Appraiser and Investor
Bruce Norris is joined this week by Mike Novak-Smith. Mike is with REMAX Results and is in the top 1% of agents nationwide. He is an expert in the disposition of REO, short sales, bankruptcies, asset management, and negotiation.
Bruce asked Mike how long he has been in the business. Mike answered that he just made it to 24 years full-time. This puts him about right before the last downturn back in the 90s. In 1989 he had already been in it a couple years before it went south in early 1991. Bruce said it is very unusual that he basically become the largest REO agent, but he did not go through a period of time where REOs dominated before then. Mike could probably see REOs coming this time because he was involved in them in the 90s. To get big in the 90s, you would think you would have to have a prototype before that.
Bruce asked Mike what gave him the idea that this would be the place to look for business. Mike explained that he was working at a Century 21 office, and in those days a 6% commission was very important. It still is, but a lot of times there is a lot more negotiation on commission. In those days there was nothing ever cut, it was just 6%. The Resolution Trust Corporation called to say they paid 5%. Mike, having read a lot, was paying attention to the news and could see real estate starting to slide. He did some quick math and saw if he could take certain deals at 5%, then he could still make his house and car payments. He knew what was going on and was okay doing it, but you really could not give REO away at the time. This was how he got into it. The more you do it, the more you become known for it and can work with it more. You get the referrals you need, although most all the clients he had then are long gone. Since REOs were something you could not give away, then he went with them.
The cycle we just went through started out like gang busters. Bruce wondered when the peak was with Mike’s business as far as REOs. Mike said their peak was about September of 2008. By the time you got to the foreclosures a few months later, we were starting to slow down a little because the governor put a moratorium on them. In 2009 they were still really busy, but it has slowed down a little. Mike went about an 18-month period where every day of the week he received a new REO every day. He would have about 10-12 of them, while other days he would have one. By the end of 2009 it was fairly noticeable that it was slowing down, although they still accomplished a lot.
During the time it slowed down, Bruce wondered if he was more inclined to hear conversation that he needed to stay geared up because they are coming, or if he might as well realize it is going to be a gradual slide to where they just go down to a very small amount. Mike said it is hard to tell everybody that the party is over. He would have clients who were employees of a bank not tell them they were going to be out of a job. Everybody thought the REOs would continue to go on. The data did not take into account the government intervention. It was probably a reasonable assumption to say it, but Mike did maintain overhead longer than he should have. You do not want to end up with a lot of properties and nobody to help you work on them. Mike finally realized with some of them that they do not have the work and have to cut back. The whole business did not want to accept the fact that there is less property.
Regarding the concept of shadow inventory at this point, Bruce asked Mike if he thinks it is a dead issue. Mike said he has never really seen shadow inventory. If you understand the way banks work, once they repossess the property they have to pay the overhead on it, the code liens, and property taxes. Mike thinks there may be shadow inventory where they have not foreclosed on it, but between the loan mods and principal reductions he does not think it really applies. Mike would hear people say that the major banks have 100,000 houses just sitting around that they repossessed. Mike has never seen that, and you really cannot do this. He does think that the ebb and flow to the REO side is controlled. A lot of times some houses sit at six months, and they delay the foreclosure sale on a weekly basis where they can simply foreclose. There is no reason to do this, so there is some kind of control on how many REOs we will have and keep the prices increased. However, Mike does know that they do not sit on inventory they own.
Bruce asked what his chances would be if he was looking to buy an REO tomorrow in Moreno Valley. Mike said his chances would not be very good since there are not very many of them. The minute you put REO on it, you get a lot of offers. Mike’s theory is always to find the best property in the market you are in, no matter who the owner may be. Right now just going out and saying you need to buy an REO is not going to happen. Bruce asked about if you had an FHA buyer as a client how long it would take them to buy a property at full listing price. Mike almost thinks if an FHA buyer is a client, making a business decision is not worth your trouble. He does not even know if you will be paid back for the number of hours you put into your work unless you want to be paid $2 an hour.
Mike has gotten offers where they rehabbed the house for FHA type buyers, and they end up selling it to a cash-buyer anyway. There are a lot of cash buyers out there who are afraid of home repair and contractors, and they are looking for a turn-key product. You do not hear much about this, but it is huge. With few exceptions, Mike thinks the FHA buyer is in a real hurt lock. The VA, FHA, and anybody who is going minimal down right now has a real problem since there are not a lot of products and their chances of getting it is not very good.
