I'm Proud of My Fellow Americans

As of this writing, I'm proud to be an “average” American and I am proud of my fellow, average Americans. They did not buy into the “crisis.”

For the most part, I keep my political opinions to myself and like a true capitalist, I study the situation and try to profit from events. In this case, I can't do that.

The majority of Americans are against a bailout and so am I. Regardless of what happens this weekend, the majority of Americans are right. This bailout is bad policy, bad for Americans, and I'm proud to be among those Americans.

Here is the history. About 10 years ago, the Clinton Administration, as part of their legacy, made it easier for low-income demographics to buy a home. As can be expected in a Capitalist country, the less stringent lending standards were exploited. What ensued was a lending and housing boom and run up in home prices.

After making the dubious loans, the underwriters packaged the loans in Collateralized Mortgage Backed Securities (CMBS) and investors bought the CMBS because they were backed by what they assumed was good Real Estate—for a while, the mortgages were getting paid. At this point, the mortgage industry created an asset base supported by inflated appraisals and sold to people with weak credit.

Wall Street than guaranteed the CMBS base with Collateralized Debt Obligations (CDOs), which was ingenious. They were able to generate an income stream with no money down based solely on their ability insure the CMBS holders against the risk of their investments going bad. They actively disregarded the simple fact that they did not have the assets to cover their obligations if/when the CMBS instruments went bad. Hence, the predictable results: the bank failures; Government bailouts; emergency mergers; and asset purchases. These same Wall Street players further exacerbated the situation by trading these instruments amongst themselves.

In short, Wall Street built a whole industry based on real estate sold to people that could not afford the debt they took on to buy the real estate. The only asset of value in the entire chain was the base real estate that in most cases was overvalued to begin with.

As the the teaser periods ended, rates on the mortgage instruments increased, and many home owners started to default on their debt, driving down the value of the housing market. This led to paying homeowners who had mortgages greater than the value of their homes; and resulted in the execution of clauses that increased mortgage payments. Another round of defaulting homeowners accelerated the devaluation of the housing market.

These defaults, in turn, destroyed the value of the CMBS market. When CMBS holders went to the CDO holders to collect on their insurance, the CDO holders couldn't make good on their guarantees. What's important to note here is that the CDOs were only as valuable as the financial strength of the guarantor, which we now know was not strong enough to cover the obligations. In other words, they had no value! It was ether!!

If an investor can generate a return without putting money down, then the return is infinite. That's what Wall Street was doing with the CDOs. This led to the credit crunch. Banks will not lend money to each other because they all know that the banking and investment industry are carrying Billions of dollars of assets on their books that are worthless! Now that the ponzi scheme is coming apart, Wall Street wants to value the worthless assets at $700B, sell them to the American Taxpayer, and get their last return on the assets.

As of right now, the American public is not buying it.

You have to hand it to Wall Street—they made money from worthless assets. When they couldn't make money from these assets any more, they went to the Bush Administration to sell the assets to the American public.

In the process, Wall Street told the American public that if the bail out doesn't work, the American people face financial Armageddon. In the ultimate act of Economic Immorality, the President of the United States got on National television and told us if we don't have a bail out, we'll lose a million jobs.

Bullchips!!

Yes, we have a credit crisis, but I submit the storm is about over. At this point, Wall Street is making a final money grab—a $700B money grab!

Fannie Mae, Freddie Mac, and AIG were bailed out by the Government. IndymacBank, Lehman Brothers, and WaMu failed. Morgan Stanley and Goldman Sachs sought protection as federally regulated banks. JP Morgan Chase gobbled up Bear Stearns and WaMu. Bank of America absorbed Countrywide and Merill Lynch. And Citibank and Wells Fargo are strong enough to weather the storm.

As of this writing, Wachovia is negotiating their merger into a stronger bank. The players have consolidated and with every round of consolidation the assets get further written down (or depreciated). There is cash on sideline; when the winners are clear, the cash will capitalize the winners. In the meantime, Americans need to live within their means—credit is scarce. But this is not financial Armageddon.

I don't buy it, and I'm proud of my fellow Americans that don't buy it.

If Congress and the President want to pass legislation to free up the credit markets, then go straight to the hard assets. Set up an RTC-like organization, clean out the bad inventory, and restore confidence in the market at the core asset level.

Don't value the worthless assets at $700B and sell them to the American Public.

I'm not buying it and neither should the American Taxpayer!

For more information contact Chris at christofer.pacheco@gmail.com .

