Fiduciary Magazine

Archive for the ‘Real Estate’ Category

Paul Habibi is a real estate lecturer at the UCLA Anderson School of Management, has my vote for the most passionate and dedicated professor at the institution and someone that I’d like to consider a friend.

At the close of the previous quarter he published a letter to students sharing lessons from business and from life. Paul insights are should be taken into consideration not only by future graduates but much more seasoned professionals. 

My personal favorite is #4: ” Try not to put all your eggs in one basket, but if you do, make sure you do so knowing the risks, and walk slowly.  Remember that it’s harder to keep money than to make money, so once you get a nice nest egg, make sure you are vigilant towards preserving capital and reputation.  If you’re a high-flyer and just want to grow at all costs, admit that to yourself and then learn to have a tough stomach so you can weather the ups and downs.”

http://www.habibiassociates.com/2010/03/life-lessons-closing-escrow-on-another-quarter/

You can also follow his blog on real estate at http://www.habibiassociates.com/blog/

Feds bust five local scammers in Van Nuys.

They’ve been offering consumers help in repairing bad credit, landing new jobs, starting lucrative work-at-home businesses and obtaining government money to pay off bills. These scams — which are surging along with the jobless rate — are touted on websites and infomercials, and have bilked consumers out of hundreds of millions of dollars, said David C. Vladeck, director of the Federal Trade Commission’s Bureau of Consumer Protection.

Schiller and Akerlof did a good job providing a historical context for scams during the Depression.

“Success is never final. But failure can be,” Bill Parcels, the former NFL coach, once observed. Investors in real estate investment rusts (REITs) might want to pay particular attention to this truism.

REITs, as the name suggests, invest in real estate of various types. But what the name does not suggest is that REITs usually utilize leverage in their pursuit of investment returns. Leverage, as many investors learned during the last 12 months, is fun on the way up, but potentially fatal on the way down (unless you happen to be one of America’s 19 largest financial institutions).

At the moment, the REIT industry finds itself squarely in the middle of the “way down” phase – both because asset values are plummeting and because interest rates are climbing. Just yesterday, the yield on 10-year Treasury notes kissed 4%, which means that the 10-year yield has nearly doubled since the start of this year!

When long-term interest rates rise this dramatically and rapidly, many different industries suffer. But few industries suffer as much as the commercial real estate industry. Even in the best of times, rising interest rates increases the cost of capital, while also undermining the value of commercial real estate assets. In the worst of times – or even in less-good times – rising rates can produce catastrophic consequences.

Today’s commercial real estate market was distressed, even before rates starting rising. The problem, in a nutshell, was excess capacity. During the last several years, America constructed shopping malls and office buildings to satisfy the excess, phony demand that easy credit produced. But now that home equity loans and other readily available forms of credit have disappeared, so has the phony demand.

The unfortunate result: a glut of shopping malls, office buildings and hotel/motel properties.

“Vacancies are definitely rising across the commercial real estate market,” observed hedge fund manager, Jason Stock, at last month’s Value Investing Congress in Pasadena, California. “You’ve got office vacancies well over 15%. We think those are going to approach 25% before this is over.”

Stock and his partner, Will Waller, oversee the M3 Fund, a hedge fund that invests solely in the banking sector. Stock and Waller claim they are finding a number of attractive stocks to buy. Nevertheless, they remain very anxious about the health of the overall banking sector. In particular, they fear that commercial loan defaults will skyrocket from current levels, causing a large number of banks to fail during the next two years.

“So far this year there’s been just over 30 bank failures,” Stock reported in early May. “We expect they’ll be roughly 150 bank failures by the end of the year. And we would actually expect that number should be significantly higher.

Stock continued:

“Every Friday night (we jokingly call it ‘death watch,’ because that’s when you get the notices of the banks that have failed [from the FDIC]), when we look at the banks that are coming across as failures, we’ll say to ourselves, ‘Geez, that bank is a lot better off than 20, 30, 40 banks that we can think of. The regulators right now are completely overwhelmed. You have to have people to close down banks. And it’s not a very quick and easy process. It takes a fair bit of manpower. So if the regulators had the staffing to do it, there are definitely 50 to 100 banks that you could say, ‘This Friday we are going to go in and close all these banks down.’ So it’ll just be a matter of time before that pace picks up.”

In last month’s letter to their investors, Stock and Waller reiterated their skeptical outlook:

“The Government’s release of the ‘stress test’ results on May 7th was a key driver of the rally in large bank stocks. The results indicated that nine of the 19 firms have adequate capital under the test’s most adverse scenario…In our opinion, this ‘stress test’ was in no way stressful and could more accurately be compared to a beach vacation in Hawaii where the weather forecast had a 10% chance of afternoon showers.

“The ‘worst case’ scenarios that the Government utilized in this test included unemployment reaching 8.9% in 2009 and 10.3% in 2010 (as of May 31, 2009 the unemployment rate was 9.4%), and GDP growth of .50% in 2010. We believe unemployment could easily exceed 10.3% and that it is absurd to use a positive number as a worst case scenario for GDP in 2010. This ‘stress test’ created a false sense of stability in the banking sector and created a historic opportunity for banks to raise capital at significantly inflated valuations…While extremely beneficial to the banks, we believe the investors who participated in these offerings will be choking on these investments over the upcoming months.”

