Distressed Real Estate Times book by John T. Reed
|Real estate values have tanked... now what?|
How to profit from opportunities which arise during distressed real estate markets. Also, how to minimize the distress you may suffer during those same markets. Important tax ramifications of various forms of loan renegotiation, foreclosures, and deeds in lieu of foreclosure. Opportunities in foreclosures, IRS auctions, OREOs, bankruptcy sales, preforeclosures, and more.
I first encountered your books about 15 years ago when we first got started buying rental real estate. Yours has been amongst the finest advice we've received. Your words ring in my ears to this day and I'm looking forward to reading more. THANKS!!!
Developments since September 2008
The 56 new pages in the third edition discuss developments since the stock market crash in September, 2008, including:
- detailed actual case history of buying an OREO (bank-owned foreclosure) in the current market
- the lack of bargains in spite of the record numbers of foreclosures
- an unexpected bargain niche: heavily vandalized OREOs
- an actual case history of a successful short sale offer
- the crucial increased importance of liquidity
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The book also covers: How to finance acquisitions when cash is scarce. Cash sources. Avoiding fraudulent transfers. Bankruptcy avoidance and planning. Recognizing early warning signals and action to take to avoid losing control of your finances and avoiding the high costs of losing financial control. Explanation of the unexpected quirks and safe harbors in the laws pertaining to debts and defaults.
The subprime crisis has created opportunities for investors. This book will also benefit homeowners & those contemplating bankruptcy.
Being distressed or buying distressed
Distressed Real Estate Times covers tough real estate markets from two perspectives:
- that of a property owner who is in distress himself
- that of an investor looking for distress situations where he can make a bargain purchase
When down markets end, almost all investors regret not buying during the hard times. Too many investors want to wait until they are sure values won’t fall any more. But by that time, they have climbed back up to an extent. Then everybody wants back in. Buying when others are selling is called contrarianism.
Starting in September, 2008, we had the:
- stock market crash
- The Housing and Economic Recovery Act of 2008
- FNMA/FHLMC nationalizations
- nationalizations of banks, insurance companies, GM, Chrysler
- tightening of rules of serial home selling ($25,000 per spouse long-term capital gain exclusion)
- the election
- Obama’s becoming president
- Democrats taking over Congress with almost filibuster-proof majorities
- Earmarks bill
- monster deficits
- The American Recovery and Reinvestment Act of 2009
Major events like theses had to be addressed in the new edition of Distressed Real Estate Times. The new third edition which was delivered today has 56 more pages than the second edition—164 compared to 108. The first edition had only 67 pages. The price is still the same: $29.95.
In theory, you can still buy at the pre-foreclosure stage if you do a short sale. That’s a deal where the lenders agree to release the property from their lien for less than they are owed because the property will not sell unless they do. But my son’s recent experience and reports from around the country cause me to conclude that short sales are generally a waste of time. The lenders take forever. Time is money. Screw them. You have better things to do..
Some investors take the attitude that the long time it takes to get answers from the lender on most short sales is good because it drives away impatient buyers. Certainly that is an important factor in bargains available as a result of postponed auctions of foreclosures and other lien forced sales. As long as you do not have to make repeated follow-up calls to make sure the lenders do not forget about your offer, that could make sense. Also, you need to be careful that the market does not change during the wait such that you no longer want the property in question at the price the lenders finally agreed to.
Lower minimum bid
A similar thing can happen with underwater properties at the foreclosure auction. The foreclosing lender can set the minimum bid below the loan balance. They should if they want it to sell at the auction. But they rarely do.
You need to wait but cannot—avoiding lack of liquidity forcing bad decisions
Liquidity is the ability to come up with the cash you need now—to pay mortgages and operating expenses, take advantage of opportunities—while you’re waiting for the market to be willing to pay a non-distressed price—purchase or rent—for your properties. Also, falling market values create more leverage in your portfolio than you intended.
I am currently reading When Genius Failed about the colossal failure of the Long Term Capital Management hedge fund in the late 90s. They saw interest rate spreads between Treasury bonds and corporate and other bonds getting too wide. They bet the interest rates would change so the spread would get back to the normal difference. They turned out to be right in the long run, but they could not hold on until the long run arrived Their leverage started high and got higher as the market temporarily moved in the same direction it had when they placed their bets. They did not have enough cash to meet their margin calls (lender requirements that they restore their equity percentage).
