Satori Alliance | Financial Counseling | Real Estate Investment Products | Financial Guidance Seminars

Regular readers of this column know DBNR Investments’ goal: in response to this unprecedented housing crisis, we’re committed to putting people back into homes that need them, want them, can afford them, and who are willing to work to keep them.

But regular readers also know that it’s not as easy as it sounds. Not for us, and not for the people we’re trying to serve. It’s arguably difficult to help someone make the transformation from living paycheck to paycheck to a financial life that involves long-term commitments. It requires a stick-to-it-iveness that is not part of many people’s makeup.

But when I do run into that kind of person, it always makes me smile.

I’ll call this man NavyDaddy, not only because it’s his e-mail name, but also because it clearly represents two of the things he’s most proud of: his service to his country, and his kids. He and his wife live in a small town in Michigan, and she called our toll-free number about a house in Gary, Indiana, about an hour away from where they live.

Now, we make every attempt to return every phone call within 48 hours, but sometimes that doesn’t happen. People are usually okay with that, except that Mrs. NavyDaddy was so excited about this house that she called a second time. And she left a message on our Web site. I’ve been doing this long enough to know that this is someone committed to changing their situation.

I called them back and talked to NavyDaddy, a man with the wonderful lilting accent you only find in eastern Tennessee and South Carolina. I learned more about their situation. She’s pregnant with twins. They live in a 40-year-old trailer in a mobile home park. They have illness and disability issues, which means that they derive their income from social security, but the amount still qualifies them for this particular house. In fact, the amount they’re paying for rent in the trailer park is almost the same as they’d be paying for this house in Gary.

I also learned how much he wants to provide for his family. He wants to go see this house in Gary, he tells me. He wants to know if there’s a way to get it without having anyone else bid for it.

As much as I want to help him get this house, I tried to convey to him that it was not in move-in condition. The house and the roof are structurally sound, but the inside needs work. I was not about to have a pregnant woman move into a house in such condition. I told him that he could certainly see the house, but he had to take a notepad, write down everything that needed to be done, and provide a plan for how he was going to do it. Was he going to fix it, or was he going to hire someone, and on what time frame?

I also sent him an emergency contact form, which includes next of kin information. It’s not that I’m expecting anyone to die, but I want information about relatives in case I have to track anyone down later. I knew NavyDaddy was different when he sent me the name of his landlord instead. Nobody has ever volunteered landlord information. Having been burned before, I asked the landlord a lot of questions about the mobile home park just to make sure he wasn’t a shill. He wasn’t.

That made NavyDaddy one of those clients I live for. The story’s not over yet, but I’m eagerly anticipating a happy ending for NavyDaddy, his wife, and his kids.

It’s spring, and there are signs that the economy is blossoming along with the flowers. The stock market threw off the cloak of panic from what looks like a trader’s typo earlier this month and is back at its previous levels. Personal income, personal consumption expenditures, and personal income were all up in the latest figures from the Bureau of Economic Analysis.

However, there are some disturbing trends.

Item: While the Bureau of Labor Statistics reported multiple industries increasing their numbers, the overall unemployment rate edged up from 9.7% to 9.9% in the latest reports.

Item: We have heard of some clients with equity in their homes, secured assets, and dual six-figure incomes being turned down for refinancing requests because one of the parties is self-employed and (guess what!) their income decreased last year.

Item: The federal government is still working on legislation to “fix” the mortgage issue, but some experts feel these new laws may cause more trouble than they solve. As Robert E. Story Jr., chairman of the Mortgage Bankers Association, wrote in an editorial earlier this month:

“Enacting broad risk retention, requiring lenders to keep a portion of the original loan on their books, has the potential to eliminate a sizable percentage of the mortgage-lending capacity in this country. There is an entire segment of the residential mortgage-lending industry that only does mortgages and does not take deposits from customers. Those lenders make loans to borrowers, sell the loans into the secondary market (with representations and warranties) and then use the money they receive from the sales of the loans to make the next mortgage to another borrower.

