The last couple months or so I’ve been having some interesting, sometimes funny, sometimes very lively conversations with some pretty knowledgeable people. They come from all over the country. Both genders. Over 70, under 30, and everything in between. Two had experience with Fannie/Freddie — one with each, and both impressively high on the regional pecking order in their area.
I asked all of the The Question: If you were King how would you go about healing our real estate problem?
Caveat — Told ‘em not to take the concept of ‘King’ literally. Within the fabric of what’s possible in our political/economic system. In other words, the had to be realistic — more or less.
I won’t go through the whole laundry list of their suggestions, or as one lady put it, her fixes. Some ideas were beginning to sound pretty solid ’till they kept talking. Wow, what some folks think is possible boggles the mind.
One guy though was like listening to my own thoughts on the subject, which of course led me to conclude he was no doubt on to somethin’. 
If he wants to ID himself he welcome to, but I didn’t feel comfortable doing it myself.
I’ll keep him anonymous as I don’t wish either to embarrass him or violate his professional privacy.
I’ve been thinkin’ this for awhile now. Here’s what we both thought would work. And no fair being disappointed when you see how simple it’d be to execute. This problem’s genesis isn’t akin to figuring out the final answer to whether or not we’ve ever been visited by aliens.
Here’s what I’ve been thinkin’ for quite awhile now. It’s so simple, so doable, and so easy to execute as to be maddening. In fact, I’ll go a giant step down the road. There are vast amounts of what I now refer to as ‘Hostage Equity’. That equity investors would love to exchange, tax deferred into much more property, but due to the above mentioned limitations, they simply don’t have the option. No loans — no tax deferred exchanges.
First we expand FHA loans to investors. 10% down payments minimum — and absolutely no negative cash flow allowed. The down payment would rise ’till the underwriter agrees the property would be paying for itself with market rents, reasonable operating expenses, and vacancy rates. But there are plenty of small income properties around the country that would easily cash flow with only 10% down. The underwriting itself would be stringent but not blood sucking in nature. In other words, the property and the investor/borrower qualify using reasonable standards — or no loan. The interest rate would be 4.5% fixed for 30 years, plus mortgage insurance if the down payment is less than 20%.
Second, and maybe even more critical, is the lifting of Fannie/Freddie’s silly, arbitrary limit on the number of loans an investor can have. Four? Are they seriously thinking they’re helping with that policy? It’s like the well meaning folks in charge of the then infant Federal Reserve, in response to the crash of 1929, who decided higher interest rates and a depressed money supply was the cure. What? No leaches? That worked out well, didn’t it now?
There should be no artificial limit to investor loans period. Some of these policies are just plain stoopid.
Let’s use an example of how this policy is impacting the nation’s lending problem not to mention the unsold supply of very salable property.
How ’bout a couple with half a million in cash, massive liquid reserves, mid-700′s for credit scores, and a hankerin’ to buy a bunch of income property? Problem is they already own their own home. Strike one. They still own their first ever home too, having kept it as a rental. Strike two. Finally, eight years ago they bought a couple duplexes as part of the Plan to grow their capital. Strike three — and they’ve not even grabbed a bat and left the dugout yet. They lose — the sellers of several income properties lose — the lender hasn’t made several solid loans (and received the fees) — and the taxpayer will surely end up holding the bag for much of the unsold property.
Sound ridiculous? Of course it does. I deal with this Keystone Kop Krappola daily.
Now let’s explore what they’d be able to do if my plan was in play.
They’d be buyin’ $2-3 Million in investment property in all the right places. They’d have $30-50,000 in completely tax sheltered before tax cash flow. $60-100,000+ in yearly depreciation. Not to mention the capital growth as real estate markets emerge from this correction as they always have and always will.
‘Course it’d be sooner if they’d adopt this plan.
If we go all Solomon on ourselves and slice it down the middle, they’d acquire $2.5 Million in property. This would mean, using a few of the growth regions I currently favor, that 10-12 pieces of real estate that have been sitting around bolluxing up the economic scenery, would now be in solid productive use. They wouldn’t be vacant, ‘cuz there’d now be a family living in them. The lender(s) would have, give or take, a couple million bucks out makin’ them a profit instead of gathering mold on their books. Their bottom lines would look a whole lot sexier too. Duh.
