The point I am going to make in this post is you can use the different markets outside of Real Estate to help with timing your Real Estate transactions. Great timing can do wonders for your bottom line. I have to setup my point so read all the way through. I will put it all together at the end.

To continue my argument, (see past posts), that I believe that at the very least if you are a Real Estate investor you should have an eye on different markets outside of the Real Estate world I am going to highlight Mortgage Back Securities and what it means for the common Real Estate investor.

First lets define what a Mortgage Back Security is, or MBS. More or less a MBS is a bond sold on wall street from the big government backed firms Fannie Mae and Freddie Mac. These loans are originated by banks we all know and love. Then the banks sell these loans off to Fannie Mae, and Freddie Mac in big pools (collections of mortgages). For example (and to keep things simple), lets say Bank of America lent out 100 thousand dollars to 10 people (total of 1 million dollars). Bank of America collected a bunch of fees for putting the loan together (from the borrower), also mostly likely will get to continue to service the loan (charge more fees for the service of collecting loan payments).

Now, BofA will sell this pool of loans to Fannie Mae or Freddie Mac. So the amount of loans BofA is willing to make each week/month/year is almost a factor of how willing Freddie and Fannie are willing to buy the loans.

Once the pool of loans are sold and out of the bank’s hands, Fannie and Freddie then bundle the loans up into bigger pools and sells them off on Wall Street as bonds. So when you make your home mortgage payment you send the money to your bank, then the bank send your payment to Fannie and Freddie, and then Fannie an Freddie sends your payment to the owner of the bond. You can learn way more about this process at Wikipedia.

Why should you understand all this?

It is one big chain of influencers; The seller, the buyer (borrower), the bank, Fannie/Freddie, and the bond holder. Each phase of this chain relays on entity below it. So lets look at each phase.

• Bond holder
  • The bond holder, often a big time money manager, has the job of gaining the biggest profit he can based on the investing principals of the fund. So there are times when MBS’ really are an attractive investment relative to other options. If some other area with the same risk profile is starting to heat up and return more profit than MBS then the money manager is going to purchase this other asset. Lets say the dividends of stable blue chip companies are starting to increase then a money manager might buy stock in those companies instead of a MBS.
• Fannie Mae / Freddie Mac
  • These guys are in the business of selling MBS to the money managers on wall street. If the money managers are in big demand for MBS they are selling tons of these things. If the money managers are interested in other asset classes these guys are not selling as many MBS.
• Banks
  • Since banks sell many of their loans to Fannie and Freddie they can only lend out as many loans as Fannie and Freddie are willing to buy.
• Home Seller (you)
  • You have two things you are worrying about, finding a buyer and finding that buyer at your price.
• Home Buyer
  • All you care about is purchasing the home you want and being able to get the loan for that home.

Putting all this into context

Through the chain explained above the Real Estate demand is a factor of how willing a money manager is to buy a MBS. The more demand for MBS the more loans banks are willing to give. Further more the more standards the banks are going to have to be flexible on to keep selling loans to meet the money manager’s demand. So the price I can sell my house for is in an odd sort of way determined by money managers on wall street.

Why is it important for me to follow all this? Lets use an example to explain. I purchased a house and am renting it out. Some day I want to kick the tenants out and remodel it and then sell it for a profit. The remodel is going to take 6 months. If I look at the wall street markets as a whole and see some hot sector starting to get everyone’s attention (ie, the tech boom in the 90′s) I might guess the demand for MBS’ will go down because these money managers will be investing in what is hot. So from look at other markets I notice this and I realize that maybe home prices might not grow as fast in the near future (or even worst go down) because MBS’ might not be in demand in 6 months. Meaning there will be less buyers able to get loans when I am done with the remodel and ready to sell.

Lets give another example. Lets say I notice blue chip stock prices are starting to raise, (make dividend decrease in yield). That is a sign, (I am only giving example not sure or not), that maybe new money entering the market might be more interested in MBS’s because relative to blue chip stocks MBS’ are more attractive. I might decide it is time to do the remodel and get my house on the market because there is going to be more buyers with more money to spend making real estate go up.