Requiring these independent mortgage lenders - many of which are small businesses - to retain a portion of every mortgage they sell would render their business model unsustainable. Elimination of this critical segment of the market - often smaller lenders that serve underrepresented areas and borrowers -would limit capacity and choice for consumers, driving up borrowing costs or limiting access to mortgages altogether, which is the last thing we need in a real estate market that is just beginning to see signs of recovery.”

While these developments roil the traditional segments of the industry — including many of our friends and colleagues — we can’t help but feel that they will end up helping DBNR Investments’ business model to blossom along with the spring flowers. As we noted in last month’s column, The Road Ahead, we’re making a transition to a new phase of real estate investing.

Because lending institutions are still unable to deal with the massive number of abandoned mortgages and the distressed property left behind — whether because of their own inertia or governmental regulations — we feel we’re offering a valid alternative in the marketplace. With the government and in turn lenders turning back the clock fifteen-plus years on qualification criteria for getting new loans, they have effectively blocked a majority of the U.S. population from the ability to finance a home.

DBNR Investments is renewing its commitment to putting people back into homes that need them, want them, can afford them, and who are wiling to work to keep them, and we are doing this without forcing buyers to endure the expense, hassle, and frustration of the conventional real estate and lending communities. We believe we can return to a time when deals were based on performance and trust, and in doing so, contribute to the revitalization of property and local municipalities.

In dealing with the Soviet Union, Ronald Reagan had a favorite saying: trust, but verify. It was something the Russians understood innately, because as it turns out, when he said it, Reagan was quoting Felix Edmundovich Dzerzhinsky, one of the architects of the Soviet secret police.

Although Dzerzhinsky and Reagan used it in the context of politics, the concept has strong roots in business. There, it’s called due diligence. Just as with the U.S. and the U.S.S.R. in the old days, both sides in a business transaction have strong motivation to accept the word of the other. Common sense, however, dictates one take steps not only to confirm what you hear but to consider its validity.

I find myself thinking about trust and due diligence a lot these days. When I was watching U.S. senators questioning Goldman Sachs on CNBC recently, I was struck by how little seemingly rational and intelligent people relied too much on the first and too little on the second. The topic of discussion was stated-income loans - loans given based not on documentation, but on the borrowers’ word. Borrowers stated their income, and the figure was accepted.

The use of stated income began logically enough. It was used with high-net-worth individuals, people so well-entrenched that their companies paid most of their expenses. They really had no income per se; there was no need of it. But these people clearly had other assets, assets whose existence could be verified.

The meltdown that we just witnessed came when the banking industry realized that it could charge more money for loans with additional risk. So they adapted stated-income loans for a much larger pool of people for whom it was never intended. Fold in derivatives, in which the risk was supposedly shared, and you have institutions buying into loan pools, thinking 1) that someone had performed due diligence on the original set of loans and 2) that real estate values were only going to go up.

Too much trust, not enough diligence, and a trillion dollars of value went poof.

As I’ve written about previously, in putting people who have never been homeowners before into distressed properties, I’ve had to reconfigure my thoughts about trust and due diligence. Trust has three components: sincerity, reliability, and competence. If I can’t judge a buyer by their credit history (because they don’t have one), I have to come up with new ways to judge them. How much money is in their bank account? How much does what they say align with what I see and hear? How fast do they get back to me with information?

Interestingly, it has paid off financially. We had originally planned to sell properties in exchange for notes, and then sell the notes to re-circulate the cash. We initially planned to sell notes in the first six months after the transaction, but because the risk is higher, we pay more discount say, 60-70% of the note’s value. After a year, the discount goes way down to about 25 or 30%, because people have demonstrated that they can make their payments on time. More competence, less risk, more value for us. It’s built-in evidence of due diligence.

It’s working great for DBNR. I wish the bigger financial companies were as committed to getting people back in homes as we are.

Last week I wrote about two different kinds of investors who contacted me about a multi-unit property DBNR is selling in Syracuse, New York. One was a couple who was dedicated to converting a recent inheritance into real estate, looking for quick returns and cascading profits after a series of purchases, flips, and new purchases. The other was a meticulous woman who spends a lot of time researching potential investment properties, asking a lot of questions, and making extensive calculations.

