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By Bruce Norris Bruce Norris.

Rick Sharga, Vice President of Carrington Holding Company, LLC, Joins Bruce Norris on the Real Estate Radio Show #329

Friday, May 10th, 2013

Rick Sharga

Vice President of Carrington Holding Company, LLC

(Full Bio)

Bruce Norris is joined again this week by Rick Sharga. Rick is the vice-president of Carrington Mortgage Holdings and one of the country’s most frequently quoted sources on foreclosure, mortgage, and real estate trends. Rick has appeared on every major network and news show in the country, and he has even briefed government organizations such as the Federal Reserve and Senate Banking committee on foreclosure trends. Prior to being with Carrington, Rick was senior vice president of RealtyTrac, which is responsible for marketing and business development.

Bruce and Rick touched on the subject of low interest rates and affordability. Bruce heard Leslie Appleton-Young do a talk and mention that these interest rates are at 50-year lows. Bruce asked her where she got these statistics from, and she said it was from one of the data providers. Bruce called the provider and asked them where they got their information, and they told him that was as far back as their data went. Bruce thought this was an interesting comment since sometimes we really don’t have data that goes far back enough. He and Sean O’ Toole went to Washington D.C. to the Library of Congress and pulled up microfiche from 1850 to the present. They looked at the Sunday advertisements for real estate interest rates. No one alive has seen these interest rates.

Bruce said this was all interesting since for him this sets off an interesting scenario regarding affordability. You have had a lot of price increases, but the affordability is still very high. Even with the price increases we have seen over the last year to 18 months, we are really only back nationally to 2003 price levels. Essentially, an entire decade of home appreciation vanished. LPS and CoreLogic both put out recent reports on affordability; and the LPS study suggested that if interest rates don’t go up, with current income levels prices could go up almost 35% and still be within the normal range of home affordability levels. CoreLogic’s report was similar in that they said home prices could go up another 22% even with a marginal rise in interest rates.

It clearly is an amazing time to be able to buy in terms of affordability. The catch is how few people how few people actually qualify for the loans. This is a little bit of a Catch-22, but what is interesting is that it usually comes around as loan programs do not produce losses. Bruce said he would think that when we look back at 2011/2012, we are going to discover that was the safest batch of loans ever written. The performance we have seen on loans in the last 2-2 ½ years is better than historic averages. The delinquency states of loans after twelve months are below 2% for the last three years’ worth of loans. Normally, you have a percent of your loans in foreclosure and about 4% that are delinquent. They are performing roughly twice as good as you would expect them to perform.

Bruce said you are also given a ratio because normally the ratio is two delinquencies for every foreclosure. When you have price increases, those delinquencies very rarely result in a loss. What fed some fuel to the real estate boom back in the early part of the 2000s was that home prices were rising ridiculously fast. However, even if somebody got themselves into trouble they were able to get out by simply selling the home at a profit. It really was not until home prices flattened out that all of this became as apparent as it was. You look at your portfolio and see that everybody is qualifying with their eyes closed and we still are current.

Somebody wrote a book in California about a crash coming, and it seemed pressing at the time. You look at the numbers and realize the funny part that you wrote it and don’t even know what a collateralized debt obligation is. The funny part is there were huge financial institutions in New York that were issuing them, and they didn’t know what they were either. It turned out there was only a handful of people who actually knew how to bet against the income that was so obvious if you took time to look at it. The solution that keeps coming out of a certain group of politicians is we need more regulations and regulatory control. The regulators missed all of this, and this was really one of the reasons why the fallout was as bad as it was. It was not just the value of the homes or the mortgages issued against the collateral, but it was all of the exotic financial products that were layered on top of it that really added to the enormous losses.

Rick has been at the forefront about reporting statistics, and he has talked about shadow inventory. Whatever definition you put toward it, which has changed over time, it does not really look like it is going to have the impact that we once thought. Rick said he has been wrong a fair number of times in making predictions, but early on he said shadow inventory was not going to be the big problem that everybody thought it was going to be. It just seemed incredibly unlikely that the entire financial services industry would suddenly release hundreds of thousands, even millions, of distressed properties into the market all at once. All we would see would basically be a smoking pit of rubble where there used to be a housing market.

If you look at the number of REOs that are not listed for sale, properties in foreclosure not listed for sale, and homes where the borrower is seriously delinquent, you see those numbers go from about 6 million down to about 3 million today. The housing market is very interested in buying distressed properties. There were about 1 million short sales last year and half a million REO sales. You can see that distressed inventory being absorbed by normal demand over the next few years without really causing any major repercussions. The flip side is that as long as we have that backlogged, it does keep housing prices from accelerating even more rapidly because there is always that shadow of distressed priced properties waiting to come to market.

What relieves this better than coming onto market as a distressed inventory is a price increase that does not make it underwater. The really amazing part is how few underwater borrowers are actually delinquent. The overwhelming majority of people that are upside down on their loans are still making their payments on time. With home price appreciation, a single percentage point increase puts a whole slew of people from negative equity to positive equity, and this relieves a lot of the pressure. In California, if we had a 20% price increase, half of the upside-down people would have no more problems. This is a huge deal and completely changes the dynamic in the housing market. It also has to change the payment patterns if there are going to be somebody who was thinking of defaulting. It is encouraging to see a price increase against your loan get pretty close to breaking even. If you have already hung in there for as many years as it has been upside down, you are still going to make the payment.

History will most likely indicate that the majority of people who did default on those kinds of loans probably did so because there was a life event. It was not just because they were upside-down, but something else bad happened. From what analysis they have been able to see, this does seem to be the case in most instances.

Bruce asked Rick what he would say was the main reason we have had price increases. Rick’s answer was simply that there is no inventory. This is classic supply and demand economics if you look at what is available on the market. In some California markets, there is less than a month’s supply of homes available for sale. For those people looking to buy and those looking to take advantage of today’s low interest rates, there is a lot of competition for so little supply. This drives up prices. The other factor is that the mix is changing a little, so we are not seeing 40-50% of the sales being deeply discounted distressed properties. We are starting to see some higher-priced properties moved as well, and this changes the numbers pretty dramatically.

Bruce said he was always looking for these deeply discounted properties in the last couple years, and he still does not understand the discrepancy between what he sees in the marketplace and what seems to be a big discount when your chart shows the difference between an REO and an equity sale. Those discounts do not represent the same discount as what is showing. Rick said Bruce is a lot more precise in his calculations, and he looks at one specific house compared to another specific house that is the same model and size. If you are looking at large data pools, what you wind up doing is blending everything together. Rick knows from working on some of the reports in the past that if you simply did something like adjusting the numbers for price per square foot as opposed to flat costs, you would end up with less of a discount. A condo was measured against a mansion, so the numbers became at least something of a gauge. The discounts were either going up or down, but most people did not get 30-50% discounts on property.

Rick said there are three ways you can get inventory in the market. You can have new homes, existing homes for sale, or distressed homes for sale. Nobody has been building new homes for the last five years, so new home inventory right now is at about a 40-year low. There are simply not a lot of new homes to go around at the moment. We have been in a position for the last few years where 25% of homeowners were upside-down on their loans. They did not want to sell those properties at a huge loss, so we do not have a lot of existing inventory on the market. Partly because of things like the robo-signing scandal and legislative maneuvers, we have seen foreclosures take much longer to process and get to market. Once they get to market, they are getting sold off pretty quickly. An anomaly right now is that all three categories of housing stock are at unusually low periods.

Bruce asked Rick if he sees any of this changing in the next twelve months. Rick said he does because we have seen foreclosure starts increase over the last couple months, and we have also seen building activity and housing starts both go up in the last few months. Rick said he could see a situation where a year from now we may have a little bit too much inventory for what is available in terms of loans. However, there is not enough where we will see a huge falloff in home prices. We are seeing a softening, then acceleration, then this starting over again. Bruce wondered if when Rick says we are avoiding a huge fallout in price that he believes we will have at least a flat price. Rick said he does not think we will continue to see prices accelerate at the rate they have been both this year and last year. Certain markets will probably be outliers, but Rick looks at it as being a saw tooth recovery. We are going to see prices go up and down, and generally trend upwards. However, it is not going to be a straight shot up.

Bruce specializes in a part of the country where this could be one of the outliers. We have seen the most highly accelerated prices in the markets that had the most precipitous fall off from the peaks. If you are looking at San Bernardino, Riverside, or somewhere else in the Inland Empire where prices literally fell off a cliff, you could see sustained home price increases in those markets. It is other markets that are going to behave a little more traditionally.

Bruce looks at the inventory levels, and he sees that they are a third of what they were a year ago. Bruce wondered how you would get this tripled since this would literally be to get back to a six-month inventory. To go from two to six you have to triple, and Bruce does not see how this is possible. Rick said it probably is not, so it will take longer for that area to normalize. You are starting to see some home building getting started again, and some of these distressed properties will come to market. The other thing that will happen over time is as home prices go up, fewer and fewer borrowers will be upside down. There have to be some borrowers in those situations who would have already sold their house and, if they had a chance, re-enter the market. You will most likely not see an immediate tripling, but over time you will see all three of those categories start to fill back up again.

Bruce wondered if they will be repeat buyers who will sell and go on to another home. This has not been happening in the last few years. Those people have been doing short sales, taking a loss, and they are gone. Rick thinks we are also going to see increased household formation, which is going to provide more renters and homeowners over the next couple years as parents decide it is time to kick their kids out of the basement. What is interesting is that there is definitely the generation that is dating everything late. What is funny is Bruce has heard people speak on how this generation does not even want what the other generations want. You come to find out that at about thirty, they do the same thing as the prior generation.

Rick said he remembers in the ‘60s you could not trust anybody over 30, and now he does not trust anybody under 30. This is also tied into employment. If you looked at the recent homeownership rate report that came out; the group that had the lowest percentage of homeownership was the 35 and under group. Rick believes only about 43% of them were homeowners. This was a huge drop from the national averages. Rick thinks they are waiting longer, but this is also the group that has the highest unemployment in the country. Until they are gainfully employed and in a job they want to stick in for a while, they are probably not going to be anxious enough to sign up for a 30-year mortgage.

Bruce asked Rick if he thinks college debt is as big a deal as people are saying. Rick said what is interesting is that the only category of consumer credit spending that is going on is student loans. Rick thinks it is a mitigating factor when it comes to the length of time it takes a younger person today to buy a home since they do have to get that college debt paid down. It is a debt that will follow them forever. Bruce asked why we can’t sell them the house with nothing down in California. Then they can own it for two years and pay off their debt. Have them start a business that has to hire five people. Rick said you could have them default on the house, then pay them $20-$30,000 to leave. Then they could use that to defer the student debt.

Bruce asked Rick what he expects in price movement. Rick said if you are looking at median prices nationally, we are probably looking at somewhere in the neighborhood of a 4-5% price range increase this year over last year. California is obviously going to be higher than this, but he does not have any specific numbers on what they are expecting in California. One of the categories Rick brought up was the construction of new homes. It is like when you have an interest rate hike and someone says interest rates went up ½ a percent. You say to yourself that it is all the way up to four, but to Bruce and Rick this is laughable to have something that is under 6. When you say construction of new homes is up 25%, it may be up this amount but it is down by 90%. It is going to take a long time to come back.

Rick Sharga said at the peak of the boom they were selling 120-150,000 new homes a month across the country. We are at a 40-year low in inventory and a 30-year low in sales. Whether we are talking about home price appreciation or new and existing home sales, we have to keep this recovery in context. This is not 2005 again. Home prices are all the way up to 2003 levels. New home sales are up to a third of what they used to be. Inventory levels are a third of where they are in a healthier market, and we are still going to sell 2 million properties less this year than we did at the peak. We are off the bottom and coming back. Although it feels better, we are not yet where we need to be to really call this a successful recovery.

Bruce asked Rick what he would call a successful recovery. Rick said the obvious ones are you look at sales volume as one metric, and until you are up over 5 ½, approaching 6 million units a year, it will be hard to believe that you would be at a real recovery. The other is you look at inventory levels. Until you have a steady 6 months’ supply of inventory, it suggests you are going to have a lot of the volatility we are seeing today. Bruce said the truth is you never have a 6 month supply of inventory once you start a price increase, specifically in California. This is why Bruce looks at charts and does not really know about caring about the average, but he can say that when you have price increases in California you have a real hard time having inventory increase.

Rick talked to the Chief Economist at a conference a couple weeks ago, and they have a metric out right now where they say the housing market is 56% back to normal. Somebody asked when it was 100%, to which he laughed. He acknowledged that it is really never at 100%. Sometimes it is at 101, other times it is at 73. It is kind of a floating number. The other number he looks at is on the distressed side of things. With foreclosure activity being where it is, it feels a lot better than it did back in 2010. However, we are still running at 3-4 times normal levels, so this is another metric to watch in terms of where the market is and how much further it has to go.

Sometimes the California Association of Realtors will do a presentation showing that Riverside is still in the 45 percentile of some type of forced sale, whether it is a short sale or a foreclosure. Normal is probably 5%, so even at the improved levels we are about 5-10 times that level. This shows the very serious localization of real estate trends. We talk about national tendencies, but it really comes down to a local market and what is happening in Riverside and San Bernardino. It is very different than it is across the border in Orange County, even if you split it between the north and south counties. Rick looks at broader market trends to see if everything is going the right direction.

What is interesting is that when Rick mentions us being back to 2003 price levels is if you convert that to a payment level, that is more revealing in the sense that you look now at what percentage of income is being required to buy the median price home. Getting back to the affordability discussions, it is probably about half of what it was at the peak of the real estate boom. The affordability levels are at, if not all-time lows, they are at least as good as they have ever been.

For more information about The Norris Group’s California hard money loans or our California Trust Deed investments, visit the website or call our office at 951-780-5856 for more information. For upcoming California real estate investor training and events, visit The Norris Group website and our California investor calendar. You’ll also find our award-winning real estate radio show on KTIE 590am at 6pm on Saturdays or you can listen to over 170 podcasts in our free investor radio archive.

Tags: affordability, bruce norris, Carrington Holding Company, Federal Reserve, inventory, price movement, Realty Trac, reo, the norris group, The Norris Group Real Estate Radio Show
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Rick Sharga, Vice President of Carrington Holding Company, LLC, Joins Bruce Norris on the Real Estate Radio Show #328

Friday, May 3rd, 2013

Rick Sharga

Vice President of Carrington Holding Company, LLC

(Full Bio)

Bruce Norris is joined again this week by Rick Sharga. Rick is the vice-president of Carrington Mortgage Holdings and one of the country’s most frequently quoted sources on foreclosure, mortgage, and real estate trends. Rick has appeared on every major network and news show in the country, and he has even briefed government organizations such as the Federal Reserve and Senate Banking committee on foreclosure trends. Prior to being with Carrington, Rick was senior vice president of Realty Trac, with is responsible for marketing and business development.

Bruce asked about what kind of experience it was to speak in front of the Federal Reserve and Senate Banking Committee. Rick said it was an eye-opener, particularly when you realize how broad a range of subject matter on which these people have to become instant experts. This was especially true in talking about some of the more arcane aspects of foreclosures, how the processes work, and how there are 51 different jurisdictions across the country that all operate a little differently. This gave Rick an appreciation for the magnitude of the job they try to do because there is so very much that they need to try to absorb.

Speaking in front of the Fed was a little humbling for Rick. He was talking to the chief micro economist and the chief macro economist, and they were asking for Rick’s opinions on the market. He said it should be the other way. It was very gratifying for him and humbling to have enough of a reputation within a certain subject matter to be able to share it with other people who can put it to use.

It is a daunting task for the committees when you think about all the subjects on which they have to get up to speed. They most likely invite experts in and tell them to get them up to speed. This explains why well-intended and seemingly logical legislation that gets passed goes so horribly wrong. There really isn’t the expertise that comes with the business aspect of being involved in the everyday aspects of the operations like a lot of people like Rick are. The other part is you have agendas that really step up to play, so you really have to consider if you are hearing facts or if you are hearing wishful agendas. Rick jokingly said he was shocked that Bruce thought there were agendas playing in Washington.

Bruce asked where Carrington Mortgage Holdings is located. Rick said their headquarters is in Orange County in Alisa Viejo. They have an investment group that is headquartered in Connecticut as well as servicing operations with facilities in Santa Ana, California and Fishers, Indiana. Bruce also asked how many people all together are employed by the company. They have a little over 2500 employees and are continuing to grow. They are seeing growth in a number of their businesses, including the servicing business, loan origination, and real estate brokerage. Rick said it has been an interesting transition coming over to Carrington and seeing all these various aspects of mortgage and real estate related businesses we never had.

Bruce asked if this was the very definition of vertically integrated. Rick said they stopped talking about vertical integration because nobody really understood it. Rick said the CEO does like to say that they do just about everything involved in residential real estate transactions outside of cutting down the trees. It is an integrated operation in the regard that they have business units that invest in pools of loans, that write loans, service loans, buy and sell properties for consumers or investors, write title insurance, do property preservation and construction. It is really does run across the board; and the flip side of that is, depending on the customer, they do not have to work with all those entities.

