[pup55]

What with all of the doom and gloom around, I thought it might be time to check into the local real estate market for some fire-sale bargains.

I am in the exact epicenter of suburbia, biking distance from two giant shopping malls, close to the local freeway. My local community was listed in Money Magazine's "Top 10 Places to Live" a year or two ago.

There are now 20-30 foreclosures per month in the area, so it made sense that it might be time to pick up a couple of places and rent them out to some of the locals who, for one reason or another, do not want to be in an apartment, and cannot buy their own place.

First, I filled out one of those online applications for financing, and got approved, found a local realtor, and started exchanging emails. She forwarded me a lot of listings from the local multiple listing service. I had price and square footage limits, and also limited it to my zip code, plus the adjacent one, since I am familiar with the area.

I made it quite clear to her that I would be looking for a place that was priced so that I could make a greater rate of return vs. a CD right now, based on cash out of pocket vs. rental income. Example: I put 10K down, I have to put 10K in repairs, and I get a rental stream of X per month, which, after taxes, gives me a rate of return on my 20K out of pocket better than a CD.

I had a big spreadsheet that did this calculation no problem, which I forwarded to her.

To her, this was completely unfathomable. She was looking at places based on the value of other houses sold in the same neighborhoods (comps, short for comparables) which to her said that some of these places were quite cheap.

I explained to her that these "comparables" were based on last year's prices, did not reflect the fact that over 50% of the transactions in this neighborhood are foreclosures, at about a 35% discount from the local so-called market, and that it is quite likely to get much worse, since we are just at the beginning of a big economic drawdown.

She sent me a big printout of all of the rental properties in the neighborhood. Quite useful. I was able to do an extensive pup55-like analysis of the whole market. I laid this out to her, and she sent me a few lists of candidate properties. I took a couple of months (in my spare time from posting on PO.com) to ride my most fuel efficient vehicle around the area, and inspect these places from the outside. I really only asked her to get off of her butt and tour me through two of the 70- or so places I went to.

I have not made any offers yet (still no properties that fit my economic model), but she is so frustrated with me that she fired me the other day. I passed on a couple of places that were priced attractively to her (because they had dropped about 25% vs. the local market) and she said were perfectly good deals, but when I laid out for her the projected rent vs. the cash out of pocket, it did not give me a positive ROR.

She was firmly fixed on the notion that the current situation is a once in a lifetime opportunity, and the market will return to somewhere around its normal state in a couple of years, and "look at all of the equity you will have in these houses when they go back up".

I said "I am not at all convinced these houses will ever recover in price, so to me, their "value" as an investment will be a function of their ability to bring in money as rent".

She, of course, was completely unable to get her mind around the idea that real estate would not perpetually go up in price, despite the fact that we were standing around in a house that had dropped at least 40% from its last sale.

Also, she was completely unable to get her mind around the idea that the "market' for homes in this area should include the selling price of the foreclosures. "Those don't count" she says. "When they're over 50% of the market, the regular sales don't count", I say.

So, based on my experience on this:

a. The real estate market is still not bottomed out in this area. Prices have gone down steadily since I started this exercise in August. Nothing is moving except an occasional foreclosure. Rents are also declining in the area.

b. The so-called real-estate "professionals" are completely unaware of what just hit them. A lot of them will be looking for some other form of work shortly. This woman even said at one point she is going to have to get a day job.

c. The so called real estate "professionals" are also lazy. A couple of showings, and this woman fired me? What next?

d. The so-called real estate "professionals" have not up until now needed to understand basic concepts in finance, such as rate of return. They think that since house prices go up perpetually, all you have to do is get a good entry price, and time makes up for any mistakes.

e. Financing is not really a problem, the rates are about 1% higher than a comparable rate for an owner-occupied place, so you can get mortgage money if you have a job and good credit. note that the 6 1/2% I am asked to pay is a lot higher than the prime rate (about 2%) so maybe I am better off in the other end of the transaction, which is lending money to people like me so other people can buy rental property.

f. A couple of minor points on some of these places: You can tell that a lot of them were cared for by their original owners, and a lot of the original owners made some money on them when they sold them in 2005 or 2006. In a lot of them, the second owners got 110% financing, and now, a couple of years later, are out of the place foreclosed. Presumably the original owners went farther out to the nearby slightly ritzier area, got even bigger houses, and potentially, they now have more house than they can handle. We will see on that.

g. I have priced construction materials and other things needed to fix some of these places up, and found them to be quite a bit cheaper than a few years ago.

