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01-31-2009 |
Bruce Norris is joined once again this week by Principal and Co-Founder of Beacon Economics, Christopher Thornberg. Bruce and Christopher continue their conversation about paying the debt we are currently giving our children. Christopher talks about World War II and how quickly we paid the debt back. Christopher doesn?t have a problem with raising money but government has a problem sometimes paying it back. Bruce brings up that the State of California can?t raise money so how do you fix the issue. Christopher says California?s problem is $40 billion of a $1.8 trillion in economy which is only 3.5%. It?s not that big of a number. California is 18th in the list of states as far as paying taxes. We?re a little above average. We just collect them in strange ways. Instead of taxes on a ton of small things, we have larger taxes for a smaller bunch of things. Christopher says we have the most regressive property tax. There?s a small group of people who pay a larger portion of the taxes. There?s other ways to make California more tax friendly and pay off debt. Bruce brings up Prop 13. Christopher thinks Proposition 13 is ridiculous. Voters would have to overturn that proposition. Bruce brings up Citibank and the concept of cramdownsn which they agreed to cooperate with in bankruptcy court. Bruce asks if that?s possible and Christopher said it is. There?s a new president and an administration that?s more left leaning. Certainly some would pursue bankruptcy as a way to do so but it does incur costs above and beyond just losing your home. Other assets will be at risk. Christopher asks if judges will really consider this alternative as some of these people lied on their loan applications. Bruce says we haven?t put much pressure on the people who exaggerated income. Christopher says the FBI came out early and said they would not be pursuing the consumer. He finds it hard to believe a judge would take the same stance if a consumer blatantly lied on their application and then were seeking a cramdown. Christopher talks about the huge issue of people going in to default after the payments are adjusted through loan modification. Reports suggest 50% go back into default. Bruce brings up TARP and the term crawl back which is when CEOs have to give back bonuses if the banks restate their earnings. Christopher says they should have to give it back. Christopher says the problems in the market stems from the problem with executives in the financial system because they were grossly compensated for short-term returns. Christopher talks about some of the ways these executives made millions. He brings up a Lehman executive who made $400 million in six years and how he did it. Executives need to have some skin in the game. Christopher says mortgage backed securities were used to hide risk. Bruce brings up what they used to call these instruments in the 1900s and how they were made illegal. Christopher is not apposed to derivatives, they?re just extremely complex. We just need to understand them more and the motivation for why people use them. Bruce asks what the next shoe to drop will be in California. Christopher says asset values are now returning to normal. Savings rates are ridiculously low and debt is way up. Americans thought they were rich. Wall Street tricked these people into believing they could retire early. America has to get spending under control. It?s healthy but painful in the short run. Our economy is too reliant on feeding consumers what they want. It?s not we are buying too few cars today; we bought too many the past few years. Bruce brings up that the consumer spending was a lesser percentage of the GDP in the past as it was in recent history. Christopher expects that to get back in line. Huge trade deficit was also part of this equation. There was a trade deficit and a savings deficit. In two years, there will be more exports, less imports, and less consumer spending and then we?ll have a healthy economy ready for growth. Bruce brings up that China won?t appreciate it much. Bruce talks about a report Christopher Thornberg wrote called ?Waiting to Save? which is about the habits of the younger generation (24-34) and their saving habits. Bruce says this generation will be picking up some tabs that they didn?t even create. Christopher says this generation grew up in a market where you borrow to speculate. People have to learn to live within their means. Bruce asks about defined benefit plans. Christopher says for the most part they have left the room and only reside in government. He?s afraid these benefits might never happen and we might figure that out in the coming years. Many of these programs have lost much of their value. Join us next week for a chat with Mike Cantu before we release his Rental and Property management seminar February 21st. |
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01-24-2009 |
Bruce Norris is joined this week by Founding Partner and Economist with Beacon Economics, Dr. Christopher Thornberg. Bruce asks what Christopher thinks about the phrase, ?Since the Great Depression.? Christopher says it?s a bit of an exaggeration and there are definitely sectors that have been hit hard but it?s not that bad. Some assets are still holding well. Bruce asks about the benchmark numbers that clue us in on a depression. Christopher says that before World War II, every recession was a depression. The word ?recession? was created so there could be talk about economic downturns without alluding to the Great Depression which might cause panic. He says you could categorize a really bad recession as a depression. Bruce asks about employment and if they?re measuring differently as there are several categories including under employed. Christopher says employment numbers are measured the same and there have always been those other categories. We?re mainly talking about people who want to find