WATCHING REAL ESTATE CYCLES.

Why is Real Estate Cyclical? Just about everyone knows that real estate prices cycle from high to lows depending on market conditions. As markets improve more and more investors, builders, and flippers want to get into the market. Rising prices and higher profits result in higher demand until prices strain affordability to the breaking point. When that happens prices level out or drop until speculators decide that opportunities are limited. Prices then level out or even drop. We watch several statistics to get an idea of the risk level in a given market. One very important factor is the number of building permits being issued. In one of our previous posts we showed that the number of single-family building permits decreased by 34% from 2006 to 2007. Condo/townhome permits decreased by 8.3% over this same period.

Is This Trend Continuing? Looking at January 2008 compared to January 2007 certainly leads to that conclusion. Last January there were 344 single-family permits issued compared to 548 the previous year. Looking at condo/townhomes, we saw only 88 new permits this year compared to 614 last year. This represents a decrease of 85.7%. Of the 88 permits issued 58 or 66% came from Denver and Jefferson County. Arvada, Aurora, and Arapahoe County reported no new permits.

Its Not Yet a "No Brainer." Markets may drop even further and there is no guarantee of success; however, each month has brought us some new encouragement. Stay tuned for the next chapter.

Cash flow Is Improving. Vacancy rates in rental units is dropping slowly and rental rates are starting to rise. One investor I know who has 40 years experience in the business is beginning to acquire units to rent out and hold for up to three years, at which time he believes the market will rebound and he can sell those units at a profit. Not a bad strategy for patient investors. Generally, the best buyer for these investments will be nearing peak earning years with ample income from other sources.

LOOKING FOR NEW ENERGY SOURCES

Why Don't We Just............. You fill in the blank. This statement is usually followed up by suggesting some alternative energy source like bio diesel, ethanol, hydrogen, solar, oil shale, etc. I don't want to burst any one's bubble when I tell you that it ain't gonna happen folks. At least, not in a hurry. So-called experts used to tell us that alternative energy sources would be practical when oil was 60 dollars a barrel or higher. With oil at almost $110 a barrel, you would think companies would be scrambling to bring new sources to the market. You can always bring the old paranoia back and say that the oil companies are protecting their vast wealth by destroying any attempts by entrepreneurs to develop alternative energy sources. Let me assure you that these companies are just as eager as you are to develop alternative energy. If they don't, their future is limited by a finite pool of fossil fuels waiting to be found. Many of these companies are using their profits to buy back their shares rather than search for new reserves because of the high cost of finding and developing those reserves. Here is the most important point you need to remember about alternative energy sources: It Takes Energy To Make Energy. What does that statement mean? Using ethanol from corn as an example, you have to use fossil fuels to cultivate the soil, fertilize, water, and harvest the crop. Then you have to convert the corn to ethanol and distill the ethanol to the desired purity. At the end of this process you have a fuel that you can use for energy; however, you get very little more energy out than you used to manufacture the ethanol. This example holds true for a number of alternative sources. Using current technology, by the time you consume the fossil fuel it takes to produce these alternative sources, you might as well have burned the fossil fuel for energy in the first place.

Are We Doomed? I don't want to imply that we can never have alternative energy sources, only that we have to use fossil fuels until we develop the technology to make these sources economically feasible. Of course we can conserve by limiting our consumption which means driving less, lowering thermostats in the winter, buying more fuel efficient cars, etc. This can help a lot in the short run but it only buys time. We need to obtain more domestic fossil fuels to use in the transition period between now and the availability of alternative sources. We need to utilize more of one alternative source that is currently available and that is nuclear energy.

I Am An Environmentalist. I love this planet and I believe we need to limit those things that do harm to it. I differ from the majority of those who call themselves environmentalists in that I realize we have to be practical. It is insufficient to just call our attention to the problems, we have to find solutions. Don't just tell me that the planet is growing warmer, tell me a practical, economically feasible way to prevent it. Don't tell me that we can't develop known fossil fuel reserves in the US, tell me how to find the energy we need without enriching the treasuries of those countries dedicated to bringing us down.

On a More Positive Note. I don't know how many of my fellow Colorado residents have heard about the purchase of the Louisville Storage Tech site by Conoco-Phillips. They propose to develop a huge research facility dedicated to energy research. They will be looking for alternative energy sources and more efficient ways to utilize fossil fuels in the interim. This could be very positive for the Colorado as well as the national economy. These are the kinds of steps we need to take.

How Important is All This? A recent poll shows that more people want to solve these energy problems than want a cure for cancer. While this may sound appalling to those of us who have lost loved ones to cancer, it shows how important this issue is to Americans. I will strive to discuss this issue more in the future and relate it the management of our current finances.

