On Friday, October 19, the Norris Group proudly presents its fifth annual award-winning event I Survived Real Estate. An incredible line-up of industry experts joins Bruce Norris to discuss perplexing industry trends, head-scratching legislation, and opportunities emerging for real estate professionals. Proceeds for the event benefit Make a Wish and St. Jude’s Children’s Research Hospital. This event would not be possible without the generous help of the following platinum partners: ForeclosureRadar and Sean O’Toole, the San Diego Creative Real Estate Investors Association and President Bill Tan, Investors Workshops and President Shawn Watkins and Angel Bronsgeest, Invest Club for Women and Iris Veneracion and Bobi Alexander, San Jose Real Estate Investors Association and Geraldine Berry, Frye Wiles, MVT Productions, and White House Catering. Learn more about the panel and how to attend at isurvivedrealestate.com.
Bruce Norris is joined this week by Sean O’Toole. Sean is the founder and CEO of ForeclosureRadar.com, the only company that tracks every foreclosure in California with daily updates on all foreclosure auctions. Prior to ForeclosureRadar, Sean spent 15 years building and launching software companies before entering the foreclosure business in 2002. Here, he has successfully bought and sold more than 150 properties. What is funny is Bruce and Sean fairly often disagree, but they both respect each other’s processes and how they reach a decision that they almost always can end up with an improved answer if they listen to each other’s side of how they reached a different answer for whatever question they were contemplating.
When Sean was ten years old, he received a birthday gift that turned out to be real significant. He received the original Apple 2 computer, and he was absolutely fascinated by it and by the fact that you could write a program on the machine. His parents purchasing the computer at that age gave him opportunities the rest of his life. Sean’s dad was a professor and was involved in the computer science lab, so his parents had an idea of the significance of a ten-year old owning a computer. They had an inkling that computers were going to be important, although Sean said he was not sure they gave it too much thought other than an inkling.
Bruce wondered how the budding computer genius in Sean ended up getting into the foreclosure business. Sean said it was mostly by accident. After the .com bubble in 2000, he took a break from starting software companies, which he had done the prior 15 years. He moved out to his vacation house, where his water ski buddy had a good friend who was buying foreclosures. He asked Sean to give his friend a hand and that he could use some software to run his business. At first Sean did not really have much interest in it, but his friend introduced him. At first Sean was not sure it was the right way to go, but he let him look at his last twenty deals. The returns were amazing, and he told him he was in.
At the time, accessing information was a very different world than what we are now accustomed to, so there was research that had to be done. Sean said he remembered being at the courthouse steps, and there were shoeboxes organized by date. In the shoeboxes were polaroids of each property with their notes on the property on the back of the polaroid. On one property that was postponed to a new date, they moved it back in the shoebox to that date. These were the best of the best since they were there at the sale. Everything was organized, and there were photos and notes of each property. The shoebox polaroid system was one of the better ones, and if you wanted to get an update on a time of sale or change of date, it was not automated in the least. You had to get on the phone, call, and try to figure out the system. Back when they first started, there was nothing on the web for the most part. They built all of their tracking systems pre-website from most of the trustees and posting and publishing companies. It has gotten better now, but there are over 150 trustees who work in California. It is easy to find about half the data, but then it gets considerably harder from there.
When Sean was buying at trustee sale and had tools that he invented, that was a big advantage. Bruce wondered what gave him the idea to say he was going to share the tools with others. Sean said the change in the marketplace always creates the need for an invention of new things. At the end of 2005, Sean decided he wanted out of the foreclosure business since he thought there was going to be a crash. His partner disagreed with him and wanted to keep going. They ended up parting ways, and it turned out to be pretty fortuitous timing. He had most of the rest of his inventory sold in late 2005/early 2006 before things crashed. It was the perfect exit time. At that point he was already tracking foreclosures throughout the state of California. He had all this data, and he was kind of addicted to it. He did not want to get rid of it or stop tracking it. However, he did not want to invest at this point either because he felt like the market was overvalued. It was at this time he came up with the idea for ForeclosureRadar. At the time he did not think it was a good idea since realtors had no interest in foreclosures at the time. There were only about 40 people in the state who were actively buying at the auction. There was not much of a market, but Sean had faith this would change.
