“Unsystematic risk” can be defined as being the company- or industry-specific risk that is inherent in each investment.  Unsystematic risk is, for the most part, a microeconomic consideration and only applies to a company or industry, but not the overall economy as a systematic risk would.  Accordingly, unsystematic risk can be reduced by appropriate diversification of funds into different types of investments.  The easiest way an investor can minimize unsystematic risk in any investment category is to just switch to, or diversify to, different categories in which to invest.  There are no extra rewards given out for taking on unnecessary unsystematic risk so it’s best to minimize this whenever possible.  In contrast, systematic risk affects entire economies and includes macroeconomic factors, such as inflation and Gross Domestic Product (GPD), and is pretty much out of the control of individual investors.

Systematic risk tends to stay relatively constant regardless of how diverse or uniform your investment portfolio is, but unsystematic risk can be significantly reduced through proper portfolio diversification…theoretically.  In reality, we tend to put too much trust in only a few investments, or even in just one investment, to be able to significantly reduce unsystematic risk in our real estate investments.

I know you’re thinking, “Well, golly gee!  So how does this apply to real estate, Mr. Wizard?  Why should we be concerned about this thing called “unsystematic risk” when all we want to do is invest in real estate?”

Lemme tell ya why you gotta think about unsystematic risk in real estate investing, Alfalfa.  No matter what you invest in, you have to consider the unsystematic risk associated with that investment and decide if it’s still worth making that investment or not, as well as if you really need to make that investment at all with any amount of unsystematic risk.

The whole irony of this is that, even though unsystematic risk is usually easier to determine and control than systematic risk is in real estate investments, we usually get taken to the cleaners financially because we underestimate the amount of unsystematic risk in a deal by dealing with incompetent investment managers who we mistakenly trust too much, or by putting all of our financial eggs into a single basket only to find that someone has stolen our basket of eggs and is long gone by the time we realize it.  We often read in the news about billions of dollars being lost because of systematic risk factors, such as rising interest rates, but we much less often read about unsystematic risk causing financial ruin unless it’s about some guy like Bernie Madoff who stood out because of the vast amount of money that he mismanaged and stole.

What got me started on this blog post was recently reading that Donald Trump just licensed his name out to a $250 million apartment complex development in Soviet Georgia with the licensees hoping that the Trump name will bring investors running to throw money into the project.

I can’t say whether or not this will be a successful project and give its investors good returns on their money since I don’t know the details of the deal, but I do know that The Donald ain’t immune to failure and has lost a lot of investor money in projects that failed here in the Americas.  As recent examples, consider how the Trump name was licensed out to lure investors into throwing money into projects that eventually failed in Baja, Mexico and Tampa, Florida.  The investors in these “Trump projects” lost millions of dollars of their own money in these two projects while Trump actually made money with them by licensing his name out to them.  I seriously doubt that The Donald pulled a Madoff and spent the money on unrelated luxuries via Ponzi Schemes, but I’m sure he didn’t lose any money in these failed projects, either, unlike the investors who mortgaged their homes, raided their kids’ college funds, and scraped up money anywhere else they could so that they could invest in “Trump projects that were sure to make a lot of money for them”.  I don’t care whose name is on these development deals, they’re still huge risks no matter how you look at it and they deserve especially careful scrutiny when performing your due diligence on them.  Granted, there were systematic risk factors, like falling demand and a faltering economy, that doomed the Trump projects to failure, but even with a real estate mogul like him supporting the deals, the projects couldn’t be saved and unsystematic risk reared its hoary head in the form of project and fiscal mismanagement once the project managers realized that maybe the Trump projects weren’t such great ideas after all.

There are subclasses of real estate investing that have different amounts of unsystematic risk associated with each subclass.  Real estate development typically carries the highest amount of unsystematic risk of all the real estate subcategories just by its nature of first requiring obscene amounts of capital to develop and build something, and then by hoping that your market studies are accurate and that your project will meet or exceed the investment returns that you anticipated and told to your investors to get them to ante up the financing for it.  Now let’s compound that industry-specific unsystematic risk with the possibility of incompetent project managers running a development and you don’t just get an additive effect that further increases unsystematic risk, but rather one that increases unsystematic risk exponentially, kinda like how corporate managers like to use the term “synergy” to describe exponentially increased benefits resulting from the combination of individual resources, except that, unlike the intended corporate meaning of “synergy” to be for the greater good, the exponential compounding of unsystematic risk is a bad thing, not a good one.

There are many disguises that unsystematic risk can assume.  As investors, especially as private equity investors, we have to be wary of them and perform enough due diligence so as not to get sucker punched by having an investment that has been portrayed as a high-flying eagle suddenly turn into a turkey once we buy into it.  One of the many disguises that seems to fool unwary investors, including me, is one in which investment sponsors liberally drop names left and right of credible people and organizations with the implication that they are “good buddies” with them and that they work with them regularly.  The idea behind this is for the investment managers to give themselves credibility and to make you believe that their supposed competence greatly reduces the amount of unsystematic risk in any investments that they are trying to sell you on by giving the appearance of being associated with a reputable entity.  Be careful of this as it comes dangerously close to the same kind of affinity fraud that Bernie Madoff used to scam billions of dollars from his victims when he targeted Jewish investors at his synagogue and in his social circles.  By our very nature as human beings, we tend to believe that there is safety in numbers so we follow the masses, even if it’s off the edge of a cliff like lemmings.

A well-respected real estate investor and educator in Virginia (I leave out his name since he may not wish to be associated with this blog post) emailed me a link to an article in which two well-known self-directed Individual Retirement Account (IRA) custodians are being sued by investors who claim that they lost money because those IRA custodians let them put their retirement funds into scams.  While I sympathize with the investors who lost retirement money, this is the nature of self-directed IRA’s in that the custodians of these accounts can only do what they are told to do by the account owners.  When you choose to use a self-directed IRA custodian, you are taking on the responsibility of doing your own due diligence on any investments you make with your retirement funds, including determination of the amount of unsystematic risk in each investment that you consider.  I use self-directed IRA’s to invest in real estate quite often and am very familiar with both of the IRA custodians named in the article as well as their standard operating procedures.  I know that they sometimes allow themselves to be marketed by real estate investors seeking to raise private capital to increase their market shares of the self-directed IRA markets.  But as evidenced by the lawsuit against them, this marketing strategy can backfire and give them more headaches than business.

The above being said, I’d like to tell of an incident that occurred over two years ago in which one of the IRA custodians being sued, Entrust Group Inc., was marketed by an investment sponsor, Copper River Funding, LLC, on a series of webinars.  I’d never heard of Copper River Funding but they seemed to be affiliated with, and endorsed by, the Entrust Group which I had heard of and am well familiar with their services.  Indeed, after I watched one of the webinars in which Copper River Funding was trying to solicit private funds for investing in commercial real estate, I got a phone call from a representative for Copper River Funding (I’ll leave his name out of this blog post…for now) who gave me a great sales pitch on why I should put money with them to buy commercial real estate nationwide.  He said that Copper River Funding was partnering with Entrust (which seemed to give them credibility by partnering with a well-established company like Entrust) and that they were very experienced with commercial real estate.

Two big red flags came up about Copper River Funding, one of them during my phone call with the Copper River representative.  During our call, this Copper River Funding representative told me that they use Zillow to determine commercial property values when I asked how they determine property values nationwide.  For those of you who are not familiar with Zillow, it is an online service typically used to determine property values for residential properties, not for commercial ones, and even then it’s not very accurate in my experience.  This was the first red flag about Copper River Funding.

The second red flag was when I called Entrust after hanging up with the Copper River guy and asked them how long they’d been partnering with Copper River Funding.  The Entrust representative told me that they don’t partner with or endorse anyone but merely offer self-directed IRA custodial services to those who wish to self-direct their IRA investments.  At that point, I made up my mind to avoid Copper River Funding as well as most other private investment sponsors with whom I had little or no knowledge about.

Copper River Funding is still around and soliciting private funds.  Perhaps they’ve improved from the times when they used Zillow to try and determine commercial property values or maybe they’re flying under the radar of the Securities Exchange Commission (SEC) and just haven’t been caught yet.  Regardless, placing funds with them would incur too much unsystematic risk for my taste.

Raising private money for investing has become quite popular and is even being taught by a growing number of people who claim to have done so themselves.

As mentioned in a previous blog post, I just wish that there was a way to not only teach how to raise private capital but how to properly manage it as well.  I know of several local real estate investors who lost millions of dollars in private money because they were great at convincing private lenders to fund their deals but lousy at managing the money and the deals.  The unsystematic risk in their deals went unmentioned in their sales pitches to secure this private capital which often came from people who knew very little about real estate.