Bruce said it would sound like Rick and the employees have been in the business for fifty years, but that is really not the case. It is like an accidental success story that the company really started as an investment management business. They began in 2003 investing in pools of subprime loans and managing the credit risk on the loans. When the market went sideways, the company bought the loan servicing business from New Century when they filed bankruptcy. They did this primarily because the loans that had been purchased were sitting in that servicing platform, so it was a defensive move. Bruce Rose, their CEO, likes to say that he had visions of running a hedge fund in Connecticut and suddenly found himself with a 600 person servicing operation. All the other businesses really have grown since then to support some of the other businesses.

It’s funny how things work out sometimes. Rick said Bruce Rose never had a master plan to be involved in all the various aspects of mortgage and real estate operations, but he has certainly been flexible enough in that he had a vision once he got started to put together a good business model.

Rick’s company also has a new loan origination business. Bruce wondered if this was originating loans only for owner-occupants or for investors as well. Rick said it is primarily for owner-occupants. It is aimed at this market, and they do a lot of FHA loans. They also do refis and retail lending. They have branches in about 22 states, and they have a wholesale channel, so they are also working with mortgage brokers and helping them to get consumers funded.

One of the services Rick mentioned was he buys existing note pools. Bruce wondered if this is usually a national note pool. Rick said a lot of the pools are regional, although they are buying nationally. Very often the pools have some regional influence to them. What they are really buying mostly are pools of non-performing loans since their servicing group is very good at getting those loans to re-perform. This is a win-win since it is best for the borrower and ultimately best for the investor as well.

Bruce wondered who the seller typically is, whether they are FHA or Fannie. Rick said they have participated in both government agency pools as well as pools sold off by large lenders or other financial institutions. Typically they work these loans through their servicing group and ultimately wind up foreclosing on less than 20% of the loans they purchase. The guys are very good at finding a way to come up with alternative disposition strategies other than foreclosures. It is a big deal when 8 out of 10+ families get to stay there and retain ownership. Bruce wondered if this is typical, or if they turn to lease or sometimes renters. Rick said no but that this is an interesting phenomenon. They really expected to see more of an interest in people handing over the deed and taking a lease. What they found was that the people who want to stay in the homes really want to stay in as the borrower and just do a loan modification. Since they are buying the loans at a discount, they can usually pass on some of the savings in terms of lower payment prices on a mortgage.

A lot of the people don’t really want to stay anymore, so they become very good candidates for short sales or even sometimes deeds in lieu. In other cases, people are really just ready to move on and get on with the rest of their lives and are happy for the opportunity to do a short sale so they don’t have debt hanging over their head.

Bruce asked Rick if a high percentage of the time the occupant owner is cooperating with a short sale or if they are getting the loan recast and stay to make the payment. These two categories make up the 80% that he talked about with Bruce. A lot of it depends on the pool and what part of the country you are in, whether the Northeast or elsewhere. If you are in the northeast and in a state like New York where you have 1100 day foreclosure cycles, it is sometimes harder to get a borrower to agree to a short sale since they know they do not have to do anything for a couple years. It takes 1100 days for a foreclosure in New York and 1,000 in New Jersey. It will ultimately wind up having a negative effect on the real estate recovery since the distressed inventory will be around for so long.

Bruce asked if Rick thinks we will ever see a national foreclosure law. Rick said probably not, at least not in our lifetime. The CFPB recently put out national loan servicing standards, and those were mostly aimed at servicing of delinquent loans. After they issued their national standards, they issued an addendum saying that state laws trump these national laws. From the perspective of a company that does loan servicing in many states, it would be great to have one set of foreclosure rules and one set of servicing standards, but it really does get into the whole state rights versus federal rights issue. Right now foreclosure laws are all managed by the states.

Carrington is also buying properties, although very selectively. They think the market is very frothy right now. Rick and Bruce have talked about how well some of the business models hold up or don’t hold up as home prices appreciate very rapidly. Right now there are better opportunities in things like non-performing loans and mortgage servicing right now. They are just not willing to pay 125% list price for a property they are going to hold onto and try to get a rental return. At the same time, there seems to be a new player willing to do that almost every day. Everybody has a different business model. There was an announcement recently about one of the companies having an IPO. If you are overpaying a little bit but put some leverage into your purchase by getting other people’s money, sometimes the returns look better. Rick said he does not know what the implications are for the people that are doing the follow-up investing on properties that were intrinsically over-valued. There is a lot of money coming into the return rates, so it will be really interesting to see if they are able to deliver what their perspectives indicated they would.

Rick is probably a lot more familiar with the different business models that are out there. For Carrington’s purpose, Bruce wondered if whenever they bought a property it was always the intent for them to have it occupied by a renter for some period of time and then resell it for a profit. Rick said typically when they buy a property this is the model. It is almost always with the notion of having somebody rent the property out for a period of 3-5 years and then sell it as home prices appreciate. Their model was and is a hybrid model. There are rental returns built into it as well as home price appreciation. When a market overheats, it really makes both parts of the model difficult to achieve because the underlying collateral is potentially over-priced.

Bruce wondered what surprised Rick as he went through the buying effort. He wondered if there was something more difficult than he thought it would be originally. Rick said there were a couple things, and the two biggest really come down to inventory. The properties of REOS and lender-owned properties really dried up much more quickly than they or anybody had anticipated. As part of that, there had been speculation that they would see a lot of bulk sales and fairly large pools of properties sold. This has really not been the case as there has been a couple exceptions over the last few years, although really not that much. The other surprise was how much interest developed in the particular asset class so quickly. It seemed there was a new company announcing a new $100 million fund every day. It went from an interesting idea to the investment topic de jeur.

Bruce said when they are bidding at the trustee sale they can always tell that somebody has gotten their first $100 million since it is usually spent in a 3-day period. Along these lines, Rick heard an anecdotal piece from an auction in Atlanta where one of the institutional people ran out of checks. What is sad is that because they are doing so much business, the auctioneer actually waits for them to come back. From the auctioneer’s perspective, it makes sense to wait for the person who is coming back with the fresh set of checks.

Since people worry a lot about home price inflation rather than appreciation, the encouraging thing Rick has seen is that as the investors have come and gone from some of the markets, the prices have held. They may have accelerated the price appreciation and driven prices up a little faster than they would have gone on their own. However, once they have hit that new level they have generally held. This suggests that the value is still right for the properties that are being purchased. Rick brings up a really important point and something that is really a concern of people that are investors. Bruce does not think the homeowners really thought things out because this is a new experience. Bruce does not recall ever having this money invested in single-family homes. To Bruce, this is an unprecedented group of people. Collectively, all of these companies together have become market-makers.

Rick thinks the aforementioned is over-stated in the press right now. On a localized basis you could sometimes make an argument that they could become market makers. If you look at Phoenix last year and Atlanta, you see it happening. Collectively, there was $10 billion of funding announced last year, which was not all spent. $10 billion as a percentage of the overall housing market where there were about 5 million units sold is really a rounding error. Bruce has been studying foreign buying, which is about $800 billion. Rick does not think the institutional investors are really market makers in a broad sense. It has been interesting press conversation since it is not a new phenomenon. In terms of actual impact on the overall market, this affect has been overstated.

Bruce wondered if he also feels the same way about rent values. He wondered if they would not have so much inventory that they would sway. Rick said not yet since rental units are still occupied somewhere north of 95% across the country. What they have seen on a short-term basis is you take a neighborhood in Phoenix, and suddenly there are a lot of homes on the market for rent. You might have a temporary over supply because you cannot break their lease and move into something new. There could be some softening of rental rates, but he does not think it is because the entire inventory is hit at once.
FHA just announced that they were selling 40,000 notes this year, which is in a competitive bid situation. Bruce wondered if the FHA retains part ownership of this. Rick said he is not aware of any of those types of arrangements where the seller retains partial ownership. Rick believes they are all at right sales. The government pools, specifically FHA pools, tend to come with more specific requirements and language about what the buyer may or may not do with the pools. In the FHA pool that was sold earlier this year, there was some language that restricted buyers from being able to foreclose on properties for a certain period of time. It required a certain percentage of loan modifications. There were more restrictions and requirements with the government pools than with the private pools, and Rick believes they are all outright sales.

Bruce wondered if these are all auction type settings to where it is just the highest bidder who receives it. Rick said he is sure highest bid is one of the factors, but there are also performance and disposition considerations. He is not sure it is necessarily 100% based on the highest bid, but they do at least have to be competitive.

Carrington has a model where they are going to buy and sell a property. Bruce wondered if there are other models he is aware of that are going to have the single-family homes with a different disposition where they may be putting the homes into a scattered apartment type REIT. Bruce said they would not come back on the market; although Rick said they will at some point, and this is one of the differences between a traditional apartment REIT and a real estate investment trust. It would make sense to build flexibility into a REIT like this where you can move certain properties out and replenish with other properties as they come to market. Rick is not aware of anybody’s plans that call for a permanent hold of the rental properties. The big variances tend to be the length of the potential hold and how much of the return for your investors you are planning to get for rental rates as opposed to home price appreciation.

Rick talked to a group in Indiana, and they were looking at 18-20% annual yields on the rentals, but they were really ultra holds. They did not see prices appreciating in a suburb in Indianapolis any time soon. Rick said they saw another big investor get out of Northern California since they were buying three $400,000 homes. You cannot simply have rental yields since you cannot charge $3-$4,000 a month rent for too many tenants. What they saw was home prices appreciating more rapidly than they thought, so they got out and made their profit. The REITs would be long holds. What you are basically counting on is the cash flow from the rental units being what you are investing in. Those building units would stay in the REIT longer than a typical buy and short-term hold. There could be some transactions that move properties in and out of that REIT.

Bruce asked Rick what a long-term hold would be. Rick said it would probably be anywhere from 5-10 years, which is a long-term hold. The average for most people going in was they were looking at a 3-5 year old. If you are looking at a REIT, you are probably looking at something a little longer than that. Bruce said it would seem to him that most of the product they would have in the REIT would have to be bought in the next 6-12 months. One of the largest investment groups looking into this was Blackstone, and they really believed there was about a two-year buying window, and we are in the second year of this right now. As prices go up, it gets harder to get the returns you are trying to find.

Bruce wondered if they keep switching locations, or if they do them all simultaneously. Rick said you are actually seeing a movement right now away from some of the more popular states. Typically everyone started where the foreclosure numbers were the highest, so you go for states such as Arizona, California, Nevada, Florida. What we are seeing now is a movement into second tier states, or states that did not have as terrible a fall from peak to trough in terms of home prices. In this case, you can buy reasonably priced homes and get a reasonable rental yield for the next few years. It is really not a buy/flip business so much as it is something that already cash flows and you might as well keep it.

Bruce asked Rick if he thinks this model is going to be gone at some point and they will find something more traditional to do with their billions of dollars. Rick said as there are other opportunities to deliver good returns, you will see less interest in this. However, he thinks you will see a more permanent group of large investors in the single-family rental space when we come out of this cycle than when we started.

Tags: bruce norris, Carrington Holding Company, Federal Reserve, FHA, mortgage, Realty Trac, REIT, senate banking committee, the norris group, The Norris Group Real Estate Radio Show
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Cary Pearce, Sales Production Manger for Provident Loans, Joins Bruce Norris on the Real Estate Radio Show #316

Friday, February 8th, 2013

Cary Pearce

Sales Production Manager for Provident Loans

(Full Bio)

Bruce Norris is joined again this week by Cary Pearce. Cary is the sales production manager for Provident Loans, and he has been involved over his lifetime involved in loans and about $ 1 billion and a half in closings.

One of the things Bruce and Cary began discussing was trying to qualify somebody for being a buyer. It is one thing when a loan does not close for somebody who is the lender; but when you have a hard money loan and are making a payment at 12% interest that falls out, there is a real hurt there. It is one of those situations where you would like to not have too many dry runs unless you happen to be a in a pretty bull market where you can say it is no big deal and you will make it up in price rises. This is something we have not had the luxury of in a while.

Because unemployment has been such a big factor, Bruce wondered how long somebody has to be on a job in order to receive an ok from the lender. Cary said generally with most any loan they want to see a two-year work history. There are some exceptions where if you have a college student with a four-year degree in his particular field and they get a job in that field, then you may be able to receive a loan on less than two years. Cary said in some cases they have done it with only thirty days of pay stubs. However, with a conventional loan this would never fly. The idea that improved employment will immediately help the real estate market is really not true. It is going to have a big lag affect. There are some people who had a two-year work history, were laid off after a year, and are now one month back on the job and wanting to buy a house. This is not going to work since the people at Provident want them to be back on the job for at least a year.

There are some overlays that still overwrite FHA’s 4155 and still do a manual approval. In cases like these it does not have to go through the automated system. However, most of the lenders are doing everything automated and have the overlays where they want the minimum FICO score and employment.

If you are self-employed, it is still required that you have two years of work experience. This means two years average of net income off the tax returns. Usually people try to be aggressive in their deductions, and it does not work so well nowadays. That is the biggest problem with a self-employed borrower, and that is why at Provident they would love to see the stated income loan come back for them because of the fact they write off a lot.

Bruce also asked about the down payment required by FHA since there was some talk about it increasing. It is still at 3 ½%, although they are hearing rumors that they are trying to get it to go up to 5%. However, Cary said he does not know if they will pass this or not. Cary does not think this was originally part of Dodd-Frank, but with a lot going around FHA right now there are many saying they are financially in dire straits. They have to make changes, and this is one of the things they are talking about changing to try to make their program a little bit more stable. Bruce wondered how down payment would help them financially. It may be safe for paper, but that is not much safer. What they are looking at is overall foreclosure ratios with a higher skin-in-the-game and less chance of default.

The safest loan in the country for the last 50 years is a VA nothing down loan. Down payment has nothing to do with it. You could not tell a VA loan from a Fannie 20% down loan. Bruce was able to present in front of Fannie and Freddie in Washington D.C., and they pointed this out. When they showed them the chart, they were surprised. It’s all nonsense about Dodd-Frank being the big saver for the mortgage industry. Whatever VA does must be good enough for the underwriting process. Obviously their percentage is not as high as FHA’s or Fannie or Freddie’s, but they are still doing a fair share of loans. It is the percentage, not the number of foreclosures historically. It is the nothing down borrower with whatever they are doing as far as underwriting, which apparently produces a fairly successful loan. They do scrutinize this package; so it will be full doc and they have to meet the ratios to make sure it is a quality loan.

Bruce asked about cash reserves for an occupant buyer. Cary said FHA does not have a reserve requirement. They have plugged some in where they have $500 left over after all their down payment in costs, and it was still approved. There are some exceptions on investor overlays that come into play. For instance, if the seller or a buyer is going to keep their current home as a rental and also want to buy a new primary residence, then in this situation the overlays will come in and they will want them to have at least a couple months of reserves on both houses. Conventionally it is even worse where in that same example they want them to have six months of reserves for every property that they own plus the new property.

Regarding property condition, Bruce wondered if there have been inspections recently that are really not so critical. Cary said they are still seeing repairs on a lot of their FHA approved appraisals, not so much on conventional. FHA flips are probably the worst only because you have to have two appraisals, a home inspection, and after reviewing the home inspection the underwriter will add any and all health and safety items to the appraisal as repair items. Those typically come in with more repairs, but those are usually the cleanest houses in the market.

Bruce asked what the theory is behind two appraisals. Bruce wondered if the right one or the low one wins, to which Cary said it is the low one. Although he already knew the answer, Bruce wondered why the low one is always right. Cary said it boggles the mind because when they order an FHA case number, you would think that the FHA appraisal should be the go to value. However, the second back-up appraisal is typically ordered conventionally. If it comes in lower, that is the number they are going to go with. There are some people out there who, on the flips, can still get it done with one appraisal. However, most people doing the flips have to have two. Bruce thinks this is insulting, and if he were an appraiser he would be asking the people why they even have a license if they cannot trust the number.

Bruce also asked about down payment gift programs and if any of these exist anymore. Cary said most of them do not. The Nehemiah, Heart, and others all went away because it was seller-driven. However, they knew the money was coming from the seller, and the market just did not like it. Bruce also wondered if there are still a fair amount of gifts coming from relatives now. Cary said they do see a lot of gifts on their FHA loans, approximately 30-40%. He also wondered what percentage of loans were multi-generational or multi-family qualifying. Cary said it was not a whole lot, but there are some out there. There are some other down payment programs, such as Cal FHA’s program Chittap where they do a 3% silent second. This is still a very popular program and helps many first-time buyers as long as they can meet the income limit.

Bruce also asked about fourplex limits. In Orange County it was around 1.2 million, although Cary said generally for a fourplex the number is a little over this number. FHA on Orange County is 1.4, and this is still with 3 ½% down. On multi units 3 and 4 they do a special calculation to make sure you go through an extra procedure and run all the numbers to see if it will still qualify for the 3 ½% down payment. There are some cases where it will qualify.

Bruce wondered if the deals Cary sees come through are mostly purchases or refis. Cary said last year their percentages went way up, and typically their branch runs at least 70% purchase to 30% refi. Sometimes they have been higher than that at 80/20. Just this last year they were about 55-60% with a higher concentration of refis, but this is only because rates were so low. Bruce said it occurred to him that there would not be much of a refi market once we leave this era since no one will touch a 3 ¼ mortgage. They will just keep it as a rental or leave it alone.

