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In part I of this three-part series,we talked about how real estate investing is changing. In part 2, we discussed a key opportunity for implementing that change: land contracts. In part 3, the topic is passive investing.

Once you’ve worked hard to make your money, you want your money to work harder than you did. That’s really the concept behind passive investing: doing minimal work for maximum return. That’s everyone’s dream.

The problem, frankly, is that there are opportunity costs everywhere. The less work you do, the more work someone else is going to have to do, and you’re going to have to pay that person to do it. The trick is to find the happy medium.

There are several ways people currently conduct passive investing. You can invest in real estate investment trusts (REITs). Generally found through financial planners and regulated by the SEC, REITs tend to invest in large commercial properties. You can expect a low return (about a four-to-eight percent monthly cash distribution) and some percentage of any profit when the property is sold in three to five years). Minimum investment is usually $100,000, and you can add further investments in increments of $25,000, $50,000, or more later.

You could go to a real estate agent who does property management and invest a minimum of $50,000 to $75,000 there. You should expect to get ongoing reports about your properties. But you’ll also have to pay ongoing fees for repair and other upkeep. The fact is, if you’re going to be completely passive, other people are going to have to do more of the work, so you make less money.

In the world of distressed properties, the best model is to find a local expert and work with them to manage the sales, rental, and upkeep. You put your money in, and that person does the work. You can own it, and you’ll make more money. DBNR is focusing on this area, and we can handle the property management. There are fees involved, but because the properties are distressed, the potential profits are higher.

A couple of points that you should consider when it comes to passive investing:

• You can be as passive or as active as you want. Just make sure the people with whom you’re investing agree on the level of involvement you want to have.
• Make sure what you’re investing is discretionary income, because you will not be able to liquidate it quickly.
• Think about passive investment as a group to make your money go farther. In the 90s, a womens’ investment group met in my real-estate office, and they did pretty good.
• Remember that the IRS has specific rules regarding what constitutes passive investing, some of which relate to real estate investing and some of which relate to entities such as limited liability corporations.

My overall point is this: if you want to invest in real estate, but don’t feel you have the expertise, worry not - there are other options for you to take advantage of in this area that still have profit potential.

In part I of this three-part series, we talked about how real estate investing is changing. In part 2, we discuss a key opportunity for implementing that change: land contracts.

You don’t have to look far to find experts in the financial industry declaring today’s real-estate lending process badly broken. The evidence is extensive: the over-subscribing of worthless mortgage securities, the resulting meltdown, the foreclosure crisis, the robo-signing mess. It’s like watching a train wreck in slow motion.

How are real estate investors supposed to continue their efforts to develop equity and a strong financial foundation when the process for borrowing is so horribly mangled? One answer is to turn to land contracts, which DBNR frequently uses for its investments.

Just like it sounds, a land contract is an agreement between a buyer and a seller in which the seller agrees to give full and equitable title to the buyer once they meet certain conditions. These conditions could relate to payments, payment schedules, occupancy, repairs made, payment of back taxes and utility bills. Each contract is as different as the property it relates to.

For instance, you can set up your land contract so that the buyer makes payments, but the seller still gets the depreciation deduction. The seller hands over title at some point in the future when the buyer has fulfilled the conditions set forth in the contract, and that’s done through the traditional escrow process.

Land contracts are becoming increasingly popular for private investors who don’t want their deals mired in the quicksand of the financial industry mess. While it’s hard to estimate how many such contracts have been created over the last few years, based on the number of companies offering them and their new listings, it’s safe to say there are at least 100,000 properties being offered this way. And while we’re beginning to see some regulations put into place for these transactions, until recently, it’s been between private parties and government has been staying out of it.

It’s becoming popular because of the built-in safeguards. The seller does not transfer title initially, so if the buyer doesn’t fulfill the contract, the seller is protected and retains the house. It’s like buying property complete with a renter.

