Dec272012
The folly of negative-cashflow investment (redux)
Real estate investors during the housing bubble put their money to work on faith. There is no logical reason to believe house prices only go up. In fact, there have been two prior periods in California’s recent history where house prices did, in fact, go down. However, with kool aid intoxication, otherwise known as faith-based investing, reality is ignored.
If you truly believe house prices only go up, no price is too high, and you don’t have to worry about a backup plan if house prices don’t go up. There is only one viable backup plan when a speculative play on appreciation does not pan out: renting the property until you get out at breakeven.
For some people, this was as far as they took their analysis. A glib idea of renting it out gave them all the assurance they needed to pull the trigger on a foolish deal. If they had stopped to do the math, they would have quickly realized rents would only cover a portion of their monthly cost of ownership. A wise person would have recognized this risk and passed on the speculative bet. Investors during the housing bubble were not very wise.
I have read many accounts where everyone claims a collective ignorance. “Nobody could have seen the crash coming” or some other such nonsense. Any investor who bothered to consider their plan B would have quickly realized the risk of an extended period of negative cashflow was an unacceptable risk. Prices didn’t have to crash to make this risk a pocketbook-burning reality. Even a flattening of prices for an extended period would have been a problem.
The people who ignored this risk and bought properties are now bagholders. They own property consuming their income and providing no benefit to them whatsoever. Many still cling to their denial and hope for rapid appreciation to bail them out, but many others capitulate to the market and sell. As they sell they keep prices from rising and discourage others. One by one, each market participant moves from denial to acceptance and capitulates by selling at a loss.
When to cry ‘uncle’ on an investment property
August 16th, 2011, 6:00 am — posted by Marilyn Kalfus, real estate reporter
Christine Donovan, a Realtor and attorney who does the weekly “Huntington Beach real estate minute” on listings, homes in escrow and sales, offers some advice in her blog about when to unload real estate bought as an investment that’s failed to pay off.
She writes:
“Have you been watching the value of your investment property go down and wondering what you should do about it?
“It likely depends on what your goals are. If you have lost value, are living in the home, can afford the payments, and it meets your needs, you’re one of the lucky ones, and you should probably just stay where you are. Perhaps when you’re ready for your next home, your home will have regained some of the lost value.
Or perhaps you are just a fool in denial.
“If on the other hand, your investment property is underperforming, perhaps you need to look at it carefully. For instance, let’s look at the following scenario.
“You have equity in your home …
- But, it’s $250,000 less than it was in 2006.
- You put money down on the home, and you’ve made payments for several years.
- You feel that selling it would result in a loss.
- It’s a rental, and you’re losing $600/month after your mortgage payment.
This is the folly of negative cashflow investment. Nobody should ever be in this circumstance. Nobody who follows my advice ever will be. I advise owner occupants not to pay more than rental parity for the same reason. Negative cashflow is a black hole on your balance sheet sucking the money out of your family never to be returned.
“At this point in time, you may want to do a few things:
Actually, you only need to do one thing: sell. Any rationalization you come up with is foolish denial.
- Review rental rates and see if you can increase rates to limit the loss or make the property cashflow
- Sit down with your accountant and see if you need the loss for income purposes.
- If you don’t need the loss and still can’t make it cashflow, it might be time to consider selling the property and reinvesting in a better performing one.
- Some people don’t want to “give up” and think that holding it might make more sense.
- But, if you’re losing $7,200 per year, you need to gain that amount in equity plus the amount that you lost when the market values fell, especially if you bought it for less than current market value.
I doubt many investors can review the rental comps and find they are under the market by $600 a month or more. Nice idea, but not very practical.
This woman claims to be a financial advisor, yet she perpetuates the myth that anyone should take a loss for tax reasons. Perhaps tax implications may favor taking the loss this year or next, but waiting several months or years will usually make for larger losses as the negative cashflow eats you up.
The people who doesn’t want to “give up” are the ones still in denial. Holding a negatively cashflowing investment never makes sense. Her final point is a good one. For an negative-cashflow investment to make sense, the appreciation must compensate for the negative cashflow. If you examined such an investment’s internal rate of return, it would be horrendous because the ongoing negative cashflow compounds against you. It isn’t just the lost money, it is the lost opportunity cost on the lost money that really hurts.
“So, when is it time to cry “uncle” on your home? When the loss on your investment property just doesn’t make sense any more.