Bruce wondered how sensitive he thinks due on sale clauses will be. It is a very attractive niche to say you will sell a property and just wrap it. There are no assumable loans anymore, so it is a due on sale situation. A VA loan has a clause where you can swap the entitlements and someone else can take it over as long as they qualify. As to whether the lenders will actually exercise that due on sale and if somebody does take it over and start making the payment is not known. If they are making their payments on time, they may not ever touch it.

Bruce asked Cary if he gets a sense about where prices are headed over the last six months as far the local market. Cary said they are definitely increases. He and Bruce had talked earlier about how the appreciation is hopefully going to be at least 10% or more. We need this because Riverside alone was down 40-50%. What is interesting about the reticent saying they will have a price increase is they forget they are pairing it with a 3 ¼ to 3 ½% mortgage rate. You start calculating how much the price movement means per month, and it just disappears. At the height of the market there were 2 bedroom, 1 bathroom homes in the wood streets going for over $400,000. Today they are around $220,000. Regarding the interest rates back in the day, if they had to get a fix it was around 5 ½%. You start looking at the payment difference, and it is just night and day. That is why when it goes from $200-$260, which is a big move up, then you take $60 grand and compare it with 3 ¼% mortgage, you see that it is no big deal.

Bruce asked if there is any concern for the industry on the direction. The lending world is getting hit and blamed, some of it deservedly so, New York being an exception. Bruce asked about the changes that could be enacted by Dodd-Frank qualified residential mortgage, to which Cary said the biggest thorn in their side is the whole appraisal process. They used to be able to pick any appraiser in their local market and have them do the appraisal. Today, they have to go through a panel. As the loan officer, they have no say so in who gets the appraisal order. It goes to the corporate office, then they randomly assign it out to someone. Once the appraisal comes in the find out who received the order.

What is interesting is there is not really the same due diligence on the quality. It may come down to if you can do it faster and cheaper. Cary said when they were at National City they went for a short time through one of the national appraisal companies, Street Lengths. Here they would get some really low appraisals because the people there were just trying to get the reports back as quickly as possible without showing any concern about the comps. It was because they were only receiving half of the fee. This was a huge problem, and there is only so much due diligence you can do for $200. Thankfully with Provident’s philosophy, they paid appraiser the full fee, and the management company involved is only paid $25 to help them through the ordering process. However, the appraisers do receive a high quality report, and they are not seeing nearly the number of low appraisals they used to see.

Bruce wonders if Cary sees any evidence of lenders loosening standards. Cary said he does not see anything yet. Stated income is a program they would love to see come back, but it is not on the horizon as far as they know. Bruce wondered if that was always a conventional product that was outside of Fannie and Freddie, to which Cary said it is. Mainly things such as World Savings was very popular with that as well as Downey and a few others. Provident had broker relationships with them and sent them that type of loan.

Bruce asked how changes in loan policies usually take place and who the deciding body is that says when things will be okay. Cary said it is usually Wall Street and whatever they are willing to buy. In Cary’s experience when he was with Home 123, a company owned by New Century, he saw how fast things change. New Century was closing $4 billion a month in mostly subprime loans. The paper division was maybe 10-20% of the overall volume. In late 2006/early 2007 when they took $8 billion to market, Wall Street said they were not buying it. New Century was out of business in two weeks.

Bruce remembered early news articles that said we have basically gone back two decades in loan programs in ten minutes. It was so fast, and it was amazing how quickly the programs started dropping off. He immediately left Home 123 because he was forced out when he was told they could not fund loans or originate new loans. They took the whole team to National City, and slowly but surely they started pulling back all the programs. They took construction financing off the table as well as home equity lines. The alternate A products, where you had a lot of jumbo loans, were also pulled. The lenders and people working for the lenders had probably never even done one. The speed at which everything happened was just a matter of a few months, and it was just amazing how many programs died.

Coming back to today, Bruce wondered how Fannie and Freddie differ in regards to if you are an investor trying to receive a loan. Cary said typically you are looking at at least 20% down to do a non-owner occupied loan, but Fannie and Freddie both have their standard program where you can only have up to four financed properties which has to include the subject you are trying to buy. However, there is an overlay where they will go up to 10, and with that program you have to have 25% down and heavy reserves for all your properties. On this one they will let you go up to ten finance properties. Bruce asked if this is now for both Fannie and Freddie. Cary said he is not exactly sure who they are selling them to since Corporate does not really inform them of it. Bruce and Cary both think it is only for Freddie, but the sad thing they both found out is that they will not do cash out refis on them. Cary checked around with a couple sources in the industry, and they both told him their program would only do purchase and written terms as well. Thankfully for Bruce they found a source out in Orange County, so hopefully all goes well there.

What is interesting is you wonder about a cash out refi from a free and clear property and how yes answers either come about or don’t about in the lending world right now. You just look at the reasoning behind some of the programs and see that you are missing a lot of very safe loans just because you cannot do them. The investors would definitely help the market come back since there are so many of them out there. It is not only the Wall Street crowd buying them, but also the local investor who is really forced to write a check and hopefully get his money back.

If they do in fact just buy a property and want to get their money back, Bruce wondered if it is okay for them if they use One to Four loans. Cary said yes and that they have a program for that called the delayed financing program where an investor would come in, pay cash, and immediately pull some of the cash back. They will go up to 70% on a cash out on a property that has been owned for less than six months. However, you have to document where your down payment came from, and it had to be your own money. It could not be any gifts, so there are some restrictions to it. However, there is a program out there for it.

Bruce asked if you have a credit line on your residence if it counts as one. Cary said it does, but Bruce wondered about if it was unused if the maximum amount you could borrow against it is counted against you as well. Cary said it does, so if you have a $450,000 equity line and have zero owed against it, they are going to count the $450,000 owed against you as if you owed it all. They know you could go out and write a check tomorrow for that whole amount.

Bruce wondered if the eleventh loan exists yet. Cary said it does not as far as he is aware. The only thing you could probably do is go to a commercial local bank to receive either a line or have a loan with a very short fuse. There are some investors out there who have their own equity lines at their bank and are able to go out and do what they want. This is an elective relationship, and it still has to be renewed every year. It is a whole different thing since this will not necessarily work if you want a whole group of rental properties.

The problem with these programs is they can grow out of favor. This was Bruce’s first experience when he had a credit line. He had a $200 grand credit line and it was not a big deal, and they basically used it to just buy trust deeds in the margin. The difference in interest was something they earned. However, at the end of the renewal it was not renewed, and Bruce wondered why. Bruce found out it had nothing to do with him, but that his whole industry is out of favor. Bruce is a perfect borrower, has perfect credit, managed it very well, and none of this mattered. Provident had clients who had the same exact situation where they had no balance on their equity lines, and they received notices in the mail that their line was being closed. This is a bad day because sometimes that cushion is your cushion. You have the $400 grand line for a reason in case something happens and you can float on the boat for a long time. When they eliminate the boat, then that is not good.

If Bruce had a rental property for which he was receiving $1,000 a month free and clear, he wondered what percentage of the income actually gets credited to his side of the table. He wondered if there is a certain percentage that goes to expenses if the people qualify. Cary said in the old days they used to take 75% of the gross rent and minus out any payment you had. The excess was then used as income. Today, at Provident they have a chart they go through where they take your tax returns from the last two years, whatever your bottom line income or loss was, and they start adding back depreciation, mortgage interest paid, and tax and insurance. After a two-year average, out of all of that they deduct the PITI payment. If there is a positive it will count towards income, and if it is a negative it counts as a debt. The old rule went out the window; and in most cases when they look at somebody’s tax returns it hurts them and it is almost twice as bad. They could even have a positive cash flow and have a negative net result.

Bruce also wondered about trust deeds income. Bruce recalled in certain guidelines from a long time ago that if you have a short term trust deed that is one year or less, they won’t use it. It has to have three years of life left on it. If you do have a one-year trust deed, Bruce wondered if it is an asset in addition to being non-income. Cary said they should at least count it as an asset, but they will not count it as income or cash. It doesn’t really make sense since it is like an asset class with no home.

Regarding VA lending to investors, this only counts if the buyer purchases a VA property. At Provident, they do not do anything non-owner VA. It could be on their own inventory they would allow it, but nothing else. Any new buyer coming in and trying to purchase a VA has to be owner occupied. Bruce also wondered about self-employed investors and if they still exist. Cary said they see a few out there, and there are a lot of companies out there where they are showing the strong bottom-line net and are fine. The challenge with 70% of self-employed borrowers is they write off too much, and it hurts them when they go to qualify for anything.

If Bruce had a property that has a pretty strong negative cash flow, he wondered if this in itself would not end his loan app but rather was a ratio of everything he had. Cary said as long as you ratio out you should be okay. They have had some situations where the payment was $1500 and the fair market rent was only $1200. At Provident they can only use 75% of that $1200, so you have $900 offset to $1500. Now you have a $600 loss on paper that will go against you in the debt ratio.

Bruce also wondered about selling immediately after rehabbing and what the guidelines are now as far as conventional and FHA. Cary said for less than 90 days they can still get them done conventionally as well as FHA. Conventional loans will usually require an appraisal and at least a field review just to make sure that the value is solid. If an FHA loan is less than 90 days, then with Providence overlay they have to have two full appraisals and a home inspection to both check the value and make sure the house is in good condition. Bruce wondered if they looked at anything like rehab estimates or margin of profit. Cary said there are some rules when it comes to the profit that fall into the overlay. If it is over 100%, they are really going to scrutinize it.

Tags: bruce norris, Cal FHA, Cary Pearce, Dodd-Frank, fannie, FHA, FHA 4155, FICO, FREDDIE, National City, New Century, PITI payment, Provident Loans, sales production manager, The Norris Group Real Estate Radio Show, VA nothing-down loan
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Cary Pearce, Sales Production Manger for Provident Loans, Joins Bruce Norris on the Real Estate Radio Show #315

Friday, February 1st, 2013

Cary Pearce

Sales Production Manager for Provident Loans

(Full Bio)

Bruce Norris is joined this week by Cary Pearce. Cary is the sales production manager for Provident Loans, and he has been in the business since 1985. He has closed about 2500 loans himself, and he has also supervised about $1.5 billion in closing.

One of the things Bruce looks forward to every week is Cary sends him his weekly Inside Lending newsletter. Bruce wondered if it had been around for over a decade since it said Volume 11 on it. Cary said it had been around quite a while, and they subscribed to the service that did it for them. The main reason they put it out was to give the agents insight as to what is affecting interest rates on a daily basis. One of the things they mentioned was mortgage principal reductions and cancellations by lenders not being treated as ordinary income. This is a big deal, and it was in place for all 2012 and even before that. It came to an end December 31; and if it had not been renewed it could have been a real problem since most of the things going on were short sales.

Cary asked Bruce what percentage of the market was short sales, whether it was 60-70%. Bruce said if you look at it on a chart it is actually 25% with 30% cash. It sure seems like it is the dominant player, and it is certainly overtaking REOs. It is replacing REOs in its own little pack of inventory. In 2013, if we have price increases the normal seller will start emerging with equity, and fewer short sales will be necessary. However, this is still going to be the dominant thing for most of the year. Cary said they would love to see it get back to a normal market where we have regular sellers out there.

One of the problems is you still have approximately 40% of California, specifically Riverside and San Bernardino County, upside down. They cannot be a participant yet, even if they don’t want to be a short sale, and a lot of them don’t want to be. They are a nonparticipant until they have equity, and that really gets to the inventory problem. The question becomes what you are going to buy, and this is one of the issues for Riverside and San Bernardino County. Every county has the same chart, showing it has gone from seven months to 1 ½ month’s supply of inventory.

There was an article over the weekend where they thought about a 20% price increase for California this year being set in writing. Bruce doesn’t see how it doesn’t happen if you only have a month and a half’s supply and the kind of demand we have. Cary talked with Bruce at lunch about how so many buyers are being outbid, especially cash buyers, and they are going over list price. It is going to feed on itself.

Another thing talked about in the newsletter is the unemployment level. In California, you do not solve this until you have construction, and if this is part of the master plan it is actually brilliant. Bruce does not think it is, but it is going to happen anyway. We will probably have prices accelerate until construction pencils. All of a sudden, it’s game over and we know how the dominoes fall. Getting the prices beyond cost replacement has really been the challenge. Cary said we have seen so many cycles like this already, and it is bound to start going the other way. This one has really been the worst one where we had most of the real estate in Riverside and San Bernardino upside down. Subdivision creation is down 95% over the last five years, so the builders still cannot look at a piece of dirt and say they will carve it up to build something on it. It still does not work and you need some hefty price increases.
Cary deals with a lot of people receiving loans for the first time. Bruce wondered if they have any appreciation at these rates being so low and that they can have something at 3%. Cary said yes and that when people see rates spike up like they have over the last week from 3 ¼ to 3 ½ , they don’t need to panic since 3 ½ is still a great interest rate. From the research Bruce has done, no one alive has seen the interest rates we have now. It’s human nature to think that 3 ½% is bad and to want the 3 ¼%.

Bruce wondered what interest rate was prevalent when Cary was first in the business in the mid-80s. Cary said it had just come down to 12 ½%. Bruce became a full-time investor in 1981, and at this time he was able to refinance a house at 17 ½% fixed. Bruce did some refis on a some rental properties because it was ridiculous how the interest rate was under 4% for non-owner occupants. He does not want to walk away from this era without borrowing some money and investing in more properties. He did this since he expected inflation to kick off.

The newsletter also talked about how it expected GDP growth to be very small at about only 1%. Bruce wondered what effect this has on interest rates going forward. Cary said this is a tough question, but we have to have growth to get the unemployment down. Until that happens, we could have rates this low for 2-3 more years. When we talk about GDP, that is a national situation. You could have a very different real estate market in California because of those interest rates. Even if we started flying in price, we could still have those interest rates. If the GDP growth of the nation gets really small, we could start enjoying a nice bull run in price. However, interest rates will not change since the national picture has not changed. The affordability is still going to be very good for most. Until that unemployment number comes down, it seems to be the magic thing that everybody is seeing.

When Cary was in the business from 1985-1989, that was one heck of a price run. When you just get into the business, you do not have any reference points to refer. Thankfully Cary bought his first house in 1986, and it was about a 1500 square foot house for which he paid $104,000. They sold it in 1989 for $175,000, about a 65-70% increase.

Bruce asked if Cary remembered the lending programs as they progressed from 1985-1989. He wondered if Cary felt they were assisting the price increase. Cary said they definitely did not get more lax since the stated income programs had not really been created yet. However, back then there was the graduated payment mortgage, which allowed the buyer to come in for a lower payment to start. These loans have potential negative equity, which was a small problem. However, it was not a big issue at the time since we had appreciation. The other loan that was also out there was the buy-down, which was a really popular program back then. Usually what most people did was they would call it a temporary buy-down, where they would buy it down 3% the first year, 2% the second year, then 1% the third year. The fourth year it would go to the note rate.

Usually when we have a price boom you end up with fewer and fewer defaults that cause losses. Even if you have defaults, it would be hard to have them cost anybody anything especially back in 1988. Everybody thinks this loan program is perfectly safe. The problem with this last time, even for people like Cary who had been in the business 15-20 years, was it seemed unreal. Cary said the stated income loan was a high-performing loan when it first came out because it required 20-25% down. Even though you are giving to self-employed borrowers who did not always show a high enough net income, it was designed for that borrower. They had a great credit history, large down payments, and a decent equity position in the property at the time of the sale. When they started doing zero down stated income loans, then on top of that adding in the negative ARM with the low 1.5 or 2% payment, these were what really created a problem.

When Cary looked at those programs being enacted, he was also competing against other companies. Cary advises against these loans, and he only had one client who begged him to do it. He went ahead and did a refi on this one, but anybody coming in to do a purchase was shied away from these since he knew they were not good loans. This causes qualifying to seem to go out the window since the way they were marketing the paper had certainly changed from normal. When you tell somebody they can have a $1 million mortgage and have a payment of $1200-$1500, then who would not want to do this?

Bruce wondered how different lending is now from what it was back in 2003-2006. These years were pretty lax when there was all the stated income loans. At this time the 80-20 loan really was a popular program, even on the subprime level. Now, everything has gone back to when he first started. There are no stated income loans, and the quality is there in the loan package because they have to meet the ratios, have the credit, and they have to have the down payment.

Bruce asked Cary if he thinks we have overshot on the conservative side. Cary said we have a little bit, although he thinks there should still be a stated income loan with a 20-25% down payment as this fits a very niche part of the market. The skin in the game would seem to be equal to a Fannie Mae 20% down as far as spread. This is something we are definitely missing.

Cary said they have had some situations on FHA where they ran a client through the automated system and it spit out an approval. In some cases, it might be really close to a 60% debt ratio. Provident will not touch a loan over 55% debt ratio. Even though they have an automated approval that says they will take it, they will not because they have their own internal guidelines that limit them. This is called an overlay. One of the interesting overlays is the time lag between someone having lost a property and when FHA will offer them a loan. Bruce asked them about this on the radio, and their answer was 6 months. Cary was completely shocked as it should have been three years.