Poof! The same thing, roughly speaking, happens to real estate investors who fail to have enough cash or access to it to wait long enough for their good investments to perform. One niche where this is especially true is vacation homes. They tend to go up and down more than regular homes during hard times. And they take longer to recover. See page 12 of the third edition.
American Recovery and Reinvestment Act of 2009
This new law lets debtors delay and spread out tax on so-called “phantom income” caused by debt being forgiven in a work-out or loan modification. That law also delays, in those situations, application of the Original Issue Discount Rules, sometimes called the imputed-interest rules.
Detailed OREO purchase case history
Starting on page 80 of the 3rd edition of Distressed Real Estate Times, I tell about my oldest son and his wife buying their first home—an OREO. I accompanied them on a number of their house-hunting trips, for a mortgage lender meeting, and consulting throughout the process.
The book now tells how my son and his wife got a non-recourse mortgage which is super financial protection in these scary times.
50 houses. That’s how many my son looked at. He made over 20 offers. He neither got nor saw anyone else get bargains during the several months he pursued his first home. Understanding the bargains that were expected in this crisis, but have not appeared, is a big part of profiting from it and avoiding losses based on inaccurate assumptions in it.
Many homeowners associations, and their homeowner members, are in financial difficulties because of the economy today. In some cases, these difficulties provide bargain opportunities. In others, they hurt property values of homes in the association because of inadequate money for maintenance.
Blind optimism is no virtue
Sometimes armies attack. Sometimes they must retreat. They have to know how to do both.
Sometimes football teams are on offense. Sometimes they are on defense. They have to know how to do both. The same is true of real estate investment. You must have both attack and retreat and offense and defense in your repertoire. Blind optimism is no virtue. Being able to deal with current realities, including when they are adverse, is no weakness.
What is the difference between an offensive tactic and a defensive tactic?
An offensive tactic is a tangible or intangible action that increases the value of a property with skill, not the good or bad luck of market-wide appreciation. A defensive tactic is reducing losses, protecting yourself from risk, etc. You need to know offense and defense to maximize your investment return.
During hard times in real estate, the number of certain opportunities goes up, namely:
- foreclosure auctions
- FHA and VA repos
- conventional repos
- bankruptcy properties
- IRS auction properties
Distressed Real Estate Times tells you how to take advantage of those increased opportunities. In addition, almost all the other types of bargain-purchase opportunities are enhanced by hard times, like probates. The number of people dying stays the same, but the estates have greater difficulty selling than normal.
About half the book is focused on the opportunities created by distress. The rest of the book helps both the distressed owner and those trying to profit from working with distressed owners.
It’s good to be young, for most purposes. But it’s also good to have experience, a situation only available to the old. Distressed Real Estate Times artificially gives you the experience of those of us who have been in the business since the 1960s. You need it.
Young people tend to notice how the real estate market works when they come of age, conclude that is normal, then expect that version of “normal” to return soon whenever it goes away. Those who came of age in the early 2000s during the subprime boom, therefore, think that was normal. Ha!
That is not only wrong. It is a very dangerous notion to carry with you in the real estate business. A brash young computer company man was interviewed on 60 Minutes II during the height of the dot.com. The interviewer wondered asked about the fact that the young man was making millions but didn’t know anything about business. “Get used to it,” the young man said. I hope the young man did not get used to it because it all blew up in his face in April, 2000 when high tech stocks crashed back to earth.
Only by looking at a longer time period can you get the necessary, proper feel for the cyclicality of real estate investment. Distressed Real Estate Times covers recessions, cycles, the Depression, and the emotional swings that come with the ups and downs of real estate investing. Investors can lose self-confidence during distressed times unless they know how to deal with the downturn in a mentally healthy way.
The notion that real estate always goes up in value over the long term is incorrect and overly simplistic. So is the notion that all downturns are so brief that riding them out is the best course.
