In part I of this three-part series,we talked about how real estate investing is changing. In part 2, we discussed a key opportunity for implementing that change: land contracts.

Once you’ve worked hard to make your money, you want your money to work harder than you did. That’s really the concept behind passive investing: doing minimal work for maximum return. That’s everyone’s dream.

The problem, frankly, is that there are opportunity costs everywhere. The less work you do, the more work someone else is going to have to do, and you’re going to have to pay that person to do it. The trick is to find the happy medium.

There are several ways people currently conduct passive investing. You can invest in real estate investment trusts (REITs). Generally found through financial planners and regulated by the SEC, REITs tend to invest in large commercial properties. You can expect a low return (about a four-to-eight percent monthly cash distribution) and some percentage of any profit when the property is sold in three to five years). Minimum investment is usually $100,000, and you can add further investments in increments of $25,000, $50,000, or more later.

You could go to a real estate agent who does property management and invest a minimum of $50,000 to $75,000 there. You should expect to get ongoing reports about your properties. But you’ll also have to pay ongoing fees for repair and other upkeep. The fact is, if you’re going to be completely passive, other people are going to have to do more of the work, so you make less money.

In the world of distressed properties, the best model is to find a local expert and work with them to manage the sales, rental, and upkeep. You put your money in, and that person does the work. You can own it, and you’ll make more money. DBNR is focusing on this area, and we can handle the property management. There are fees involved, but because the properties are distressed, the potential profits are higher.

A couple of points that you should consider when it comes to passive investing:

• You can be as passive or as active as you want. Just make sure the people with whom you’re investing agree on the level of involvement you want to have.
• Make sure what you’re investing is discretionary income, because you will not be able to liquidate it quickly.
• Think about passive investment as a group to make your money go farther. In the 90s, a womens’ investment group met in my real-estate office, and they did pretty good.
• Remember that the IRS has specific rules regarding what constitutes passive investing, some of which relate to real estate investing and some of which relate to entities such as limited liability corporations.

My overall point is this: if you want to invest in real estate, but don’t feel you have the expertise, worry not – there are other options for you to take advantage of in this area that still have profit potential.

In part I of this three-part series, we talked about how real estate investing is changing. In part 2, we discuss a key opportunity for implementing that change: land contracts.

You don’t have to look far to find experts in the financial industry declaring today’s real-estate lending process badly broken. The evidence is extensive: the over-subscribing of worthless mortgage securities, the resulting meltdown, the foreclosure crisis, the robo-signing mess. It’s like watching a train wreck in slow motion.

How are real estate investors supposed to continue their efforts to develop equity and a strong financial foundation when the process for borrowing is so horribly mangled? One answer is to turn to land contracts, which DBNR frequently uses for its investments.

Just like it sounds, a land contract is an agreement between a buyer and a seller in which the seller agrees to give full and equitable title to the buyer once they meet certain conditions. These conditions could relate to payments, payment schedules, occupancy, repairs made, payment of back taxes and utility bills. Each contract is as different as the property it relates to.

For instance, you can set up your land contract so that the buyer makes payments, but the seller still gets the depreciation deduction. The seller hands over title at some point in the future when the buyer has fulfilled the conditions set forth in the contract, and that’s done through the traditional escrow process.

Land contracts are becoming increasingly popular for private investors who don’t want their deals mired in the quicksand of the financial industry mess. While it’s hard to estimate how many such contracts have been created over the last few years, based on the number of companies offering them and their new listings, it’s safe to say there are at least 100,000 properties being offered this way. And while we’re beginning to see some regulations put into place for these transactions, until recently, it’s been between private parties and government has been staying out of it.

It’s becoming popular because of the built-in safeguards. The seller does not transfer title initially, so if the buyer doesn’t fulfill the contract, the seller is protected and retains the house. It’s like buying property complete with a renter.

Even better, the land contact can work as either a real estate investment or a financial investment. As the holder of a land contract, you can re-sell it just as a retail store might sell a financing deal to a third-party. If you buy a land contract worth $40,000, you can get it at a 25% discount, or $30,000; there’s a quick $10,000 profit. If you want to take a bigger risk, you can take a contract with a shorter payment period and some other issues (perhaps the renter has been late with payments a couple of times) and get it for a 50% discount. Again, the options are as varied as the properties themselves.