Even better, the land contact can work as either a real estate investment or a financial investment. As the holder of a land contract, you can re-sell it just as a retail store might sell a financing deal to a third-party. If you buy a land contract worth $40,000, you can get it at a 25% discount, or $30,000; there’s a quick $10,000 profit. If you want to take a bigger risk, you can take a contract with a shorter payment period and some other issues (perhaps the renter has been late with payments a couple of times) and get it for a 50% discount. Again, the options are as varied as the properties themselves.

If you want to know more about how you can benefit from land contracts, contact me.

There is a subtle transition underway in real estate investing these days. It involves a shift in the way people think about their real estate investment, a movement toward being more dispassionate, a movement toward being more quantitative than qualitative.

People traditionally look at real estate differently than they do other investments. They look at real estate with the same perspective that they look at their house - with some pride of ownership. You wouldn’t look on your technology stock with pride of ownership (unless it was Apple and you were a Macophile, I guess). But with real estate, there tends to not only be pride, but - to extend the stock analogy - a buy-and-hold mentality.

What I’m both seeing and suggesting is a shift away from that. For one thing, if you go into real estate investing with that attitude, it’ll break your heart. You can’t think about investment property with the same pride of ownership that you have for your primary residence. We are protective of our primary residences. We strive to make sure it looks good and stays that way. When tenants leave a property, it’s likely to be in less-than-pristine condition. Every time someone departs, you have to call in the painters and carpet layers.

Real estate investment, like any other investment, is about either making money or reducing your tax liability. It requires an entrance strategy, a holding strategy, and an exit strategy. It requires thinking about numbers, because it involves either time or money, or both. For instance, here are some questions real estate investors need to ask themselves:

• Are you researching available properties yourself or working with a professional? If the former, there are plenty of opportunities at sites such as Bigger Pockets and EconoHomes.
• Will you be managing the property yourself, or will you pay someone to do it?
• Do you want to buy property with little cash (i.e., be highly leveraged) or do you want to make a big down payment in order to retain more of the value and increase your passive income? Do you want to invest in residential or commercial property?
• If residential, do you want to invest in distressed properties in depressed areas that may increase in value or middle-class or upper-class properties that are more likely to hold their value?

In the transition to being dispassionate, there are even more numbers that investors need to think about, both prior to and after the investment.

• ROI. You need to think about the return on your investment - what’s your payback? Are there better ways to invest your money? Real estate isn’t the automatic jackpot it used to be.
• GRM. This statistic is the Gross Rent Multiplier, which is derived from comparing the annual income of the property to the property’s value; 10 is a good measure ($12,000 annual gross rent / property value of $120,000 = GRM of 10).
• Capitalization Rate. How much is it costing you to service your investment (i.e., paint, carpet, mortgages plus other expenses? Your cap rate comes from an analysis of costs vs. income.

Finally, there’s the exit strategy. Remember, your identity should not be tied up in this investment. You should be as dispassionate about getting rid of it as you were about acquiring it. Are you going to sell entirely, or do an exchange? Exchange is an investment term for buying up or down. In a positive exchange, you sell a $100,000 house and use the proceeds to buy a $200,000 house. In a negative exchange, you sell a $100,000 house and buy a $50,000 house. It depends on how leveraged you want to be. You can also sell the house and carry the financing yourself to get the monthly cash flow as a return on your investment.

But however you do invest, you have to do it with your head, not your heart.

In Part 2, we’ll talk about more about carrying the financing in a discussion of land contracts.

An apocryphal story: there was once a law in Kansas that if two trains running on parallel tracks met at a railroad crossing, neither could move until the other was gone.

In light of the latest hiccup in the foreclosure crisis - the discovery that thousands of foreclosures may have been done in a slipshod manner (to put it kindly) — that’s an apt metaphor for the real estate industry right now. It’s not clear what has to happen to get real estate moving again. It could be stuck like a Kansas locomotive for quite a while.

Let’s start with Realtors. They list properties for sale. Clients call, get qualified. Realtors negotiate the contracts. But with anywhere from 40 to 60 percent of transactions involving some sort of foreclosure, the robo-signing crisis slows the process down. If banks actually start confirming that they own what they’ve foreclosed on, that’s going to take some time. Realtors who specialize in these homes won’t be getting as much inventory.

