The national economy is in a state of confusion and the local economy is in a state of confusion. So what does this mean for the market for investing in trust deed based loans?

Well of course nobody really knows–and this is just my take on it–but here goes:  First of all, let’s talk briefly about investment choices.  With so much uncertainty in alternative investment vehicles, maybe trust deed secured loans are a pretty good place to put your money.  After all, you will have real security backing up your value, and that can’t be said about most investments.  And you certainly have the opportunity to receive a nice double digit return on your investment, and that being so even if you opt for the best and most potentially safe such investments.

The key thing to keep in mind is that real estate markets are uncertain and potentially volatile.  And thus you need to be particularly rigorous in making loan selections.  I would say that the most important keys are: (1) Make sure you know as much as possible about the recent price history of the particular market you are considering.  This will most likely allow you to better gage the potential future volatility of the market.  (2) Keep the loans either short or long.  1-2 years for quick-turn projects, and maybe 5 years to those borrowers looking for and able to afford the long hold.  The danger zone in my opinion tends to be in between.  (3) Make sure that your borrower has a solid exit strategy (no exit strategy is foolproof given the seemingly scare nature of bank financing, but some strategies look a whole lot better than others).  And (4) Keep your LTV a little lower than usual so as to better absorb potential market depreciation during the life of your loan.  We still have clients who lend 75% LTV on very solid transactions, but these days most investors feel better at or around 65%.

With regard to demand, the following is relevant once again: Markets are uncertain and potentially volatile.  How does this apply to the market for borrowers of private money? To answer this question, we have to look at who borrows private money. I would say with complete confidence that easily 80% of all of the loans that we do (Fairfield Financial) are to those who buy, sell, renovate, and construct real property with the intention of earning a profit.

The relevant point here is that most real estate investors are likely to be avoiding the long-term hold and attempting to make the good buy and turn properties for a quick profit. This is a market where properties are going back to the banks at a frightening rate, and where this spells bad news for home owners who over-borrowed, this means opportunity for the quick-strike investor. The bottom line of all this is what? Again, it’s hard to say, but I think it would be fair to conclude that if you are a private money investor (like most of you on this list), you might want to look particularly for: (1) those borrowers looking to buy and sell property on a dime to make a profit (many times you can justify lending up to 100% of fix up money and repair money to these borrowers when they are buying well), or (2) borrowers that have a longer hold scenario (closer to 5 years) that fall between the cracks of the more conventional lenders, generally already own the property,  and might bear a 10-12% holding rate to bridge the gap for several years. The idea is that this type of borrower can afford private money sized payments over the longer haul and will utilize this option to get to from point A to point B.  And point B–I might add–is a place that we’d all like to believe is a better place, a place where life is predictable once again and property values are something we can hang our hat on.

– Clay (clay@privatemoneysource.com, 503-476-2909 or 800-971-1858)

Clay is Vice President of Fairfield Financial, a primary source for private money loans since 1964.  Fairfield works with a broad range of private money investors, in a broker capacity, finding, underwriting, presenting, closing, servicing, and when necessary, assisting in the workout of difficult loans.

Back in January, in my post entitled, “Won’t somebody please call a plumber … the banks are clogged,” I addressed what I consider to be the essential question regarding what it will take to get the real estate economy on track and moving in the right direction assertively and with confidence again.

And now, nearly six months later, my final paragraph seems quite equally relevant.

“And so even though a lot of good things are happening with our economy as of late, real estate prices will not correct until lending institutions provide adequate funding once again to owners and buyers—and the economy as a whole will remain at least partially broken until this occurs.”

There used to be a lot of talk about getting toxic assets off the books and getting banks to lend again, but I hardly ever come across serious discussions of this issue in the financial press these days.  It is as thought government officials and journalists and such have decided that this question is just too difficult to answer and thus should just be ignored.  Like a stray dog, maybe if we don’t make eye contact it will just go away.

I used to think that the banks would have to begin lending again as soon as they cleaned up their books a bit.  After all, if a bank doesn’t lend, what then does it do, and wouldn’t it go out of business?  Well it turns out that, “no” it is not necessarily so.  From what I can tell (and this is not a terribly informed position mind you), many of the banks and bank-like entities have taken to investing in various commodity style investments.  They have effectively become investment houses, and are doing quite well, thank you.

So I pose the question to my dear readers, as I honestly don’t have a clue: what will it take to get banks to start lending again—and I’m talking about loans across the spectrum (residential, commercial, development and construction)?  If you have a position on this matter, please share it with the group.  Or if you have access to an informed article that seems to reasonably address the question, won’t you please pass it along?

I’m sure we’d all like to know.

– Clay (clay@privatemoneysource.com)

I just recently finished reading The Greatest Trade Ever, the 2009 book by Wall Street Journal reporter Gregory Zuckerman.  It is a terrific read.  I really enjoyed it.  It evolves primarily around John Paulson, and tells the story of how he managed to make billions of dollars for himself and his hedge fund investors by arranging a series of investment positions that bet against the rapidly expanding subprime positions in the market.  In particular it tells the story of how he worked with banks such as Goldman and Bear Sterns to construct and facilitate such trades.

