Monthly Archives: June 2010

Confessions of a Real Estate Schmuk

schmuk (shmŭk) A clumsy or stupid person; an oaf.

In 2005, I bought a $96,000 Mercedes Benz E55 AMG sedan, a $62,000 Correct Craft Pro Air Nautique ski boat, a $400,000 second home located in the cool pines south of Flagstaff, a $350,000 lot on a water ski lake west of Phoenix and an $8,000 Rolex watch.  Of course, I can’t leave out all the first class airline flights I took, the Ritz-Carlton hotel stays in San Francisco and Chicago and the Phoenix Country Club membership.  Yes, I thought I had earned it all. 

In the three years leading up to this I had knocked on more than a 1000 doors and had purchased and sold more than 60 properties.  I had net more than $280,000 in profit on one real estate deal in 2005.  By January of 2006, I owned $16,000,000 in real estate with over $8,000,000 in equity.  I had reached my goal.  If I had sold off a portion of my real estate portfolio I could have owned my own home free and clear, along with 10 rental properties and our second home.  My passive income would have exceeded $10,000 a month.

But I got greedy.  I was a real estate schmuk.  Consumed with the status that came with being a wealthy real estate investor I kept on buying houses after the music had stopped.  By August of 2007, the market had completely collapsed and I lost it all.  Even though I was buying houses for 70% of retail value it wasn’t enough.  The market would eventually correct itself by more than 50% in some areas.

With all of this failure you would think I would have sworn off of real estate.  Actually, I’m more certain now that real estate is the BEST way to accumulate wealth and achieve financial freedom than I have ever been. 

The funny thing about failure is that you learn from it.  I have learned far more through my failures the past two years than from any of my five years of success.  If I could build a $16,000,000 real estate business in arguably the hottest real estate market this country has ever seen, then couldn’t I do the same now that prices and interest rates are historically low?

At Sun Valley Community Church this past Sunday Chad Moore, our teaching pastor, discussed how arrogance and ignorance are intertwined, as are maturity and humility.  For me, success brought the arrogance and ignorance.  The failures brought me maturity and humility.  As I rebuild my business my primary focus is now God, my wife and my daughters. 

Don’t get me wrong.  I still love the finer things in life.  I’d much rather have a Mercedes than the 1995 Honda Accord I’m currently driving.  The difference now is that I understand the possessions didn’t make me a schmuk; it was the love of the possessions.

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Sharp Drop in Demand Following Expiration of Tax Credit

In my last post I said the housing market was juiced by the federal tax credit.  It appears as though my analogy is more accurate than I thought.  New single-family housing starts were down last month 17.2% and new mortgage applications were at their lowest level since 1997.  What does this mean for the Phoenix housing market?  Mike Orr of the Cromford Report discusses the issue below.

By Mike Orr of the Cromford Report, 6/21/10

The government incentive tax credit for house purchases required that the contract be signed by April 30, 2010 for the buyer to be eligible. The resulting sale could close any time up to June 30, 2010 and it now seems very likely that this deadline will be extended. This will particularly help those involved in short sale situations.

Sales numbers will not be affected immediately by the loss of this incentive. By April 30 we had seen a big build up of buying interest and therefore very high levels of both pending listings and AWC (active with contingent contract) listings to generate closed sales during May and June. So we have seen only very modest sales volume declines over the following two months. However the fall-off in pending and AWC listings during June has been more dramatic, as can be seen in the Weekly Pending Listing Chart. This means two things:

  1. Sales volumes will probably drop lower for the third quarter.
  2. A change in market balance with demand likely to fall below supply for the first time since May 2009 making the situation less favorable for most sellers than it has been for the past year.

