"HOW TO” Call the Bottom - 101

    The most frequently asked questions I hear, are about calling the bottom. Let’s face it, we’ll know it was the bottom after we pass it and see it in the rear view mirror. The only way to know it is a bottom, is to see things on a clear rise up. All the multi-million dollar analysts will be writing about the bottom . . . months after the best investment opportunities have passed, so I’m going to share one of my crystal balls with you.
    I’m going to give you a peak at the most obvious one, but not all of them. That is reserved for clients. For now, I’ll give you a little “color.” Strike that. I hate that word. I cringe every time I hear it on a conference call. Color? Is that just a way to paint with a broad brush, when you don’t know what to ask? Or is that a polite way to softball the company to tell you anything they want to tell you. Just once, I want to hear Bob Toll or Ara Hovnanian respond . . . Color? Okay, teal with a splash of summer mint, trimmed with pomegranate and gold flecks. Just once.
    I’ve developed 20 tools to help me call the bottom for my clients . . . months in advance of the bottom. But the bottom will be different in different markets and regions. And yes, there is a huge difference between a “market” and a “region.” In fact, there are markets within regions. 
    I will share a few of the tools with you, but caution you to understand that it takes all 20 tools, and then it depends upon avoiding a total collapse of the US economy. With that said, even when we call the bottom, the best investments will be those that are going to take creative management. Here are 15 of the tools, in no specific order. I have used generic tags for them, but they all need further explanation to understand how I look at them, on the ground with my binoculars, versus how an Ivy Zelman might look at them while sitting in her jammies at home through her rear-view mirror.

1 - Cash Flow
2 - Demographics
3 - Uniqueness
4 - Location
5 - Inventory Analysis
6 - Rental Supply, Demand, Rents
7 - Inventory Mix
8 - Future Housing Development
9 - Future Commercial and Business

10 - Future Appreciation
11 - Local Business Environment
12 - Regional Business Environment
13 - Future Employment Review
14 - Interest Rates
15 - Alternative Investments
16 - Term of Investment
17 – 20 For Clients Only

    Before I start, let me state that investors like Ichan that were going to turn around WCI and take advantage of hidden assets, were out of touch with the basics of supply and demand . . . and the “on-the-ground” market. They were listening to idiots like Ivy Zelman, Steve Kim and the rest of the Uber-Analysts that were dead wrong. The same holds true for Wilbur Ross buying mortgages that are going to fail because housing is still out of equilibrium and he’s listening to the second tier of Uber-Goobers. We must return to the fundamentals and the basics of supply and demand . . . and on-the-ground work. All the fancy models are useless if you don’t know what to put in the model.

    So here we go with just one of the 20 Tools we have developed to call the bottom . . .

1 – Cash Flow - The most basic problem we saw with the housing bubble, was that investors were buying property for flips without regard for supply and demand. More importantly, they all thought they could cover their expenses through renting if they did not flip. In fact, every real estate agent we spoke to promised the sky when it came to rentals. I never built a single spreadsheet with positive cash flow. When I finally gave in to clients that wanted to buy real estate as an investment, I used negative cash flow models and slashed the appreciation rate to single digits, even though all markets were appreciating by 10-30% a year. I was still uncomfortable, so I looked for unique locations and unique properties. And I’m proud to say, not one of my clients lost a penny.

Vultures - To call the bottom, the most basic element is Cash Flow. Significant investment in housing will not return until it makes sense. And it does not make sense now. The big shots that followed the advice of rear-view analysts include Carl Icahn, Wilbur Ross and Morgan Stanley to name just a few. The latest to join the “I Ate A Double Bowl of Stupid for Breakfast” club is private equity firm Matlin Patterson Global Advisers. They think they see hidden assets in SPF. What can I say? Complete nonsensical idiots, but last I checked SPF was still on Ivy’s BUY list. Builders don’t need cash. They need buyers, and you can’t buy buyers. Vultures like Icahn and Ross are now sick on what they swallowed. Matlin will be just as sick, since I believe SPF has no business being in business. And the current growing gaggle of Condo Vultures will learn it the hard way as well. For all of these guys, they fail to look at Cash Flow in realistic terms for the near future or the long term, because the near term burn will kill the long term.

Bail Outs – The only bail out will be Cash Flow. All other bail out plans are meaningless. There is no possible way to put together a mortgage bail out because there is no way to determine who deserves to be bailed out, and a bail out would not return markets to normal functions. The only bail out will be when investment moves back into the markets. Until then, there will be tremendous pain that will spread like a virus through all areas of our economy. This is an inventory problem that is not going away with a bail out, unless we find a couple million immigrants from a foreign country with enough cash to buy up the excess inventory.