Especially with private equity investments, perhaps the most important thing to keep in mind as a potential private equity investor is the amount of unsystematic risk in any deal in which you are considering participating, especially since unnecessary unsystematic risk can often be avoided with proper due diligence and some independent thinking.

I needed material for a new blog post but have lately had very little to write about other than real estate complaints regarding a dishonest Realtor in my local markets named Mason Barrett who sells houses in North Augusta, South Carolina; Augusta, Georgia; Evans, Georgia; Martinez, Georgia; and Hephzibah, Georgia (basically in the CSRA – Central Savannah River Area).

I have a habit of mentioning specific names, both in praise and in condemnation of people with whom I’ve dealt with little thought to real estate complaints it might cause.  I always mention that these are my personal experiences with them and that you may have different experiences with them resulting in different opinions about them.  When I was a kid, I remember how people told me never to mention specific names if someone was dishonest or in any way a scumbag to you or your community since this was the job of the local newspaper and TV station to do.  I grew up hearing that credo and lived by it for many years.  Then one day it hit me that many people, including me, often learn more from the mistakes made by others than from their successes.  Well, I recently made a big mistake that I hope others can learn from and avoid making the same mistake.  It involves real estate complaints about a dishonest Realtor in my local markets named Mason Barrett.  Lemme give you some background on my beef with Mason Barrett and why I have real estate complaints about him.

Back in August of last year (2011), a fellow investor approached me to help short sale an investment property of his.  Just to clarify for those who aren’t regularly involved with real estate, a short sale in real estate is when a property is sold for less than what is owed on a mortgage loan with the blessing of its lender who agrees to discount the balance owed rather than require the seller or buyer to bring cash to the closing table.  Basically, it’s the lender taking a haircut on the loan and agreeing to take whatever money is left and run rather than try to squeeze blood from a stone-dry seller who either can’t or won’t pay off the loan.  To make my specific deal a bit more convoluted, the property owner in my deal is not the mortgagor or in any way a guarantor of the mortgage loan, but he does own the house and has every right to dispose of it as granted to him by the mortgagor/guarantor (and original owner who deeded it to this investor with full disclosures given to all parties).  This investor has no real estate complaints against him as far as I know.

Prior to my real estate complaints about Mason Barrett, I was looking for a good Realtor in the area who is familiar with short sales to help me with this.  I don’t focus just on short sales in my business but I keep up to date on them to avoid legal problems with the ones that I do take on, especially now in an economic environment where our government is paying very close attention to short sales since dishonest investors have made investors look bad by ripping people off.  It’s bad investors who ruin things for those of us who stay true to the laws.  Likewise, its dishonest Realtors like Mason Barrett who give investors like me good reasons for valid real estate complaints and who make all Realtors look bad.

When I do take on a short sale as an investor, I typically buy the property just long enough to resell to someone else and hold on to it with my own funds for anywhere from a few minutes to as long as three months, whatever is required to resell the property without real estate complaints.  But lenders who are considering releasing their liens at discounts often have problems letting investors buy properties by discounting their loans and then making profits by reselling them quickly and most of them require that the properties first be listed with Realtors for a period of time before letting them be sold via short sales.  In fact, there have been investors and Realtors who went to prison for mortgage fraud for not following proper procedures to make this kind of short sale investing legal.  As of the time of this blog post,  a key to making this kind of property flip legal is to have the Realtors list the properties with the short sale investors, not the owners/mortgagors.  This way, a Realtor’s fiduciary duty (responsibility) is to the short sale investor, not the owner/mortgagor/lender so, by law, they don’t have to disclose anything to anyone except to their clients, i.e., the short sale investors.  This one little change minimizes real estate complaints.

Getting back to what caused my real estate complaints about Mason Barrett, this guy knew my short sale model from the start but now claims that he doesn’t understand it and used this feigned ignorance to steal the deal from me.  This short sale started back in August of 2011, got stalled, and recently started back up again when the lender waived a bunch of the requirements that stalled this deal.  Mason Barrett is an experienced Realtor but pretended to have taken a stupid pill by claiming not to know the difference between a client and a customer, which is taught in basic Real Estate 101, i.e., the very first licensing course (I know this since I went through the licensing requirements as well).  Mason Barrett’s feigned ignorance of basic real estate law adds to my real estate complaints about him.

The owner gave me contractual authority to market his property any way I see fit so as to avoid real estate complaints from anyone so I brought Mason Barrett on board as my short sale Realtor who would list the property with me, not with the property owner.  Mason Barrett knew this up front, he knew my short sale model, and he listed the property with me back in August 2011 with full knowledge of why he was doing that even though I was not yet the property owner.  My phone conversation on August 18, 2011 with Mason Barrett prior to my real estate complaints about him can be heard by clicking the link below.  This shows that he was well aware that he was listing the property with me and that I was also the buyer for it:

http://soundcloud.com/aesir-2/august-18-2011-thursday

When the short sale stalled, I set aside the file as did Mason.  But now that the lender has requested that this house be put back on the market, Mason Barrett went around me directly to the owner with claims that he doesn’t understand my plan.  Our last phone conversation on April 26, 2012 goes something like this…oh heck, it’s easier if you just listen to it yourself by clicking the link below and you’ll see why I have real estate complaints about this guy:

http://soundcloud.com/aesir-2/april-26-2012-thursday-mason

From the April 26 phone call, in which I blanked out specific names except for mine and Mason’s, you can hear Mason Barrett playing dumb and asking the same questions repeatedly to stall for time to think of how he is going to weasel out of his moral responsibility to me.  To add to my real estate complaints about him, at the end of the call, Mason said he would set up a conference call between us and his Broker-in-Charge for Friday, April 27, but he never did and instead just sent me the following email late on April 30:

—

Monday, April 30, 2012 11:27 PM

FROM: Mason Barrett <csrahomes@gmail.com>

TO: Bob Kim <rkim777@yahoo.com>

I spoke with our Broker, Kathy, and she said we couldn’t list with you until you
owned it. You can still make an offer and/or I could pay you a referral fee if
your license is active. Mason

Sent from my iPhone

—

An interesting thing about this situation is that I recently spoke with yet another investor in the area from whom Mason Barrett tried to steal a deal as well.  I’ve known this investor for several years and yet my hubris prevented me from contacting him to ask about Mason Barrett before ever getting him involved.  Had I called this investor and my other contacts in the area, I’d have found out that Mason Barrett is well known for stealing deals from investors and I never would have used him or had these real estate complaints.  But live and learn.  I won’t make that mistake with anyone ever again.  I’m not a psychology expert but one thing I do know about human behavior is that how we do anything is how we do everything.  Translation: If Mason Barrett will rip off established real estate investors, I predict that he would readily scam those who wish to buy homes for themselves and their families in which to live, if he hasn’t already done so (in my humble opinion), as well as rip off other real estate agents.

It’s interesting how Realtors claim that they have higher ethical standards than just real estate agents who are not Realtors (I blogged my opinion about this a while back).  Yet, Mason Barrett is a Realtor and he just stole a deal from me after I gave it to him as a listing to work on with me.  Does this strike anyone else as being a bit strange given that Realtors spend so much money advertising how much more ethical they are than non-Realtors?  Or are my real estate complaints about Mason Barrett invalid?  For those of you who believe that I’m not being ethical by putting Mason Barrett’s name out there, I’m just following the laws governing full disclosure regarding real estate by pointing out as a material fact that you take your chances when dealing with a Realtor like Mason Barrett, especially as an investor.

Whether you are someone who wants to buy a house in which to live or an investor who wants to make money from it, be sure to perform thorough due diligence to avoid dishonest Realtors like Mason Barrett and to avoid having your own real estate complaints about these weasels.

Earlier this week, I was watching a rerun of “Piers Morgan Tonight” on CNN with my Mom who, with my Dad, was visiting from out of state to make sure I didn’t kill myself with my own cooking.  I don’t watch a lot of TV, much less Piers Morgan or any of the other talking heads out there who don’t just objectively report the news, but that night he had Suze Orman on as a guest and they were discussing the economic outlook 2012 as well as fielding questions from the studio and online audiences.

I don’t know much about Suze other than from the massive publicity she gets as being one of the most famous experts on personal finance.  Until watching her on Piers’s show, I’d only read, and believed, that she was the Richard Simmons of personal finance, i.e., just a rah-rah motivational cheerleader and little else.  But my respect for her jumped exponentially after watching her answer questions thrown at her by Piers and the audience.  What really caught my ear was her opinion on the economic outlook 2012.