Others would see what’s possible and do the same. There are literally thousands of real estate investors, big, small, and tweeners, who’d love to be able to acquire more real estate while the gettin’s hot. But they’re stopped before they get outa the starting blocks because either they can’t find a lender in the area, (Hellllllo FHA) OR they’re too successful as real estate investors and, golly Aunt Bea, we don’t want that, right? After all, who do those thousands of investors think they are anyway — Americans investing for their retirement? Guess they should be waiting on all that money they’ve been makin’ with their 401(k)’s, right? (Ouch!)
FHA is beggin’ folks to borrow money with only 3.5% down payments, and credit scores of under 680, but our example investors can’t buy more units ‘cuz they’ve already proven themselves to be solid citizens and great risks? Do the math. My plan would have investors with about 3-6 times the ‘skin’ in the game as the folks FHA is wooing. Am I the only one waiting for Rod Serling to begin his narration?
What’s the government gonna think of next, indoor plumbing?
The Einsteins who’ve saddled us with this ridiculous and artificial loan limitation, just won’t learn what Grandma taught me so many moons ago. I liked it so much it’s become my favorite axiom.
BawldGuy Axiom: About the time the farmer got the old mare to work without eatin’, she died.
It’s funny, but it’s not, is it? How long before those in charge show up for work one day and find the old mare layin’ in the field — cold, stiff, and very dead.
OK, enough. I’m confident this approach would begin working almost overnight. Will it happen? Not if somebody tells the government yahoos in charge how much sense it makes. So, everybody, ‘mum’s’ the work, OK? Cool.
Think your ready to make a move? Been wondering if you and I should talk? Stop wonderin’ and start clickin’. The Contact BawldGuy button’s there so we can get together easy as pie. Have a good one.
Related posts:
- How Does The Real Estate Investor Know When It’s Time To Make The Next Move?
- What’s Up In Texas? We Are — It’s Boots On The Ground Time Again + A Seminar
- Realizing Big Time Capital Gain — Payin’ Little Or No Taxes — How He Do Dat?
- 10 Ways Real Estate Investors Can Ensure An Abundant Retirement
- The First Time Real Estate Investor: A Chronology — Part III
About BawldGuy
The simpler approach would be to eliminate the capital gains tax on any property bought in 2009, 2010, and 2011. That would be enough to motivate a lot of snall investors and other folks sitting on the fence to buy.
Getting FHA involved is cumbersome and unnecessary. The arbitrary conforming loan limit should be removed and stricter standards for borrowing applied in place of the limit. Did dropping the loan limit from 10 to 4 stop any of the speculation? Of course not. Most of the people that bought “investments” at the market peak did not have four other properties nor did they any idea what they were doing.
I thought the real estate “growth areas” you favor do not have an oversupply of inventory. If that’s the case, buying investments in those markets does not require stimulation. Letting the FHA nose into the tent might create too much demand. And we all know where too much short term demand leads.
Investor — Thanks for your thoughts.
Bringing FHA into the picture isn’t cumbersome at all, as they’ve been loaning money on the very properties of which I speak for generations. Unnecessary? Only if you want to believe there are enough lenders out there making loans now. Hardly the case.
What did or didn’t happen when the limits were moved from 10 to 4 is hardly relevant here. The virgin speculators you speak of aren’t in today’s mix. Experienced investors are however, and they’re being blocked, a point with which you apparently agree.
Your point regarding areas I favor is excellent. But it assumes monster facts not in evidence, primary of which is that most people still insist upon remaining in their local market. For instance, there are still inexplicably large numbers who can’t be talked out of buying income properties in areas like Palo Alto, or the Bay Area in general.
Eliminating the capital gains tax would be spectacularly helpful, another point on which we agree wholeheartedly. We both know that just ain’t gonna happen in at least the next four years. In fact, it could be going up.
We disagree on what the consequences would be if my plan was implemented. The feds are already slamming interest rates down as they scoop up MBS. All my plan would do is allow the process to take place more rapidly. Also, do you want more properties bought with 3.5% down, or 10-20%? Do you want the credit scores to be what I suggested along with the strengthened underwriting, or scores in the mid 600′s with relatively relaxed standards?
Homeowners simply cannot compete with the capital investors can bring to the table, nor can they bring the underwriting horsepower.