Bruce wondered if an overlay in time is lender induced since it does not seem to be FHA induced. Cary said it is actually right in their guidelines in the 41-55. This has certainly changed or the FHA spokesperson did not know about this. Conventionally they will consider you after two years on a short sale if you are putting a 20% down payment. They say on a foreclosure they will consider it after three years with a 10% down payment. However, the normal rule is 7 years on a foreclosure for Fannie Mae or Freddie Mac.

Bruce asked if we were selling a property as an investor and taking a look at somebody’s application what the important criteria would be. Cary said a FICO score is definitely critical. It used to be where FHA was really doing a lot of business with under 619 FICO score. Now it is 3%. Cary said they never actually had a minimum FICO score until the last four years. There are still some lenders out there who will go down to 580 on an FHA loan. At Provident they have the investor overlays that require 620, and some lenders are as high as 640. There are also programs out there where a client can have no credit. They could also do non-traditional where they get 12 months verification of rent, 12 months on a utility bill, and maybe a phone bill. With those three items they can get an FHA loan. Unfortunately at Provident their investor overlays don’t allow it, so you have to have at least a 620 middle score.

Cary could have been in the business from 2003 to 2008 and literally have no idea what he was just talking about in the above paragraph because they never did an FHA loan. 80% of the production that Cary did in mid-80s to early 90s was FHA loans. Then in 2001 when the 80/20s became really popular and the appreciation ran up so much, FHA was out of business because their loan limit was too low. In addition, when people could get in for 0 down and not have any mortgage insurance, it was a huge attraction and the rates were still very attractive.

Regarding loan limits, we are at a 340-350,000 median price right now. Bruce wondered what the loan limit is for FHA. Cary said they have extended it to the $500,000 again for 2013, which is over their normal limit of $340-$350. However, it was extended back when they did a lot of legislation back in 2007 when they passed the various bills to help housing. Riverside was extended again for $500,000 for this year.

Bruce said what the FHA loan limit was the first time we reached $340,000 going up from the ‘90s was $160 grand. Even the $340-$350 that is equal to the state median is way higher than the ratio it used to be, which was half the median. Bruce wondered how important the FHA program is to the current market. Cary said it is huge and we cannot live without it, especially people who have lost properties over the last 3-5 years out. This has to be the loan predominantly. Cary heard a statistic that around 2005-2006, FHA’s business had dropped to around 4% of the overall volume in the market. Today, it is over 60%.

One announcement Bruce does not want to hear is that FHA is going back to the other limits. They keep raising their monthly mortgage insurance, and they have already raised the one-time MPI. They keep trying to say they are herding for money and have increased the revenue. However, Cary and others are scratching their heads thinking that all the volume they are doing are great loans and people are well-qualified, so how are they losing money? Bruce said they are losing money because of what they did right after the crash when they started getting popular, which happened a little too early. They were doing a big amount of loans in 2008 and 2009, which still had negative equity runs. After that they will most likely look back at 2011 and 2012 as the safest years ever to make a loan. Bruce thinks this will come full-circle to where they won’t even have a foreclosure. Maybe we can cut loose a little bit and get some more people involved, which seems typical to Bruce that this will happen somewhere along the line.

Bruce wondered what percentage of the mortgage market is under the hats of FHA, Fannie or Freddie. Cary said it has to be around 80-90%. When Bruce was interviewed by the LA Times, they had a panel where one person was talking about the lender programs and intervention. Bruce asked him if there is anything that concerns him about a lender looking at the changes forced on them after the fact and saying they are going to be really careful about making the next loan. Bruce wondered if anything they have done where they cannot foreclose and have to do a certain thing have ramifications for the future where the lenders are really going to be careful.

Cary said the market that has been hit the hardest by this is the jumbo market because it has been so slow to come back, and they have been so cautious. For 2009 and 2010 jumbo almost did not exist, and that is where the higher Fannie Mae loan limit came in to help out the market. However, the jumbo investors finally started coming in slowly, and today we do have a 20% down jumbo loan available that we did not have for a while. They are still very restrictive on debt ratios and want the cream of the crop credit scores as well as a ton of reserves, which you never had to have in prior years. For loans today on a jumbo, they want twelve months reserves on a lot of these reserves. In the past you only had to have two. Bruce said if you are going to borrow $1 million, then that may not be unreasonable. Cary said 12 is excessive, although they may have gone overboard on some of the guidelines. Hopefully we will see this relax a little bit as the jumbo investor comes back.

Bruce wondered if every time they do a jumbo loan it is a foregone conclusion that it is a portfolio loan. Cary said no because they sell everything, as well as most of the other lenders. This may not be the case with the big banks such as B of A or Wells Fargo, but at Provident they sell everything. They have to find that investor who is willing to take it, and maybe this causes Cary and the people at Provident to be a little bit more selective or not quite as liberal. Bruce wondered if this is bought by a mortgage-backed security. Cary said Provident is selling loans to the big banks, including Bank of America, Wells Fargo, and Chase, as well as are private groups on the jumbo side such as Redwood and Citibank; and they are the ones who make the rules.

One of the concerns for any lender is a buyback. Cary said with something similar, if the client does not make the payment then they go through the notice of default and foreclosure. In a buyback, if Provident misrepresents a package to the lender in some way or made an error, then the customer forces Provident to take it back versus them dealing with the whole foreclosure process. Bruce asked if it has to be late for that to happen, to which Cary said not necessarily. There could be other problems in the file, such as miscalculated ratios, that could cause a loan to be kicked right back to you.

Cary said they have had it happen on FHA loans where FHA would not insure loans they funded even though they wrote them to their guidelines. They found one little problem and would not buy the loan. This would explain the scrutiny over and over again for the files. When Provident buys them back, it either becomes a portfolio loan or they have to sell them to what they call the “Scratch and Dent,” and for this you take about a 15% haircut on principal. When something like this happens, the Provident branch gets hit for it and it affects their PNL.

Bruce also asked about debt ratios and what is common for the front and back ends of the ratios. Cary said in the old days and if you look in the FHA 4155, their rules are 29% housing ratio and 41% debt ratio. When he first started in lending, they had to really push to get a 43% debt ratio approved. You had to have at least two compensating factors, whether it was excess money in the bank, housing not going up much, or very little debt, just to get to the 43 debt ratio. When the automated underwriting kicked in, they really loosened up quite a bit, and today they are seeing loans get approved at 55-56% on an FHA loan. The back end consists of any monthly payment that is going to last for a year. For an FHA loan it is everything on the credit report. Their rules are a little tougher because you could have a guy who has a car payment that is $100 a month who has 6-7 months left. They are still going to count it because they view it as a large payment. Cary and Bruce do not view it that way, but they view it as a large payment, so they are still going to count it.

If someone receives a $1,000 a month raise and it nets him $750 more a month, then he can utilize under FHA and aggressive guidelines and have his payment capabilities bumped up to $375. Bruce wondered if they change the front end as generously. Cary said there are actually some limits on the front end, so you have to be careful. About the highest they see get approved on the front end is 46, and this is when somebody has virtually no debt. A 46 over 47 might fly, but a 46 over 56 probably will not. It is either one or the other. If somebody owns something free and clear, he is going to get the chance to be in the mid-40s on just the real estate debt.

Tune in next week as Bruce continues his discussion with Cary Pearce on the Norris Group Real Estate Radio Show and Podcast.

Tags: bruce norris, buyback, Cary Pearce, debt ratio, FHA Loan, Inside Lending newsletter, jumbo loan, portfolio loan, Provident Loans, sales production manager, The Norris Group Real Estate Radio Show
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Sean O’Toole, President of ForeclosureRadar, Joins Bruce Norris on the Real Estate Radio Show #313

Friday, January 18th, 2013

Sean O’Toole

President of ForeclosureRadar

(Full Bio)

Bruce Norris is joined again this week by Sean O’Toole. Sean is the founder and president of ForeclosureRadar.com, one of the finest websites a real estate investor can get involved with on a regular basis. Sean has done an excellent job on the website and put his computer genius to work in the industry, saving a lot of people a lot of money. He has also created competition that did not exist prior to his website by making it easier for people to become very proficient.

What is interesting is that people do not even know how to appreciate it. Bruce remembers watching a blog discussion where somebody was surprised by the mention of $50. Bruce thought to himself, “You have no idea what this business was like prior to this site.” You can absorb $50 in a half hour of time and never even check out 1/100th of the trustee sales since you are on hold. Sean had a customer early on who said they are now in double the number of counties that they were before and laid off two people, saving him $4,000 a month. Sean did not know whether to feel good about saving the money or bad about folks who lost their jobs, creating unemployment in California. This is the dilemma.

Sean’s site is not just a foreclosure website, but it has grown into the short sale referral network also. This will be a big thing for the next couple years as far a lot of properties going this route, even for investors. Short sales continue to be very important as lenders are on board with them pretty much across the board. So finding those opportunities certainly has been a key part of their business to help realtors do this and be a partner with the California Association of Realtors with their business products division. To help realtors with this has definitely been an important part of the business.

Bruce asked if there was anything new on the horizon for the website. Sean said there is, and they have been hard at work for two years. Those who have been regular customers know they really have not released much new in quite a while since they have been hard at work with something big. It is coming now very soon and will be out to their existing customers. They will receive the first peak at it, and hopefully later this month they will start dribbling it out. By spring, everybody should be able to have access.

The California real estate market usually improves when it gets employment to improve. This comeback has been orchestrated by policies that really have not included anything significant in the improvement of unemployment. One of the things Bruce feels pretty comfortable with is when you start having price increases to the extent that you will end up with building starting to pencil again, this is the most important domino. Once this tips over, you actually have a legitimate reason to be optimistic because those dominoes are the traditional ones that cause the comeback. Even if we force feed it to go there, once it goes there it is a big piece of the puzzle for California’s budget problems and migration. There are a lot of good things that happen if we have to build something.

California’s budget problems are primarily driven by unions, but that is a whole different segment. Sean thinks it is possible that we will see some more building. It is like what happened after autos when they got so low and we received all this straight news that they were up 5-10%. However, they were up from nothing to nothing; which is still nothing. We really have nowhere to go but up. In Riverside there was the announcement that construction is up 17%. Bruce looked at the chart, and it actually meant 8 houses. If you have one month of inventory and you have price aggression that starts to pencil, Bruce said he does not know where else inventory will materialize if every other policy is sending it to the sidelines as a rental. Sean said he was really surprised by the 2010 Census because he really expected it was going to show that we had overbuilt throughout California. It really didn’t show that; but it really showed that housing units for most of the state were really on pace with population growth. Certainly in a downturn you get some negative household growth, whether it’s kids moving in with parents or parents moving in with kids, or families, brothers and sisters moving in together to save money. However, Sean thinks we do not have a fundamental overbuilding in California, Merced and a couple other spots being an exception. We are going to need more housing units, and we should absolutely have some construction crew.

One of the things that happens when you have a recession as bad as we have had is you have delayed household growth. You have the 29-year old with the Master’s degree still living in the Irvine third bedroom, making $120 grand a year and still paying off his college loans. Aaron Norris, Bruce’s son, graduated from Irvine with a Master’s degree and was in the group that was single and wanted to be mobile. Last year, 20% of them got married. All of a sudden, the maturity level for that group who had really been delaying all those things joined what was typical, only they did it seven years late. This is another factor in that you do have the echo boom generation wanting to be a household much later in life, but it is actually about to be now that they want to do it. The multi-generational housing is probably not what everybody wants, it’s just what everybody needed to do. You want to say that a lot of these will be reemerging as households, and they don’t have to move anywhere since they are already here.

Bruce looks at a lot of pieces of the puzzle. He knows job creation will kick off after construction, but because of a pent-up pile of buyers coming out of foreclosure and credit damage from three years ago. Bruce said he does not even know if we need an employment increase to have such demand for houses, especially when it is paired with a one to month supply of inventory. This is really the kicker. Bruce said if you gave him six months of inventory, then he would be pretty benign on price increases. You have six months of demand on top of a month’s supply.

Sean is really in the cat-bird seat for information since he is predominantly dealing with people in the buy/sell business. What ends up happening is you get a property when you finally get the eviction done; you start to fix it or put it into the MLS with the phrases that you will fix things, and you receive offers as is that exceed your asking price. A few months later, they exceed any possibility of an appraisal being equal to the offer as is. You then realize some dynamic is going on that hasn’t really existed. This is largely in markets where payments are well below rents. Sean is not really seeing this type of thing except in these very employable areas. It’s a little different in Silicon Valley, but Sean thinks in most other areas where you are seeing a hot demand is where ROIs are above where they should be and payments are below.

Sean also has a service where it extends to Phoenix. Bruce mentioned the hedge funds that showed up in droves, and he wondered if they left the building. Sean said they have, most of them last year. Sean started hearing a lot of people, some of them based in Phoenix, saying they were done there and it no longer fit their profile. One of the predictions Sean has for California in 2013 is we may see the hedge funds move on from certain markets like Sacramento and possibly San Bernardino and Riverside. This will depend on how quickly prices come up compared to rents. Sean thinks they will leave; and when they leave that will certainly dampen the demand. What is interesting about that is one of the things happening when you are a buyer with financing is you can’t get in. It’s not like your needs are being met and you’re done. Rather your needs are not being met and you wait. Sean does not think the players in the market are large enough to be market makers where they are all that matters. If they go away, it would not spell doom for the market.

Bruce asked what percentage of the market is made up of hedge funds since cash sales are about 30%. Bruce wondered if the big people are 3 or 4% and if they would be equivalent to the foreign investor buying things in California. Sean said this is something they have been trying to get a handle on and figure out if they can get a more accurate number. The only thing Sean has currently is anecdotal where you talk to some people who bought 1,000 homes last month, and you think there is ten of this. This is nationwide, so we are still talking single-digit percentages of the market. It sounds like a tremendous impact, and it is a comp. If they are willing to pay something more than everybody else, then it presents a comp that the appraisal world can pay attention to and raises the boat for the other purchasers. These people have also been a market maker for aggression in Phoenix, where they are also market maker’s in the level where the rents decided to stay.

The question is what impact they will have on rents. Sean has heard a couple people say these people are really going to push rents down and be super aggressive. At the end of the day, their job is to push the yield up. They are pretty motivated to push rents up, not the other way. Sean does not think seeing these guys coming in and buying a lot of units means lower rental prices for sure, especially when the position the last market maker can take is exiting all at the same time. Some of these guys have different models. Where we run the biggest risk is that some have a longer term buy/hold than an exit model. They are going to sell back to individuals and single-family buyers. Others plan to package the properties up as a REIT and take public investment in them. As they go to float those REITs, as we should see fairly shortly, if there is not a market for them and they cannot finance them, then they need to exit. This could put a few homes back on the market very quickly in some specific areas they have been focused on. They will need to exit; they will not trickle them out over a long period of time.

A lot of these people are using leverage to acquire these properties to then float as a REIT. That leverage is short-term leverage since they are planning to exit through taking the portfolio public. Bruce was not really sure how long the commitments were that they had, so Bruce wondered how long Sean means by short-term, whether it’s a year or five years. Sean said it’s actually one to two, which is a pretty brief period, especially if anything significant changes to interest rates. In some of these markets, you could go in and buy houses at a ten percent yield. This means given your investment you get 10% of your money back a year. If rent is $2,000 a month and you have expenses of $4,000 a year, that is a $20,000 a year income stream. This is what they are buying; and at 10% you would value that asset at $200,000. If you are willing to take a 10% yield, the house is worth $200.

These people, these market-makers, are coming and saying in these markets where things are selling at a 10, they are only willing to pay a 7. This pushes prices to $285,000, which is pretty big increase. Sean said this is really what they have been seeing. People are coming into the market and have really pushed prices up quickly and are buying cash. Where they create comps, it pushes prices up. At least for some of the people who plan to take the portfolios public, they are hoping to do it more like a 5% return, which values that same asset, that house, at $400,000. When they do this and take this public, it will not actually create a comp in the market. Sean said this is where he thinks if you are buying into this REIT and paying $400,000 for a house that a year ago was worth $200,000 and only got pushed up to $285, it will be interesting to see if these REITS fly and what the repercussions will be.

Affordability is probably still close to all-time highs. In California we have come from $245 grand to $340. We have moved almost $95,000, close to 38%. Yet, the affordability number is the highest Bruce has ever charted. Even though we have had this pretty aggressive price movement, we still have to dole out monthly the least percentage compared to our income. Regarding payment sensitivity, you may feel like there is only so much room for the person to qualify. Bruce wondered where this line is for the lender. Sean said it looks like FHA is going back to a more conservative stance. Even though we are at an all-time affordability, Bruce wondered if the brakes will be applied by the lender on a monthly cost basis. Sean said he does not know, although he does know that Bernanke recently expressed dismay over the fact that they pledged to buy all these mortgage-backed securities, and it has not pushed interest rates further on housing.

Sean definitely thinks we are hitting the bottom end there and that folks realize these rates are probably not sustainable. You look at the $250 to $350 increase, and $250,000 was the median back in 2000 when interest rates were more like 7. Now they are half of this, and we are only at $350. If you were just to look at that in a vacuum, it would say we were underpriced as well as it is a ridiculously low rate. Sean thinks we are seeing now concern about rates in the future and that rates going up in the future are actually holding prices back. If we knew interest rates were going to stay at 3 ½ for thirty years, it might help prices. On the other hand, if we knew rates were going up, in the short term it might help prices since people who rush out get aggressive and purchase something.