A 700 Billion Dollar Bail Out, What Does That Mean to Me?

I, like everybody, have an opinion regarding the Government bail out of Wall Street. In the end, however, I am not in a position to influence policy. The next logical step is to study the policy and understand how to position my clients, my business, and ultimately my family and me to best benefit from the policy.

By now there isn't an American that hasn't heard the terms CDO and CMBS. Both are financial instruments that enabled Wall Street to grossly over leverage itself. Its not a new concept, investors have been using leverage to multiply earnings for as long as investors have existed. Leverage, in moderation, is a powerful and effective investment concept. Unchecked, leverage, fueled by greed, leads to a trillion dollar U.S. Taxpayer funded bail out.

I am a Real Estate Investor and I consult for Real Estate Investors, so naturally I want to understand how this bail out affects my clients and me. I firmly believe Government debt is bad, it serves to crowd out private sector investment, reduce savings, drive demand side price increases (inflation) and weaken the dollar.

Over the past 5 years, the U.S. has run annual deficits around $400 billion per year. Last week the President of the United States announced a bail out that will cost the U.S. Taxpayers a trillion dollars. That's two and a half years of budget deficits dumped on the U.S. Economy in less than one year, in addition to the systematic debt our Government creates annually.

Ostensibly the bail out isn't really debt, because the monies spent are backed by assets. The Government will buy these assets at steep discounts; and will be able to sell them back to the market at a profit at some point in the future when the markets have settled. If that occurs as planned, the long term effect is reduce the Government's debt, and the long term implications of reduced debt is good.In the short term, however, the bail out is massively inflationary. The bail out will have the same effect as the Federal Open Market Committee buying a trillion dollars worth of Government Securities in a short period of time. That move weakens the dollar against other currencies, drives up the price of goods in the U.S., increases interest rates, and drives down the value of hard assets, including real estate.

If you are seller or a landlord, in the short term you'll see more demand for your asset, depending on the credit loosening effect of the bail out. That increase in demand, however, may very well be offset by capital leaving the market for dollar denominated real estate.

What that means for my buying clients is that they will continue to have good deals in which to invest, the competition for assets may increase as the bail out should loosen up the credit markets, allowing more players to enter the market. More players in the market is good thing, as it serves to offset downward pressure on asset values created by inflation. What it also means to my clients is that they will have to buy long. They need to buy strong returns, maximize depreciation, and - yes - leverage to maximize returns. Buyers are better served by looking for value and strong returns rather than waiting for blood in the water. The great deals will come, but focus on buying good deals.

Time will tell if the bail out was a good decision. In the short term it avoids a melt down of the credit markets in the U.S. which would destroy demand and in turn our economy. It's short term effects are inflationary and will force down asset values for an undetermined period. In the long term, if the Government, and by extension the U.S. Taxpayers, can profit from buying these assets and the profits aren't spent by congress the overall impact of the bail out is positive for the U.S.

For more information contact Chris at christofer.pacheco@gmail.com .

Buying Distressed Assets from Banks

I make a living finding good real estate investments for my clients. I'm good at what I do and I make a good living. I find good deals by looking for real estate assets priced at wholesale as opposed to retail, so I deal with a lot of asset mangers and banks. For asset managers, I find buyers for their distressed assets and for my clients, I find good deals. I'm very busy these days.

Over the past 12 months the pendulum has swung. At the retail level, a year ago I was reviewing deals that looked good at a 7 CAP (7% return on purchase price), for medium credit tenants. Now I'm finding retail deals at 10+ CAP guaranteed by National credit tenants.

For wholesale deals I work with banks and court appointed receivers. As a point of clarification, I'm talking about hard assets or hard asset backed notes from banks and regulated lenders, not the toxic waste (CDOs) that the investment banks will unload on the Federal Government. I digress.

In terms of distressed assets, all lenders are required to “Mark to Market” non-performing assets. This means they value the asset in accordance with their current market value. Not all banks treat or value their distressed assets in the same manner. In other words, banks are reluctant to write down their portfolios too much, so naturally the definition of marketable value of an asset fluctuates.

Not every distressed asset deal is a good deal. For example, I found an income producing property for one of my clients that is a good investment at the right price. The investment had a recent appraised value of $20,000,000.00. The loan on the asset was $40,000,000.00. The bank had lent money on the post development value of the property, and somehow convinced themselves that loaning $40,000,000.00 on a $20,000,000.00 asset had a 60% Loan to Value (LTV) ratio. After preliminary discussions with the bank, we decided to offer $.75 on the dollar for the asset. We offered $16,000,000.00. The bank wants $30,000,000.00. When we asked them how they valued the asset, they explained the entitlements associated with the project carry a $14,000,000.00 value. We let our offer stand, but did not increase the offer. We'll get the opportunity to buy that asset in time.