Finally, if you and I are lenders, to whom would we rather make a real estate loan? A silly rhetorical question, but one begging to be asked nonetheless. Lenders prefer higher scores, more experience, and most of all more skin in the game when it comes to borrowers.
Again, thanks for your thoughts, they’re much appreciated.
Sounds like to me your old homily that “lenders lend, that what they do” is taking a beating. Are lenders really turning down investor owned properties where the borrower has 700 scores and putting down enough to cash flow?
Or do they just punish these folks with a higher interest rate?
Because my inclination is to not have a government program designed to help folks buy a primary residence be used for anything else. In my opinion real estate investing already has much incentives built in to overcome having to pay a slightly larger interest rate?
But of course, it all depends upon underwriting that knows what it is doing as opposed to computers that only follow a matrix. Bring back the art of underwriting!
David — Lenders still lend — unless Big Brother puts in artificial limits handcuffing them. That’s what the limits are doing in a very literal sense.
Baseball teams wanna play ball, but when you take all their equipment, then lock the field up, there won’t be any baseball regardless of the players’ desire.
Since FHA isn’t making loans but insuring them, this allows private sector lenders a bit more security/cover, while making loans far safer than the typical FHA insured loan.
You and I are singing from the same songbook when it comes to underwriting.
Nice job. Thank you! The good people are being hurt by this. Fannie mae now says that a borrower can have no more than 4 financed properties at one time. Even if you have 800 credit scores and are putting down 50%. Out of luck.
Newton Ranch — Thanks more bring more evidence to the party. Much appreciated. And don’t be a stranger, OK?
FHA has a very specific job, and that is to get owner occupant buyers who would otherwise not qualify into homes. The insurance motivates lenders to lend to borrowers to whom they might otherwise choose not to lend. Over the years, FHA has done a good job and in a stable, non-speculative market, the insurance functions very well.
I personally would rather own rentals in stable neighborhoods predominately populated by owner-occupants. In a stable market with affordable houses, FHA loans with minimal down payments work very well and these buyers are not huge default risks. The FHA has done a great job in creating and stabilizing working class and middle class neighborhoods all over the country. These are the neighborhoods I want to buy in.
We have seen in Phoenix what happens to neighborhoods and even entire cities when unknowledgeable investors pile in and buy everything. Just look at Queen Creek or Maricopa. I think a wholesale extension of FHA loans to investors would just create these pockets somewhere else where the pro forma cash flow met the underwriting standards.
Lenders don’t really care who they lend to any longer, as long as the loan can be insured and sold. They have no responsibility once the loan is sold, so they have no motivation to do anything other than follow the GSE checklist. They will lend 105 percent to someone with a 450 credit score if they can sell the loan without recourse. I completely agree stronger underwriting standards imposed by the buyers or guarantors of the paper should be part of the investment loan criteria, whoever is lending or insuring.
Solving the excess inventory problem can be done more smoothly by encouraging lending to a variety of buyers. I wholeheartedly agree the arbitrary loan limit should be dropped. It never did anything to solve the speculation problem, and it is an impediment to clearing the inventory in today’s market. Eliminating the loan limit, and requiring the GSE’s (or GOE’s – government OWNED enterprises today) to buy properly underwritten (as in to your proposed standards) investor paper will encourage investors to buy. Owner occupant buyers can receive additional help through FHA.
While we all expected the Obama administration and the Democratic congress to raise taxes, it appears tax increases will be off the table for now. From what has been circulated, it looks like tax CUTS will be used to stimulate the economy. It may not be under consideration today, but I don’t agree a temporary capital gains tax suspension is impossible. I would bet all methods of clearing the excess inventory will be discussed and modeled, including a capital gains tax cut or suspension.
Finally, I don’t agree with your statement that most investors won’t leave their local market. Here in the Bay Area, the purchase of local residential investments is dominated by folks from cultures that think about wealth and cash flow for the next generation and beyond. Locations near where they live, work and feel comfortable are of tantamount importance to these investors. However, many more investors are willing to go outside the Bay Area and California, because they think about building wealth and cash flow for themselves, not their grandchildren. Most of the money that was thrown at Las Vegas and Phoenix from 2003 through 2006 came from this group of people, many of them right here in the Bay Area.
Unless the capital markets freeze up completely and we start a downward spiral into a full fledged depression, I think we will see money start to flow later this year. Once the lending starts and markets form a bottom, brokers in your niche will have more business than you can handle. Is it frustrating today? You bet. As always, however, creative people will find ways to do deals and survive until the log jam breaks.
