There’s an interesting post on the National Association of Realtor website in response to a recent Harris Poll that ranked real estate agents as the least prestigious of professions.  The reason for the disappointing placing, reasons the NAR, is that "real estate agent" was offered as an option in the multiple choice survey instead of Realtor ® .  The NAR reasons that a Realtor® is to real estate agents as Mercedes is to car. 

Some of you will have read Steven Levitt’s excellent book Freakanomics, a thought provoking read on diverse topics relating to economics and market forces.  I look at Levitt’s blog every now and then.  He has an interesting comment on the NAR argument above:  “While I guess you’re supposed to assume that a Mercedes is more trustworthy and downright better than a plain old Car, you could just as easily assume that, in the eyes of most people, it’s simply more expensive.” 

Note:  I fear that two professions that would most accurately describe me -  real estate investor and dot.com entrepreneur - would have limped in even lower than real estate agent had they been included in the survey.  Oh well.  But I used to be a Military Officer and that ranked pretty high...I'll take that as some consolation. 

More bad news from the ethics in real estate file...

WCNC in Charlotte reports on a local company that’s being hammered with complaints from home buyers and sellers who claim they’ve been victimized by the company’s unscrupulous practices. 

The victims allege that Charlotte Home Solutions defrauded customers in a rent-to-own scheme gone bad.  The ringleader – a guy called Bill Keaton. 

Evidently the scheme worked like this.  Keaton managed properties for homeowners, promising to find rent-to-own tenants and handle mortgage payments & taxes.  Owners were expecting their properties to be cared for, and tenants were expecting their rent payments to be going towards a future purchase. 

But both renters and owners got the shaft.  Keaton left mortgage bills unpaid, ruined the credit of owners, and made off with the cash that renters expected to be applied to downpayments in the future. 

Keaton refused comment when approached by 6NEWS reporters, but his response to internal emails from Charlotte Home Solutions employees regarding complaints from angry clients:  “F_ _ _ them”. 

Class act.  But a note to investors considering hiring a property manager: there are some creeps out there – do your due diligence!

Continuing on the theme of ethics and real estate investing...

There was an interesting article published in the Chicago Tribune recently on foreclosures rescue services. 

Foreclosures offer a lot of opportunities for investors, and often investors can offer a service to distressed homeowners that is both profitable to the investor and benefits the homeowner.  But the real estate business being what it is, occasionally unscrupulous actors prey on unsophisticated victims in a way that casts a negative light on the ethics of the entire industry. 

The article was posted on the Creative Real Estate Online messageboard, a useful forum for interacting with other investors around the country.  I’ve met some interesting investors there with some good ideas. 

From time to time I contribute to business publications on topics concerning real estate investors.  In October I wrote a piece on Ethics and Real Estate Investors that appeared in the Houston Business journal.  Until today it was available only to Business Journal subscribers, but it is now available to the general public. 

In the piece I discuss ethics from three different perspectives: the community, the tenant, and the investor. 

I'm sure that you've noticed by now that real estate can be a sleazy business.  But the good news is that the adage about nice guys finishing last isn’t true; good ethics is good business.  Ethical investors avoid costly legal entanglements, build positive relationships, mitigate risk, and in the end invest more profitably. 

I hope that everyone reading this note has had a restful holiday weekend.  This is my favorite time of the year.  In our go go go society we rarely take time to pause and reflect on the fact that even when life may seem difficult or stressful there are many things for all of us to be thankful for. 

Now, after taking some time with family and friends I’m back to the blog…

Thanks to those of you who have forwarded suggestions on the evaluation tool; two-way communication is vital for our business model here at EquityScout.com and I welcome feedback.  We’re working on a redesign of some of the features of the evaluation tool and plan to be announcing something in this space very soon – changes that will take an already user-friendly tool and make it even more intuitive. 

However, one question that I’m always at a loss to answer is “how come my numbers don’t work?”  Well it’s not exactly that I’m at a loss to answer – it’s just that the answer that I have is one that investors often don’t want to hear. 

In certain areas of the countries – areas in which homes are priced at or below the “theoretically correct” valuation – it’s relatively easy to invest in properties that produce positive cashflow from the day buy them.  In other areas, however, it’s tougher. 

In some areas of California $500,000 buys you a fixer-upper two bedroom starter home that you can rent out for $2,500, maybe $3,000.  That’s a recipe for negative cashflow. 

Does that mean it’s a bad investment?  Well that’s not for me to say.  What it does mean is that if you invest in that property you’re essentially stating your conviction that prices in the area will continue to skyrocket.  The only way the investment will make a reasonable rate of return is if that properties continue to appreciate at double digit rates. 

If that’s  your view, then you can act upon it by buying the property.  If it’s not your view, however, stay on the sidelines for now.  Ask yourself: are you investing in the income generating potential of the property based on what you’re paying for it, or are you speculating on what you think the market will bring.  There’s a role for both speculators and investors in the market.  Either approach can work – but where you get in trouble is if you think you’re in one camp but your actions actually put you in the other. 

