Arbitrage, Profiting from the Spread: Sunday Morning Thoughts 19 May 2013

Arbitrage The simultaneous purchase and sale of an asset in order to profit from a difference in the price. It is a trade that profits by exploiting price differences of identical or similar financial instruments, on different markets or in different forms. Arbitrage exists as a result of market inefficiencies; it provides a mechanism to ensure prices do not deviate substantially from fair value for long periods of time.  http://www.investopedia.com/video/play/arbitrage/

 

Understand when you look up the word arbitrage, you will find many varied references to the stock market, for this post the term will be applied to real estate investing.

In real estate as a private lender arbitrage will be the spread between the costs of monies.  If you borrow $100,000 at 3% interest then loan the same money at 6% interest then you would have 3% interest as a gain.  Many private lenders and real estate investors have taken advantage of arbitrage.

Flipping houses is also a form of arbitrage.  The method is slightly different today but it is still the buy low/ borrow low and loan/sell at a high rate and the difference will be the profit.

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Related articles

• Hedge Funds Rush to Debt Trading Where Wall Street Tread – Bloomberg (bloomberg.com)
• Arbitrage and Real Estate: Sunday Morning Thoughts 14 November 2010
• Negative Arbitrage and the Effect on ROR:  Sunday Morning Thoughts 12 December 2010
• Neutral Arbitrage and the Effect on ROR: Sunday Morning Thoughts 19 December 2010
• YOUR MONEY: How to see the world and ‘arbitrage’ your retirement (uk.reuters.com)
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Profiting as a Real Estate Private Lender

Real estate investing does have its risks, but with a properly structured deal, the risks can be kept to a minimum, making the return on investment reach maximum potential.  A private lender should never allow their investment to be the down payment on a property.  Instead having a seller held second if a down payment is still needed is a better option, but it should not be lender money.  A second position is riskier than a first position but a down payment position, the money is not secured by the asset and possibly not collateralized.

There can also be a primary position coupled with being an equity partner.  As an equity partner, a private lender will contribute to the down payment in return for a percentage of equity in the property.  This strategy tends to lessen any down payment issues since it’s shared, while reducing risk of the down payment money by having an equity partnership in the property.

Syndication is also a possibility if you have a group of people wanting to invest and everyone in the group is contributing varying amounts of capital.  If an equity position is also in play, then the syndicate would be the equity partner, not just a few of the members.

The other consideration for impact on your return of investment would be fees.  Fees accompany many investments such as CD’s, Stocks, bonds, etc.  Those fees can cut into your final profit.  With private lending, secured by realty, there is a tendency to not have maintenance, origination, or any other type of fees involved.

In conclusion, as a private lender, after being presented with a deal, then checking the numbers for yourself, remember to keep in mind:

• The cost of money
• The impact the cost of money will have on your profit
• Level of risk
• Covering the downside if the loan should go bad
• The profit/ return of investment

These are just a few tips for being a private lender in real estate with minimal effort.  Keeping these tips in mind may aid in the reaping of the rewards on your investment. 

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Private Lender Tips If a Loan Goes Bad: Sunday Morning Thoughts 05 June 2011

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The goal for many private lenders is to make a return on investment better than CD rates.  If you chose the real estate investment wisely, you could stand to make more than CD rates, which is currently 2.39% for a  5 year term offered by Ally Bank.  Also to note with the volatility of the stock market, if you continue to invest in the stock market, then you will need to have more resolve than in previous years.  But with growth comes a little pain, does it have to be that way?  Short answer, no.

A private lender, with an investment secured by realty, may realize a profitable and safe return on investment.  Safe can be accomplished by being the first lien holder or as close as you can be to being the first lien holder.

As a second or third lien holder, a default can wipe-out your investment if the first lien holder files foreclosure first.  This isn’t to say that the second and third lien holder cannot file foreclosure if they are defaulted on to protect their interest in the property.  Most defaults begin with the lesser liens than with the primary.

So if you are the second or third lien holder then you can proceed with foreclosure per the contract you have with the borrower.  The loan servicing company can help with the process of foreclosure.  After filing foreclosure on the property, as the second or third lien holder you will have to begin making payments to the first lien holder or suffer foreclosure.  If the first loan has become delinquent then you will have to negotiate to bring the first loan current.

If you are the third lien holder on a property, you still can file foreclosure and you may be able to buy out the second lien holder’s position to make your interest in the property more stable, and if you can acquire the first lien holder’s note, then that would make you investment in the property even more stable.

Being the first lien holder not only yields you a better return on investment, but can also give your investment better stability.