Piers asked Suze about the economic outlook 2012 and I just figured that she would give some wishy-washy, noncommittal answer so that she could sell her books and other information products to anyone by not creating any controversy with anyone else about their opinions of the economic outlook 2012.  She was surprisingly candid (surprising to me but probably not to anyone who watches and listens to her regularly) and elaborated on facts, not just on the opinions of other financial “experts”.  She mentioned that, while the stock market is at its pre-2007 recession highs, the so-far stellar performance of the stock market doesn’t mean that our economy is any healthier.  Unemployment is still high, banks are not lending like they did prior to 2007, and foreclosures are still at all-time highs.  I was wondering if I’d been wrong about my own opinion of the economic outlook 2012 being as gloomy as it had been for 2011, but it’s a slight comfort that at least one financial guru appears to validate my opinion that the economic outlook 2012 is one that we, as investors, should be wary of so as not to get caught in the same trap of burying too much money into languishing investments as many of us did prior to 2007, including me.

Several recent news clips and articles seemed to indicate that the economic outlook 2012 is getting better.  Our stock markets are, indeed, near their all-time, pre-recession highs again and are even being called  bull markets now, jobs seem to be coming back, and at least some commercial lenders appear to be loosening their grips on the purse strings to start lending again.

Our federal government is even contemplating the forgiveness of student loans, a previously-untouchable obligation to our government that can’t even be shrugged off in bankruptcy, to relieve new college graduates of their crushing debts incurred from attending their chosen schools to learn new skills with the belief that these new grads could use the forgiven funds to start new businesses and put other investments into our economy.  As a former college student, myself, as well as being someone who deals with people in distressed financial situations, regularly, at all economic levels in society, I can assure you that the overwhelming majority of new college grads would not use forgiven student loan money responsibly and invest in our floundering economy, but would use it to buy big-screen TV’s, go on vacations, and otherwise treat it like free lottery winnings with which to splurge on themselves and on others.  I can assure you that forgiving student loans will not help our economic outlook 2012.  Our federal and state governments are still struggling with their finances and still have to deal with shortfalls in funds for providing such critical services as mail delivery, law enforcement, and we will yet again have to deal with another possible shutdown of our federal government as the previous vote to raise the federal debt ceiling to prevent a shutdown accomplished nothing other than to increase our country’s debt levels.  We have, in effect, “kicked the can down the road” just so we can deal with it later instead of now.  We need to make money by creating marketable value and reselling that value to international markets, not just domestic ones.  By forgiving student loans, not only will our government be throwing away money but we will also just create an entitlement mentality in these new grads, much in the same way that our welfare system and other broken entitlement programs don’t create productive citizens as intended but, instead, create generations of people dependent on government largess to sustain them.

Now even the real estate “gurus” are back out saying how now is the best time to buy real estate, their courses and coaching programs will show you how to buy now since the real estate markets have now bottomed out and can’t go any lower, blah, blah, blah…  I believe that, after a brief uptick in consumer and investor confidence, the economic outlook 2012 will get worse quickly.

I can’t say whether it really is the best time to buy real estate or not since this all depends on the prices and terms you are able to negotiate for anything you buy.  If you buy at the right price and terms, you can get a great real estate investment no matter what the economy is doing, but woe is you if you think that the economic outlook 2012 is all peaches and cream and that we’re no longer in a recession.  I have a hypothesis that the real estate “gurus” are hyping up this economy as being great for finding “amazing real estate deals” now just to sell their courses and events to unwary buyers of such information as well as to build buyers lists of suckers to whom they can flip their overpriced properties with little or no risk to themselves.  Just remember that the words, “caveat emptor”, are especially meaningful in this uncertain economic outlook 2012.

If you are buying real estate, I’d like to suggest that you buy as if we are still in the 2007-2009 recession and not blindly trust anyone trying to get you to chase increasing prices that are likely caused by others who are gambling that the real estate markets have hit bottom and are on the way back up…because they ain’t on the way back up, not by a long shot.  As mentioned in a previous blog post, one of the best indicators of the health of our real estate markets, from a real estate investor’s perspective, is a checkup on whether or not banks are lending again, especially in the residential markets.

Since the banks aren’t lending nearly as freely as they did prior to 2007, you have to factor in a greatly reduced buyers pool to whom you can flip your properties.  Investor confidence is up…for now.

Build your own buyers lists so that YOU don’t get stuck with unwanted properties, and don’t get taken by surprise when the economic outlook 2012 takes a turn for the worse.

Have you ever been kicked in the head for following really bad advice from someone, especially really bad real estate advice?

First, as an apology in advance, this blog is not meant for my personal rants but after observing some webinars and teleseminars in which the hosts are trying to sell pathetically bad real estate advice, I can’t help but put this out as a warning to those who might fall into the same trap of purchasing worthless real estate advice like me and many others who didn’t know any better at the time we bought it.  The last truly personal rant I had on this blog involved Realtors and their ethics.

In the past month and a half, I’ve had the (dis)pleasure of listening to teleseminars and webinars in which some self-proclaimed real estate “guru” was trying to sell worthless real estate advice to unwitting investors and, worse yet, to distressed homeowners just to make a fast dollar.  In many states, it is now illegal to sell “loan modification services” or “foreclosure services” by taking up-front fees from distressed property owners.  So how do the fake “gurus” get away with taking money up front for this?  They do it by selling worthless, but expensive, real estate advice in the form of seminars and courses, not as services.  Lemme explain a bit more here and why I’m putting this rant out on this blog.

On January 9, 2012, a friend of mine got an email from one of these fake “gurus” trying to sell him bad real estate advice.  Part of this email, verbatim, goes like this:

*** START bad real estate advice email***

“Foreclosure investing as we know it is changing. This Wednesday, January 11, at 8pm ET/5pm PT, I’m holding a special call to explain what’s going on and what it means for investors.

Register now at https://www2.gotomeeting.com/register/362828354

The courts are finally recognizing that the banks have been illegally foreclosing on people for years.

“We conclude that this is a question of great public importance, as many, many mortgage foreclosures appear tainted with suspect documents.”

The attorney general has officially petitioned the court to take action in a move to “protect the people of the state from such invalid and unlawful practices.”

What does this mean for us? It means we’ve got to change the way we’re doing business.

Register now at https://www2.gotomeeting.com/register/362828354

We’ve now got a way to force the banks to negotiate on our terms!

Not only that, but we have a chance to make serious profits while helping people stay in their homes.

Quiet Title Actions are the future of real estate investing.

There have been huge developments all across the country as more and more courts are forcing banks to work with homeowners.

***This is NOT a sales webinar. This is an educational call, and we’re going to be answering your questions live***”

*** END bad real estate advice email ***

While it’s disturbing enough that such worthless information is being propagated by fake “gurus” like this guy to investors who want to make honest money, it’s even worse that this worthless real estate advice is being marketed to people, like my friend, who happen to be in foreclosure with their primary residences.  My friend has no money left and was trying to get a $1600 loan from his parents to attend a 3-day seminar by this scammer who is selling worthless real estate advice on this very webinar despite his email saying that “This is NOT a sales webinar”.  If you don’t believe me, I’ve uploaded a brief audio clip of this scammer for you to hear in his own words on how he is marketing worthless real estate advice.  Listen or download by clicking here –> Bad real estate advice audio clip #1.

The gist on this bad real estate advice is that you can pay about $1000 (discounted from the original $1600 if you buy via his webinar) to go to this guy’s event (one was already held on January 27-29, 2012 in Orlando, Florida and I’m sure more will be forthcoming) to learn how to buy heavily-discounted houses, if you are an investor, or to save your own home from foreclosure, if you are a distressed homeowner, by using a quiet title action to pressure the banks into doing what you want them to do, i.e., wipe out the mortgage loans or at least heavily discount them.  Bad real estate advice, really bad real estate advice.  Here’s why.

In layman’s words on this real estate advice, coming from me who happens to be a layman, a “quiet title action” is just having an attorney file paperwork to put in the public records on a piece of real estate that anyone having a claim to that real estate must either come forward within a certain period of time or forever lose any claim to that piece of real estate.  I know this because I had to have a quiet title done on a property I bought that had been inherited by the seller and it was uncertain as to how many of the seller’s relatives still had claim to that property.  I needed to have clean and marketable title on that real estate in order to flip it and the quiet title action  accomplished this by wiping off any claims from other possible heirs to the property.

So how do the scam “gurus” try to sell us their real estate advice to use quiet title in order to erase mortgage liens from a property?  They try to convince us, through a bunch of convoluted wording meant to confuse us, that the banks didn’t loan any money at all and that a quiet title action will expose this so that we can either get the house free and clear of the mortgage loans or, at least, at heavy discounts from the loan balances.  If you don’t believe me or just want to be amused by the attempts to baffle us with bull$hit, listen or download by clicking here –> Bad real estate advice audio clip #2.

