Real Estate Investing Benchmark

In the 1980′s there was a real estate boom, commercial loans had gone from 7% to 12% of banks total assets in the US. The market went up and then it came down again following its typical cycle and the government had to bail things out. They had to spend over 157 billion dollars to protect borrowers and bank’s assets at that time.

Over two thousand banks and savings and loan associations disappeared between 1986 and 1994. More precisely, 1,043 savings and loan associations and 1,248 banks failed with assets of 726 billion dollars which equates to 1,19 trillion dollars in today’s houses. At that particular time, Congress came up with the idea of creating the Resolution Trust Corporation, a united States Government-owned asset management company charged with liquidating mostly real-estate assets that belonged to savings and loan associations declared insolvent by the Office of Thrift Supervision.

The following video is taken from an event I have just helped organize and the first speaker of the event, George Hurst, of Coldwell Banker Commercial, mentions a particular property out of his memory that was about a 200,000 sq ft regional mall that had been built in 1987 in Hudson Florida, very close to US 19 highway.

It was the size of a Super-Walmart and had been never occupied, sitting on 30 acres of commercial property. RTC disposed of it and sold it to GE Capital Corporation for 650,000 dollars, and there was an investor at that time in Saint Petersburg Florida that was willing to pay 2,6 million dollar for it and that was already a steeply discounted price.

From 1990 onward, commercial real estate became again the popular vehicle of investment for several reasons:

1. the economy was growing and therefore there was an upswing demand for office and retail space
2. regulatory problems in the government had been resolved
3. the restructuring of investment in REIT‘s (Real Estate Investment Trust – a corporation investing in real estate in a way that reduces or eliminates income taxes) increased from 10 billion dollars to 176 billion
4. Wall Street investors and banks found it easy to get into these investment projects with low capital
5. the tax reform of 1986 had dropped taxes from 50% to 28% and brought in low income tax credits, a lot of tax deductions for rental properties
6. the technology bubble exploded in 2001 drove investors back to commercial real estate.

During the real estate boom of mid 2000′s we see the same things happening again: interest-only loans, very lax underwriting standards (it was very easy to get a loan), banks being caught up in the dream that the market prices would rise forever. In 2003 large banks had commercial real estate portfolios equal to 156% of their risk based capital (the amount of capital based on an assessment of risks that a bank should hold to protect customers against adverse developments).

By 2006 that figure was 318%, it had more than doubled in three years in commercial real estate alone. In 2007 we had the crisis of the sub-prime residential mortgages, the bubble began to burst and although the FDIC (Federal Depository Insurance Corporation – it guarantees the safety of deposits in member banks) had already identified commercial real estate as a problem, the main focus was on residential.

Congress created in 2008 the Emergency Economic Stabilization Act and the Trouble Asset Relief Program known as TARP.

Now it is time to tackle the commercial real estate crisis and in the next post we will take a deeper look at it.

Roberto Mazzoni

Commercial Real Estate sales in Florida are down about 80% and in general the commercial investment market is off completely, this is the summary given to us by George Hurst a real estate broker with Coldwell Banker that is specialized in troubled assets during and that delivered the opening speech at seminar we organized recently.

Massive amount of commercial foreclosure coming up.

Transactions of commercial properties that are still occurring are mostly owner occupied or REO’s (bank owned), rents are falling and vacancy rates are increasing considerably; therefore we are going to be suffering from the explosion of bubble that took place in 2005, 2006 and 2007, primarily in 2006.

We are getting into a six year term of increasing foreclosures due to the peculiarities of commercial lending which is usually just for five years, and then you need to renegotiate based on the current performance. Therefore if we simply project from 2006 we see that in 2011 many properties will go in default because unemployment and the consequent decrease of rental income will not allow them to renegotiate their loan effectively.

There are two types of risk that get into play in a situation like the one we are going to experience: credit risk, which means that the reduction of cash flow makes it difficult to service the debt (make the loan payments) and credit contraction associated to an economic downturn which is what we are in right now.

Up to about four years ago, both bankers and developers where caught up in a dream a nobody believed there was going to be an end to the continued increase in prices, but it was just all artificial inflation and it reached an end due to a number of things:

Very lax underwriting standards by banks. In 2007 almost 60% of commercial loans granted were interest-only, so you paid only the interest without repaying the principal.

Faulty appraisals just like in residential.

Now these loans are coming for review in a few months and it is very likely that the bank will refinance only 60% of the new value which means much less than the currently outstanding balance. Do you think that the owners will bring cash to the table just to keep the loan going on a property that continues to devaluate: very unlikely.

