Jonathan Ghaly

Investing in Real Estate 2 - Assignments

This blog will discuss a type of real estate investment, assignments, in the University Park area in Denver.

What this investment is: An investor who is interested in Assignments gets a property under contract for an attractive price then assigns the contract to another buyer, usually another investor. The first investor will be paid a fee for the work. If you don't have much equity to work with, and/or if your credit power is limited, assignments can be a way to get started in real estate investing. You will need to have a strong "sales" personality to succeed at it, though.

Equity needed: None, just earnest money.

Importance of credit: Not important, since you are not purchasing the property yourself.

Importance of experience with contractors: Not important. The person that you ‘flip' the property to will be doing the work.

Important of experience with property managers: Not important. The person purchasing the property from you will be managing the tenants.

The next few blog articles explore related topics, such as rentals, fix and flips, and new construction.

Recap of First Quarter 2008 Home Price Performance

The average home price in Metro Denver increased +2% in the full year 2005 to the full year 2006, from $309,000 to $317,000. Comparing 2006 to 2007, the average home price across the metro dropped 2%, to $311,000. The first quarter of 2008 was $278,000 vs. the first quarter of 2007 was $296,000: a 6% decrease. Note that prices in the first quarter are usually a bit less than the rest of the year. This is because families that tend to purchase larger, more expensive homes tend to move in the summer months when their kids are out of school.

The average price of a foreclosure or short sale dropped -3% to $188,000 from 2006 to 2007. The average price of a non-distress sale increased 5% to $370,000. Sales volume over the last twelve months is off -4% for DSF/ASF. Foreclosure and short sale volume is up +31%; non-distress seller volume is off 20%. This trend continued in the 1Q 2008; foreclosure volume was up another 15% at the expense of the non-distress sellers.

Some areas did better than others. The attached chart shows different neighborhoods in Denver. Each region has the neighborhood's name and the percentage of sales in the last twelve months that were either short sales or bank-owned properties. The second line has the price change the twelve months from April 2007 to March 2008 vs. the twelve months immediately preceding. Next, you'll see the average home price in the last twelve months and the number of homes that were sold.

The good news is that the foreclosures are likely to peak in the next six to nine months. Many of the foreclosures were due to resetting rates on ARMs (adjustable rate mortgages). There are two reasons. First, according to Bank of America data, the volume of ARM resets is set to peak in March 2008. It often takes six months or a bit longer for an ARM reset to conclude in the sale of a foreclosed home. Second, the index rates that many ARMs use have declined lately. As a result, some borrowers that might have had a huge shock if their rate reset a year ago might get less of an increase today. For these reasons, we're likely to hit the bottom of this cycle this year.

There had to be at least twenty sales in the last year for an area to be included. The numbers are more reliable in areas where there were more sales.

Source: Your Castle Real Estate analysis, MLS data

Take a look at the first page, for AUN (Aurora North). Note these positive market trends this year:
- number of active listings steadily declining
- average list price pretty stable (finally!)
- U/C up dramatically
- Number of sales / month up (partially seasonality)
- DOM dropping
- Stability in average sold prices and sold price as % of list
- Sold price as % original price UP a lot - banks are getting better at pricing
- Number of expired listings down

Every indicator is improving this year in AUN. You will see the same trends in DSW (southwest Denver County), but not as marked an improvement as AUN.

By contrast look at DSE (southeast Denver County).
- listings are up (they should be - seasonality)
- Note the average list price ($758,000) is a lot higher than the average sold price ($418,000). Lots of expensive listings brining up the average ask price, but apparently they are not selling
- DOM (Days on Market) declining as it normally would due to seasonality
- Average price declining rather rapidly. Probably a mix issue - smaller, cheaper homes are probably selling better.

Since these homes in DSE are pricier, it has more of an effect on the "average" sales price on metro Denver. Oddly, we could see improvement led by the cheapo neighborhoods, with the lux neighborhoods falling behind for a while. It will be interesting to watch.