Let’s move onto title companies. They are a crucial component in the process, because without their confirming that the previous owner legitimately holds the title to the property, there can be no legitimate transfer of said title. Title companies have a vested interest in selling title insurance. And they don’t want to become party to their own version of the class action lawsuit that’s bound to hit the banks.

Lawyers aren’t normally part of the real estate cycle in this state, but they’re likely to show up too. Some owners or former owners are going to claim that their lender defrauded them. No one wants to buy a property that’s tied up in a lawsuit.

Of course, there are the lenders and the buyers. The lenders seem to be flummoxed into paralysis by this whole mess. They’ve instituted rules about lending that seem to eliminate a good portion of the potential buyers who, even though housing prices AND interest rates are down, can’t take advantage because their own income or net worth has been impacted.

The pace of transactions is stalling, and there’s no way of knowing how long the stall will last. The irony here is that real estate drives the economy. When people buy new houses, they buy new furniture. They hire exterminators. They hire landscapers. They hire painters. Without consumer demand, the economy isn’t coming back. If the economy isn’t coming back, companies aren’t going to hire more employees. And neither locomotive could get going again until the other was gone.

What’s the takeaway from all this? Real estate has changed from the way it was in the 20^th century. If you’re lucky enough to be sitting on some cash (perhaps you own Apple stock), and are thinking of investing in real estate, move with more prudence and caution than you’ve ever exhibited. Know the income potential of the property in the new context of the wider market. Know your tax implications. Know your exit strategy. Don’t get stuck at the railroad crossing waiting for someone else to make a move.

One of the most poignant scenes in American cinema takes place during the original Great Depression. In It’s A Wonderful Life, there’s a run on the Bailey Building & Loan, and Jimmy Stewart passionately explains to his panicky depositors that their money isn’t there: it’s in each other’s houses. “You’re loaning it to them,” he says, “and they’re paying it back as best they can.”

That’s the way things used to be, and I’m beginning to suspect that we might be returning to those days sooner than we think. In the old days, there weren’t lenders and mortgage brokers and title companies. You went to your local banker and borrowed money to buy a house; the house served as collateral for the loan.

Somewhere the system has gone horribly awry. It was bad enough when Wall Street started securitizing loans, knowing that more than 28% of them weren’t compliant with underwriting regulations. But when the other shoe dropped, and it turned out banks were foreclosing without being compliant with those regulations. You can’t sign 16,000 transfer documents (part of the foreclosure proceedings) and confirm that they’re all correct. What’s the rush?

Even worse, I fear that this latest so-called robo-signing scandal is just the tip of the iceberg. In fact, Bank of America has just suspended foreclosure proceedings in all 50 states, up from the original 23 where the process known as judicial foreclosure is the law. If it wasn’t bad enough with the investors and the lenders knee-deep in muck of their own making, now the lawyers are going to surge in with class-action lawsuits.

I’m frankly astonished that the highly regulated financial services industry can find so many new ways to screw up. And even though it is highly regulated, I’m also confident that the government will enact new regulations to keep this from happening again. Talk about a vicious circle. Wall Street oversteps the boundaries of sound investing and lending. The government enacts legislation. Wall Street complains that there’s too much regulation. No matter what happens, it seems to translate into higher costs and more delays for potential homeowners.

Nor is the future looking bright. It means that a foreclosure crisis, which was already beginning to move from bad loans to good loans held by people who are running out of financial resources, is going to be drawn out even longer by this delay. It could take two to three years to cycle foreclosures through the entire process. Don’t forget to factor in the issue that if the ownership of foreclosed houses is murky - because a bank didn’t foreclose properly - investors are going to be more hesitant to take a chance on buying them. And until foreclosed properties stop hitting the market and staying on the market, housing values aren’t going up. They may even get devalued.

One thing is for sure - what with increased regulation and litigation, even with interest rates at historic lows, it’ll be much harder to get a mortgage through traditional means in the coming years. Will that kill the drive for home ownership and real estate investing? If the financial services industry keeps dropping boulders in the pond, who knows what shore the waves will crash upon? Who knows when life might be wonderful again?