So a major wave of foreclosures is likely to happen, but it will follow patterns that will be quite different from the residential world and will find out more about that in the next articles inspired by this special seminar.

Roberto Mazzoni

Concentrated as we are in selling a specific house or “making a deal” in our own market, we easily lose sight of the major factors that can make all the difference between fighting every day for a result and growing an healthy real estate business. Real estate is local by definition and therefore you need to know your backyard well or you need to have means to cover multiple markets by serving a specific type of client. In the last couple of days I have met a Realtor who is specialized in dealing with customers from Australia and who has managed with his firm to close one deal a day in the last few weeks and there seems no end in the supply of cash he is getting from overseas.

Capital flow is a key factor in US real estate right now.

He did a very good work in creating the relationship of course and is very diligent in procuring the types of properties that his clients ask from him, but would you like to be in his same position? Well you need to be familiar with the global forces that impact your local market and that can dictate whether you should stay there or change market altogether.

The first and foremost of this force is called “capital flow” and it is intimately connected with international real estate. Capital flow is not only currency exchange and the transferring of cash from one nation to another in order to buy goods, it can also involve the transfer of assets, capital goods (machinery or goods used in producing something else), debt and credit.

Therefore we see India, that has been receiving a very strong flow of capital from the US for outsourcing activities, that is now sending some of this cash back to the US purchasing cash flow producing properties at a discount price. We also see international investors purchasing notes (debt) or Canadian investors leveraging credit in their own country, that gives loans at only 2.5 % of interest, and use it to buy cash deals in the US.

North American real estate is for sale and somebody is definitely going to buy it at very discounted prices as a long or short term investment using strong currencies or even better weak currencies that get converted into dollars.

According to a research published by the Association of Foreign Investors in Real Estate, the United States are the country that today offers the most stable and secure real estate investment environment:

http://www.afire.org/foreign_data/2009/3.shtm

Of course you must know what you are doing otherwise you will still lose money, and that’s why you should combine your local market or multi-market knowledge with attention to capital flow forces around you to become the specialist that is able to direct them and profit from them.

Roberto Mazzoni

Today I have begun my formal training as a CIPS (Certified International Property Specialist) which is the official US designation for Realtor that are specialized in dealing with transactions that involve foreigners and that can also involve properties abroad. There area about two thousand professionals with the CIPS designation throughout the world and therefore I am getting ready to join a very selected group.

One of the first key elements that I have discovered and that I want to share with you is the importance of the Corruption Perception Index is securing the trust of your potential buyer or investor. It evaluates the desirability of a whole nation as an investment platform so it is obviously the first thing the potential investor would consider before even deciding on which property to invest.

As a matter of fact, the first hurdle I have to overcome when talking to my Italian investors is convincing them that the US is a safe place for their money and that they will be able to get their profit back once the project is completed successfully or that they will be able to continue to enjoy the property they have bought for long time to come.

But now I have a new tool that I can use: the Corruption Perceptions Index calculated and published by Transparency International, a non profit organization located in Berlin that calculates every year a sort “transparency vote” for 180 nations, combining different factors like the behavior of government, the ease to conduct business or transactions, the availability of public information and so on.

The United States are classified at position 19 with a 7.5 score, as compared to New Zealand that scores at the top with 9.4 and Somalia with 1.1 at the very bottom. The vast majority of countries score below 5, like for example Italy is placed at position 63 with a score of 4.3. The UK and Germany are respectively at position 17 and 14.

The strength of the US is that it provides a very solid protection on property rights and often very transparent information on past transactions and the market and the overall perception is improving since it has climbed one position since 2006: from 20 to 19, despite the real estate bubble.

So this index can be used effectively to enlighten investors who maybe are thinking in putting their money in some other emerging markets or that reluctant in crossing the ocean.

Roberto Mazzoni

Banks have become much stricter about appraisals and loan values. Now you really need to be in the know for being able to sell your house for what is really worth and not become a victim of a low ball appraisal that will kill your sale and prevent your potential buyer from getting financing.
Aside from a general tendency in reducing values and incorporating bank repossessed houses into the market evaluation formula, appraisers have now different guidelines to follow in establishing the “real” value of a property and therefore steering underwriters towards an approval or a denial of the loan.

Evaluating houses is becoming more challenging.

I have been recently at an official meeting of my Realtor’s organization in Florida and I have gotten a very detailed explanation from a major bank underwriter of the criteria he follows in establishing whether an appraisal is good and in deciding about every single loan application that comes to his desk.

The first idea he as in mind when he evaluates a case is that the house could come back as an REO (bank owned property) and therefore the current trend in REO properties on that specific market and neighborhood is very relevant. Not only the values of recent REO sales are taken into account, but also the tie it took for those properties to sell and any peculiarity in their location.