SOME INVESTMENT PRINCIPLES

What Principles Govern My Investment Policies? I've never claimed to be a guru when it comes to investments and I have often said that there is no one approach that works all the time for everyone. Still, I have several principles which strongly influence the decisions I make. Here are some of them.

1. Cash Is Not King. Never has been. The real king can be seen in the title to this blog: Cash flow. I'm sure none of my regular readers will be surprised to hear this. You can generate cash flow from a stock portfolio in several ways but the main two are dividends and capital gains. Of the two, dividends are the most reliable; however, it depends on your station in life. If you need the cash flow to sustain your lifestyle, dividends are definitely preferred; however, if you are younger, with ample income to support your needs and a long time frame before you need the cash flow, you can depend more on capital gains. A friend of mine once said, "You can't eat growth."

2. You Can't Time the Market. Over the years, I've met advisors who use several different methods to get you in the market or out at appropriate times. Few, if any, are still around today. While there may be some who are successful at this, I have never met anyone who can deliver consistent results. Anyone who left the market last September and stayed out until the present is sitting on a bunch of cash they can use to re-invest. If you will look at my posts from last summer, you can see that I had some fears about the stability of the market. Still, I didn't have enough confidence to go totally out of the market.

3. You Cannot Not Forecast. I am reminded of Thomas Dewey who once forecast that he would be voted president of the United States. Before he went to bed on the night of the election he told his wife, "Tomorrow night you'll be sleeping with the president of the United States". The next morning, he and his wife heard the news and his wife asked, "Tom, will I be going to Washington or will Mr. Truman be coming here." (I must give credit to my friend Steve Goodier of lifesupport.com for that story). Even if you have no intrinsic forecast in mind, every financial decision you make involves a forecast. For example, if you choose a lower interest rate adjustable mortgage over a 30 year fixed rate, you have forecast that interest rates are unlikely to go though the roof and the current lower payment will be less than with a fixed rate for some time. I would encourage everyone who doesn't have a set of assumptions about what you think will happen in the future, to write some down. These should have an influence over your current decisions and you should always ask yourself if a decision you are making is consistent with your assumptions. You might be surprised at how often they are not.

4, Price is What You Pay, Value is What You Get. The Motley Fool website gets credit for that little slogan. What it really means is that the market may "misunderestimate" the value of a stock. A stock may drop for a number of reasons, not all of which are indicative of the fundamental value of the underlying business. An example in recent times is the large drop in the price of all oil service sector stocks right after Slumberger reported disappointing earnings. Stocks in a given sector often advance or decline based on some event that influences the price of an industry leader. While this isn't always irrelevant, it often is.

5. Watch The Business Not The Stock. I have mentioned before that you are buying into a business any time you buy a stock. Instead of becoming enthralled with the fluctuations in the market price of the stock, watch the business fundamentals and management action. Base your buy/sell decisions on these rather than price changes.

6. Patience Is Genius. It's OK to bail out of a stock if you change your mind about the prospects of an investment but if the company you buy is still fundamentally sound, have patience even if the price drops. I have been advised by a close friend to use "stop losses." which are automatic sell orders if a stock drops to a certain price. Granted, these can be invaluable when a stock drops before the news about the fundamentals come out but I have found it preferable to base my decisions on fundamentals not price. In the late 90's I bought real estate investment trusts, even though the rest of the market thought they were less valuable than the high tech stocks that were all the rage. I chose to stay with them and buy more, a strategy which allows me to work on my own schedule now rather than being chained to my office every day.

These Are Trying Times. High home foreclosures, volatile stock prices, falling home values, and inflation worries are rampant. I know astute investors who have made the decision to get out of the market entirely. My approach is as it has always been. Stay informed and act accordingly.

EXCESS CONSUMPTION

I Try To Stay Away From Sugar. That's because I have diabetes. Fortunately, they make everything from Hershey's chocolate to Jello Pudding without sugar. Sometimes they use a substance called "sugar alcohols" which are chemically altered sugars that have a sweetening effect without causing an increase in blood sugar. If you read the label carefully, you will see a warning that says: "Excess Consumption may have a laxative effect. As one who has experienced excess consumption of sugar alcohols, I am here to tell you not to ignore that warning.