I asked the question, whom do you think I enjoy working with more? The answer may surprise you. I won’t keep you in suspense - I far prefer working with the meticulous woman.

You may think I’d prefer to work with the couple who has scads of cash and is looking at real-estate investing as an exhilarating rollercoaster that will only take them up. But the fact is, I don’t think these people should be buying real estate. Let me explain why.

There are only four things you can do with money: spend it, earn it, save it, or invest it. This couple knows about earning and spending, but they don’t know about saving or investing. You could argue that because they didn’t earn the money that was burning a hole in their pocket, they didn’t know how to deal with it. But the fact is, we just got through a period of history when too many people looked at real estate as a quick path to riches. You can’t look at it that way anymore.

Even more important, you need to have a plan. Clearly, they don’t have one (which is how they got to this point in their life where they had no savings). When I asked them when they thought they would want to take the money out of real estate, they didn’t know. When I asked them what they might do with their profits, they didn’t know. All they know is that they had a problem - no money for retirement - and now they have a solution - the inheritance. Everything else will take care of itself. They don’t know about cash flow. They don’t know about return on investment. They don’t even want to be landlords. They just want to flip real estate.

You might think that having a client like this is perfect for someone like me. They have no metrics for success, so no matter what happens, I can’t be held accountable for not meeting non-existent goals. But more likely, whatever happens, they’ll blame their advisors because their expectations are no match for reality.

I would much prefer the woman who does her homework, even when, as it turns out with this one, she didn’t buy the property. Why not? As part of her research, she talked to another investor who already had property in that neighborhood. That investor told her that the people who rented in that neighborhood were difficult to deal with; they’d pay rent when they could, skip it when they couldn’t, and work the system to stay in the property until they were evicted. Being a landlord in that situation would have either been too time-consuming for her or too expensive to have someone else manage it. She passed.

But I want to work with her again. Because she’s smart, patient, and conducts appropriate due diligence. That’s the kind of client I prefer, because in the long run, that’s the kind of person who’s going to appreciate the work that I do and have realistic expectations about the outcome.

You may think that dealing in real estate, I’m happy to see anybody come in the door (or over the Internet) as long as they have money. Nothing could be further from the truth. Imagine a house-painter - one who takes pride in his work - with a client who wanted a house painted mango orange. Do you think that house-painter would point to that house as an example of his or her best work? Probably not.

I’m the same way. Let me illustrate by telling the story of two investors. You pick whom you think I like working with best.

Let’s start with a couple who called me about a property in Syracuse, New York. She was a social worker and he was an Internet researcher. It was a classic bad news/good news situation. The bad news was that, though they had been married a while and had three kids, they hadn’t put much aside for their retirement. The good news was that one of their parents had passed away and left them a sizable inheritance with which to rectify their financial situation.

These people looked upon real estate investing as something akin to a trip to Disneyland. They are throwing money into it with abandon. They wanted to buy houses, fix them up, and sell ‘em for a profit, and then start over again. They look at real estate investing with an unalloyed optimism, thinking of it as a money machine. When I asked them how well they wanted to do, they said, “As well as we can.”

Does that sound like heaven? A couple with money, optimism, and time.

Let’s contrast them with someone working from a different perspective, a woman who called me about the same multi-unit property in Syracuse. She’s a very studious investor. When she called, she interrogated me about our business model. She spent a lot of time mulling over a potential investment, even though she is already familiar with that particular area. She visited the properties to see their condition in person. She sent a contractor over to get an estimate of how much it would cost to get the property in shape. She even took the time to research the title, making sure DBNR actually owned the property and that there weren’t any liens against it.

She spent a long time on the phone, explaining to me with her extremely meticulous strategy. She buys properties and holds them until they increase in value, unless she derives significant cash flow from them. She determines whether the cash flow is sufficient by looking at what she gets in tax deductions and her return over three years. No matter what, she says, she needs to see a realistic exit strategy within five years.