[Jotapay]

Thanks for posting that. What are the prices you are dealing with? Like last year's average price for the area, this year's average sale price of foreclosed homes and this year's average sale price of non-distressed housing?

I'm always keeping these numbers in my head when I look around because I think I may have the opportunity to buy a doomstead with cash later if the market gets as bad as I think it will.

[dinopello]

Your experience with that realtor comports with my own. If your decision criteria or world view doesn't jive with theirs, it makes their head spin. Having said that, the one I used when I bought over 10 years ago wasn't lazy and actually found my house before it was listed through chatting it up with the neighbors.

[evilgenius]

Did you find that the average house that needed repairs was in need because the previous owners had either trashed it or not kept it up or that it needed repairs because it had sat idle for so many months? I am curious about human nature on this one. I wonder if people trash houses they can't keep or if the kind of people who find they can't keep a house are the kind that trash a house just by living in it.

[Maddog78]

It is typical of realtors in my area too.
I know some sellers that are in denial, still living in 2007 mindsets, and realtors are telling them, "Wait until spring to relist, prices will be back up then"

Whaaaat?????

[Armageddon]

Pup,

I wouldn't touch the housing market with a 10 foot pole no matter how much more it drops. When your renters lose their job, good luck collecting rent money. It's just not worth it.

[MarkJ]

Our local Real Estate Professionals are generally developers, builders, tradesmen, investors, landlords and people skilled or knowledgeable in all phases of construction, renovation, building codes, material & labor costs etc.

People that build, buy, rent and resell a lot of properties generally have a better idea of real property/rental values than most real estate agents.

It's funny to hear the unrealistic comps, rents and the line of BS many real estate agents have when I do walk-thu pre-inspections for friends and customers looking at buying a home or investment property.

Real estate agents get pi$$ed when I mention all the structural defects, code violations and poor building practices I spot on a ten minute walk-thu.

There are an awful lot of what we call Polished Turds on the market. The owners make cosmetic improvements to the homes while neglecting the foundation, basement, structure, drainage/waterproofing, plumbing, electrical, heating, cooling, insulation, ventilation etc.

The real estate agents will often compare an outstanding move in condition ready home to one that needs tens of thousands of dollars in repairs.

[Zardoz]

Really remarkable post, pup. One of the best yet on this sorry subject.

...The so-called real-estate "professionals" are completely unaware of what just hit them. A lot of them will be looking for some other form of work shortly. This woman even said at one point she is going to have to get a day job...

Some are very much aware of the reality of the situation, and have been for a while. My nephew and his wife are both RE agents, and they were predicting this catastrophe well over a year ago. They laid out a full-on doom-and-gloom scenario that has proved to be uncannily accurate. He recently left the business and has gone back to work as a civil engineer.

[pup55]

What are the prices you are dealing with?

I am looking at about 1800-2100 sq. ft homes, single family only, lots are about 1/4 acre around here. The 3br models around here were selling for about 150 at the peak, maybe in early 2007, and now are "listed" at 100 to 120. I know this will shock a lot of people on the west coast.

For the same sized house, the local rental market seems to be anywhere between 950 and 1200 per month. There is a premium for "niceness", that is, there is a direct correlation between potential rent and the age of the place. There is actually a greater premium for a nicer house than there is a fourth bedroom.

So with my little spreadsheet, if you can tell me the age of the house, I can tell you the potential rent, plus or minus.

With the current interest rates, plus taxes and insurance, 25% down payment, the payment will be between 750 and 800. So, clearly, the prices are not low enough yet around here for a property that rents for that. If you work backwards from the rent, to the price the places need to be, the selling price needs to be in the low 80's.