We Can Extend That Warning To The Economy. A natural consequence of excess consumption causes considerable discomfort in our economy. That's why the Fed and JP Morgan had to bail out Bear Stearns. The Bear got in trouble because they were stuck in the sub-prime mire. The sub-prime fiasco was started to allow borrowers with no down payment and marginal income to buy houses they couldn't really afford (excess consumption). During the past five years, virtually anyone who could fog a mirror could buy a house. Lenders who originally made sub-prime mortgages cashed in big time. Because few lenders offered these loans, they had little competition and could charge high enough interest rates to offset the projected higher delinquency rates. Because of property appreciation and a high demand for housing, the projected high delinquency rate didn't happen. Because of the high profit margins, more and more lenders got into the business and competition forced lenders to lower their rates and relax their qualification standards. The Fed didn't help when they lowered the fed funds rate to 1%. The yield on savings accounts went through the floor and investors had to utilize a more speculative approach to get higher investment returns. We are now experiencing the "laxative effect" that the labels on sugar free foods warn us of.

So Now What Do We Do? The Fed is trying. They even took time yesterday (Sunday) to lower the fed funds rate by a quarter per cent. Another cut is expected on Tuesday. This is the same practice that caused the present fiasco, only now some other unintended consequences are taking place. The dollar has lost much of its value. In Europe, oil prices are up over 100% as opposed to 200% in the US. This is because of the weak dollar. I may sound like the people I complain about, those who love to point out problems but have few solutions to offer. Here are some of the more obvious measures you can take.

1. Raise cash. I don't mean to imply that you should sell everything and go to cash; however, instead of re-investing your interest and dividend payments, leave them in cash. This will allow you to withdraw money for emergencies without having to sell assets into the current soft market.

2. Avoid excess consumption. Don't use credit cards if you can't pay the balance monthly. Don't borrow on your home to buy depreciating assets (cars, furniture, etc). Before making a major purchase ask yourself if you really need it and make sure you can afford it. If you aren't willing to pay cash or write a check, you probably are better off foregoing the purchase.

3. Diversify. Don't put all your money into any asset class. While I recommend emphasizing certain market sectors to fit what you want to accomplish, don't overdo it, especially in this volatile market.

4. Don't quit your day job. Unless you are absolutely certain you will have adequate cash flow to replace your employment income, don't quit working just yet. If you've already retired, look for new employment, at least part time. This income can help you weather some tough times and may even be better for your mental health than a life of leisure.

Reflections on Turning 70. I guess I am now one of the "elderly" but I am not retired. I still have clients and I still manage money and consult for my former company, "Westmont." Frankly, I am as retired as I want to be. I am reminded of the 103 year old skycap at the Beaumont airport who considered himself extremely fortunate to have such a fine job at his age. He called in sick on a Friday and passed away the following Monday. A much better fate than being "warehoused" in a nursing home waiting for death to set you free.

POLITICS AND YOUR PORTFOLIO

Your Check Will Soon Be In the Mail. Hey! Let's send everyone six hundred dollars. That will solve our economic problems. It's doubtful that many investors believe that. If the stimulus package is an example of how the government is going to solve our problems, I prefer the problems. In my last post, I was critical of those who believe the declining value of our homes and our 401k plans is more important than international conflicts. One of my readers reminded me that a lot of folks are in "survival mode" and are so worried about their financial situation, they have little energy left to worry about anything else. I can understand that. I've been there. In reality, it is difficult to separate what's going on in the political arena from what's taking place in the financial markets. The government has little power to control the markets and their attempts to try have consequences that are often different from those intended.

We've Been On A Binge. In an attempt to encourage home ownership and full employment, as well as mitigate the economic consequences of 9/11, the FED lowered interest rates to unrealistic levels. Investors seeking high yields bought sub-prime mortgages. This allowed borrowers, who could barely afford to pay rent, to buy homes they couldn't possibly afford long-term. Buyers who needed a 1500 square foot home bought 3000 square feet with adjustable mortgages and low initial interest rates. The party is over but no one wants to go home. How can we prolong the party? Sending everyone 600 dollars that we borrow from China will only add a few hours and we will still have to go home and sober up. Allowing congress to change the terms of existing mortgages might save a few homeowners from the horror of foreclosure but it will also discourage lenders from making new loans without higher profits. The bottom line is that we will have to solve our own problems and not depend on the government for solutions. Betty and I will donate our $1,200 to Wounded Warriors and pledge to make sure we live within our means. We will continue to practice prudent investment strategies that emphasize cash flow over capital appreciation. We will keep an eye on the markets and government policies in an effort to preserve capital and obtain a reasonable rate of return.

It's A Cold, Clear Day In East Texas. Looking out my window I see Azaleas blooming, green grass, and Magnolia trees with glossy green leaves. I am indeed fortunate to have survived 70 years on this beautiful planet. I know I can't predict what tomorrow will bring but I am extremely thankful for this day.

MAKE LOVE NOT WAR.