When working with banks make sure you do your due diligence. Do your research prior to making the offer. In many cases, when dealing with distressed assets, you don't have a long time to inspect the investment after making an offer. The inspection/feasibility period is often short – sometimes as short as two weeks. Take the time to understand the asset prior to making an offer. At face value, paying $30,000,000.00 for a $40,000,000.00 note may seem like a good deal. Not when the asset is worth $20,000,000.00. This sounds like common sense, but there are several entities out there looking to place billions of dollars on hard assets, especially real estate. When placing that amount of money in an environment with a lot of discounted assets to choose from its easy to overpay for an asset, even if you are buying a distressed asset below par.

For more information contact Chris at christofer.pacheco@gmail.com .

Finding a Good Investment in a Target Rich Environment

The current downturn will last for the next 18 - 24 months. Banks just finished the first round of writing down, or acknowledging the issues associated with sub prime loans. Banks still need to deal with the Alt-A ("no-doc" or "stated income") loans coming due, or resetting at higher rates. The issues are the same as the sub-prime market, lenders relaxed their rules, assets were over-valued, and money was lent to fund properties assuming continued appreciation. Now as the loans are coming due or resetting, the balance due on many assets is above the value of the asset. A recent article on bloomberg.com estimates "About 3 million U.S. borrowers have Alt-A mortgages totaling $1 trillion, compared with $855 billion of sub prime loans outstanding."

Assessing the environment, this is what we have - the CMBS market went away based on the sub-prime loan crisis, credit markets dried up as a result. Now the banks that survived the sub-prime wave must now deal with the Alt-A wave. In parallel, these factors have dried up lending on commercial projects. The lack of commercial lending will lead to a third wave of defaults.

What I'm experiencing as I find and examine discounted investments for my clients are several things. The biggest is that most banks don't yet have a handle on the size of problems in their commercial portfolios. Asset managers are overwhelmed and are managing real estate assets they have little experience managing. Also, the amount of developers that will walk away from their projects is still undefined.

The result for investors with capital is that there many discounted investments to choose from, and many more coming to market over the next 12 months. So how does one pick a good deal? First, have investment criteria and stick to the criteria. The second, stick to fundamentals.

Investment criteria - for example, I have a client that wants investment properties only, 8 CAP or higher (CAP rate or Capitalization rate, is the rate of return of an investment measured as percentage of the purchase price), for the following type of investments: hospitality, retail, single tenant industrial or office, national credit tenant with 10 years or more left on an absolute NNN lease. By sticking to these criteria, I'm able to quickly sort through investments that my client will consider. The evaluation process starts at that point.

Part two is sticking to fundamentals, recently I found an investment meeting all the above criteria. The national credit tenant was a publicly held outdoor equipment/camping equipment/hunting equipment retailer. When I started evaluating the tenant, I found that even though they were publicly held, they had not made a profit in the 5 years they were public. Considering the current weakness in the retail sector, and the expected length of said weakness, we passed on the investment. Although the deal looked good from many aspects, the fundamentals were not. The tenant isn't financially strong, they have a weak market cap, they have never shown a profit, and the prospects of increasing margins and/or revenue in the current retail environment are weak. Debt financing, will come at a steep price, if at all; and chances of raising equity financing in the next 24 months are also suspect. We concluded, they probably will not last through the life of their lease.

As another example, I found a client two good investments that matched all the investment criteria, and had good fundamentals. In this scenario we took the evaluation one step further. One investment had a higher CAP than the other (in other words, as a multiple of income, it was priced lower). On the surface, we would choose the higher CAP rate investment, but the equity requirements were different for both deals. The lower CAP investments required less equity, making the cash on cash return higher for the lower CAP investment. We chose the lower CAP investment.

Current credit and economic conditions are going to make the next 24 months a target rich environment for well funded investors. The key to picking good investments hasn't changed; define your criteria and stick to fundamentals. The failure of lending institutions to follow these investment fundamentals caused the current market correction. Many investors that followed sound principles through the boom, now have the capital to pick up good assets at steeply discounted prices. Which are you? Which do you want to be?

For more information contact Chris at christofer.pacheco@gmail.com .