The real estate advice given by fake “guru” #2 is that, since the banks never loaned money to us to begin with, they have no right to foreclose to get the property if we default on mortgage loan payments.

Let’s see how he thinks this works and how he wants us to think it works as well so we will give him money to show us more (he is trying to get people to cough up almost $8000 in advance for his bogus real estate advice).  Let’s take an example where you (BORROWER) borrow money to buy real estate and the original lender (LENDER #1) gives you money to pay the SELLER.  There’s a pretty good chance that LENDER #1 will sell your loan to LENDER #2 shortly after closing the deal to get cash to put into another deal.  LENDER #1, despite selling the loan, often remains as SERVICER of the loan to still collect payments on behalf of LENDER #2 and any subsequent lender who may purchase the loan down the line.  In fact, your loan may be sold and assigned to a number of lenders, let’s say all the way to LENDER #10 as shown in this example.

The “quiet title wizardry” to make the mortgage loan disappear is supposed to happen since, in many cases, one or more assignments of the loan to one of the lenders have not been properly recorded in public records to protect the ultimate note holder’s interests.  The quiet title action is supposed to wipe out this unrecorded claim to the mortgage loan since the end lender, i.e. to whom you owe the money, won’t show up in court to claim the loan interests.  Folks, filing quiet title to wipe out a mortgage loan is really bad real estate advice and here’s why.  Let’s get a reality check and see what your mortgage loan, after numerous sales and assignments to other lenders, ultimately looks like.

Just because any interests in any of the loan assignments may not have been properly recorded in the public records doesn’t mean that you don’t owe the money to someone, in this case to LENDER #10.  You still owe the money to LENDER #10 who still retains interests in the remaining balance of the mortgage loan, albeit an unprotected interest that can be usurped by anyone who publicly records an interest in the loan before LENDER #10 does.  All LENDER #10 has to do is have an attorney file a claim to the loan and all the time and money you spent to learn this bad real estate advice from real estate fakers like “Guru #1″ and “Guru #2″ go down the drain and you still end up losing your property to foreclosure!

As a real estate investor, I am trained to seek out properties from very motivated sellers, including distressed homeowners.  The difference between investors like me and information sellers disguised as real estate experts like “Gurus #1 and #2″ is that, unlike them, I don’t take up-front fees from distressed homeowners.  I only get paid after finding and implementing fully-disclosed solutions that are satisfactory to all parties involved, including distressed homeowners.  I don’t collect fees for dispensing bad real estate advice to desperate people trying to save their homes like “Gurus #1 and #2″ do.  I get paid only after buying and then selling real estate.

After reviewing the email from my friend in foreclosure and watching some of the webinars put out by these fake “gurus”, I summarized the basis of this bad real estate advice to him so he won’t be spending any money on scams like this.  Oh, I have no doubt that somewhere in this country someone did actually use quiet title to wipe out a mortgage loan, but I’m quite confident that this is an extreme rarity with odds overwhelmingly in favor of this use of quiet title failing to wipe out the loan or even allow for negotiation of any significant discounts from loan balances.

In summary, be wary of unproven people who try to give you real estate advice, especially if they are trying to make money by selling it to you.

As of the date of this post, I count 21 separate “gurus” trying to sell me their techniques for obtaining private money with claims that banks are no longer lending in this tough economy.  If you doubt that this many “gurus” even exist to sell information on obtaining private money, I gladly give you the initials of each one, not the full names, though, since some of them are actually legitimate gurus who I respect but just wish that they’d teach a bit more on what I’m ranting about, i.e., the pure risk associated with private money.  The aforementioned “gurus” (their initials only) include, in no particular order: AG, AC, DL, LE, SL, PR, JS, JB, TM, LA, RO, RL, JM, GA, BL, RS, LB, PG, ET, JO, and DL (a different DL than the first one listed here).  I’ve attended the private money events of four of them (AC, DL, PR, and JB) and all of them lack a critical topic, in my opinion…the topic of being responsible borrowers of private money.  In other words, there is very little in these courses and events that teach private money borrowers about minimizing the pure risk associated with private lending.  To those who borrow private money, myself included, we gotta ask ourselves: What investments are we putting our private lenders into and do the potential rewards to our lenders justify the risk, especially the pure risk, to their money?

What is meant by pure risk?  Let me give a few definitions as I see it.  A private lender can be pretty much anyone you know who has money to lend, whether that person is sophisticated about money or not.  Pure risk has nothing to do with potential rewards but only has to do with getting back the invested money.  Put another way, pure risk is not about “winning” but is just about “not losing”.  While people most often associate the financial term, ROI, as meaning “Return ON Investment”, there is a second ROI that many people often forget about…”Return OF Investment”, i.e., the pure risk associated with an investment.

When you attend a private money event by one of these gurus, you learn how to sell private lenders on investing in your deals and how to legally protect yourself from getting in trouble with the law if something goes wrong with your deal.  But you learn very little on how to minimize the pure risk in your deal or even sufficiently letting the private lender know about the pure risk to the money placed with you.  The best analogy I can give is that these gurus who teach how to get private money are often placing loaded guns into the hands of children since, from what I’ve seen, many of these private money event attendees can’t even responsibly manage their own money, much less the money of any private lenders willing to trust them enough to place money with them.

I can give two specific case studies in my markets where the trust of private lenders was abused by their borrowers and all of the private money was lost in bad deals.  The first one involved a residential property investor who lost about $3.7 million of private lender money by using this money to typically pay off junior liens on residential properties so that she could buy the properties “subject to” the senior lien(s) remaining attached to the properties.  The second one involved a commercial property investor who lost an undetermined amount of money on bad commercial deals such as trying to convert a war-zone apartment complex into condominiums.  I have personal experience with this commercial property investor as he tried to get me to put $160,000 into this deal that he eventually lost to foreclosure, but fortunately I backed out of the deal after doing a background check on him and finding out that most of his commercial deals at the time, as well as his reputation, were pretty much el-stinkeroo, leaving some other sucker to take the fall in my place.  In each case, the pure risk of these “investments” was not adequately explained to the private lenders who trusted the borrowers with their money or else these lenders probably would not have put their money at risk with them.  Both of these investors appeared to prey on whoever had money whether their marks knew much about money or not.  In my own experience with the condo conversion genius, I was never asked to ascertain whether or not I was an accredited (experienced) investor and I was only told how great my return on investment would be by investing in his failed condo conversion project, never about the pure risk associated with it.  In both cases, millions of dollars of private money were lost to foreclosure because the pure risk was way too high and based on the private money being placed into severely over-leveraged properties just to get the deals rather than safeguard the private lenders’ interests by properly mitigating the pure risk associated with each deal.

When I first really dug into real estate and private equity investing back in 2005, I listened almost solely to what the private money “gurus” taught and put some private lenders into some bad deals as well because these “gurus” didn’t teach me enough about mitigating pure risk with proper deal management.  Fortunately (for the lenders, not me), I was able to use my own money to buy them out of these deals but lost quite a bit of my own money by doing so.  I didn’t fully understand the pure risk and responsibility associated with borrowing private money back then like I do now.  The saving grace is that I put them into relatively small deals and was hesitant on borrowing too much private money until I fully understood how to responsibly manage it and the pure risk associated with each private investment.  These days, I am very picky when choosing an investment and do whatever I can to minimize the pure risk to the money of my private lenders as well as to my own money.  For example, a relatively recent deal into which I put my own money has an estimated loan-to-value of less than 60% which should minimize the pure risk to my money.  This is supposed to be a passive investment for me so I’m waiting to see how the borrower does with the money before lending him any more even though he’s asked to borrow more.  I have no desire to manage any deals that he messes up and I’m sure a lot of of other private lenders have the same mentality.

One thing I truly believe is to place my own money into each deal in which I have private lenders.  This is called “putting skin into the game”.  I believe that it is important to put my own skin into any game in which I have private lenders involved so if there is a loss, especially because I underestimated the pure risk involved, then I also lose.  Too many “gurus” teach private money courses that tell borrowers how not to put any of their own money into deals but also to actually collect “acquisition fees” at closing and get paid a lot of money just for putting the deals together.  In some cases, these “acquisition fees” can range in the millions of dollars that the private money borrower actually walks away with at closing.  When private money borrowers walk away with none of their own money at risk, and even get paid by putting their lenders at risk, there is no incentive for these borrowers to stay in the deal and properly manage it.  There is a local investor in my area named Carl (I referred to him as “Hal the earthworm” in a previous blog post but will use his real name here) who doesn’t know what he’s doing but is reasonably good at selling people on his deals no matter how bad they are.  Carl and I went to some of the same events that teach how to get private money to fund our deals and, in my opinion, he is one of those who abuses the responsibilities placed in him by private lenders by first and foremost trying to collect large “acquisition fees” at closing rather than considering how he will responsibly manage the deal that he places private lenders into.  My personal experience with Carl is that he once put $13,000 of my own money at risk with very little concern about the pure risk to my funds.  I no longer return his calls and won’t do any business with him since this would be a waste of my time and subject my money to more unmitigated pure risk.  In a nutshell, I think the guy’s an idiot.  Remember: You invest with idiots at your peril.

