how we were going to lay our hands on this obscure document that could have been anywhere between here and Des Moines. Life is very educational when you get a glimpse of what’s going on outside your bubble.

If the title of this post sounds vaguely familiar, it’s because it’s from a song in the 1958 Broadway musical Flower Drum Song. It predates “Kids” from Bye Bye Birdie, but had the same sentiments.

However, I’m not complaining about the younger generation; I’m worrying about them. Not surprisingly, these concerns blossomed after a call this morning from my 33-year-old daughter. She lives with her spouse and two children in a two-bedroom rented duet home (one that has one common wall). With housing prices potentially bottoming out, she was asking about her options in terms of moving into home ownership.

This got me thinking about all the post-Boomer generation, colloquially known as Generation X (or the “baby bust” for their lower numbers), born between 1961 and 1981. My daughter was born in 1976. What are her peers’ options for home ownership, especially in light of so many economic shifts? For example:

Down payments. Because of new qualification criteria, it takes a lot bigger down payment to get into property these days.

Employment issues. The downturn has impacted employment in a devastating way. Families that used to have two incomes are down to one. For the most part, people are making do, but are not saving a lot.  Plus acceptable forms and proof of what income they have has gotten more difficult to produce.

Parental problems. Down payments in the past used to come from what were jokingly called “GI loans,” where GI stood for “generous in-laws.” But now many parents, having lost their nest eggs in the stock market or declining real estate values, are in no position to help out.

Aggravating the situation is the fact that (my daughter excepted, of course) we have raised a generation of kids accustomed to instant gratification. The idea of saving for something and going without is as foreign to them as Studebakers.

The outlook is not completely grim. As with most difficult situations, I believe we’ll come up with creative solutions.

Rent. This may be the simplest option. With more single-family homes sitting empty, housing rental (as opposed to apartments) may increase. If the federal government rescinds the mortgage deduction to boost tax revenues, this option may become even more attractive.

Lease or co-ownership options. Lease options or rent-to-own options popped up in the 1980s when interest rates were appallingly high. Essentially, you rented the property with an option to buy, and the cost of the option was computed into your rental payments. At the end of say, three years, assuming you’d made all the payments, your option was converted into a down payment.

This arrangement has its drawbacks, of course — you end up with a higher monthly payment than if you’re simply renting; you have to be confident that the place you’re in is the one you want to buy; you have to be confident that your employment will stay in that area; and it’s not always easy to know what the value of a home might be three years hence.

Equity sharing. This is akin to co-ownership, where somebody owns the house and you set up an agreement with them that you’ll eventually share ownership as well. This probably works best between family members; otherwise, it’s a partnership, and in my mind, those are the only ships guaranteed to sink.

Regardless of what happens, I have one strong recommendation for Generation X: stop spending what you don’t have and start saving what you do. You don’t know the economic future, but I maintain that it’s always better to be master of your real-estate destiny.

A Catch-22, as defined by author Joseph Heller in his famous novel, is an unsolvable paradox of logic. As we approach the 50^th anniversary of Heller’s novel in 2011, those paradoxes show no sign of abating.

For example, consider the number of people with underwater mortgages. These are not necessarily people in danger of being foreclosed; they are simply people who bought at the wrong time for the wrong amount, whose houses are worth considerably less than the mortgage being serviced.

According to a February 3, 2010 article in The New York Times http://www.nytimes.com/2010/02/03/business/03walk.html, more people are ignoring both the potential impact on their credit scores and the possibility of a market turnaround, and simply walking away from their homes. They’re asking, why should I keep paying for an asset that’s worth less than I paid for it? If this trend continues, there’s going to be a second disastrous wave of empty homes, creating problems for banks and municipalities alike.

However, this is America, and in America, we like solving problems. Here at DBNR, we’ve become affiliated with a company called RescueRefi. Let’s look at how it works, using the example of one of my clients who has three rental properties, all of which are underwater. For one of them, in Riverside, Calif., he paid $637,000, but it’s now only worth $325,000. His remaining mortgage: $560,000.

The goal of RescueRefi is to reduce the principal of the loan, which in this case would be a $290,000 loan; it charges interest rates of prime + 3 percent (+ 4 percent for people with poorer credit ratings). RescueRefi charges a non-refundable fee of $1600.