employment but can?t. Bruce asks if Christopher thought he would ever see these big financial corporations fall. He said he did about six months before it happened because they had really leveraged themselves and it was unsustainable. Debt to equity ratios were 80 to 1. It became apparent any turmoil would cause a failure. The thinking was the more leverage, the more return. During bad times, that same principle works the other way; it magnifies losses. Now the government is picking up the pieces. Bruce talks about the rating systems that we thought were independent and we find out they were getting commissions. Christopher says people who listen to Moody?s and S&P need to understand the system a little more. Many of these assets they were rating were new and didn?t have much history. Their ratings came from modeling so there was not a complete knowledge of risk. Bruce says that?s an issue because people were looking to these companies and they thought they could trust them. Christopher says people have to do their own due diligence. People stopped looking at fundamentals and weren?t doing their homework. When the market was working, people got lax. Bruce and Christopher talk about Bernie Madoff and how he could possibly get away with that for years without getting caught. Bruce asks why it seems that when our bubble popped it seemingly caused the rest of the world to collapse. Christopher says that the U.S. is definitely the financial guerilla in the world at 25% of the world economy. However, the U.S. was not the only place where abuses of the financial systems were going on. The kind of borrowing going on in Eastern Europe is a perfect example. Some countries are in much worse shape than we are currently. Bruce asks Christopher if there are ramifications to the U.S. and its reputation because of the fall. Christopher says there won?t be. Our dollar is good by comparison. In the U.S., you know what you?re getting and we have a very diverse and large asset base. U.S. Government debt is considered the best. The talk that everyone was going to Euro was all talk. In 2005 there were some issues but the problem spread to other banks in other countries and the dollar got everything back that it lost in 2005. Bruce talks about TARP and if Christopher thinks the first half was spent wisely. Christopher said yes. Congress is upset that there is not enough oversight. Christopher says TARP was not meant to force banks to lend money. It was meant to stabilize the banking system. The system is still in horrible shape. There was an enormous increase in asset value and not just in real estate. The delinquencies on all sorts of debt are way up. Banks will possibly lose trillions. The banking system needs to keep going and we have to step in and help the banks recover. The initial TARP program Christopher did not like. They were going to go in and overpay for assets. They?ve been taking chunks of the money and give it to banks that are too big to fail (Citigroup, Bank of America) and small banks that are healthy that haven?t participated in the debt frenzy to allow them to expand. It allows these banks to pick up other banks as they fail. Christopher says the TARP money is all borrowing and the government creating Treasury bonds. The government is also facing a huge fiscal deficit so they need t borrow. Bruce talks about interest rates and its effect on inflation and trillions in deficits. Christopher sees about another two trillion to total 11.5 trillion. It will be 15% of GDP. It?s all relative and it?s not that bad. And they unfortunately have to pick up next week. More about Christopher and Beacon Economics at beaconeconomics.com. |
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01-17-2009 |
Bruce Norris is joined this week once again by appraiser and investor, Rick Solis. Bruce and Rick start by talking about market value. Rick says market value is what a ready, willing, able, and knowledgeable buyer is willing to pay for a property. Bruce asks if this definition is being held up with lenders in today?s market. Rick says that lenders are not. Bruce talks about how real estate auctions do not reflect true market value compared to fixed inventory. The majority of the inventory needs fixing and must be sold in a certain time frame. Rick says the market is very different from the 90s. In the 90s, Rick says that there used to be a box that said ?declining market?. If that box was checked, the deal wouldn?t go through. Now, the lenders will do those transactions but lenders require more comparables. It becomes difficult to find similar inventory. The banks will want to see the appraiser adjust for the market. Appraisals used to be good for 6 months. With a declining market, comparables need to be 60 days or less from the day of funding. Lenders want at least 2, preferable 3, comps within 60 days of funding. Bruce asks how long appraisals are accurate in today?s market. In some areas, Rick says prices continue to drop quickly so not long. Every area is different. Bruce says in the last 60 days, appraisals are becoming more of an issue. Bruce talks about a recent example of an issue with an appraisal on a property with multiple offers. Bruce asks Rick what will happen if lenders don?t change their stance on valuing properties and creating comps that reflect perfect condition. Bruce heard recently that lenders are considering doing refinances without appraisals because of the price declines which Rick has heard as well. He thinks that?s an interesting way to solve the issue. Rick says they keep throwing whatever they can at the issue. Rick says they did the same type of things during the Great Depression. Bruce talks about similarities with policies from the Great Depression and now. Bruce asks if before and after pictures on properties are helpful. Rick says videotaping properties before and after would be a great help but if there are too many repairs they may want to