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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.
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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 11th 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 50th 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.
What Black Friday in November is to retailers, early spring is to real estate. It’s been a very dependable cycle as long as I’ve been in real estate. Both properties and buyers sprout like flowers.
Why is not entirely clear. Do people make New Years’ resolutions about changing their work or their lives? Is it pent up demand that blooms after the slowdowns during the holidays? Certainly, a lot of people want to make their transitions before summer vacation. And, for some strange reason it all seems to begin right after the Super Bowl, now why is that?
This year it’s an especially good time to think about buying, not only because of the traditional “spring fling,” but because the market holds a great deal of potential. There are still a lot of properties out there — and not just DBNR’s. Because of more-stringent loan policies, people with cash on hand are in a much stronger position to make deals. (Check out the article in Time [http://www.time.com/time/magazine/article/0,9171,1952326,00.html] about potential homeowners being aced out by people with cash in hand.)
Finally, with the reach of the Internet, it’s much easier to find great deals. There are people auctioning houses on eBay, with the “buy it now” option also prominent. Last time I checked, there were 19 homes on eBay in Flint, Michigan, and twice that many in Detroit.
It’s an especially good time to make the leap, just from a sense of timing. The media will continue to bad-mouth the economy, especially when it comes to jobs. Those who act now will not only be ahead of the market, but they’ll have more flexibility than ever before in terms of where they can buy and how they can pay for it. If there was ever a golden time for real estate investing, this is it.
Now that the barn door is open and the horses have galloped off into a landscape of foreclosed homes, the U.S. Department of Housing and Urban Development has developed guidelines to help people more aware that they’re entering into dubious mortgage arrangements.
The Real Estate Settlement Procedures Act www.hud.gov/offices/hsg/ramh/res/respa_hm.cfm) took effect on January 1, and represents a whole new set of guidelines lenders must follow in order to keep consumers from doing stupid things and avoiding common sense entirely. Part of RESPA is the requirement that lenders deliver a new four-page good-faith estimate about the costs of a mortgage. In response to the government tradition of trying to bring simplicity to finance, Wells Fargo has issued a 35-page document to help brokers understand the four-page form.
I’m not going to come out against consumer protection, but these changes are doubling or maybe even tripling the workload of real-estate financing professionals. It’s not clear who’s going to pay for this added administrative time, though it’s likely that it’ll be taken care of by higher, hidden fees. Then the vicious circle will continue: the government will require another form to explain the hidden fees. The lender will have to have still another form for borrowers to sign saying that they have been given the hidden-free form and understands what that form explains.
Where does this extra work come from? We used to be able to get a good-faith estimate of costs at the beginning of a client’s search for a home. It was always helpful to give the client a sense of what kind of property to look for. Now RESPA requires one form at the beginning of the process, and another good-faith estimate when there’s a property in sight. And that good-faith estimate must be within a small percentage of the final cost, or the lender is out of compliance. This makes one wonder, then, why it’s called an estimate.
It’s a merry-go-round. Consumers do stupid things, like applying for no-money-down, interest-only loans, in the expectation that their property value will rise. Economic laws kick in, bringing down the house of cards, and the government comes along trying to fix a problem that’s already taken place. It asks for more forms and more signatures from consumers who still don’t know what they’re signing; they just look to their real-estate professionals, who confirm that if they don’t sign the form, they can’t get the loan. Those two-hour hand-cramping signing sessions are just going to get longer.
In writing about navigating a new real-estate landscape and starting a new business, I have frequently referred to the challenge of letting go — the process that all entrepreneurs, if they’re to be successful, encounter as their business grows.
Entrepreneurs by nature are prone to doing things themselves, especially those things they do best. That’s how they get started in the first place — they have a skill or talent or invention that lets them be a provider of one. They can work 16 hours a day and create a business. It’s what made America great and — if this is indeed a jobless recovery — will probably have to make it great again.
But the growth part makes the process sticky. At some point, to grow, you have to hire employees. You have to train and trust other people to do the work you can do yourself. I’ve been through that with my salespeople, and I’m generally happy with the results.
But now I have to let go even more. Our next marketing phase we must take on for DBNR is to post our properties on appropriate Web sites to give them wider visibility. This means hiring someone to do that posting, which is essentially 21st-century data entry with a marketing and promotional twist.
I could hire someone here in the office to do it, but it’s a short-term proposition; that means bringing someone from a temporary agency at what are, to my mind, exorbitant rates of anywhere from $25 to $60 per hour. Looking for less-expensive assistance, I posted an ad on elance.com, a site where freelancers can bid on work. I only asked that respondents speak English and have a Skype address. I got six responses —from Pakistan, Egypt, Boston, Las Vegas, and two others. Their rates ranged from $2 per hour (Pakistan) to $10 per hour (Boston & one other).
The price is right, but now I am faced with another management decision. How do I choose? And once I choose, how do I manage the person and control the process? I don’t want a management situation where it’s more time-consuming to deal with back-and-forth discussions potentially hindered by geography, time, language, and culture. That would ultimately be more costly than having the work done locally.
