REAL ESTATE SURVIVAL

Its a Tough Market Out There. The Denver market is in better shape than most. The main reason for this is that our market started to slow almost 4 years ago. Other parts of the country didn't slow down until a couple of years ago. As the market approached a more normal state, those who bought when the market was overheated found that they couldn't sell the properties for what they paid for them. Complicating the situation is the fact that people bought with little or no down payment so instead of seeing their equity decrease to a smaller number they found that it decreased to a negative number. In other words, they owed more than the property was worth. If they bought a house that could be rented for the payment amount, they could afford to wait. If not, they were looking at taking money out of pocket each month to do repairs and make payments and there was no end in sight. As if the initial negative cash flow wasn't bad enough, many buyers had sub-prime mortgages that escalated drastically after one or two years. Despite "stimulus packages" and interest rate cuts, foreclosures are still high and many builders have inventory they absolutely have to sell. These make formidable competition for the average home seller. In some subdivisions builders are selling existing inventory for considerably less than current home owners paid for their properties two years ago. This situation exists in the Denver area as well as other parts of the country.

So why is the Denver market is in better shape than most? As I posted two weeks ago, the current inventory of resale properties, especially townhomes, has finally started to decline after several years of increases. This means that the supply is shrinking to be more in line with existing demand. Another factor is that builders are producing fewer new properties. During the first 11 months of 2006, there were 10,478 single-family building permits issued. This dropped to 6917 during the first 11 months of 2007, a decrease of 34%. Over this same period, condo/townhome permits decreased from 4922 to 4510, a decrease of 8%. While the decrease in townhome permits is not as dramatic, bear in mind that the decrease in building permits has been occurring for several years. Last year's level of townhome permits was already 50% lower than in the early 2000's.

So How Do You Sell Your Existing Home in This Market? The first thing that comes to mind is don't. Those who hang on will almost certainly get a better price in the future than they will now. If you plan to sell and move up to a bigger house, it is not as important to get top dollar for your present home since you are buying another home in the same market and what you lose on your old home will be compensated for by a better price on the bigger property. If you are an investor with a rental unit, your first move should probably be to try to maximize your cash flow from that property. This doesn't mean you go to the tenants and tell them you have to have more money because your negative cash flow is too high. They don't care what your cash flow is. On the other hand, if you are renting at a below market rate, you can raise the rent to the market level or slightly below with little danger of losing the tenant. If you do, you should have little trouble getting a new one. Rental rates are a function of supply and demand for rental units, not your need for additional cash flow. You can also look at improving your property to get higher rents. Those properties that are in top condition will always attract more tenants or buyers than marginal units. It never ceases to amaze me how many owners will put their properties on the market in sub-standard condition. Buyers will always pay for quality. Trying to rent properties in sub-standard condition will face an additional risk in that they will get tenants who are willing to accept the situation because they have no pride in where they live. As a result, they will almost always vacate the property in worse shape than at the beginning of the rental period. It has been said that the most important three factors in real estate are, "location, location, location." While this may be true for raw land, I believe the most important factors for rental real estate are, condition, condition, condition.

There is Always Risk in Investments. We are holding more cash in our own portfolios and those of our clients to temper market risk; however, we are well aware that holding cash is not without risk. For example, if you invested $500,000 in cash at 5% a year or so ago, you could receive a $25,000 annual return. Next year when that CD matures, you will only get $15,000, Good luck if you need this money to fund your living expenses. Over the long run, a well-constructed portfolio of real estate and financial assets will almost always outperform cash by a wide margin. Next year will be particularly difficult but there are bargains to be had in the marketplace. It is much better to be a buyer of assets at this time than a seller.

RIDING ACROSS COUNTRY

Listening to Talk Radio. I've been on the highway a bunch during the past month. How does 4,000 miles sound? When I told a friend about this trip, he said he had driven about 4 miles in the same period. What can I say? I hate the hassle of airports and I like the freedom of being able to come and go as I please and not by the some airline schedule which is often wrong anyway. In this last leg of my trip from Denver to my lake house, I forced myself to listen to financial talk radio. What an experience that was. The underlying theme of most of these shows was an emphasis on what to do if you are losing money in the market. One commentator, Kathy DeWitt devoted two hours to extolling the virtues of their fixed income investment that guaranteed 18.74% return for the first year. "Yes folks, That's Eighteen point seventy four percent guaranteed by the second largest money manager in the world. You can get out of the risky stock market and get Eighteen point seventy four percent. If you'll just call for your appointment today we will stop your stock market losses and guarantee you Eighteen point seventy four percent. Our financial advisors are standing by for your call so you too can get Eighteen point seventy four percent". She said virtually nothing more than that for two hours. Can you believe I stayed with the program for that long. I wanted to find out what kind of investment she was talking about and who the money manager was but she never said. Would you make an appointment to drive to her office and hear the presentation? I can't believe anyone would but surely the company wouldn't be buying two hours of radio time if they didn't anticipate a lot of business from the program. Fear can drive you into some even more dangerous situations than the stock market.

