Peter Pays Paul

Through the use of a clever experiment with a skating rink, John Stossel argues the faults of central planning.

National Real Estate Investor Online had an article on the number of “Opportunity Funds” that have formed to take advantage of distressed real estate. As of the article 35 funds raised a total of $33.5 billion.

Real Estate Opportunity Funds Overfloweth

We are living in rare days. The financial turmoil is on the headline news every night. The U.S. government has decided that it is the savior of the markets. Congress fought over “The Bailout”. The market can’t decide which way it wants to go.

The news is very gloomy.

Weathering the Storm

Much if not the majority of the news it outside of our individual control. The “winds of destruction” are swirling around our heads.

We can’t stop the winds from blowing. But we can keep our heads down.

You can do nothing anything about macroeconomic problems. You can’t buy enough plasma televisions to save the economy. You don’t control the price of the stock market. You can’t force banks to begin lending.

If you focus on the global economy, the number of unemployed, or the weather forecast for January, you are distracted from the items that you can do today to improve your bottom line.

Focus on Things You Can Control

Focus your energy and emotions on daily items within your sphere of control to ensure that you survive these times. Wasting time and emotions on things outside of your control is ultimately unprofitable.

Focus on Your Attitude

Stay positive. Do not be preoccupied with all that you don’t have. Thinking about toys/gadgets/money we don’t have leads to grumpiness. No one likes a grumpy person.

Rather than focus on what you are lacking, focus on what you do have. Be thankful for things like family, friends, a job, a home, and food. Remember there are always people less fortunate than us.

Focus on Being Productive

What activities can you do daily that will impact sales? Is it phone calls, emails, or personal visits? Focus on completing these tasks. Focus on meeting people, generating referrals, and results.

When will you do these activities on a daily basis? Plan the activities that are profitable into your calendar. Block time in order to attain the results necessary. Turn off the phone. Don’t check your email. Stay on point and accomplish your goals. (Even as I write this I am being distracted by something.)

How many [blank] do you have to do to generate the income that you want? If you reach 5 people a day will it generate the income you want? Do you need to phone 10 people a day? If you email 200 people a month will it generate the results you need?

Focus on Adding Value

If you constantly seek to add value as an employee, as a salesman, or as a consultant you will be rewarded for the value you add.

Too often we are myopic and only think that the item we sell adds value. However, we can add value by relaying good information, referring a new customer, or by offering insight. All of these can be done at no cost to our clients, yet it endears them to us. Caution: Don’t expect to get something in return immediately.

What value are bringing to your boss/client? You are only worth the value you add!

Get Back to Work!

It is easy to see that in these coming times, work will win the day. Those that work harder and perform at a higher level will be rewarded.

The “Times of Plenty” are over. Now by the sweat of our brow we will have to generate income.

Don’t let the negativity distract you from production, staying positive, and adding value.

The University of Southern California organized a panel of speakers on the current financial and real estate market. (Ht: Richard Green)

Finance & Real Estate Market Meltdown

CBS’s 60 Minutes investigated the CDS market that Wall Street created.

The “bailout” or “rescue” is the hot topic on most lips these days. In fact it is hard to escape on any of the media outlets.

Below are a few articles for you to ponder on this issue.

Is Purchasing $700 billion of Toxic Assets the Best Way to Recapitalize the Financial System?

Nouriel Roubini argues against the proposed plan. He summarizes, “Thus, the Treasury plan is a disgrace: a bailout of reckless bankers, lenders and investors that provides little direct debt relief to borrowers and financially stressed households and that will come at a very high cost to the US taxpayer.”

You Can’t Rescue the Financial System If You Can’t Read a Balance Sheet

John Hussman details the reasons that the current plan only provides a benefit if the Treasury pays above market value for the value of the securities, a very reassuring thought (sic). (HT:Naked Capitalism)

Bankruptcy, not bailout, is the right answer

Jeffrey Miron from Harvard argues that the government should do nothing and let the companies that invested in the bad investments go bankrupt. He states, “Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.” He argues that bad government policy should not be fixed with more government. He also reasons that credit markets are frozen is likely caused by the current owners of bad securities being unwilling to sell them at the offered price, because they are waiting for Uncle Sam to come in and pay a higher price.

Real estate investors that are seeking to grow their invested capital commonly use 1031 Tax-Deferred Exchanges.

These exchanges allow the borrower to apply more of the proceeds from the sale of an existing investment property to the purchase of a new investment property.

1031 Exchanges Defined

This is an explanation of an 1031 exchange according to the IRS website:

Generally, if you exchange business or investment property solely for business or investment property of a like-kind, no gain or loss is recognized under Internal Revenue Code Section 1031.

My explanation in a nutshell: a real estate investor can sell a piece of investment property, defer the capital gains tax until a later date, and roll the entire gain into the purchase of a new piece of investment real estate. The taxes are deferred (postponed) until the investment property is sold the final time.

Benefits of 1031 Exchanges

Deferring the taxes due on capital gains (appreciation) can reap huge rewards over time. Deferring payment of capital gain tax allows the savvy investor to apply more capital towards the purchase.

Leverage should allow the investor to generate a higher return through appreciation and/or cash flow.

1031 Exchange Hurdles

Now of course the government doesn’t make it an easy process and sets limits and restrictions on how a 1031 Exchange must be executed.

One of the main restrictions is the timing on completion of a 1031 Exchange. The exchange must be completed within 180 days of the transfer of the exchanged property. This deadline can put pressure on all involved to complete the deal within the 180 day period.

The costs of missing this deadline can be large. The borrower will be forced to pay capital gains tax on any gain as well as any penalties that might be incurred if the contract date is not met.

