New Rules or Foundational Concepts??

I just read a fascinating article regarding 5 New Rules of Real Estate. The author made some interesting points in the post, and I believe, accomplished the overall goal of inspiring a solid response. The responses are quite telling, because there seems to be an overall consensus that people are afraid of real estate.

The reality, as discussed in one of my previous blogs Opportunities Abound, is that the rules of investing are not new at all. In fact it is now that the foundational concepts of supply and demand, market motivations, and market rent versus property expenses must come into play.

Supply and demand we all understand. When the supply exceeds the demand (as it does today) buyers are placed into the driver’s seat and as long as no one is looking for a quick flip they are unlikely to get hurt at today’s prices. But the real question is not a question of value. The real question is one of financing. If someone needs to borrow money to purchase a property, they are placing themselves at risk. This factor of risk was always the case, but generally, consumers ignored this risk with the assumption that the lender is the one putting up the money and the one who would suffer the loss. The real loss is that when the consumer loses their home, their creditability and esteem, the price of this foreclosure is often more than the typical borrower can bear.

The more equity a buyer can establish when purchasing the property, the better. This statement is so very obvious and yet it is amazing how many people did not seem to understand this concept. Of course the gurus will tell you to leverage your money, by carrying a higher loan to value ratio you can hold on your cash and keep it liquid; however, anyone who followed this advice has found themselves in a world of hurt at this time.

Market motivations of course refers to the reasons that potential buyers are attracted to a particular property type or location. When a property has a particularly attractive location because of its school district, or its wealth rating, or its positive economic influences, this property will generally sell before homes without these attractions. Understanding potential purchasers and their motivations will help a buyer or investor to set a price when they purchase the home.

The concept of income analysis can become quite complex and should not be taken lightly. An experienced real estate appraiser would make an excellent advisor, as would a real estate broker or property manager. The basic idea is that the debt service of the property (i.e. mortgage + taxes + upkeep + vacancy and collection loss + management costs) should be equal to or less than the market rent a property can earn. If the market rent will not support the expenses related to the property a home owner is thinking of purchasing, then their option of renting out this home, should they lose their job, has been removed from them.

Bottom line, real estate like any other investment, needs to have a very clear purchase price that takes into account the factors noted above and a very clear exit strategy. Most people make the mistake of investing without an exit strategy and the purchase price only takes into account the competing properties without considering debt service, or market rent.

In short, now is a great time to buy property as long as the buyers do not lose their common sense along the way. A real estate purchase is not about emotion or pride, it is very much about logic and gain. KISS – Keep It Simple Stupid my father used to say (not an original saying), but this method works in life and in investing as well.

See you around the water cooler!

Appraiser Independence

As we are all no doubt aware the HVCC, which (in my opinion) was simply an expedient way to force all small business owners to funnel their working relationships through newly formed appraisal management companies, has been done away with.  Its replacement Dodd-Frank Wall Street Reform and Consumer Protection Act, Enacted into Law on July 21, 2010 was put in place “as an early warning system identifying risks in firms and market activities, to enhance oversight…”

A current example of this wondrous legislation that has been put in place to save us from corruption is as follows.

I was recently requested to conduct a retrospective forensic review for an appraisal of a residential property in NE Texas. The appraisal was 3 or 4 years old, and I was instructed by the appraisal management company (a relatively new kid on the block from the North Eastern States) to make sure that I made the basic assumption that all the information about the subject’s condition was accurately reported as of the date of value since there was no way for anyone to find what may or may not have been in place 3 or 4 years ago.  My field inspection revealed the property was vacant and being managed by a company for REO purposes. So I proceeded with inspection and gained entry into the home. What I found was a home of average condition that had an addition to the rear of the property. The addition was clearly designated on the sketch of the origination appraisal and the reported described the property as containing 3 bedrooms and 2 full baths.

The report did not provide interior photos of the alleged second bathroom. A casual inspection of the home revealed the following. The original home was built on a 12-inch slab, the addition was a 4-inch slab which had not been tied to the main foundation. The roof line of the addition did match the original home, but the interior showed evidence of much structural movement. Much of the work for the addition was found to be unfinished, electrical was not to code, and the “bathroom” was not finished. There was a concrete slab with plumbing stub ins and nothing more.

A trip to the city building inspection department revealed that permits were pulled for this addition, but no inspections were made by the city and no final approval was ever issued for this addition. This unpermitted addition was addressed in the review. It was documented that the appraisal report stated one thing, and an inspection of the property revealed another, etc.

The punch line is that the management company had a “fit” because I did not simply assume the appraisal was correct and because I had made a full inspection of the property. Fortunately for the client, after several days of discussions, the management company relented and turned in the review as it was presented. The client was not harmed and no one was mislead in the process; however, the concern is that appraisers now have a whole new dimension of training that we must conduct to do our jobs.