Bruce asked how many houses are for sale in Moreno Valley, and how does this correlate with what a normal inventory would be. Mike said the last time he looked there was 93 single-family detached homes available. We have very little inventory, and it is way low. Bruce said he remembers at the peak of ’09 when he pulled up listings in Moreno Valley, and there were 500 that were under $90,000. The highest amount of active listings that Mike ever had was 570. There were other REO agents who had quite a bit also, so this tells you what the inventory ones were. The worst he remembers was one day the inventory being at 1200 properties. Today there is just not much active.
Bruce wondered what he is seeing as far as price movement goes in that market. He said prices are going up because there is not much inventory. Many people are paying far more than they’re worth, and the prices keep increasing. Mike told about a couple in Riverside who looked at the data, and one in particular showed that the house was worth $460. However, since he did not want to look bad with his REO client, he decided to bump it up $30,000. Not only did we get that $30,000 after they were done, but they also received $20 over that. It is even harder trying to arrive at values today and they be accurate. A market will take your tried and true methods of appraisal and evaluation and pump them drastically. A lot of it does not make any sense, and there are a lot of investors out there who get into the auction vitality and pay too much.
It was interesting what Mike said about the appraiser coming in and appraising it at the amount he did. He would have had a hard time finding any comps. One thing Mike did with the appraiser that he does a lot of is he hands them the offers. There is nothing that will support your price more than showing them the market. If you are an appraiser, have twenty offers, and eleven of them are over list price, then it tells you that the house is worth this amount. It is usually because they have a hard time getting the lender to buy it, although this may be starting to change.
One house he looked at was a nice 4,000 square foot house with a pool and a lot of upgrades. One appraiser would feel comfortable pushing the envelope since there were a lot of adjustments that had to be made. Bruce wondered if this was a property that was bought by an owner-occupant, to which Mike replied it was. They bought it, obtained a new loan, and closed it within fourteen days. It was pretty spectacular, but there were no cash offers since the house was over half a million. Your cash offers thin out at about $350,000. You get over $400,000, and you do not see a lot of cash. He has done cash way over this, but it really does thin out.
There are several buyers in the marketplace who are successfully buying properties in Moreno Valley, and Bruce wondered if they are cash buyers. Of these, he wondered how many are investors like himself or hedge fund buyers. Mike answered most are hedge fund buyers, not your local investors. They are people who seem to want to pay anything for the property and are happy to get it regardless of cost. Bruce also asked about the people who are going to live in the property and if they are first-time buyers or people coming off of credit damage who are now able to receive FHA loans. Mike said he has not really dealt with any first-time buyers lately and is not entirely sure. Everyone he has seen has been investor types. He does not think he has even done an FHA deal this year. They have all been cash, investors, and hard money.
The FHA deals just get blown out of the water. He had a house in Fontana earlier in the year where they had 156 offers with $20 grand over list price, and it went cash. A lot of people he did deals with over the years called him to see if he could help. He said if money talks, he does not really know what to tell them and they have to step up to the plate. A lot of times the asset management companies, managers, banks, and anyone who is handling the REO will take less money just to take cash and close it in the month they are in currently. They are more worried about making their goals. If they have to take a cash deal for $5,000 less than a financed offer, they take it. It is really difficult for a first-time buyer. Bruce said he would not want to be starting looking for his first FHA purchase with 3% down or hoping somebody would pay closing cost.
Bruce asked how agents are surviving who do not have a clientele or a base. Mike’s opinion is the majority of the active agents do not make a living at real estate anymore. He would say there is about 200 agents in Riverside and Moreno Valley who make a living at it. A lot of them now are part-time or have dropped out. You can run numbers and see that you cannot live on one deal for six months, which a lot of people are trying to do. For those who have not brought rental property, saved their money, or kept it at an overhead low, they are in trouble.
Bruce asked Mike what his opinion is of the hedge funds being in the marketplace. He said is a little concerned when he sees 93 houses for sale one day, then after he ran the numbers he saw 195 houses for rent. He has never seen this before since it always used to be far more houses for sale than rent. Mike said it seems to him that the hedge fund buyers who are paying anything for property are diminishing the value of having rentals. He is afraid that one day they are just going to bail out of the market. Bruce said one of the things they have to deal with in the upcoming report is that these people are collectively potential market-makers and are raising the prices, lowering the rents, increasing vacancies, and potentially damaging the price by exiting.
With one property in particular, he had a regular seller who sold his property for cash and had multiple offers. He had to go to the property because it was not vacant and clients were still living there. He meets with the contractors for the hedge fund, and he had even offered to fix a roof for about $800. The hedge-fund contractor said he would replace the roof, put in granite countertops, and replace everything. They took a rehab Mike said he could do using high-end legitimate contractors from about $8500, and these guys made it into a $20,000 job. They then paid too much for the house when the end result is people go to rent the houses and rent them for too much money. You will see this in the MLS listings that are for rent. Houses that are worth $1300 are trying to get $2,000.