Anyone in a negative cashflow investment should dump it as soon as possible. It was a bad idea when it was purchased, and holding it makes it even worse.
This is really about investor psychology. Many, many speculators in Orange County are sitting on negatively cashflowing investments waiting for the magic appreciation fairies to wave a wand and make them whole again. It isn’t going to happen.
So how do you recognize capitulation when you see it? From the comments on the OC Register post:
InTheSameboat says:
Sounds like the situation my wife and I are in. Bought a condo in 2006 at the price peak (sigh). Lived in it for 2.5 years then started renting it out while renting out a bigger place for ourselves and new baby hey not so bad right? 2.5 years later and the loan modification (discount) expired when you add up the taxes, insurance, hoa. It looses 400 a month. $800 a year for the corporation to lease it under of course. Pay for those taxes filed separely of course. Like a lot of young couples on the move fast and making decisions fast we never really factored in all the costs to rent it out in a professional manner. Now with a second child on the way its more like good grief as long as we have a mortgage on this condo we don’t live in and loose so much money on we will never be able to buy a home for 25 years unless we drop it.
So we cried uncle, after 6 months of thinking about it and stubbornly thinking “just keep it” we just couldn’t shake the feeling that rents are going to go up, but only a little bit. The value will go up, but only a little bit. You can call it a recession, and recession part 2 but I think this is the new norm. The painfull and humbling decision was made to short sell it.
With noteable employers leaving the state its going to slow down the recovery and price increases we all prayed for the last few years. Jobs came back and values went up… just not around here. Accepting this reality strenghtened this decision and suppresed the remorse feeling.
I would like to know more about this (if you lived in it 2 years of the past 5 you won’t have to pay capital gain taxes) Our CPA told us otherwise, he said we would have to move back in for 6 months and then sell it to avoid the heavy taxes. Other than that we’ll just have to eat it.
That is capitulation.
The title should be major banks are HOA squatters. You really can tell me a bank can’t figure it out.
Payback time: Florida homeowners foreclosing on banks
By Les Christie @CNNMoney December 26, 2012: 5:29 AM ET
Since the housing bubble burst in Florida five years ago, more than 400,000 borrowers have had their homes foreclosed on by their lenders. But for some, it’s payback time.
Hundreds of homeowners and condo associations are foreclosing on banks that have failed to pay dues and other expenses on the properties they’ve repossessed.
When banks foreclose on a home they become responsible for paying fees to the homeowners association — both any unpaid fees going back as far as 12 months and all expenses going forward.
In many cases, however, banks are failing to pay, leaving these associations short on cash, according to Miami-based attorney Ben Solomon.
But now, homeowners groups are putting liens on the properties until banks pay up and foreclosing on them if they don’t.
Related: American Dream homes: Prices in 9 cities
So far, Solomon’s firm has filed more than 1,100 liens against banks on behalf of homeowners and has pursued 131 foreclosures. In more than 90% of the cases, he said, the banks settle by paying the bills.
The banks’ failure to pay dues has consequences. Other homeowners have to make up the difference, or the homeowners associations may lack the money they need for things like routine maintenance, security, water and garbage collection.
Don Gonzales owns a townhouse in a condo community on a golf course in Homestead, Fla., where Solomon recently filed suit to foreclose on JPMorgan Chase (JPM, Fortune 500) to recover $20,000 it owed on more than two years of dues and common charges.
“I own two properties and it really ticks me off when the banks don’t pay their fair share,” he said. “Everybody else has to make it up.”
Because of the shortfall, the condo association had to cut down on security and postpone maintenance. “We haven’t had our blacktop resurfaced for years: It looks terrible,” he said. “We have palm trees where we used to have the coconuts taken off. It’s a safety issue, but we can’t do that now.”
Related: There’s a home price recovery but it’s really, really slow
Chase would not comment on this specific case but did confirm that it is responsible for paying all dues or fees on properties it owns after foreclosure.
The Southbridge Homeowners Association in Pembroke Pines, Fla., is owed about $1 million by several owners, many of them banks that took possession after foreclosures, according to Marc Lebron, the association’s treasurer. To make up for delinquent payers, Southbridge has had to hike maintenance fees to $260 from $145.
But it’s also trying to get what’s due. The association filed for foreclosure against Deutsche Bank (DB) last spring after the bank failed to pay fees for more than two and a half years on a home it owned since September 2009.
Deutsche and other banks claim that they are just trustees of the property and that the mortgage company servicing the account is responsible for paying the fees.
