Last week I made a brief reference to a bad experience that I recently had with a Farmers Insurance agent.  Here's how the sordid little drama played out. ¹

 The characters

	the Investor is played by Christopher Smith
	the Lender is played by Wells Fargo
	the Insurer (aka, the Villain) is played by a Houston based Farmers Insurance Agent 2

The setting: 

The Investor makes a New Years Resolution to sell a high-end rental property and use a 1031 exchange to reinvest in a multi-family property.  He sells property the property to the current tenant and identifies a fourplex to buy, negotiates a deal, and heads to closing. 

Act I:  Week of closing

The Investor calls the Insurer for a quote.  The Insurer provides a written Farmers quote.  The Investor accepts the quote and asks the Insurer to proceed and provide coverage.  The Investor calls the Insurer several times to ensure everything is in place; the Insurer assures the Investor that everything is in order.  The Insurer says they're having some problems getting the printout, but not to worry. 

Act II:  The closing - Friday the 13th of April

At closing the Lender calls the title company to inquire about the insurance binder, which hasn't been received.  The title company calls the Insurer.  The Insurer gives verbal confirmation of coverage.  Based on verbal confirmation the Lender instructs the title company to proceed with the closing. 

But…drumroll…it turns out that the Insurer had quoted the Investor in error, but for some reason doesn't want to admit his mistake.  Farmers, as it turns out, is not writing coverage for multi-family properties in Houston. 

Instead of admitting his mistake, the Insurer scrambles around to find a quote from a third party carrier but doesn't tell the Investor; he just tries to slip a revised invoice to the title company after the closing - considerably more money for less coverage. 

However, the Insurer takes no steps to bind the policy.  None of the paperwork is in place.  Based on the Insurer's fraudulent statements the property closes with no insurance in place. 

The Investor now owns the property, but unbeknownst to him (and the Lender) there is no coverage. 

Act III: The cleanup

On Wednesday of the following week the Investor gets a call from the Lender.  "Hey man," the Lender states, "you need to call your insurance guys."  So the Investor calls the Insurer.

The Investor gets insurance with another carrier on the 18th of April, five days after closing.

 --------------------

The moral of the play: 

We like to assume that representatives of major companies will behave like responsible, ethical professionals, but sometimes this is not the case. In order to avoid revealing his mistake, the Farmers Insurance agent wove a web of lies over a five day period which resulted me assuming a huge risk. 

Had a fire occurred during the uninsured period I would have entered a hellish maze of he-said-she-said which would have made a bunch of lawyers a lot of money.  Something seemed fishy from the start; had I followed up more aggressively I would have uncovered one of the agent's lies at an earlier stage.

Footnote ¹:  This of course is a stylized account of the course of events, but my official complaints to Farmers Insurance and to the State Insurance Regulatory Agency will document the Agent's fraud in explicit, meticulous, gory detail, along with supporting witnesses. 

Footnote ²:  I debated long and hard about whether or not to reveal the name of the Farmers Agent on this blog.  In the end I decided not to.  If you're a Houston based investor and want to steer clear of this guy then send me a note via the contacts page. 

Footnote ³:  In the text above I didn't list all of the false statements that the agent made.  This is just a sample of one.  And no, the agent didn't send any forms to the title company. 

There’s a multi-factorial equation brewing out there that is going to impact real estate investors. 

Concerns about flatting property prices tend to get the most press time, along with the ongoing sub-prime lending soap opera. And we’re all keeping an eye on interest rates and hang on Bernanke’s every word. But in my opinion the real story will be how all these factors impact all those risky loans out there, and this is a die that has yet to be cast. 

First American CoreLogic recently released a study on Mortgage Payment Reset and the potential impact that it will have on our economy. Note that First American CoreLogic is an arm of First American – and many visitors will be familiar with First American Title, one of the nation’s largest Title companies. The point being: just like the National Association of Realtors the title industry has a dog in this fight so be careful about taking all of CoreLogic’s conclusions without a bit of scrutiny. But that said, there’s a lot of good data in this report. 

Here’s something that jumped out at me. In 2006 lenders issued $200 billion in ARMs w/ their first reset in 2006. Of that $200 billion worth of quick reset mortgages the vast majority was at super-low teaser rates of less than 2%. Seemed like a good idea at the time: rising prices and brisk home sales made the risks easier to stomach.  Now that market has cooled those 2006 resets are causing problems for many buyers who were overstretched in the first place, and that’s what’s triggering the current wave of foreclosures. 

But, there’s more to come. Most of the ARMS originated in 2006 w/ 2008 resets ranged from 6% to 9% initial rates. Sub-prime territory. And these folks, based on CoreLogic’s assumptions, will be facing increases of from 30% to 50%. The second half of this story is that 23.9% of ARMs originated in 2006 have negative equity, versus only 10.3% of fixed rate loans taken in the same period. 

So not only were ARMS used by the most vulnerable buyers, they were also more than twice as likely to be used for properties in which the owners had no equity. The punchline: during the run-up ARMS were used as an instrument to buy homes that people couldn’t really afford. 

The New York Times ran an interesting article today advising those homeowners who are about to get into trouble to negotiate with their lenders. Many owners don’t realize what we do as real estate investors: the bank doesn’t want your house. Foreclosure is a disaster for the homeowner, but it’s no picnic for the bank. Expect troubled owners to take a page out of the short-seller’s playbook.

...don't lose sight of the forest for the trees. 

Day-to-day volatility grabs headlines.  Money.com recently fielded in inquiry from a reader regarding the pros and cons of buying now in a buyer’s market vs. waiting for rates to drop.  Another story reported on the fact that mortgage rates ticked down a bit over the past week, down to 6.22 percent from 6.30 percent a week ago.  

But you’re a real estate investor, not a day trader trying to time the bond market, so be careful about letting the media push impact your decision making process.  One thing I like to do is look at long-term data series – a practice that helps me put the day’s headlines in proper perspective.  Take the interest rate example.  HSH Associates is a financial publishing company that provides some excellent historical information on a number of statistics, including national monthly averages for fixed rate and adjustable rate mortgages .  The chart below shows the monthly national average for 30 year fixed rate mortgages since 1986:

 
The Federal Reserve raised rates 17 consecutive times over the past couple of years responding to fears of inflationary pressures, so we’re not reading about record lows like we were back in ’03 and ’04.  

The green part of the series represents data points that are lower than the current rate, whereas the red data points are higher.  So yeah, there's a good bit of green over the past few years.  But when you look at twenty years of data you realize that in a historical context rates are still extremely low.  

I’ve used ARM’s before but right now I’m a fan of the 30 year fixed.  The spread between a 1 year ARM and the 30 year fixed can get up to 3 or 4 percent, but currently it’s contracted back to around half a percent.  And with national averages still hovering in the mid six’s long term investors should see a lot to like about locking in at these levels.  
 
 

BusinessWeek recently ran an interesting article on Option ARM mortgages (also known as pick-a-payment, negative amortization mortgages, NegAms, deferred interest mortgages, and various other aliases).  There are variations on the theme, but these loans all offer flexibility, ultra-low initial payments, and lots of risk to go along with it.  Each month the borrower can select from a variety of payment options, but the lowest payment amounts are not enough to cover the interest on the loan – meaning – the outstanding principal actually goes up. 

Now with rates rising and property prices flattening in many parts of the country many homeowners are waking up to the fact that perhaps that deal that  was too good to be true wasn’t so good after all. 

Stay tuned – soon EquityScout will be posting an article to the features page that gives a rundown of all of the popular mortgage options out there, with the pros and cons of each.