Being the investor, Bruce is looking at a window of opportunity and saying that his bet would be we will relive 2004 and 2005 in the next several years. This is because the payment is so ridiculous and interest rates are half of what they were the last time we were at these prices. Bruce is completely concerned about the day that they stop having those interest rates if they do it too late. If we get to a $600 grand median price at a 3% interest rate, that is a problem. If you take a regular 30-year loan and look at $250,000 and 6%, that is a payment of $16.63. Today, if you can get 3.75, that is a payment of $1620 on $350,000. If you think about the payments being flat and incomes being up from 2000, it makes sense that affordability is low. However, it does not necessarily say that the housing market is still strong compared to 2000. Bruce thinks the lenders are going to say yes to people long enough to have a substantial price increase because it does not change the monthly payment to an unbearable number for either the lender or the borrower.

What Bruce is wondering is if someone will break loose with the new policies that always seem to follow price aggression. This was a subprime issue. They were making junk loans, but prices were accelerating and no one was defaulting. Everything looked like an A-paper loan, so when you start having good paper written it seems you will have policies that get somewhat lax and continue this thing. They say history repeats itself, but Sean hopes we are not that stupid to go play this out over again. The Fed seems intent on doing it, so if the Fed is any indication then we’re probably going to blow another big bubble and do this all over again. What is interesting about if we do it this time is we are going to have a $600 grand mortgage with a 6% interest rate. If they go to a 6% mortgage rate and your price goes to $400, you wonder if you will default on your $600 grand mortgage since your payment will be less at $600 than it will be at $400. You may have negative equity, but you have a positive payment.

The folks who want to stay put will probably stay put since there is probably also a low payment versus rent. You will probably stay put and make your payment until you have to move. The one thing that does not change is that life events happen. This could include divorce, job transfers, death. The people who go through these are going to have to move. If 5% of the population moves in a year for these reasons, but they are stuck underwater and with reasonable payments, this could be a problem. This is one of Sean’s problems with the whole loan modification where you leave all the principles outstanding and reduce the payment, the non-principle reduction loan mods. It flies into the face of reality, which is that people have to move. You are kicking the can down the road and spreading out the problem over years and years. However, it does not mean the problem is solved.

Sean thinks some of the policies right now around loan modifications and low interest rates are insuring that we are going to continue to have housing problems and issues, artificial government involvement, and an unhealthy overall market. Hopefully we can land on the right side of it and exit before it is a problem and make some money in the meantime.

Tags: bruce norris, California Association of Realtors, foreclosure, ForeclosureRadar, Phoenix, REIT, ROI, SEAN OTOOLE, short sale, The Norris Group Real Estate Radio Show
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Sean O’Toole, President of ForeclosureRadar, Joins Bruce Norris on the Real Estate Radio Show #312

Friday, January 11th, 2013

Sean O’Toole

President of ForeclosureRadar

(Full Bio)

Bruce Norris is joined this week by Sean O’Toole. Sean is the founder and president of ForeclosureRadar.com, a website that has pretty much revolutionized the trustee sale-buying business.

Bruce wondered if there were any surprises at the end of 2012 Sean was not expecting to happen. Sean said he was expecting foreclosures to drop, which they did more dramatically. Sean was one of the few people who thought they would drop at all since there is always the big glob of something that was supposed to show up in droves that ended up never showing up at all. Sean said many have predicted foreclosure wave after foreclosure wave that have yet to come to fruition that they have still not seen happen. Sean can understand why they would predict it since it probably should happen or should have happened. It’s still not expected to happen since it is a political-driven market rather than an economics and fundamentals-driven market.

Bruce asked Sean if there was some reaction at the the end of the day when you remove foreclosures from the market. He said yes and that there is no question that some removal of so many foreclosures has left a lack of inventory throughout the state, even in areas where you would not expect a lack of inventory. Where there should be a lot of foreclosure activity, instead there is nothing to buy. It has really come about gradually and then increased. Bruce said he looked through the charts, and in the first half of the year it bounced along and was reduced by 20%. All of a sudden, six months ago it made a beeline from six months down to a month in most of the counties in Southern California. Bruce wondered what policy decisions drove this and what Sean’s policy decision for 2013 is that would reverse this trend.

Sean said there were a lot of things coming together, but the biggest thing that changed in 2012 was everyone realizing that yield, the income return from rents on real estate, was more important than price. That led banks to say that maybe they were disposing of things they should not have been or there was a better way to dispose of it or resolve it. This brought in some major new investor players, some that started in 2011 but really got underway in 2012 with large hedge funds coming in and buying up property. Those things conspired to both reduce inventory further and get the banks to question their foreclosure practices and look at other alternatives. This came with the policy decisions around the attorney general’s settlement and the Homeowner Bill of Rights.

A lot happened in 2012, there is no question about that. It seems like not one of the policies was responsible for a bulk of it. It has really been a historic disappearance of things for sale. Going forward, unless they change policies, Bruce feels pretty comfortable that we will have a hard time getting from one month to six months of inventory. However, he does not know where this will originate. Sean said for those predicting it will come from a foreclosure wave, they just have to note that it takes 6+ months for that to happen, and there is no sign of it happening now. The chances of it happening in 2013 are slim-to-none.

Regarding the potential for people still in California, Bruce wondered how many people are 90 days late or in foreclosure. He wondered what numbers of people are in trouble and why this will probably not cause a problem because the policies to be foreclosed on at all. Sean said right now the number of foreclosures is roughly 180-190,000 homes. These either have notices of default outstanding in pre-foreclosure, are scheduled for auction, or they are bank-owned. It is about equal. 60,000 are pre-foreclosure, 66,000 are scheduled for sale, and 62,000 are bank-owned. None of these are terribly scary numbers if they had to deal with them. Sean said they sell 40-50,000 homes a month in California, so even that is not that much inventory.

The bigger issue is the people who are delinquent, which is somewhere around 450,000. A lot of these folks are in the process of a short sale or a loan modification, so some of them may make it into foreclosure while others won’t. Many have been sitting for an awfully long time. The biggest number, however, is the number of people who are underwater, but they seem to be hanging in there and continuing to make their payments. Altogether, it is a quarter of homeowners in California who are either underwater or in trouble already. It’s a terrible housing market if you think about it from a commercial standpoint. Historically, it is an unprecedented number, even if it has improved a ton.

A price increase of about 23% takes care of half of the underwater people. It makes a big difference and also encourages the other half to see that they are almost there and are about to get rewarded for hanging in there. To Bruce, what is important in 2013 is the strength of a price movement really starts solving a lot of these things. Shadow inventory all of a sudden becomes half equity sellers. There is no question in Sean’s mind that Ben Bernanke and the Federal Reserve agree with Bruce and are trying to create an asset bubble to get out of this problem. This will probably ultimately lead to long-term inflation even though they have never said this. It’s the easiest way to solve the problem of too much debt when you take control of your own currency. You devalue, and the debt becomes less because you have pushed asset prices up. Sean thinks it is absolutely the goal of the administration and the Federal Reserve.

Bruce asked Sean if he thinks 2013 will be a fairly significant price movement in California. He said he read Bruce’s prediction of a 20% across-the-board increase, and his only issue with this is he does not think these dynamics are exactly the same throughout the state. This is where he takes some issue with it. Bruce said whenever they do predicting, it was always a discussion on median price, which is an inaccurate number anyways. It is a 20% price movement and will probably include more high dollar sales than 2012. There is a fudge factor there where it makes sense you will end up with more move-up buyers since people are starting to have equity. There are fewer foreclosures at the low end, and the one place they were quick to foreclose was in the lowest end properties. These seemed to be foreclosed on much more quickly than the higher end properties. Having to move up in median because of this is reasonable, and having real price appreciation in areas where payments are significantly below rents in areas such as San Bernardino and Riverside, it makes perfect sense.

It is quite possible we will see a 20% median increase. What he would hate for a listener to take away is this means that their house is going to go up 20% when they could do better or worse. Sean is in Northern California and is familiar with more pricey areas than Bruce is, who lives in the epicenter of foreclosureville. Sean lives in an area that probably has a higher dollar median price by quite a bit. Bruce wondered if he is seeing price firmness or acceleration in these areas. Sean said it is a mixed bag, especially on the peninsula. Here we have a very strong technology market that is moving beyond the social media bubble as it were. Silicon Valley continues to be very strong on the employment front. There are still quite a few winners here financially putting pressure on that area. The Bay Area is very strong, and there is a lot of investment buying when you come into the Central Valley. There is an awful lot of investment buying, and prices are still low compared to rents. However, they are catching up pretty quickly, and he does not know how much room there is here. Sean said he does not expect much appreciation in these areas, and you will have a lot of different pockets. It’s almost hard to say by city since it is almost by areas.

The difficulty in predicting something is there are so many micro markets inside of the picture. Sean feels a lot of the price has been driven by a cap rate mentality that is about to get uninteresting. If you are willing to take prices up because you are willing to take a 7% return while the current market is 8 or 9%, prices will move pretty quickly. You don’t want to get to 7%, unless there is an appetite for 6 or 5%, he does not see any indication of them continuing to move up. Bruce feels pretty strongly that even though the Bull Run has been dominated by the cash buyer, the small guy, medium-sized guy, and giant guy, there is a very big underlying owner-occupant crowd that was foreclosed on in 2008 and 2009. This is now an overwhelming number of people that will carry on the boom even if for no other reason it saves them money monthly over rent.

Sean said he certainly hopes people are smarter than they were in 2004 and 2005. They may be willing to pay a little bit more than rent to have the stability of a home, but we had in some areas returns that were down to 1-2% when you looked at price versus rent. You would be better off putting your money into treasuries. Sean said he just does not see us having the kind of boom that we saw from the end of 2000 to 2006. Sean thinks what we are doing is recovering to where our prices should be, and this is really where prices should be given these artificially low interest rates. We will probably recover to a point where it makes sense given the low interest rates, but not where it would make sense long term. This sets us up for some longer-term challenges. Bruce completely agrees with the longer-term challenges, and he would feel a lot more aggressively comfortable with it getting to that uncomfortable number just because of the unprecedented rates.

Bruce and Sean went back to Washington D.C, did a little research, and saw that the interest rate has just not been seen since the 1900s. This is an unprecedented interest rate, so the question is what unprecedented dominoes fall because of that. Sean said on the one hand the low interest rate for purchases are certainly unprecedented as far back as we could find. On the other hand, Sean’s thoughts on what a reasonable return on investment was on real estate should have been 8-10%. Everyone is up in arms about these hedge funds wanting to come in and accept 7%. Sean does not understand the business, and the people don’t understand how hard it is to rent single-family homes. As we look back to that, even as far back as the 1800s, returns on real estate in the 5-7% range, are far more the norm than 8-10%. This actually made Sean a little bullish than when they showed up in Washington.

Sean mentioned inflation, which Bruce thinks is a very likely outcome. By fixing a payment, if you are talking about a premium today of your payment versus rent, that is one thing. But you are fixing that payment for 30 years. Your renter next door is not going to have that same rental bill ten years from now. This is where the wisdom of the decision kicks in. Sean said the problem he has with this is that the average person believes the Fed when they say we are in for a period of unprecedented low inflation and that inflation is not a problem or a risk. There is not a perceived risk of inflation to push them accept a significantly higher payment. It is up to the point where there is that really truly widespread risk of inflation. This will be offset by rapidly increasing interest rates. Only a handful of folks are smart enough to realize that we have this belief that there is not going to be inflation when in fact this belief is wrong. With these low interest rates, that is a pretty sweet spot that probably will not exist for a long period of time.

Being the normal guy rather than the investor guy, Bruce said he would want to control his own environment and pay premium for it. Whatever premium it is will be whatever the lender will allow him to qualify. It seems there is still a willingness to own something if the lender will loan them the money. Here there is an interesting transformation. Sean has some great charts that showed while prices really progressed, payment was amazingly consistent because the loan programs became so aggressive that the payment did not move very much at least for the first-time guy. We went from the median price of $250 to $550, and you could have the same payment if you were a median income earner in California. You could have the same payment at $250 and $550 six years later.

In a way, you do not have a loan program that is doing that, you have an interest rate doing this. Bruce said this is why he thinks there could be price aggression since never before has a $100 grand price increase meant so little monthly. However, this interest rate has been in place now for some time and will most likely not go dramatically lower over the ne t year. There is no emphasis for it to dramatically change over the next year. Bruce said this will definitely not be the case for interest rates, and Sean thinks this is also true for price. Easier lending will definitely not be a driver behind price increases this year.

Sean said he thinks the primary driver is going to be the two things Bruce touched on earlier in terms of median price. One is the fact that we are going to have a mixed shift to higher-end homes, which does not mean prices did not change at all. It just means the homes that are selling are higher-end because the low-end foreclosures have been going away. It is not a change in price, it is a change in median because of the mix of homes being sold. Sean thinks we have certain areas in the state, possibly half the state at most, where payments are significantly below rents. Those areas will most likely go up to at least match rents if not to have payments exceed rents as they traditionally have.

Bruce said one of the things that he noticed when he looked up loan programs is we will most likely not see anytime soon stated income variety, but we have a very aggressive FHA program in the sense of its available quantity of money. In Riverside it is $500,000, while in the most expensive counties it is in the ballpark of $700,000. We have a $340,000 median price the last time on our way up from the ‘90s when we got to $340,000 at the time when the FHA loan limit was $160. Bruce thinks this is a significant change, and he doesn’t know that we need the subprime world. We have FHA, who wrote the safest book of business ever in 2011 and 2012. They might be allowed to loan to some of these other people that had a foreclosure, even though we already know they will. This is where Bruce is looking at this huge glob of people that could get a loan with a 3 ½% down payment and improve their monthly cost. Even if it is a premium to rent, Bruce thinks they make the decision. We are so far away from this on a monthly basis, and you could have price aggression. 20% of $340 is $68, and if you back this off into a monthly cost, it seems a reasonable number to Bruce.

The only thing on the other side of this is FHA is under a lot of pressure because of their drawing share of the business to tighten their credit requirements and other things to tighten up. There are definitely some in Congress who are worried about the loans that they are making and creating in other bubbles. Whether they will be allowed to this time is the question. This is definitely the big question when we talk about things that matter. If there was an announcement saying that if FHA will now have a loan balance of the median price of California, for Bruce this would be a big uh-oh. Even this month they are making changes to if you have a lower credit score since you now have to have a lower debt-to-income ratio and some other things along those lines. Regarding larger down payments, there are also new changes coming in if you have a lower credit score.

What is interesting is in the credit world, what is starting to happen is you can improve your credit faster. Whoever has changed the rules here used to take 2 ½ years and now takes 9 months. It seems like we are bound and determined that somebody is going to be able to buy a house, and if it takes too long for their credit to improve we should improve it more quickly. If we can’t change it on one end, let’s change it on the other end wherever there is the political will. If you help people fix their credit score faster, then you are helping homeowners. If, on the other hand, you tighten up credit scores you are showing prudence. Prudence does not seem to be the fiscal cliff. The stock market had a big day when we basically completely ignored the fact that we have to at some point cut back.

Tags: bruce norris, California, Federal Reserve, FHA, foreclosure, ForeclosureRadar, inventory, median price, SEAN OTOOLE, The Norris Group Real Estate Radio Show
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Susie Leivas of Leivas Associates Joins Bruce Norris on the Norris Group Real Estate Radio Show #311

Friday, January 4th, 2013

Susie Leivas

Chief Financial Officer with Leivas and Associates

(Full Bio)

Bruce Norris is joined again this week by Susie Leivas. Susie is the CFO of Leivas Associates. She has been doing taxes for Bruce for many years and has gotten a lot of referrals from him and other real estate investors.

Sometimes when they change tax laws, they think something is going to be revenue-positive, and it does not turn out this way. One specific thing was when they changed capital gains to the equivalent of the highest personal rate. This generated way less revenue because these people decided not to sell anything. You have to be careful about this, and this is one of the things you have to consider when discussing the fiscal cliff. They talk about raising taxes and pulling a certain amount of money out of the system at a certain point, it will be revenue negative. You will have more tax per person and less total tax. This is why they have to be careful.

For capital gains, one of the topics that has to be on the chart for them is how we get more revenue. If you are in almost a zero tax bracket and you have a capital gain, it is zero. On the upper end, it is 15%. However, you cannot just say it is 15% because the money ends up on the front of the tax return. This increases adjusted gross income, and everything comes off of adjusted gross income. For some deductions, such as medical, the first 7 ½% of your adjusted gross income does not count. You can’t just say 15% because other things happen on your return when you throw more income on it. It could make your social security become taxable, you could lose some deductions, have alternative minimum tax. When a client asks Susie if they should sell a property or a stock, that requires a consultation. Susie said she is going to run the numbers since an off the top of her head answer is not good enough. This also means extra California tax since there is no capital gain on the state side.

Bruce wondered when social security is taxable and if it varies with age. Susie said it does not vary with age but rather how much money you have. If you are a single person whose total income is under $25,000, that social security is not taxable. However, once you have a pension or a part-time job, this can be taxable. Another thing that really throws it off is gambling. What happens with gambling is you put the winnings on the front of your return, making your income higher. This can then make your social security taxable. You also have to be able to itemize your deductions. Often when someone is not itemizing, they do not receive the deduction for the loss. The moral of the story is if you are going to gamble, gamble little.