Whom do you think I enjoy working with more? The answer next week…

In The Shawshank Redemption, Morgan Freeman played a convict who could “get things for you.” Whether it was plum job assignments or pin-up posters, he was the go-to guy within the confines of that community.

The idea of a go-to guy in a community is a common prospect, especially in real estate — without the criminal aspect, of course. There’s somebody (or multiple somebody’s) in every metropolitan area who knows the best contractors, the richest investors, the savviest real estate agents, the smartest mortgage brokers, and are even on a first-name basis with the folks in the municipal permits department. And as a result of knowing all these people, they have a keen insight of what’s happening in real estate in that community.

We’ve recently met a guy named Charles who fills this role in Chicago, Atlanta, & Dallas. He’s been doing it for fifteen years and he’s well-connected. He not only knows what properties are undervalued, he also understands financing. Best of all he has a database of local investors with cash on hand. He is a one-stop shop for anybody who wants to do business in Chicago.

What Charles doesn’t have is that same capability in other communities.

As DBNR expands its focus to include “light rehab” properties, we see a strong value in connecting with people like Charles. It dovetails with the trend we’ve been seeing (and writing about) of a trend away from regional real estate expertise toward national real estate expertise, in which professionals can take advantage of investment opportunities beyond a particular area. Imagine Charles’ counterpart in highly depressed Las Vegas want to share insight — and risk — with people in other parts of the country, as opposed to betting on the revival of his overbuilt city.

I’m working toward becoming a different type of valuable resource like Charles in Silicon Valley. We want to be his partner and the partner of his counterparts elsewhere. The problem — as always when people first come together through electronic and other impersonal methods — is trust. Establishing trust within the confines of a any community is easy. You say what you’re going to do and you do it, on time, and everybody in the neighborhood knows you stand behind your word. That’s not so easy when someone isn’t from the neighborhood.

The problem comes when someone’s stock-in-trade (who they know) are also their references. People are cagey about sharing that kind of information. We’re working through that. We’re still doing due diligence to confirm that Charles and others like him are who they say they are. We’re using social networking tools, like national real estate forums, to find people who know them or know of them. The tools are there. The process may take a little longer. But the ability to go to one person and spread your real estate investments nationally rather than locally is becoming a viable reality.

Even Bill Gates would tell you that some of the hardest — and most necessary — moments in the life of a business are the ones when you stop, take a breath, and ask yourself some questions: is this strategy working properly, just as he did in 1996 when he “redirected Microsoft to become an Internet-focused company”. Can I make adjustments to be more profitable?

It’s almost an antithetical move for entrepreneurs, who are supposed to be confident in their strategies even in the face of setbacks. But once you’ve been speeding down the road for a while, it makes a great deal of sense to pull over to the side and recheck your roadmap. After all, if you headed off to a ski vacation in Tahoe, but you hear the highway is snowed in, you’ll have to find a different route to get there.

That’s what we’re doing here at DBNR right now. We knew there would be challenges like these:

Speed. Cities and municipalities are razing dilapidated properties more quickly than in the past. We had one property in Indianapolis that we had no illusions about — in the initial photographs we received, there were tarps on the roof — but it was demolished last week without us being notified. As the economy improves, cities are moving faster than in the past to rehabilitate “blighted” neighborhoods.

Lack of motivation. We were highly altruistic going into this project, hoping to put people who hadn’t had the opportunity to have homes previously into properties that they themselves would fix up. We’ve spent hours on the phone talking to people who are supposed to call back, but they didn’t because they were apparently wrapped up in March Madness. On one property in Detroit, I’ve talked to 15 people and we still don’t have anybody who is willing to do what it takes — small though that might be — to get in there. Why is that?

So what do we do? Every entrepreneur knows that out of challenge comes opportunity and we have found one we like a lot. Over the last several months we’ve built relationships with other bulk REO investors and told them our story. Turns out we’re not the only ones encountering these issues. What a surprise! One investor even told us how he’s changed his business to adapt.