As an aside, I am not too far from a couple of rather exclusive golf-course type neighborhoods, and there are a couple of foreclosures in the 1-million plus level in there too, so it is hitting all the way up the line.

I'm just targeting the low end though, so I do not know the detail of what is going on above that.

this year's average sale price of non-distressed housing?

Dunno. All of the recent sales have been distressed.

Did you find that the average house that needed repairs was in need because the previous owners had either trashed it or not kept it up or that it needed repairs because it had sat idle for so many months

I have seen very little deliberate trashing, and no real incidence of people looting these places for the copper (yet). However, there have been some cosmetic/light structural issues, and some inside cosmetic stuff. A few of these places were clearly places that people tried to buy at whatever their price was in 2007 and try to "flip". The appliances gone, halfway through the installation of some hardwood flooring and granite countertops, but the flippers evidently ran out of money or whatever, and the job halted midstream.

Mostly just normal wear and tear. Carpet, a little paint, some light fixtures--- that kind of thing.

This area has a fairly proactive local police force for the time being, which might be keeping down some of the vandalism from non-residents.

Your experience with that realtor comports with my own

A lot of these people got into this business in the first place because they couldn't make it as an engineer, or succeed in a corporate environment. I forget the number of people that got into this business during the boom, thinking they were going to make a lot of money i.e. homemakers who wanted to do it part time. I do not remember the raw numbers right now, but I think in this area there is 1 licensed realtor for roughly every 40 houses. So, naturally there will be a little shakeout in this area too.

At a certain level, a certain kind of person, if a bit sharp, could at one point have made some money in this business if they were congenial, able to schmooze the customers, and able to run the transaction in an efficient manner. Presumably, the survivors will be in that category.

Fanny Mae and Commonwealth and a few of the other big players in this business have contracted with a few local realtors to list these empty places and gradually sell them off, rather than dump them into the market at once, thus screwing up the market for everybody. This works in the temporary favor of the banks, who do not want their portfolio of properties, including the performing loans, to collapse in price, thus further screwing up their balance sheets.

These realtors are, of course, working on the old paradigm as well, and not allowing these places to get to the level of the market which we need, based on the economics above, to make sense from an investment standpoint.

Interestingly, I have also been viewing some of the auctions on Realtybid.com, and you can see that there are a lot of bidders who are working with a very similar spreadsheet--- plenty of bidding up to the point of economic rationality, then a few that take the prices up higher.... most of these places do not meet their reserve price so this is still not an efficient way to move these places off of the books of these screwed up institutions.

There are a few giant apartment communities around here--hundreds of units--the rent is about $750-$800 per month for a two bedroom apartment, with some common areas with amenities. These things were built in the 2003-2007 time frame, using borrowed money, with a known cost, with their economics all dependent on their ability to keep people in these places at a known rate.

What happens when all of the twenty-somethings that populate these places get laid off and move home to Mom and Dad? Once these things start to go under, what happens? Ghost towns?

For now these places are providing a floor under the real estate market, where I am looking, by setting a rent under the low end of the market. People will pay an extra couple hundred a month over and above one of these places for a backyard and a place to run a dog. You can a scenario where if something happens to them, it causes a lot of problems.

A further point: Contractors right now are cheap and plentiful. No problem getting some concrete work done at my house the other day.

[pup55]

When your renters lose their job, good luck collecting rent money. It's just not worth it.

I've considered this point of view, but I am not as much of a doomer as others on here. I think there is a bottom somewhere above armageddon. You have to live somewhere. At a certain point, I can start paying "cash" for these places, so the financing stops being a problem, so, any rent I get is some hedge against me myself losing my job.

Thus far, I have budgeted a six-week eviction time per year into my little spreadsheet to accommodate me having to throw peoples' asses out into the cold night.

There is some risk, of course in just about any business transaction. There is also risk in taking your cash and burying it in the backyard, because of the inflation risk. So, what do you do?

My theory for the moment is that at some low enough prices, the risk is reduced. The trick is, getting to that price.