Life Settlements Were Another Popular Pitch. Ever heard of these? My first experience with these came in the early 90's when the AIDS epidemic was nearing full swing. What they did was buy an insurance policy from a terminally ill AIDS patient for some discount below the face value. Then, when the patient dies, you get the face value of the policy. Everybody wins except the insurance company and the heirs. These investments, called viatical settlements, became less popular when the new drug regimen was discovered that prolonged the life of AIDs victims. Now AIDs patients are being replaced by "unhealthy senior citizens 78-80 years of age." Check it out folks. Call your elderly parents or grandparents and see if they have an old policy lying around that they would like to sell. If they don't just call Life Partners of Waco, Texas and we will get you one of these investments. You know what you will get the day you make the investment (the face value of the policy). The only problem is you don't know when. Just hope medical science does not discover a way to prolong the lives of "unhealthy senior citizens" like the way they did AIDs patients. On a more serious note, Life Partners is a company that has been around for a very long time and they perform a valuable service for many terminally ill patients who need money for their care. I have nothing against the company, only the unseemly way their product was marketed to investors who are anxious to stop the bleeding from their stock market and real estate investments.

How About a Variable Annuity? Some of these guarantee a return of your capital if you die. You are also guaranteed a minimal return if you hold it long enough. In addition, they promise some participation in the upside if the market does well during the holding period. These products are very complex and many of those who sell them don't really understand how they work. Just remember the "no free lunch" rule.

Everyone Has A Solution To The Current Market Volatility. Unfortunately, I don't believe any of them. I'll just stick to buying cash flow and believing that as long as I have income, the market will gradually return to historic levels.

SOMETIMES I FEEL LIKE A BROKEN RECORD.

Can Cash Flow Make Up For Falling Prices. Clients often ask me how I can hold on to a stock when the price is dropping. The question they ask is, "What good is a quarterly dividend of $1.00 when the price of the stock drops $10. If you think the stock is going to continue to drop and will never rebound, it is probably best to sell it but that is seldom the case unless the dividend is reduced or discontinued. Using a American Capital Strategies, company I have held since December 2000 as an example, we can see the value of dividends over a long holding period. The stock was paying a $2.08 annual dividend when I bought it for $22 per share. Based on dividends alone, the annual return was 9.5%. I have held it for the past 7+ years, during which time the dividend has increased steadily to the current $4.00 per year. My total dividends collected over the holding period were 19.93, only slightly below my $22 acquisition price. During my holding period, share prices ranged from 17 to 48 per share. In February of 2007, the price was $48 per share. Since that time it has dropped to as low as $26. It is currently at around $34. If I were a genius, I could have sold at 48 and rebought at $26 but I have no way of knowing how share prices of an individual company are going react to market dynamics. There is a whole volume of research that shows share prices don't react to news in a consistent, predictable manner. Another volume of research shows that the majority of investors tend to be worse off when they guess when to get in and out of the market. It has always worked out better for me to monitor a company performance and sell only when I think the fundamentals of a company have changed. I really don't care that the market price of American Capital Strategies has dropped from $48 to $34. I am satisfied with my $4.00 annual dividend.

Some Financial Experts Agree With Me. Wharton Professor Jeremy Siegal has published some calculations that show 97% of the market return over the period from 1872 to 2003 have come from dividends and only 3% come from capital gains. Despite my preference for cash flow, I am surprised that those figures are that high. Kathleen Fuller and Michael Goldstein published an article that show, in a declining market, dividend stocks out perform non-dividend stocks by 1 to 1.5% per month. Even more important, they do it with less risk. In view of these statistics, I am surprised that you don't hear more about dividend stocks.

Will The Market Value of Your Portfolio Decline More? I think it probably will, especially after today's 370 point drop. You can get out if you want. Safe returns are 2-4% and going lower. For me, this is a surefire way to being forced to lower my spending habits. While this isn't all bad, I prefer to change my habits by choice, rather than by necessity. You can take your licks in non-dividend stocks, or you can move into some of the higher dividend stocks. You may have to wait for a rebound in price, but at least you'll be paid to do it.