Archive for September, 2007

I received an interesting call yesterday.

Turns out the caller, who’s part of a fairly large and well known real estate company (at least around the Detroit News classified ads), had just picked up a block of 100 foreclosures directly from a lender without going through a realtor.

Big deal you say. Happens all the time.

Maybe, but that wasn’t the noteworthy part of our conversation. He went on to tell me that this was part of the one lender’s effort to “clear the decks” before they blow out a ton of their foreclosure inventory before year-end.

A tidal wave, he said. His words, not mine.

And this really isn’t all that surprising. You see, accounting rules are pretty strict as to when you need to take a hit for bad or uncollectible debt, and it seems like lenders have been trying to string it out as long as they can. But ultimately they have to pay the piper, and it looks like this is the year they start cleaning out their balance sheets.

Which just so happens to be good news for us. I’ve never seen so many nearly-no-rehab foreclosures available, much less available at something like 40% or less of ARV. I found a half dozen of them just a weekend ago.

Finding the deals used to be the biggest challenge in this business. Now it’s deciding which deals to do. (Which is a conversation unto itself. More on this later.)

In the mean time, get ready to catch the wave. December 2007 may be the best month to buy Detroit area real estate in history.

Excerpted from the Detroit News this morning. . . .  

• Michigan’s unemployment rate in August was the worst since since September 1993.  
• Massive automotive buyouts and a sharp decline in residential construction were cited as factors for the state’s jobless rate. 
• Last month 28,000 jobs were lost in Michigan, bringing the total number lost since this time last year to 96,000. 
• Since August 2006, employment in Michigan has dropped by 2 percent while nationally it has increased by 0.8 percent. 
• The data shows that people are leaving the state. The pool of workers dropped by 16,000 in August and has declined by 81,000 (1.6 percent) since this time last year.  

What does all of this mean? Again, on the face of it not a great deal, because all of the information is based on lagging indicators, which means the cause of everything in the above list happened six to 12 months ago.  

It’s what’s behind the scenes and between the lines that’s significant. And actually critical is a better way to describe the two things that hold our economy in the balance.  

I am perplexed.

If you read the paper you can tell how bad the housing market is here. With that comes the decline in home improvement which hits the trades people hard. Very hard. I know of at least three crews that I had bid jobs over the winter that are no longer in the business.

It’s gotten so bad that the high end contractor that I always use on my personal residence asked me if he could bid on a large renovation project that I did a while back – and he actually met the lowest bid.

So it seems that contractors and trades people, even the very good ones, are hurting.

Which brings me back to my first point. I’m perplexed. About painters.

Why? Because in the midst of all of this hardship and strife, I’ve have had two consecutive painters that have screwed up such that not only will I never use them again, but I want to make sure that nobody else does either.

The first one is Marvin Riley Custom Painting out of Flint.

This guy had it all. He had all of my business, and a good slice of the business from a number of other investors that I know because he was reasonable in terms of price, quality, and timing. Then something strange happened. He stopped showing up. Stopped returning my calls. Stopped answering his cell phone. He just disappeared. He left my job partially done, and forced me to hire someone else to finish the job, which ended up costing more than if he would have finished the job as we had agreed to in writing. Bad Marvin.

So if you see the name Marvin Riley Custom Painting come up – ignore it and move on. This guy isn’t worth it.

The second perplexing painter is Rodney at Top Notch Painting out of Hazel Park. I needed a new painter after the job that Marvelous Marvin ditched, so I asked around and came up with Rodney’s name from another very active investor that I have known now for several years.

I called Rodney for an estimate on painting my new rental. He comes by and quotes me a price that’s high, but we negotiate it down to a more manageable level. I walk him through the house and give him instructions. You want to know what they were? The same instructions that I use on all of my rentals: bathroom walls, kitchen walls and kitchen cabinets semi-gloss white. The entire rest of the house antique white satin. Full stop. Could there be simpler instructions?

He says no problem – he’ll get it done in 8 days. I say great – let’s make it 11 days and put it in writing so I can count on you absolutely being done on time. He writes it down. We sign the agreement. He leaves.

The first thing that happens is that he DISAPPEARS. He gets tarps laid and material delivered – then – nothing. I call him – no reply. I call him again – no reply. I finally get a call back on the day he’s supposed to be done, which was the day before my renters were supposed to move in. He now says SUNDAY is “a better estimate”. I tell my renter. The renter says he needs to move Saturday so he walks.

Rodney then calls me Monday morning saying that he’s “99% done”, and that by the end of the day he’ll be done and the place will be clean. Riiiiiight.

I go by Tuesday to check on the now supposedly completed job. It turns out that my instructions were far, far too complex for him to comprehend. The entire house is painted antique white! AAAARRRRRRGGGG!!!! Kitchen walls. Kitchen cabinets. Bathroom walls. The only white paint in the entire house was on the ceiling in the living room and dining room! (Do you remember the Love Boat episode when captain Steubing has his cabin painted, realizes he hates the color, then tells the painters to paint “everything” blue, so they paint EVERYTHING blue? This was kind of like that.)