see permits. He says to document all multiple offer situations. Bruce and Rick then start talking about the principle of substitution. Bruce says there?s a short supply of good inventory. There?s a glut of inventory that needs fixing. Bruce feels bad for appraisers who have to fight for real prices and they have to be careful. Banks are only looking at pictures and don?t really understand what?s happening in the area. Rick takes many more pictures than is required to show banks why prices are where they are at. Bruce asks about arms-length transactions. Bruce asks about what would happen if The Norris Group carried its own paper and created higher comps. He asks if that would be a conflict because of arms-length transaction rules. Rick discusses the potential issues and uses the example of builders. Bruce asks what percentage of sales has concessions in the current market. Rick says almost 100% of transactions on properties that are on the market for two weeks or more have concessions although it?s not always easy to figure out what those concessions are. Appraisers don?t always know the concessions. Bruce asks what percentage is allowed for condition in appraisals. Rick says condition can be about 10%. If you adjust more, it can become and issue. It becomes easy with comparables but more difficult if the data isn?t there to support line item adjustments for over 10%. If the appraisal comes in wrong in the eyes of the bank, you get blacklisted and there?s a possibility of not getting paid. Rick says review appraisals were not as common when the market was going up. Some did but they were way more lenient. Review appraisers typically do a desk review and never go see the property. They are looking at online information. These review appraisers are typically hired independent contractors. Bruce asks Rick what he would like to see changed. Rick says not having the lender paying for the appraisal would be better. That way there would be no pressure and more honest appraisals could take place. |
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01-10-2009 |
Bruce Norris is joined this week by appraiser and investor, Rick Solis. Rick has been appraising properties since 1989. Rick says it was a perfect time to start because he got to see both cycles. In 1989, you didn?t even need a license. Education, Rick says, has not improved appraisals. Bruce talks about how he got his appraisers license and why. They both say much of the business is street smarts. Rick got into the business because he purchased a Dave Delgado seminar. He started buying a lot of houses. He realized he needed to know how to evaluate properties. Bruce asks if appraisers are under pressure to come in at a certain number. Rick says pressure is coming from several sources including agents, buyers, sellers, and banks. From 2004-2006 the pressure was for the appraisers to come in high. Today, banks put appraiser reports through many more hoops. They are looking for something wrong with it and they have review appraisals done. They also use an automated valuation model (AVM) to check numbers. In a down market, the AVM is not an issue. It?s a real problem in an up market. Everyone is just being much more conservative. Bruce asks Rick how he compares this downturn from the 90s. Rick says this downturn is much worse. There was a more gradual decline over several years in the 90s. Prices are much more erratic in the current market and it varies from month to month. Rick says areas with lots of new houses, where there are lots of first-time homebuyer inventory, and far out areas seem to have gotten pummeled. Sometimes 60% of the value disappeared. Rick tries to turn down appraisals for irregular products (dirt roads, manufactured homes, etc). It?s very difficult to find comps and arrive at a number. Rick says in 2009 he expects to see drops in pricing every month for the Inland Empire. Rick says in his area in LA, sales seem to have dropped by 75%. Prices are still coming down there too. Bruce asks Rick what percentage of sales in Victorville were REO. Bruce says 92% of all sales in the area were REO. Reselling in that area would be very difficult. It would be very difficult to get an appraisal too. When 98% are vacant and need work and almost all sales are REO, it?s very difficult to get comps to substantiate a higher price. Bruce asks what Rick is running into when working with investors. Rick says too many investors are going off the sales price in the MLS. The numbers are incorrect at times because of bad data entry or concessions. Some of the busy REO agents are having assistants enter in the data and they aren?t being careful. Rick says he uses the MLS but confirms those prices with public record. He uses Real Quest and Dataquick to make sure his numbers are correct. Luckily, data is getting a little better and more complete. Rick says listings aren?t so much calculated into his appraisals but he does spend more time on pending sales. Bruce asks if the goal for appraising properties for an investor is different then doing to for retail buyers. Rick says working with buyers is different because the buyer is dictating the price. It becomes its own comp. The investor purchase is more difficult. Tune in next week as the conversation continue. |
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01-03-2009 |