That could be the case if the mortgage servicer held the property’s title after the foreclosure, said Michael Gelfand, an attorney who has instructed the Florida Bar Association on the rights of homeowners associations and banks in these cases. The title holder is responsible for the fees, he said.
Typically, however, after banks foreclose on a property they are almost always the official holder of the mortgage, said Solomon.
Related: Short sales jump ahead of tax hike
As in a vast majority of the cases Solomon has filed so far, Deutsche Bank settled. After the foreclosure paperwork was filed, the bank agreed to pay the back dues of $25,513.
Only in very rare cases do homeowners associations end up pushing the foreclosure all the way through to the auction sale of the properties. This has happened only once for Solomon.
In early November, Keys Gate Community Association in Homestead, Fla., brought a foreclosure on a property owned by mortgage servicer, NovaStar, which owed $22,890 in back dues and fees.
In mid-November, the association foreclosed on NovaStar and the home was sold at auction to a third party for $62,000, fully paying off the debts to the association. Novastar did not respond to a request for comment. To top of page
The mini bubble is now at peak. Next comes additional foreclosures.
Distressed Real-Estate Investors Begin to Cash Out
By NICK TIMIRAOS
The business of investing in portfolios of distressed single-family homes has come to the point in its current cycle that investors who got into the game early are beginning to cash out.
Consider MACK Cos., a Chicago rental and property-management firm that has been buying, upgrading and renting single-family homes since 1997. Now MACK has sold a portfolio of 196 homes in the suburbs south of Chicago to American Residential Properties, a Scottsdale, Ariz., firm that began accumulating homes three years ago and now owns about 2,000 in seven states.
The deal was priced at $28 million, according to Steve Schmitz, chief executive of American Residential. “It makes us bigger. Bigger is better in this business,” he said of the purchase, which closed Dec. 17.
Single-family rental homes are finishing out 2012 as one of the hottest real-estate assets as more investors look for ways to bet on a housing recovery. Home prices have climbed this year amid rising demand and big declines in the number of homes for sale. Investors have contributed to this trend by scooping up homes and holding them off the market.
National home prices were up by 6% from one year ago in October, according to CoreLogic, a real-estate research firm. In Phoenix, where investor demand has been red hot, prices are up by 17% over the past year.
Until now, bulk sales have been limited to small sales of one or two dozen properties, and sales of homes with tenants in them have been even rarer. Fannie Mae in February marketed eight pools of 2,400 homes for sale, with most of them rented out. But the mortgage-finance company opted against selling any in bulk. Instead, it entered into three joint-venture arrangements this past fall that effectively sold minority stakes in seven of the pools.
Mom-and-pop investors have long dominated the single-family rental space. But over the past 18 months, larger investors have begun acquiring thousands of homes and developing the infrastructure needed to manage scattered rental properties.
The MACK-American Residential deal shows how the single-family asset class is maturing as larger firms, looking to build scale, are snapping up portfolios pieced together by smaller investors over the past few years.
American Residential started buying homes in Phoenix and expanded to Las Vegas, Southern California, Georgia and Florida. Others like Colony Capital LLC and Blackstone Group LP also are trying to put together a rental business in multiple markets. American Residential raised $224 million in a private stock offering in May and has formed a private real-estate investment trust. It plans to file for an initial public offering during the first quarter.
For its part, MACK’s sale doesn’t take it out of the market. The firm, which will continue to manage the 196 properties it sold to American Residential, manages around 600 homes in suburbs south of Chicago and still owns an additional 150 dwellings.
“You’ve now got institutional funds saying, ‘We’re not going to do this on our own. We’re going to trust the experience and knowledge of smaller companies that know their streets,’ ” said Eric Workman, vice president of sales and marketing for MACK.
Mr. Workman said the company had entertained several offers from different Wall Street-backed investors over the past six months. It chose American Residential as a partner because both companies as “very tenant-focused,” he said. “They’re looking at this as a long-term ownership play.”
Surging demand for entry-level homes that can be rented out is creating windfalls for investors that bought homes at deep discounts a few years ago.
Landsmith LP, a San Francisco-based rental firm, said in June that it had sold 75 homes out of 250 it had acquired in Phoenix for $7.5 million to an undisclosed buyer. It paid around $5.3 million to acquire the 75 properties individually. People familiar with the transaction said the buyer was Colony American Homes, a real-estate investment trust held by Colony Capital. Representatives for Landsmith and Colony declined to comment.
