BUD BREWER
One Man's Opinion
Buying at Discount “The Short Sale”
June 3,2010: Good investment strategies always call for some cash reserves. In todays real estate markets, those who have cash reserves and are willing to take some unusual risk, the “short sale” offerings in more modest priced neighborhoods could make it possible for those who are looking to buy a home to live in or for investment to make a good relative value purchase. A short sale is a real estate transaction in which the price for a property is below the total amount of morgage loans that exist on it. It is a process by which the lender takes control of the property in cooperation with the legal owner to sell it, usuallly well below the value of the mortgage(s). In some regions, short sales are by far the majority of transactions that are being done in the current real estate market. This is much like 1994-5 when it was common to find properties “under water” due to the recession and the fact that many homeowners had loans taken out during the super high interest period of the early “Eighties”. One case in point was Budor’s purchase of a condominium in Newport Beach in 1995. The property was purchased on a “short sale” for $435k using a personal guaranteed $180k mortgage loan. The existing loans on the Condo totaled $575k so the property must have cost the prior owner $650k or thereabouts. After a $100k remodel and 12 years of net lease income of $24,000+ per year Budor sold the property for $1.3M at the peak of the bubble. Of course we didn’t know it was the top but the demand for Newport real estate was causing some pretty high prices so we elected to take advantage of it. The result was that Budor experienced a solid return on equity over the eleven years of ownership. The key was that the property fit the location, location, location pre-requisite and was purchased for a reasonable replacement cost or 60% of its last sale price. When this criteria fits a real estate property (or stock prices for that matter), it is always worth while having some cash reserve in order to be able to take advantage of any investment selling at a distressed price or where the current fair market value has strayed significantly away from its mean price trend. You want to stick your toe in the water when someone is forced to take big discounts on what they want to sell. In this market nobody is anxious to buy because they are not confident where this Administration is leading the economy. There is plenty to be concerned about regarding the future consequences from fiscal policies of this government, but mortgage rates are artificially low and if the offering prices of a property fit the rental value providing 6-8% cash flow on market value then with a 50% mortgage (reasonable but conservative leverage) an investor could expect to experience an annual cash return of 8-10% on equity even after property taxes and Association fees if any. I wouldn’t speculate that we will have sharp price appreciation soon especially given the probability of high debt caused inflation or currency devaluation in the foreseeable future. Housing prices may even go down in the future discounting higher interest rates, but rental values should hold pretty well, notwithstanding.
Applying the same point of view to the stock market
As I said, the same potential risk investment in stocks would be to buy British Petroleum on the theory that even after paying all the adjudicated damages for the oil spill, the residual value of BP would be worth more than the current market price. Prior to the spill, BP was priced at $60 per share paying a dividend of $3.36 for a cash yield of slightly over 5%. The company has 3.6 billion shares and earned $38.7 Billion EBIDTA in 2009. It currently is $36-7 per share and the decline since April is over $75 billion in market value. That is a pretty big loss in anticipation of damages, law suit awards, clean ups costs, etc. Last year, the company had $265 Billion revenue and a book value per share of $33.00. Now if you believe that the cost and damages attributed to the spill will severely hamper the company’s future profits of $38 billion from producing, refining and distributing oil and oil products, then the company may see its stock price continue to erode, but given their cash position of $6.8 billion, it is hard to conclude that the ability of this company to survive and recover isn’t more likely than not. I think, although clearly a risk given the politics operating, this company will not only recover but in several years will be benefitting from higher oil prices and, strangely, benefitting also from the likely restriction upon deep water drilling by our all knowing government since it will cause the company to stop exploration in this area which is currently causing negative cash flow to the company. BP is doing deep water drilling now even though they are losing money with the oil price at $70 per barrel. Like all oil companies that are successful, they continue a business plan expecting the trend for oil prices to increase to levels where current investment in deep water exploration will enable profitable production in the future.
The risks are that our populace government policies cause Congress to enact higher corporate tax rates, penalty taxes, and some sort of insurance reserve charge or fees for potential spills on all future oil revenue. Our government and most consumers don’t like the oil companies anyway so they may support some pretty drastic(stupid) legislation regarding them especially since the average person thinks oil companies profits are obscene. All these negative risks still don’t seem to justify the severe decline in the price of British Petroleum. But what do I know “I’m only the 200 pound gorilla in the room.
One Man’s Opinion -Bud Brewer
Good stuff! The real estate market is definitely a mess now. I work Colorado Springs short sales and we are a couple years behind much of the country. Things have just started dropping out here the last year or two.
I was just hunting around to prepare a similar post and stumbled upon this. Great post! As a San Mateo County short sale specialist, I also believe it is extremely important to educate a home owner about about their options. Keep up the great work!
I appreciate you taking the time to write this. I’m an agent myself and things are definitely a MESS out there right now. Good news is that prices are extremely affordable around here for a change.