The first private money event I attended had me believing that if you find a good deal, then finding private lenders to fund the deal is no problem.  Now I know better after seeing private money placed into bad deals with high pure risk because of the borrowers being able to sell themselves and not the deals.  Private lenders generally invest in the borrowers, not the deals.  Case in point, Bernie Madoff was able to steal money from many private investors ranging from the very sophisticated to those not so knowledgeable about money because they blindly trusted him and not the deals he supposedly put them into.  Turns out that Bernie didn’t put his investors into any deals at all but spent the money living the high life.  Same with Donald Trump, an experienced developer, who lost millions of private dollars in deals that went bad in Mexico and Tampa because people believed in him more than the deals into which he put them.  I have no doubt that The Donald didn’t steal the money like Madoff did, but I’ll bet he had none of his own money at risk and probably even got paid for putting people into bad deals with unconscionably high pure risk associated with them (think “acquisition fees” as well as other fees paid to him such as those for using his name on these projects to help sell them to private investors).  The civil laws in this country are very weak, in my opinion, so the chances of private lenders getting money back from deals that went bad with their money in them are pretty much slim to none.  Private investments are not subject to the same scrutiny that publicly-marketed ones, like stocks on the New York Stock Exchange, are so the likelihood of getting money back from bad private investments is often much less than that with publicly-marketed ones, especially in the case of investment mismanagement.

For those who borrow private money or not, I’d like to throw a few possible deals your way.  Just be sure to especially minimize the pure risk to your money and to the money of those who place their trust in you.

If you get nothing more from this post, look beyond what the private money “gurus” teach and always keep in mind the importance of minimizing the pure risk to the private money that you borrow.

With interest rates on money markets at historical lows, uncertainty in our faltering economy, and steady increases in the cost of living, now might be a good time to look at alternative investments offered by established investment managers and investment syndication sponsors but just beware that the rate of return formula that you think you know might not put the amount of money back into your pocket that you expect when all is said and done.

Have you ever spoken to someone who presented you with an investment opportunity and gave you a projected return on your investment that seemed to be a much better one than what you could get in a bank money market or certificate of deposit (CD)?  If so, did you ask what rate of return formula was used to determine that projected return on your money?  Okay, so what do I mean by asking for this rate of return formula?  There can be a different rate of return formula used for investment returns on the same investment.  All are perfectly valid as far as fiscal definitions are concerned but some may be more more suitable for what you want your money to do while others may be completely inappropriate.  In the words of one of my favorite entertainers, “Lemme do some ‘splainin’, Lucy.”

When I was a kid, I had a savings account at the local bank into which I’d deposit money from my newspaper delivery route or from cutting grass and I was told that my deposited money would grow at a certain interest rate.  It was never explained to me what rate of return formula was used to figure out how much my money would grow so I assumed that there was only one rate of return formula that was used by everybody in the whole wide world.  Silly me. Now I know better after having been given a comparable interest rate by a friend, who borrowed money from me, and getting back a lot less than what I expected.  You see, the bank paid me compound interest on my money while my friend paid me only simple interest on it.  Both are valid returns, it’s just that one rate of return formula is different from the other.

Fast forwarding to 2006 when I really started to dig into real estate and other private equity investing, I recall watching sponsors of private investment syndications pitch their investment opportunities and trumpet out to those of us in the peanut gallery that our projected annual cash-on-cash returns would be over 12% while we held the investments and, after resale of our investments five years later, our final annualized total returns on our money would be at least 20% at a time when bank CD’s were yielding around 3% to 5% annually.  Compared to such low bank returns, 20% seemed to be a great return on my money.  Around then, a good index mutual fund, like the S&P 500 Index fund that is managed by several of the large mutual fund companies, was yielding double-digit returns as well since the S&P 500 Index was steaming along at a 15.8% annual growth rate in 2006, with lower risks than those associated with private investments.  Investment risk is a subject that I’ll save for another blog post but for now just be aware that private equity investments aren’t subject to the same kind of regulatory scrutiny that publicly traded investments such as stocks and bonds are.  When you start tinkering with private investments, you must pay special attention to whoever you are investing with and do your own due diligence on the sponsors of these investments as well as on the rate of return formula they are using to project returns on your money.

In geek speak, the technical rate of return formula for internal rate of return can be described as being the “annualized effective compounded return rate” or “rate of return” that makes the net present value of all cash flows from a particular investment equal to zero while calculation of the annualized total return does not require that the net present value be equal to zero.  The best analogy I can think of is comparing the growth of money at a compounded rate of return versus a simple rate of return.  The amount of money accruing at a lower compound interest rate can easily equal or exceed the amount that accrues at a higher simple interest rate since the rate of return formula allows for compound interest to accrue based on both principal and past interest but simple interest only accounts for money growth based on the principal amount alone.

Perhaps the simplest way I can explain how the rate of return formula can vary from investment to investment is by giving an example.  Let’s take a hypothetical apartment complex that costs $10 million to acquire and that has an annual net operating income of $850,000.  Let’s also assume that the mortgage loan on it is $8 million amortized over 30 years at a 6% annual interest rate and that rents increase by 3% each year while expenses increase by 2% each year.  While I can do the calculations manually to figure out investment returns by plugging the numbers into each relevant rate of return formula, let me take a shortcut by using an investment property analyzer that we developed for our own use (the full version which we now sell).  As a side note, we give away a free version of this investment property analyzer to those of you who opt in to receive our occasional emails.  Let’s see what the numbers tell us about this hypothetical apartment complex investment.

As can be seen above, our hypothetical apartment investment, upon sale of the investment after five years, yields us a 20% total annualized return but only a 16.7% internal rate of return, all just because of a difference in the rate of return formula used for each one.  So which one is correct?  Answer: They are both correct.  You, as the one putting money into the investment, must determine which rate of return formula will satisfy your financial wishes.

Annualized total return will always be higher than the internal rate of return on the same investment so investment sponsors often use annualized total returns to sell their investments to less savvy investors while using internal rate of return when presenting to more seasoned ones who might be insulted if presented with projected annualized returns.  Just be careful which rate of return formula is being used so you truly get what you expect to get without any disappointments later.

Another thing about annualized total return versus internal rate of return and how the rate of return formula differs between them can be seen if we graph the performance of our hypothetical apartment investment (performance graphs can be plotted with the full version of our software).

The cash-on-cash and total annualized returns will increase indefinitely with time as long as investment fundamentals remain unchanged but internal rate of return performance levels off after some time passes which tells us that no investment should be held indefinitely if you want to maximize the potential investment returns that you can get with your money if the fundamentals remain unchanged for that particular investment.  While both kinds of returns are valid, the difference is all in which rate of return formula is used to calculate each one.

Now that we’ve cleared up how the rate of the return formula can affect how much money you can expect to receive from an investment, I’d like to throw some more potential commercial deals to my fellow vultures to join me at the trough as we feast on the carrion of floundering commercial investments.

In summary, a very important part of financial due diligence is knowing what rate of return formula is being used to make projections so be sure to watch out for this and you’ll avoid disappointments as far as the numbers are concerned.

Given the gridlock that we have in our government about what to do and after observing almost a full year of fiscal mismanagement, I think it’s safe to say that our economy ain’t getting healthy any time real soon and that any real estate market forecast I make will be equally gloomy.  Our federal government has almost shut down at least twice this year for lack of money, city governments are being forced to drastically cut their budgets to the point of shutting down vital services such as public safety, and even our once-invulnerable Postal Service is on the verge of having to declare bankruptcy.  “Neither snow nor rain nor heat nor gloom of night stays these couriers from the swift completion of their appointed rounds” but lack of funding can apparently accomplish what Mother Nature can’t by shutting down our post offices.  I tell ya, it’s enough to make a guy go postal.  As for our true unemployment rates, not the ones put out by our federal government via the media…well…

Even though I originally meant for this post to give a commercial real estate market forecast, I may end up slipping in a thing or two about the residential side of things to give a similar but much briefer real estate market forecast regarding this as well.  Commercial and residential real estate are hopelessly tied together so to comment on one without the other would be like trying to ride a bicycle with only one wheel.  It can be done but not without a lot of stumbling and fumbling.

