Before I jump into the history lesson for the day, let me set the context by explaining the elementary moral of the laws of economics. As they say, “economics is the painful elaboration of the obvious.”  And while this old joke is true, the laws of economics do not bend or bypass stature. This is why we call them laws. There is no immunity to a government or an individual who accumulates too much debt. You either have to spend less and balance or face insolvency.  The same law of economics applies to the United States Federal Government.

Our first option is to implement austerity measures. Australia, among other countries, should be looked to for inspiration.  Australia went through a downgrade experience. In 1986, both Moody’s and Standard and Poor’s downgraded Australia’s foreign currency rating. Australia was downgraded a second time in 1989, after little action was taken to make the necessary changes. The shockwaves of the second downgrade sent Australia into a deep recession. The treasurer, Paul Keating, cautioned that Australia was in jeopardy of becoming a “banana republic.” Instead of running budget deficits and playing the blame game, he altered the direction and, after two years, delivered the first surplus. “But that did not get our credit rating back,” Keating said. “We did not recover our AAA rating until 2003.” It took a little over 17 years after that first downgrade for to Australia completely recover.

Canada also endured a manifold stage downgrade over a period of several years. In October of 1992, S&P dropped Canada’s foreign debt rating by one notch from AAA to AA+. Interestingly, there was little impact on Canadian markets. Moody’s followed S&P and downgraded the foreign debt rating by one notch. The 10-year note increased 0.45% over the subsequent months and stocks plunged 6%. In April 1995, Moody’s downgraded Canada again. In reaction to the downgrades and severe negative economic news, Canada enacted strict budget reforms. Prime Minister Jean Chrétien slashed federal spending by a monstrous 20%.  He fired 23% of public sector workers, raised taxes, cut defense expenditures by 15%, lacerated certain subsidies by 40% to 60% and eradicated some ministries completely. Canada did not regain the prestigious AAA rating until 2002.
There are two things to be cognizant of in the next few years. Both Australia and Canada reported minor hiccups in economic growth after the 1st downgrade. It was only after the second downgrade did both countries experience a chain reaction to brutal economic consequences. They also reacted with swift and bold changes only after the second downgrade. If history is any guide, not much will change with the 1st downgrade. As it sits now, S&P has the United States on a negative outlook. It only seems reasonable to assume we will be downgraded again. A second downgrade seems especially eminent because Congress has such a wide ideological rift in remedy for the debt problems. The second thing to be aware of is the status of other AAA rated countries. Besides Australia and Canada there are 12 other countries with a AAA credit rating. The other countries are Austria, Denmark, Finland, France, Germany, Hong Kong, the Netherlands, Norway, Singapore, Sweden, Switzerland and England. In the near future, I can see most, if not all, of the European nations challenged with a downgrade. France and England seem especially vulnerable in these volatile times.

Option number two is to inflate our way to “prosperity”. Quantitative easing is a fancy way of saying the Fed is going to print (or as they say “digitize”) money to ease our debt and stimulate the economy. Hoping that this will pave a way for a brighter economic climate is just as wishful as magically finding the other side of the rainbow. It does not work. The by product is always inflation or hyperinflation. Inflation is a law of economics. History is my witness.

Think Weimar Republic, Germany, post World War I. The German Mark ratio to the U.S. dollar was 4 to 1 near the end of the war. It was 8 to 1 in 1919, 250 to 1 in 1921, and 2000 to 1 in 1923. Hyper-inflation hit so hard that newspapers sold for $100 billion marks! It was reported that most people were paid by the hour so individuals could purchase goods during their lunch break before the mark slipped further into the value of nothing.

In 1989, after years of massive budget deficits that were financed with borrowing from abroad, the Argentinean government resorted to the printing press. Hyperinflation soon kicked in. It was reported that grocery stores did not price any inventory. A man with a microphone would broadcast the prices of numerous items, frequently increasing the price every few hours by 30% or more. Workers would get their pay in cash and dash to the store to buy anything. By the end of the week their pay would be worthless.
Zimbabwe has been plagued for years with colossal deficits. In 2008, Zimbabwe’s annual inflation rate reached 516 quintillion per cent, that is 516 followed by 18 zeros. For the common Zimbabwean, the end result is atrocious. They must spend money as soon as they get it before it loses its value. The dysfunctional economy means that goods are in dreadfully short supply and they must spend hours searching for things to buy.

