Short Sales Riches Blog » $700 billion

TARP Bailout Criticized by Oversight Group

Chris McLaughlin — Wed, 10 Dec 2008 19:55:16 +0000

Mid-Day Market News & Commentary by Chris McLaughlin, December 10, 2008
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Ouch! The Government Accountability Office, along with the Congressional Oversight Panel for Economic Stabilization, blasted the Treasury Department’s management of the $700 billion TARP program. The 38 page document noted that “Treasury cannot simply trust that the financial institutions will act in the desired ways; it must verify.” The report further commented that the Treasury had “administrated the TARP without seeking to monitor the use of funds provided to specific financial institutions.”

And other eyes were on Capitol Hill today as the Big 3 Automakers got a lot closer to sealing a $15 billion bailout package. The package will lead to the creation of a “Car Czar” to oversee the loan grant, in order to avoid the “take the money and hoard it” approach that many banks have taken after receiving their bailout. But several Senate Republicans were outraged, with Sen. David Vittner of Louisiana called the approach “ass backwards” and promising to filibuster it.

More money is headed out the window to the morons at AIG, the folks who partied it up at the St. Regis and seem to have no ability to control their spending. The Wall Street Journal reported that the insurance conglomerate owes other Wall Street firms about $10 billion for because of speculative investments that didn’t pan out.

Now on to real estate investing information …

Gross Income Multiplier

Short sale investors are a different set; they take action when others are too cowardly to act. They remain informed while others rely upon others for information and perhaps most telling of all…they crunch numbers. Last week we examined how to calculate the Cap rate of a property in order to determine the price of an income producing property. Although the Cap rate is a favorite among many bankers and brokers alike, another widely used formula is the Gross Income Multiplier.

How to Calculate

To calculate the Gross Income Multiplier you will need to divide the asking price or market value of the property by the current gross rental income (or potential rental). For example, let’s assume a home is listed for $150,000 with an annual rental income of $10,000. The Gross Income Multiplier would = 15. The higher the better. To provide some perspective, it may be useful to draw examples from other industries and areas. For example, if you were purchasing a publishing concern then you (and the banker) would expect to see earnings worth 5 to 10 times the pre-tax earnings on an annualized basis whereas insurance agencies sell for 150 percent of annual commissions.

When to Use

Using the GIM provides an excellent method to compare the asking price with industry norms or as a potential negotiation tool when making an offer for a short sale property. It is a good idea to use conservative numbers when calculating the GIM since it does not take extraneous expenses or future tax and insurance rate hikes into account. Repairs, utilities and other considerations may wreck havoc on even the most robust calculations so it isn’t a good idea to use the GIM when dealing with older properties or those in need of extensive renovations and/or repairs.

A Quick Word about Hedonic Pricing Models

No discussion of GIM would be complete without a quick word about hedonic pricing models. Like the government itself, builders and brokers alike will often try to maximize value by including the full “value” of hedonic measures. While that is a valid method during robust economic times, during downturns in the economy those same granite countertops, luxury pools and other customized features tend to lose value – or worse – may actually be considered a liability by some buyers. Short sale buyers would do well to base GIM calculations on conservative building alternatives or sharply discount hedonic estimates especially during tough economic times.

Caution is Advised

There is a reason the GIM is favored by corporate raiders and strategists; as a general “rule of thumb” price estimate it often results in an aggressive method for determining valuations especially when dealing with more “favorable” properties that require minimal maintenance, upkeep or repairs. Short sale investors may find this a more desirable alternative than the Cap rate formula for some properties; just keep the limitations and risks in mind or you may find yourself on the losing end of a tough negotiation strategy.