A couple of weeks ago, in a blog entry entitled The Battle Between Capitalism and Altruism,

I wrote about competing offers for properties in Chicago, Ill., and Hartsville, S.C. The battle referred to the fact that, in each case, one of the offers would have involved our getting paid off months or even years sooner than with the alternative offer.

In each case, however, the alternative offer was from exactly the kind of buyer DBNR has been targeting since its inception - people who are willing to work diligently to get themselves ownership of property.

As you may remember, in Chicago, one of the offers came from someone who was better at words than action. He regularly put me off with assurances that his own clients would come through with cash, but it never happened. When I gave him his final deadline, he never even bothered to call back. Sheila (not her real name) called me to find out what had happened even before I had a chance to call her. She signed her contract, got a money order, and sent both via overnight delivery.

That wasn’t quite the end of the story, though. When she took possession, she was astonished to find that the other party had been so confident in getting the property that he’d already had workmen inside. Sheila is not someone to be trifled with. She told him to get out and stay out. His response: he started making the same kind of all-cash offers to her. Sheila came back to me, asking about this guy. I told her, “If he hands you a certified check, take it. But if he could back up his words with cash, you wouldn’t be the owner today.”

In Hartsville, as you remember, I was talking to one prospect’s father, who was negotiating for his son, who lives outside the country. He had first lowered his offer and then, after finding out that there was another party interested in it, raised it again. When I called to determine the son’s level of interest, I never heard back.

The other prospect, Ronnie (not his real name), wanted to buy the property and park his trailer there. His ability to make his down payment, however, was predicated on his wife being approved for Social Security. There was a period of about ten days during which I wasn’t hearing anything from Ronnie, either, but I’ll be darned if he didn’t call me Saturday before last and say she had been approved and he was ready to send me a $500 nonrefundable deposit.

I told him he was still going to have to come up with the rest of the down payment - another $1,000 - but he was confident he could do that. I can still hear his Southern accent coming through the phone: “Ah don’t quite know how we’re going to make that happen, but we are.”

It may be longer before DBNR gets its money, but that’s okay with me. I like being part of a real-life Frank Capra movie where the little guy gets a piece of the American Dream by pluck and dedication. It makes me feel good.

One last thing about Ronnie - call it just one more indication of his confidence in his ability to get his dream property. He said to me, very politely, calling me Mr. Noble, “Do you mind if mah friends and Ah start cleaning off that lot for mah trailer?”

I told him I didn’t mind at all.

The National Bureau of Economic Research announced last week that the recession ended in June 2009. For a lot of people, it was kind of like watching the roll call of recently deceased stars during the Oscar ceremony and thinking, “So-and-so died? Why don’t I remember that?”

Except this time, it’s “The economy recovered? Why don’t I remember that?”

For a recession that felt like a depression, this is a recovery that feels like a recession. Job growth is minimal. Businesses are concerned about impending taxes (how else to pay for the deficit?), and so are reluctant to hire workers.

In the housing market, it’s even bleaker. People who were just barely hanging on waiting for the recovery are now losing their grip. Foreclosures are up. According to a recent article in Money, “foreclosure filings climbed in 75% of the nation’s metro areas during the first half of 2010 … with unemployment [replacing] toxic mortgages as the leading cause.”

This leads to even more trouble, not just because of people losing their homes, but because of the effect it would have on current housing prices. With prices dropping, potential buyers are also likely to hang back, hoping to get an even better deal.

As in any uncertain time, there are people with the wherewithal who can benefit from the situation. But even that takes more savvy than I’m seeing from most people. As you know, I am happy to offer advice to potential investors. Last week, I talked to a couple just getting into the real-estate investment business, and their naiveté frankly scared me.

Why? Because they want to tackle it the way things were before the recession: buy the property for its list price, use traditional financing methods, and then sell it again quickly. Even worse, they wanted to involve all the traditional, highly regulated strategies that caused the downturn in the first place. All of these entities add significant cost to any deal.