Regarding interest deductions, a long time ago we were writing off interest on credit cards. The Holy Grail of interest deductions is the real estate ones, which they keep talking about being changed. It used to be unlimited, then it was changed to $1 million dollars on a residence. It was unlimited on rental properties as long as the money was for the rental property. This will most likely not change, although there has been talk on the residence side. Bruce wondered if second-home deductible interest is still deductible. Susie said this actually goes under the umbrella of $1 million.

Bruce also asked about charity deductions. If you have a basket of deductions that is $25 grand, that could be a very significant thing if it took out charity. Susie said she can’t imagine the lobbyists will allow this to happen. She can see in her practice just with everyone being a little less liquid that where they are making up the difference is they are giving less to charity. This is already a problem, so she can’t imagine this would totally go away. Our economy relies on the nonprofits in a lot of ways, so if the nonprofits really did not have the funds to function and handle a lot of the social things that they do, it would be an expense to the government. Most of this is funded by folks raised by these values. It could be a really low-income family that was raised to tithe 10% and have this value system. There are some folks that make a lot of money and don’t give it away. If you are going to tax people who make all this money, then they are probably not going to have the desire to give the rest of it away.

Bruce and Susie talked off-air about sale of a residence, which Bruce was surprised even existed. He made a phone call to the late Robert Bruss who was the brightest person he knew. Bruce was wondering how many states could ever take advantage of it, so it seemed like lobbyists from five different states tried to sneak it in since it would be helpful to them. It is still in place and will most likely not go away. When you start thinking about it or live in one of the states where it may be possible, it’s not a bad way to go. Susie has some younger folks, some in the construction industry, and she has always shared with them how it would be a lovely way to accumulate wealth tax-free.

The idea is to acquire a home in a decent neighborhood, live in it, fix it up for two years, and sell it. A single person could pocket $250,000, while a married couple could pocket $500,000. In the old days there was a requirement to repurchase, which is not the case now. You can put the money in your pocket tax-free and go repeat the process every two years. In the old days it was a one-time thing, and you had to be 55 or buy a more expensive house. It’s a radical change and why when Bruce looked at it he saw it as a game-changer and a ticket to make a quarter-million dollars a year free. What is interesting is that this is your home and is personal, and not too many people want to move every two years.

One of the things that is facing a fair amount of investors and owner-occupants is they have had short sales. The owner-occupant has been under one set of rules until December 31, and the investor has not been under that same set of rules. Bruce asked Susie if she saw some surprised faces in her tax year when they realized they had a tax bill. Susie said this is usually before the transaction happens that she sees their surprised faces. Susie talks real estate a lot, and was talking about it before a lot of the things happening now even started. She has done some planning before so people can decide if they were going to let something go and what the tax ramifications would be. She would show them what it would require them cash-flow wise to do regards to making payments versus letting it go. There are a couple code sections, although the one for personal residences is too sudden-set. At every seminar she has attended they have talked about this one being extended.

There are two other code sections that can really be used. One is if you can show that you are insolvent to the extent of the debt or filed bankruptcy. These are two options, but unfortunately the investor often is not insolvent when you look at retirement assets recorded in the mix. Typically they don’t want to do bankruptcy, so they are looking at a tax bill. Getting a tax bill you expect is one thing, but getting a tax bill when you are going to go off on your own and do something may require you to have an advisor. Bruce had his first audit when he did not have Susie on his team, and his IRS agent looked at all the things he had done. The agent saw how many properties he had done and thought he must be a dealer. He thought it was a compliment, but later realized this was not a good thing.
Bruce was surprised that a bankruptcy could do away with an IRS lien. Susie said it is not necessarily a lien, but a cancellation of debt. If the debt is included in the bankruptcy, then it does not become taxable. Bruce also wondered if there was any talk about messing with 1031 exchanges, which Susie said she has not heard. This would be nice to be left alone.

Bruce gave an example of you going for a deal to sell your home every two years and exceeding the number. For example, if your house sells for a $400,000 profit, the $250 is free and the $150 is long-term capital gain. We just don’t know right now what long-term capital gain will be. If you are single and over the $200 or married and over the $250, you will have that additional 3.8% on top of your tax rate that looks to be increasing. You really have to make some tax-free income to deal with some of this. This will really be a viable strategy because you know the one bucket that will be taxed to death, so you want to have at least some bucket not get taxed at all. The blended thing is we are back to where we were.

The really important thing about any of the changes is that you usually have to change you game plan, but there at least is usually a game plan to pursue. Bruce wondered if it does not force investments in directions that it would not otherwise go. Susie said the talk in her office is the Roth conversion, which has been talked about for a very long time. Not a lot of people have been taking advantage of this because not too many folks either have the cash flow to pay the tax or are willing and trusting enough to pay the tax. She thinks the IRS really thought they were going to see quite a number of these. She was at a financial conference recently, and the question was raised about how many clients were doing these conversions. Not too many clients are doing these, and then they changed it and asked how many advisors were doing conversions. Not a hand went up, and when they started asking the audience why they weren’t doing it when you can see that it makes sense, there are not too many people who want to give up the money and trust that if they do it will remain non-taxable.

This is a scary sentence since this was the deal, and you really don’t want to think your government can do this to you. Susie said she personally does not feel this way and if you do a ROTH conversion, you will be fined. Every time you hear people talk about Social Security running out of money, this cannot happen. We already know they don’t have any money, so they will just figure it out another way. There is no way to make this fall apart, and Susie said she feels the same way about ROTH. However, Bruce said he has heard these suspicions and sees how this would be a major breach of trust. He would not want to be the person making this decision since this would be basically theft, which you cannot do to too many people without somebody being really unhappy.

Bruce said every year Susie does his taxes there is an odd line that is called alternative minimum tax that sneaks off with some more money for reasons he can’t explain. Susie said the reason for this is it is a lovely little loop. They only want you to get your tax bill so low. Following every deduction legally, if you get too much of a good thing they will still limit you. This is one of the scary things out there on this whole fiscal cliff that needs to be fixed. Every year they have been fixing it to where it has been affecting some people, but not to the extent the law was written. She would imagine they will fix it again, but what is interesting is they have not permanently fixed it. They keep doing this patch work. Everybody thinks they will repair it again, but we will have to see. However, it is not as significant as people think it is. Bruce said in just the last three years he has paid $45,000 to that cause. It really adds up after a while, and there is only so much you can do about it. Bruce does not just pretend to understand the formulas and sit there trying to figure out what he can avoid and why.

Bruce asked if there were any smart year-end tax moves. Susie said it is the opposite of what you have always been told. In all the years, Susie has always told Bruce to put off taking income if he can and pay as many bills now as you can in order to get your taxable income as low as possible. This year is the exception where we are going to do the opposite. She said she would make sure all her clients paid her before December 31, and she will not be aggressive in her spending. One thing business owners might consider if they are in a business that has a lot of equipment, such as a backhoe operator, is that the big piece of equipment still might be a nice idea since we have the bonus depreciation.

The Section 179 is still up in the air, and we don’t know what number it will land on right now for 2012. However, we do know the bonus depreciation is still there. This means you can take 50% of the purchase price and write it off. There is also some bonus depreciation on an automobile, but they would have to do two radio shows just on this topic since it would really depend on how much your vehicle weighs and how much you use it.

Regarding setting aside money when you are trying to retire, Bruce wondered if the rules are going to change. For example, for what he makes right now Bruce could set aside 25%. Susie said the numbers are out and they have all inched up by about $500 as far as the maximum contribution. She does not think they are going to take them away. It would make more sense if they were more aggressive to allow them to fund more. Forget about Social Security and plan for your own retirement. It would make sense for them to put in some additional incentives. For the very low income people, there is a credit to fund their pension plans. She does not know the limit and does not see it too often since it is the lower income client. However, she would think they would incent us to do these things.

When you are working for somebody else, Bruce thought there was a small amount of money, such as a $2500-$7500 maximum. Susie said this applies for a 401k, and this number also changes every year. It is right now in the $15,000 range and has inched up another $500. Bruce has friends who every once in a while talk about setting ¼ million dollars because of their age in a year. It is just like this massive funding of this program late in the game. Once you’re 50 there are catch-up provisions, but it is not that big. This is what they have been telling him, although it does not necessarily mean it’s right. If you are told something wrong by an advisor or even the IRS, you still have liability. If you call the IRS and they tell him to do something wrong, it is still on you. You may be able to get out of the penalty, but you are definitely not getting out of the tax.

Bruce asked how he could set aside money for his grandkids’ education. He wondered how it was not taxable to them and if it was ever deductible to him. There are three easy ways. The most common one right now is the 529 plan. That one is not deductible for Bruce and gets to grow up in their account tax free provided they take the money out for education. The very first one that ever came out was the Covered L IRA. This is another thing that could sunset since when it first came out it was at $500 and was later bumped to $2,000. What some business owners are doing is if you have a child who could actually earn some money from you and do an after school job, it’s earned income and they can open a ROTH. In order to take earnings out without paying a penalty, they have to be 59 ½. However, if you fund a ROTH and don’t get a deduction, you can take your contribution out as long as that ROTH has been opened for five years. Susie said she does have some business owners who are paying their children on a W2, then taking the full amount and putting it into a ROTH.

Bruce wondered about if you come in late in the game when your kids are no longer kids but already in their teens. Susie said you can do this with a 529. The gifting rule is $13,000 a year, which is going to go up with inflation as well. You can take five years of $13,000 and put it into a 529 plan. The beautiful thing about this plan is you stay in control as the owner, but it is off your estate as far as your gross estate.

Tags: bruce norris, capital gains, charity deductions, interest deductions, IRS, Leivas Associates, ROTH, Section 179, social security, Susie Leivas, tax laws, taxes, the norris group, The Norris Group Real Estate Radio Show
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Susie Leivas of Leivas Associates Joins the Norris Group Real Estate Radio Show #310

Friday, December 28th, 2012

Susie Leivas

Chief Financial Officer with Leivas and Associates

(Full Bio)

Bruce Norris is joined this week by Susie Leivas. Susie is the CFO of Leivas Associates. She has been doing taxes since the ripe old age of thirteen, and she just started a new venture in the last year. This new addition to the Leivas family of companies is something she never thought she would do. A man walked into her office who she thought she had a tax appointment with, and he introduced himself as being from H & R Block. He was interested in her becoming a franchise owner. Originally she was not interested, but she decided to give him fifteen minutes of her time. A year later, she is a franchise owner and very happy to be one.

Bruce asked what was different and what assumptions of hers were not correct. Susie said in some regard it is thought of as being for the unsophisticated client and the staff took the basic 60-hour course and became a practitioner. Although this happens on occasion, the additional office they obtained came with a seasoned staff, most of whom had been at H&R Block for over twenty years. Susie took their basic course when she was a junior in high school, where she introduced herself to the new staff. One of the gals in the back raised her hand and said she was her teacher. She was over 80 and had been doing returns for a very long time. Susie really expanded her client base by quite a bit.

That office now does quite a number of those smaller returns, a business Susie never had. Her clients do not come in until the middle to end of February, and they are slammed until the very end. A good number of the clients come in the minute you can file a return, 1200 of which were done by Valentine’s Day by this office. This is half the volume of the returns that they do in a season. This was not a clientele she was used to.

Bruce asked Susie what the length of her day is when she is in full-swing. She tries to get to the gym at least three days a week by 5:30, and then she is in the office after this. She usually does not go home until she is finished since she is booked on the half from nine until about eight. She takes a lunch break but usually not a dinner break, and she does not leave the office until her work is done for the day since she will have a full day the very next day. She is still taking new work assignments at 8:00 and finishing everything else after this. Sleep is usually optional for her during the season, although it is amazing that your body allows you to work this hard and not really require too much.

Bruce asked what was so interesting about this subject. She was a teenager and somehow figuring out that she liked this more than normal junior high and high school things. Her father was in management in the grocery business, and he was building a practice on the side. It got to the point where he needed assistance, and he asked for her help. To have a calculator, typewriter, copy machine, and files at thirteen was something she loved. What was really interesting was back in the day when she was in high school; one of the things that was part of a tax return was income averaging. The old-timers still ask her if they can income average. There was a lot of math involved; and what was really funny about everything was she started doing taxes when they were only using carbon paper before computers. What prompted her to do block was she looked at her thirty-year career, saw she started with carbon paper, and sees how they are now doing electronic filing. The question is what it will look like in the next twenty years considering how far the past thirty years has come.

This makes things a lot easier. Bruce is one of her clients, so when he goes in she can pop up last year’s information or the year before that. She can make different changes, and it is all through the system. Just like in real estate when you do appraising, it is all easier and quicker to do much more. However, if you don’t know what you’re doing, then you are also making mistakes more quickly.

Susie has the title of an enrolled agent, which is a federal designation given by the Internal Revenue Service. A CPA will take a state exam, which lasts two days. In addition to tax, it includes auditing and accounting. The exam that is given by the Internal Revenue Service is two days on tax. It is individual corporate partnership trust and total tax. When you are an enrolled agent, you get to go represent a client if they are being audited. They have the same rights that an attorney or CPA does in front of the Internal Revenue Service.

Bruce wondered what makes an audit more likely, whether it is exaggerating deductions or hiding income. Susie said if you are trying to hide something they know about, then it makes an audit a lot more likely. This is not even an audit, but rather a CP 2000. This is a matching, or the system comparing all the information that it receives on you and compares it to the return you filed. They will give you a chance to dispute it, let you know what was missing from your return and give you the opportunity to let them know whether it is correct or not. Susie had just come from the IRS before the interview, and what really prompted that visit was an economic reality audit. He had a commercial building, so the mortgage interest was posted to the Internal Revenue Service. He also had a home, which had a mortgage, as well as he is a self-employed contractor. It did not look like he made enough money to pay all his bills, so the IRS was very suspicious. The IRS is broke and looking for money, and this would be a good one since they would want to know how he supported himself if he only made $20 grand a year.

Fortunately, the particular client she represented that morning was amazingly detailed. Often when she writes for Bruce’s newsletter, she stresses on bookkeeping. It may sound ridiculous since most people want to talk to her about how to save money on their taxes. However, it really does boil down to being an amazing record-keeper and doing your bookkeeping. In this case, this particular client did do all this. The reason he was able to get through the year with not a lot of profit was he had a windfall from earlier. The money was in his savings, and he was living off of his savings. They were able to prove it; but until you are in audit they don’t know this. Their assumption is if you are self-employed, they are thinking that you are doing stuff under the table.

With audits, you sometimes you go in; but other times they come to the field. Bruce wondered when either one happens. Whether they are in the field or the office, these are often lengthy and often more entities. It is either the partnership or corporation, although occasionally it will be the sole proprietor. Often it is the entities that will come to them, while the individuals and smaller proprietors will ask them to go into the office. What is becoming even more popular is not doing either one of these things; picking out an item or two on the return, and making it a correspondent’s audit. There were a couple in the last year who were specialty contractors, such as a plumber or electrician, and they wanted to see their mileage log or backup for their tools. You are then preparing all the information and mailing it in.

Bruce wondered if the IRS changes gears and target specific categories certain years as opposed to other categories. They do check to see where they think their focus should be. Often it is on the areas where they are expecting fraud. If you see somebody walking through the door with a smaller return, but they have many children they are looking for different credits. The earned income credit has been a big target. On the sole proprietor side, if they are seeing losses, then often they are double checking to make sure it is really a viable business and not a hobby. Bruce wondered how this differentiates from the former, to which Susie said it does not involve time spent but rather doing everything you would do to be a business owner. Do you have a business plan, can you show that in time you will have a profit, or are you conducting yourself in business-like manner? This includes having a separate bank account, doing advertising, having a business license, or doing all the things where you can really show that you are really out to make a profit and not just doing it for fun.

One of the things Bruce talked to her about over the years is that she sees a lot of people and gets the general mood of the participant taxpayer. In 2005 and 2006 everybody was very happy, but 2012 is pretty grim. She is noticing even in the last couple months folks coming back in from falling out of the system. Life was so horrible that they did not file. Being as the state and Feds are broke, they are sending those notices out saying they have not received a return and therefore we are seeing an upswing of people who are doing multi-year.

When you get behind like this, there are no penalties unless you owe taxes. The one thing to keep in mind if you are looking for a refund is you only have three years on the Federal side to get it and four years on the state. If you have something older than this and need to do a refund, you will no longer receive it.

Bruce asked Susie if her year is affected by the people she is sitting in front of. He wondered if it wears her out if everybody else is down and out. She said it is her job to pick them up. The reason she has a successful practice and why people are drawn to her is because she does have a knack for picking people back up and showing the brighter side as well as giving them ideas and pointers on how to fix things.

Bruce asked her what she thinks 2013 will feel like. She said we are all listening to the news, hearing about the fiscal cliff, and we all know in our hearts that taxes will increase. Three things are a given: we will have increased taxes, inflation, and interest rates will increase. These are all a given; it is just a matter of when. Whether people really have a handle on it is debatable. As long as they pass the laws and fix the withholding tables right away to where everybody is paying a little at a time on their paychecks, it is not quite so bad. California just passed Proposition 30, which is a retroactive increase for those in a higher income level. If your income is over $250, that is when you are seeing this. Those folks might be short this year since there was not a withholding to compensate this. This goes all the way back to January 1 of 2012 when taxes were raised and they did not let them know until 11 months later.