In my previous blog post, I mentioned how our media praised the decrease in unemployment and said how this is an indication that our economy is improving.  I call bullsh%$.  In this previous post, I also mentioned that the bottom lines are the net revenues that a government can take in, not how low that unemployment rates can be driven.  Of course, revenues and employment rates are tied together but how can a person making the federal minimum wage of $7.25 help as much, financially, as a person who is making $1000 an hour?  To make any realistic real estate market forecast, both metrics really  should be considered but somehow weighted to reflect the differences in pay.  For example, even though our unemployment rate supposedly decreased to its lowest level in more than two years, according to our  media, the net worth of American households drastically decreased by $2.4 trillion this past quarter.  This tells me that maybe people are finally finding employment, but they are getting paid a lot less for those jobs than prior to the most recent recession.  As a result, there is a decrease in net revenues to them and to our governments.  This, surely, affects any real estate market forecast since this adversely affects not only the abilities of people to pay for things to keep money in circulation but, perhaps more importantly, this adversely affects the confidence in their own abilities to pay for things so they understandably hoard money instead of let it circulate as is done in healthy economies.

But even though a newspaper as venerable as The New York Times ran a story proclaiming that the unemployment rate decreased to 8.6%, I disagree with its assertion that it appears that the American economy is improving.  I think that this economy will continue to stagnate for at least another five years so my real estate market forecast will closely parallel this belief.  For example, even though employers supposedly added 120,000 net jobs to their rosters in November, this falls well below the monthly average of 132,000 net jobs for November.  Again I’ll mention that even if jobs were added, they are likely to be lower-paying jobs than in previous years resulting in lower net revenues and, accordingly, lower disposable incomes.

Perhaps the most difficult things to account for in a real estate market forecast are consumer confidence and investor confidence, both very important factors in determining the status of the economy.  For example, let’s take an extreme example and assume that the unemployment rate is 0% and that each person gets paid $1000 an hour but nobody spends any money to buy goods or services because of lack of confidence in the economy.  It makes very little difference if people can’t pay for anything or if they just won’t pay for anything, the money remains tied up rather than flowing so the economy stagnates.  Let’s add on top of this the gridlock in our federal government caused by disagreements in where to raise taxes and cut budgets, and now investor confidence decreases which ties up investor money as well as consumer money.  Anyone still think that any real estate market forecast is going to be anything but gloomy?

So how is investor confidence looking these days?  I think that cap rate is a pretty good indicator.  If investor confidence and expectations never change then I believe that, theoretically, the cap rate shouldn’t change either since purchase price would be adjusted to account for change in net operating income and we would all live happily ever after.  But in reality, most investors will want higher returns for what they perceive to be higher risks and will settle for lower returns when they think that risks are lower.  Let’s take a look at what’s happening now and use it to make a realistic real estate market forecast.

Cap rates have generally decreased from their peaks around the beginning of 2010.  This tells me that investor confidence is on the rise.  That doesn’t mean that our economy is getting any healthier.  It just means that investors are willing to pay more for the same asset class performances than they were two years ago and that they perceive the risks of investing in those assets classes to be lower than they were two years ago.  But do investors know best what’s happening in our economy?  Not necessarily.  Anyone can be an “investor” if they have something that is perceived as being an asset to someone else, especially if it’s money.  Let’s take a look at what I see and apply it to my real estate market forecast.

As can be seen above, commercial mortgage-backed securities (CMBS) have the highest default rate of any commercial mortgage loan type.  A real estate market forecast will factor this in and point us in the direction of CMBS mortgage loans as possibly being good deals to pick up and I’m not the only one who thinks that CMBS defaults are soon going to rise drastically.  Trepp and Morningstar, both of whom specialize in CMBS defaults, think that the CMBS markets are in for some serious financial pain as well.

I have a hypothesis for that high CMBS default rate.  CMBS mortgages are often securitized and sold on the secondary markets to investors who have faith in their investment advisors selling them on these with an often overly-optimistic real estate market forecast.  I’m not saying that all investment advisors are scumbags but think “Bernie Madoff” and the amount of trust that people put into him.  Investment advisors are essentially salespeople who are educated about securities laws and definitions.  As with all salespeople, the more they sell, the more they make.  Not to say that all of them purposely sold lemons to their clients for investment vehicles by putting them into CMBS mortgages but let’s face it, the compensation structures of how these licensed salespeople make their money are such that they get paid while their clients are the ones who take all the risks.  Now I know some very competent and honest investment advisors but in the end, nobody will care more about your money than YOU.

So now that that we’ve identified CMBS defaults as possibly good hunting for finding deals, what else is there?  How about matured and maturing mortgage loans?  Could these be good game animals to take home to our dinner tables?  In a previous blog post, I gave references to sources that indicated that record numbers of commercial mortgage loans are set to mature within the next four or five years.  How will the lender handle these maturing loans, especially now that many commercial properties are worth less than what are owed on them?  What, pray tell, will a real estate market forecast tell us here?  Well, let’s see what a recent survey of commercial real estate lenders tells us.

Note that while most of the surveyed lenders, almost 54% of them, would rather modify and extend these matured/maturing mortgage loans, this only tells us what they want to do, not what they can do because of lack of equity caused by declines in property values.  Hey, when I was a kid, I wanted a pony but never got one.  I’d put into any real estate market forecast that more lenders than what is indicated by this survey will end up having to sell off their loans in order to satisfy regulatory requirements and remain solvent.

So, as is tradition with my blog posts, I’d like to put out a few possible deals that show up on my radar for the note-buying vultures who might want to hunt down matured and maturing commercial mortgage loans.  But just beware that my real estate market forecast includes an economy that will continue to deteriorate in the face of our federal government’s budget problems and inability to properly balance a checkbook.  I suggest that you factor at least an additional 5% increase in vacancy rates, on average, into your offer prices.

As with any real estate market forecast, mine is just an opinion so take my real estate market forecast and any others with a grain of salt and use some common sense.

As we approach the end of the year, there was a recent announcement by the major media outlets that the unemployment rate 2011 took an unexpected, but welcome, dip to its lowest level in two and a half years from about 9%, where it had been for most of the year, down to 8.6%.  This news is based on a recent story by The New York Times, a well-respected and widely-circulated newspaper.  Also, in that same story, the opening sentence states, verbatim, that “Somehow the American economy appears to be getting better, even as the rest of the world is looking worse.”

Y’know, in the words of a friend of mine back home, “I may be dumb but I ain’t stupid”.  I don’t buy that this small dip in the unemployment rate 2011 is a sign that our economy is getting better or that commercial finance is getting any easier.  Not by a long shot.  Despite the downtick in the unemployment rate 2011, Bank of America and other big players in the lending game plan on laying off tens of thousands of employees within the next few years, the European debt crisis is still out of control, and we still have gridlock in our government regarding the unsolved budget issues that regularly threaten a government shutdown as our politicians maneuver for political positioning going into the 2012 election year.  As a side note, there has always been an uneasy friendship between our politicians and the media.  Our politicos need the media to portray them in a good light so that they can have job security and, in return, the media needs cutting-edge information from our elected officials so that they can sell this information to us, John Q. Public, and stay in business and have job security, themselves.  It’s just as well that I don’t watch TV because of all the misinformation and economic sleight-of-hand that’s constantly tossed out at us, especially with the unemployment rate 2011.

Let’s get back to a bit more of an in-depth look into how our government determines the unemployment rate 2011 and its effects on commercial finance.  The unemployment rate 2011 has been a significant concern and is a statistic that has been placed before us many times.  Indeed, this has yielded supporting data for trying to determine the health of our economy for this year and lender sentiment regarding the finance of real estate and businesses.  But just how important has the unemployment rate 2011 been in determining the health of our economy this past year?  I think that people placed too much emphasis on this one metric and not enough on other information.  I’m not an economist by any stretch of the imagination but I do know how to balance a checkbook.  All it takes to balance any checkbook is a solid mastery of 5th-grade math, i.e., basic addition and subtraction.  If we look back to just a year ago, online news sources trumpeted how unemployment claims had dropped to their lowest levels since 2008 with the not-so-subtle implications that things were looking up and that our economy was on its way to a slow, but steady, recovery.  Gee, that’s funny.  I haven’t seen much change since then.  This reminds me of a quote that has been attributed to former President Herbert Hoover who supposedly told businessmen in the middle of The Great Depression in 1932 that “Prosperity is just around the corner” when, in reality, the only things just around the corner for another 10 years were people selling apples and pencils.