Looking at the various cities we see the following:

City Pending 4/30 AWC 4/30 Pending 6/21 AWC 6/21 Under Contract Change
Anthem 117 82 77 68 -27.1%
Apache Junction 142 65 94 61 -25.1%
Arizona City 63 15 44 15 -24.4%
Avondale 332 179 267 189 -10.8%
Buckeye 381 234 346 177 -15.0%
Carefree 9 5 8 9 +21.4%
Casa Grande 188 77 148 66 -19.2%
Cave Creek 93 66 67 80 -7.5%
Chandler 638 392 483 398 -14.5%
Coolidge 64 21 58 23 -4.7%
El Mirage 179 121 143 98 -19.7%
Eloy 14 8 11 6 -22.7%
Florence 98 42 80 33 -19.3%
Fountain Hills 73 25 63 22 -13.3%
Gilbert 795 520 659 538 -14.9%
Glendale 729 353 582 339 -14.9%
Gold Canyon 58 28 44 19 -26.7%
Goodyear 348 217 260 207 -17.3%
Laveen 266 176 214 157 -16.1%
Litchfield Park 136 77 108 82 -10.8%
Maricopa 410 275 305 265 -16.8%
Mesa 1,086 564 816 505 -19.9%
New River 34 25 27 20 -20.3%
Paradise Valley 40 31 48 28 +7.0%
Peoria 577 327 472 341 -10.1%
Phoenix 3,115 1,476 2,349 1,380 -18.8%
Queen Creek 790 485 564 442 -21.1%
Rio Verde 9 1 6 3 -10.0%
Scottsdale 690 417 614 395 -8.9%
Surprise 645 404 545 363 -13.4%
Sun City 149 46 100 51 -22.6%
Sun City West 116 20 49 12 -55.1%
Sun Lakes 44 11 22 10 -41.8%
Tempe 167 107 139 89 -16.8%
Tolleson 214 100 174 87 -16.9%
Waddell 47 18 40 22 -4.6%
Wickenburg 20 3 9 4 -43.5%
Wittmann 23 5 17 3 -28.6%
Youngtown 25 22 24 18 -10.6%

What can we deduce from this table?

The largest declines were in the 55+ areas, but this is mainly due to a special seasonal effect which is unique to these types of communities and happens every year. Summer is always a very quiet period in these communities. This year the effect is even more pronounced.

The outlying areas were also disproportionately affected: Anthem, Apache Junction, Arizona City, Casa Grande, Eloy, Gold Canyon, New River, Queen Creek, Wickenburg and Wittmann all showing a fall in listings under contract of over 20%. What do they have in common? They are a long way from downtown Phoenix. Not every distant community was affected however; note Coolidge, Florence, Rio Verde and Waddell.

Note that two areas had an INCREASE in listings under contract: Carefree and Paradise Valley, the two most expensive cities in the valley. Clearly the end of the tax credit had no negative effect here. In fact the top end of the market continues a improving trend in demand that has been in place for over a year now.

The Cromford Market Index™ has so far only dropped from 110 on May 22 to 103.4 on June 21. But the rate of decline is quite steep and it is almost all due to loss in demand rather than the small increase in supply over that period. What we don’t know is whether this downward trend will continue or stabilize but at the moment we can only observe that it is significant.

Clearly the incentive brought forward sales into the spring which would otherwise have either not happened at all or have happened later. It is also possible that demand has fallen due to other factors, although it is difficult to measure this since the effect of the incentive is currently overwhelming other market factors. It is too early to tell if the underlying demand has fallen very much if at all. However, even with the steep fall, pending listings remain at a high level compared with all prior years except 2009.

Will this drop affect pricing? Not in the short term. Sales pricing is very much a trailing indicator and at the moment pricing is hitting a short team peak around $93 per sq. ft. However the mix of homes among the pending listings has changed and this changing mix will probably cause average pricing to fall over the next 30 to 45 days to around $89 to $91 per sq. ft. This is mainly because the pending sales contain an unusually large proportion of short sales (37.2% compared with 31.8% a month earlier) and fewer normal sales (25.0% versus 29.7%). In addition August is usually a very weak month for pricing, so we anticipate price declines throughout the next 60 days.

Which direction we go after August will depend on what the market balance looks like after the effects of the tax credit have worn off. If the Cromford Market Index™ falls below 90 and stays there then we can expect sales pricing to weaken. If remains above 90 and/or starts moving upwards again, the pressure on sales pricing will probably remain neutral to positive as it has been since April 2009.

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The Housing Hangover and Hair of the Dog Cures for the Investor

Juiced, a book written by the infamous baseball player Jose Canseco in 2005 was widely dismissed in the sports community at the time of its release.  In the memoir Canseco accused many famous players, including the beloved Mark McGwire, of using performance enhancing drugs.  Players, managers, front office executives and the media cried foul, figuratively of course.  The book was a pack of lies they said.

