A Tale of Two Shadows
I ran across a couple of articles on shadow inventory that were telling two very different stories. I thought the S&P article was a little too pessimistic, but the NAR article was entirely too optimistic. I found the way they measure the shadow inventory and the time it will take to clear it quite interesting.
The S&P article states it will take 46 months to clear the shadow inventory. This is a national number and as we know this varies by location. The NAR article goes a bit deeper and shows a state by state breakdown. I have highlighted below how each calculates the inventory and the months to clear.
According to S&P
The data from S&P define shadow inventory and the months to clear as follows:
“S&P includes in the shadow inventory all outstanding properties on which the mortgage payments are 90 or more days delinquent, properties in foreclosure, and properties that are REO. The agency also includes 70 percent of the loans that became current, or “cured,” from 90-day delinquency within the past 12 months because S&P says these loans are more likely to re-default.”
S&P’s calculation of the months to clear the shadow inventory is the ratio of the total volume of distressed loans to the six-month moving average of liquidations. Although S&P’s analysis of the shadow inventory uses only non-agency loan data, the agency’s analysts believe the months-to-clear is similarly high for the market as a whole.
According to NAR
Another article from the NAR shows the following breakdown of months supply of shadow inventory by state. The NAR is showing a much rosier picture.
“The map shows the number of months it would take to clear the shadow inventory by state. The months’ supply is estimated by dividing the shadow inventory and the monthly number of distressed sales. The numbers range broadly from 51 months in New Jersey to 7 months in Nevada. When looking at months’ supply it is important to keep in mind that this estimate highly depends on saturation of distressed sales. Given that New Jersey over the past year on average reported about 20 percent of existing home sales to be distressed sales, it will take a longer period for the shadow inventory to clear. In contrast, Nevada’s distressed sales averaged a considerable 70 percent share of the existing sales and at that rate the current shadow inventory would clear in 7 months.”
http://economistsoutlook.blogs.realtor.org/2011/03/21/state-by-state-estimate-of-shadow-inventory/
Missed Property #3 – Out of State Landlord
I had an out of state landlord approach me about possibly buying one or two of his properties. Val and I met him at our current primary as he rents his old primary home in our neighborhood. He was just in town to check on his properties and visit some family. He lives in California and owns 13 properties in the Dallas area. It sounds like he wants to start investing in CA.
We exchanged business cards and a week later he was calling me. He provided me with 2 addresses. One I somewhat like, but the other one is in an area I don’t really like. It is also over 2,000 square feet and just won’t make a great rental in my mind. The one I like is a standard 3-2-2 about 1,500 square feet. It’s in an area that I have wanted to own a rental. The only problem is he is not motivated to sell. It sounds like he is preparing to 1031 Exchange into some properties in CA, but he is not in a hurry. I went ahead and made an offer. I reminded him I can close quickly and get the sale done whether the house was occupied or vacant. He is not a deferred maintenance landlord. He uses a local property manager, and keeps his properties in above average shape.
My first offer was all cash. I wanted to start him off low and then let him walk me up, but this is when I like to convert over to owner financing. I reminded him – “I am an investor too and just like you – I have to make my money when I buy.” The problem is he could just as easily wait for a vacancy and list the properties and take his time getting top retail dollar. I need sellers that need out. It was obvious he and I could just not come to an agreement. I think this was just a fifty something year old landlord who ran into a buyer of rental properties and he just had to see if he could dump one off. I would probably do the same.
Ultimately his motivation to sell was just not there, but it’s still great to get these calls. Ideally he will be calling me back with an urgency to sell someday. Here are the numbers on this one:
Sale price: 130k (initial number he threw out – he had to start somewhere)
Tax value: 130k
ARV: 130-140k
My first offer: $80k cash
Currently rented at: $1,295
Another house flipping show…
So I watched A&E’s – “Flipped Off” premier show last week. I thought this one would be good as the group is in Houston, Texas – It was terrible – this might be the worst one yet. These shows are less about the actual business and more about the personalities on the show. I guess that is what makes for good TV. A&E should just stick to ‘Storage Wars’. That flip show with Vanilla Ice is better than this one.
It makes me curious how many new investors are out there as a result of these TV programs. The biggest problem I have with them is how they show the financials and over dramatize the cost. They show a rat in a toilet and then need to spend $8k to re-pipe the entire house. Everything is shown to an extreme. Most of these shows still don’t show any agent commissions being paid. I suppose you can make the numbers say what you want, but it would be nice to see the real numbers once in a while.
I guess a show with a group of landlords in it would never make it past a few episodes. There is just not enough drama in landlording. As we all know there is drama, but it does not occur rapid fire like it does with all the moving parts involved in a house flip. This is probably good as I don’t want to see even more people bidding up properties trying to be a landlord.
Being in the Middle of the Market
On page 182 of Gary Keller’s book,“The Millionaire Real Estate Investor”, Keller shows a chart that illustrates the sweet spot at the low end of the middle of any market. I like his chart – it does a good job of illustrating the whole property class issue. As an owner of a mix of these property types – I think he is spot on.
His graph illustrates almost exactly what I have experienced – my high-end property does not cash flow as well as my low-end and still has some of the same hassles. I think this is due to a combination of more property to maintain and tenants that expect a higher level of product.