Bruce Norris is joined once again by Craig Hill (hard money loan officer at The Norris Group) and Greg Norris (full-time property buyer for The Norris Group. Bruce asks Craig about calls from first time investors purchasing homes with structural damage and mold. Craig says he steers newer investors with no construction background away from heavy fixer uppers. Houses don’t have to be a complete disaster. You don’t want their first house to be a bad experience. Bruce asks Greg what he is doing differently from one year ago to buy and sell properties. Greg says he hasn’t changed that much but has gotten more efficient. At the very beginning he was doing cheaper repairs but now there’s a little more upgrades. Instead of linoleum we use tile in some areas and instead of tile on counters he puts in granite. We need to be the best on the market. Realtors that deal with buyers are saying great things. One in particular isn’t wasting any more of her time on REOs and has decided to only show our homes because of the quality. Greg says price and condition are really important in this market. Greg says the higher end listings have disappeared and TNG is typically the highest. Inventory is very low. Even though The Norris Group is the highest, the homes still sell. Consumers don’t want to deal with the fixers and want a nice home. Appraisals are a bit of a problem. Greg says he’s having to set a top level. Buyers are wanting to see a top payment to be $1200-$1400 per month which is similar to rent if not a little less. Greg talks about the staging of the homes and how it helps with presentation. It helps online showings. Bruce and Craig talk about the hold ups with selling. Craig says financing and appraisers are the biggest issues. There seems to be willing buyers for fixed homes. Craig says homes are being fixed better than they were in the 90s. More is being spent. Craig is having to tell people not to chase the market and get very realistic on price. He often calls clients if a loan has been going more than five months. He wants to make sure the investor gets to the finish line. It’s difficult when prices are declining. Bruce asks Greg about appraisal issues. Greg says the last 30 days has been much more difficult. Banks are so scared they are overcompensating. Appraisals over one month are considered old. Three months is considered too old. Bruce asks about FHA transactions and the 180 day rule. Greg says he’s never been asked for a second appraisal. Bruce thinks maybe the review appraisal is the second appraisal. Bruce says that some of these appraisers are sitting 500 miles away. Bruce asks Craig about loans that can’t seem to close. Craig says there is willingness on the side of the buyer but it’s the financing piece that’s causing problems for California real estate transactions. The checks and re-checks of the buyers stall closings. Bruce asks Craig about the many new trust deed investors The Norris Group has had come on in the last 90 days and what makes them feel secure about doing investments. Craig says perceived safety is key. Craig makes small loans amounts, the investor is a special borrower, and typically the worst case would be the money lender ends up with a property. Bruce brings up the fact The Norris Group was very conservative over the past few years so some of TNG’s main money investors placed their money elsewhere. Bruce asks about some of the uh-oh stories Craig has heard about. Craig says money investors are attracted to the return and sometimes forget there’s risk, especially if they had been working with TNG who has a very good record.. He told some to be patient and that TNG would be busy again soon. Some of these investors didn’t wait, went elsewhere, and now have a small portfolio of non-paying loans. Bruce asks Greg what the secrets are to keep good contractors interested in doing our work. Greg says that it’s important to be easy to deal with. We don’t stand in their way and we have work. Consistent work is a big deal. Bruce asks if there’s red flags when dealing with contractors. Greg says when contractors ask for money before work is done it’s a red flag. Greg typically pays every two weeks. The Norris Group pays for the parts. TNG knows what parts we want installed and we’re really just contracting labor. Greg says contractors resisted his method of buying all the parts at first but later said they liked the system. It allows them to have less money out of pocket and actually take on more jobs. Home Depot was difficult to work with at first but now after dealing with them for a year, it’s really easy and everything happens over email. Craig says repairs is still a big hurdle but they get used to it. Sometimes Craig forwards them before and after photos and videos of an investor’s work. He’s had money investors turn down a project but then they see before and after videos of an investor’s work and they sign up for several. Once they see what investors do, they feel more comfortable. Craig talks about holds for repair money. Most houses are needing major repairs so almost all loans have money held for renovation. Red flags for Craig are investors who want money before repairs are finished. Draws are given after things are completed. This protects the money investor and also makes sure the investor stays on track. Bruce asks Greg how he handles all the showings of the properties since he lists all of the properties for The Norris Group. Greg says he doesn’t show them at all. If interested buyers call, Greg used to tell them to call their local agent after figuring what they were looking for. Greg wants buyers to be pre-qualified and doesn’t have a time deal all of that. He really relies on buyers agents. Bruce asks Greg how we protect ourselves during escrow. Greg says he does all of his due diligence up front now to make sure he doesn’t go into escrow with someone who can’t close. He wants all buyers to be pre-qualified and not just pre-approved. |
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12-27-2008 |