Mike from Pleasanton, CA told us that now, instead of purchasing “C” class property, he purchases property that doesn’t need nearly as much rehab. He then hires a local contractor to rehab and then sell on a land contract just as we are doing. He’s found that using this method his hassles have gone way down. He has a greater number of sales, his default rate is lower and since he “cherry picks” the properties he buys he gets to weed out the nightmares. Yes, his properties cost more, but overall he says it’s worth it.

How do we take advantage of this? We think we’re no more than 30-60 days away from getting additional investors on board. In addition to being able to purchase more property, we’ll be able to test various adjustments to our model to improve performance, including Mike’s. We’re building relationships with real estate professionals and contractors in Chicago to be able to test this “light rehab” model as soon as we’re funded, and possibly on property we now own.

Every entrepreneur likes to hear and act on new ideas. We’re excited to evolve and adapt to challenges we face and we don’t have a problem adjusting our business when an opportunity presents itself. After all, there are many roads ahead you can take to get to your destination.

Alfred Lord Tennyson thought spring was for love, but it’s appears to be different this year. To be sure, spring is a time for change. After being cooped up for the winter (yes, even in California), we emerge into the sunlight, ready to absorb its healthy Vitamin D. Polls show that spring traditionally brings better moods and positive expectations for most of the population.

Certainly, for many years this elation has been channeled into real estate-related activities. In all my years in the business, I’ve seen activity pick up around mid-February and continue through April. Sellers list property, prospects start looking for property. Even the activity around home improvement increases, whether in anticipation of selling or just because the weather’s better. Maybe it’s the culmination of projects you notice must get done when you’re stuck inside.

Of course, people focus on real estate in the spring because they want to make moves before summer vacation, and they want to make sure deals are finalized before the kids go back to school.

This year, however, there seems to be even more of a hubbub in real estate as spring begins. I’m seeing lots of reasons for this.

Low interest rates. Last week the Federal Reserve voted to keep interest rates at their historically low rates. This is giving people incentive to think about entering or investing in the real estate market again.

Number of properties available. No secret here. With lots of foreclosures and short sales out there, the market has never been better.

Number of sources for properties. More than ever before, properties are available both through traditional real-estate transactions and non-traditional seller-to-buyer transactions. Going the latter route requires a trusted advisor, but the traditional 6% commission structure is under fire as never before.

This silver lining has a cloud, of course — one that we’ve talked about before. The delays involved in appraisals, financing, and mortgage approvals are worse than they’ve ever been, stretching out to months instead of weeks. Even people whose credit histories are stellar and who have equity in their homes are seeing delays in simple refinancing deals. If you really want to either buy or invest in property — no matter what the source — before summer vacation or the autumn school year, the time to start your efforts is now.

Earlier this month, I wrote about the challenges of obtaining what’s known as an abstract of title for a property in Des Moines. It’s a legal document unique to Iowa that requires the services not of a title company, but of a real estate lawyer. If you never owned real estate in Iowa, you’d never know such a document existed.

But now that DBNR is investing in real estate across the country, I’m beginning to realize that not only are there many arcane, regionally specific rules, but also that municipalities are grasping on out-of-town investors as a faceless source of income. Some of our properties have been abandoned, which means that no one is there to see legal notices posted on the door regarding issues such as weed abatement. When the city receives no response to an order, penalties, fines and interest begin to mount up. Out-of-towners, after all, can’t vote, and so are frequently powerless to effectively argue liens and other orders.

We have one property on Logan Street in Minneapolis. It’s a stately, 4BR/2BA two-story house on a good size lot. We’ve gotten more call volume on this property than any other. But even before we obtained it, because of its deteriorated condition, the city had imposed a tear-down order.

We talked to city officials, who told us we had two options: raze it or bring it up to code, at a cost the city estimated: $80,000. If the city razes it, it’ll send us the bill. Interestingly, when we talked to contractors in Minneapolis about this situation, we learned that if you have a local person who knows how to deal with the city, the costs come down considerably. It just requires someone local who knows how to deal in person with the system. One contractor told me, “We do this a lot because there are lots of old properties in the city that have been abandoned. It’s a fairly generic process.”