Investor — I don’t see any real disagreement, in a major way at least. I will opine though, saying that if Obama does indeed lower cap gains taxes it’ll surely mean both the Speaker and Majority Leader have been replaced.
FHA? We still disagree, but with limits removed it no doubt becomes a moot point. The insurance you mentioned isn’t a factor once the appropriate LTV is attained. Many props would begin with that level.
Keep bringing it here — I enjoy your thinking very much.
Oh, and one more thing. My experience and the raw numbers say your take on investors staying local is incorrect. You may have impressive numbers of folks who’ve indeed invested far from home, but when they’re viewed as a percentage of the whole, they’re easily in the minority.
OK, I will bite. Since our experience differs, what raw numbers convince you that the majority of investors are staying local?
Using the power of deduction. Example: There are roughly 50-100,000 real estate investment property owners in San Diego county. I have deduced that FAR less than half of them have taken their equities out of SD county.
Is my deduction flawed?
I’m really curious about where you get your estimates and how you draw your conclusions.
The San Diego County Assessor’s website states there are approximately 975,000 parcels in San Diego County. Not all of those parcels are houses, apartments, or commercial buildings, and some projects occupy more than one parcel. Some investors own more than one property. You could add all of the single family residences and condos with a different mailing address and without a homeowner’s exemption to all of the properties with use codes corresponding to an improved multi-family, commercial or indutrial use and come out with an approximation of the number of improved investment properties. It would be laborious, but you could go through the ownership data and eliminate multiple properties to get the number of current investors in San Diego County properties.
You could then repeat the process to the extent possible in Maricopa County (Arizona), Clark County (Nevada), and other major investment areas. Then select all the San Diego County mailing addresses, eliminating duplicate properties, to get the number of San Diego County investors.
Is there an easier way to do this? Anyone up to the challenge? Or is the answer obvious from some other data?
Of course, investment is not an “either or” proposition. Some folks are hedging their geographical bets, owning properties inside California and beyond the state line. And if your most recent post is accurate, a lot more folks will be moving or acquiring equity outside of California.
You and I both — it’s all about estimates. I’ve not seen reliable hard data on % of local investors going outa state. This is why I use my local experience, wet my finger, and hazard a wide ranged guess.
My point remains the same. The vast (read: huge) majority of SD income prop owners have stayed home. If anyone can show otherwise, I’m always willing to say I was wrong. Tell ya what though, bettin’ San Diegans have been streamin’ out of here is a losing wager. Most think property here is forever blessed — regardless of recent events.
You’d laugh out loud at some of the things they predict for the next 5-10 years here.
Yeah, and the Dow was going to 40,000 not so many years ago. Projecting compound growth rates over long periods of time leads to, um, interesting results.
It’s possible that lots of folks investing out of state are talking to out of state brokers and bypassing California brokers that sell out of state investments. If someone out there has the ability to assemble the data, I would really like to know if urban coastal Californians (i.e. the ones who really want to buy that 4-plex in Palo Alto if they could only afford it) are really investing out of state in large numbers. For example, could Clark County NV or Maricopa County AZ easily provide the number of parcels or properties owned by people or entities with San Diego County mailing addresses from their records? I’ll bet a title company out there might have that data.
I guarantee they have that data — the problem is mining it. It’s been made far more difficult since New Year’s day, due to the severely restrictive new RESPA rules. If you want those facts now, you must write a sizable check.
Again, the numbers of SD investors having gone elsewhere to invest isn’t my point. It’s the percentage of them I say is low.
Your point about talking with non-CA brokers might indeed be true. I’ve heard many stories first hand from many of my clients who’re now with me, but started with the ‘local’ guy. Problem was, the local guy was a house agent who could barely spell real estate investment on a good day.
It’s not the location of the expert pro, it’s the fact they are indeed investment experts.
Also, your point about predicting long term cap growth rates is well taken. It’s why when asked by clients what they should expect, we always tell them two things. 1) Our crystal ball broke ages ago. 2) Even when we think it prudent to predict a very low appreciation rate (range) of say 3%+, we tell them only time will tell.
RE: your 40,000 Dow comment. The SD version of that was how our median price would eventually reach a million bucks. Like you, I just shook my head in wonder.