Bruce Norris is joined this week by the loan officer for the Norris Group, Craig Hill, and the full-time property buyer for the Norris Group, Greg Norris. Bruce asks Craig about how long he’s been in the hard money loan business and who the typical borrower was when he first started. Craig talks about buyers he used to work with and how it changed 20 years ago because of rule changes. Craig then talks about how he started working with Bruce and how it made much more sense to lend to investors. Craig says the investor has made not only more sense but are better at making payments. Bruce then chats with Greg about his past year and a half as a property buyer. Greg talks about his early experience watching trustee sale buyers and what they liked to buy. Greg talks about loans available for investors and how conventional loans are currently at a liit of four. Bruce asks Craig why lenders are hesitant to lend to investors. Craig says lenders have a false perception that investors are bad to lend to. An investor has more money down and has just as many reason to stay in a home as an owner occupant but lenders don’t want to be involved in that transaction. Greg talks about how long ago he started making offers straight out of the MLS. Greg says making offers straight out of the MLS was not successful in early 2008 as the lenders wouldn’t budge. In the first six months of 2008, zero deals came out of the MLS, most were coming from auction. Now towards the end of the year, almost all came from the MLS that The Norris Group purchased. Now, The Norris Group is buying about 5% of the offers made. Craig talks about last minute funding calls and why these investors are in a rush. Craig goes into detail why people with money make these investor loans. Craig says our main target market are seeing loans being made of $85,000 to $120,000 where last year those same homes were being bought for $200,000. There’s been a big change in price. Money sources have become a little nervous. The perception right now is everyone wants a cookie cutter deal. Everyone wants a $100,000 loan and money sources do not want to be aggressive. Those that want larger loans or are buying in areas out of comfort zone areas will need more in money in the transaction. Money sources in Northern California are wanting to invest in smaller loan amounts and also invest in Southern California where they feel TNG performs best. Most hard money loans have to have investors put more money into the deals right now. Different sources have gone out the window because of the market. Bruce asks Greg what he is looking for now as he is making offers on things inside the MLS. Greg says he is looking for anything within a $30,000 range where he thinks he can buy it and make a profit. Sometimes these are short sales and sometimes his offers don’t get accepted for months. Sometimes he gets deals because other investors fall out and he’s the only one left. At this point, Greg is not being able to talk with people directly often. Right now, banks seem to be dictating to REO agents where before there was much more relationship involved. Greg says he sometimes gets no reaction from REO agents when making offers. Every agent reacts different. Some email when we didn’t get a deal and some do. Bruce says between 2000-2006 most of our hard money loans came from investors purchasing from people directly. Craig says it’s now changed almost completely where 100% are bought out of the MLS, through auctions, and occasionally from trustee sale and probate. The MLS at this point is creating the most real estate opportunities. Out of the 40 properties Greg has purchased this year, 30% of the deals were auctions, the rest were from the MLS. Greg is not looking forward to attending auctions. It’s a lot of work for sometimes no results. REDC and Hudson and Marshall have been mixed this year. Craig says the inventory he is making hard money loans on is different form the 90s. In the 90s there were more 30s and 40s built home located in San Bernardino and Moreno Valley. This time, the investors are being savvier. Investors are buying a little bigger homes and newer homes. The inventory is much better. Craig talks about why some investors get frustrated because they can’t participate in our money program. Credit issues aren’t the biggest issue. Liquidity is just very important right now. Most people don’t mind hearing “no” because we’re trying to set them up for success. Some investors just don’t understand the process. Bruce talks about deals Craig turns down and investors coming back later thanking him for now allowing them into the deal. Craig finds that very gratifying. More next week. |
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12-20-2008 |
Bruce Norris is joined this week by the Senior Resident Fellow of Finance for the Urban Land Institute, Stephen Blank. Bruce asked about the ULI Emerging Trends report and how long it?s been around. Stephen says it?s been around for 30 years and has always been national in scope. The report has gone through different partnerships but the report is now a joint venture between the Urban Land Institute and Price Waterhouse Cooper. The report interviews 100s of people in the real estate business and compiles their opinions. Interviewees include developers, private and public owners, advisors, institutional investors, service providers and lenders. Stephen says the people that were interviewed in 2007 actually said they were expecting 2008 to be difficult. Emerging Trends is unique because of the process and the one-on-one interview process. These interviews tend to be very frank in nature. There is one writer and three editors to help put the report together. The real estate industry has been very supportive in being involved in this report. Bruce asks Stephen where the blame is in his opinion. Stephen says there was a period of unparalleled liquidity. With that liquidity came an increasing need for income-producing assets and increased competition to lend money so interest rates were forced to low levels. Increased liquidity increased leverage pushing down rates of return. The subprime market was unregulated and obviously became an issue. Mortgage bankers took these loans and then passed them on to Wall Street. Some argue the models that were used were too old and relied to heavily on ratings. There was a failure to do due diligence and it?s created a big mess. People ended up day trading condos. Bruce