Of course, these are extreme examples however it goes to show, inflation is not a theoretical issue; it is reality. There are many other examples such as Hungary (1946), Japan (2001), and the United States (1933).The history and consequences of hyperinflation is required material in most Latin American schools. The United States is not exempt to these fundamental laws. Expect QE3 to be on the horizon despite many assertions to the contrary.

We are at the crossroads of a very important historical decision. Quantitative easing is the hail marry of economics. It is the last resort. For the sake of the future of this country, I hope we can find a way to reduce federal spending and find a way to balance. It really is the only way of out of this hole.
Brandon Saylor
-Associate

The Bank Allowed What?

Wow…has is been a long time or what?  I have been so busy with a real estate class (six weeks) and purchased an apartment building within the same time frame.  Just plain crazy so a lot of things got neglected…especially this blog.  Looks like we have another apartment building in the works (thanks to KB Realty)….things are looking busy for the next few months…at least I hope!

Anyway….

There is one thing I never heard of when it comes to investing… A Bank Approved Wrap.  BUT this one thing is a HUGE deal.  I have done several wraps before…..but never a bank approved wrap.  Now…remember…a wrap is when you “wrap” an existing mortgage with a brand new mortgage.  Read more about wraps HERE.

So what is the big deal?  Well, usually on wraps, there is always a small risk that the loan can be called due to the fact that the asset has been sold yet the loan is still in place.  This is a small risk because banks usually do not exercise the “due on sale” clause call if the loan is in good standing.  In other words, the payments are still coming in on time.  But…there is always a chance.  In any case, when we first approached the seller, the seller did a “no no” and asked if the lender if it would be okay to wrap the note.  Surprisingly, the lender said “yes”…..at first I thought there was a mistake….and I just felt someone misunderstood something.  But….I was wrong.  So, in the last week of December, we closed on an apartment building with only about 6% into the deal (commissions and closing costs).  No joke!

I even talked to my lender friends….they all NEVER heard of of such a thing….especially in commercial.

The beauty of the deal was that it was 80% occupied and still cash flowing.  The issue with the property was mismanagement.  Bad management with out-of-town owners is a great formula for opportunity.

Now…I have to give credit where credit is due.  Preston from KB Realty found this deal and made it happen.  James, a.k.a. “J” our attorney, worked hard during Christmas to get things right.  Having solid relationships was the only way to get this done….but I digress.

There were problems with the deal….more specifically, timing.  The sellers wanted to close before December 31, 2009….which only gave less than 30 days to close.  Now…. trying to close in 30 days during the holidays is impossible….so I thought.  I told Preston “there was NO WAY we could do it.”  Due diligence, attorneys, inspectors, banks, title companies….are hard to round up to work on a project anytime of the year….especially during the holidays….Forget about it!  Well…Preston pushed and pushed and the rest is history.

My partners and I learned something…..we don’t know everything…but thinking we do can lose us opportunities.

Thanks to Preston…David….J….

On to the next project!

I found out today that New Mexico is not LAST in everything.  We are first is DWIs as well as the first state to adopt a Real Estate Recovery Fund…which has now been adopted by most states.  So…yes…we do have pride in being first….or maybe we have pride in being last?

Anyway…

Quick thought….

A while back I was reading  a book by Nassim Nicholas Taleb called The Black Swan.  Great book by the way.  Anyway…I remember Mr. Taleb talking about banks and how over the years…the banks have gotten bigger all over the world (smaller banks being absorbed by the big ones).  What was more interesting was how he stated that all the banks are tightly connected in a dangerous way.  More specifically, how if one big banks goes down how it impacts all the other banks.

Now…we all saw this when big banks started failing in the United States….but have we really been impacted by failing banks in other parts of the world?  I am sure we have in one form or another…but what is happening in Dubai brings Mr. Taleb’s words back to life.  If…by some chance the ordeal with Dubai explodes.  Will we see another big bank fall?  Which we all know is possible.  If another big bank falls…what will be the impact to us Americans?  ….to the world?

I am sure I am showing my ignorance…but in the big picture of things….I do know this is a dangerous situation.  Chances are someone will save the day ….for now….but I am sure we have not heard the last of this situation.