Susie goes to school every year to receive the tax update. Bruce thinks this should have been an interesting year since there were some things they don’t know yet. There is a page and a half of things that are likely to sunset by December 31. Everybody has their opinion of what they think will be extended, but really no one knows. This is kind of a big deal because if you are withholding tax, it could be a big mess if you have a large company. You’re one month into the year and realize it is not what you just practiced for a month, and this gets expensive. It is like playing the game of monopoly where you are told the rules as you play. This makes it a little harder for tax planning or even tax advantages at the end of the year. There are a lot of times people make decisions that are better to make now as opposed to next year. However, you are kind of sitting in the dark wondering if this is true or not.

Susie said the basic rule of thumb through almost her entire career was to push off income to next year and accelerate deductions. This is the very first year she is telling her clients to do the opposite. Susie was included in this. When you use a credit card, it is deductible the day you charge it, not the day you pay the credit card company back. Normally on December 31 she is filling up her gas tank and stocking all the supplies on her shelves. However, she is not doing this at this time this year, but rather waiting.

The Bush tax changed when taxes were lowered. Bruce wondered what the categories were that were affected. For one, the Federal rate went down quite a bit from where it was under Reagan. He was the big one who really changed things. The big song and dance was he is leaving tax rates low. This was the year we lost a lot of deductions, including interest. Susie has the feeling this might be the play we see going forward where they won’t frighten people too badly with the actual rate. However, they are going to start chipping away at some of the things we are used to having. Therefore, our taxable income will be higher and we will essentially pay more even though the marketing might be spent a little differently. It won’t feel so bad since we will think our rents will be the same, but we are paying it on more things.

Bruce wondered what changes are definitely in place for next year. Susie said we know about the 3.8% for single folks who make over $200,000 and $250,000 for married couples. That is 3.8% on investment income. This will be Bruce’s folks following him and the net profit of the rental property. Hopefully all his people have positive cash flows. It is the mental income, interest dividend, stock sales, and all the unearned income.

Most likely they will raise the rate from the maximum rate from $36 to $39 with the 3.8% and increase in capital gain on top of this. If you are lucky enough to have this $250 number, Bruce wondered about the number that is not 39.6 on the whole but that is after a certain number. Bruce wondered what this number is and when we pass the lower ramping up until you get to that number where everything afterwards is the biggest number. Susie said she did not know without seeing the chart, but what is happening is the very small rate, 0-10, is gone. It is now 0-15. All the rates are shifting a little, but Bruce is correct in saying you go from one place to another paying $15, and the method of how they do this is the same. However, they are juggling the numbers.

Bruce said he has seen some charts where 40-50% of people pay no income tax, and he wondered if this was true. He asked if the credits were so amazing that they really don’t pay. Susie said it was the beginning clientele she was talking about that comes in January whose income is lower. If they are receiving earned income credit, child credit, education credit, those people will definitely be down to zero and often are.

Bruce wondered how often major changes get changed again. In the years where the apartment business were booming because they could write a lot of things off of their income, things were suddenly changed that changed the whole industry radically for that industry. You can have major changes, and then they can make changes of the changes, constant and unending. Often you will see a big bill, but then you are left with not really understanding what the intent was really. All the interpretive regs then have to be written, and this is really the whole healthcare issue right now. This will start taking effect in a year, and it is going to be based on your 2012 return. When Susie went to a discussion to learn how to become the expert in that area, there is so much they don’t even know. They will feed you what they do know, then your brain kicks into gear and you start asking questions to which you cannot get answers.

It is just like the mortgage industry. They have the Dodd-Frank Act, so they came up with a bill two years ago and still don’t know what it actually means since it does not say anything. They are still arm wrestling over what it does mean. You can see this happening because this fiscal cliff arm wrestling match about increasing revenue by taxes but only raising it on the rich will not be a permanent solution. We’re going to raise it on everyone else, but maybe not this time. You are in for a round of this going on, which is a little tough for people in Susie’s business since it demands constant education.

One tax that has grown over the years is Medicare. This used to be limited to a certain amount of income, and this is not true anymore. If you make a lot of money, you are going to pay the medical tax on that money. The percentage is 1.45% for the employee and employer. If you are self-employed, it is 2.9%. This is significant. When you bring this up, you look at Social Security and see it has that cap of $110,000. This number changes every year. Susie is thinking this is where we are going to see the change. They will either remove or increase this limit substantially to help fund Social Security. The percentage here is 6.2 x2, which is not little. If you are someone who makes $250,000, you need to start panicking. You take the additional firm of the state and some additional Social Security in addition to the 3.8% and the higher tax rate, it is a little scary. You really start thinking you are going to have less of what you make. The people making way less are complaining that we are not making our share, which Bruce said he is having trouble grasping.

Bruce wondered if the Federal Tax Rate is headed to 39.6%. Susie said she can see this, although in prior years it has been way higher. If you look at history, you see this as well as that there have been more deductions. When you look at the rate prior to Reagan it was 80%, but the question is of what number. You don’t want to get to this one because it is pointless.

Tune in next week as Bruce continues his discussion with Susie Leivas in part 2 of the Norris Group Real Estate Radio Show and podcast.

Tags: bruce norris, Dodd-Frank Act, Federal Tax Rate, franchise owner, Internal Revenue Service, Leivas Associates, Susie Leivas, the norris group, The Norris Group Real Estate Radio Show
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John Burns of John Burns Real Estate Consulting Joins the Norris Group Real Estate Radio Show #309

Friday, December 21st, 2012

John Burns

President, John Burns Real Estate Consulting

(Full Bio)

Bruce Norris is joined once again this week by John Burns of John Burns Consulting Services in Orange County.

They had just begun talking on FHA. Bruce wondered how important he views the FHA program for the health of the real estate industry over the next couple years. John said if the mortgage liquidity from FHA had not kicked in 2006 through 2008, there would have been no 80%+ loan-to-value loans made. We also would have seen home prices fall another 10-15%.

California has a $340,000 median price right now. When we were going up the last time and coming off the $97, headed up, and got to $340, the maximum loan in Riverside County for FHA at that time was $160 grand. Now the maximum FHA loan is $500 grand. That is very supportive of the market, yet they are most likely writing the safest paper they have ever written. John has had conversations with them about this, and their 2010, 2011, and 2012 books are performing really well. They are getting the highest insurance premiums ever; and even though they have not changed their policies that much, the banks have voluntarily not made loans to the people who are sub $600. They are going to earn their way out of it.

What is interesting is when you are trying to make policy decisions, a lot of times people are stuck in 2005-2007. They start saying if down payments are not 20%, that is a big problem and is Dodd-Frank’s idea. Sheila Bair is a big proponent of this. Their idea is 80% LTVs to people with $100,000 incomes and 20% debt-to-income ratios are safe loans. This is something with which John does agree. However, we cannot just roll to this overnight as this would kill housing.

Bruce said what is interesting is whenever you look at a performance chart for a portfolio of loans, the safest loan over the last 50 years is a VA no-down borrower. When somebody puts 20% down, they have a huge stake in the property. Then when you look at a chart that says you cannot tell the foreclosure difference up until this last ridiculous downturn where all the loans were stated income. Prior to that segment, you would not be able to tell the foreclosure rate from any program. They were all within 1/8th of a percent. To make a national change that is that radical for no reason is amazing. It is amazing that it gained momentum, and this is still up for grabs. John said he does not think this is really the consensus; the only real consensus in Washington D.C. is that nobody wants to see the housing market collapse. Whatever comes out of the Dodd-Frank when we receive the qualified mortgage and qualified residential mortgage is going to be relatively reasonable. What is absurd is that it has taken them more than two years to define what that is.

There is so much lobbying going on that it is unbelievable. The banks are telling everyone to tell them the rules, and they will play by them. Bruce said he knows they have had input on the rules, and this has been asked by Congress a number of times. Bruce asked John if he feels that Congress has a depth of understanding sufficient to make the correct decision. John said they do not, but he feels that the professionals in D.C. do. The folks at Fannie, Freddie, FHA, the Treasury, and the Fed are very smart people who have studied the issues and know these things. They hear the lobbyists too, but they hear what is reasonable and what is not reasonable. For the most part, most of the decisions that have been made in D.C. during the downturn have been pretty wide. We have really weathered this completely ridiculous five-year period; it’s not really as bad as it could have been.
Bruce asked what kind of mood the builders are in for 2013 and what they expect to happen. John said if you are a publically traded homebuilder, you are for it since your stock is up 150%, which Bruce wondered if this is getting ahead of itself. John said it definitely is, but he has a number of clients who have been buying the builders. What they tell him is to look at is what other industry you can count on to double in volume and be able to raise prices over the next several years. There are not many, and it is almost like a safe harbor investment for them. John said it may go down and he may be way ahead of himself, but at some point he thinks they will justify the current chair price. It is hard for them to choose other industries where they can feel as confident.

Bruce asked where the stock prices are now compared to 2005 and 2006. They are not remotely close to the peak of the fall, and John thinks they are not even halfway there. Bruce asked John where he thinks the market will be a year from now. He does not know which price structure John will mention since there is median price and a Case-Shiller price. However, he did wonder what real price movement we will have, whether it will be a positive movement in California, and if there is any price segment that still could be under pressure. Bruce wondered if there is any residual downward pressure for any price range because of financing being tough to get. John said he does not see any residual pressure downward at all unless we have job losses. You could the see a number of markets take a dip, and there are some pretty heavy defense markets like Colorado Springs that are not doing as well right now. John said they have their own price index since there are not enough of them out there right now.

John said when he rolled up all the markets that he saw having a 5% growth for next year and 6% the year after that, he compared it to the 113 economists that Shiller used to survey who were the most bullish. John said as he and Bruce were discussing, you could build a case that it could be a lot more than that if the economy continues to grow and mortgage rates stay low. Bruce said you do need the interest rates to stay low, but he does not think you need anything to be created job-wise. It is only because we foreclosed on so many people that if even 80% of those people have jobs, the quantity overwhelms the supply. Oddly enough, the question is what we are doing at one month’s supply. Whatever policies we have created has taken the inventory from six to one month, and he does not see any policy that is going to kick it back up to six months. You have maybe 6-8 months demand trying to buy one month of inventory in California. This is usually the problem in a way in that when you are trying to create national policies, you probably have 45 states asking what they are talking about; particularly when you talk about the $500,000 cap on mortgage interest deduction in 45 states that don’t even care. People are looking for where they can get the low-hanging fruit.

Real estate seems to have a few targets, and the one that Bruce said he never understood in the first place was the idea to sell your house every two years and make $500 grand free. First of all, you have to be in the right state for that, and it probably is not even possible for more than a few. Also, you would think this is a lot of money and if it should be under discussion to just forget about it. John said he does not think the money they are playing with is that significant. If they cut the mortgage interest deduction from $1 million down to $500,000, that only raised $5 billion a year for the IRS. They have a $1 trillion problem. He would imagine this tax thing is even less. Losing the mortgage deduction becomes less likely since it is not such a great revenue generator. The lobbyist he is paying the most attention to is what is being discussed the most in D.C. regarding putting a cap on all your deductions, either $25 grand or $35 grand. This seems to be the way they are leaning toward taxing the rich. Bruce wondered if this includes charitable, but John said it does not as this would be a real problem.

AMT is another interesting problem. Bruce looked over the last three years of tax returns, and he has paid $40 grand in AMT tax. This is over and above what the chart proves, but for some reason you are getting too many goodies, so here is your tax bill. They are talking about if they don’t make some of those changes that a lot more millions of people will have a tax bill they had never seen prior. It would have much more of an impact in California too because somebody who makes $150,000 a year in Arkansas is incredibly affluent and doing great. However, a two-income couple in coastal California is an entry-level buyer. It is hard to do these national numbers fairly.

Bruce also asked about Proposition 13. We had an election that was pretty well dominated, so Bruce wondered if this changes the outcome for Prop 13. Bruce wondered if it can now be voted out. John did not know the answer to this, but if it were to change Bruce wondered if it would have a very negative impact. John said if they go to Oregon to assess your property and you pay 1% or more of this, it would have a huge negative impact on older people who have lived in their home for 40 of 50 years on fixed incomes. John said if they do that, he is betting they will exempt those folks. The real benefit of going to property taxes theoretically is to keep a more stable income base, but our home prices go up and down so much John is not sure property taxes are stable either.

Bruce had a well-known economist on the radio show within six months talking about Proposition 13, and he was a big proponent of it changing and taxing certain people. Bruce brought up the older people who would probably not be able to afford their taxes and have to leave their home. He said this is the purpose of reverse mortgages, and Bruce could not believe he would say this. This is not very sensitive, but Bruce thought maybe this is how some people think. John said this is not how the majority thinks, to which Bruce said he would think this would be pretty politically the third rail and something you should not do.

John said the most amazing thing to him about the recent election is the lack of voice in seniors. The ones who are really being penalized with these low interest rates are savers and people in their 60s and 70s who thought they would have 5% interest income per year for the rest of their lives, and they are getting 0.5%. They never spoke up, so who is speaking for them? Bruce said this is a game changer because you then take risk of principle since you are now being aggressive on return. You have to go buy junk bonds and a lot of other things just to get a 7% return.

Cal Poly Pomona had a demographer come in, and he was talking about how radically different construction would be in the future. He was talking about people living in high rise communities in California that you see underway in Irvine. Bruce wondered if this was a true statement or if people always prefer to live in their single-family home. John said this is something you cannot really generalize. Molly Carmichael leads all of their consumer research, and it basically showed there would be a growing percentage of boomers who want to live in some kind of high rise as a retirement style. You will most likely see some growth in this area. The younger generation values their time more than their parents did, so they are going to be less likely to spend two or three hours a day on the road to have a backyard rather than having a small yard and the amenities being with your friends and around your family. John said he does see this as kind of a trend, but he does not see the young people in high rises since they are expensive.

One person in Utah was potentially saying that the family law in California was completely dead. Bruce could barely keep his mouth shut as he was listening to this. He was sitting right next to him before he stood up and started speaking. A very smart person with a PhD certainly believes he is telling the truth since he is out there. However, the PhD does not necessarily mean you know what you are talking about. However, regarding demographics, this is something that plays a big role in the next 20 years. When a builder is looking to build something, the question is if he is really looking at if we have built all the 3-4,000 square foot homes we need and are going to concentrate on another segment.

In coastal California we are seeing a lot of affluent foreigners move in, and if you come from a lot of these countries where it is not as safe to live, the affluent people live in high rises for safety and are more accustomed to this type of living. There is likely some demand here. With the demographics, it is not just the US growing and people have children. There is a lot of immigration coming in from all over the world. Despite our problems, people still believe the United States is one of the best places to live in the world because it is safe, our schools are better than theirs, and our medical system is good. John said he is pretty bullish on immigration, and this is where the builders have been spending a lot of time now because they have been noticing that homes are being built for people like them. Homes are being sold to people of completely different cultures, and we really do not understand it.

Bruce said he remembered John mentioning a builder in Utah not understanding the lay of the land up there and being surprised. You might have multi-generational housing more often in, for example, a Hispanic culture. In the U.S. culture it is weird to live with your parents when in the rest of the world people do want to live with their parents. If you bring up Lennar primarily, they trademarked what is called NextGen Housing where they are building some homes that are really designed for two sets of adults living in the home together but having the same kind of privacy that you might want. This could include your own garage entry or your own little mini kitchen area. It is like a quasi-duplex. It is a bit of a zoning challenge, but if you look in the neighborhoods today, you have to see how many people are living with their parents. This could be a 25-year old living with mom and dad or an 80-year old living with their children.

What is interesting is this is all like shadow household formation. You would probably have a lot of instances where this is an economically-driven decision, not necessarily a lifetime preference. As soon as jobs are created, you will probably have a lot of households emerge from the back bedroom, and maybe they are not being calculated. John said what is interesting is there has been a fair amount of research done, and for the baby boomer the badge of honor was to get out of the house. The echo boomer seems to like their parents more, and vice-versa, so there is an economic reason as well as a good situation. Bruce said he remembers the marriage age for the echo boom generation is around 26 and 28 for a male and female. This is very different from Bruce’s generation when the marrying age was low 20s.

This is what demographers sometimes look at in studying. The people want to be mobile and move where the job market is. They find they want to get married, and then they become just as stable as everyone else. What is surprising to John is the mobility has turned it down, but what has turned it up is two incomes. It is not as easy to pack up and move to Dallas when there are two of you who have to go. It seems to be that single owners would probably represent a pretty health percentage of the marketplace. John said this is true, especially single women. Asking the question about what to build, these would be people who would not want a 3,000 square foot house.

One of John’s former clients specialized in affordable town homes, primarily for single women. They would find placed where a new hospital was going in or a university was expanding, and their business did great. However, it just expanded too fast. Bruce was curious about the builders who went through the last 5-6 years and if the national builders survived better than the local ones. John said they did, although technically it was the public builders who survived better because they had a different debt structure. Private builders have a construction loan on every single asset, and almost every single asset had distress and you had to deal with the bank.