Hell No...We Won't Go. War is not healthy for children and other living things. What would happen if they gave a war and nobody came? Remember those statements? I sure do. They were part of a fierce anti-war campaign brought forth during the Viet Nam era, almost 40 years ago. These protests were certainly a major factor in our decision to abandon the war effort. Almost 10 years of effort, 50,000 American lives wasted, and hundreds of thousands of Asians were down the drain after we left. We didn't lose the war because of our military, we lost it because the folks at home lost the will to fight. Should we have been in that war? Two democratic and one republican president thought it was worth trying to win. They had huge brain trusts of military and diplomatic advisors who thought so. Looking back, I can't imagine why so many thought they knew more than the commanders in chief and their legions of advisors.

How Does This Relate To The Current Conflict? One similarity stands out. We have more than a hundred thousand of our young people with their lives on the line while the rest of us go about our daily business. In the Viet Nam era, the "sex, drugs, and rock and roll" crowd marched the streets, attended events like Woodstock, and smoked dope on the streets of San Francisco while our troops were sleeping in the mud and rain if they were lucky enough to survive the day. What are we doing while our soldiers are being killed and maimed? The vast majority of us are more more worried about the value of our homes and our 401k accounts than we are about our kids. Don't take my word for this. Look at all the polls taken during this primary season. They show that the economy is by far the main concern of the voters.

Should We Have Gone To War In The First Place? My position is that I don't consider myself qualified to out-guess those who began this venture. They had access to far more information than I. Most everyone blames President Bush. How can we possibly believe he made this decision by himself? Prior to the invasion, I heard politicians from both parties proclaiming the danger from weapons of mass destruction that were proven to be present in Iraq at one time. Most of those politicians conveniently forgot these statements and place all the blame on Bush.

What Should We Do Now? It's too late to dwell on the question of whether or not we should be in Iraq. The real question is whether or not we should beat a hasty retreat. I tend to think that would be the worst strategy. We can ill afford to leave that area to those who who want destroy us. I'm tired of those who complain about what is going on without offering a solution. Want to close down Gitmo? What do we do with those who are detained? Don't tell me we shouldn't have established the facility in the first place. It's too late to change what has occurred. I could support any solution that made sense.

One Serious Question Is Whether Or Not You Will Read This. I have tried to stay away from politics on this blog and I am tempted to erase this entire post before anyone gets a chance to see it. I know much of what I have said sounds partisan but the main point is that we need to make this conflict our main concern and we need to work together to find an honorable solution.

MANAGING YOUR RISK

What Can We Do To Lower Our Risk? Just when you think your portfolio is coming back, we have a day like yesterday when the Dow Jones average lost more than 300 points. Retail stocks, financial stocks, and even energy stocks were hit hard. The sub-prime mortgage debacle and lousy housing markets are spilling over into a number of other sectors. Oil at $100 a barrel has resulted in consumers spending much of their discretionary money on gasoline to get to work and the grocery store. None of this adds up to a favorable economic environment. As I have said before, much of this correction is a healthy payback for the excesses of the previous 5 years when people bought bigger houses than they need and borrowed on their home equity to finance purchases they didn't really have to make. Stocks and real estate have dropped because they were driven to unrealistic levels by easy money. Everything became over-priced and now a correction is necessary. All this is an attempt to explain that which really can't be explained. The real question is in the first sentence of this paragraph. What is an investor to do? Here are some suggestions.



Get Out of The Markets. This is what happened in the late 70's and early 80's. (See my last month's post entitled, Turn Around and Run Like Hell). To a certain extent this worked in the 70's and 80's because people were able to get 8-12% on insured bank CD's. The trouble was that they saw these rates drop to 2-3% over the years that followed as inflationary excesses were wrung out of the economy. With rates already down to 3-4%, it is difficult to settle for returns that low. Despite my encouragement to stay with the markets, I have reduced my and many of my clients exposure to the markets by increasing cash reserves. A radical change to 100% cash is nothing I would recommend, so here is another approach.



Stop Worrying. Suppose you bought 1000 shares of 3M in August of 2007 at the high for that month of $91,000. Six months later the "value" of your investment is $78,000. That's a loss of $13,000. Or is it? What you bought was a share of an operating business. The market thought that business was worth $91 per share. A scant six months later, the market thought that business was worth $78 per share. Has the business really changed that much? Not to my way of thinking. Worrying about daily market fluctuations is like planting carrots and pulling them up every day to see if there are carrots forming yet. My philosophy is to buy great businesses like 3M and stay with them unless the fundamentals of the business change. The market is a manic-depressive. Don't let it make you one. There is another criteria I use .