If you want to know more about how you can benefit from land contracts, contact me.

People traditionally look at real estate differently than they do other investments. They look at real estate with the same perspective that they look at their house – with some pride of ownership. You wouldn’t look on your technology stock with pride of ownership (unless it was Apple and you were a Macophile, I guess). But with real estate, there tends to not only be pride, but – to extend the stock analogy – a buy-and-hold mentality.

What I’m both seeing and suggesting is a shift away from that. For one thing, if you go into real estate investing with that attitude, it’ll break your heart. You can’t think about investment property with the same pride of ownership that you have for your primary residence. We are protective of our primary residences. We strive to make sure it looks good and stays that way. When tenants leave a property, it’s likely to be in less-than-pristine condition. Every time someone departs, you have to call in the painters and carpet layers.

Real estate investment, like any other investment, is about either making money or reducing your tax liability. It requires an entrance strategy, a holding strategy, and an exit strategy. It requires thinking about numbers, because it involves either time or money, or both. For instance, here are some questions real estate investors need to ask themselves:

• Are you researching available properties yourself or working with a professional? If the former, there are plenty of opportunities at sites such as Bigger Pockets and EconoHomes.
• Will you be managing the property yourself, or will you pay someone to do it?
• Do you want to buy property with little cash (i.e., be highly leveraged) or do you want to make a big down payment in order to retain more of the value and increase your passive income? Do you want to invest in residential or commercial property?
• If residential, do you want to invest in distressed properties in depressed areas that may increase in value or middle-class or upper-class properties that are more likely to hold their value?

In the transition to being dispassionate, there are even more numbers that investors need to think about, both prior to and after the investment.

• ROI. You need to think about the return on your investment – what’s your payback? Are there better ways to invest your money? Real estate isn’t the automatic jackpot it used to be.
• GRM. This statistic is the Gross Rent Multiplier, which is derived from comparing the annual income of the property to the property’s value; 10 is a good measure ($12,000 annual gross rent / property value of $120,000 = GRM of 10).
• Capitalization Rate. How much is it costing you to service your investment (i.e., paint, carpet, mortgages plus other expenses? Your cap rate comes from an analysis of costs vs. income.

Finally, there’s the exit strategy. Remember, your identity should not be tied up in this investment. You should be as dispassionate about getting rid of it as you were about acquiring it. Are you going to sell entirely, or do an exchange? Exchange is an investment term for buying up or down. In a positive exchange, you sell a $100,000 house and use the proceeds to buy a $200,000 house. In a negative exchange, you sell a $100,000 house and buy a $50,000 house. It depends on how leveraged you want to be. You can also sell the house and carry the financing yourself to get the monthly cash flow as a return on your investment.

But however you do invest, you have to do it with your head, not your heart.

In Part 2, we’ll talk about more about carrying the financing in a discussion of land contracts.

In light of the latest hiccup in the foreclosure crisis – the discovery that thousands of foreclosures may have been done in a slipshod manner (to put it kindly) — that’s an apt metaphor for the real estate industry right now. It’s not clear what has to happen to get real estate moving again. It could be stuck like a Kansas locomotive for quite a while.

Let’s start with Realtors. They list properties for sale. Clients call, get qualified. Realtors negotiate the contracts. But with anywhere from 40 to 60 percent of transactions involving some sort of foreclosure, the robo-signing crisis slows the process down. If banks actually start confirming that they own what they’ve foreclosed on, that’s going to take some time. Realtors who specialize in these homes won’t be getting as much inventory.

Let’s move onto title companies. They are a crucial component in the process, because without their confirming that the previous owner legitimately holds the title to the property, there can be no legitimate transfer of said title. Title companies have a vested interest in selling title insurance. And they don’t want to become party to their own version of the class action lawsuit that’s bound to hit the banks.

