Real Estate News & Commentary by Chris McLaughlin, January 11, 2010

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Apartment prices fall 3%, vacancies up 8%

The national apartment vacancy rate rose to 8% in the last three months of 2009, according to Reis Inc., a commercial real estate information provider. That is the highest level Reis has ever reported. The vacancy rate barely inched up from the third quarter — just 7.9% to 8% — but it rose significantly from a year ago, when it stood at 6.7%. Even more dramatic, vacancies spiked 45% from the third quarter of 2006, when they had bottomed out at 5.5%. According to Reis economist Ryan Severino the main culprit is the recession. Not only do people lose their jobs during downturns, many others are afraid of being laid off. And they all feel pressure to reduce their housing costs. “Household formation rates slow down during recessions,” said Severino. “They may move in with their families or rent larger apartments and partner up with friends. They partner with others much more then they do during more prosperous times.” Occupancy rates did climb during the quarter, with nearly 10,000 more apartments being rented than had been three months earlier, according to the report. But vacancy rates still managed to climb because 28,000 newly constructed units hit the market. A total of 120,000 new apartments came online during 2009, the most since 2003.

Americans borrowing less

Americans borrowed less for a 10th consecutive month in November with total credit and borrowing on credit cards falling by the largest amounts on records going back nearly seven decades. The Federal Reserve said Friday that total borrowing dropped by $17.5 billion in November, a much bigger decline than the $5 billion decrease economists had expected. November’s $17.5 billion drop in total credit was the biggest amount in dollars terms since records began in 1943. That represents an 8.5 percent fall from the October borrowing level. That was the biggest percentage drop since total credit declined 9 percent in May 1980. The borrowing category that includes credit cards fell by $13.7 billion, an all-time record decline in dollar terms. The drop was 18.5 percent from November, the biggest decline in percentage terms since a 29.6 percent plunge in December 1974. The Fed’s credit report excludes home loans and home equity mortgages, only covering borrowing that is not secured by real estate. The drop in overall credit for 10 straight months was a record in terms of consecutive declines, surpassing the old mark of seven straight declines set in 1943 and again in 1991. Americans are borrowing less for a number of reasons. They remain fearful about their job prospects and they are also trying to replenish depleted investments.

DSNews.com – Future of Mortgage Purchase Program?

According to minutes released this week of the Federal Reserve Board’s closed-door December meeting, Fed policymakers have already begun debating whether the program should be extended, to ensure the already-fragile housing recovery maintains its course, but the decision has left a dividing line down the central bank boardroom. The Federal Reserve has said it will end its purchases of mortgage-backed securities (MBS) from Fannie Mae, Freddie Mac, and Ginnie Mae on March 31, but the decision wasn’t unanimous. Over the past year, the U.S. central bank has purchased nearly 75 percent of the mortgages that Fannie, Freddie, and Ginnie have securitized. It currently holds just over $900 billion of these MBS bonds, and says by the time the program ends it will have bought a total of $1.25 trillion.

On Wednesday, federal banking regulators, including the Federal Reserve, issued an advisory to the nation’s financial institutions, warning them to ensure procedures and practices are in place to minimize their risks from loans and an increase in financing costs when interest rates do rise. The government has already moved to reassure the market that the Fed’s withdrawal of its support won’t have as big a sting as some fear. In late December, the Treasury pledged “unlimited support” to Fannie Mae and Freddie Mac, and lifted the mandate that the two companies begin selling off large chunks of the securities they hold. But some investors aren’t convinced. Ronald Temple, portfolio manager at Lazard Asset Management, told the Wall Street Journal that if the Fed stops buying mortgage bonds, we should expect mortgage rates to rise by at least a full percentage point. He says that combined with high unemployment and still large numbers of foreclosures could push home prices down as much as 20 percent.

Redefault Rates ‘Tragic’, Says Amherst

According to Amherst Securities Group, default and prepayment rates on non-agency, private-label mortgage-backed securities (MBS) were constant in November. However, re-performance rates, where payments return to less than two months delinquent, were down and re-default rates “tragic” in November, according to market commentary provided by the firm. The Amherst report, based on November payment data covering 98% of loans backing private-label MBS, said cash flow velocity continued to decline. Based on performance data, Amherst projects that always-performing loans fell to $905bn in November from $930bn in October, as first-time defaults came in at $16bn, from $16.8bn in October.