Read more here on the situation in Dubai:

Dubai Scrounges for Cash as New Deadline Looms

Until next time…..rob

Jefferson Memorial was purchased on a Wrap.....okay okay...that is not true

Greetings from Washington D.C. (actually…not anymore…but when I wrote this…that’s where  I was…as if you cared).  Still my favorite metropolis (other than Cedar Crest, NM…of course).

Anyway….

With all that is happening with our economy, specifically, lenders not lending.  Creative financing (owner financing) is showing up a lot more.  Great for us…the investors.

In most cases, many of the “owner financing” deals have an existing mortgage in place.  So…for a seller to sell his/her asset with seller financing, the seller may choose to sell via a Wrap Mortgage.  What in the world is a Wrap Mortgage, a.k.a, a Wrap-Around Mortgage?

I have seen many definitions for a “Wrap Mortgage.”  But for us, the investors, a “wrap” is basically taking the existing asset’s mortgage and wrapping it (hence the word “wrap”) with a brand new mortgage.  In other words, a new legal document is created that refers to the existing mortgage (first position) but with the wrap mortgage now making the new owner liable.  The beauty here is, the new owner is only liable to the seller.  The “Seller” is still liable to the original lender.

****Note….A “true” Wrap is NOT an assumption….at least what I am defining here as a Wrap.

There is a lot more to this but the above is the general idea.

Many investors and sellers get a little jumpy when they find out there is a “Due on Sale” clause in the original mortgage when selling an asset creatively.  A “Due On Sale Clause” is simply where the lender can call a loan due if certain points of the mortgage are compromised i.e., a “wrap mortgage.”

Have I ever experienced a lender initiate a “Due On Sale” clause? No.  Have I heard of other investors have to deal with a lender exercising the “Due On Sale” clause?  Yes…but only in a residential investment he or she bought on a wrap.  But….that was the only one.  Even in that instance, the lender worked with the investor on refinancing the asset.  Go figure!

I have yet to experience or hear of it on a commercial deal specifically due to a “wrap mortgage” transaction.  That is not to say that it does not happen.  But my question is, will a lender excercise the Due on Sale clause on a performing note?  I doubt it….but none-the-less it is a possible downside.

Just a few more thoughts regarding a Wrap:

1) the terms of first-position mortgage may or may not be reflected in the Wrap.  Usually, the terms are negotiable with the first-position mortgage being the base line.

2) Legal instruments are used to put the Wrap in place, i.e., REC (Real Estate Contract).  Usually, in a commercial transaction, the documents are a little more sophisticated (uhh…hmm…more complicated since attorneys are involved).

3) In some cases, an escrow company or attorney is used for the ongoing management of the transaction.  In other words, a third party is usually used to make sure payments are collected from the new owner and payments are made to the first-position lender.  This protects both parties.

Of course, there is a lot more detail involved but overall….I love buying assets with owner financing and a Wrap is a great tool.

Until next time…..rob

100% occupancy.....think again

Greetings from the metropolis of Cedar Crest, NM !

Back from my trip to Texas and trying to close on some deals.  Dealing with lenders has always been difficult…..but I think lenders are looking for ways to make it even more difficult…but I digress.

Anyway….

Today’s post comes from the help of my friend and commercial mortgage broker Terry Painter from The Apartment Loan Store.

In my analysis of an apartment deal in Texas, I asked Terry about estimating tenant turnover from a lender’s perspective.  I got a great reply from Terry and I wanted to share it.  Terry’s response is below…..

Rob, there are 5 main factors that our HUD appraisers use to estimate tenant turn over:

1. Quality of tenants (mesured by how long each tenant has occupied) (will
need monthly rent rolls for the past 3 – 6 months to determine this)
2. Historical occupancy (based on monthly rent rolls for the past year)or
market data for the submarket
3. Type of tenants (Students occupy an average of 9 – 10 months, Military
about a year, Seniors 4 years and longer,General public about 8 months)
4. Demand for the property in relationship with other properties in
the market
5. Time to make-ready the unoccupied units (critical on properties that stay
full)

So it is different for every property.  Even newer in-demand properties with
a waiting list average 2 – 3% turn over rate and result in 97% annual
occupancy.

Hope this is helpful…

Terry Painter, President
Business Loan Store
104 Monterey Drive
Medford, OR  97504
Mortgage Banker

Office  541-326-0570
Fax     888-404-7089
Cell     541-840-3078

Thanks Terry!

Until next time……rob