For example, houses on a very busy street that contains mixed residential and commercial building are very unlikely to get a loan since the bank already knows that they will be very difficult to sell. They they consider four key factors in establishing the correct value:

1)The comparable sales must not be older than 90 days. If you have comps that are 6 months old or even one year old, you are in bad shape and it is very likely they won’t be considered at all and a new evaluation will be asked or the application will be denied.

2)In order to be considered a real comparable, the sold property must have a size (square feet) that is very close to the subject property: usually between plus or minus 10%. It is actually advisable to have comparables that are a bit bigger or a bit smaller (an approach technically called “braketing”) but you should stay within the 10% variation.

3)Room counts and bathroom counts must be equal. The bank will not consider a 2 bedroom/1 bathroom house as a valid comparable for a 3 bedrooms / 2 bathrooms. A 3/1 could do.

4)Distance is a bit more flexible than before. The usual role used to be that you searched for comparable properties within 1 mile radius from the subject; but now that you need to be much stricter on the square footage and the room/bathroom count, they will allow you to stretch up to 2 miles and, in some rare case, up to 4 miles. This is particularly true when you have very peculiar houses, like water front mansions, and you need to travel some distance to find something really comparable.

Age or effective age (the rejuvenating of a property due to rehabbing) are not very important and the presence of other peculiar amenities, like inlaw apartments (small dwelling units separated from the main house), are usually disregarded in the overall evaluation.

These rules are both important for investors, that now need to consider them when acquiring a property to rehab, for sellers that need to establish a reasonable value for the home, for buyers that need to make sure they can be financed, for appraisers that need to play by this tune if they want to keep their job and for brokers or Realtors that have to improve their evaluation skills to not lose sales.

Roberto Mazzoni

In a previous article I have already reported that Llenrock Group counts on international real estate funds to come to the rescue and this might very well be the case (see “International Investors Coming to Rescue the US”). But what does this mean to you? If so many banks collapse all at the same time, many businesses will also go due to the lack of financing to support them and the market will spiral further.

Small community banks are at risk due to the coming commercial foreclosure wave.

And the main problem won’t be with the big office buildings, but rather with the small office and apartment buildings or the small strip malls. So we need to facilitate a solution by directing any small commercial property owner that is facing foreclosure, and they are going to be many, to the right sources to solve their situations in an orderly and timely fashion.

This might include loan modification, short sale or partnering with a domestic or an international real estate investor who can help them get refinanced and survive, in exchange of equity. You can direct people to this blog that will keep them informed of the options they have and the way to use them. And you will have made a big service to yourself and to your community.

Roberto Mazzoni

P.S. The commercial real estate foreclosure wave is something we can deal with. Refer anybody you know might be in trouble or interested in becoming a solution provider to the MEETUP we are holding in Tampa on June 9.

What is the basic formula of success in commercial real estate investing when you are looking to attract local or international real estate investors? The properties you are looking to acquire should have multiple rental income streams but should not have a business connected with them. It is that simple.

Commercial buildings are more attractive when they don't require managing a business.

Let’s make an example: an office building that rents space to individual companies offers a pure rental return potential, you can rent the premises, you can rent the use of some common spaces (like conference rooms), you can rent equipment. You can offer an excellent level of service to your tenants by improving the premises and keeping the basic systems always operational (air conditioning, heat, and so on) but you don’t need to deal with a centralized reception or the office support staff that some companies provide as part of the rental service.

The management of the staff connected with the additional services prevents any standardization of the management activity. If you are acquiring, managing and turning around more than one property you need to standardize the type of services you provide so to make them less expensive and more effective.

But why rent and not just a straight flip? You lose most of the gain potential or you leave it to the next investor. Let’s take an example from a different market. Wayne Huizenga is the only man to have built three Fortune 500 companies practically from scratch: Waste Management, Blockbuster Entertainment e AutoNation. He began as the owner of a small garbage collecting firm and he built it to the national level by acquiring 133 other similar small companies, he then took over Blockbuster and AutoNation and expanded them big time and sold all of them for billions in profit.

The basic formula of his success was to find service based industries where he could create a recurring income and provide a higher level of services in areas where the existing industries were not meeting customer needs. So if you acquire a distressed commercial property you can remedy the management mistakes of the previous owner while you create cash flow for yourself and your investors and then you turn the project around in 18 months time and sell or refinance for a major profit.

