[T1159]Top Ten Mortgage Lenders

In the wake of negative news after negative news stories filling page after page of print media coupled with negative outlook stories air time on radio and TV the public is found pacing the floor wondering what is going on. Fear can be a crippling emotion to many would be investors who thought nothing of buying a high priced property a year ago with little prospect of even breaking even. Everything was going to be made on the come. The savvy investor who has experienced a cycle or two now recognizes the opportunity knocking at the door. Yes, some areas will get a bigger bounce than others, BUT in the worst of the worst economically depressed areas there are deals which can make sense. There are areas where the affordability index is still good. Commercial and other income producing properties where over extension on part of developers utilized poor projection models and what if scenarios to now bring them to the cliff’s edge of financial ruin.

Per contrarian actions of the past, this class of investor gets as far away from the maddening crowds as possible. The public usually has it wrong on a consistent basis while arriving at the party late and staying too long. Whether stocks, real estate, Dot Coms or other hot and flashy investments the public investor, in far too many cases, lose. In the cases of long term investment would be the exception with regard to real estate IF they can stand to hold it. There are high inventories of foreclosures in many areas of the country with more coming. Commercial and residential properties in trouble are ripe for acquisition. Now, the Debt Service Ratios and Capitalization rates might actually make some sense IF the price is right. In most areas, the rents have been holding if not slightly appreciating. There are exceptions of course, but overall, returns are possible at the right price. Banks and mortgage lenders are compelled to dispose of real estate owner (REO) quickly. Thus with a flooded market of foreclosures (in many areas of the country) and other non-performing assets coupled with a slow real estate market situations are ripe for working something out with lenders. After all efforts to bring residential defaults current have failed and the foreclosure action has taken place the bank or mortgage lender owns the property it is here that the opportunistic contrarian may take a shot.

It is here say with a single family home the rents are imputed for a long holding period to determine the “strike price" of the deal. At this point there is no lack of properties to make contractual purchase offers on Real Estate Owned inventories. Working backwards, the contrarian investor will plug in the projected rents based on current market rents while backing out the monthly maintenance and upkeep, the hazard insurance, the taxes, professional management, a vacancy factor of 5% or more and other expenses. Like the massive tax changes that took place with depreciation schedules in 1986 large portfolio investors moved to a low to moderate leverage positions. The reason these properties became REO properties is that debt has the potential to suck the life out of value based returns versus similar investments. The same can be said in this scenario. A buy and flip strategy may work IF the acquisition price is low enough for a quick turn by strategically pricing the property say 10% to 15% below the market and has been put in reasonable or great shape. A little higher leverage could be considered in this instance, but until the market strengthens this could turn out badly. Deep discounts can cure many a risky investment.

Back to the watching paint dry method of renting and holding. It’s slow and steady and not as flashy as the buy and flip program.

As an example: Bob the “Neighborhood Contrarian" is looking at a REO owned property serviced by an out of state lender in bankruptcy. A court appointed trustee is temporarily handling the portfolio of loans, where this loan is serviced. Bob has an interest in a property that is listed by a local Realtor. Originally the home had been purchased two years prior for $250,000.00. The prior owner closed on a piggyback first and second mortgage loan with a first mortgage of 80% LTV (Loan To Value) of $200,000.00 and a 20% LTV second mortgage of $50,000.00. The first and second mortgage holders were two separate lenders. The home has been vacant for over five months and the grass gets cut periodically. A string of open houses and marketing efforts have gone for naught with zero results. Bob and his sharpened pencil begin to figure returns. The foreclosure action on part of the first mortgage holder wiped out the second mortgage holder who chose not to bid at auction. When the gavel fell at the court house sale of the foreclosure sale, the first mortgage holder was the only one left subject to real estate taxes as a superior lien.

Bob determines after careful due diligence that the market rent for this property will be $1,800/month. The taxes are currently $3,600/year or $300/month. The hazard insurance is quoted at $1,800/year or $150/month. The professional property manager’s fee will be 75% of the first month’s rent and 10% per month of the collected rents. A vacancy factor of 5% is applied to the equation. The home has four bedrooms, 2,000 square foot ranch style with two baths and a two-car garage with a pool. The pool has a security fence and child alarm system. Schools and employment and shopping centers are close by. The carpet and paint need immediate attention. The appliances need to be upgraded. The roof had been replaced five years ago. Bob figures new carpet and tile will run $6,400.00 with a total interior painting color scheme change at $3,900. New refrigerator and stove and updated microwave above the stove will run $2,800 installed. The tenant will pay all the utilities and pool and lawn maintenance and minimal repairs.