says there?s been some confusion between investor and speculator. Now, we?ve assured ourselves the downturn because the investors are limited to the number of loans. Investors can?t 1031 exchange and investors can?t buy rentals due to limits put in place by lending institutions. Purchase prices are being driven down even further because of this issue and the government isn?t addressing it at this time. Bruce asks if Stephen thinks the residential problem will move to commercial and if it will be as severe. Stephen says he doesn?t think they?re related and that an economic downturn needs to happen. Commercial is a lagging indicator. Residential could cause a downturn in the economy which would then spill over to commercial. Stephen says we didn?t build as much so we?re not going to have over supply meeting under demand like the last down market. Only some areas like Las Vegas and Florida will have issues because of over building. Bruce asks if he sees commercial lenders taking back a glut of properties in the coming years. Stephen sees sharp increases in foreclosures for loans adjusting in 2009-2010. The loan-to-value ratios are going to be an issue unless their income has increased a great deal. Bruce and Stephen discuss if lenders could leave a loan in place to avoid taking back a building, also known as performing non-performing loans. The debt is still being paid. Lenders, if they can, would rather nurse these along until the market improves. Not all lenders can do that unfortunately. Bruce asks if commercial lenders did the same kind of stated income programs that we saw in residential. Stephen says that as competition increased, banks started looking at other factors to base loan amounts on. Reserves were lowered. If the markets had continued to go up, the property could afford this new method. In a decline, it?s an issue. Stephen sees cap rates going up. 15-20% price decline could occur because the cap rates are changing. Not as much personal guarantees are on commercial. Moving forward from now, more lenders are requiring personal guarantees. Historically loans had an amortization with ten year term assuming a 25 year amortization period. In ten years you would historically amortize 12-13% of the loan which added protection for the lender, even if prices declined. As the market was more competitive, amortization period was eliminated and the loans were interest only. As these are refinanced, no equity exists. Bruce asks about unemployment and commercial. Stephen says it will be an issue and vacancies will increase. Declining lease rates will also be an issue. Stephen says REITs are not originators of loans but purchase already existing debt. They may originate mezzanine loans but are not conventional lenders. REITs are owners of income producing properties. Primary lenders are commercial banks (40% of markets), insurance companies (20% of market), and commercial mortgage-backed securities (40% of market). Stephen says that the mortgage backed system is on life support. Insurance agencies are a major source now but it?s taking more time and they have the pick of the market. For more information on the Urban Land Institute, visit uli.org. |
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12-13-2008 |
Bruce Norris is joined once again by Paul Earnhart (Founding Principle) and Erik Hernandez (Senior Vice President) of Lee and Associates in Ontario, CA. Bruce asks Paul how this downturn compares to downturns he?s seen before. He says this one is broader compared to the 90s. In the 90s there was an oversupply of four years. Lenders ended up taking back large quantities of properties and the RTC got involved. Values fell rapidly because of quick liquidation. The Inland Empire survived because of the influx of companies from the LA area looking at their bottom-line and moving into cheaper areas. Capital, however, never dried up. Banks were still making loans. Capital now is much tighter. This time it?s systemic and more problematic. Bruce asks about oversupply of inventory. Erik says certain categories are overbuilt and in certain areas there?s lots of standing inventory. Some inventory is too far along into building to stop. There?s more coming in the coming year. They started building when vacancy and absorption rates looked good and the world has changed. Bruce thinks there is going to be a vacant building glut. He asks how vacant buildings are going to be appraised. Paul says appraisals will be looking at income values not at sale comps. If someone wants a loan on a vacant building the financing will be of the hard money variety or you?ll need to prove a tenant is coming in. Owner occupied is still good but the income will still be scrutinized. Bruce talks about what happened in the past with the City of Perris. Bruce feels the next two years will be ugly but long-term migration outlooks look good. He asks Paul about unemployment and how that changes the commercial real estate industry. Paul says it?s a two-edged sword. Warehouses are a very small piece of commercial and over 100 million square feet over the past five years. The assumption was that consumers would keep spending so it?s been really overbuilt. The question becomes now if there?s a structural vacancy. Some companies are already gone: Linen and Things, Bombay Company, Levitz, etc. If people aren?t working they aren?t spending. There?s less need for these kinds of spaces. Bruce asks if the new tenant that takes over for some of these large spaces pay much less. Erik says landlords are very motivated and list lease rates and significant discounts. Bruce talks about reading through loan docs for his line of credit and how he was surprised at the ways the lenders can get heir money back. He asks if commercial is the same. Paul says that lenders do have some say if things start going bad. If lenders see the balance sheet doesn?t look good then they can take action. Bruce talks about some