I believe you have to pay attention to this stuff to help with your timing of Real Estate transactions. Timing does have a big affect on bottom lines when it comes to Real Estate.

Wise investors can spot a downturn coming, such as the one in late 2007. No one really knows how bad a downturn is really going to be, but a wise investor should know when to shift from capital appreciation mode to capital protection mode. Below are the things you can do to protect your stock and real estate assets in a downturn.

Protecting Your Stock Portfolio

• Sell your stock: If you think we are going to have a down turn, sell your stock holdings and return to cash until there is more clarity about what is happening in the economy.
• Hedge you portfolio: Add some short positions to protect against declines.
• Buy options: Unlike Real Estate it is very easy to purchase an insurance policy against a decline in your stock value. This is called a put option. For a small fee you can purchase a put option that will protect against a decline in your stock holdings.

Protecting Your Real Estate

• Sell: First thing you can do is put your property on the market. You have to make sure you have enough equity to pay the selling costs and you have to make sure you can find a buyer. If you are scared enough to sell your property there most likely are not many buyers out there.
• Lock In Your Tenants: Get rid of the risky tenants, and replace them with good tenants, (the ones with good stable jobs), on longer term leases.
• Start Building A Reserve Fund: When owning Real Estate you need to be doing this anyway but you should start adding more to the reserves to help cover longer periods of loss rent.

When a downturn is coming, within seconds I can protect my stock assets, and within weeks (and maybe not at all) I can protect my Real Estate assets. One thing I am not mentioning here is a down turn in the stock market can be hard and fast, while a down turn in a real estate market will be slower giving you more time. What I am saying here, is use the different strengths to protect your net worth to the fullest.

I will close this posting off with a personal example. In late January 2007, I realized (through indicators in the stock market, not the Real Estate market), that the world was about ready to slow right down. I quickly moved my stock holdings to cash, and began some hedging. I also put much of my Real Estate on the market. Within seconds I protected my stock asset class, and began the process of protecting my Real Estate assets. The bad news was I was unable to sell my Real Estate. After sometime, my properties dropped in value below my loan amounts which meant I could not sell the property, without doing a short sale (where the bank agrees to take less to settle your loan). You might say you had tenants so who cares, and the tenants were paying the mortgage. While this was true in some cases but what really happened was it became increasingly harder to find tenants. My vacancy rates were raising and rents began to drop. Within 8 months of the economy going upside down, I was left with Real Estate I could not sell because the value dropped below my loan value, and they were not cash flow positive because rents had gone down and vacancy rates increased.

In this real example lets look at the positions my assets were in at the end of 2008. I had a Real Estate portfolio that had more debt than value, and it was cash flow negative (which means I was keeping the Real Estate bills paid with other income). Now, lets look at the stock portfolio. Since I sold all my stocks I was sitting on a pile of cash. While this cash did not increase in value throughout this time period it did not go down in value nor did it cost me anything to hold on to it. In my case I used some of the cash to keep my Real Estate afloat. Had I been 100% in Real Estate there would be a good chance I would have had to file bankruptcy because I did not have the cash from the stock sales to subsidize my Real Estate.

By paying attention to the stock market I was able to see early indicators of the economy going upside down, and I was able to protect my overall portfolio of assets far better than if I had been in all Real Estate. While the direct control of Real Estate has it clear advantages, do not discount the power of being able to liquidate your assets on a moments notice. Just having the simple ability to liquidate can outweigh the hands on nature of Real Estate.

First of all lets clear somethings up. When I say Real Estate investment I am not talking about your home, or a vacation home. Those have personal emotional aspects; you need a home to live in and you love staying at your ski condo on the weekends. I label these assets as personal property, there is a luxury element you may or may not be paying up for. I am talking about the rental property you purchase, to collect rent, or even flip.