It turns out Jose Canseco wasn’t a liar after all.  He was a whistleblower.    We would find out later that Mark McGwire, Roger Clemens, Barry Bonds, Jason Giambi and Andy Petite all used performance enhancing drugs.  Since baseball started testing for steroids in 2005 home run numbers have steadily decreased, from Barry Bonds record setting 73 home runs in 2001 to 47 last year by Albert Pujols of the St. Louis Cardinals.

We don’t need a whistleblower like Jose Canseco to let us know that the housing market has been juiced by a performance enhancing drug – the $8,000 federal tax credit.  Much like steroids in baseball, it artificially propped up and may have even inflated housing numbers over the past 12 months.

How else do you explain that with interest rates in the high four percent range and pricing nationwide at rock bottom, applications for mortgages hit a 13-year low in May?  Or that, according to the Cromford Report, last month pending listing counts for homes in Maricopa County, Arizona priced in the 125-150K range dropped by 21%?  Please don’t say it’s because of unemployment.  Are you kidding me?  We’ve been hovering at 10% for over a year and that didn’t slow the so-called housing recovery down.

The housing market is just waking up to the effects of a full blown hangover.  Too many tax credit shots were the cause.   The bad news is the party is over.  No more multiple offers.  No more highest and best responses to the buyer.  No more urgency.  Anyone that had the ability (credit and income) to buy a house did so in February, March or April to take advantage of the tax credit.

So what is the hair of the dog cure to this nasty hangover for the real estate investor?  Please don’t say bringing back the $8,000 tax credit.  I would rather us entrepreneurs create our own solutions.  Here are few flipping strategies that have been working for my investment group since the tax credit expired April 30th:

  1. Buying homes with special selling features – let’s face it, the few people out there that are buying now will have a lot to choose from so make sure that you are selling something that stands out in a crowd (highly upgraded kitchen, swimming pool, large lot.)
  2. Seller financing – Tom Ruff of the Information Market estimates that 40% of homeowners in the Phoenix housing market are underwater.  Many of them will strategically default in the next 12-24 months.  These are people with otherwise stellar payment history to their creditors and significant cash reserves.  Why not offer them terms (say 15% down at 8-9% interest) and 3-5 years to refinance?  We’re marketing two of our homes this way and have multiple offers on one of them after just one weekend on the market.

If only curing a real hangover was this simple.  Now let’s get this party started again.  This time no shots for me.

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REO Tapes: The Loch Ness Monster of Real Estate

Unicorns.  UFOs.  Big Foot.  Sasquatch.  Leprechauns.  The Loch Ness Monster.  Everyone has heard of them, but no one has ever seen them.  As far as I’m concerned, you can put REO tapes on this list too.

What is an REO tape?  It’s a package of foreclosed homes that a bank (i.e. Bank of America) or insurer (i.e. Fannie Mae) elects to sell for a discount.  The theory is here that by selling them in bulk they solve a big cash shortage problem in a short period of time.  The buyers of these tapes (usually hedge funds or private investors with deep pockets) pay from .30 – .67 cents on the dollar per property.  Sounds like a win-win right?  Absolutely!  That is, of course, you can find one of these tapes.  It seems like tracking one of these down is like finding the proverbial pot of gold at the end of the rainbow.  Here are a few examples…

Where Did the Houses Go?

I ran into a well-connected colleague two weeks ago at a seminar in Scottsdale and he told me that he was about to close a 182 property tape.  I asked if he was interested in wholesaling any of these homes to my investment group.  He said yes.  We spoke two days ago and the deal blew up.  Why?  52 of the homes in the tape had already been sold and 6 of them had no property tax records.

The Meeting

It took place in a posh conference room in the swanky Gainey Ranch area of Scottsdale just two months ago.  My business partner and I were introduced to a very professional gentleman, well-spoken and well-groomed.  He explained that he had connections at both Bank of America and Chase Bank.  He could find us one of these tapes consisting of properties that fit our investment strategy.  Two months, four emails and three phone calls later and still no tape…my last email to him, sent last week, still has not been returned.