Stupid Money – These knuckleheads are chasing “deals” with no regard for cash flow . . . in terms of reality. Sure, they have “modeled” cash flow, but they don’t have “on-the-ground” analysis to back it up. So we start with Cash Flow. Right now there is a lot of stupid money chasing declining assets. And the stupid money is chasing with a premium. This applies to single family, multi-family, commercial, office, warehouse, and more. But let’s look at the most basic segment of the crisis . . . single family homes. (And I could just as well do this with office space, retail or any other segment of the market.) So with SF, let’s start with a median priced home of roughly $250,000 home that was selling for $400,000 two years ago. In Florida, you can rent a $250,000 home in the range of $750 - $1,250 month. Let’s use $1,000 a month. And for this example, taxes at $4,500, insurance at $1,500, maintenance/repairs at $2,500, and management at $1,500 for a rough total of $10,000 against income of $12,000. For some people, that would be a winner in the positive cash flow analysis with overall appreciation moving forward. Unfortunately, my clients don’t consider $2,000 on $250,000 acceptable in a declining market with high risk, when you can earn $5,000 on the money with no risk. I have not included closing costs or selling costs in this basic discussion. Moreover, I realize I did not use a mortgage or appreciation in this example, but I am just giving you a glimpse at how I am looking at the markets. A broad glimpse . . . like color on a conference call.

Timing – When the purchase of this $250,000 home generates a return that meets the objective of the investor, then we might be approaching the bottom. BUT . . . It depends on an analysis of the other tools. One of the most important factors, is the Term of the Investment. The investors with longer term investment periods will be the first to see the bottom . . . in their eyes. The shorter term investors face higher buying and selling expenses as a percentage of their investment, making it more difficult for them to find appropriate investments when competing with more realistic investors. The overall market will not bottom out and start to climb, until we see prices decline to levels attractive enough to sufficient numbers of “qualified” investors for the absorption of the inventory to be meaningful. I say “qualified” investors, because the stupid money is going to be bailing out voluntarily or through default. And that just feeds the problems further.

Pulling the Trigger – At the most basic analysis, one of two things must happen. One, the rent on the $250,000 home must go up. Very unlikely, as SF and MF inventory is still growing. Two, the $250,000 home must fall in price. Very likely. At $150,000, the expenses on the $250,000 home change to: taxes – $2,700, insurance - $1,200, maintenance/repairs - $2,500 and management - $1,500 = $7,900. Now we have $4,100 in gross profit on a $150,000 investment, based on the $1,000 a month rent. When we compare the 2.7% profit margin versus 0.8%, plus a projection for appreciation, rising rents and the tax benefits of depreciation we have a viable investment for many investors . . . in the current market.

Total Analysis – This was very basic, but it is a starting point. And my point is this – Bail Outs - Schmail Outs. The markets will adjust themselves, which means we are in for some terrible times. If we do use a magic Bail Out, we pay for it down the road. And when I last checked with the Bail Out Jeannie, she said the United States of America was already overextended on Bail Outs . . . and she had issued a hard-cutoff on any future Bail Outs.

Back to our example. While the 2.7% is not going to be attractive to most investors, if you add to that an appreciation rate , rising rents, and some tax benefits, you can see the light at the end of the tunnel. I used all cash, because there might not be the ability to leverage if appreciation rates remain low. However, if you pick your markets and regions, the rewards will be much greater. Overall, this analysis might be better run on multi-family or retail, but we’ve never had such an imbalance of SF to MF, so it is appropriate to run on SF.

Conclusion – Once again, this is basic and without the other 19 tools, Cash Flow is not enough. If you believe we avoid a complete economic meltdown, then we are starting to see opportunities that might be appropriate investments. Not many, but a few. Nothing on a grand scale either. The guys with the big stuff are not ready to walk away from it. In fact, there is no reason for them to walk, but that is reserved for clients. The only things that we see that make sense are some office properties, SF REOs, and a few condo and MF projects. If you’re interested in becoming a client or you want more information about the 20 tools, feel free to call me.

Ciao for now.

P.S.  If you would like to be on my Quick Notes distribution list, email me at Mike@MorganFlorida.org   You can view blog comments to my Quick Notes at - http://realestateandhousing2.blogspot.com/