Second thing I want to clear up, I am giving general statements and rough numbers in this blog series. With any investment there is always another side, another stat, another point of view. I get that. This is what makes markets if we all thought the same way no one would buy or sell anything. This is just one man’s view. I hope you can share you view points in the comments below.

Lastly, I am not talk to the people that do this for a living. If you are a Real Estate Developer, or a hedge fund manager you have built a business around a particular asset class. While I think every point I am going to make applies 100% to you as well you can make a business case against some of my statements and I might agree with you.

Now, that we have that stuff out of the way lets look at what it takes to buy property.

• You have to identify an area that you would like to invest in.
• You have have to set some bounds, (I can afford X, and it must produce Y in rent….).
• You have to start reviewing all the properties in the area. Might even hire a broker to show you around and give you his or her thoughts.
• Then you find a property you like and you start diving deep into it. Doing way more homework on this particular property than any other one you reviewed.
• If it passes all the tests, you buy it (often with a little help from your bank).
• Now, you start working on your thesis. Fix it up, get tenants, collect rent, whatever else.
• You keep it up until it is time to sell and take your profits. Investment over.

Now, lets take a look at what goes into a stock investment.

• You identify the sector you would like to purchase (tech, banks, retail….).
• You set your bounds (how much you want to spend, dividend, PE, and so on….).
• You start reviewing all the companies in that sector. Might even hire a broker or pay an analyst to help you.
• You pick the stock you think you might want to buy. You then go in and do tons more homework just to make sure.
• If your stock passes the test you buy it, (you can even buy on margin like you would with a real estate loan).
• Now, you watch your stock. Daily, weekly, monthly; You continue to review it to make sure your reason for buying it still holds true, and you are still collecting the dividend you purchased it for.
• When the time comes you sell it and take your profits. Investment over.

Is it just me or are those two processes nearly the same? They both have about the same set of interactions. You really need the same skill sets to purchase either a stock or an investment property. You need to understand the markets, you need to understand financials, you need to understand risk, you need to have continued management over your investment. I am going to make the case in a later blog posting that I believe you are a fool if you purchase an investment property or a stock without fully understanding the other market. I am also going to make a case that you are a fool if you do not have exposure to both asset classes in your portfolio. I don’t mean to be calling people fools but I have studied these differences to death and am an active investor in both asset classes and now I am preaching my thoughts . More to come soon!

I had to evict a tenant this week for being over 30 days past due with rent. These days people are not past due with rent because they are just unwilling to pay rent, they are past due because they truly have no money. This particular tenant truly has no where to go nor the means to go anywhere. The particular labor market this tenant works in is just dry right now. There is no work. So I am left with a very big decision to make; Do I move forward with the eviction, or continue to hold out. Part of me says it is my American duty to help out others in this slow economy, and part of me (the business man) tells me I have to do what is best for my business.

Furthermore, I also have the problem of this tenant might not have anywhere to go. I can post 72 hour notice but the tenant will not leave because they have no where to go. Leaving me with the addition hassle of having to file papers with the local court and have the tenant removed. Normally, this is the best way to go because then you would get a judgement for the amount owed as well, but if the person is not working you will not have any means to collect anyway. So whats the point?

So, I think I found a middle ground. I have done this before in better markets as well. This option really stinks because it hits my pocket book twice, but it was the best thing to do both personally and business wise. What I did was offered the tenant a settlement to pack up and leave. Hand over the keys by a certain date and time and I will relieve the tenant of all debt and give the tenant a sum of money (cash) for handing over the keys. So not only does the tenant get out of 45 days worth of rent, and fees, this tenant received a cash bonus to get lost. This will allow the tenant to start fresh with no debt (from me), and have a little money to start fresh with. I then can get in the property and quickly get it back on the market. Even in easier markets this is a good way to get a tenant out instead of going through the court system. Don’t feel trapped by the court system, it can be overwhelming, there are other ways.

On, a fresher note, we have been making great progress on RentalBooks. We are really excited about finally getting this product to market. We are are shooting for a release in May.

Just Get Off Your Butt And Start Building

Don’t Discount Anything, Learn/Do It All