(C) Copyright 2008 Your Castle Real Estate

Loan Considerations for Buy and Hold Investors

As far as investment loans, little or no money down loans are impossible. However, lenders do permit the use of Home Equity Lines of Credit or second mortgages from other properties owned by the borrower as a source of down payment. Or, self-employed borrowers are using funds from business lines of credit to fund down payments or renovations (please note: there are asset seasoning guidelines for doing so and the debt incurred by accessing other credit lines must be accounted for against the borrower’s debt-to-income ratio). Thus, we have clients leveraging themselves with other homes they own in order to get in with little or nothing down.

There are exceptions, but practically every lender requires Full Income Documentation on any investment purchase. Full Documentation requires the proof of income through W2s, pay stubs and/or tax returns, as well as proving liquid assets with bank statements. The max LTV is 85% on a non-owner single family property (75% for a 3 - 4 unit); however, most homes are being affected with the ‘declining market’ tag. As such, the maximum loan permitted would be 80% of the purchase price. This is due to mortgage insurance companies refusing to provide MI on investment properties in declining markets. Also, if an investor does not have landlord experience in the past two years, new rules will now not allow any rental income to be included as monthly income. Hence, the buyer would need to qualify with the entire payment going against his/her debt-to-income ratio.

Another point to keep in mind is that Fannie Mae and Freddie Mac are only permitting a maximum of 4 financed properties on a borrower’s credit report. Hence, if a borrower is looking to purchase or refinance a fifth home and already have four loans on their credit, they will face a tremendous challenge in securing financing. This latter rule only affects someone purchasing or refinancing an investment property/second home and NOT an owner occupied purchase.

All this being said, if an investor can put down 20% (or borrow a good chunk of that 20% from other homes they own or lines of credit), is Full Doc, with a 680+ credit score and DTI below 50%, rates are in the upper 6% range on 30yr fixed mortgages with no prepay penalties. With home prices bottoming up in most neighborhoods, coupled with a bullish rental market with increasing rents and low vacancy, investors can easily generate hundreds of dollars of cash flow per month. In fact, many investors choose 15 year fixed mortgages to pay off the loan quickly, yet still cash flow tremendously.

Loan Considerations for Fix & Flip / Short-Term Investors

Securing conventional financing on a fix & flip or short-term loan is not recommended. Most conventional lenders sell off their mortgages to investors on the secondary market. If the loan is paid off early (before six payments are made), the investor has not recovered their initial investment. The investor will attempt to recover their loss from the lender, who will ultimately come after the loan originator. The loan originator would then be obligated to pay back any premium paid out by the lender. If such activity becomes habitual with the loan officer, the lender can cease doing business with them and their firm.

Furthermore, conventional loans require conventional appraisals. The lender will require that the home is a) habitable in its present state b) in at least ‘average’ condition and c) not in need of any repairs greater than 2% of the purchase price. All three points can be challenging to overcome for investments properties, especially bank owned homes. Consequently, many investors use private money, hard money, home equity lines of credit, cash or specialty investment lenders to avoid failing a conventional appraisal. All of the aforementioned sources of funds can be worthwhile to pursue, but they are meant for short-term loans. Hence, the borrower needs to have a clear exit strategy(ies) to avoid costly extension fees and holding costs. Such loans carry higher interest rates and up-front fees due to their considerable risk. They can be a great route to pursue; however, the investor better be prepared in case the home is not able to sell.

Fix & flip investors should also be cognizant of title seasoning issues. FHA guidelines require that a seller be on title for 90 days before a buyer can purchase the home with an FHA loan. Most flips take longer than 90 days to renovate, market and actually close. But, some deals need limited work and can be turned around quickly. Ultimately, you will want to verify that the new buyer’s lender understands the title guidelines of the lender being used. Furthermore, a flip investor is going to list the remodeled home for significantly higher than what they had paid for it. The lender providing financing to the buyer purchasing the renovated home will scrutinize the new appraisal to ensure the value is justified. Lenders got burned in the past on property flipping schemes and are wary of substantial value increases in short periods of time.