Prepayments of $8.3bn were unchanged from the previous month. Re-performing loans totaled $117.3bn in November, down from $118.1bn in October. Loans totaling $12.8bn became re-performing in November by getting back within two payments delinquent, down from $13.4bn in October. Total non-performing loans were $484.8bn in November, from $486.1bn in October. Re-defaults after modification were $12.8bn, or 10.9%, up from 10.5% last month. Laurie Goodman of Amherst has said the fundamentals of certain modification programs put them at a disposition for unsuccessful modification. The Treasury Department’s Home Affordable Modification Program (HAMP), for example, is “destined to fail” as it does not address negative equity.

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Price Impact on ROI

One of the most commonly used valuation models for single family homes and short sales includes the Return on Investment or ROI. Despite the ease associated with using this calculation, the ROI is a robust measure of investment value that is both quick and convenient. However, it is also subject to a high level of volatility based upon the price of the property and type of funding in place. In fact, ROI is so dramatically influenced by funding mechanisms it is frequently considered a cornerstone by investment advisors. Let’s take a look at a few hypothetical short sale situations to demonstrate the impact of price on the ROI as well as how it can be used to your advantage.

Cash is still king and it speaks louder than ever especially with tightening lending standards and other banking irregularities; however, one area where cash doesn’t hold up quite as well as the use of leverage is in the calculation of ROI or return on investment. Let’s assume a short sale investor opts to purchase a property in cash for $100,000. If the property generated a one year rental return of $10,000 the total ROI is a fairly straightforward 10% or perhaps the property was flipped for a $20,000 profit and thereby the ROI was a handsome 20%. Both are completely realistic examples and certainly above and beyond what stocks, bonds or other inferior investments are currently able to deliver but the total return is a bit misleading. This can be due to the cost of borrowing the money in the first place (ie, what interest rate is being paid on the funds borrowed or the “spread” of the borrowed interest rate versus the total ROI received). For example, if the short sale buyer took out a home equity loan or borrowed against a 401-k plan, the interest rate may be a very reasonable 3 to 4 percent versus a total return of 10% – leading to a “spread” or ROI of 6-7 percent.

On the other hand, some properties are truly purchased completely for cash so the entire ROI is theirs to keep…but is this always the best situation? Maybe-maybe not. There are a multitude of reasons to purchase a property for cash – not the least of which is the inability to obtain full financing on a distressed property, the ease and convenience of closing and the cost savings of not having to obtain PMI or other add-ons. However, there are very strong reasons to finance a property or use the maximum amount of leverage possible to maximize ROI. Going back to the former example, let’s assume you financed a property for 80% of the value…$80,000 of the total price of $100,000. You used $20,000 out of pocket and received the same $10,000 annual rental or flipped for a quick $20,000. Instead of a respectable 10% to 20% return, you will now realize an eye-popping 50% to 100% return on your investment!

Now let’s take this one step farther…how important is price when it comes to ROI? The final answer is “it depends”. Certainly buying right is a critical consideration in any short sale deal however, when using leverage, price becomes much less important due to the extreme rates of return generated. In the above examples, every $1,000 addition in cost reflects a significant gain or loss in the final cash ROI but in the leveraged position, paying an additional $1,000 for a property results in a paltry difference in the final ROI. Short sale investors should fully understand how to maximize ROI depending upon the price and funding source to be utilized for the deal. By doing so it is often feasible to pay more for a property while still maximizing the full profit potential of your portfolio.

See you at the top!

Chris McLaughlin

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About the author:

Chris McLaughlin is widely known as America’s top
Real Estate Attorney and Investment Consultant.

    * As the top Florida foreclosure and pre-
      foreclosure expert, he oversees more than
      100 short sale & REO closings each month
   * Long-time authority on real estate investing
      and rapid reselling of distressed homes. Owns
      portfolio of nearly 100 high-value, high-profit
     properties
    * Owner of one of Florida’s largest Real Estate firms,
     running 4 different offices, supporting over
     400 agents, uniquely positioning him to help
     thousands of investors make money in the
     biggest market opportunity ever!
   * Highly sought-after speaker, consultant, and
      seminar leader for current trends and hot topics
      in Real Estate Investing, Entrepreneurship, and
      Wealth Building
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