[ReverseEngineer]

When your renters lose their job, good luck collecting rent money. It's just not worth it.

I've considered this point of view, but I am not as much of a doomer as others on here. I think there is a bottom somewhere above armageddon. You have to live somewhere.

You answered your own question here in the prior post. As people lose their jobs, they will start moving in with parents, relatives, friends who own outright. If they don't own, the movers-in might take what money they have to help pay off the mortgage.

Definitely, I wouldn't buy a property on a mortgage that you have to pay on, and hope to keep a paying renter in the place enough of the time so that you don;t have to pay out of pocket on the mortgage. Even if you buy it at $80K now, soon as it drops to $60K in resale value, you are underwater. With no bottom in sight to the real eastate market, how could you bet that it wouldn't drop out from under you right after you bought it?

If you have $80K cash, it might be a slightly safer investment than keeping the money in a bank or in stocks for sure. However, for that same $80K plus what you could get for your current home, I would take the whole kit and kaboodle and get out of the subuurbs and buy a doomstead somewhere. JMHO from the Doomer camp.

Reverse Engineer

[pup55]

Code: Select all

A lot of these people got into this business in the first place because they couldn't make it as an engineer, or succeed in a corporate environment.

He recently left the business and has gone back to work as a civil engineer.

Oops (lol) Sorry.

Well, it sounds like he could make it as an engineer, so he does not fall into this category.

[evilgenius]

Have any of the auctions for distressed houses considered moving to sealed one time bids? It seems to me that would be a quicker way to find the sort of equilibrium that you are describing that the mix of participants in the system needs to operate at, it being heavily your sort now. In other words, the system needs rid of those irrational types that will run prices to levels that are not sustainable. Since the irrational types tend to thrive in an atmosphere of comparative competition you need competition that is not comparative, but reality (mathematically) based.

I don't know, it might help to put a floor under this mess or it might simply create a way station on the path further down. What does everybody think?

[pup55]

If you have $80K cash, it might be a slightly safer investment than keeping the money in a bank or in stocks for sure. However, for that same $80K plus what you could get for your current home, I would take the whole kit and kaboodle and get out of the subuurbs and buy a doomstead somewhere.

Yeah, I have already done the calculation on paying cash vs. borrowing, and at the moment the calculation favors borrowing the money. I can even envision building a little empire out of it, if I can get some cooperative renters. I am of course monitoring the situation all the time, and have not committed to anything yet. One of the ideas I have toyed with is renting out the place I am now living in, and moving into one of these "pay cash" houses, and getting a big supply of popcorn. I get a rototiller off of Craigslist, plant enough garden space for food, etc.

For the difference between my current house payment, and the rent I can get, I think I could live in one of these little foreclosures for free, and have a little monthly income over and above that for taxes and insurance, that is, if the hard headed spouse will agree to it.

Of course, all of this is based on the current period being more like 1979 rather than 1929. If this theory is wrong, then I will have to be alert to it, and come up with a different plan.

buy a doomstead somewhere

I'm way ahead of you. We can get into this topic in a separate thread if you want.

[pup55]

Have any of the auctions for distressed houses considered moving to sealed one time bids?

The current model is an Ebay-type auction, with a starting price, a reserve price, below which the bank can negotiate a sale if the bidder is willing, and bid history viewable by all of the bidders.

There is an annoying $2500 fee to the "successful bidder" plus agents on each end can get into the transaction for a commission, which is paid by the selling party. The seller assures a clear title, free of second mortgages and back taxes, etc.

I haven't thought much about the sealed bid concept, but perhaps it has been delayed because everyone currently running the game still has some skin in it.

[Heineken]

I would not consider buying any real estate at this point.

The real estate problem has hardly begun to be resolved, and many of the ideas they are talking about would make things worse. The sooner prices get to where they need to be, the sooner some stability will return. But people, like that real estate agent, cannot mentally grasp the amount of phony equity they have lost. The equity only existed due to an insanely out-of-control credit machine that propped prices up like gas floats a hot-air balloon.