Money Magazine lists two real estate itemsb among the six best ideas for 2007.

Tip #2:  Real estate in 2006 turned a corner - and not a good one. In the past year, home prices have dropped 2.2%. In this kind of a market, once you've found the house you want, start the bidding at least 15% below the asking price…

Well bidding at 15% below asking price is advice that won’t fly in some markets (yet?)  In some areas prices are still holding up, and in undervalued markets like Houston low-end properties still fetch full asking price and go pretty quickly.  But overall stories like this show that the popular media is getting behind the idea of a buyer’s market.  Call it info-tainment, but when CNN gets behind an idea dealing with consumer confidence in a particular sector a self fulfilling prophecy can ensue. 

Tip #3:  The reason so many people are stuck with a house they can't sell is that they haven't priced it right. Most of us grow attached to our home, and good memories and ego distort how much we think it's worth.

Summary:  Buyers,  buy cheap; Sellers, sell cheap.

This comes at a time when investors are continuing to renew their confidence in the stock market, with the S&P 500 closing at a 6 year high and the Nasdaq continuing to make back ground lost when the dot.coms blew up.  This could cut either way for the national real estate market – either consumers feel less jumpy because their 401k plans are starting to look a bit fatter (soft landing?) or the appearance of a healthy low-risk alternative on Wall St. causes investors to hasten their departure from speculative real estate investments (not so soft landing).
 

From the glass is always full file: Today’s economic numbers reveal prices down 1.2% in the third quarter, w/ sales volumes off by nearly 13%.  But interestingly, the lead sentence in today’s press release from the National Association of Realtors (NAR) read:

"Conditions for home buyers improved during the third quarter as existing single-family home prices in many metropolitan areas experienced corrections, and most states saw sales activity below a year ago which helped to build housing inventories... "

One seller’s pain is the next buyer’s opportunity, so applause to the NAR for highlighting the fact that we might be entering a period which will offer some deals for savvy value investors, but I remain wary of his sunny outlook for a quick turnaround. 

The national median existing single-family home price was $224,900 in the third quarter, down from $227,600 a year ago. 

Interestingly, the market is still jumping in some areas.  Salem, Oregon saw a 24.7 percent increase over a year ago.  Elmira, New York was up 21.4 percent, and the Salt Lake City area saw a 19.2 percent increase.  Disparity between under- and over-valued markets has been slow to close.  Median values in areas like San Francisco and San Jose are nearly nine times those in affordable Decatur, Illinois. 

NAR’s chief economist David Lereah doesn’t foresee a market correction, predicting “…modest appreciation in most of the country in 2007.”   In an earlier posting I referenced a somewhat more candid comment made by Lereah speaking to a group of agents in September, referring to the $740,000 median price for a single family home in the San Francisco area. 

RealtyTrends, the monthly newsletter from RealtyTrac.com, reports that foreclosures are up 17 percent in Q3 – 318,355 properties went into some form of foreclosure during the period.  This represents an increase of 17 percent over last quarter, and a year-on-year increase of 43 percent.

Foreclosure levels varied widely across regions, with Colorado, Nevada and Florida leading the pack.  Florida saw a 55% spike in foreclosures to lead the nation with a total of 40,136.  Texas is in second place at 39,363, but in terms of percentage of total properties ranks sixth. 

Increases in foreclosures can be linked to a combination of increasing interest rates, flat property values, and stagnating economic indicators for some regions. 

In addition to paid sites like RealtyTrac.com, information on foreclosures can be found at government sites such as the U.S. Department of Housing and Urban Development website.  They list a number of local programs broken down by state. 

Real estate investors who have built equity in investment properties in high value areas might want to consider teardown options before selling their property.  A builder might be your best buyer.

Teardowns.com links sellers, buyers and builders.  There are a few rules of thumb.  Upscale new construction can go for $200/square foot or more, meaning that a 3,000 square foot house would go for around $600,000.  Factoring in land and other expenses properties in the neighborhood would generally need to sell for north of $1,000,000 for the strategy to work. 

This narrows down the candidate list to certain regional areas, but in situations where it's viable selling to a builder for teardown can save the seller a considerable amount.  Commissions through resources like teardown.com range around 2%, compared to the standard 6% - a $20,000 savings on a $500,000 property.  That goes straight to the bottom line.   

Selling a house as a teardown is an emotionally difficult decision for someone selling their primary residence, especially one where they might have raised a family.  No one wants to condemn their beloved home to face the wrecking ball.  But for a real estate investor who's fortunate enough to be holding a property in an area where values have skyrocketed this might be an attractive option. 

The National Association of Realtors has made available online a popular presentation by Chief Economist David Lereah on The Road to Recovery.  <link opens a powerpoint file>

Lereah examines economic trends and predicts a soft landing for the real estate market, pointing to statistics that show the market to be stabilizing.  An interesting chart shows year-on-year price appreciation since 2000.  Note that these are national averages, but on the whole it appears that the market hasn't yet given back the supernormal gains of the last several years. 