Understanding Depreciation in Real Estate

Chris McLaughlin — Wed, 03 Dec 2008 22:02:16 +0000

Understanding Depreciation in Real Estate

Mid-Day Market News & Commentary by Chris McLaughlin, December 3, 2008
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In the latest on the botched government bailout, the Government Accountability Office blasted the internal controls over the handling of the $700 billion allocated for the TARP bailout. The report specifically noted that the ultimate outcome – providing liquidity and getting banks to lend –is not being monitored. As it notes: “Treasury has no policies and procedures in place for ensuring that the institutions are complying with these requirements or that they are using the capital investments in a manner that helps meet the purposes of the act.”

So let’s give the banks $300 billion … but put no requirements that they actually lend it. Hmm… and guess what’s happening? They are hoarding the cash, so Main Street still gets hurt. Our bet: the next $350 billion that goes out has a lot more strings attached to it, not just restrictions on executive pay and dividend payouts.

And in the latest sign of desperation from the Big 3 Automakers, Jim Press, the Vice Chairman of Chrysler said the big D work: depression. “We’re on the brink with the U.S. auto manufacturing industry,” Press told The Associated Press. “If we have a catastrophic failure of one of these car companies, in this tender environment for the economy, it’s a huge blow. It could trigger a depression.”

Depression? Really? That’s really pushing the envelope folks. First they fly in with corporate jets asking for help. Now they’ve gone to scare tactics because the American people are not happy about another bailout. How about designing cars that are fuel efficient? Novel idea, eh?

President elect Barack Obama nominated New Mexico Governor Bill Richardson as the Secretary of Commerce. “We have everything we need to renew our economy, we have the ingenuity and technology, the skill and commitment — we just need to put it to work,” Obama said.

Now on to our real estate educational section …

Understanding Depreciation—Especially on Short Sales & REOs

When it comes to buying and selling short sales, foreclosures or other distressed real estate an understanding of depreciation is essential. To begin, let’s use a working definition of depreciation; depreciation is simply an accounting method of reducing accounting income by spreading the deductible fixed asset cost over the estimated life-span. Two questions should quickly come to mind; “what is a fixed asset” and “what is the estimated life span”?

When dealing with real estate the house and property are considered “fixed” assets; other items such as appliances are also assets but not long term. For tax planning purposes, the government has established typical life-spans associated with most assets; for example, buildings often have a life-span of 27.5 years, appliances 5 to 7 years etc…land, which doesn’t deteriorate or become obsolete, never depreciates.

There are several ways to calculate depreciation depending upon your specific needs and situation but it is important to understand the benefits and consequences of each; once you select a method it is difficult to impossible to change to another formula in future years. The two most common methods are the straight-line and units of production however, for the purpose of real estate, most short sale investors will only use the straight line formula.

The straight line formula is easy: Depreciation = cost-salvage value/number of years of useful life. So for example, if you purchase a new HVAC unit for a home at a cost of $5,000 then subtract a salvage value of $500 for a total of $4,500 divided by a 10 year lifespan you would derive an annual depreciation of $450.

Alternative depreciation calculation methods include “Sum of the Years’ Digits” and “Double Declining Balance” are useful when additional depreciation is needed earlier in the lifecycle of the asset. Keep in mind, whatever method is used, the total depreciation will result in the same amount by the end of the period. It is only the annual amount of depreciation that changes.

A few depreciation tips to keep in mind related to short sales:

1. Bonus depreciation is currently authorized for investment properties – this accelerated depreciation is a major tax advantage to those seeking a shelter or hedge against gains. If you currently need additional tax breaks then take it; otherwise, use the standard straight line depreciation method without the acceleration.

2. Calculate depreciation when crunching numbers; depreciation can turn marginal homes into the black rather than the red.

3. Consider selling or doing a 1031 exchange on properties nearing their full depreciation schedule; be careful to calculate depreciation recapture.

4. Depreciation isn’t optional; short sale investors that fail to take depreciation will still be liable for it later.

5. Always review accumulated depreciation expenses reported on income statements/other of investors/sellers etc; accumulated depreciation on a fixed asset is a solid method of determining book value and the real “worth” of a fixed asset.