Many today think that the subprime crisis is unique. Nah. These financial crises in real estate come about every seven years, like locusts. Indeed, I first wrote Distressed Real Estate Times in 1991! Back then, I was inspired by my experience in the so-called savings and loan debacle of the 1980s. The very first article I ever wrote about real estate investment was called “Whatever happened to Real Estate Investment Trusts.” It was assigned to be as my audition to get a summer job writing real estate articles. Real Estate Investment Trusts were the subprime disaster of the early 1970s. I wrote the article in 1976.
In between we had the tax shelter syndications disasters.
And it’s not as easy as just buying when the market is down. A 40% overpricing followed by a 15% drop in prices does not offer bargain-purchase opportunities. A doubling in foreclosures accompanied by a tripling of the number of bidders at foreclosure auctions does not increase bargain-purchase opportunities. You still have to analyze the deals one by one and know value when you see it.
Investors know to diversify geographically so they do not have all their eggs in one basket. But they do not know to diversify temporally, that is, over time. If you buy all your properties at the same time, you may hit it big or lose big. Better you should buy them at a relatively steady pace. That will insure you buy at both good times and bad times but will save you from buying all your properties at the top of the market.
Hard times in real estate are a teaching moment where investors temporarily became more receptive to the risk-management techniques they should have been employing all along. The new edition of Distressed Real Estate Times covers some of those.
Coming up with cash
Cash is king in hard times, both for staving off falling behind in your payments and for seizing bargain-purchase opportunities. Distressed Real Estate Times has a long checklist to help you find needed cash. It also discusses ways of cutting back on personal expenses and ways of replacing your employees and subcontractors to conserve cash.
Not the same as good times only with a minus sign
Investors who have not been through hard times tend to assume they are the same as good times, only with a minus sign in front of their numbers. It’s a lot more complicated and different than that. All the stuff in your mortgages that you previously referred to as “boiler plate” suddenly becomes the most important clauses in the document and the stuff you thought was important when you signed it becomes “boilerplate.”
Knowing how to deal with them helps you with both your own distress, if any, and with capitalizing on bargain-purchase opportunities by showing you how to structure deals to help the guy you are buying from.
You have to watch out for “phantom gain” tax: tax on the difference between your adjusted basis and the amount of your mortgage if you deed it back to the lender. If you can find a buyer for your property, you may have to negotiate with the lender to get them to agree to a short sale. Or you may have to find sources of cash other than the sale proceeds to pay the transaction costs and federal income taxes caused by the sale.
Suspended losses caused by the passive loss limits in the Internal Revenue Code come into play when you are forced to sell a property to get out from under negative cash flow. They are a great annoyance when times are good but are life savers when times get hard.
New laws in 1993 and 2007 changed the way discharge-of-indebtedness income is taxed. Investors typically have discharge-of-indebtedness in many distressed times situations. Whether you have personal liability on the mortgage matters more than you realize if you have no experience with distressed mortgages.
Deeding a property back to the guy who sold it to you and took back a mortgage triggers unexpected tax effects that you need to know about when dealing with those situations.
There are also tax issues involving at-risk rules and below-market seller-finance interest rates.
Some criminal laws like those against equity skimming are triggered by common behavior by those in distress. Some civil laws may also be triggered like those prohibiting fraudulent transfers in anticipation of bankruptcy. You need to know all this stuff either as a distressed owner or as one trying to capitalize on the opportunities created by distress.
At bad real estate seminars, they joke about how you can push mortgage lenders around because “they don’t want the property back.” They also don’t want to be pushed around either. I have been through two of those renegotiations and learned a ton about how to do them in the real world as opposed to the fantasyland of seminar meeting rooms. Distressed Real Estate Times shares those lessons learned.
Distasteful as it may sound, people who may be in distress need to understand the bankruptcy laws. Once bankruptcy becomes a probability, it is probably too late to legally reposition your assets to maximize the amount of your net worth that survives bankruptcy. Again knowledge of how bankruptcy works helps you both if you have to declare it as well as if you are trying to buy a distressed property.
Although many schemes are sold as asset protection, bankruptcy planning is the only one with solid legal basis. All the others are weaselly and may get you into trouble and/or penetrated by creditors.
Best wishes, Jack Reed
$29.95, 164 pages, 8 1/2 x 11 paperback book