Nevertheless, in some markets buying opportunities are appearing.  It's particularly important in this environment for buy-and-hold investors to pay attention to the fundamentals.  If prices take a dip will the cashflow that your new investment is generating carry you through the cycle?  This is the fundamental question that EquityScout.com's real estate evaluation software is designed to help investors to answer. 

I’m signed up on a lot of real estate mailing lists – a good way to stay abreast of trends going on in the real estate community.  Every now and then a real beauty pops up in my mailbox – one that I have to memorialize in some way before I hit the delete key.         

Check out these quotes from a note I got today from a guy hosting real estate teleseminars (emphasis mine):      

-----------------

 "Hi Christopher, I want to make sure you get one of the few remaining open spots for my free upcoming teleseminar...

...If you for some reason feel the need to get rich slowly, with lots of trial-and-error and a ton of work, then this call is not for you...

...however, if you suspect that some people make big profits in real estate very quickly, and would like to know how they pull it off...you need to be on this call...

My mystery guest will explain the very fastest way to make big profits in real estate...

If you're not curious about this unusual investing technique by now, well, I guess your name is Bill Gates, and you're all set with investments...." 

-----------------

He goes on in this vein for a while, explaining that the secret techniques he’s going to unveil don’t involve risk, hard work, big downpayments, or any other such unseemly elements. 

If I'm insulting your intelligence by stating the obvious in pointing out that these guys are sham artists then please accept my apologies...but I think it deserves a mention.  If people didn't sign up for these things then these guys wouldn't be in business. 

A good reference for investors, especially new ones, is the John T. Reed guru checklist which spells out 53 tips to sniff out sham artists.  Reed isn’t the most positive guy I’ve run across on the web, but he gets an A for ethics (and he’s a fellow West Point grad.)

Bad advice abounds on the web.  If you see a particularly galling or amusing offering send it to me - if I feature it here you'll get a free three month subscription. 

If you’re a subscriber to the EquityScout.com economic model you will have noticed by now that Internal Rate of Return (IRR) is the primary result that we use to rate the attractiveness of a real estate investment.  This is a note to comment on what IRR is all about, and why we like it here at EquityScout.com.

As investors we’re always evaluating different alternatives for our investing dollars.  Stocks? Bonds? Mutual Funds?  Or…real estate?  All of the options have different levels of risks and rewards.  At the end of the day we need a measure to indicate if the reward that we expect from a given investment is worth the risk and effort that will be required to reap it. 

IRR:  Bang for you Buck.

IRR is a useful measure for comparing dissimilar alternatives.  Suppose you buy a bond with a $1,000 face value, a 5% coupon and a ten year maturity.  You’d pay $1,000 to purchase the bond and then receive an annual payment of $50.  In ten years you’d get your $1,000 back.  The cashflow would look like this:

This investment yields an IRR of 5%.

So if you have $10,000 to invest the question you might ask yourself is: should I go out and buy ten 8% coupon bonds, or should I use the $10,000 to invest in a rental property?

Risk and Reward

That 5% return in the example above is pretty easy money.  The risks are low, and all you have to do is cough up the $1,000 and the coupons start rolling in.  However, a 5% return isn’t anything to get particularly excited about.  Investing in a rental property is an alternative, but in return for the additional effort and risk you’d expect the reward to increase proportionately. 

Say you took that $10,000 and put $5,000 down on a $100,000 property and used the other $5,000 to fix it up and get it ready for rental.   Is this a more attractive investment than buying bonds? 

Well it depends on the rent you can charge, taxes, expenses, property appreciation rates, mortgage terms, and a myriad of other variables.  All of these factors will contribute to determining your annual cashflow.  You’d expect a return that is considerably more attractive than the %5 that the bond gives you.  If, based on your assumptions, the economic model tell you that this isn’t the case, you’ll probably want to keep looking. 

Problems with IRR

In some circles there’s a surprisingly passionate debate about whether or not IRR is a good measure.  Arguments against the measure tend to follow two trends: technical objections and practical. 
IRR has some technical drawbacks (assumptions about reinvestment of cashflow, possible multiple answers, etc.).  I won’t get into these here, except to say that all approaches are going to have some limitations.  If you use IRR as a compass to point you in the right direction (as opposed to an infallible final answer) then our opinion is that it’s a pretty good measure.  Maybe I’ll elaborate in a future post if there’s any interest…

The practical objection is a bit stickier.  This objection tends to go along the lines of “you can back into any rate of return you want if you play with the variables and assumptions.”  This is true enough: it’s the old garbage-in-garbage-out syndrome.  There’s no getting around this one, but the main benefit of the EquityScout.com model is that it forces you to be explicit about your assumptions.  If your evaluation yields a respectable expected return of 15%, but only if you enter a sky-high property appreciation rate then at least you’ll know where the weak link was when the investment doesn’t pan out as expected. 

Look for an article on this topic soon in the Media Room.