Real Estate Safety Net

History has taught that smart real estate investment can provide a safety net for personal wealth

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Real Estate Safety Net

The Great Recession has taught some very hard Lessons! However, history has taught a more important one, that smart real estate investment can provide a safety net for personal wealth.

Although a little different for each individual investor, two common themes throughout the real estate mania of the last decade were timing and leverage. Loans were available for the asking: Low Down, No Down, 103% Loans, No Doc, Interest Only, Option Arms - all tailored to over encumber the investor, and in so doing, force payment of as many fees as possible to the loan originators. Higher loan amounts meant greater origination fees; more loans created increased document preparation and underwriting fees.

The loans were never meant to generate income in-house over the life of the loan; rather the loans were engineered to be sold in the secondary market, with only the servicing of the loan retained for a small monthly income. The profit was made at the closing of the loan, and the risk of default was shifted from the loan originator to nameless securitized pools of money anxious to invest in the secure AAA rated market of US Housing.

The signposts along the way flashed warning as early as 2005. Investors were replaced by speculators who bought high and sold higher. "The Greater Fool Theory" played true, with the first fool selling to a greater fool. Concepts such as return on investment were abandoned when returns evaporated and investments required monthly support. The investor fed the investment instead of vice versa. How many "investments" can a person make that require maintenance of $5,000 to $10,000 a month before the "investor" and the investment goes broke? Everyone wanted to get rich quickly, while risk and leverage were ignored.

Builders Build, Developers Develop & Speculators Speculate

The timing of such actions over the past three years has been the worst in three decades. Projects take time to create, design, fund, and build. Yet the market kept moving, and those who started late finished too late. The crescendo crashed, destroying well laid but badly timed plans. The signposts were ignored... the maniacal cycle had a short lifespan, and good builders, developers, and investors did nothing wrong other than start too late. That simple fact doomed them. The one simple adage used for centuries held true: Timing Is Everything!

The returns had evaporated and value was non-existent. The projects, investments and developments should have stopped, but money was available and builders build, developers develop and speculators speculate. The rest is history, and the clean up is still underway, but at corrective pricing. A new cycle has started and the timing is exquisite.

Although prices have risen in most markets, housing can still be purchased at prices greatly discounted from their highs and near replacement costs. Rents have declined to decade lows, but multi-family construction has virtually ceased for lack of financing resulting in the beginning of the absorption of existing supply. New home construction is well below projected demand of the one million new homes needed to keep pace with US population growth. Long-term mortgage rates are at historical lows, resulting in affordability indexes at historical highs.

The worlds' governments have added enormous liquidity to their financial systems, and although there is excess capacity around the world, global population will continue to grow from over 6 billion to exceeding 7 billion in the next 10 years. The newly empowered markets of the world will all demand cars, computers, cell phones, meat, bread, and a place to live for their citizens. The excess capacity of the last couple of years can quickly vanish, and demand for goods and services could drive prices higher everywhere! The result is the potential for inflation; not necessarily hyperinflation, but mild to more than mild inflation should grind away at purchasing power, especially as one ages. Timing is everything! It is time to build a real estate safety net!

Real Estate investments are by nature long-term, developing and maturing over years. The signposts point toward higher trending home prices. Rising population pressures development needs for higher and higher housing density, resulting in more condos and townhouses and fewer single-family homes. An unattached home with a backyard will command more of a premium in the future, as household creators will not buy their first home, but rather their first condo because of affordability.

"The goal is to create free and clear properties as quickly as possible."

I believe single-family homes should also be accumulated. Long-term mortgages with rates in the 5% range should be used to finance purchases, with leverage contained to no more than 80% loan-to-value (less is better). Rents should begin to trend higher, perhaps significantly higher. Cash flow should be used to reduce debt as quickly as possible. If rents increase 3-5% per year for 5-10 years, the resultant cash flow used to reduce the principal can reduce the debt levels so significantly that loan payoff can be shortened from 30 years to 10-15 years. The goal is to create free and clear properties as quickly as possible.

Housing rents and values will track the cost of living and provide dependable current income in any economy. Wealth and purchasing power would thus be maintained and grown. Many strategies exist to achieve a portfolio of free and clear properties to secure an individual's future. Remember, it was not the Real Estate that destroyed investors; it was the DEBT.

"... housing is having an enormous clearance sale."

Many economists believe a new cycle has started, and fewer jobs are being lost. Currently high productivity should lead to new job creation in 2010. Higher unemployment will be with us for a couple more years, and as business cycles repeat, risks are never absent. However, most shoppers will agree it is better to buy when things are on sale, and now housing is having an enormous Clearance Sale. So I suggest you check with your financial advisor, and start building your free and clear real estate safety net.


Editor's Note: Article should interest investors in Bank of America (NYSE: BAC), Freddie Mac (NYSE: FRE), Fannie Mae (NYSE: FNM), Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), Wells Fargo (NYSE: WFC), Toronto Dominion (NYSE: TD), UltraShort Real Estate ProShares (NYSE: SRS), Ultra Real Estate ProShares (NYSE: URE), ING Clarion Global Real Estate Income Fund (NYSE: IGR), Xinyuan Real Estate Co. (NYSE: XIN), Rydex Real Estate Fund H (Nasdaq: RYHRX), T. Rowe Price Real Estate Fund (Nasdaq: TRREX), Toll Brothers (NYSE: TOL), Hovnanian (NYSE: HOV), D.R. Horton (NYSE: DHI), Beazer Homes (NYSE: BZH), Lennar (NYSE: LEN), K.B. Homes (NYSE: KBH), Pulte Homes (NYSE: PHM), NVR Inc. (NYSE: NVR), Gafisa SA (NYSE: GFA), MDC Holdings (NYSE: MDC), Ryland Group (NYSE: RYL), Meritage Homes (NYSE: MTH), Brookfield Homes (NYSE: BHS), Standard Pacific (NYSE: SPF), M/I Homes (NYSE: MHO), Orleans Homebuilders (AMEX: OHB), Vanguard REIT Index ETF (NYSE: VNQ) and Avatar Holdings (Nasdaq: AVTR).

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