How to Profit From the Housing Crisis

David Cline, Director of Sales and Marketing for REO Fund

Investing today has become a difficult and often scary proposition. How can anyone know where to put their money when it seems that all stocks and sectors are going down?

You may not know the best individual stocks or funds to invest in right now, but there are certain aspects of investments including real estate that you probably do understand. You know that the price of real estate has been coming down, and you know that there are thousands of banks, real estate investors and Hedge Funds that desperately need to move their non-performing properties. These entities have learned that holding on to these properties in institution hands is costly and an inefficient use of their capital. REO properties tend to depreciate faster when they are left vacant. Vacant properties are targets for vandalism, theft and overall deterioration.

Smart lenders realize that in order to minimize their losses, they will need to quickly get these non-performing assets off their books. This is easier said than done. In order to sell the properties, they must steeply discount the price they are willing to accept. In these cases, the lender must accept much less than they are owed. Each time they sell an asset at such a discounted price it could have an adverse effect of continuing to bring down values in local neighborhoods. To counter this, the lender will try to sell their assets in bulk to quickly remove the assets off their books.

“How do regular investors profit from this?” you might ask. Even an investor with deep pockets would have a problem coming up with the necessary capital and credit facilities needed to buy several properties at a time much less several hundred or thousands of properties. Add to this the management challenges and potential cash flow problems associated with owning multiple properties and then you have to ask yourself, “Why would I want to do that?”

The ideal situation would allow an investor to pool his or her funds with other likeminded individuals to have the buying power similar to major Wall Street Hedge Funds as well as the diversification that multiple assets provide in various submarkets. This pooling of funds allows the average investor to buy into a diverse number of properties without the costs, the headaches and liability it would have as a sole owner. Secondarily, with this strategy an investor can spread its risk over all these properties thus realizing true economies of scale with a minimal investment.

Investing in such a fund is a great idea, but what should you look for? Certainly an investor would want to know that the properties in the portfolio are positively cash flowing. Positive cash flow means nothing however if factors such as management fees, replacement reserves, repairs, vacancies, taxes and insurance are not taken into consideration. How salable is the property? If the property has lots of equity but can’t be sold, what’s that equity worth? Has the fund done all the due diligence to ensure a profitable investment, i.e. appraisals, inspections, proper financial analysis as well as a realistic exit strategy? Does the fund manager have the experience and connections to manage such a diverse cross section of properties?

Investing with a hands-on operator who has the skill set to both oversee the investments as well as experience in creating value from underperforming loans is important in this environment.

Finding discounted properties for such a fund is the key. Hard money and rehab lenders typically will provide a great source of properties to make up such a fund. They typically base the original loan on the equity in the property or the future value of the property, based on repairs being done. This builds instant equity for the lender. The other intriguing part about using these lenders is the type of assets they usually target. Generally speaking the loans are in areas that are ideal for rental income, lease options and land contract sales.

If you decide to buy discounted properties in this challenging environment you will need to perform the following functions:

• A high level of due diligence with complete property analysis of each property and the surrounding neighborhood
• Create a direct plan to enhance the profitability of each property.
• Assemble a knowledgeable management team experienced in handling and marketing REO’s.
• Have a high level of flexibility to determine the best course of action for each property. Depending on the area and market environment, the best course of action may be any one of the following:
  

    1. Negotiate and restructure the current mortgage or lease with the current owner/tenant
    2. Sell the property As-Is
    3. Make improvements to property to sell for greater returns
    4. Lease option the property
    5. Rent out the property to qualified tenants
    6. Sell these properties in time as the real estate and credit markets open up

The goal is to quickly identify the outstanding issues of the property, address the issues head on, and turn it into a cash flowing and profitable investment!

If you wish to “cherry pick” the best available REO opportunities, you need to quickly identify market trends, risks, and opportunities to carefully assess the viability of any property solutions. Each market presents unique challenges that must be analyzed for the opportunities and pitfalls that could arise. These challenges can vary geographically or even block to block in densely populated cities.

It is important that you investigate the area where you wish to buy your properties. Some of the criteria that you would need to research include: average days on market for unsold inventory, crime rates, percentage of rentals to owner occupied residence, the average sales price, number of recent foreclosures, tax rates, quality of school districts, unemployment rate, industry trends, employment opportunities, median income, population and growth rates, and housing trends.

REO properties are all different and there is no cookie cutter solution for how to best maximize cash flow. However, properly investigating your target properties can help determine the potential cash flow generated from rents and lease options, and determine the ideal hold period to maximum sales prices, (and which properties need to be avoided altogether).

Buying REO properties with your self directed IRA’s can be very profitable, but you need to either invest the appropriate amount of time or you team up with the right fund that has the ability to comprehensively analyze a property, determine the best strategy and finally, properly execute on that strategy. So take advantage of the mistakes and the discounts that banks, Hedge Funds, and real estate investors have made!

Disclaimer: Equity Trust is a passive custodian and does not provide tax, legal, or investment advice. It does not endorse or recommend any contributor, company, or specific investments. Any information communicated by Equity Trust Company is for educational purposes only and should not be construed as tax, legal, or investment advice. Whenever making an investment decision, please consult with your legal, tax, and accounting professionals.