Another example of good and bad: a standard apartment building that has just tenants in them is a simple enough operation to standardize and keep efficient for an investor. An hotel, even if partially converted into an apartment building, is a totally different scenario. If you acquire an hotel you now have to manage the hotel business in addition to the real estate and it can get quite complex. The potential of profit can be much higher, but also the risk increases in proportion. You will be absorbed by the project fully for a couple of years and you won’t be able to do much more.

So recurring income and standardization of services and “brand” are the way to go in the current commercial real estate scenario, whether you are an investor or you are looking for deals to bring to an investor.

Roberto Mazzoni

P.S. If you want to get street-smart information on how to find and evaluate commercial deals join my MEETUP and come to our meeting on June 9th.

Foreclosures are the main focus for real estate investment activities both in residential and commercial. They allow to garner significant benefits from acquiring a distressed property at a very discounted price and turning it over so that it regains most of its current value and yielding a substantial return in the process.

Commercial foreclosures bear an important difference from residential in that they offer two main ways of changing the value: fix what is broken (just as in residential) or change the property use (which is usually not an option in residential. This doubles the exit strategies and the earning potential.

As far as fix what is broken is concerned, you can rehab the property, bringing value to the actual structure, or you can improve its management and its marketing presence. When “flipping” a house, you can only work on the house itself, with some cosmetic or maybe even some serious rehab work (like replacing the A/C or redoing the the roof and so on).

On a commercial property you can fix the property inside but usually you get the best return by “massaging” it from a management perspective: improving the service to your tenants (office or apartments), increasing rent, reducing maintenance costs, improving the marketing efforts and thereby reducing vacancies.

You have therefore much more latitude of action so to bring about a substantial change in value but you also need to have the experience to produce such a result. It is all very fine to “flip” commercial properties just on a wholesaling basis: you find a deal and negotiate it down to a certain price and then sell it immediately to somebody else for an higher price, but still you must know what your final buyer would need in order to provide her a good deal that will also make you money.

And you must be able to understand the need of the seller and become a problem solver for her as well. Look first of all for problem properties: those that need repair or those which are vacant, as they will be acquired at much lower price than pristine properties going in foreclosure.

Remember, you always have two exit strategies possible: bringing the property back to a workable condition or changing its use altogether. Even if you might not be an expert in this field, your final investor will know what to do if you bring her a good deal. And a good deal is measured not only by the price but also by the terms for that price. There is a saying: “You can always get your price if I can get my terms”.

Commercial foreclosure is a “problem solving business” and you’ll be working with sellers that are sophisticated enough to understand the value of a solution when they see one. So look for properties that are in bad shape and start working for them. One word of caution: avoiding hotels in Florida, the market is just plummeting and it often takes a super-hero for turning them around. Small office and apartment buildings, small strip malls should be your main focus.

Roberto Mazzoni

P.S. If you want to know more on how to look for deals that can make a big payday, join our Meetup group.

I have reviewed the traffic statistics of my blog and there are 5 articles that have gathered the most attention of my readers in the last few weeks.

Picking the best for you.

Here they are in the order of preference expressed by the readers themselves:

Selling a Home in 21 Days

Which provides practical suggestions for a very needed ability, today.

The top six mistakes in social media

A nice summary of the most common errors people face while dealing with this fascinating new world.

Being captured by the third tribe

An introduction to a completely new way of doing marketing, which is much closer to the spirit of a blogger like I am.

Learning from a magazine publisher

The best advices I have gathered in a long time.

The top ten sites for real estate investing

This is very recent and comes from detailed research I did on the subject, which gives a very complete description of the various different approaches.

Roberto Mazzoni

Real estate investing in the residential market has been counting on many buyers getting financing from the Federal Housing Administration also known as FHA. It is the best and only program available for first home buyers that have some credit and little money to bring as a down payment for the house. I have personally sold most of the houses I have rehabbed to FHA buyers.

FHA can now stop a lender if there are signs of fraud.

Few days ago the House Financial Service Committee has approved legislation so to enable FHA to continue in providing loans even after the financial reserves that the federal agency has to maintain by law have fallen below the minimum level (2%) due to the high number of defaults on loans insured by FHA.

In a nutshell: the FHA will charge more fees that will be distributed during the life of the loan, it will be able to punish lenders that are guilty of fraud, will maintain the current low down payment (3.5%). You can read a more detailed article here by Bryan Hellis.

This new legislation shows a definite effort on the part of the current government to give people a house they can own, with a very little down payment and with a distribution in time of the initial costs that won’t have to be paid all upfront. The good news is that the bread and butter residential housing market is going to stay, the bad news is that we still don’t know how effective the new legislation will be at preventing foreclosures.

Roberto Mazzoni

P.S. Remember that a new Meetup has started in Tampa Bay and will provide the only free available information on commercial foreclosures in the area. Join now!