Opportunity Knocks in Real Estate Despite the Crisis – May 2009

The altered U.S. real estate market, triggered in large part by the meltdown of the market for securities backed by sub-prime mortgage loans, has ushered in a new economic reality. Value matters more than ever. And even as the experts sort out the changing economic tides affecting the U.S. and global economies, opportunity is knocking.

Since real estate is all about making money – either by buying low and selling high, generating positive cash flow, or capitalizing on government give-aways to fund investments – today’s market with its abundant foreclosures and new government programs presents opportunities. For the first time in years, middle class earners with regular paychecks and money saved, can afford to buy a home. And if they are first time home buyers, they can benefit from an $8,000 tax credit.

While the prior real estate boon had some major flaws, there is money to be made as the ground shifts.

Real Estate Always Has Value

The reason real estate investing is how most people get wealthy is because real estate has inherent value. “Value” as the barometer of a good investment is again in vogue. The financials and returns which are not examined, will no longer be passed along thoughtlessly. Too much was lost.

As if emerging from a long coma of only upward market cycles, the reality that even real estate can go down in value has been remembered. The renewed focus on “value” comes as part of this reality. As many became drunk with home equity to fund retirement, expensive colleges for their kids or their own materialism, the hangover may last longer than a few days.

But valuable lessons have been learned.

Read the Fine Print

Whether you were caught short with a bad investment or are now planting seeds for financial success, make sure you check everything you can before you sign on the dotted line. If you don’t understand what you’re getting into – find an expert trusted advisor to explain it to you. Don’t assume you are dense; if we’ve learned anything in the wake of this crisis it’s that the unscrupulous and greedy prey on those who don’t understand and follow like sheep – - even when something defies all logic.

“Due diligence” is making sure you have uncovered all you can about an investment, a property or any deal or transaction. If something doesn’t feel right or make economic sense, walk away. Here’s an example:

Around the time the Madoff scandal broke, a local Florida investment advisor was interviewed some 12 years after she had been ridiculed and shamed for not recommending Madoff’s funds to her clients. She’d checked around and found no reputable trading house handling the volume of trades that Madoff’s funds and activities would have required; it made no sense to her so she gave it a thumbs down. At the time, Madoff’s reps claimed she was jealous of their returns. It took her 12 years to be vindicated, but her clients weren’t ripped off.

In today’s market, the return to fundamentals means that you will look long and hard at what you’re buying, leasing or investing in – to determine if it really has an economic upside. If your real estate activities are not based on sound economics, then you may as well be gambling. But if you do your homework, run the numbers and consider both the upside and downside, you will get better at becoming a savvy investor.

Relationship of Price/Value

The difference between price and value hasn’t been greater in almost 20 years. In many places you can acquire property for less than its true value and if you can hold or lease it – you can make money in the long run. Making money in real estate today may not be the same as in the hey-day of buying and flipping – but with value, the investment is solid. Real estate always has value – even in a declining market.

Compare this with investments in stocks and securities – so called “paper – assets.” The value of these investments is based on the underlying assets. The meltdown in the housing market was triggered by paper assets based on the value of sub-prime mortgages. These were bundled and securities based on their value were issued by financial institutions. When the mortgages were going into default, the “paper” issued also lost its value; paper has no inherent value without the asset which “backs” it.

As recently as two years ago, AAA-rated mortgage backed bonds were selling at a premium. Today they would be selling for 75% below face value, which essentially means they can’t be sold at all — because if buyers can’t determine real value, i.e. they don’t know what those derivative-based assets are worth, they don’t buy them.

Banks and other legitimate lenders are reeling from bad judgment and will likely tighten loan qualifications until their balance sheets are restored. And with or without the trillion dollar bailout – that will take time. As in the early 1980s and 1990s when bank lending was tight, private lenders will step in because money can be made on good properties that always have value.

The Good News

There are two pockets of good news when it comes to real estate. First, the federal government has enacted legislation which provides incentives. For example, new home buyers can take advantage of a “first time home buyer credit” which offsets up to $8,000 in taxes otherwise due. Incentives are also being offered to lenders who renegotiate certain uneconomic loans, and federal funds/grants are available for neighborhoods flooded with foreclosures.

The second bit of good news comes from real estate experts. They observe trends which provide valuable guidance for making good real estate investments today:

• Distress in the housing market is benefiting the apartment market, which now tops the lists of good “buys.”
• Moderate-income apartments in core urban markets near mass transit offer the best buy, a trend that has been reported since 2007
• It is anticipated that commercial markets will recover more quickly than most housing markets.
• Homebuilders will be dumping large tracts for “cents on the dollar” or face foreclosure on their holdings – creating opportunities for those with cash to invest.

Bottom Line: Real estate always has value and if you do your homework, look for value and make sure you understand economic reality, you may just find that opportunity is truly knocking.