Prices could fall another 50% from here, esp. if unemployment continues to rise drastically and owners continue to increase rentals. Renting houses out murders valuations. It is also just a terribly risky and potentially unpleasant thing to do.

[Heineken]

Land, for your own use, certainly seems safer, Shanny. But prices will almost certainly go lower, so why buy now unless absolutely necessary? (I probably overpaid for my tree farm, so I know this lesson from personal experience.)

Overall, land prices seem to have held up somewhat better than housing prices. But they're falling too.

[threadbear]

My income is generated through rental real estate. I frequent a forum where people like yourself, realtors, sellers and buyers get together in the mixing waters of public perception, expert opinion, and analysis of the fundamentals. Same exercise you engaged in pops up frequently, always with the same conclusions. I mentioned on one thread, the other day that seeing as Vancouver B.C. has been sited by the Case Schiller index as the bubbliest market, in North America, and one of the bubbliest in the world, the prices are going to correct an average of 70%, in the next few years. This would drop the prices back into the range of affordability, bring them into alignment with rents, and also reflect an economy that is weakening tremendously.

Some of them didn't like to hear it, but many agreed. The ones who agree are generally those who do this for a living. The ones who don't, realtors who still think prices will always keep going up (in the long run). The long run, could turn out to be 300 years, to correct for prices that have strayed so far from fundamentals in an irrationally exuberant and profoundly stupid blitz of hysterical optimism and cheap credit.

[pup55]

why buy now unless absolutely necessary

If I can reply to this a little:

There is some merit to at least studying the situation to understand what is happening in the local market. No commitment needed yet, except occasionally I will tick off a realtor by trying to make sense.

The pros:

Potential for some side income

way to clear out depreciating dollars from the bank (already got most of it out of the stock market) currently paying terrible interest rates.

Way to buy something of value for what appears to be cheap. The value of the home is some multiple of the value of the copper and salvage building materials.

Everything you do is tax deductible if you are doing it in conjunction with this (warning: this is not to say that you should do anything illegal such as pad this a little so as to avoid taxation).

If this is 1979, the prices actually do stablilize and maybe in a few years, there really is some capital appreciation, which is also tax-deferred until you sell the place.

If this is Weimar Germany, you pay your mortgage back with hyper inflated dollars.

If this is 1929, you become Mr. Potter from "It's a Wonderful Life", and you have a little wealth stability.


Cons:

Have to deal with moocher, destructive or idiot tenants

Repairs and other maintenance issues

Local rent market collapses and screws up your economics.

Local rent market changes, property values are screwed up (influx of immigrants, for example).

Delays in renting the place out once you throw out the moocher tenants.

No assurance property values will not continue to go down another 50%.

Potential changes in local taxation and/or income tax laws that screws up your economics.


In general, I think most of the cons can be dealt with by staying in my local area, and some attentiveness on my part. The local laws and regulations are pretty friendly toward landlords at the moment, and the community is stable. If I make the assumption that there will be no capital appreciation, the rest of the risks can be dealt with by getting a low enough entry price. So, the only issue is: is this better than leaving my investment in the bank at the current CD rates, which is stinking.

I have also thought about a low end strategy, of buying a piece of land nearby, buying some old single wide trailer homes for cash, and renting them out, but this seems like even more work, and an even lower level of tenants.

Anyway, it all comes down to your theory of what the conditions will be like in a couple of years.

[Rubin_Flagg]

Pup55,
This is just the beginning of the end for the housing bubble. We have not seen the massive layoffs and all other kinds of economic disruptions that will be caused by the Greatest Depression. It's really important not to "catch a falling knife." Right now we are in the falling knife arena.

The inability to trust the balance sheet of almost any financial institution means the risk is really huge right now for the kind of invest you want to make. Wait for a while...this crisis is not going to end in the next six months. You will be able to get some really good deals soon...ones that fit into your models and will generate some great returns for you. However, expect rents that are 50% to 75% lower than what they are now when doing your projections.

Preservation of capital is always the name of the game.

Rubin Flagg