When you start marketing the house, the tenants are going to come look at it and say it is fabulous. They sign up to rent the house, and within two months they are in default on the rental payments. You can look at it and see that you are trying to collect too much rent on some of these places, and it is not going to pay it. Somebody who has good credit and money is not going to pay 35-40% more than what the house is worth. Somebody is going to look at this and start thinking they may have paid too much for the houses. This is something Mike sees coming.
Another thing he sees is there are many entities who are counting on owning rental properties as being as easy as having a brokerage house fund. In other words, you could take having mutual funds as being pretty passive. You take your quarterly statement, made some money, and are happy without having made any effort. Mike said he sees rental properties being portrayed as this. He knows that owning rental properties is a great business and a good way to make money, but there are hassle factors being discounted. When some of these groups are not looking at their vacancy factor and asking why we paid a lot of money for costs and repairs, they are going to get a little sour on it.
When properties go into escrow with an all-cash buyer, whether a hedge fund or other means, Bruce wondered if Mike had any sense of what percent of the time they fall out. Mike said what happens is there are certain investors who play this game where they are going to pay a price, then come along a week later and try to get a price reduction. Mike warns agents that their deal will fail if they do this, so make sure they like it right now since that is what they are going to get. This does happen, but he sees less of this than he used to since the strategy does not work as well today. If you do not want to buy it, they will just put in the next person. Bruce has a friend in Sacramento who is dealing with hedge funds, and half of his properties fall out at this point since the negotiations after the fact do not work.
Mike said a lot of it depends on what is going on. Mike had a house last year in Redlands where they went to check it, and they saw that the foundation had some problems. The house was built in 1890, so you looked at it and saw that it was something nobody knew about. They had legitimate bids, and the seller said the other party was reasonable and he would split it with them. Nowadays we just come along and don’t like something. You get all the REO paperwork from the seller, and you send it to the buyer’s agent. Before they send it back with the check, they start trying to negotiate it. It is very easy for Mike to send an email to have them cancel on the guys and move on to the next one. When you have 100 offers on each house, it is not too hard to pick the right one eventually. This was more of a problem a year ago for Mike, and he does not see it nowadays much. A lot of people are just happy to get the property.
Bruce wondered if people who are investors hanging onto properties much more than they are selling them right away. Mike said the majority of the strategy today is buy and hold since there is not enough room in them to flip them. Bruce said he is seeing this in the loan business. They have more buy and holds, although they are not doing too bad on flips. They are busy to the point that he never would have believed, and they have people who are finding properties without necessarily dealing with the MLS. They have about 50 loans in play right now, and this is a lot of properties for a market with no inventory. Half of those will be buy and hold since it makes sense to let these things keep going up.
Mike said the companies fixing these rentals in good shape and going for high rent. However, they are probably not going to end up having that work out. Bruce asked Mike if he sees pressure on rents currently with the rents having to go down in order to find people. Mike has rental property, and it is fairly soft. He has properties in Vegas, the region, and in the High Desert. Right now he has not raised anybody’s rent in 2 ½ years. When he runs the data, he really does not see anything to support it. He thinks rents are really going down, not a lot but they are soft. As far as occupancy, they have rentals and have not had trouble keeping people in the properties. Mike does not do his own property management since it is part of the business and does not have the patience. He has property managers, he just does not enjoy it as much. They get on it, it gets done, and he does not have any trouble in this regard. He does not have trouble with people paying the rent since he keeps it reasonable.
Mike does not keep raising it on people, nor does he have payments that he has to make where he has to make a certain amount, and this is what his rent is based on. This is what the hedge funds are doing. They paid a lot of money for a lot of these houses, and they are trying to get the rent that makes the cash flow. Often times rental properties and people who count the investments minimalize the overhead of having a rental. They minimize the management costs and repair factors, and people are misled.
Bruce asked when he was dealing with the RTC in the last round of REOs in the 90s, Bruce wondered if there was any Wall Street effort to dominate them in the market the way it is going on today. Mike said not at all. Some of the PMI companies he used to deal with had a lot of people who invested in the jumbo loans who were in Wall Street companies. They got out of it and all got soured on. The stock market in those was more stable and had a lot more steady rise. People were making money, and he does not know what the fascination is for them to leave the stock market. Bruce’s take on this was that as soon as life returns to normal in the areas they are used to, their money will flee. You get concerned when you see the rents they are trying to get and what they are paying for some of these houses. It gets to a point where the numbers just do not make sense.
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