I find my low-end properties certainly cash flow better. However, this is where I have had the most turnover, late pays, city citations, etc. If you are good at dealing with these tenant issues and don’t mind the hassles then the returns in the low-end spectrum are very enticing.
Keller’s recommendation is to stick to the solid cash flow, strong appreciation, and low hassle offered by mid-market properties. I am beginning to think he is right. I would classify 4 of our 7 properties as mid-market, 2 low-end, and 1 high-end. Our low end stuff is paid for and our higher end properties have long-term mortgages. I like this mix and think it makes for a great balance overall.
What are your thoughts? Where are you playing in this market? Has your strategy evolved at all?
Why a portfolio of rentals is less risky than your 401k
I ran across this article on Hedging the 7 Big Retirement Risks. Val and I consider our rentals a major part of our retirement strategy – so I found it quite interesting to compare these 7 big risk of traditional retirement portfolios to that of a portfolio of rental properties.
Here are the 7 Big Risks highlighted in the article. I then compare these risks with those of a rental property portfolio.
- Longevity Risks. This is the risk of outliving your money. As people continue to live longer this is the biggest fear in the ‘build a balance and then hurry and die before your run out of money’ mentality. With a portfolio of rentals you essentially have a monthly stream of income each month vs spending down from a large balance.
- Inflation. With a retirement portfolio inflation eats away at your purchasing power. With a portfolio of rental properties inflation is working for you not against you. You get increased rents and an increase in property values with inflation.
- Stock Market. Even with diversification you are still exposed to global market risk. The nice thing about a portfolio of rental properties – the rent is still due on the first no matter what the market is doing.
- Re-investment Risk. The risk here is as your cds come up for renewal you have to reinvest them at the then current rates. Rental property returns are much more consistent and there is no need to move in and out of investments – just keep collecting the rent.
- Sequence of Returns. This is essentially the risk of retiring and starting to draw down your portfolio right as the market takes a downturn. Here again rentals are not driven by the market.
- Fraud. This risk is more than just avoiding the Bernie Madoff’s that are out there. The fees that some of these financial planners lock retirees into should be criminal as well. With rental properties you control your destiny.
- Taxes. With a market portfolio you really need a financial planner to help you navigate through all the tax implications. On the rental portfolio side, there are many deductions available that make taxes an advantage – not a risk.
Another big risk is the Risk of Loss. The stock market could easily result in a loss of principle to your portfolio. With real estate there is an inexpensive way to protect against this – Insurance. If one of your properties burns to the ground then you are covered with your insurance. Good luck with insurance against loss in the market.
The biggest advantage that a portfolio of rentals provides vs a market driven portfolio is the ability to leverage. With the power of leverage, you can get to a sizable portfolio of rentals far quicker than you can build a balance in your 401k.
Missed Property #2 – HUD
I missed another property close to one of my current rentals. This one was in a Class C neighborhood with rents ranging from 650-850 depending on bedrooms. I actually did not even get a chance to bid on it – This one was a HUD and picked up in the owner occupant period. I despise HUD’s just for this reason – it’s very frustrating. They had this one listed at $35k and it was snapped up right away.
I would have actually bid over the list price on this one. I am very familiar with the area and know what properties sell/rent for. This one had a build out on the back of the house, but they left the garage in tact. The build out added a bedroom and a bath and made it a 3-2. This is somewhat rare in this neighborhood of 1950’s homes – most are 2-1 or 3-1’s with many built out garages.
This property was not perfect and needed maybe $5k-$6k to be rent ready. It was mostly cosmetic stuff. Hardwood floors were really scarred up, missing baseboards, needed paint. The add-on bathroom looked like it needed some work and they also added central heat and air and put the inside unit in one of the bedroom closets. This was quite awkward and would need to be moved to the hall closet. The kitchen was in decent shape.
Although I did not even bid on it, I thought I would go ahead and post about it since I have pics and details. It’s unfortunate this was a HUD and not some bank owned property – I would like to have had a shot at it. Not sure why they had it listed at $35k – perhaps there was more wrong with it than I saw with my initial glance.
List: $35k
ARV: $60-$65k
Est rehab: $5k
Rent: $850
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Hurry – Taxes are due Monday…
Monday the 17th is the last day for you last second tax preparers. We hire an accountant for ours each year. It’s just too many forms, deductions, depreciation schedules, etc. This is just not my expertise. I could certainly do it, but I might mess something up and I just don’t have a passion for all these details. Similar to many rehab projects – sometimes it just best to call in a professional. Besides, It’s nice to know if I get audited I will have someone in my corner. We use the same guy that has prepared my father’s taxes for the last 20+ years. He has extensive experience with rentals.
Having a tax preparer does not get you out of all the paperwork. I initially had this vision of just handing him a sack full of receipts. This is not the way it works. We end up consolidating all expenses, revenue, mileage, and other deductions into a spreadsheet for him. We then bring it to his house and sit at his kitchen table and walk through everything. This year I tried to keep up with all of the receipts throughout the year and log them as I went. This saved some time, but the wife and I were still up past midnight the day before we went to meet him.
I developed a worksheet a few years ago as an input for the Schedule E. My tax guy likes it and it provides us with a view of exactly how our properties are performing for the year. Attached is that document (with numbers changed). I am sure everyone has something similar, but I don’t mind sharing mine. BTW, our taxes were quite a mess this year and we had to pay a tidy sum. On the bright side my preparer is quite a bargain in my mind - $225.