That’s bad because I believe investors should avoid anything that adds cost to a deal, not just in the short-term, but for the long-term viability of your investment. Selling again quickly for a profit is not going to happen for a while. Do the math: there’s been a roughly 28% decline in property values. Take a house that was worth $600,000 and reduce it by 28%, it’s now worth $432,000. If property values increase at 3% per year (and that’s a big if), in 10 years, that property would only be worth $583,000. Loosing 28% of value in one year, taking 10 years to get it back has got to be sobering and a wakeup call for moderation.

The parameters for real-estate investment have changed. It’s back to basics. Homeowners should look for home price within their means as a place to live, not invest. Investors should look for cash flow and investment opportunity, not future value. There is no massive recovery around the corner. There is no panacea.

Ratchet your expectations down, because the real estate market has evolved. A couple of years from now, you don’t want to be scratching your head and saying, “Why didn’t I remember that?”

The late Speaker of the House Tip O’Neill was famous for saying, “All politics is local.” As it turns out, he could have said the same thing about real estate.

I’m reminded of this as I deal with a contractor in Cleveland whom I’ll call John. He contacted us after he saw an ad on Craig’s List (which has regional editions) about a property we have on Elmarge Avenue there. John is one of those people who really understand the community he’s in, but who is also pursuing his own business aims.

The house on Elmarge Avenue, to put it kindly, is a mess. It has roof and foundation problems. It’s in a blighted area. Worse, it has $16,000 in back taxes attached to it, and we wouldn’t mind if the city took it back from us in lieu of the taxes. It’s one of about a third of the distressed properties we originally got that is in need of this kind of repair.

That’s exactly what John wants to do. John specializes in the construction of steel-frame houses, which are being touted as a green alternative to wood for a variety of reasons; steel is cheaper; it’s stronger; it’s recyclable. John wants to tear down the house and build a 1,500-square-foot model home there, one that’s made of steel so he can show what the material can do. Then he wants to rent the home to the city so they can house Section 8 (low-income) tenants there. He’s also done this in other Cleveland suburbs. In the meantime, he’ll be paying off the note to DBNR for the lot.

The local kicker is how John plans to deal with the $16,000 tax bill. His response, “I’ll call someone I know. He’ll come out and take a look at it. The taxes’ll go away.”

What I’ve learned is that this is actually not unusual. Municipalities will frequently waive past-due expenses for locals. They’ll forgo out-of-towners who can’t vote, but locals are okay. He’s even confident that the city will ask him to do the tear-down on the house. That’s the way local real estate works.

In fact, John is so confident that he’ll be successful that he’s asked for the addresses of our two other properties in Cleveland, and I was happy to send them to him. It is our intention to have someone like John in every major city where we’ve got property.

I’ve discussed the downside of working with distressed properties, and I’ve talked about being an unabashed altruist, the guiding philosophy of DBNR: giving people who want to own homes the opportunity to do so.

I still stand by that. But standing where I am, I now also face a situation where I have to take into consideration not only the needs of our customers, but also the needs of our company. I think it interesting that I’m facing a battle between altruism and capitalism in not one but two situations.

There is nothing similar about the locations. One is urban Chicago, the other a town in rural South Carolina named Hartsville, not far from the Darlington Raceway (for you NASCAR fans). But there is something similar about the stories. In each case, I have two potential buyers. In each case, one is the prototypical DBNR client - in need of a hand (not a handout, as we used to say) to get into a home, and who will take advantage of our process by making monthly payments over time. The other is someone who is willing to pay cash for the house.

See the dilemma? If I sell to the latter buyer, I get a house off DBNR books and have the cash now. If I sell to the former buyers, I serve DBNR’s philosophy but I run the risk of getting the properties back if the new owners default. Because we don’t surrender the note, we maintain ownership of the property, but then the process starts again.