Lawyers aren’t normally part of the real estate cycle in this state, but they’re likely to show up too. Some owners or former owners are going to claim that their lender defrauded them. No one wants to buy a property that’s tied up in a lawsuit.

Of course, there are the lenders and the buyers. The lenders seem to be flummoxed into paralysis by this whole mess. They’ve instituted rules about lending that seem to eliminate a good portion of the potential buyers who, even though housing prices AND interest rates are down, can’t take advantage because their own income or net worth has been impacted.

The pace of transactions is stalling, and there’s no way of knowing how long the stall will last. The irony here is that real estate drives the economy. When people buy new houses, they buy new furniture. They hire exterminators. They hire landscapers. They hire painters. Without consumer demand, the economy isn’t coming back. If the economy isn’t coming back, companies aren’t going to hire more employees. And neither locomotive could get going again until the other was gone.

What’s the takeaway from all this? Real estate has changed from the way it was in the 20^th century. If you’re lucky enough to be sitting on some cash (perhaps you own Apple stock), and are thinking of investing in real estate, move with more prudence and caution than you’ve ever exhibited. Know the income potential of the property in the new context of the wider market. Know your tax implications. Know your exit strategy. Don’t get stuck at the railroad crossing waiting for someone else to make a move.

That’s the way things used to be, and I’m beginning to suspect that we might be returning to those days sooner than we think. In the old days, there weren’t lenders and mortgage brokers and title companies. You went to your local banker and borrowed money to buy a house; the house served as collateral for the loan.

Somewhere the system has gone horribly awry. It was bad enough when Wall Street started securitizing loans, knowing that more than 28% of them weren’t compliant with underwriting regulations. But when the other shoe dropped, and it turned out banks were foreclosing without being compliant with those regulations. You can’t sign 16,000 transfer documents (part of the foreclosure proceedings) and confirm that they’re all correct. What’s the rush?

Even worse, I fear that this latest so-called robo-signing scandal is just the tip of the iceberg. In fact, Bank of America has just suspended foreclosure proceedings in all 50 states, up from the original 23 where the process known as judicial foreclosure is the law. If it wasn’t bad enough with the investors and the lenders knee-deep in muck of their own making, now the lawyers are going to surge in with class-action lawsuits.

I’m frankly astonished that the highly regulated financial services industry can find so many new ways to screw up. And even though it is highly regulated, I’m also confident that the government will enact new regulations to keep this from happening again. Talk about a vicious circle. Wall Street oversteps the boundaries of sound investing and lending. The government enacts legislation. Wall Street complains that there’s too much regulation. No matter what happens, it seems to translate into higher costs and more delays for potential homeowners.

Nor is the future looking bright. It means that a foreclosure crisis, which was already beginning to move from bad loans to good loans held by people who are running out of financial resources, is going to be drawn out even longer by this delay. It could take two to three years to cycle foreclosures through the entire process. Don’t forget to factor in the issue that if the ownership of foreclosed houses is murky – because a bank didn’t foreclose properly – investors are going to be more hesitant to take a chance on buying them. And until foreclosed properties stop hitting the market and staying on the market, housing values aren’t going up. They may even get devalued.

One thing is for sure – what with increased regulation and litigation, even with interest rates at historic lows, it’ll be much harder to get a mortgage through traditional means in the coming years. Will that kill the drive for home ownership and real estate investing? If the financial services industry keeps dropping boulders in the pond, who knows what shore the waves will crash upon? Who knows when life might be wonderful again?

I wrote about competing offers for properties in Chicago, Ill., and Hartsville, S.C. The battle referred to the fact that, in each case, one of the offers would have involved our getting paid off months or even years sooner than with the alternative offer.

In each case, however, the alternative offer was from exactly the kind of buyer DBNR has been targeting since its inception – people who are willing to work diligently to get themselves ownership of property.

As you may remember, in Chicago, one of the offers came from someone who was better at words than action. He regularly put me off with assurances that his own clients would come through with cash, but it never happened. When I gave him his final deadline, he never even bothered to call back. Sheila (not her real name) called me to find out what had happened even before I had a chance to call her. She signed her contract, got a money order, and sent both via overnight delivery.