If we look at how the unemployment rate 2011 is determined by our federal government, maybe you will see the same flaws in the data collection techniques that I see.  Let’s forget for now that, in terms of just pure numbers, a person who is employed and being paid the federal minimum wage of $7.25 an hour carries just as much weight, statistically, as an attorney or medical doctor who typically gets paid $200 an hour and higher for their time in determining the unemployment rate 2011 which renders such numbers as being almost completely useless for determining the overall health of our economy.

When determining the unemployment rate 2011, a nationwide survey of 60,000 households, which is approximately 110,000 people, was done to represent our entire country of over 300,000,000 people.  Now I know that basic statistics tell us that this is valid since a sample size of 110,000 people is supposed to be large enough to represent a normal statistical distribution from which reliable results can be interpreted, but somehow dis here theoretical, egghead stuff just don’ make no sense to dis country boy.  C’mon, there are college football stadiums that can hold 110,000 people.  How can a sample size of people, who can all cheer at once and in one location for Michigan to beat Ohio State, possibly give a reliable indication of the true unemployment rate 2011?  The answer is that it can’t.  Not only can there be significant errors in choosing sample households that truly represent our entire country’s population, sometimes the surveyed people can be incorrect by being knowingly or unknowingly dishonest.  Remember when the media used statistics on a limited population to erroneously predict and proclaim that Thomas Dewey defeated Harry Truman in the 1948 Presidential election?

Other flaws in the methodology for determining the unemployment rate 2011 include how our government determines who is employed and who is unemployed.  For example, there is an official employment category called “unpaid family workers” which includes any person who worked without pay for 15 hours or more per week in a family-owned enterprise operated by someone in their household.  This could be little Jimmy or Susie who work for mom and dad by taking out the garbage and doing other “home business” chores each morning before getting on the bus to go to school.  Now I’m not against having kids learn the value of hard work, especially when it contributes to the good of the family, but I deem such a classification of “employment” to be irrelevant in trying to determine where our economy is going and this classification shouldn’t be used in determining the unemployment rate 2011.

The unemployment rate 2011 can be helpful in determining the health of our economy and the status of commercial finance.  But the bottom line is always going to be what is the income versus the outgo, i.e., what are the net incomes to our government and to us as citizens.  The unemployment rate 2011 should be put into its proper perspective as ancillary data and not heralded on the front pages of all the major newspapers.  I recently read in the December 12/19, 2011 issue of Jet Magazine on page 14 that at least six cities (Cincinnati, Ohio; Topeka, Kansas; Highland Park, Michigan; New Rochelle, New York; and Camden, New Jersey) have drastically cut vital services, such as police and  other public safety, since they just don’t have the money to sustain them.  Even if these cities had 0% unemployment but all the jobs were of the minimum wage kind, I seriously doubt that the tax revenues could sustain the services necessary to keep their populations safe and secure, much less finance necessary commercial projects to jump start their own local economies.  This is why the recent unemployment rate 2011, as much publicity as it received, isn’t much more than a footnote in my mind.

Now that I’ve done a bit of complaining about how misleading the unemployment rate 2011 can be, I believe that for every complaint we put out, we should always counteract it with at least one possible solution to whatever ails us.  Ergo, I’d like to put out one or two possible solutions for thought.  Insomuch as our government is concerned, just looking at revenues and expenses should tell us all we need to know.  For example, a previous blog post of mine showed that the Obama Administration spends much more than it brings in.  Simple math tells me that just ain’t gonna work.  A quick look at our governments’ finances and a little math tells me that we’re still in a recession, even though the recession supposedly ended in 2009.  Since there is some lag time from when our federal government acts to when the effects of those actions are felt by us at the local level, my crystal ball tells me to factor in a deteriorating economy for major purchases in the commercial real estate arena, especially those that depend on the government to finance any portion of these acquisitions.

So what would I do to determine local economic conditions and how it affects my ability to get a lender to finance my real estate acquisitions?  What esoteric charts and data tables would I recommend looking at to see how the economy will affect real estate and business finance?  I say none.  Just pick up the phone and stay in regular contact with your lenders.  Be careful with this one now.  A mortgage broker is not typically a direct lender so if you call a mortgage broker, you may or may not be getting the most up-to-date information since the mortgage broker may be giving you outdated information, especially if they haven’t originated any loans recently (ask me how I know this).  It’s best if you can call the direct lenders and ask them what programs they still offer to finance your projects.  Back in 2007, I was considering the acquisition of some residential properties with the main exit strategy being to rehab them and then flip them for a profit.  A friend of mine, Scott Lane, who is the co-founder of our local real estate investment association in Columbia, South Carolina, the Capitol City Real Estate Investors, told me to be careful since his lenders told him that they were no longer offering certain loan programs.  I foolishly disregarded what Scott said and am now stuck with a few properties that I don’t want.  The moral to this story is to lead with the financing.  First find out who will finance your acquisitions and on what terms, and then make offers based on what you know that your lenders will finance.  Please note that nowhere in this paragraph, other than now, did I mention the importance of the unemployment rate 2011 or any other widely-heralded government data.

As is customary with my blog posts, I’d like to put out a few leads presently on my radar for anyone to work and maybe to pick up a good deal or two:

In a nutshell, I don’t find much of a correlation between the overall unemployment rate 2011 and commercial finance unless there is a large portion of unemployment being contributed by commercial lenders so don’t let that statistic, alone, determine your view of the economy.

Mezzanine debt to finance commercial real estate is not secured by the real estate but is debt that is secured by the assets of the entity owning the real estate. 

A previous blog post on mezzanine debt may help clarify this concept for those who don’t typically work with commercial financing.  Mezzanine debt can be like a double-edged sword.  If used improperly, it can result in large risks to the borrower(s) since it is usually subordinate financing that can be relatively easily wiped out in the event of borrower defaults.

Mezzanine debt can be very risky when it is used to obtain subordinated financing in high leverage situations.  Let’s take a look at the Extended Stay Hotels debt stack, again, from the previously-referenced blog post above.  Total financing in the amount of $7.4 billion was used to purchase this 680-hotel chain with $3.3 billion of this being mezzanine debt secured by interests in the entities having claims to the underlying real estate.  When the owners and debtors inevitably defaulted on the loans, tranche warfare erupted between the many creditors to recover as much money as possible for themselves.  Bottom line is that the owners paid wayyyy too much for this hotel chain and used highly-leveraged mezzanine loans to fill in the missing pieces of their financing puzzle.  When the dust cleared and a new buyer purchased the troubled chain at a steep discount, almost $5 billion of debt was wiped out which included all of the mezzanine debt and a good portion of the actual mortgage debt.  So who lost out?  Private equity investors and smaller banks who invested in the smaller chunks of mezzanine debt since the primary mortgage financing required was too large for them to buy into.  Since the mezzanine debt had no direct attachment to the actual real estate, it was relatively easy to wipe it clean from the real estate to deleverage the properties sufficiently enough to allow another buyer to step in and purchase the chain.

Mezzanine debt can also be very rewarding when used properly.  While conservative investors may want to steer clear of mezzanine debt investments, this type of subordinated financing can be a very powerful and rewarding way to finance real estate, especially for value-add deals that conventional lenders might not lend much on such as extensive repositioning and conversion projects like condo conversions.  Of course, any subordinated financing like mezzanine debt will typically demand higher possible rewards due to the increased risk associated with them.  If the rewards justify the risks, then mezzanine debt can be good investments provided that extensive due diligence is done.  For example, typical senior commercial mortgage liens these days might have an interest rate charged to the borrowers of 6% to 8% annually.  These senior liens are the most protected in that they usually have first claim to getting money back in the event of borrower defaults.  An exception to this senior lien protection is if the borrowers declare bankruptcy in which case the bankruptcy judge determines who gets paid first and how much.  Mezzanine debt typically carries higher interest rates on account of the increased risk taken by these subordinate lenders.  The interest rates for mezzanine debt these days is often in the range of 10% to 15% annually.  As long as the intercreditor agreements and property values are favorable to the junior lenders, mezzanine debt can also be reasonably safe.  Mezzanine debt has often been used by small-to-medium sized investors to lend money so they can get into the lending game without having to put up the really big money usually put up by senior mortgage lenders.  But there is a special case where even the big, senior lenders will invest in mezzanine debt.  That is the case in which a discount of the overall debt is warranted and it is desirable that junior liens be wiped out and foreclosure be done quickly.

