Hard Money Loans: What if the Music Stops ?

Question

Like a sleepy frog in boiling water, we're all getting comfortable with the idea of rising home prices.  In some price ranges - largely caused by hedge funds and institutional and non-instutional investors buying up everything and driving up prices.    (Not a "real market" if you look at the long term)

What if other yields increase and the hedge funds / institutional guys/gals stop buying ?  Or worse, sell ?

Of course, we know that "this time it's different."   And it is, all boom markets end in a "different" type of downturn.   The next downturn will be the fourth one I've been through.

For investors, for hard money lenders, we're all in the same boat if the weather turns nasty.

The question:  If you think that "this time it's different," please share your theory as to how the market holds up, even if hedge funds, etc., pull out and all we have left to buy the houses are..........homebuyers.

The water is nice and warm right now, though.

Joffrey Long
Los Angeles, CA

Sam W. · Answer

While this gets into the soft, squishy world of trying to predict the future, in my opinion it is very important for REIs to understand the dynamics of the market and position themselves propertly...just as it is important for stock and bond investors to do the same...or  those who invest in rare coins.

First, institutional money is driving up prices in certain markets.  That is by design.  Just as with other commodities, institutions provide the environment for rapid appreciation: scarcity and demand....then they allow private investors to take it from there.  In reality, the hedge funds just jump-started the train - private investors like us are driving it by jumping on anything with 4 walls and an address.  I'm amazed when I read some posts about 20-30 bids on a property and it selling within days (hours) of it being on the market.  This isn't the hedge funds .... this is individual investors jumping on the train because they are afraid of being left behind (and the funds are loving it).

In my mind, the savvy investor positions his/her self by following the rules and not being distracted by the shiny objects.  If you are a buy and hold investor, stick to your metrics.  If you subscribe to the 50% rule (as I do) use it religiously (or the 40% rule...or 61.5% rule...or whatever works for you).  Don't feel compelled to make a bad decision because you think the train is leaving the station.  Maybe that's one ride you don't want to take.

Last thought...and this is strickly a gross over-generalization...but it seems that some areas of the country make it very difficult to employ certain strategies based on prices, the market, and completition. You might have to look other places.  Granted, some folks are so good and smart that they can make money anywhere.  But for most of us smucks, I think the less travelled road is pretty attractive right now.

Karen Margrave · Answer

Joffrey Long I asked about the hard money, because I thought maybe I missed something. As I've emailed you before, we use hard money in our business frequently.

Good buys are hard to come by in O.C., but if you're doing buy and hold there are deals to be had. What are you looking for? I assume you belong to MLS, but if there's any way I can help you, let me know.

We are working on a medical office building in Fullerton, to be built down the street from St. Jude's. I know you don't do construction loans, but if you have any HML's that do, maybe you can message me. Or.. if you know any investors looking for investment property.. but I digress :)

The upside is if you do own property here in O.C., it's a pretty good bet it's going to appreciate! What areas do you have property in?

Joffrey Long · Answer

Karen Margrave

Thanks for the question - and a good one.

The following are reasons why I titled this "Hard Money....."

First, because I hold my properties long term, and even during the downturn rents didn't drop that much, the GREATEST exposure I have to potential losses from real estate price declines is in my hard money loan portfolio.

Next, many hard money investors do not have the "long term, buy and hold, sit it out" mentality that I have in my property ownership.  They're really only in it for monthly income, and prefer not to have any excitement, such as taking property back.  If prices decline, it hits you faster when those are your (or their) goals.
Hard money borrowers/loans are more likely to make payments (or find a new buyer) when prices are stable or rising.  So, in my hard money practice, I have the issue as an investor (holding 75% of the portfolio myself or in my own pension fund) or the issue of a trust deed investment provider (25% of the trust deeds are owned by private investors.)

Flippers are largely in and out, so they will usually sell before a major shift in the market, so where a lot of the readers here are flippers, this post was more directed to the group I feel is most affected by a declining real estate market - trust deed investors.  ****

In summary, as hard money lender, or as trust deed investment providers, we have to have more of a "finger on the pulse" of the real estate downturns, as our position tends to "leverage the disaster" of a down market.

Luckily, a small group of us backed off a little (not enough) when the market was puffed this last time.

I'm really benefiting from the feedback and different viewpoints here on BP and I agree with your comments on Orange County, I own several rentals there.

HOWEVER, I'm right in the middle of trying to make another purchase there, so it would be convenient for me if the OC real estate market wasn't quite as darn healthy as it is right now.

