CURRENT REAL ESTATE MARKET CONDITIONS

Understanding Current Market Conditions

Finders, brokers and investors are finding in today’s market it’s harder and harder to purchase notes.  Many banks, financial institutions, brokerage firms and hedge funds are becoming more stringent on lending practices.  This is expected to become worse as time progresses and recovery time isn’t expected until third quarter of 2009.  Can note holders wait that long?  The longer they wait the steeper the discount.  Need to explain what is going on and why it’s better to sell now and not later.  Note holders need to be educated on today’s real market.  Many feel they should receive full price for note and are willing to hold out for their expected price.

Some seller financed notes may become delinquent within the next year or so due to payors inability to refinance or obtain home equity loans through a more conventional lender.  Banks and financial institutions are not providing home equity financing to those with poor credit.  Credit scores must now be around 700 or better to obtain loans.  Home equity was easy to obtain a few years ago and now payors are further in debt because of these loans and may now find it hard to repay that line of credit.  Remember payor is not only paying monthly mortgage to note holder but also a bank mortgage on that home equity loan.  Just in Miami, FL alone there have been 4,000 foreclosures this year.  Banks foreclosed and are now stuck with empty homes they are unable to sell. 

Note holders believe they can acquire property back in foreclosure and resell at same or higher price than before.  First problem is paying foreclosure costs; it usually runs around $2,000 to $4,000 and approximately 30 to 60 days to foreclose.  Second is resale, not in today’s market with sub prime lending fears hardly any real estate is being sold.  If they are able to sell, it will be at a lower price and probably have to carry back another seller financed note returning to same problem they had before.  Banks and lending institutions are not lending money freely and now have strict lending policies.  This crisis is not expected to ease until sometime in 2009 or later.

Note holders believe they are making a good return on their money because of interest rate of note. 

Here is a true story. 
 
Note holder thought he was making an 8% return on his $50,000 seller financed note. Note was created in 2004 at 8% and we presented a great offer at around 92% of remaining balance.  After discussion with his consultant who informed him he would have to make 11% return to receive an 8% yield, seller decided not to sell.  That assumption is correct if note holder had created note in 2007.  He forgot to factor in cost of living rates which are around 3% every year (8 + 3 = 11).  Note holder would have to sell property today and carry back a seller financed note at 11% to make an 8% return.

 

If seller holds steadfast and considers an 8% rate of return good, he is really only making approximately 5% (8% – 3% cost of living) and only if he had created note in 2007. Again in this case, he has held note for 3 years so in actuality he is losing money on note created just 3 years ago. 

1. You must factor in 3% cost of living increases every year and note was created 3 years ago.  If one multiplies by number of years (seasoning) you get 9% (3 x 3 years). Original note created in 2004 was 8%, so today he is actually losing approximately 1% on his money (8 – 9 = -1) based on its 2004 value. (By using website calculator below, it now takes $54,475.65 in today’s, 2007, money to equal buying power of $50,000 in 2004) 

2. If note holder doesn’t increase interest rate yearly to match cost of living increase he’s incurring, eventually interest rate will erode over time and at some point note holder will begin losing money on investment.  (A good example of this is when an employer provides a cost of living increase to employee’s salary at end of each year.  It’s usually around 3% of yearly salary and distributed over course of following year.  This reflects salary keeping pace with inflation.)

3. With above statement, our note holder would have to adjust financed note yearly to reflect cost of living increases.  So that 2004 note at 8% interest rate would now have to be adjusted upwards to 17% (8 + 9) to receive same monetary value it had in 2004. 

4. This is an over simplification of time versus money but you see the picture. He couldn’t understand what I was telling him and only listening to his consultant who obviously doesn’t understand the concept of time versus money.  Best part of story is his consultant works for AmeriSource, a financial institution that manages money.

Following excerpt taken from 2006 Social Security web pages.  Legislation enacted in 1973 provides for automatic cost-of-living adjustments, or COLAs. The COLAs prevent inflation from eroding Social Security and Supplemental Security Income (SSI) benefits.  The latest COLA is 3.3 percent for Social Security benefits and SSI payments. Social Security benefits will increase by 3.3 percent beginning with December 2006 benefits, which are payable in January 2007. Federal SSI payment levels will also increase by 3.3 percent effective for payments made for January 2007. Because the normal SSI payment date is the first of the month and January 1 is a holiday, the SSI payments for January are always made at the end of the previous December.  The Social Security Act specifies a formula for determining the COLA. In general, the COLA is equal to the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter of one year to the third quarter of the next.

Cost of Living Comparisons

What Things Cost

      2005    2007  Increase

Gallon Gasoline $2.27 $2.70 18.9%
Gallon Milk $3.19 $4.50 41.0%
Loaf Bread $1.05 $1.60 52.4%
1st Class Postage $0.37 $0.41 10.8%
Dr. Visit  $60.00 $75.00 25.0%

As you can see as time moves forward prices increase.

Below examples show how purchasing power has eroded over time. Cost of Living calculator can be found at http://www.aier.org/research/col.php

Table below represents purchasing power of $100 in today’s money over previous 7 years.

Year   Value Decrease

2007   $100  0.00%
2006   $98.01 -1.99%
2005   $94.75 -5.25%
2004   $91.78 -8.22%
2003   $89.45 -10.55%
2002   $87.46 -12.54%
2001   $86.10 -13.90%
2000   $83.71 -16.29%

Table below represents purchasing power of $100 in today’s money over past 5 decades.

1990   $63.54 -36.46%
1980   $40.06  -59.94%
1970   $18.86 -81.14%
1960   $14.39 -85.65%
1950   $11.72 -88.28%

So $100 of today’s money will only buy what $11.72 did back in 1950.  It would cost you $426.62 of today’s money to purchase a $50.00 refrigerator in 1950.
 
I’ve tried explaining this simple concept but no one listens, the longer you hold a note the more money you stand to lose.  That relates back to the common phrase “Money today is worth more than money in the future”.