investors writing themselves a check into savings from their home equity line of credit and the bank then taking the money out of the account and then closing the line of credit altogether. All agree it seems far reaching but more and more, even the most credit worthy individuals are having credit disappear. Bruce asks Erik if we?re gaining commercial tenants. Erik says people who don?t have to be here are gone. Paul says the taxes and bureaucratic nonsense of California is not very business friendly. Businesses are only here because they have to be due to logistics of distribution and manufacturing. Those that don?t have to be here go to states like Texas and Arizona who are more business friendly. Bruce asks if businesses tend to lease or buy in this market. Landlords are being very aggressive so buying a building would need to pencil. Commercial leases vary by sizes. Fixturizing a commercial building can be expensive so companies who put in the infrastructure for larger buildings will stay in longer leases. All three talk about the very short time frame that economists and experts give industry constituents as far as market outlook and much of it is wrong. For those in commercial, there?s a very long time line and the world can totally change. Those that came out early saying there was a real problem took lots of heat. Finally, Bruce asks where Paul and Erik see opportunity in the commercial sector. Paul sees land opportunity coming first followed by small to mid-sized office product. Industrial on mid to large size won?t be good for 12 to 24 months. Liquidity is the real issue here. |
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12-06-2008 |
Bruce Norris is joined this week by Paul Earnhart (Founding Principle) and Erik Hernandez (Senior Vice President) of Lee and Associates in Ontario, CA. Lee and Associates specializes in industrial commercial real estate. Bruce asks when the commercial real estate market peaked. Paul said the peak was about the same as residential but that it became more obvious in July of 2007. This is when several partners backed out of deals and much more scrutiny started taking place. Bruce asks Erik about financing and if commercial had its own version of stated income. Erik says Lehman was doing commercial lending as well but it wasn?t as aggressive. Paul says lenders were willing to finance on sales comparables instead of income streams. No income stream analysis was taking place but now that has changed. The typical buyer from 2004-2006 in the commercial Inland Empire market were Asian entrepreneurs and domestic buyers for consumer services. The market has receded but some areas on the outer edges of the Inland Empire are being hit harder. No new development is taking place. Foreign investors haven?t disappeared but are slow and cautious when making decisions. Bruce asks if commercial deals were leveraged or if they were bought cash. Erik says if it was an owner occupant (owner user) the deal would typically have 10% down and 90% would be financed. Lenders would do a first trust deed at 50% and then a second at 40% would be guaranteed by the Small Business Administration (SBA). Erik says this program is currently still around. Wells Fargo, Bank of America, and some regional banks are still active in the commercial arena since they are only 50% into a transactions. Bruce asks if the SBA is in line for the bailout. Paul says prices are down around 15% from the peak. There are a few spots where it?s worse. For those that can?t refinance, they are letting the building go into foreclosure. Paul says they are expecting a rough road for the coming year. Rents and values have dropped and financing is impossible for some. The SBA financing is only good up to $3 million dollars. Anything over must use conventional financing. SBA is also more conservatively underwriting their loans. SBA is paying more attention to debt-coverage ratios (DCR) as opposed to pure sale comps. DCR measures your ability to pay the property's monthly mortgage payments from the cash generated from renting the property. SBA has not dried up so financing is still there. Conventional financing is now limited to 65% of value. Lenders are much more cautious here. Bruce asks about mezzanine financing. Paul says it?s changed. Mezzanine financing used to be anything above 75% loan to value. Now it?s 60% loan to value. If the underlying lender will allow it, it?s much more expensive. 14-15% rates will apply and the financing will be for 3-5 years typically. The first can be around 10 years. They will want to get as much risk out of the way as possible. If the property is very good construction and has good tenants, Cap rates are held low. Investors feel better protected here. The all cash buyers are looking for these nicer buildings. Leveraged buyers see higher cap rates. Caps rates are up 25% and Paul expects it to go up another 10%. Bruce asks about what happens when a cap rate goes up from six to eight and what happens to the value. Paul says about a 25% in value takes place. Any new development is nearly impossible because land and construction can?t keep up with price adjustments. Bruce says similar things are happening for the residential market as properties are being bought for land value. Bruce brings up that there is $100 billion of commercial financing that comes due in 2009. Bruce asks if Paul and Erik think it?s a problem for those hoping to refinance. Paul thinks that number is low because that number is premised on individual loans and some business have leveraged their building for lines of credit and those are coming due as well. Paul says that lenders can also make margin calls on these lines of credit. It could be a huge problem. Bruce asks if pension funds buy real estate free and clear. Paul says that is true and pension funds don?t act as quickly and have a longer range outlook for investments. REITs are structured differently and some are fairing better than others. Bruce and Paul talk about REIT values going through the floor and if that will change how they are able to fund future projects. There were many non recourse loans being made in commercial. Non recourse loans are now much more difficult to get. Bruce asks about how insurance companies are involved and if they are big players in the financing of commercial real estate. Paul says they are much more risk averse and have pulled back in availability of funds. Paul says vacancies are not out of control yet but they are starting to increase. Erik talks about vacancy (buildings with no tenants) versus availability rates. Many companies are subleasing space since down sizing is taking place. Vacancy numbers may be around 6% for the West End but availability rates are around 12%. More coming next week and you can find Paul and Erik at lee-assoc.com. |