What happens? The homeowner lowers his loan amount and his payment, the city of Riverside has to lower his taxes, and he now has 10% equity in the property. RescueRefi pays off the old mortgage at a significantly reduced rate, and gets the income from the new mortgage payments. The original lender avoids having to foreclose and resell a property with significantly reduced value.

Back to the Catch-22. The first problem is that RescueRefi is managed by a hedge fund, and many people blame the derivative-happy hedge funds for causing parts of this financial crisis in the first place. The second problem is that the hedge fund is a private company; there are no SEC statements or reports available to confirm its funding, its validity, or even the identify of its executives (to do this, one would have to hire someone to check its Certificate of Incorporation in its home state). As an affiliate of theirs, I can only conduct so much due diligence in order to convince my client that they’re legitimate. Their name is beginning to show up on sites devoted to scams, but only in the context of people asking if anyone else knows who they are. There are testimonials on its Web site, but anyone can write a testimonial.

This is the sad state we have arrived at in this crisis. Hank Paulson and Alan Greenspan have gone on Meet The Press and said that the government can’t make any further financial commitments to solve the housing crisis; it’s in the hands of the private sector. A lot of people are in need of assistance to reduce their expenses and the threat of foreclosure. A company in the private sector has stepped up, but no one knows whether they’re trustworthy or not. We have reached a point where an industry that thrives on trust no longer has any.

With apologies to William Shakespeare, a recurring suggestion for solving the real estate crisis seems to be eliminating commissions for real-estate agents. Firms like Help-U-Sell and Zip Realty offer either reduced commissions, or services for fees, as opposed to commissions. For people who have a high level of comfort with their own understanding of the legal and ethical pitfalls of real-estate transactions, these are acceptable options.

The latest salvo in the commission war was a recent article [http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2010/02/02/ED4C1BP3O5.DTL] in the San Francisco Chronicle by Al Lewis, author of OOBonomics: 12 ‘Outside Of the box’ Ideas to Improve the Economy. He’s promoting the idea that buyers should get a $1,000 tax credit, which they can use to pay a real estate agent (even though the commission on a house with a median price in the San Francisco Bay Area would be about $15,000). Sellers would apparently still pay their 3% commission.

The fact is, commissions frequently depend on the Realtor. One of our first DBNR sales was through a Realtor. She listed the property and found the buyer, and she had no qualms about insisting on both commissions (the price was so low that we ended up compensating her more than appropriately). A friend of ours was able to get more cash out of the sale of her townhouse recently because both Realtors kicked in $1,000 from their commissions.

It’s not clear what Lewis’ qualifications are to talk about the real estate industry, since his primary job is in the health care industry (he’s in disease management, which has something to do with chronic care on a grand level). Admittedly, he speaks the truth when he says the real estate industry is a cartel, but there are multiple reasons why you hire a real estate agent for a fee, and not by the hour.

The old saw about airline pilots comes to mind. Pilots aren’t paid to fly the plane; that’s a fairly simple process. They’re paid to fly the plane when something goes wrong. Granted, there are too many rules and regulations around real estate these days (and the deluge isn’t stopping), but are consumers going to know enough to protect themselves during transactions they may make only once every few years, if that? Probably not.

Furthermore, there are a lot of activities a Realtor does that are transparent to the buyer, such as coordinating the result of a multitude of service providers in a transaction. In that way, they’re like actors. If they’re good, you don’t see the mechanics behind what they’re doing.

A few years ago, during the technology revolution, there was a lot of talk about the Web enabling buyers and sellers to get rid of the middle man. Well, guess what — there was a reason the middle man was in there. He was a trusted intermediary that had, through experience, gained insight into the pitfalls of the sales process. Realtors have the same kind of insight plus enormous local area knowledge.

More recently, CNBC broadcast a report about the current administration vilifying people who fly private airlines as being elitist. That’s one way of looking at it, but the people who do it (notwithstanding their carbon footprint) can bypass the mess at our nation’s airports and be much more efficient, effective, and productive in their work.

The point is, it depends on your perspective. From my perspective, Realtors earn their money. This is one part of the real estate structure that we shouldn’t be tinkering with.

Last week, I wrote about a client who was a homeowner and always paid his bills, but because of the economic impacts of the recession, was facing two of life’s most stressful moments: a divorce and a foreclosure. He is facing the prospect of joining the segment that only transacts in cash, because his credit rating is facing ruin.