That wasn’t quite the end of the story, though. When she took possession, she was astonished to find that the other party had been so confident in getting the property that he’d already had workmen inside. Sheila is not someone to be trifled with. She told him to get out and stay out. His response: he started making the same kind of all-cash offers to her. Sheila came back to me, asking about this guy. I told her, “If he hands you a certified check, take it. But if he could back up his words with cash, you wouldn’t be the owner today.”

In Hartsville, as you remember, I was talking to one prospect’s father, who was negotiating for his son, who lives outside the country. He had first lowered his offer and then, after finding out that there was another party interested in it, raised it again. When I called to determine the son’s level of interest, I never heard back.

The other prospect, Ronnie (not his real name), wanted to buy the property and park his trailer there. His ability to make his down payment, however, was predicated on his wife being approved for Social Security. There was a period of about ten days during which I wasn’t hearing anything from Ronnie, either, but I’ll be darned if he didn’t call me Saturday before last and say she had been approved and he was ready to send me a $500 nonrefundable deposit.

I told him he was still going to have to come up with the rest of the down payment – another $1,000 – but he was confident he could do that. I can still hear his Southern accent coming through the phone: “Ah don’t quite know how we’re going to make that happen, but we are.”

It may be longer before DBNR gets its money, but that’s okay with me. I like being part of a real-life Frank Capra movie where the little guy gets a piece of the American Dream by pluck and dedication. It makes me feel good.

One last thing about Ronnie – call it just one more indication of his confidence in his ability to get his dream property. He said to me, very politely, calling me Mr. Noble, “Do you mind if mah friends and Ah start cleaning off that lot for mah trailer?”

I told him I didn’t mind at all.

Except this time, it’s “The economy recovered? Why don’t I remember that?”

For a recession that felt like a depression, this is a recovery that feels like a recession. Job growth is minimal. Businesses are concerned about impending taxes (how else to pay for the deficit?), and so are reluctant to hire workers.

In the housing market, it’s even bleaker. People who were just barely hanging on waiting for the recovery are now losing their grip. Foreclosures are up. According to a recent article in Money, “foreclosure filings climbed in 75% of the nation’s metro areas during the first half of 2010 … with unemployment [replacing] toxic mortgages as the leading cause.”

This leads to even more trouble, not just because of people losing their homes, but because of the effect it would have on current housing prices. With prices dropping, potential buyers are also likely to hang back, hoping to get an even better deal.

As in any uncertain time, there are people with the wherewithal who can benefit from the situation. But even that takes more savvy than I’m seeing from most people. As you know, I am happy to offer advice to potential investors. Last week, I talked to a couple just getting into the real-estate investment business, and their naiveté frankly scared me.

Why? Because they want to tackle it the way things were before the recession: buy the property for its list price, use traditional financing methods, and then sell it again quickly. Even worse, they wanted to involve all the traditional, highly regulated strategies that caused the downturn in the first place. All of these entities add significant cost to any deal.

That’s bad because I believe investors should avoid anything that adds cost to a deal, not just in the short-term, but for the long-term viability of your investment. Selling again quickly for a profit is not going to happen for a while. Do the math: there’s been a roughly 28% decline in property values. Take a house that was worth $600,000 and reduce it by 28%, it’s now worth $432,000. If property values increase at 3% per year (and that’s a big if), in 10 years, that property would only be worth $583,000. Loosing 28% of value in one year, taking 10 years to get it back has got to be sobering and a wakeup call for moderation.

The parameters for real-estate investment have changed. It’s back to basics. Homeowners should look for home price within their means as a place to live, not invest. Investors should look for cash flow and investment opportunity, not future value. There is no massive recovery around the corner. There is no panacea.

Ratchet your expectations down, because the real estate market has evolved. A couple of years from now, you don’t want to be scratching your head and saying, “Why didn’t I remember that?”

I’m reminded of this as I deal with a contractor in Cleveland whom I’ll call John. He contacted us after he saw an ad on Craig’s List (which has regional editions) about a property we have on Elmarge Avenue there. John is one of those people who really understand the community he’s in, but who is also pursuing his own business aims.