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11-29-2008 |
Bruce Norris is joined this week by chief economist of First American Corelogic, Mark Fleming. First American CoreLogic, Inc. is the nation?s largest provider of advanced property and ownership information, analytics, and solutions. Mark starts by explaining what Corelogic?s Core Risk Monitor is and what it evaluates. This evaluation tool is used to forecast mortgage default risk areas. The report makes use of house price dynamic trends, economic trends, foreclosure delinquency trends and collateral risk trends. Bruce asks of those trends which is the one that causes the others to follow. Mark says the economic and house price trends are the most important. Issues with price decreases and the ability for people to pay their mortgages continue to create problems. Bruce asks if the downturn from 1991-1997 in California is following the same model we are seeing today. Mark says it?s slightly different. Mark says in the 90s it was more a function of unemployment. This time around, the house price downward trend is causing more of a problem. The economic downturn is following. Bruce asks if the core factors are different for different states. Mark says yes but these two primary conditions are key. Mark talks about the Midwest and how their market has changed and reacted. Bruce asks Mark about his take on affordability and if increasing affordability means less risk. Mark says that increasing affordability means more individuals will be able to enter the market on the demand side and means that inventory will be able to stop the price slides. There are a few steps along the way to get the market really going but affordability is important. Bruce asks about Corelogic and how much emotions play part in the economy. Mark talks about the emotions to prices and houses and how individuals don?t like to lose. Bruce talks about people and the fear of people not wanting to buy for fear of losses. Mark says that some homes become such a good deal they get back in anyway. In Corelogic?s report in the 3rd quarter of 2007, Bruce asks how Ohio and Michigan topped the highest risk market but aren?t in this year?s report. Mark says it wasn?t that they improved, other markets got worse. In Corelogic?s 3rd report of 2008, California has 8 of the top 10 riskiest markets and did not appear in their 2007 report. Mark says the price declines got these areas on the list. Bruce talks about the historic nature of price declines in California and how it?s the worst he?s ever seen. Mark says even nationally it?s bad. What once were the top markets are doing so poorly it?s bringing down the national numbers. California and Florida are seeing large price declines and they are two of the largest markets. Historically, housing recessions are more localized. Bruce asks about the percentage of houses that are upside down in California. Mark says 28% of loans in California are in the negative equity position. Corelogic only recently started these evaluations so has no idea what happened in the 90s. Corelogic uses market trends and valuation models to figure out home prices and ran data for September for their most recent report they released. Bruce asks if there are states that are in worse shape compared to California. Mark says Nevada is in the lead with 48% of homeowners owing more on their property then it is worth. The 48% includes investors and anyone with a mortgage is counted. The mortgage stock in Nevada is much younger than California. They didn?t have the time to pay down the mortgage hence the reason they are so upside down. California has many more mature loans. Bruce asks about unemployment and how it might cause further price declines. Mark says rising unemployment will lead to more foreclosures as more people can?t afford their payments. However, when individuals are in the negative equity position, studies shows mobility decreases and will tend to look locally instead of moving out of state for jobs. Bruce brings up that California is a nonrecourse state and people will find it easier to walk. Mark says it will be interesting to watch the behavior of people in this cycle. Bruce asks if the bailout will help stem the foreclosure situation. Mark says the more loans that are modified the better we?ll do. Bruce and Mark discuss the moral hazard of re-writing some loans but not others. Mark says this is part of the challenge for those creating these mortgage modification programs. Bruce says the actually foreclosure data says we?re actually down in foreclosures because of SB1137. Lenders have to go through more steps in the foreclosure process now and data is very misleading at this time. Corelogic says they are ignoring the seeming improvement in foreclosure numbers because of this bottleneck. Bruce asks if in the model if the percentage of those over encumbered include those that refinanced to get money out of the house. Mark says the report includes all mortgages. For more information, see corelogic.com. |
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