I will be once again letting go of my entrepreneurial desire for controlling the process and take the plunge. We’ve had enough success with outsourced assistance — an outside service answers our toll-free number and a service collects note payments from our buyers — as have other people I know, to give it a shot. Also, my altruism supports the idea of creating jobs, even in other countries. Stay tuned for the results.
As longtime readers of this blog know, my goal for DBNR Investments has been simple: to put people into homes who want them, can afford them, and will improve their situation in life through home ownership. Without apology, there is more than a little altruism there, a throwback to the philosophy espoused in that Christmas classic It’s A Wonderful Life.
I believe, as Jimmy Stewart’s character George Bailey did, that at the heart of all our actions is simple human decency, however you characterize it – as a concern for humanity or the planet or people or just making a difference.
In this business, however, that philosophy sometimes collides with another strong American philosophy, capitalism. (Or, as it was described in that other Christmas classic, Miracle on 34th Street, “Make a buck, make a buck, don’t worry about the other guy.”)
Don’t get me wrong – I have a strong profit incentive here, and my commitment to getting property back into the hands of people who need it is carefully balanced with the profitability that a business and its investors require.
But what I’ve been noticing recently – perhaps in counterpoint to the holiday season just passed – is that the conversations I’m having with potential buyers relate more to the idea of revenue and profitability than with our original goal. I understand that, but I miss the background element that I had hoped would drive the conversation. I’m looking for George Bailey and the people I’m meeting are Mr. Potter, the money-grubbing skinflint of Bedford Falls. I worry that we are losing sight of what we’ve committed to.
I’m looking for that same altruism in my colleagues as well. I was talking to my brother, who’s doing some sales work for us. He and I are a lot alike. While we acknowledged that there has to be some income for him to continue with this project, given how much time it takes, we also agreed that you don’t get wealthy simply by looking for ways to generate money. You get wealthy doing the work you’re passionate about, and that’s what pays you well. He’s going to continue, of course, because he believes. As Natalie Wood said in Miracle on 34th Street, “I believe. I believe. I know it’s silly, but I believe.” She was talking about Santa Claus, but the theory still holds.
As the new year dawns, I’m going to keep believing, keep having faith, and keep looking for the George Bailey in everyone.
Frequently in business you’ll hear someone talk about “not re-inventing the wheel,” an attempt to take advantage of something that already exists, rather than building something from scratch.
At DBNR, that concept has made our lives — and those of our clients and investors — much, much easier. We’ve taken advantage of an old but little-used concept called a contract of sale. (It’s also known as a land contract, or contract-for-deed.) It’s the basic agreement with which we’ve been able to put people into distressed properties.
At its essence, it’s a way to set up the financing of a property transfer on deals that traditional lenders shy away from. It was most popular back in the late 70s and early 80s when money was tight, interest rates were in the 18% range, and most people were reluctant to pay those rates even when the banks were willing to extend them.
Here’s how a contract of sale works: the owner (or, in our case, a vendor) retains title to the property. The buyer gets what’s known as equitable title. This gives the buyer all the advantages of property ownership, including the ability to write off mortgage interest and taxes. In exchange for equitable title, the buyer is expected to fulfill a certain set of obligations set forth in the contract; these include, not surprisingly, making the mortgage payments, paying property taxes, and paying any back taxes or outstanding utilities payments.
In one instance we had with one of our distressed properties, the municipality had so much pending in back taxes, they threatened to take possession of the property. We will probably have to offer a certain amount to call off the city dogs for a year or so.
But we can accommodate that concession into the contract of sale. That’s the beauty of it — you can structure it however you want. Because it’s for private parties, it’s designed to bring flexibility to a transaction. It can also bring simplicity — because it’s a purchase and financing all in one, our contracts of sale are only 16 pages long.
It protects both parties as long as the payments are made. The buyer puts up a deposit, and the owner agrees not to sell it to anybody else. Flexible milestones based on time, money, or other activities are built into the contract. After a year, it converts to a mortgage and deed of trust.
Contracts of sale have been a boon to DBNR because the properties we’re selling wouldn’t qualify for the traditional financing process, based on their condition. We would have had to ensure a raft of repair work before a traditional lender would touch them, based on what are known as habitability standards. This gives us — and more important, our buyers — the ability to enter into a contract outside of the existing financial structure. It’s the ultimate in flexibility, at a time when it’s needed most.
The late Speaker of the House Tip O’Neill used to say, “All politics is local.” That used to be true about the real estate industry too. In order to make investments, you needed a local expert, someone who understood the market and could guide your way.
The evidence continues to mount that the world is changing in that regard. I’ve talked frequently about the increasing number of opportunities for private individuals to invest in real estate anywhere, circumventing the need for assistance from traditional players in the real estate and financial community.
Part of it is, of course, the reach of the Internet, and the ability of anyone to track comparative housing prices through sites like Zillow, Cyberhomes, Eppraisal, Realtor.com, or to check advertising in multiple cities through sites like Craig’s List or Backpage. But that’s not all — low-cost travel through airlines such as Southwest is changing the landscape too.