When Sean was tracking foreclosures in 2004 and 2005, he was not tracking very many numbers. Statewide they probably had fewer than they ever had in the average county. At the peak in 2008, that changed by several thousand percent. Bruce wondered how difficult this transformation was, going from a small number counting to a large number. It was good that they figured out a revenue model fairly quickly since costs escalated fairly fast. It went from one person tracking the whole state to quite a few. Bruce wondered if it was something where you are charged by the piece or if it was a contract. Sean said they have a flat-fee, fixed rate service. They still have the same pricing today that they launched with in 2007. Sean charges $49.99 a month for everything, yet the numbers they were tracking started escalating dramatically. What is interesting about this is that the people who are familiar with websites and are used to everything being free think $49 is a lot. When you look at the information and come from an experienced level such as where Bruce comes from prior to any of that information being available at all and not all in one spot, you think they’re joking since the list itself used to cost several thousand dollars a year without any of the goodies. In a way, Sean has really transformed access to information, and in some ways you may have different reactions.
Bruce came up with the term “the forty thieves” when referring to the experienced buyer. He wondered what their reaction is to Sean making it very easy for them but also allowing everybody else to have access to it. Sean said he has had a lot of these conversations, and it is usually two-fold. On the one hand, they think Sean made their life so much easier since they no longer need to do all the things they used to do. On the other hand, they feel like he bought a lot of competition to the market and changed the margins amongst other things. Their responses are usually, “Wow, thank you for making my life easier, but boy do I hate you for bringing all these competitors into the market.”
Sean went from a small amount of foreclosures to a huge amount in 2008. Now it has been declining. Bruce said a few years from now he would expect the decline to be still pretty serious. Bruce wondered how Sean’s customer base changes when you go from a glut of foreclosures to back to levels that are normal. Sean said it is an interesting thing since the market could get stronger and there are fewer foreclosures. There is almost more demand for those fewer foreclosures since they all have profit centers. It is kind of a mixed bag since there was a period of time, especially in 2007, where realtors did not understand why they would need information on foreclosures. By 2008 and 2009, they finally understood why that was important. There are other opportunities in the market; foreclosures are a little harder for realtors. Sean said he expected to see the realtor business to decline, but he we will probably see more interest from investors as they see the market improve.
Each of the customers who subscribed to Sean’s data probably have a different use. For instance, Bruce said if he was a realtor he would probably be paying attention to people who were over encumbered because of short sales. Bruce said if he is an investor, he would not do that. Part of the list may be of interest to somebody, and another part of it would be of interest to another group. We have government and other customers, so we have a nice mix in terms of customers. Sean said he thinks as it declines further we will see changes in the mix of our customers.
Bruce asked Sean to compare the margin of spread when he entered the business in 2002, when he left in 2005, and again today in 2012. When Sean first started, his partner gave him a little spreadsheet of profit that was required before they would invest in a deal. For a $150,000 investment, the expectation of profit was $50-$60,000. This was only on one deal, so you could do that 3-4 times a year. The margins were pretty incredible. Sean said this started changing even right then from just 2002-2003 in his first year. Things went from 60-20, so even back then margins were falling. Now a realistic expectation or return is maybe 5%, or $500 on the $150,000. For somebody new entering the business, Sean said this is probably where he would set their expectations. If you feel really good about what you do, you might feel a little bit better than that. As long as you are efficient in how you do the business, you should be able to flip that money four times over the year. A 20% minimized annual return is a reasonable expectation going into the auction-buying business. If you are good at what you do, you should be able to do a little better.
What is interesting is when Sean started in 2002, there was a ramp-up to the process in the sense that he knew in advance what foreclosure had equity and probably had it in his hands for over 100 days. Now the market gives you four hours notice for the same decision. You usually get the dropped opening bid at the last minute, and then you have to make a pretty quick decision. The volume is so high now; back when Sean was involved they researched every single deal. Nowadays that is hard to do, especially when you are actually going to buy them. When you are buying, and in your best case scenario you net 5%, you are hopefully going to do this four times. You have a nanosecond to make all the decisions, and you are not meeting the people inside or seeing inside. When you are comping it on the fly and getting title basically the same way, the odds of an error start increasing, even for the best people. On the other hand, back when Sean was buying there was a lot more second mortgages coming to market and a lot more of those mistakes being made. Seconds do not foreclose as often, and a lot of the people that started in 2008/2009 got a pretty soft entry into the business since a lot of the foreclosures were homes that were just recently built. It was the purchase money first going to sale, and there was not a lot of hair on the deals. Now, with the larger firms coming in and buying up easier deals based on yield at almost the full market value, they guys who are flipping are having to work harder, make those deals that have some hair on them, and learn to deal with the things which you did not have to deal with a couple years ago.