Foreclosure on a bad loan is not the only option.  As a private lender you can allow the borrower to have another entity assume the loan. So instead filing foreclosure, if you or the borrower can find someone else to assume the loan, and use the down payment to bring all liens current, then that would be a win—win situation without the cost of court.  Being a private lender gives the flexibility to do more than just a standard few things as long as it is agreed upon by all involved parties.

Another option as a private lender is to allow the borrower to exercise a deed-in-lieu of foreclosure.  This can also avoid costly legal fees and you can either sell the defaulted note, or property.

Quick recap on what to do if the loan goes bad

1.    Be the first lien holder or as close to being the first lien holder
2.    Use a loan servicing company
3.    Have contracts in place for the what if’s
4.   Allow the loan to be assumable
5.   Use deed-in-lieu of foreclosure over a traditional foreclosure

Covering your downside can make all the difference in having an upside in passive income.

 

Level of Risk in Real Estate Investing: Sunday Morning Thoughts 22 May 2011

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As with all types of investments, there exists a level of risk.  Risk can range from low to high.  The range also has an impact which can be directly proportional to your return on investment.  Often times, the more the risk the better the profit.  But does that actually apply when considering real estate investing or private funding of real estate?

In a previous post we explored the amount of risk and the impact on return of investment.

Using the previous examples from part #1, the lower risk investment was the 60% occupied apartment.  The high risk and low yield was the strip mall.  The medium risk investment was the SFR.  But even then the determination of level of risk is based on what we already know about each project.  This isn’t to say we will jump into either investment of low or medium risk without knowing more information; now it is purely a judgment at first glance, to see if the potential investment warrants any more analysis time.

First we will examine the apartments with 60% occupancy and knowing the current management/owner is tired of owning rental property.  And for good reason, the tenants always seem to have some sort of an issue; maintenance always has to be performed from general maintenance keeping the grounds neat and tidy to fixing other issues such as plumbing, electrical, etc.

Now with the current owner letting things go, his rental income property has become his nightmare.  As long as the property can support itself, and generally 60% occupancy can do that, then the investment becomes a steal of a deal for another owner, one who will make sure the property has great people oriented management.  This one would definitely garner a request for the financials and a deeper analysis in order to make a reasonable offer.  This investment would be a medium with a superior yield even in its current state.

The other medium risk investment would be the SFR.  The SFR is in a middle class area without too many homes for sale.  The area is considered desirable for families to move into.  Once the house has been rehabbed and cosmetic touches have been applied then we would have either a passive investment property as a rental or sell it for at the fair market value.  This property could also become a lease with the option to purchase.  This one would also garner a further look to make sure the numbers are in order, and that the return on investment is worth all the hassle of the rehab, if rehab is necessary.

Not all houses are worth the rehab effort.  Some houses may only have a value due to the land which they have built on, versus the amount of work needed to fix the place.

As for the high risk and low yield investment, the highly vacant strip mall or office space, would be an investment that would not receive consideration if the typical strip mall/ office space in the area are almost empty or empty.  It would be a matter of evaluating employment statistics for the area, in addition to taking a look at the local demographics.  All of which is just a mouse click away.  Most of all the information can be found quickly on the internet.

But if the area is dense with vacant strip malls/ and or office space then it might be best to move to on to a more viable investment.

As a private lender, the investor presenting you the deal for funding should have already checked the numbers and made sure the deal is profitable.  But as a private lender you still need to look for profitable characteristics in all possible deals before funding.

Risk Management Covering the Downside

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When investing in real estate risk comes with the territory, but minimizing risk to a manageable tolerance is crucial.  Some investors can tolerate huge losses while others would find a small loss difficult to handle.  It is a matter of considering all your options and then proceeding from there.  You do not need to have a vast knowledge as a private lender for a possible deal but you will have to make a consideration of many aspects of the deal.

Aspects to consider is the structure of the deal, what is the percent collateral to debt, which position are you 1st or 2nd, etc., and when will you receive your profit.

With the four aforementioned considerations you may be able to limit high risk and maximize profit. Remember the four points are when you initially look at a deal, if these things are not answered the way you want, then you can let the deal go or improve upon the deal to make it profitable for you.

The structure of the deal, how will the property be obtained?  Will it be seller financing and at what percent and length of time?  Will it be bank financing along with private funding, if so then how much bank financing is needed?

With seller and bank financing are you the second lien holder or even further away from the collateral?   Are you the rehab money?  The first lien holder is the best position especially if the borrower goes into default.

These are just a few things to consider when minimizing risk.

The downside would be being the 3^rd or even lesser lien holder on a collateralized note, a property having no to low occupancy (occupancy under 55%), a property with major rehab needed, and a property with poor management.  This is not the end of the list but only a few of the normal problems which can be encountered on a real estate deal.

Of course each one can be covered to help benefit in profitability.