What does this mean to us as an economy and a society? Since World War II, we have become increasingly geared toward instant gratification. If we want something, we finance it. There has always been a segment of society that did that; that was the way they lived; I dubbed them Segment B. They always managed to survive, frequently because of the rising value of their homes. Now Segment B is shrinking, with more people moving into Segment C, a world built on cash.

From a societal standpoint, how are people going to manage the urge to get what they want, if they can’t get the credit to buy it? Are we going back to a cash society? Will people actually begin to save in order to acquire something?

From an economic standpoint, what’s going to happen to an economy built on consumer spending? If people can’t get credit, that affects commerce. The people in the business of supporting credit are now having trouble too. If people start paying cash, why do I need credit?

There are some pros and cons to this. Perhaps retailers will go back to offering credit, before the days that they passed off those notes to finance companies. They’ll offer credit to people they know best, so there will be an advantage to staying in one place and shopping in the same place. Consumers and retailers will get to know each other better.

At the same time, people may get more conscious about what they do with their finances. They may become more prudent in their spending choices. Cash will only go so far, so they’ll control their wants more. This may presage a return to the pre-World War II world.

There is talk about trying to keep the marginalized people in Segment B in it, as a way to preserve the status quo. There is talk about giving people like my client some forgiveness. Should we give a one-time pass to people who have had these kinds of issues, people were buffeted by life’s unfairness, both within their family and beyond?

I think that’s an unlikely turn of events. I see credit standards getting tougher, and most institutions becoming more risk-averse. More and more, financial software spits out automated results regarding risk with little input from human affairs or emotions. Regardless of how the foreclosure happened, people who experienced it will be judged as untrustworthy.

The result: Segment C will only grow, and a cash economy along with it. It means that we face a completely new economic world going forward, one whose ways may very well be foreign to most of us.

There is a magic number in consumer credit reporting: 800. It represents a really good consumer credit report. That number — or rather, your proximity to it — affects whether you can buy appliances, a car, or a home.

Most people know they have a number representing their credit rating, but not necessarily how that number is derived. Sure, it’s based on whether you pay your bills on time, and whether you’ve ever declared bankruptcy, but there are other factors that enter into it. How many credit cards do you have? How high are the balances? How much do you pay off each month?

Another important one: what’s your utilization ratio? Utilization represents the amount of credit you have versus the amount of credit you use. If you have a $50,000 credit line and you generally charge about $10,000 per month, that’s a 20% utilization rate, which is okay. If you’re constantly bumping your head against your credit ceiling, that’s a problem.

Most of this is well-known to the segment of the population that regularly buys houses, cars, and applies for credit cards; call that Segment A. There is another segment of the population to whom this is completely unknown. The people in Segment C are not necessarily poor or unemployed or on welfare; they simply live their lives without benefit of credit cards, and frequently without benefit of checking accounts. They are paid in cash and only spend cash. Though they are frequently highly contributing members of society, they are financially “off the grid.”

In the middle is Segment B. In this group are people for whom credit has been difficult, but not impossible, to get for most of their lives. Some of them may be the people who saw housing becoming more accessible in the mid-2000s and got a loan with no down payment that assumed housing values would just go in one direction — up. Some of them may be people who were seeing friends and colleagues enjoying the good life and plundered their home equity lines for the wherewithal to keep up with them.

But also in this group are people who played by the rules all their lives and are now facing catastrophic events. I have a client who has always paid his bills on time, but his spouse lost her job. The financial strain has pushed them toward divorce. They’re facing the prospect of selling a house without any equity. Whether the house is sold at its current price (if they indeed can sell it) or it goes into foreclosure, his credit will be negatively affected; he’ll be forced to live off credit cards, but he doesn’t have an abundance of credit.

My sense, based on stories like this, is that a whole cluster of those in Segment B are about to be joining Segment C, perhaps permanently. And with credit getting more difficult to get — car dealers are having trouble financing loans — what does that mean for this group? Credit reports are a measure of trustworthiness, so if someone does not generate data to appear on a credit report, does that mean they are not trustworthy?

Certainly not. One of the people DBNR sold a house to is a very successful craftsman who simply had a cash business. He didn’t have a credit rating, but he had tax returns that told us what he made.

But as the numbers in Segment B begin to shrink and those in Segment C swell, the trend could have massive impact on our economy — both good and bad. Next week: the economic and societal ramifications.