The rental agent confirmed Bob’s findings that with the upgrades the rent could command $1,800/month. Bob’s investments in the market and Certificates of Deposit were yielding a little over 6% per annum. To move quickly, Bob decides to make an
all-cash offer which can close in ten days or less. The only thing better than cash in buying a foreclosure is FAST CASH. Bob continues to sharpen his pencil. Starting with the rental amount of $1,800 less $293/month (includes initial rent up) for management, $300/taxes, $150/month insurance, maintenance and reserves budgeted at $100/month and a vacancy factor of 5% or $1,800 x 12 = $21,600 x 5% = $1,080/12 = $90/month. The total projected offsets to the rent are $933/month. Taking the gross rent of $1,800 less $933 gives a gross rental net of $867.00. If Bob demands a 8% initial return on his money (not including appreciation or tax benefits) just on the surface it would be $867 x 12 = $10,404 divided by .08 (8%) gives us $130,050.00 with no annual income tax considerations on the income stream. The upgraded carpet and tile is running $6,400 and the new paint scheme is $3,900 and the appliance upgrade of $2,800 for a total of $13,100. So taking the $130,050 less $13,100 upgrades and $2,200 for acquisition costs the penciled offer would be $116,950 or $116,000 CASH with a TEN DAY CLOSE subject only to a home inspection, termite inspection, survey and a clear title. An attorney would be advised. All figures and calculations could accompany the offer to the mortgage holder with the upgrades and improvements necessary to capture the necessary market rents. This will give decision-makers at the mortgage holder company cover in the CYA game of justifying a huge write down.

The key, Bob has found is to make several offers at bargain basement prices on properties that have an opportunity to appreciate over time with benefits of appreciation.
Dealing with highly motivated REO portfolio holders will lead to an eventual YES on the offers. If Bob chose to look at this deal on a five-year basis while assuming a 3% appreciation rate the numbers might look like this. Let’s assume the original owners overpaid and the home is really now worth $180,000 as-is. In five years $180,000 would appreciate to $208,669 or say $208,000 at the 3% rate. A real world deal, prices would be much higher than this. Here we are showing an under appreciating scenario. The land has been determined by tax assessment to be worth $50,000 leaving ($130,050-$50,000) $80,050. Let's further reduce this number by the appliances and take them over a five-year period. $80,050 less $2,800/5= $560/year. The improvement would be $80,050-$2,800=$77,250/27.5 years = $2,809.09/year in depreciation. The total depreciation would be rounded to $3,369/year including the longer-term period on the improvement and the shorter term on the appliances. If Bob is in the 25% tax bracket he would shelter $3,369 x 25% = $842.27 in taxes per year or $842.27/12= $70.19/month. This is a real worst case scenario with the deflated value, low appreciation over the five-year holding period. With an on surface cash flow of $867 plus tax savings of $70.19/month = $937.19. However, there are taxes on the annual cash flow of the property. This net amount then would be $720.44/month. Based on a 30-year mortgage with a rate of 6.5% with a principal and interest payment of /month would be a mortgage of $113,981.40 or say $113,000. This is close to the acquisition price so to avoid PMI an 80% LTV would allow for a mortgage of $116,000 x 80% = $92,800 with a payment based on a rate of 6.5% on a 30 year loan would be $586.56/month.

So Bob, after the cash all cash closing could take out cash out refinance with a low closing cost lender and gain the bulk of his cash to buy another deal. With $937.19 adjusted monthly cash flow less the new $586.56/month principal and interest payment would leave a $350.63/month cash flow with tax savings. However, now Bob would also be able to write off an interest deduction. That would be $92,800 x 6.5%= $6,032 in mortgage interest which would save additional income taxes of $6,032 x 25% = $1,508/12 = $125.67/month in projected tax savings on the mortgage interest deduction.

So how does Bob do at the end of the five-year period? Let’s say the home is now worth a measly $208,000 and Bob decides to sell it with an 8% selling cost giving an adjusted sales price of $191,360. If then the improvements are added to the basis for figuring capital gains tax that will be a point of beginning to determine returns. The acquisition cost of $116,000 plus improvements for carpet and tile, appliances (*some depreciation recapture may be required at sale) and paint for a total adjusted basis of ($116,000 + $6,400 carpet and tile + $3,900 paint + $2,800* appliances + $2,200 acquisition cost) = $131,300.00. On the surface the capital gain would be $191,360 - $131,300 = $60,060 x 15% = $9,009 capital gains tax. Overall on the full cash basis purchase with no mortgage: the $131,300 investment would give back approximately $191,360 in adjusted sales price. Then add the 60 months of net monthly income of $720.44/month x 60 months = $43,226.40 less $9,009 in capital gains for a total return of $191,360 - $131,300(acquisition) + $43,226.40 (net after tax rents) - $9,009 capital gains for a net of $. The question would be “If I could show you a way of taking $131,300 and getting the original investment back plus $94,277 over a 5 year period on an after tax basis, would that be a good deal?" Roughly, that would be a 12.27% annualized after tax return on a Internal Rate Of Return Basis. A leveraged deal with a mortgage would be more.

The whole key for Bob, or any other contrarian, is to make lots of offers based on a valued analysis. If you don’t get the deal let someone else take the hit. There is desperation in the market place and it IS a BUYER’S MARKET. The professionals tune out the bad financial news and move out of the living room and put some serious cash to work. A year ago sellers would laugh bottom feeder buyers out of town. No one is laughing now. The continued muse of desperate sellers is “Where have all the buyers gone?" They’re right here babies! The Contrarians are on the beachhead and moving in. The maddening crowd is on the sidelines wondering if it might be time to put their toe in the water. When the temperature of the water is just right, it will be too late. The deals are here and now. With all things being equal, value based investments have worked every time it’s tried.

Dale Rogers
www.brokencredit.com