Let me use just one woman I spoke to as an example. She was from Maryland, and had called regarding a property we have in Syracuse. She told me she had 15 properties in various states, though primarily in New York, Florida, and Ohio. The properties represented $1.2 million in property value and about $9,000 in monthly income (so-called “passive income,” the amount she gets after paying the mortgages). She wanted to know more about the property because she was flying to Syracuse to look at it the following day.
This is how she spends her time — talking to people in real estate, especially in the areas where she wants to invest, and traveling to see the properties herself. She ended up not pursuing the Syracuse property because it didn’t match the parameters she’s set for her investments. She calculated that it would have a market value after repair of $50,000 in the current market conditions, but that it would take as much as $25,000 for those repairs. Though we paid $7,000 for it, we were going to sell it for around $12,000. She said she likes to have no more than 70% of current value invested, so she passed. But she wants to stay in touch with us.
This woman and people like her are changing real estate investing. Now, you still have to have a title company involved to make sure title is transferred properly, and you need to know about the regulations real estate agents are familiar with. But by taking real estate agents out of the mix, you can save anywhere from 6-10% of your costs. Add to that the opportunity of finding growth areas beyond your own back yard, and the opportunities are staggering.
One of the hardest parts about starting a business, I’ve learned over this past year, is balancing the mundane with the mission.
The mission, of course, is being successful. To achieve this, we’re engaging in planning sessions for 2010, setting strategies and mapping milestones. Our goal for 2010: becoming wildly profitable.
Unfortunately, most small businesses don’t do this. It’s difficult to keep your eyes on the horizon because the items on your desk need attention too. Each one is a distraction to the other, but each is necessary. Admittedly, sometimes I get bogged down in my little to-do list. All of those items are important, relevant, and need their space and my time. And if I don’t focus on them, the whole never makes it into existence.
But we do set aside time for strategy twice a week. My partner Bob and I will frequently have conversations over lunch, but it’s something I need to put on my calendar, so I’m committed to it.
Even more difficult for small businesses, however, is the concept of flexibility. They frequently need to shift their strategy, tweak their tactics, and then communicate that to the rest of the staff. As situations evolve differently than we anticipated, we then face the question: what now?
If we ignore reality, we may suffer financially. If we incorporate the new reality into our tactics poorly, the business becomes a mish-mash with no real purpose. Such situations must be addressed.
But that’s the way life occurs in its natural habitat. It never goes as expected. There are unimaginable variables. Real leaders — which we’re learning to become — have the ability to flex with what happens, keep moving, and maintain their eyes on the far horizon. When life goes a different way, alter the plan and keep on going.
New York Times columnist Thomas Friedman frequently talks about how technology has “flattened” the world, which both makes connections easier and business models more fragile. This is nowhere more true than it is in residential real estate, which used to be local and, thanks to distressed property programs such as ours, is now shifting toward something broader.
But even in an electronic world, when all you face is a computer screen and all you hear over a telephone line or a Skype connection is a disembodied voice, participants must trust who they’re dealing with. I’ve made some interesting connections this past week that show both the potential and the pitfalls of this new flat world.
As regular readers know, I participate frequently in the forums of a Web site called BiggerPockets.com, a social networking site for real estate investors. I got a call from another member on the site, a young man with a South American accent but clearly fluent in English. He has a bachelor’s degree from San Francisco State in business administration, and like me, has worked in both real estate and as a mortgage broker. He has big dreams, and he’s savvy about the Web.
He unabashedly told me he was intrigued by what DBNR Investments is doing and asked if I would be his mentor. Although I usually associate the word mentor with someone who’s a celebrity in one’s field, I realized doing that has some of the same characteristics as being a coach, which I’ve certainly done before. However, I’ve always charged for coaching services; I’ve never known anyone to charge for being a mentor.
It’s conceivable that I could be teaching this young man everything I’ve learned over the past few years, only to find out that he’s struck out on his own and become a competitor.
The second connection came from one of those unsolicited e-mails that pop up in your electronic in-box with annoying regularity. But this one was intriguing. It was from someone in Las Vegas offering assistance in navigating the morass of grants and loans the federal government was offering small businesses for the acquisition of assets — including real estate.
I spent 15 minutes on the phone with this person, who turned out to be a grant writer. He offered no promises regarding the money, only his assistance in navigating the nightmare of red tape that was potentially involved.
Will working with each of these individuals be sinkholes of time and effort that will come to naught? I don’t know. I do know that the structure for trusting people is the same whether the world is flat or you never venture out of your neighborhood. I converse with them. I take notes. I compare their ideas to others I’ve talked to. Are their ideas concise and logical? Do they have conviction about what they’re doing? Are they confident about their skills? Most important, do they deliver what they say they will?
I consider establishing a connection with these people a low-risk effort. Finding connections in the business world may come from longer distances and be stranger than ever before, but over time, when both sides deliver on what they said they will, trust will always develop.
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