Tapes or Trash?

Last July I met with a California investor anxious to have me help him with due diligence on a 16 property tape he had been offered by a private investment group.  Guess what?  All but one of the homes had already been sold on the MLS. 

In September of 2008 I was asked to do due diligence for a private equity fund on a 78 property tape from Fannie Mae.  38 of the properties were located here in the Phoenix metro area.  After conducting a quick search I found that 35 of these homes were listed on the MLS for LESS than the asking price in the tape.

Pie in the Sky

About two years ago I met with one of the leading REO agents in Phoenix.  With almost 200 listings at the time, I asked her what kind of discount we could get if I made an offer to purchase all of her Litton Loan listings.  She said none and then quickly asked me, “Why would they sell these homes to you for .60 – .70 cents on the dollar when they can sell them on the MLS for .88 cents on the dollar?”  It was a very good question.

So do these REO tapes really exist?  Of course they do (my Loch Ness Monster joke was intended to get your attention!)  But don’t you think that the bank is going to do everything they possibly can to sell them for top dollar (i.e. at the courthouse steps, on the MLS, at public auctions like REDC) first?  The homes that get bundled up into these tapes have typically been picked over like the bargain rack at Wal-Mart.  They back to major intersections, have power lines in close view, are in war zones or in the middle of nowhere.

Now don’t get me wrong.  I desperately want REO tapes to exist.  They would be great for my business.  If you can find me one I’m all ears.  It would be like Santa Claus came early (I know he exists because me and my daughters saw him at the mall last December.)

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Buying Houses at the Courthouse Steps? Be Quick, but Don’t Hurry

 This past week legendary UCLA college basketball coach John Wooden passed away at age 99.  I’m a huge sports fan although admittedly I didn’t know much about him.  I just finished reading an article in the New York Times, ‘Wooden’s Legend Extends Beyond Titles’.  Several of the players he coached, including Andy Hill, praised Coach Wooden for the lessons he taught on and off the court.  At practice Coach Wooden would often say “be quick, but don’t hurry.”  Mr. Hill was so inspired by this later in life that he wrote a book with Coach Wooden called Be Quick, But Don’t Hurry.

 What does this have to do with real estate?  Well, if you want to buy houses at the courthouse steps, or buy houses from someone who buys them at the courthouse steps, you must be quick.  But, if you hurry you’ll get crushed. 

 I’m frequently approached by Realtors and would-be investors that tell me they want to buy houses at the auction, either for their clients or for themselves.  After all, it’s sexy isn’t it?  Who wouldn’t want to buy a house for 30% below market value, fix it up, sell it for a mega profit, brag about it to their friends and then fly off to Hawaii to celebrate?  That’s the fantasy.  The reality is that most investors who have the resources (cash) to buy a house at the auction never do.  Why?  Because they can’t make a quick decision…the thought of purchasing a home without seeing it or performing an inspection paralyzes them.

 Last week I called a Realtor who has a client interested in purchasing wholesale properties from our company.  We had a home come up that fit their description located in Buckeye, Arizona.  I gave them the details and told them they had 24 hours to make a decision.  The next day they backed out because they were worried that because there was no power at the home they couldn’t inspect the A/C unit.  Huh?  There was plenty of spread in this deal (our price was 76K and it comps for 110K) to compensate for a faulty A/C unit, plus a whole lot of other potential problems that could come up.  Let’s not forget why these houses sell for so much less at the auction – you don’t know what you’re going to get.

 Since last summer my company has purchased and sold 25 properties at the courthouse steps.  On average we net $8,500 in profit, as long as we buy at 74% of market value (or less), spend $9,000 on repairs (or less) and sell in 65 days (or less.)  With this data I can be quick without hurrying.  So if you plan to buy at the courthouse steps know the numbers and have a plan that empowers you to make quick, educated decisions. 

 It reminds me of the Clint Eastwood movie, ‘The Outlaw Josey Wales’.  When approached by four armed cavalrymen in the street he asked them, “are you gonna’ pull those pistols or whistle Dixie?”  Josey wasn’t afraid to pull the trigger quickly because he had a plan mapped out in advance.

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