Zuckerman doesn’t waste much time judging the ethical or legal aspect of such trades.  Rather, he tells a damned good story of how a few individuals predicted an event that others just couldn’t fathom, and then positioned themselves, against all prevailing notions, to ultimately reap enormous profits from their heart-felt predictions.

It is a story of the most profitable series of trades on Wall Street, and if one theme comes through loud and clear, it is that only an outsider (and somewhat of a misfit) such as Paulson (and a handful of others) could have managed to “think” so counter to the prevailing notions of the industry, and perhaps more importantly, would have dared to defy so many others in the industry to the point of personally and professionally marginalizing themselves in the process.

Paulson is not under indictment, but as we know, Goldman is being sued by the SEC in a high profile case specifically targeting the Paulson-backed synthetic CDOs.  I personally would have to say that I lean toward Warren Buffet’s position that overall Goldman is not really to blame here.  See the New York Times story, From Buffett, Thought-Out Support for Goldman, http://dealbook.blogs.nytimes.com/2010/05/04/from-buffett-thought-out-support-for-goldman/

According to Buffet, “I don’t care if John Paulson is shorting these bonds. I’m going to have no worries that he has superior knowledge,” he said, adding: “It’s our job to assess the credit.” The assets are the assets. The math either works or it doesn’t.”

His point being that it wasn’t important for Goldman to disclose to fat-cat institutional buyers that John Paulson was shorting the synthetic CDOs they were buying.  The buyers were professional investors, and should have looked deep inside the assets to see exactly what they were buying.  Paulson certainly did.

I am now nearly finished reading The Big Short by Michael Lewis, and I must say this book—like every Lewis book I have read–is fascinating and irresistible.  It deals with the same basic material as Zuckerman’s book but tells the story from various other points of view.  It is quite a bit more technical than Zuckerman’s book, and in this sense, is precisely what I was looking for.  Lewis has a talent for explaining complex things in simple ways, and this book goes a long way toward answering unanswered questions I had regarding “How did this all work?”

What I get out of Lewis that I didn’t get out of Zuckerman so much, is that it is the ratings agencies that are at ground-zero of the breakdown of the system.  It is hard to tell if they were really stupid or really crooked or both, but certainly there had to be a good dose of both at work here.  I don’t care how you package and re-package subprime loans into bonds.  It should have been clear that such bonds could never be packaged in such a way as to earn a triple-A rating (same as US Government debt), and yet this was happening (and so much more).  Yes, the sellers of bonds and CDOs were gaming the system, but nonetheless, the ratings agencies allowed themselves to be quite easily gamed.  You might say they were easy.

The real lesson of all this is that the sub-prime collapse could have been quite readily predicted—as it was so clearly by a small number of individuals—but that there was just too much money being made and perhaps more importantly, a deeply institutionalized thought process at work here that defied those involved to even consider notions counter to the norm.

And what is the lesson for the individual trust deed investor?  It is this I think: Don’t invest in trust deed style securities unless you know what you are doing.  You must be able to evaluate the quality of any given loan.  And most of all, never–I mean never ever–let anyone else tell you what is and is not an acceptable level of risk.  Ultimately that decision is yours and only yours to make.

– Clay (clay@privatemoneysource.com)

After many years of holding relatively firm, the real estate market in the Pacific Northwest may be in trouble.  The following informative piece was printed yesterday at Business Insider.  Make sure to follow the “Check out how bad Oregon has become” link and the 14 slides that accompany the article.

http://www.businessinsider.com/oregons-expanding-foreclosure-rate-could-make-it-the-next-california-2010-2

What does this mean for Oregon and Washington?  How bad is it going to get before it gets better?  And what does this mean for the rest of the nation?  Please take a minute to share your opinions by clicking on the comments link for this site.

Keep in mind that this analysis is looking at residential properties only.

– Clay (clay@privatemoneysource.com)

One of my dear good readers sent the following e-mail in response to my last post, Home strippers coming to a neighborhood near you.

“Good topic Clay.  Now forgetting about us private lenders, the conventional lenders continue to be their own worst enemies.  They persist in bringing the properties to the city hall steps at 40% over market.  When no one buys the property, they have it inspected and insured, pay the utilities, and pay a realtor to sell it for them at a discount.  On top of all that they may face the problem that your article addressed.

Pricing it to sell on the steps would solve their problems.

In early December, I looked at this piece of bank owned junk in St Helens, Oregon.  It was rough around the edges but the bones were good.  It was a typical Ranch style, 2-bath, 3-bed, 1400 sq ft, nice large lot, fenced, but no garage.  The bank had it listed for $198,000, but they had started out at $139,000 a couple of months earlier.  I called the agent and asked them if they had a misprint on the price (as there are nice, newer homes with garages going for $165k max).   The agent said no, it wasn’t a misprint; the lender had called him when it was at $139,000 and told him to boost the price to $198,000.  What is that about?

Until the banks get their head out, their balance sheets are going to continue to worsen.

Regards, Alan”

Well I can hardly say that it is the first time that I have heard of or seen this type of thing with the banks.  One does get the distinct feeling that these institutions are somehow unmotivated to remove the toxic assets from their books.