Lien holder position, find out what it will take to make you number one or number two.  Funds necessary may only be the difference in $5000 or possibly less.

Having no to low occupancy; many profitable deals have started that way.  The upside is having new one year leases in a multi family property, or a buyer or a lease option for a single family residence.  In a no occupancy situation, finding the best management company for the area is a great start to a profitable finish.

Major rehab projects may be a time factor downside.  Time of year for weather concerns for certain areas, and or time of investment return.

A property with poor management, the remedy is to find the best management company in the area or build a team for the property.  Hiring people with people skills is the biggest key.  Many companies with less than stellar products may have high sales due to the people skills of the sales staff.  People have a tendency to stay when they have been treated fairly and respectfully.

So remember, covering the downside by taking proactive steps to maximize profitability can result in less risk of investment.

What Risk Would You Take? : Sunday Morning Thoughts 24 April 2011

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Risk—[risk] – n. 

To venture upon, the degree of probability of loss, take or run the chance of injury or loss.  To be under financial or legal obligation; held responsible.

 

In any investment one must be willing to take a risk.  The types of risks low, medium, and high, which are proportional to profit from taking the risk; normally the greater the risk the greater the profit.

A low risk investment yields a profit without much consideration for a loss.  Something comparable to a FDIC insured savings account at a banking institution.  This type of investment normally has lower profit and very minimal loss, even if the banking institution were to go into receivership.

A medium risk investment normally has a better profit than a low risk investment, but the risk is greater although the investment may still be a safe bet with a nice return on profit.  A medium risk can be something similar to investing in a slow growth fund or even a real estate investment such as a lease with the option to purchase or a class B multi-unit rental property.

The higher the risk the more likely you will have a greater return.

With that said, a high risk investment normally has a larger profit margin but if a loss is incurred it could be of a large amount, and in some cases more than what you invested.

So a good question to ask, how can I minimize the risk of loss?

Always be aware of the downside.  In any investment there is a downside.  The downside can range from a very long-term wait (5 years or more) to realize a profit, to a negative profit at the end of maturity for the investment.

How to gauge how much risk you can take, answer–what do you feel you can tolerate?

The History Lesson of the Stock Market Crash

Prior to the crash people were receiving higher incomes. With more income average people invested in the stock market driving prices up.  With an unbelievable amount of prosperity there looming in the background, was the thought of a stock market crash.

Then it happened.

Economist had warned of a crash, a bubble bursting, but it fell on deaf ears.  So then the tragedy began, the bottom fell out and everyone scrambled to keep from losing everything.

The world was succumbing to a global economical crash and a wide spread fear of a faulty recovery.

The banks began failing one by one, occasionally four or more at a time.

And don’t get me started on the whole immigration thing.

When reading this article please keep in mind the title, the history lesson of the stock market crash.

If history has taught us nothing but one thing, in time everything repeats its cycle.

The previous stated lesson is from the crash of the 1920’s the last quarter of 1929, October 24^th to be exact.

Back then a group of bankers pooled their money to buy stocks to convince others to stop selling their stocks, while in this century we experienced the Goldman- Sachs scandal, a legal pump and dump.

An Unethical confidence game.

Although there were rumors the bankers were secretly selling their stocks after the pooling and buying.  This would still be a legal pump and dump.

Unethical.

In the stock market crash of 1929 the bottom was not finally felt until July 8, 1932, an approximate time period of two years, nine months, and two weeks and two days.

Even today economist are looking at the stock market crash of 1929, comparing it with our current economy.  The global economy at that time was bleak, but not too long after, the healing did begin.

We started a new cycle of growth.

Our new cycle of growth is going to be small hops (as stated in a previous post) which will total one big leap when we look back a year from now.

A recovery is not an overnight fix.

At this time we should take advantage of the downturn before the upswing and invest in the one tangible asset that will appreciate in the very near future.

Commercial real estate is seeing more foreclosures and is due for even more, making the prices unbelievably low.  This low will not last more than two to two and half years.

The residential housing industry is also going to experience another down turn before its appreciation upswing.

As far as the stock market, well picking stocks like Warren Buffett is better than Jack Rabbit investing any day.  The Jack Rabbits seem to go broke while Warren is still making gains.

So think about where you would like to be in five years.

Would you like to be thinking about how you shoulda, woulda, coulda (sown) invested to (reap) profit, or will you be thinking about all that you are reaping because you realized it was time to invest.

Jack Rabbit Investing: Sunday Morning Thoughts 29 August2010

The current stock market reaction is looking less like investing and more like “Jack Rabbiting”.   Investors’ are quickly pulling money from one place to another, and then moving their money to some other investment. 