Read the stories and think about what you’d do in my situation. The first potential buyer in Chicago is a single mother with two kids who works in the office of Cook County’s waste management division; I’ll call her Sheila. She wants this two-flat (as they call it there; we would call it a duplex) so she has a place for her family to live and a place she can rent out. The property needs some work - not a lot - and Sheila’s father will take care of that for her. We’ll hold a 15- to 20-year note on the property.

Competing with Sheila is a wholesaler we’ve been working with in Chicago, who has another family ready to buy. He’s offering a little less than Sheila is, but he promises that the property will be paid off in three months. Complicating the issue is that this particular wholesaler isn’t always the most reliable person in transactions. He frequently wants more time, and then some more time, and meanwhile, Sheila is calling frequently though waiting patiently.

The situation in Hartsville is only a little simpler. It is a one-third-acre lot, suitable for parking a mobile home. The thing about rural South Carolina that we’re not used to here in Silicon Valley is there are people who have neither computers nor voice mail. They have to drive into town to send a fax. The first few times I called back the first buyer, whom I’ll call Ronnie, I got a recording saying that I should try again later. I began to think he was a flake.

But I’ve come to believe he is sincere. Ronnie actually rented the lot previously, and lived there in a mobile home. He doesn’t know why the people that owned it wouldn’t sell it to him, even when they were in danger of losing the lot in foreclosure (which is how DBNR got it). He’s even willing to pay more than the cash buyer, but he needs DBNR financing.

On the other side of equation is Chuck - or, to be more accurate, Chucks’ dad, since I’ve never actually talked to Chuck. Chuck works for a manufacturing company in Libya. He works for three months and comes home to Hartsville for three weeks. Chucks’ dad has been dickering on the price, offering first one amount and then less, and then more when he found out he was competing with Ronnie.

All four of these prospects have their plusses and minuses. Time may give me the answer, with one or more dropping out of contention. But it’s entirely possible that the decision will be mine. And at that time, I will be weighing capitalism vs. altruism.

DBNR’s focus has been on property in so many other areas of the country we figured it was time we offered a real opportunity to those right here in town.

The article below details an interview with Julia Dugger, Fannie Mae’s senior manager of marketing communications in May of this year. The article discusses the First Look program released last fall. The program although not widely familiar, gives individual potential homeowners and one time opportunity to purchase a home before the general investment community has a chance to use plentiful investment funds to buy and then resell the property for a higher price.

Fannie Mae is tightening up its initiative to facilitate the sale of REOs to owner-occupants and entities using public funds, such as local housing and community development agencies.

Fannie Mae says these buyers bring permanency and stability to tenuous markets where swollen inventories of foreclosures have taken their toll, and the GSE is making some changes to ensure owner-occupants and public entities have “first look” at its REO homes.

Fannie Mae initially rolled out its First Look initiative last fall. Under the program, the GSE only considers offers from those seeking to purchase a home as their primary residence and public entities during the first 15 days that a property is listed.

Julia Dugger, Fannie Mae’s senior manager of marketing communications, says the program has seen a great deal of success throughout the country, and is accomplishing its mission of building stronger communities by ensuring the GSE’s repossessed homes don’t continue to sit vacant while an investor markets the property to potential tenants.

But Dugger explained that the execution of the First Look program has been “tricky,” primarily because individual homebuyers and public entities usually can’t view multiple listing services (MLS), and consequently don’t know when the property they’re interested in was actually listed or when the 15-day First Look window ends.

To address this snag, Fannie Mae is making some changes to the program. Going forward, First Look will be tracked based on days listed on the GSE’s REO marketing site HomePath.com, as opposed to the MLS.

Properties in the First Look marketing period can be easily identified by the First Look logo. Fannie Mae also launched a new timer feature today on HomePath.com, indicating how many days remain in the First Look marketing period for each individual property.

Click this link to read the rest of the article: http://www.dsnews.com/articles/fannie-mae-hones-first-look-program-for-reo-property-sales-2010-05-03

A quick search for property in San Jose, Santa Clara county in the price range of $200,000 to $500,000 revealed some interesting values. These are properties you could actually buy at a substantial discount over current prices right now.

Here is the link if you’d like to see these: HomePath.com