Regarding the big money coming into the marketplace, Bruce said it does not just include the trustee sales but also the MLS and bulk buys. Bruce wondered how Sean sees this playing out over the next five-year period. Bruce wondered if Sean knows what affect they will have and if them are exiting the marketplace will have a negative effect. Some of them don’t plan to exit, at least not through the sale of the property. They plan to exit by taking these portfolios of rental homes public in a REIT. In this case, they will maintain those portfolio rental terms even though there may be some homes that will not come back on the market. This is something to keep in mind as well as the fact that most of these people are looking for a 7% or better yield return on investment. So long as that remains the floor, the first thing we will likely see is some of these markets that were undervalued are going to return very quickly. When Sean says 7% yield, it means taking all rent minus expenses, and this will give you a 7% return on the total investment in the property.
The big question will be whether yields get driven even lower. We just recently saw this last week a new quantitative easing on the Federal Reserve. This should be pushing interest rates and yield expectations down. If the yield gets pushed down farther, than this also pushes prices up farther. On the other hand, if the Fed starts to lose some credibility and the front interest rates start to rise, we may see the demand go up and prices go down. The game has a lot more to do with that yield and yield spread than it does with comps. It is going to be very interesting see if this ends up kicking off a building boom that should have never happened. All these properties are going to a sideline that would not have occurred any other way. If it was bought by a trustee sale buyer normally, it is resold. If it is not bought and goes to REO, it is resold through that method. Now it is going to the sidelines to be forever a rental. In the MLS in Riverside, we have about a month’s supply. At some point, especially if prices return to some normal number, some builder is going to look at the combination of fees and costs and see that they can build something.
For Sean, one of the biggest surprises from the 2010 census is he really had the sense and there was a lot of anecdotal evidence that we overbuilt in California. While this was true in a couple smaller Northern California counties, it really did not seem to be true in the larger Southern California counties like Riverside and San Bernardino. It seemed the building that was done there was supported by population growth. We will need more building here at some point regardless of these equity players. It is really a matter of getting the price back to a point where it will support that building. When you start fixing building, you also start fixing unemployment and migration. If prices go up, you also have the overhang of the debt be less cumbersome and it starts solving itself.
Year-over-year, REOs are down very significantly. However, Bruce said he just noticed last month that they went up significantly. He wondered if there was any trendsetting in the front where the numbers are going to be going up. Sean said it did seem like we had a nice little bounce in a number of new REOs last month. Year-over-year, we are still down almost 47%. Despite a 30% bump last month, it is still 47% less than a year ago. Bruce just interviewed some REO agents, and when they talked to their suppliers they had not been given any sense that this was a trend; in fact it is quite the opposite. Sean said he does not think it is a new trend of REOs going up at all, but there were some pipeline timing issues. We did see a little bounce in notices of default in March, so it is possible some of these are bouncing through right now. However, he said he would not jump to conclusions off of the one-month jump even though it is a substantial 30% jump.
A subject over the last few years has been shadow inventory. Very early on Sean said he did not think it was going to show up in large quantities, and that turned out to be very accurate. You have to come back to the key things that changed back in September 2008, which is mark to model accounting and changes in the regulatory framework where these institutions are not being pushed to get these things off their books. With those two changes, it is way better business for the banks to leave people in their home, even not paying, than it is to quickly foreclose. Ever since then, we have seen a rise in time to foreclose, a rise in the amount of time that these properties sit delinquent, and a slowdown in foreclosure rates. Things were very predictable from this, and Sean said they have been able to stick their thumbs on the “no foreclosure” wave. A lot of people continue to look at the delinquency numbers and the rest that were predicted through the foreclosure wave. We have heard it again right now with people saying there is going to be a big wave of foreclosures after the election and after the first of the year. There is no chance of either.
Sean O’Toole can be heard again on the panel for I Survived Real Estate 2012, which will take place Friday, October 19.
The Norris Group would like to thank its Gold Sponsors for supporting I Survived Real Estate: Adrenaline Athletics, Coldwell Banker Pioneer Real Estate, Elite Auctions, FIBI, Inland Empire Investors Forum, Inland Valley Association of Realtors, Investor Experts Incorporated, Keller Williams of Corona, Keystone CPA, Las Brisas Escrow, Mike Cantu, Northern California Real Estate Investors Association, Northern San Diego Real Estate Investors Association, Personal Real Estate Magazine, Realty 411 Magazine, Rick and LeAnne Rossiter, Southwest Riverside County Board of Realtors, Starz Photography, uDirect IRA, Wilson Investment Properties, Tony Alvarez, Westin South Coast Plaza. See isurvivedrealestate.com for more on the event and all of the I Survived Real Estate sponsors.
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Tags: bruce norris, California, Federal Reserve, foreclosure, ForeclosureRadar, i survived real estate 2012, MLS, REIT, reo, SEAN OTOOLE, shadow inventory, the norris group, The Norris Group Real Estate Radio Show