Not only that, but my friend Rodney had removed ALL of the window treatments – EVERY ONE – and dumped them in a massive, disorganized pile on the floor in the basement – and simply left them there when he was done.

?????

His response was classic when I called him. I lied to him about the paint color. He though that I didn’t want the curtains anymore. Blah blah blah blah. He even told me that he didn’t get my messages. I though that that excuse stopped getting used when you used a cell phone?

Maybe he heard voices from the black helicopters or something. Who knows.

Needless to say, Rodney at Top Notch Painting won’t be getting any more of my business!

And another one bites the dust. Isn’t there a single painter that out there that does what he says when he says?

The search continues . . . . .

If you’re even a semi-regular reader of this blog, then you already know that I’m a huge fan of buying and holding properties as rentals, because it can yield and infinite ROI (See the post on NOOP).

In a nutshell, NOOP demonstrated a repeatable process where you buy a property for cash (business credit, private investor, hard money, etc), rehab it as necessary, then pull all of your purchase, rehab, and holding costs out when your refi into a conventional mortgage. You then have positive cash flow, with zero invested, thus INFINITE ROI. (I have to tell you that as a finance guy this makes my heart beat faster)

But alas, opportunities to do this perfectly and pull all of your money out are exceedingly rare, and you’ll often be left with some of your own money in the property. That begs the question, then, as to how you go about deciding between two properties that will require you to leave a small amount of money behind.

Most people initially think that the decision should be made based on the amount of money left behind, so that if one choice is to leave $2500 behind in one property and the other choice is to leave $1000, then the $1000 property should be chosen.

I disagree. Here’s why.

The mechanics of this process requires a couple of things. First, that you buy at an absurdly low price. And second, that you refi at a relatively low LTV, say 60% or even lower. (This also makes your lenders VERY happy to do business with you).

In addition to high-ROI cash flow, the chief byproduct of this process, therefore, is EQUITY, and lots of it.

So I suggest that you not just look at the dollars left behind. Nope.

I recommend that you look at the cost of the equity that you’re buying. And the metric that I use is the Cost Per Equity Dollar.

Let me give you an example.

I recently purchased a rental home with an ARV of $120,000 in what’s considered a high-tax city for $53,000.

Now when I refi, I need to strike a balance between trying to pull all of my money out and having this home cash flow. In order to strike that balance in this case, my refi loan is going to be at 53% LTV. The result is that with my rehab, holding, and refi costs I’ll need to leave about $2,700 in the house when I refi.

That means my $2,700 net investment not only buys me monthly net cash flow, but it also buys $57,000 in equity.

That means I’m buying each dollar of equity for – get this – 4.7 cents.

Not too shabby.

So if I’m faced with a choice of two properties, one where I can buy my equity dollars for 4.7 cents each and another where I can buy them for 5.2 cents each, the decision becomes simple, and I choose the lower cost equity.

This is a much more meaningful decision criteria to use when evaluating your buy and hold opportunities, because it takes into consideration your cash flow, not just your net investment.

Lest you think that this is a diatribe related to politics, relax. Long, long ago I gave up letting the micro-brains in government (both elected and unelected) impact by disposition.

No, this is a post about economics. And basic economics at that.

I have long believed that the framers of our constitution should have included a minimum number of basic economics courses at the university level as requirement for holding any elected or unelected position in any federal or state-level government. And with so many idiotic decisions being made in terms of “handling” the economy, my belief gets validated over and over again.

Case in point – my great state of Michigan. (Notice that was a small-g great).

Did you hear the latest? After all of these months, and with a budget due by Sep 30 or the government will shut down, our small-g governor is STILL sticking to her belief that she can tax the state back into prosperity. With all the job losses, all the foreclosures, all the uncertainty, with Comerica, Pfizer, and now Volkswagen high-tailing it out of the state, her BRILLIANT idea is to RAISE taxes.

Unbelievable.

My frustration stems from the fact that economic data has been proven time and time again that raising taxes DOES NOT improve the economy. Conversely, though, the economic data has CONSISTENTLY shown that cutting taxes increases TOTAL tax revenue. Counter-intuitive, yes, but true nonetheless.

A prime example of this total lack of understanding of basic economics is the cigarette tax. Cigarette smoking declines, so cigarette tax revenue to the government declines. The government counts on this money, so their solution is to raise the cigarette tax. This causes MORE people to stop smoking, so tax revenue declines again, so they raise taxes again. And so on, and so on.

I feel sorry for the last guy left smoking in America – he’s going to have to pay a billion or so dollars a pack for cigarettes. (Although if the Fed keeps monkeying with the economy, with inflation a billion dollars won’t be a billion dollars anymore. But don’t get me started on this again).

This behavior is so stupid that it’s comical. Yet it continues to occur, over and over again.

Why is this so hard to understand?