And it is even worse than all that.  As if they needed additional help at slowing down the corrective process:  The federal and state governments, with all of their efforts to keep owners in homes which they cannot afford, are seriously compounding the problem.  It could take an extra year or two to get many of these bad loans off the books due to the various federal and state requirements being imposed upon the banks.  (And that assumes the banks are motivated.)  The following NYT article does a nice job of discussing the matter.

http://www.nytimes.com/2010/01/02/business/economy/02modify.html

And so even though a lot of good things are happening with our economy as of late, real estate prices will not correct until lending institutions provide adequate funding once again to owners and buyers—and the economy as a whole will remain at least partially broken until this occurs.

And so I say:  “Won’t somebody please call a plumber … the banks are clogged.”

– Clay (clay@privatemoneysource.com)

There has been quite a bit of talk in 2009 about the possibility of a meltdown in the market for commercial real estate.  I came across some statistics recently that were quite astounding in support of the idea that a wave of commercial defaults is coming.  It is estimated, apparently, that there is currently 3 trillion in commercial real estate debt outstanding in the US.  According to this particular source (which I’m sorry to say I don’t recall), 1.3 trillion of that debt will come due within the next four years.  As we all know, there doesn’t appear to be much in the way of new commercial funding available for those current loan holders (or their potential buyers), so the above statistics—on the face of it–would tend to be worrisome.

Still, 4 years is a long way out.  I personally suspect that we will get a much better feel for what is likely to occur over the long haul by looking at what happens in 2010.  But I am not a prognosticator.  You’d think that with a degree in economics, I might have the ability–or at least the inclination–to analyze and predict long-term economic trends.  But I am not that kind of guy.  I am more of a “sure it works in practice, but does in work in theory” kind of guy.  I like the type of economics where you look at what happened and then play with the numbers and try to figure out why it happened that way.  Those familiar with Freakonomics and SuperFreakonomics by Levitt and Dubner will know what I am talking about.

I recall my first day in a big lecture hall at University of Oregon attending Macroeconomics 101.  I was a fresh faced kid eager to learn and ready to believe just about anything.  When the professor said something like this:  “Okay the fundamental assumption that we will make as economists is that people are rational and that they will behave in a rational manner,” it sounded fine to me at the time—perfectly reasonable.  I hadn’t been around long enough to believe otherwise.  It was only with the passing of years, after graduating from the university and going to work in the real world, that I began to question that assumption.  And ultimately I concluded that it was downright ridiculous.  My entire economics education was based on one fundamental and ridiculous idea. It would be as though we had utilized a chicken bone as the foundation for building a skyscraper.  (Needless to say, I was not happy when considering the amount of money I had spent obtaining this degree.)

A very good read which speaks to the matter is Predictably Irrational, by Dan Ariely.  The bad news, if you wish to draw conclusions from this book, is indeed that individuals often engage in irrational behavior.  However, the good news and the saving grace–I should think–if you are trying to understand human behavior in the aggregate, is that we are as it turns out quite predictable in our irrational behavior.

Where was I then?  Oh yes … my fundamental point is that I would rather not go too far down the road of attempting to predict the economic (or any other) future.  I will only go so far as to say that I’d rather it not happen.  But it is worth pointing out that a downturn such as that discussed may not be all bad for those who invest and traffic in private money loans.  If banks aren’t lending as 1.3 trillion in loans come due and with private money lenders as the primary option, the pickings would be quite impressive indeed for those who choose to keep investing.

So what do others have to say?  As per usual, there are a wide range of opinions.  And they tend to be somewhat polarized.  I myself tend to think that the doomsday people somewhat undermine themselves by being so certain and unrelenting, but at the same time, I am suspicious of anyone who says that things are looking good.  I figure the later must work the national association of realtors or some such thing.

I guess we’ll each have to decide for ourselves, and so here is a sampling of web content regarding the matter.

From the Dallas Morning News

http://www.dallasnews.com/sharedcontent/dws/bus/columnists/chall/stories/DN-Hallcolumn_09bus.ART.State.Edition1.3cf46e6.html

From the Business Insider

http://www.businessinsider.com/michael-panzner-commercial-real-estate-2009-11

From the National Real Estate Investor

http://nreionline.com/property/retail/foreclosure_in_doubt/

From the Real Estate Channel

http://www.realestatechannel.com/us-markets/commercial-real-estate-1/national-association-of-realtors-lawrence-yun-nar-commercial-real-estate-index-commercial-real-estate-trends-2009-office-space-lease-office-space-sale-investment-1273.php

From the Urban Land Institute

http://www.uli.org/ResearchAndPublications/EmergingTrends/Americas.aspx

Okay, there is plenty more where that came from, but I won’t burden you with it here; if you wish to read it, you’ll have no trouble finding it.  I would be very interested, however, in hearing the views of those who follow this site.  We are still quite small in number, but we have enough folks to fill a good sized classroom now, so by all means, raise your hand and be heard.  Please: prognosticate.

– Clay (clay@privatemoneysource.com)