Contradicting the sanguine conclusions of the stress tests, Stock and Waller point out, “The Federal Reserve chimed in with an alarming report on first quarter loan delinquency rates at commercial banks. Total loan and lease delinquencies increased by 96 basis points, a 20.7% increase in only one quarter (from 4.6% to 5.6%)…We maintain our bearish outlook…we believe this bear market rally is unsustainable and that fundamental trends for banks are negative…”

Your California editor concurs, which is why he does not hesitate to say that most bank stocks are better sold than bought at their new and improved “recovery prices.” Similarly, most REITs are better sold than bought.

Eric Fry

Since first-time buyers are getting thousands of dollars in tax credits from the federal government to stimulate the economy, why shouldn’t all home buyers get equal treatment? What about refinancers — couldn’t they make good use of a tax credit to help defray closing costs and loan fees?

Whatever your thoughts on these questions, there is an effort under way in Congress to extend tax credits to anyone who buys a new or existing home in the coming year. In one case, legislation would even create a temporary $3,000 tax credit to help defray the costs of refinancing mortgages on principal residences.

Two Dallas-area congressmen have introduced bills that not only would broaden the reach of the current housing tax credits to almost everyone, but would keep the program going until either mid-2010 or the end of that year.

Rep. Kenny Marchant, a Republican who represents the suburbs between Fort Worth and Dallas, is pushing a bill that would expand the current $8,000 federal credit for first-time buyers, which expires Nov. 30, to buyers of all houses through June 2010.

The bill would also create a $3,000 credit to help offset refinancing costs, including closing fees and lender charges, through next June.

As for the refinancing credit, he said the idea was to encourage owners “to take advantage of current low mortgage rates.” The $3,000 credit could be used to pay for loan points, other transaction fees or to “put equity in their home if they’re a little underwater.”

Marchant’s colleague, Rep. Eddie Bernice Johnson, a Democrat who represents downtown Dallas, has introduced legislation that would extend the current credit through Dec. 31, 2010. The bill also would open the credit to all buyers of principal residences.

The near-simultaneous introduction of tax credit expansion bills on Capitol Hill appeared to put the two most potent housing lobbies — the National Assn. of Realtors and the National Assn. of Home Builders — into a political quandary.

On one hand, any broadening of tax incentives for home buying would be good news for their builder and realty broker members. But if potential buyers sense that the expiration date for the current credit might be extended, some of them may decide to delay purchases. And if all would-be buyers might be eligible for a future tax credit, large numbers of consumers might stay on the sidelines waiting for that better deal to come out of Congress.

A spokesman for the National Assn. of Home Builders said the group “does not want anything that would stop the traction the current credit is now getting. We think it would be more appropriate to address [an extension or other changes] closer to the credit deadline” in the months ahead.

But Mary Trupo, public policy director for the National Assn. of Realtors, said her 1.1 million-member group sees it differently. If the credit is working for first-time home buyers, “then why not for all buyers, with no income limitations?” she said, adding that the group would like to see the expiration date extended beyond Nov. 30.

Where’s this all headed? Don’t look for any immediate action on Capitol Hill. The summer recess looms and neither of the tax credit bill sponsors sit on the Ways and Means Committee, which must originate all tax legislation.

But later this year, you can bank on it: There will be a major push to extend the housing tax credit — and maybe even open it up to everybody.

Kenneth R. Harney

In better economic times, Santa Clarita mortgage broker Fred Arnold relied on a home equity line of credit if his cash flow was uneven and he needed to cover payroll.

But when home sales crumbled last fall, there was no such backstop for the business. His home was still worth more than the mortgage, but his bank was retrenching and had shut down the credit line. So Arnold sold his house, used some of the proceeds to keep his business afloat and bought a smaller home.

“I thought about cashing out my retirement money and the college savings for the kids, but that wasn’t the way to go,” Arnold said.

He and his wife are happy in the smaller home, Arnold added, and his home loan business is on more solid ground, thanks to a recent wave of refinancings.

That makes Arnold, president of the California Assn. of Mortgage Brokers, a lucky guy compared with hosts of small-business owners who relied on their housing wealth to start companies, buy equipment and manage payrolls. No longer buoyed by the housing boom, many now find their businesses and homes sinking in the backwash from the easy-money era.

Even in the best of times, bank financing has not been easy to find for owners of start-ups, who instead typically rely on “the three Fs — family, friends and fools,” as Alton W. Do of the Oakland Business Development Corp. puts it.

No wonder, then, that using home equity credit lines and cash-out refinancings for business purposes was widespread during the good times. After all, 95% of small-business owners also own their own homes, according to a survey late last year by the National Federation of Independent Business.