The public builders tended to have big bond offerings that may not be due for four or five with no lien on the asset. They were not being called to the carpet by the bank, and the Federal Government did a lot of bailout programs that were not necessarily intended for the builders. However, they intended to benefit the builders and allow them to go back and capture taxes paid over the last 20 years and put 100s of millions of dollars on each of their balance sheets. Then when interest rates fell, it opened up the debt markets and allows them to get low-cost debt and stick to the maturity for 10-12 years. A different debt structure really saved the public builders.

Bruce wondered if John thinks what we will do in the next four years is a Reagan immigration forgiveness year and say “welcome to the fold.” What would be the most brilliant thing to do would be what Canada does and let those in who have a net worth. Those people are not criminals, don’t take jobs, and start companies. They invest locally, and he believes this would be a good business policy for the United States to allow affluent immigrants easier access.

Bruce asked John where he thinks Fannie and Freddie will be five years from now and if they will be radically changed. John said it would be foolish to radically change them. First of all, they are back making money again. They owe us a lot of money, so why not let them pay us back. They were set up in the 1930 to provide mortgage liquidity in a crisis, and they did this. You certainly would not want to get rid of the ability to have mortgage liquidity in a crisis. They are very efficient at the securitization process, which keeps everybody’s interest rates down. They were mandated by Congress to go get more aggressive high-risk loans in 2004-2007. By doing so, the CEOs at the time were able to line their pockets. If you put the controls in place that this will never happen again, then they should be fine. Politically they may need to be called something else and then maybe they will be broken up the way AT&T was broken up. Then the structure can exist.

Tags: bruce norris, FHA, John Burns, John Burns Real Estate Consulting, NextGen Housing, Proposition 13, The Norris Group Real Estate Radio Show
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Mike Cantu, Tony Alvarez, and Rick Solis Join Bruce Norris on the Real Estate Radio Show #300

Friday, October 19th, 2012

Expert California Investor

(Full Bio)

Investor and REO Mentor

(Full Bio)

Appraiser/Investor

(Full Bio)

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, HousingWire, 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.

Celebrating our 300th radio podcast, Bruce Norris is joined by three special guests. Rick Solis is a very successful investor who flies a little bit below the radar. He is an appraiser, buys trust deeds, and buys properties. Tony Alvarez, who invented the radar, is the REO Mentor and is a very successful buyer and teacher. He works with buying to hold, buying and selling, does wholesaling, and buys currently out of the MLS. Mike Cantu is a very successful property buyer. He has been a developer, landlord, and trainer. He is specialized in talking to clients on the phone and never meeting a soul who he buys houses from.

Rick Solis is currently appraising a lot of properties for loans and rentals. He also gets a bird’s eye view of the areas he is appraising, which is very helpful. He can see trends. Rick said in most of the lower end markets, most of the places he has seen since March when the buying season started have gone up about 1-2% a month. Most of the areas he looks at have less than one month of inventory. If the neighborhood is selling 20 houses a month, for example 240 a year on average, there are less than 20 active listings. He sees every neighborhood from Hesperia, Perris, San Bernardino, Ontario, Glendora, Pasadena. Every area is a month or less, which is about 1/3 of what is normal in a normal average flat market. There is very little for sale. Under a month is almost unprecedented, even in 2005 when everyone was grabbing everything. This is half of normal. In Moreno Valley, the REO agents reported three weeks of inventory. This is 300 normal sales, 200 total listings. One of the problems, for example with dominance in San Bernardino, is 40% of its REO up until now. Riverside is very similar in percentage, only they are not replenishing that inventory. What is representing 40% of your sales is not even going to be a player six months from now.

Bruce also wondered about what he saw in Palmdale and Lancaster. These would have been a dominant REO market just like Riverside was. Tony Alvarez said the inventory has tightened up just as much as everyone else’s. He draws, organizes, and reviews his statistics on a weekly basis, and what he has seen is the differences between what someone was willing to pay at the trustee sales in comparison and what they would pay in the market. If you look at the graph, you see the two lines, and all of a sudden the one from the trustee sale shoots all the way up. It really has been justified. He does not chase deals, but he still spends most of his time creating and nurturing relationships. He lets the guys who get paid to chase deals chase the deals and then call him. This is where they are still getting everything.

Tony said Bruce did something that changed his direction a little. He brought him a statistic that Tony locked in, loaded on, and took it home. From there he changed his direction based on that statistic, which had to do with the percentage of fallouts. Bruce had done it at his crash presentation over a year ago. The fallouts were at 40%, and he went to show the reasons why. Tony said that made his life because all of his attention went from looking at new things, new MLS listings, to scratching this and looking at pending deals. Their margin has taken hits, but still 40-50% of everything that goes into escrow falls out from 1-3 times. They are doing just fine; he does not pay attention to how many listings are coming out but rather keeps focusing on the pending deals. The other benefit is they have those conversations with agents, form relationships, and gain listings they are just about to list that come from all different angles. This could be a short sale or some other problem, and they benefit by being first in line.

They have also been selling. He has had other investors approach him who were willing to buy a vacant house he had for sale for $100 grand. He said he had one that already had a tenant that he kept on keeping for ten years that was already rehabbed. They would be saving themselves a lot of trouble and may pay about $105 for the house. He has been selling some properties that came with a tenant already. He has a hard time doing this sometimes because he really does not want to sell his things, but he has had a couple good offers from the big guns who came into town and wanted to buy everything.

Mike Cantu’s area is more of a stable area than Victorville or Palmdale, although there has been a big change. In the first quarter of this year he did his usual, worked the REOs, short sales, and multiple listings. He has always been a fan of fishing for multiple pawns and has always wanted multiple deal sources in case one of the pawns dried up. Longevity has always been a goal in this business, and this is his 31st year as full-time investor. He wants to have multiple sources of deals and put a big effort in the first quarter of this year with a lot of first A listings and staying in contact with REO agents. The end result was he bought one house, and it was a standard sale probate. He looked at a lot of things, and as he was following up to see what it was actually closing at, he was absolutely amazed. There were a few big hedge funds that came into his market place that really started buying the things that were being publically offered. His deal count this year was right where it normally was, and he had been dealing in the private party arena. This was by far his preferred choice of business because it required a totally different skill set than the things that were publically offered. The publically offered things are a reactive business, not pro-active. A listing comes out, you jump in your truck, you go look at it, do the math on it, and you have to know what it is worth and what the real fix-up on it is.

With all the competition out there, that is a tight market with no room for error. Some of the private party deals he put together this year have been absolutely fantastic. If they had been offered publicly in the multiple listing, there would be an absolute feeding frenzy. With some of the other things he bought, he could not even imagine what it would have ultimately gone for, so there has been a big change. However, as far as months of inventory, every time he is up in an airplane and looks down, he says there are not months of inventory but rather multiple lifetimes of inventory out there. As long as people own houses, there are deals to be made since time and circumstances change all sellers. The private party arena will always be there. Mike has probably done mailers where the mailer will get a call a year later, and you have almost forgotten you did the mailer to that area. You ask yourself when they got it, and sure enough it has been on somebody’s refrigerator for fourteen months. On one property that was in escrow, the letter the person received was four years old. Mike was asked if he was still a buyer, and he told them he would always be a buyer. Mike had mailed another mailer to her at a point between the four years. They had saved one, but Mike kept on proving that he was still active, which is important. There was a deal earlier this year where a man had called Mike’s daughter and secretary and told her Mike had been mailing to him for seventeen years. He had a big stack of letters from him and probably had enough to wallpaper his garage. He said if Mike was still a buyer, then he was finally a seller and to have Mike give him a call. Mike has eliminated the competition because as a trust factor he has been in the same business for a long time, which makes a statement. It is important that there is some longevity to this.

This situation is very similar with some REO agents. The same set of REO agents was in this run as was in the 90s. It is much easier because Mike was already there with them. The agents were calling Bruce just like they were calling Mike asking him if he was still in. They wanted to know that they did not have to reinvent the wheel but rather do it again.

Rick is doing some mailers too, but he does not want to buy 30-40 houses a month. If he buys 1-2 good deals a quarter, he is happy. He jokingly said he was sure the rest of them wanted 30 deals a month, but he does not want that headache. He is only doing it because he sees prices going up. If prices were not going up, he would probably just sit on the sidelines. He is pretty excited that prices are going up.

Bruce wondered what the attitude is of the person receiving the mailer since he has not done a mailer since the downturn. When you mailed in 2000-2005, it was always a happier story. Prices went up, and Bruce said he sometimes does not even know what they had. When you tell the other party you can pay them more than you thought, than you’re happy and they’re happy. Bruce said he would not have wanted to do the mailer in 2008 or 2009 because somebody would have had such a recent pleasant memory of a value, and it is much better now because at least they have gotten four years of negative news about real estate because they probably think they have the worst stick in the world rather than the best. Bruce wondered what the reaction is when the number is what it is and if this is comfortable now. Mike said it all depends. For a lot of people 2008 was a terrible year to mail. Everybody was in denial, but enough years have gone by to where most people are fairly realistic. He had a conversation last Friday with a seller who responded to a mail piece, and Mike asked what the seller’s ballpark opinion was of what the property might be worth. He said he had it in escrow five years prior at $500,000, and it almost closed. Mike made a comment about how he probably wished it had closed and if he had a ballpark opinion of what he thought the place might be worth. His answer was at least half of the $500 grand, to which Mike said that is the most optimistic comment he had heard all year. Bruce said he and Mike both would have handled this with humor; Bruce would have asked if it was worth about $100 now. The fact that he at least acknowledged that it was worth half of that was a good running start for somebody who is at least going to be realistic.

Mike said he had done a little bit of preliminary homework because his client had left a message, and as he called him back he was armed with comps. There was not one single comp that started with a 2. There were some that were less than $100,000, so they went from the high 80s and 90s up to about 200, but they did not quite make it there. He truly was a bubbling optimist at that point. It’s amazing how we have lived through the Great Depression of California real estate and survived. Bruce is not sure when the large buyers started showing up, but he does know that it has been the majority of this year. This was when they started making in roads and plans, and there seems to be new funds. These are staggering numbers. Tony Alvarez said he was asked going back almost two years now if he wanted to participate in putting together a fund. Tony was involved in a hedge fund with the guy who had the largest return, 1200%, in a year named Andrew Lotti. They had discussions, and Tony spoke to an attorney they had. They told him they would like him to get involved and be at the forefront and be their mouthpiece. They wanted Tony to be involved in the acquisitions part of it. He decided to back away from this because he felt for them to succeed, everything had to go perfectly for the returns to really be recognized. A lot of it went back to what they were willing to promise as far as a return. They were extremely optimistic.

Bruce said what is interesting is the returns they were promising then probably no longer have to be promised. Even the returns they are promising are probably optimistic on the same level. In one article two different men were interviewed who were running different hedge funds. One of them said regarding the hedge funds that they are just not overly optimistic, they’re just idiotic. It is not a realistic return. When you are promising to get a 20% return to someone, those funds have high overheads. There is no other way around it; and in addition they try to save money on everything. Tony said he knows some of the inspectors they have hired, and they are just barely knowledgeable about what they are doing. What is interesting is that having been involved in the city of Riverside and in some of the meetings about the foreclosure task force, Bruce said seeing some company coming in and managing it from one location and dealing with all these cities that have their own opinion about how well they are taking care of the property is going to cause some issues.

Tony has sat down and interviewed with some of the people, and they all tend to have proprietary software. They say this is what is going to give them the edge, which is nonsense. What is built into these software packs is the ability to get someone in the field to send the information. However, the ability to transfer information from one point to another when it is inaccurate is worthless. You have proprietary software that can communicate rapidly among people, but you are coming to the wrong conclusions. Something else interesting is how people are having a hard time finding anything to buy. He said he noticed the big hedge funds coming into town way over paying for the inventory out there. He thought to himself they should turn this into lemonade. He has always had the attitude that if you cannot beat them, join them. He had conversations with several agents who represented the hedge funds, and he wanted to find out what their buying criteria was. He went in thinking he was going to sell them items and take a fee out of it. He always wanted to be a small-time operator and only have the income so he can do this life on his terms. He never wanted to be a big hedge fund, so he found out what they did not want. He needed to find out the inventory they were not touching and figure out how he could make it into a niche and exploit it. This was real easy because that was one of the techniques that he used throughout the 90s.

Bruce said he thinks it was really smart at trustee sales when they started becoming the dominant buyers there. This was what his son Greg did. He literally looked at everything they bought for months and came to conclusions. You have to understand the animal before you know how to deal with it. Tony said he really took a great interest in them and did not see them as a problem as much as he tried to figure out how they were going to be an asset to him in his market. They had bought everything that he would never touch. It was not so much that he would have to refocus his attention since it was already where it should have been. If you had described Mike’s ideal rental, these guys were buying the antithesis of this. They were buying the replacement house; they think that in the future somebody is going to build a 3500 square foot house in Palmdale and Lancaster, and we’re going to buy it for less than cost. One of the pieces of criteria that they use in their paperwork is they use the value at the peak of the market and say this is what it is. They are thinking it’s a deal because it is less than cost replacement, but they are not exactly buying the 1400 square foot single-story house. Whether it is 3500 or 2500 square feet, it is just nuts.

When regarding Mike creating his own activity, when he is relying on the MLS it is a problem. You have to fish for multiple pawns, and as long as it is being dominated by the big companies, it is a waste of time. Bruce said their loan business started to reflect things like this. They are still getting short sales because they fall out, but the REO is not getting replaced. Bruce talked to the biggest REO agents, who literally were saying they were not even sure they were going to have the doors open three months from now. They had been told that they were just not going to get it. The new REOs they are mostly seeing are the ones that have taken long evictions. These were not new assignments. Somebody who had 500 listings has five now. This is apparently not in the future. There may be another way to look at the companies. For the things that Mike bought, he does not want to hold it. He wants to exit as soon as possible. Those companies are stimulating demand and increasing property values, and he could care less if they don’t know what they’re doing. He is excited that they are coming in and sucking everything up since he wants to sell his things to them. Once it gets to the magic number, he’s out.

Bruce just wrote a newsletter about price increases that have to be inevitable. You cannot have a month’s supply of inventory with all the other factors going on and without this kicking off. One of the things they have done as sellers since they are usually in escrow with 25 properties is they put them in the MLS. The appraisal is no longer going to determine sale price, but rather it will determine your loan. If you agree to a sale price, then be prepared to bring in the rest, especially when there are 30 buyers lined up to buy. This is a statement of market value, not some appraiser who is under the gun. It is not the appraiser; it is the bank lending the money and making the rules. Their definition of market value is three closed sales. This eliminates any possibility of upside. They have literally had people bring in $25,000 on top of it, and that is a comp. They did not overpay on it. The second it closes, that is the value of the whole neighborhood. Tony said he can rent the house out and make it happen, and this is why he uses two exit strategies. He has to be able to rent it out. He had this on an FHA loan. He said he did not care; either you pony up or move.

One of the things they are doing is when they have people do applications for buying, they take a look at people who have reserved cash since they know this is what is going to happen. Tony said he does not find anything wrong with the hedge funds. If someone can write a big enough check then they can have whatever he has. The one caution he tries to look at is when you look at what they are forecasting for rents, it is right out of the Section 8 website. They are forecasting the highest allowable rent for properties, which out in his area is not reality. If you have a senior citizen sticking his money in one of these hedge funds thinking he is going to get a 20% return on his money, he is going to losing the same thing that made him his money. If the mutual fund salesman guys were out there selling these hedge funds to knowledgeable people and get into something like this, then that is their fault.

Bruce said one problem he does have is if they end up getting special access to inventory that they do not get. He does not want somebody saying they are only going to sell $100 million of notes, which FHA is actually about to do. They are about to sell a big pile of notes every quarter to a very few participants. If it hits the MLS and they want to compete with everybody else, that’s great. However, if they start being able to buy 2500 homes here, $100 million of notes, and it never passes through, then how is this good for employment. These REO agents had staff they had to let go, and it’s just crazy. One of the speakers said he received an email about three weeks ago that said they had 162 vacant houses they were trying to rent out, and the rent prices were top dollar plus about 15%. Maybe we could buy the houses from them eventually. He was sweating five vacants, so it was a little comforting seeing 62 vacants. Hopefully they won’t stub their toes too soon and it instead takes them a year or two to figure things out.

Bruce wondered if you were a land developer and you all of a sudden had a problem with how many of the hedge funds that had $100 million to $1 billion. They all said it would only be about 2-3 years, and that was 6-8 months ago. This is way too early, and they are going to have to change that dynamic. This will change their yield, and we may have some pretty strong price increases. A lot of it will come down to what they are selling to their investors, and a lot of the people who are selling it will be long gone 2-3 years from now and living a different life. They will most likely find a new toy to play with. We might as well create a hedge fund and buy everything from them. They will probably find the single-family needs some more expertise and is not the high-flyer they have advertised it to be. It is kind of a challenging time for people because if they just got in the business in the last four or five years, they do not really have the skill set to talk to people directly. This is a very different skill set.

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.

Tags: appraiser, bruce norris, FHA, hedge funds, inventory, investor, Mike Cantu, MLS, reo, REO mentor, Rick Solis, the norris group, The Norris Group Real Estate Radio Show, Tony Alvarez
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