[pup55]

What with all of the doom and gloom around, I thought it might be time to check into the local real estate market for some fire-sale bargains.

I am in the exact epicenter of suburbia, biking distance from two giant shopping malls, close to the local freeway. My local community was listed in Money Magazine's "Top 10 Places to Live" a year or two ago.

There are now 20-30 foreclosures per month in the area, so it made sense that it might be time to pick up a couple of places and rent them out to some of the locals who, for one reason or another, do not want to be in an apartment, and cannot buy their own place.

First, I filled out one of those online applications for financing, and got approved, found a local realtor, and started exchanging emails. She forwarded me a lot of listings from the local multiple listing service. I had price and square footage limits, and also limited it to my zip code, plus the adjacent one, since I am familiar with the area.

I made it quite clear to her that I would be looking for a place that was priced so that I could make a greater rate of return vs. a CD right now, based on cash out of pocket vs. rental income. Example: I put 10K down, I have to put 10K in repairs, and I get a rental stream of X per month, which, after taxes, gives me a rate of return on my 20K out of pocket better than a CD.

I had a big spreadsheet that did this calculation no problem, which I forwarded to her.

To her, this was completely unfathomable. She was looking at places based on the value of other houses sold in the same neighborhoods (comps, short for comparables) which to her said that some of these places were quite cheap.

I explained to her that these "comparables" were based on last year's prices, did not reflect the fact that over 50% of the transactions in this neighborhood are foreclosures, at about a 35% discount from the local so-called market, and that it is quite likely to get much worse, since we are just at the beginning of a big economic drawdown.

She sent me a big printout of all of the rental properties in the neighborhood. Quite useful. I was able to do an extensive pup55-like analysis of the whole market. I laid this out to her, and she sent me a few lists of candidate properties. I took a couple of months (in my spare time from posting on PO.com) to ride my most fuel efficient vehicle around the area, and inspect these places from the outside. I really only asked her to get off of her butt and tour me through two of the 70- or so places I went to.

I have not made any offers yet (still no properties that fit my economic model), but she is so frustrated with me that she fired me the other day. I passed on a couple of places that were priced attractively to her (because they had dropped about 25% vs. the local market) and she said were perfectly good deals, but when I laid out for her the projected rent vs. the cash out of pocket, it did not give me a positive ROR.

She was firmly fixed on the notion that the current situation is a once in a lifetime opportunity, and the market will return to somewhere around its normal state in a couple of years, and "look at all of the equity you will have in these houses when they go back up".

I said "I am not at all convinced these houses will ever recover in price, so to me, their "value" as an investment will be a function of their ability to bring in money as rent".

She, of course, was completely unable to get her mind around the idea that real estate would not perpetually go up in price, despite the fact that we were standing around in a house that had dropped at least 40% from its last sale.

Also, she was completely unable to get her mind around the idea that the "market' for homes in this area should include the selling price of the foreclosures. "Those don't count" she says. "When they're over 50% of the market, the regular sales don't count", I say.

So, based on my experience on this:

a. The real estate market is still not bottomed out in this area. Prices have gone down steadily since I started this exercise in August. Nothing is moving except an occasional foreclosure. Rents are also declining in the area.

b. The so-called real-estate "professionals" are completely unaware of what just hit them. A lot of them will be looking for some other form of work shortly. This woman even said at one point she is going to have to get a day job.

c. The so called real estate "professionals" are also lazy. A couple of showings, and this woman fired me? What next?

d. The so-called real estate "professionals" have not up until now needed to understand basic concepts in finance, such as rate of return. They think that since house prices go up perpetually, all you have to do is get a good entry price, and time makes up for any mistakes.

e. Financing is not really a problem, the rates are about 1% higher than a comparable rate for an owner-occupied place, so you can get mortgage money if you have a job and good credit. note that the 6 1/2% I am asked to pay is a lot higher than the prime rate (about 2%) so maybe I am better off in the other end of the transaction, which is lending money to people like me so other people can buy rental property.

f. A couple of minor points on some of these places: You can tell that a lot of them were cared for by their original owners, and a lot of the original owners made some money on them when they sold them in 2005 or 2006. In a lot of them, the second owners got 110% financing, and now, a couple of years later, are out of the place foreclosed. Presumably the original owners went farther out to the nearby slightly ritzier area, got even bigger houses, and potentially, they now have more house than they can handle. We will see on that.

g. I have priced construction materials and other things needed to fix some of these places up, and found them to be quite a bit cheaper than a few years ago.

[Jotapay]

Thanks for posting that. What are the prices you are dealing with? Like last year's average price for the area, this year's average sale price of foreclosed homes and this year's average sale price of non-distressed housing?

I'm always keeping these numbers in my head when I look around because I think I may have the opportunity to buy a doomstead with cash later if the market gets as bad as I think it will.

[dinopello]

Your experience with that realtor comports with my own. If your decision criteria or world view doesn't jive with theirs, it makes their head spin. Having said that, the one I used when I bought over 10 years ago wasn't lazy and actually found my house before it was listed through chatting it up with the neighbors.

[evilgenius]

Did you find that the average house that needed repairs was in need because the previous owners had either trashed it or not kept it up or that it needed repairs because it had sat idle for so many months? I am curious about human nature on this one. I wonder if people trash houses they can't keep or if the kind of people who find they can't keep a house are the kind that trash a house just by living in it.

[Maddog78]

It is typical of realtors in my area too.
I know some sellers that are in denial, still living in 2007 mindsets, and realtors are telling them, "Wait until spring to relist, prices will be back up then"

Whaaaat?????