Please do not confuse the term Jack Rabbit investing with moving investments strategically for a better return on investment.  The latter is a calculated move based on data about a potential investment. 

Jack Rabbit investing occurs when you have a stock market like the one we have now, a very bear market with even the best of companies lacking good profits. 

Risk is greater with our new down economy many people are looking to jump into an investment to make a quick buck, but this is not the type of market to do that easily. 

We now have a stock market with undervalued stocks set at much lower prices.  Buying the stocks now will enable a savvy investor to buy more of the undervalued stock and wait for appreciation.  One of Warren Buffett’s strategies is to buy stock in a company which meets his checks and balances.  He then holds the stock for at least five years. 

This same principle can be applied to buying real estate.  Instead of doing Jack Rabbit investing such as quick flips, buy an undervalued piece of real estate and hold for appreciation.  

It’s as simple as that, buy low, hold, and possibly sell high in the future.  

There are many quotes throughout the years about how real estate is dead.  Bu it never fails, real estate roars to the foreground and becomes the corner-stone of an economy. 

This is one of those times we are in now, real estate is undervalued in many appreciating areas and in areas down now but will appreciate again. 

You can either wait on the sidelines for the real estate market to rocket back, or you can capitalize on a market that will soon appreciate once again. 

 The Option is Yours.

Our Turtle Economy

As our American economy is turtling along, the European’s are experiencing an economy of marked growth, albeit small, as our stock market has seen its third bad day in a row the European’s are experiencing positive trade.

For France the growth for the second quarter was from consumerism, for Germany the rise is from exports.  The United Kingdom is also seeing an improving economy.  But most of the economists of said countries seem to be surprised by the improvement in their economies.  Russia’s second quarter finish is also showing growth, so what is happening to the good ole’ USA?

The short answer, lack of consumerism, credit, and jobs our countries biggest economy drivers.

On the horizon, the Federal Government will be making it easier for businesses to have credit lines and tax breaks which trips into hiring and thereby moves into a more robust consumerism economy.

With the new changes in banking and credit lending the economy will continue to experience ups and downs, mainly due to our basic nature as humans, we resist change but change does happen then we adapt.

In the future we will see housing demand being more robust and possibly experience a housing shortage, a shortage which may cause many areas to appreciate considerably.

So now would be the time to invest in real estate, residential and commercial.  The sidelines are full of those that will never take action, but action is required in this economy.  Don’t let it pass you by invest now although things may look bleak a new horizon of improved change is on its way.

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Realistic Investing vs Speculative: Sunday Morning Thoughts 01 August 2010

Warren Buffett defined the difference between investing and speculation in this famous passage from his book, The Intelligent Investor:

The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels, at which he would be wise to buy, and high price levels, at which he certainly should refrain from buying and probably would be wise to sell.

This statement can apply to the new wave in investing, binary options.  This is a loose example of how binary options work; the premises is to state whether or not a stock or commodity will go up or down in the next ten minutes.  Although this is a rather pedestrian look at the inner workings of binary options, this is basically the way you play the hand.

If you picked up on the poker, or card game reference, this is what binary options sum up to be, yet another casino game.

Currently on the trading floor a lot of speculation has been transpiring.  Many investor newsletters are giving their predictions for stocks, commodities, etc. to have in their portfolios.

When choosing to invest you will have to have a proven earning strategy to see a return on investment.   Not matter how you look at investing you will always be speculating or projecting on a number of factors.

Studying the cycles is also a proven strategy to help increase a return on investment.

Everything in nature has a cycle.  To better understand the cycle of things is to watch and make note of changes.

The changes could be obvious or very subtle.  Noting the changes in the cycle we can then project what will likely happen next.

The housing and commercial housing market also have a cycle, when the prices go up drastically in any given area that same area have a hard bottom.  Examples would be Stockton, CA and the Inland Empire.

The house prices in those areas where going up up up almost everyday by leaps and bounds.  Then suddenly the market in those same areas fell down just as hard.

The Inland Empire was a growth area in the late eighties then became a declining area a short time later.  Fast forward to the late nineties, the same area was growing past its highest peak.  Then with all things fell as sharply as it went up.

If you were to invest now in the Inland Empire the starting strategy would be to hold the property knowing it will appreciate as in times before, and then sell the property right at the peak or slightly before the peak.

The stock market also has a pattern because all things in nature follow a cycle.  This is one of those rare times when all really does exist.  But also note within a cycle are also more cycles contributing to the larger cycle.

In real estate the job market fell in the early nineties with companies cutting back to purchase stocks back from their investors.  For our current housing market the down turn initiated from the sub prime lending and over extension of credit; similar to the late eighties early nineties.

So with all cycles now is the low time in the market, the time to buy and hold.  Appreciation is waiting.