To get cash for business expenses, one-third of California small-business owners took out exotic, high-risk products, such as those that required little proof of income or allowed borrowers to pay so little that their loan balances rose, said accounting Professor Samuel D. Bornstein of Kean University of Union, N.J.

Bornstein, who has studied the issue extensively, predicts the business owners, many now far underwater on their loans, could shed 2.1 million jobs in the state over the next four years, creating even more problems than the initial wave of subprime mortgages.

“The second tsunami is particularly going to inundate small businesses,” Bornstein said.

In Southern California, many immigrants refinanced their homes to start such enterprises as food deliveries to restaurants and home remodeling services, said Namoch Sokhom, director of business development for the nonprofit Pacific Asian Consortium in Employment in downtown Los Angeles and El Monte.

These people, many with limited English skills, had no financial track records in this country that would allow them to get bank loans, Sokhom said. Instead, lenders advised them to raise capital by refinancing with adjustable-rate mortgages or using home equity credit lines, he said.

The idea of using a house to finance a business caught on in the ethnic communities, said Sokhom, 60% of whose clients are immigrants from Asia or Latin America.

“People were saying that if you don’t do it you are crazy, you don’t know what’s going on,” he said. “And they said if you can’t pay when the loan resets, you just refinance again.”

What Sokhom calls the “foreclosure crisis” among his clients started last year, when gasoline prices shot up.

“Many of them came to us and said, ‘We cannot do any more deliveries because every trip out we lose money.’ Many of these people, when they bought a truck, used their home equity or an equity loan outright to buy the truck,” Sokhom said. “Now when the business goes sour, they cannot pay the mortgage also.”

Others, like mortgage broker Arnold, have had their home equity credit lines cut off because of falling housing prices. For people in the home improvement business, that has meant no access to funds to buy materials and pay workers until the job is complete and they are paid, Sokhom said.

The evaporation of mortgage-related credit is part of a broader pullback by lenders in the recession.

Businesses that had counted on bank financing have been finding it harder to get. The Federal Reserve reported last month that U.S. banks had tightened their standards for lending to small businesses for 10 consecutive quarters.

The trend intensified throughout last year, peaking in the fourth quarter, when 74.6% of senior lending officers in a Fed survey reported making it more difficult for small businesses to obtain credit to fund payrolls, buy equipment and finance other operational needs.

The trend eased slightly in the first quarter of this year, with 69.2% of the lending officers saying their banks had tightened credit for small businesses.

But the lenders also reported that small-business demand for commercial and industrial loans and lines of credit was down sharply as the downturn took its toll and the gross domestic product fell at an annual rate of 6.1%.

No wonder, then, that both small-business owners and the public “remained pessimistic,” as the Small Business Administration said in a recent quarterly report on the economic climate. “Poor sales and access to credit are major issues.”

The National Federation of Independent Business survey found that of the small-business operators who owned homes, 26% had mortgaged the residences to provide capital for the business. Answering a separate question, more than 10% said they had pledged their homes as collateral to buy other business assets.

That’s a far greater number than those who use SBA loans, the government-guaranteed loans made by banks and credit unions.

“Only about 5% of people seeking business loans use SBA,” said Robert A. Borden, an SBA regional spokesman in San Francisco. “The majority use personal funds, borrow from friends and relatives, or use credit cards.”

Those seeking SBA loans usually wind up dependent on their home equity in any case. That’s because the government generally requires that business owners provide collateral to personally guarantee the loans along with the government guarantees.

For most business owners, that means pledging their homes to back the loans, Borden said. If a loan goes into default, the SBA guarantee kicks in only after the bank recovers what losses it can by going after the home or other personal assets.

The SBA, trying to encourage lending, recently dropped some of its fees and increased its guarantees from 75% or 85% of loans to 90%. And a program called SBA Express, which provides lenders with reduced guarantees, allows banks in some circumstances to waive the demand that borrowers post collateral.

But there’s no such thing as easy money these days: As banks tighten the credit spigot, SBA-guaranteed loans are expected to drop to between 75,000 and 80,000 this year from 110,000 last year, a decline of as much as 32%, Borden said.

The requirement to pledge a home or other personal asset to get banks to write SBA loans has put such loans beyond the reach of some otherwise well-established business owners.

A.J. Gilbert, owner of Luna Park restaurants in San Francisco and Los Angeles, said that in the past he managed to get SBA loans for his businesses without providing a personal guarantee.

But when Gilbert went looking recently for financing for a new restaurant, Henry’s Hat, that he is opening on Cahuenga Boulevard near Universal Studios, no bank would lend him money when he told them he didn’t own a home and he wasn’t willing to pledge his personal assets.

In the end, Gilbert obtained about $250,000 in financing through the Valley Economic Development Center, a Los Angeles nonprofit. But that’s not an option for most people because the amount of funds available at such nonprofits is limited. The development center made $6 million in loans last year, up from $4 million the year before but a minuscule amount compared with the demand for small-business financing.

“Most people who want to borrow from a bank for SBA money will put their houses up as collateral,” Gilbert said.

And that’s become a lot harder to do in today’s depressed real estate markets.

E. Scott Reckard
LA Times