Most exchangers will typically qualify for standard financing. However, on occasion an institutional lender will be unable to provide financing within the mandated 180 days.

Using a Hard Money Loan to Execute a 1031 Exchange

If the primary lender is unable to close on time, what is the investor to do?

One of the benefits of using hard money is the speed that hard money lenders provide. A hard money lender that lends their own funds and is well operated can provide commercial financing within 14 days of receiving a complete package.

Another benefit is that most lenders offer loans on a short term basis. The hard money loan can help an investor close the transaction while a more permanent loan is arranged.

While the fees associated with hard money may be higher than a traditional source, the benefits of completing the transaction within the mandated time may outweigh the costs.

1031 Example

The following example should help demonstrate my point. Below are the assumptions we will use for our example.

Below are the costs that would be associated with a failure to execute the contract on time. I have only included what I would cite as the most basic and immediate costs. (There would be the potential loss of future returns as a result of cash flow and/or appreciation.)

The current capital gains rate is 15% but is set to increase in 2010. By including the deposit I am assuming that the deposit became non-refundable at some point.

Below I have computed the after tax costs of a hard money loan. The pricing below is on the high side for a short-term, conservative LTV loan.

Conclusion

As you can see from the example the after-tax cost of hard money may be less than the cost of not executing the 1031 exchange on time.

Hard money is not the best option for all scenarios. When a deal is on the line and speed is needed, hard money is a good alternative to institutional financing.

For more information head on over to Jeff Brown’s blog to find out more about 1031 exchanges and when to execute them.

Part of my job is to take incoming cold calls. We advertise in a commercial lending industry magazine that generates a good deal of call traffic.

On a regular basis I get requests for “construction” loans. After asking some questions to determine the nature of the loan, I usually find out that the broker/borrower is actually searching for what I would call a “development” loan.

What’s the Difference, Who Cares?

Why does it matter if you call it a construction loan rather than a development loan?

First, it reflects on the broker/borrower. If a lender has to educate the person requesting money, it sets a bad tone for the deal.

Second, some lenders offer construction financing but don’t offer development financing. Asking the right question allows you to get a correct response and save you time.

Finally, loan to value and equity requirements may vary depending on whether the loan is for development or for construction; I know ours do. This information helps the lender determine if the loan is within their parameters.

Construction vs. Development

Construction by definition has the connotation of putting things together. In my mind, moving dirt for roads or infrastructure does not meet this definition (no offense to those in the fields of civil construction).

The definition of the word develop includes the idea of being made usable. This is perfectly suited for the installation of roads, pads, and infrastructure; as the land has now been made usable for a building.

Defining Loans

Consequently, I would recommend that if you are asking lenders for a construction loan, a building should be in place when construction is complete.

Loans to improve land should be titled as development loans.

This the third post in a series I am writing on finding distressed properties. Posts 1 & 2 can be found here.

Marketing

Marketing to owners of distressed property is the third method of finding distressed property.

Marketing Costs

For purposes of this post we will define marketing as the process of informing owners of distressed property, that you are interested in purchasing their property.

Almost all forms of marketing will have an out of pocket cost, before you see a return on the marketing investment. These costs may include printing, postage, design, or mass media expenses.

Marketing Budget

It is important to prepare a marketing budget prior to investment in any system. A budget will help you track marketing effectiveness and control spending.

Consistency is key to any marketing strategy. Most marketing takes time to show results. Dividing your marketing budget over months or weeks, will help to develop consistency and prevent you from “betting the ranch” in one marketing blast.

Market to Your Sphere

Each one of us has a sphere of influence that we touch on a regular basis. Our sphere includes friends, family, neighbors, clients, employees/employer, service providers, etc.

The easiest way of informing your sphere of influence that you are in the market for distressed property is through the use of business cards.

Business cards are an inexpensive way of informing others of who you are and what you want. By including a list of desired property characteristics on the back of the card, you remind the holder of what you are seeking.

Direct Mail

Direct mail consists of mailed advertisements to potential sellers. Direct mail is a proven marketing method, but has in general only a 2% response rate.

Printing and postage costs are both associated with direct mail. If first class postage is used, costs can be in excess of $0.50 per marketing piece. These costs add up very quickly and may limit the number of people you are able to reach.

Direct mail will have a greater efficiency if it can be targeted to individuals that have been pre-screened for relevant criteria. Criteria that may be helpful could include property owners, age of property, length of ownership, and building age. Title companies may be able to provide this information to you.

Signage

Bandit signs, fliers, and other types of signs can be used to garner the attention of would be sellers. This type of advertising is more likely to be utilized for residential properties than for commercial properties.

Fliers with your commercial property description could be distributed to local commercial brokers. This may be a way to inform the brokerage community of what you are searching for.

Classified Ads

The classified ads of your local newspaper may be a cost effective means of advertising your desire to buy distressed property.

Typically, those reading the classified section are in search of something specific. Classified users tend to be in the market.

A classified ad stressing that you buy real estate of all shapes and sizes may draw the attention of someone in need of selling or tired of dealing with tenants.

Mass Media

Mass media includes radio, television, and billboards. Though these methods have a broad reach, not everyone that sees or hears your advertisement will be a suitable customer. Thus, in general they are not a cost-effective means of advertising for distressed properties.

Conclusion

While there are many different marketing channels, you must find the method that works best for your property characteristics and fits within your budget. Once a channel begins to produce results, you should re-invest in that channel in order to produce even greater results.

Marketing takes time and requires consistency. Invest in marketing over the long haul in order to reap the rewards.