Now, investors are looking for homes in markets including Atlanta and Chicago that could offer similar bargains. MACK, which is among those on the prowl, has a separate agreement with American Residential to deliver an additional 500 to 1,000 homes over the next two years.
The real meaning of rising home prices
As home prices continue to climb, some analysts are questioning whether that alone indicates the housing market is truly in recovery mode.
The national median sales price of existing single-family homes hit $180,600 in November, 10.1% higher than a year ago, according to data released this morning by the National Association of Realtors. It marks the ninth consecutive monthly year-over-year increase, which last occurred from 2005 to 2006. Since January median prices have risen about 17%.
But experts say that spike is largely due to the limited number of homes on the market. There were about two million existing homes available for sale at the end of November, which equates to the lowest housing supply since September 2005, according to the NAR. With fewer homes to choose from, buyers intent on purchasing a property are more inclined to offer a higher price or engage in bidding wars, housing analysts say, which ultimately drives prices up.
The problem is this limited inventory underscores a weakness in the housing market: Many sellers have resisted putting their home up for sale, out of concern that it will sell for far less than they paid for it, says Jack McCabe, an independent housing analyst in Deerfield Beach, Fla. That’s set off a domino effect. Because they’ve held off, supply has remained limited, in turn pushing prices up. “Prices have gone up in the last year because of this temporary, artificial market,” he says.
Washington May Finally Take Up Mortgage Reform
America’s lawmakers may finally take reforming housing finance seriously in 2013. Assuming Congress settles the deficit debate, sorting out the government’s role in funding home loans should be its next stop. And a number of obstacles are dissolving.
U.S. taxpayers are on the hook for at least 90 percent of the nation’s mortgages through Fannie Mae, Freddie Mac and the Federal Housing Administration – a dramatic increase since 2007. But Frannie’s guarantee fees are now so low that private lenders cannot compete to wrest back market share.
Increasing the fee is the simplest policy fix. But that doesn’t wholly address the future role for Fannie and Freddie, which between them needed $188 billion of taxpayer aid to stay afloat. The general consensus is that they should be wound down – even some Democrats and the Treasury are on board.
But there’s no plan of action because the environment seemed too tricky. That’s now changing. The housing market is recovering. Home prices and existing home sales have risen steadily this year while inventory fell to a 10-year low.
Some regulatory certainty is coming as well. The Consumer Financial Protection Bureau should finalize what constitutes a qualified mortgage in January. This will exempt lenders from certain lawsuits. That will then enable the Federal Reserve and five other watchdogs to define the meaning of a “qualified residential mortgage” that will set standards – such as how much equity a borrower has in a property – for prime loans that lenders won’t need to retain a chunk of. New documentation standards will also improve transparency.
So banks and investors should feel comfortable taking on more mortgage risk. Meanwhile, Congress now has an advocate who wants mortgage reform front and center: incoming House Financial Services Chairman Jeb Hensarling.
Some hurdles remain. Industry lobbyists will make a stink about reform. Lawmakers can still make dumb decisions. And any new financing framework is likely to be implemented over several years to avoid a crash. But if lawmakers don’t realize that 2013 is a prime time to take up housing reform, it’s hard to imagine when they ever will.
All the news and financial news channels now have fiscal cliff countdown clocks.
I’ve also been baffled by the negative cash flow on “investment” properties that people have tried proving to me over the years, with arguments like, “Oh, but the tax benefits makes it all worth it” or “It’ll go up in the long run.”
“So let me get this straight, you’re buying this house for $400,000, that requires $100,000 down payment, which costs $2250/mo PITI to service the PITI, garbage, and lawn care. You rent the house out for $2200/mo, but with professional property managers, you’ll receive $1870/mo.
“What kind of stupid investment charges you $100,000 up front, then charges you $380/mo, plus inevitable repairs and vacancies ($3000/yr), for an “asset” who’s value is being propped up by Central Bank financial alchemy, not by income growth? (Might I point out the prior Central Bank orchestrated housing bubble that popped and home values dropped 35% – we’re sorta going through a mini version of that bubble).
And to get out of this investment, you have a 6-8% penalty ($24K to $32K) called Realtor commissions and closing cost concessions.
If a financial advisor or investment company sold this kind of investment to retirees, they’d be sued and possibly be banned from the business. I know fixed and variable annuities have high exit fees, but at least you get your principal back and they pay you monthly/quarterly income.