In non-judicial foreclosure states like Georgia and Texas, purchasing mezzanine debt to hasten a foreclosure action is often unnecessary since foreclosures in these states occur quickly anyway, sometimes as quickly as 20 days after the Notice of Default has been issued and recorded.  However, in states that have judicial foreclosures such as in my home state of South Carolina, foreclosures can be long and expensive processes that can be drawn out for several years before they are completed, especially with today’s ever-increasing backlog of properties undergoing foreclosure and those about to go into foreclosure.  This is when it is a good idea to purchase not only the senior mortgage note but also the first mezzanine loan at the very least.  In fact, it may be better for the existing senior mortgage lender to purchase the first mezzanine loan to hasten the foreclosure process.  The reason for this is that foreclosing on  mezzanine debt is a non-judicial process since it is not secured by real estate.  By purchasing the first mezzanine position, other liens junior to this debt can easily be wiped out and the property quickly foreclosed on in a non-judicial action, even in the states with judicial real estate foreclosures.

I’m sure you’re thinking, “Golly gee, all this trivia is fine and dandy but how will it help us find deals, Mr. Wizard?”  Well, I’d been looking for primarily for discounted first-position commercial notes to purchase but we can also now consider buying the mezzanine debt just above the first-position lien to be able to foreclose quickly on the property owners, if necessary, in South Carolina and other judicial foreclosure states.  For senior mortgage lenders, this is a defensive tactic to best protect their interests.  For opportunity seekers, i.e., us vultures, this can be a highly lucrative tactic to be able to quickly take a property away from its owners and flip to end buyers, or to keep for ourselves.  Just be forewarned that any tactics that we can use on others can also be used on us if we aren’t careful.

In keeping with my traditional posting style, I’d like to throw some carrion out for my fellow vultures.  Some possible deals that show up on my radar as of the time of this post are below if you should choose to chase after them.

Mezzanine debt can be a great investment vehicle as long as we understand its potential upsides and downsides.

For sure, REIT funds have been top performers this year.  For example, the self-storage sector posted a 22.96% gain for the first eight months of the year while the multifamily asset class had a 19.72% return during this same period.  Much better than the paltry 0.5% to 2.5% returns you might get if you had your money in money markets or CDs (certificates of deposit) these days.  It’s very tempting to say “the heck with being conservative, I want some of that action” when you see how REIT funds have performed.  But is this really the smart thing to do?

Let’s consider a few more things, not only about REIT funds but the overall economy as well.  The performance of REIT funds supposedly gives a look into the future of our economy according to some people such as those at the National Association of Realtors (NAR).  But do they really? The NAR implies that our economy is recovering because REIT funds are doing well but I’ll politely disagree with these experts.  I’m not an economist and only involved in real estate in the private equity arena so I won’t claim to be an expert at economics or in real estate, but the one thing I’ve learned after taking some losses from listening to such “experts” is that nobody will manage your money better than YOU.  I view real estate as an investment vehicle, nothing more.  I’ll put my money in any legal venture that has good upside profit potential (I do own shares of a publicly-traded marijuana company but more so because I want stock certificates with the company’s name on it, not because I expect to get a good return from this “investment”).

While it’s true that interest rates are at historical lows, this is mainly because our federal government has promised to keep them artificially low until the middle of 2013 in order to help boost the recovery of our economy.  In the typical scenario, low interest rates should spur on a flurry of home buying and refinances but this has not been the case. Mortgage loan applications actually DECREASED 4.9 percent and refinancing activity DECREASED 6.3 percent despite interest rates being so low.  While true statisticians and other theorists may be offended, I think that a recent screenshot of my Facebook page showing a flurry of replies to a simple question about refinancing asked by a prominent real estate broker in Florida pretty much tells us what’s really going on.  As further support for this informal Facebook market study, the decreases in mortgage loan and refinancing activity aren’t mainly because of people being unwilling to take advantage of such low rates, it is more because of their inability to do so.  To add to the relatively localized issues of just real estate markets, true financial professionals who play with money for a living seem to believe that another recession is in the making (not that I’m convinced that the last one in 2007 ever truly ended).  Somehow, I don’t think that the performances of REIT funds accurately reflect reality.

As much flack as my rants may receive, I think that the pricing of shares in REIT funds is overly subjective.  There are, indeed, equations and strict criteria that these pools of money must adhere to in order to be considered REIT funds such as the typical requirement that REIT funds annually distribute at least 90% of its taxable income in dividends to its shareholders, yada, yada, …  But in the whole scheme of things, the directors of REIT funds end up determining share prices based on a combination of net asset value (NAV) and the investor demand for those shares.  After all, why put a price on something that is so high that it won’t sell?  There is a saying that states “Nothing happens until someone sells something” and this is 100 percent true, so the directors of REIT funds can’t be blamed for overpricing fund shares.  Just be wary of salesmen, i.e., brokers who sell shares of REIT funds with overly optimistic claims since they have usually only have the best of intentions…for themselves, not for YOU.

Most of my previous verbiage has been directed at publicly-traded REIT funds where there is enough risk in the present economy, in my opinion, to justify any demands for huge returns.  But there are also private REIT funds where the risk is increased even more since they are not as regulated by our government and are more subject to little annoyances in life such as fraud and misrepresentation.  Pooling private money via syndication seems to be very popular these days and there is a plethora of boot camps, courses, and seminars out there now teaching people how to form these syndications to buy real estate.  But be forewarned that, when all’s said and done, any private real estate deal into which you place your hard-earned money is only as good as the person running the deal.  I have personal experience with this as I’ve been persuaded to put money into real estate deals that went bad by some good salesmen and I was the one left holding the bag by having to deal with them when things started to go downhill, not the people who sold me on those deals with promises of how everything would be “push button” and “hassle free” for me.  In a previous blog post, I mentioned some ways to avoid inadvertently falling into deals with such idiots who would put you at risk in a deal without having any risk in it themselves. I gave a real-life example about a local investor in my hometown named Carl, uh, I mean “Hal” who wanted his own private REIT funds with which to buy real estate and get huge “acquisition fees” up front upon closing more like a broker rather than as the “expert” who is supposed to be running the deals.  He almost burned me and I have a sneaking suspicion that he’s burned other people by now.  It all boils down to this: any deal is only as good as the person running it.  Never forget that and you’ll have a happy investing career.  Invest with people who are less intelligent than you at your peril.

If we step back and take a look at the bigger picture, we still have that issue with a high unemployment rate to deal with, officially 9.1 percent nationwide, with stagnant job growth that REIT funds seem to be ignoring.  I don’t believe in the “jobless recovery”.  But how can we increase employment in this country when the Internet and advances in technology make it much less expensive to hire someone overseas to do jobs that at one time could only be done by local labor such as engineering, law, and software development?  I’m aware of at least one law firm that sends much of its legal preparation work overseas via email, fax, and phone to companies in India since it is much less expensive to have workers in India do the “grunt” work rather than the more expensive attorneys and paralegals based here in the US.  I know of real estate investors who hire virtual assistants in the Philippines for $3 to $5 per hour versus virtual assistants here for a minimum of $12.62 per hour to perform the more mundane tasks such as mailings, data input, and even making phone calls to distressed sellers.  President Obama recently announced a $447 billion plan to spur job growth but, if it passes, I think most of that money will be spent in vain and it won’t fix our broken economy.

The Obama Administration is probably dealing with the most difficult economy since The Great Depression in the 1930′s and I believe that they’re trying their best, but I also think that their efforts will only put our country deeper into debt by meddling too much into private industry rather than letting free market forces naturally fix things.  There are many similarities between now and what happened back in the 1920′s and 1930′s leading up to The Great Depression.  There were programs in the 1920′s to boost home ownership with low down payments and easy-qualifying loans, rising home values, booming stock market, easy credit, etc., etc. which preceded The Great Depression which officially began after the stock market crashed in 1929.  Because of the similarities in events leading up to difficult economic times between now and back then, I can almost understand why the Obama Administration is pouring money into the economy like the Roosevelt Administration did back then to fix things.  But the big difference, as I see it, is that back then the United States was an emerging economic superpower about to lead the Industrial Revolution with job growth that was jumpstarted by World War II.  These days, we are no longer the economic power that we were back then.  We’ve been weakened by excessive wages and standards of living as compared to other countries like India and China (which is now poised to be the world’s leading economic superpower).  It would be very painful, but perhaps the best way to fix our faltering economy is to release most government control and let free market forces determine our economic recovery and subsequent growth.  Such a fix probably wouldn’t happen in my lifetime but maybe our future generations would benefit from it.  This paragraph is a long way of saying that I don’t think our economy is on its way to recovery by any stretch of the imagination and that the stellar year-to-date performances of REIT funds are just facades.  Either factor into your real estate acquisitions an economy that will deteriorate more or “keep your powder dry” for a bit longer if you want to purchase shares in REIT funds that will provide you with good returns based on solid foundations.

For those who are now bargain hunting outside of REIT funds, some possible deals that show up on my radar include:

REIT funds are fine if you truly want to invest in real estate passively but don’t be fooled into thinking that there is always little to no due diligence needed even for these.