The house on Elmarge Avenue, to put it kindly, is a mess. It has roof and foundation problems. It’s in a blighted area. Worse, it has $16,000 in back taxes attached to it, and we wouldn’t mind if the city took it back from us in lieu of the taxes. It’s one of about a third of the distressed properties we originally got that is in need of this kind of repair.

That’s exactly what John wants to do. John specializes in the construction of steel-frame houses, which are being touted as a green alternative to wood for a variety of reasons; steel is cheaper; it’s stronger; it’s recyclable. John wants to tear down the house and build a 1,500-square-foot model home there, one that’s made of steel so he can show what the material can do. Then he wants to rent the home to the city so they can house Section 8 (low-income) tenants there. He’s also done this in other Cleveland suburbs. In the meantime, he’ll be paying off the note to DBNR for the lot.

The local kicker is how John plans to deal with the $16,000 tax bill. His response, “I’ll call someone I know. He’ll come out and take a look at it. The taxes’ll go away.”

What I’ve learned is that this is actually not unusual. Municipalities will frequently waive past-due expenses for locals. They’ll forgo out-of-towners who can’t vote, but locals are okay. He’s even confident that the city will ask him to do the tear-down on the house. That’s the way local real estate works.

In fact, John is so confident that he’ll be successful that he’s asked for the addresses of our two other properties in Cleveland, and I was happy to send them to him. It is our intention to have someone like John in every major city where we’ve got property.

I still stand by that. But standing where I am, I now also face a situation where I have to take into consideration not only the needs of our customers, but also the needs of our company. I think it interesting that I’m facing a battle between altruism and capitalism in not one but two situations.

There is nothing similar about the locations. One is urban Chicago, the other a town in rural South Carolina named Hartsville, not far from the Darlington Raceway (for you NASCAR fans). But there is something similar about the stories. In each case, I have two potential buyers. In each case, one is the prototypical DBNR client — in need of a hand (not a handout, as we used to say) to get into a home, and who will take advantage of our process by making monthly payments over time. The other is someone who is willing to pay cash for the house.

See the dilemma? If I sell to the latter buyer, I get a house off DBNR books and have the cash now. If I sell to the former buyers, I serve DBNR’s philosophy but I run the risk of getting the properties back if the new owners default. Because we don’t surrender the note, we maintain ownership of the property, but then the process starts again.

Read the stories and think about what you’d do in my situation. The first potential buyer in Chicago is a single mother with two kids who works in the office of Cook County’s waste management division; I’ll call her Sheila. She wants this two-flat (as they call it there; we would call it a duplex) so she has a place for her family to live and a place she can rent out. The property needs some work — not a lot — and Sheila’s father will take care of that for her. We’ll hold a 15- to 20-year note on the property.

Competing with Sheila is a wholesaler we’ve been working with in Chicago, who has another family ready to buy. He’s offering a little less than Sheila is, but he promises that the property will be paid off in three months. Complicating the issue is that this particular wholesaler isn’t always the most reliable person in transactions. He frequently wants more time, and then some more time, and meanwhile, Sheila is calling frequently though waiting patiently.

The situation in Hartsville is only a little simpler. It is a one-third-acre lot, suitable for parking a mobile home. The thing about rural South Carolina that we’re not used to here in Silicon Valley is there are people who have neither computers nor voice mail. They have to drive into town to send a fax. The first few times I called back the first buyer, whom I’ll call Ronnie, I got a recording saying that I should try again later. I began to think he was a flake.

But I’ve come to believe he is sincere. Ronnie actually rented the lot previously, and lived there in a mobile home. He doesn’t know why the people that owned it wouldn’t sell it to him, even when they were in danger of losing the lot in foreclosure (which is how DBNR got it). He’s even willing to pay more than the cash buyer, but he needs DBNR financing.

On the other side of equation is Chuck — or, to be more accurate, Chucks’ dad, since I’ve never actually talked to Chuck. Chuck works for a manufacturing company in Libya. He works for three months and comes home to Hartsville for three weeks. Chucks’ dad has been dickering on the price, offering first one amount and then less, and then more when he found out he was competing with Ronnie.