Joffrey Long

****  Where I say that trust deed investors are more sensitive and have more risk if the market declines, that depends on many factors, and there are many arguments that could be posed to contradict that.  It really represents only the specific circumstances of the crowd I travel in.

Karen Margrave · Answer

I too have seen many cycles, but never anything like what happened this last go round. Though we hear talk of shadow inventories, so far that's all it is. As they say, all real estate is local, and we need to look at what is happening in our own backyards, and KNOW the local markets.

Here in O.C. many homes are valued in the millions, some homeowners refinanced their homes at the peak of the market; and now have homes that are under water. Those homeowners have great incomes, and can easily make their payments, but can't sell unless they take a loss, and why would they? On the other hand, there's very little inventory of homes available for sale in comparison to the buyers in the market. Our economy here is good, the unemployment rate is like 6.5%, etc.

Orange County will continue to do well, because it has so many attributes that will always be in demand (high paying jobs, education, healthcare, sports, amusement parks, entertainment, and perfect year round weather!)

I personally think OC has seen the worst of things, and prices are going to steadily increase. I don't see any bubble looming on the horizon for this area.

@Joffrey Long, What did this have to do with hard money loans as in the title?

Tevis Verrett · Answer

Gracious!

First a humbled thanks to Joffrey Long for the forward thinking to start this mindtrust.

This is the best and brightest minds of Bigger Pockets.

Thank you Sam W. and Kyle B. for discussing the wise fundamentals of our game.

I have learned from all of you, and @Ben for the WSJ synopsis.

You asked for potential safe havens and  exit strategies during the downturn.

Some off the top of my head:

Notes, performing at 10% plus (this strategy learned from Will Barnard), and non-performing at ridiculous discounts.

Buy and Hold properties in stable markets.

Hard Assets like (Gold & Silver)

Just sidelining and waiting for the mathematically solid deals (hats off to Sam)

What say you all?

To add to the knowledge base, I found a youtube video by Allan Kendall that has some prognostication value, looking backwards to predict forward:

http://www.youtube.com/watch?v=c6dtdBwQK7U

Again, this is the best and brightest use of this medium!

Tevis

Ben Skove · Answer

The WSJ had an interesting article on the front page yesterday on institutional investing in SFHs - it's a good read about their strategy. There isn't much discussion about their exit strategy, other than the claim that most are in it long-term.

As far as a downturn goes, if there's one in the medium-term I see it coming from interest rates. There's still a large shadow inventory out there, while new starts are increasing to meet the current surging demand (in some markets.) If the current surge is primarily driven by investors, increasing interest rates are going to dampen their enthusiasm for SFRs. When that surge ebbs and the market returns to being primarily homeowner driven, there's the possibility of again having a lot of inventory on the market.

So, once interest rates increase, it puts a crimp in housing and generates a negative feedback loop in the economy.

What I think (and hope) is more likely in the short- to medium-term is that the current surge will return to what's been the historical trend line - housing prices following inflation and productivity. Naturally, this depends on the economy continuing its slow, albeit unsteady, recovery. Depends on how you like those odds!

Joffrey Long If you see a downturn looming in the near future, what steps would you take to prepare?

Joffrey Long · Answer

Tevis Verrett  Thank you for the kind words - hope we'll get some good ideas from this.

Kyle B.  Thanks for your feedback.  To be sure, I'm not talking about a repeat of 08-09, as the factors that caused that to occur are a long way from occuring again.

I'm talking about a downturn specifically caused by factors other than those causing the 08 09 downturn.

Thanks again for contributing.

Kyle B. · Answer

The housing market is cyclical, so there will always be periods of expansion followed by periods of depression (and a continuous repeating cycle). The primary difference this time around was the complete lack of lending standards that led to the inability of banks to decipher (or caring to decipher) between high quailty mortgage loans and junk loans.

If yields start to go up and hedge funds/investors begin selling homes in order to chase the yields on corporate/govt bonds, then prices would fall based on supply and demand theory. However, I don't think this would create a repeat of what happend in 08-09, since this wasn't just based on supply/demand economics, but on a fundamental flaw in the system.

If or when lending standards start to sink in order to accomodate buying in a "hot" market, that is when I would see it necessary to take pause.

Tevis Verrett · Answer

Thoughtful forward thinking Joffrey Long!  Thanks for getting this started.

We either learn from the past, or damn ourselves to repeat it!

I am so subscribed to this thread.

Got my coffee, buhring on the learning my wise BP peeps!

Tevis

Hard Money Loans: What if the Music Stops ?

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