As it happens, the bank that foreclosed on the property had filed an injunction against the tear-down order, so we have some buffer in terms of figuring out how to deal with this.

We face a similar, but more optimistic situation, with a house on Bonar Street in Indianapolis. This house is in pretty bad shape, and it has $36,000 in back taxes and fines on it to boot (the city had done weed abatement on it, and assessed a fee for doing so). We found a buyer for the house, someone who knew and loved the area because she’d lived there as a child. We told her about the back taxes, warning her that she’d have to deal with the city about them. We don’t know the end of the story, but she thinks she can get the figure whittled down to around $7,000. Why? Because she’s going to be a tax-paying, voting citizen there.

Nobody likes foreclosed homes, and to be fair, municipalities are dealing with severe financial issues because of the loss of property tax revenue from abandoned properties. But it seems like they’re using this opportunity to soak absentee landlords for fees they can’t get from locals. Large out-of-state banks may be bureaucratic molasses to the rest of us, but to municipalities, they’re a godsend. Their slow-moving characteristics mean that fines and penalties can pile up quickly without someone paying attention to them, and corporations are more likely to pay the fines and write them off. The problem is that small companies like DBNR are being caught up in these nets too.

Want to know the current state of home ownership? Consider this February 2010 report from a real estate analytics firm, a division of First American Insurance:

First American CoreLogic reported today that more than 11.3 million, or 24 percent, of all residential properties with mortgages, were in negative equity at the end of the fourth quarter of 2009, up from 10.7 million and 23 percent at the end of the third quarter of 2009. An additional 2.3 million mortgages were approaching negative equity at the end of last year, meaning they had less than five percent equity. Together, negative equity and near?negative equity mortgages accounted for nearly 29 percent of all residential properties with a mortgage nationwide.

That’s a lot of people with negative equity or, to use the colloquialism, whose mortgages are “upside-down” or “underwater.” What happens when you owe more on something than it’s worth? Your pride of ownership is diminished, certainly. And we’re really only talking about two things where this applies: houses and cars. We can buy stock and have it lose value, but stocks have more liquidity, so we can sell them quickly. We expect cars to depreciate, so that’s no big deal (if you feel that way, lease them).

But homes — that’s a different story. We expect homes to appreciate, whether they’re our primary residence or an investment. So what happens when almost a third of mortgaged properties stop meeting their owners’ expectations? The First American CoreLogic report cites an interesting observation: when negative equity reaches 25% or $70,000, people begin to behave not like homeowners but like investors who don’t want to pay for a declining asset any longer. They stop making payments and walk away.

That’s a lot of people potentially giving up on the American Dream of a safe harbor, a place to raise a family, a place tightly woven into the concept of controlling one’s own destiny. If you own your home, you can’t be evicted, and your lives and those of your children disrupted. Your rent can’t be raised exorbitantly. You get a mortgage deduction (this year, anyway). You get equity (usually) over the long term.

That’s really the key phrase: over the long term. People who walk away from a mortgage clearly have no appreciation of the long term. Not only do they not believe in it relating to the value of their property, but they also ignore the long-term ramifications of their actions on other facets of their life.

They forfeit their down payment and any other payments they’ve made. They forfeit any opportunity to see the value rise. But there’s more. You want underwater? Walking away from a payment commitment is like drowning your credit rating for seven to ten years. Your credit rating isn’t just something people look at when you want to buy another house when the economy turns around in the future; it’s something they look at when you buy a car, an appliance, apply for a credit card, or even rent an apartment.

There’s more: with the easy accessibility of credit reports, employers are using them more frequently to make hiring decisions. It doesn’t even matter if you’re going to be handling money; employers look at credit ratings and payment histories as a reflection of trustworthiness and stability.

In a country nurtured on instant gratification, patience is not a virtue highly valued. But in this scenario, people must begin to value it, at the risk of devaluing — no, crippling — their future opportunities.