All four of these prospects have their plusses and minuses. Time may give me the answer, with one or more dropping out of contention. But it’s entirely possible that the decision will be mine. And at that time, I will be weighing capitalism vs. altruism.

Beautiful fixer upper!

Status: Available

Price: Make An Offer!
Type: House
Bdrs: 3
Bths: 1

Additional Information

High Points:

Low Points:

For more information refer to 4703 West Ohio St. Chicago, IL and call

The Property People at 866-233-0589

toll-free anytime day or night

OR Email us: http://dbnr-investments.com/about-contact

Map:

Additional Pictures:

Beautiful fixer upper!

Status: Available

Price: Make An Offer!
Type: 2/Flat
Bdrs: 8
Bths: 2

Additional Information

High Points:

Low Points:

For more information refer to 5218 Laflin St. Chicago, IL and call

The Property People at 866-233-0589

toll-free anytime day or night

OR Email us: http://dbnr-investments.com/about-contact

Map:

Additional Pictures:

The article below details an interview with Julia Dugger, Fannie Mae’s senior manager of marketing communications in May of this year. The article discusses the First Look program released last fall. The program although not widely familiar, gives individual potential homeowners and one time opportunity to purchase a home before the general investment community has a chance to use plentiful investment funds to buy and then resell the property for a higher price.

Fannie Mae is tightening up its initiative to facilitate the sale of REOs to owner-occupants and entities using public funds, such as local housing and community development agencies.

Fannie Mae says these buyers bring permanency and stability to tenuous markets where swollen inventories of foreclosures have taken their toll, and the GSE is making some changes to ensure owner-occupants and public entities have “first look” at its REO homes.

Fannie Mae initially rolled out its First Look initiative last fall. Under the program, the GSE only considers offers from those seeking to purchase a home as their primary residence and public entities during the first 15 days that a property is listed. 

Julia Dugger, Fannie Mae’s senior manager of marketing communications, says the program has seen a great deal of success throughout the country, and is accomplishing its mission of building stronger communities by ensuring the GSE’s repossessed homes don’t continue to sit vacant while an investor markets the property to potential tenants.

But Dugger explained that the execution of the First Look program has been “tricky,” primarily because individual homebuyers and public entities usually can’t view multiple listing services (MLS), and consequently don’t know when the property they’re interested in was actually listed or when the 15-day First Look window ends.

To address this snag, Fannie Mae is making some changes to the program. Going forward, First Look will be tracked based on days listed on the GSE’s REO marketing site HomePath.com, as opposed to the MLS.

Properties in the First Look marketing period can be easily identified by the First Look logo. Fannie Mae also launched a new timer feature today on HomePath.com, indicating how many days remain in the First Look marketing period for each individual property.

Click this link to read the rest of the article: http://www.dsnews.com/articles/fannie-mae-hones-first-look-program-for-reo-property-sales-2010-05-03

A quick search for property in San Jose, Santa Clara county in the price range of $200,000 to $500,000 revealed some interesting values. These are properties you could actually buy at a substantial discount over current prices right now.

Here is the link if you’d like to see these: HomePath.com

Beautiful Home!

Status: Available

Price: Make An Offer!
Type: House
Bdrs: 3
Bths: 1

Additional Information

High Points: The roof is in good shape and exterior is in good condition. There are ceiling fans in each bedroom, and a crawl space in the attic for storage. The grass is cut, electrical box is intact, there are no signs of mold, and there is an area in backyard fenced off for a dog kennel. This property is located in a nice neighborhood. Carport parking, and houses in the area are well maintained.

Low Points: There is drywall work needed throughout the house. There is no water heater nor furnace. This house is located 200 yards from the highway (in back of the house).

For more information refer to 2224 Macon Ave. Camden, AR 71701 and call

The Property People at 866-233-0589

toll-free anytime day or night

OR Email us: http://dbnr-investments.com/about-contact

Map:

Additional Pictures:

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 loan 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.

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.

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.

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.

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.

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.

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?

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.

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.

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.

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.

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.

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.

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.

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.

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.