[Armageddon]

Pup,

I wouldn't touch the housing market with a 10 foot pole no matter how much more it drops. When your renters lose their job, good luck collecting rent money. It's just not worth it.

[MarkJ]

Our local Real Estate Professionals are generally developers, builders, tradesmen, investors, landlords and people skilled or knowledgeable in all phases of construction, renovation, building codes, material & labor costs etc.

People that build, buy, rent and resell a lot of properties generally have a better idea of real property/rental values than most real estate agents.

It's funny to hear the unrealistic comps, rents and the line of BS many real estate agents have when I do walk-thu pre-inspections for friends and customers looking at buying a home or investment property.

Real estate agents get pi$$ed when I mention all the structural defects, code violations and poor building practices I spot on a ten minute walk-thu.

There are an awful lot of what we call Polished Turds on the market. The owners make cosmetic improvements to the homes while neglecting the foundation, basement, structure, drainage/waterproofing, plumbing, electrical, heating, cooling, insulation, ventilation etc.

The real estate agents will often compare an outstanding move in condition ready home to one that needs tens of thousands of dollars in repairs.

[Zardoz]

Really remarkable post, pup. One of the best yet on this sorry subject.

$this->bbcode_second_pass_quote('', '.')..The so-called real-estate "professionals" are completely unaware of what just hit them. A lot of them will be looking for some other form of work shortly. This woman even said at one point she is going to have to get a day job...

[pup55]

$this->bbcode_second_pass_quote('', 'W')hat are the prices you are dealing with?

[pup55]

$this->bbcode_second_pass_quote('', 'W')hen your renters lose their job, good luck collecting rent money. It's just not worth it.

[ReverseEngineer]

$this->bbcode_second_pass_quote('pup55', '')$this->bbcode_second_pass_quote('', 'W')hen your renters lose their job, good luck collecting rent money. It's just not worth it.

[pup55]

$this->bbcode_second_pass_code('', 'A lot of these people got into this business in the first place because they couldn't make it as an engineer, or succeed in a corporate environment.')

$this->bbcode_second_pass_quote('', 'H')e recently left the business and has gone back to work as a civil engineer.

[evilgenius]

Have any of the auctions for distressed houses considered moving to sealed one time bids? It seems to me that would be a quicker way to find the sort of equilibrium that you are describing that the mix of participants in the system needs to operate at, it being heavily your sort now. In other words, the system needs rid of those irrational types that will run prices to levels that are not sustainable. Since the irrational types tend to thrive in an atmosphere of comparative competition you need competition that is not comparative, but reality (mathematically) based.

I don't know, it might help to put a floor under this mess or it might simply create a way station on the path further down. What does everybody think?

[pup55]

$this->bbcode_second_pass_quote('', 'I')f you have $80K cash, it might be a slightly safer investment than keeping the money in a bank or in stocks for sure. However, for that same $80K plus what you could get for your current home, I would take the whole kit and kaboodle and get out of the subuurbs and buy a doomstead somewhere.

[pup55]

$this->bbcode_second_pass_quote('', 'H')ave any of the auctions for distressed houses considered moving to sealed one time bids?

[Heineken]

I would not consider buying any real estate at this point.

The real estate problem has hardly begun to be resolved, and many of the ideas they are talking about would make things worse. The sooner prices get to where they need to be, the sooner some stability will return. But people, like that real estate agent, cannot mentally grasp the amount of phony equity they have lost. The equity only existed due to an insanely out-of-control credit machine that propped prices up like gas floats a hot-air balloon.

Prices could fall another 50% from here, esp. if unemployment continues to rise drastically and owners continue to increase rentals. Renting houses out murders valuations. It is also just a terribly risky and potentially unpleasant thing to do.

[Heineken]

Land, for your own use, certainly seems safer, Shanny. But prices will almost certainly go lower, so why buy now unless absolutely necessary? (I probably overpaid for my tree farm, so I know this lesson from personal experience.)

Overall, land prices seem to have held up somewhat better than housing prices. But they're falling too.

[threadbear]

My income is generated through rental real estate. I frequent a forum where people like yourself, realtors, sellers and buyers get together in the mixing waters of public perception, expert opinion, and analysis of the fundamentals. Same exercise you engaged in pops up frequently, always with the same conclusions. I mentioned on one thread, the other day that seeing as Vancouver B.C. has been sited by the Case Schiller index as the bubbliest market, in North America, and one of the bubbliest in the world, the prices are going to correct an average of 70%, in the next few years. This would drop the prices back into the range of affordability, bring them into alignment with rents, and also reflect an economy that is weakening tremendously.

Some of them didn't like to hear it, but many agreed. The ones who agree are generally those who do this for a living. The ones who don't, realtors who still think prices will always keep going up (in the long run). The long run, could turn out to be 300 years, to correct for prices that have strayed so far from fundamentals in an irrationally exuberant and profoundly stupid blitz of hysterical optimism and cheap credit.

[pup55]

$this->bbcode_second_pass_quote('', 'w')hy buy now unless absolutely necessary

[Rubin_Flagg]

Pup55,
This is just the beginning of the end for the housing bubble. We have not seen the massive layoffs and all other kinds of economic disruptions that will be caused by the Greatest Depression. It's really important not to "catch a falling knife." Right now we are in the falling knife arena.

The inability to trust the balance sheet of almost any financial institution means the risk is really huge right now for the kind of invest you want to make. Wait for a while...this crisis is not going to end in the next six months. You will be able to get some really good deals soon...ones that fit into your models and will generate some great returns for you. However, expect rents that are 50% to 75% lower than what they are now when doing your projections.

Preservation of capital is always the name of the game.

Rubin Flagg