Real Estate Investing – Part III

A Bit of Valuable Theory First: Vince Lombardi Would Approve!!

Cause and Effect Relationships

We are familiar with “cause and effect” relationships. A particular “cause” or action will result in a predictable “effect”, reaction or response.

“Laws of Physics” tell us that if you throw a tennis ball at a wall, you can accurately predict the direction that it will bounce off the wall.
That is an example of a “cause and effect” relationship within earth’s gravitational fields.

Further, if you change the “angle of incidence” (the angle at which a thrown ball hits the wall) then, you can accurately predict the direction that the ball will take as it bounces off of the wall.

The angle of incidence equals the angle of reflection, and predictability exists.

“Laws of Human Response” tell us that if I use hurtful words or actions toward you, then I can anticipate that I will probably receive a predictable response in retribution from you.
If I don’t wish to receive that type of negative response, then I should be careful not to use hurtful words and actions toward you. We call that human nature.

While Laws of Human Response may be less predictable than the Laws of Physics (people can develop good acting skills), a good real estate negotiator learns to control his or her emotions in order to guide the negotiations to a desired result.

“Laws of Financial Markets” tell us about the “cause and effect relationships” between “Supply and Demand”.
If demand for a scare commodity increases, but the supply or availability of that commodity decreases, you can anticipate an increase in it market price.

Qualifying Demand Factors:

1.Demand is influenced by purchasing capacity. When dealing with “demand”, only those with purchasing capacity should be considered. Point: If I would love to own one, but can not afford to buy one, my vote does not count as part of “effective demand”.

2.Demand is influenced by availability of financing. If I could afford to buy one with a loan with an interest rate at 5%, but interest rates just increased to 6%, then my “desire to own” remains strong, but only at a lower price that would allow me to finance its purchase within my capacity to service debt. Restated: My “demand” no longer counts at the previous price.

3.Demand for real estate is influenced by the attractiveness advocacia leilões of the stock and bond markets. A large part of demand for real estate that caused the “Real Estate Boom of 2004 through 2007” was due to the wholesale rejection of the stock market and the bond market.

Point: Many people lost 40% or more of their retirement account that was invested in the stock market. Many flocked to real estate for fear of continued losses in those other markets. A “feeding frenzy” pushed prices up rapidly. Too many dollars were blindly chasing too few attractive properties.

Qualifying Supply Factors:

1. Supply Responds Slowly. It takes a while for supply for real estate to respond to an increase in demand. You can’t just leave the printing press going over the weekend at the US Mint to create more money. That is an option that is only available to the federal government.

Point One: Observation: To create a new apartment complex, it takes a year or so to acquire the right property, get plans approved as a building permit, build the complex, then rent it out until it’s full. It does not happen over night. This can cause a substantial increase in market price for an existing good looking apartment complex.

Point Two: My prediction: When the market finally stabilizes for apartment complexes, we will see a horrendous increase in “cost” of generating that new complex. Systems development charges, cost of building materials, and financing costs will boost the “finished price” of that property.

Suggestion: Consider buying existing “pre-owned” apartment complexes right now. You will look like a hero later!

2.Political Considerations Influence Financing. The federal government has the capacity to regulate interest rates. The easier it is to finance the acquisition of an income property, the more appeal it will have.

Question: Why isn’t this a “supply-side” factor?

Answer: It is. The easier it becomes to buy a property, the more available property becomes to buy.

However, it is also a demand-side issue in that it is now possible to obtain a new mortgage with ten year fixed interest rate.

Observation: Ten year fixed rate financing allows the investor to neutralize the “cost of capital” issue during a recession.

Suggestion: Take advantage of available new financing.

3.Tax Law Changes Influence Appeal. Recently the federal government provided real estate investors with the opportunity to increase their tax shelter from real estate. Cost Segregation depreciation allows such an opportunity.

Understanding Changes in the Real Estate Financial Markets

These “Laws” or financial cause and effect relationships have recently become substantially altered, and thus have become far less predictable.

Change One: Artificial Supply-Side Pricing. Real estate prices are being adversely impacted by a large number of “forced sales” caused by defaulting borrowers being forced to sell under pressure to sell, and foreclosure sales by lenders in need of a quick sale.
Situation: A borrower is unable to make the mortgage payment, and has attempted to sell the property.
He discovers that it will not sell for enough to pay off the existing loan. He then notifies the lender of the situation.
The lender must then decide which course of action to take.
If the borrower has not been declared to be in default, the lender frequently ignores the borrower’s plea for relief.
If the borrower has been declared to be in default, then the lender will either:1. agree to accept less than the full loan balance in satisfying the loan (a “short sale”); or,2. take steps to foreclose on the property, then resell it quickly to recoup the amount of the loan.
Result: Discounted sale prices resulting from “short sales” and “foreclosure sales” impact all property values and force prices down. You will have difficulty attracting a buyer who would pay more for yours than they could pay to acquire a very similar property offered through a short sale or foreclosure priced property. Even if you are successful in seemingly avoiding the impact of “forced sale” discounts, the appraiser who the buyer’s lender will use to value the property for loan purposes will include those low priced forced sale. The buyer will not be allowed to borrow as much, and your sale may be in jeopardy of closing.
Observation: Until the lenders sell off all of their REO and the number of short sales is substantially reduced, the value of real estate will continue to be adversely impacted.

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