Look For Cash Flow. I bet you knew this was coming. Using 3M as an example, in August of 2007 3M was paying a $480 quarterly dividend. Not a huge yield, but its close to what you would get in a bank. In addition, your tax rate is only 15%, less than half of what a high income investor would pay on a CD. Recently, 3M raised this payout to $500 per quarter. They have raised this dividend each year for several years (in 2003, the payout was $330 per quarter). Statistically, dividend paying stocks have been proven to be less risky than those who don't pay dividends. Using Dow Jones statistics, their are three times as many dividend paying stocks in the below average risk category than non-dividend paying stocks. Even if you earn more than enough money to fund your living expenses, the lower risk category of dividend stocks make them a must for virtually any portfolio.

I Spend Several Hours Each Day Studying The Markets. If you are one of my clients, remember I do it so you don't have to. That doesn't mean I encourage you to stick your head in the sand. If it is as much fun for you as it is for me, by all means do it. If not, spend your time doing things you enjoy. The main thing is not to spend it worrying.

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.

WHAT'S GOING ON WITH DENVER REAL ESTATE.

Are Things Looking Up? The demand from real estate investors has certainly slowed down. This means that you won't have as much competition for properties as you had last year at this time. Vacancy rates are down. This means that you will have an easier time finding tenants this year. Interest rates are down. This means that you will be able to finance your acquisitions at a lower interest rate. Of course, financing is harder to get because of the sub-prime debacle. Still, if you have good credit and a respectable down payment there are a slew of lenders eager for your business. In all, now is a much better environment for real estate investments than we've seen for some time.

A Conservative Approach is Best. My real estate investment philosophy is the same as my stock market investing philosophy. Look for cash flow. No one can predict the direction of market prices. Although we want an environment where prices can increase, we never know for sure when that will happen. If we buy when prices are lower, rents, are higher, and financing costs are lower, we have a better chance of achieving a positive cash flow. This allows us to tolerate price dips and choose a time to sell when we can obtain the best return on our investment.

So Is It Time To Buy? One factor I always look at is the inventory or properties for sale. At the beginning of 2007, we had 18109 Single family houses on the market. This year we have 18709. At the current rate of sales, the present supply would be expected to last 5.8 months vs. 5.5 last year. This means that supply/demand factors are a little worse this year than last but not by much. In contrast to other cities, the Denver market isn't getting much worse.

Let's Look at the Condo/Townhouse Market. Currently we have 5894 properties on the market or a 6.43 month supply. Last year at this time we had 6425 properties on the market or a 7 month supply. It appears that the supply/demand balance is improving slightly. These figures would indicate that, while we are not out of the woods yet, this market is improving. Potential investors in this market should look for well-located units with an established home owners association. I have always thought that the demand for single-level units was increasing faster than the supply so this is the area that I would emphasize in my search for strong investments.

We'll Keep Watching. We believe that the real estate investing environment is the best it has been for some time. We will keep watching. In 1991, the signals for a bull market in real estate were clear and aggressive investors made a bundle. We don't intend to miss it this time.

YOUR CHECK IS ON THE WAY.

The Government Rides To The Rescue. The president and congress have agreed to send you a check, that is if you don't make too much money. Somewhere between $600 and $1,200 will be headed your way. What a deal. And they don't want us to do anything productive with it. Just go out and spend it. Wait a minute. The government has no money. How can they send us a check? In fact, the government is in debt. Where will the $150 billion they need come from? They've already thought of that. They will borrow it. Just call China, Japan, etc and tell them to add it to our tab. I'm so glad they thought of that. I was beginning to worry that we might have to stop buying all this junk that complicates our lives. We might not be able to keep building larger and larger houses and taking advances on our credit cards to pay our ever increasing utility bills. We can keep doing what we're doing and leaving our grandchildren to pick up the tab.

I Have An Idea. Let's stop this stuff right now. Instead of spending the money they send. Let's use it to pay down our high interest debt. If we have any left over, let's put it in the bank. Let's cut our expenses and buy less than we can afford. Let's save our cash to take advantage of bargains in the real estate and stock market that will inevitably be available from those who have to sell to meet their living expenses. Lets invest in instruments that pay dividends so we can meet our income needs without having to sell assets.

Still In Scottsdale. We've been in Scottsdale Arizona since Sunday. My brother has his surgery at the Mayo Clinic at 5:30 in the morning. Hopefully, we will be through with this place next week at this time. I should be back in Denver by the first week in February. Hopefully, I will have time to visit with some of you before time to head back to Texas. In the meantime, stay tuned to this spot for more exciting rants about ways to cope with this weird economy.

SOMEBODY HELP US.

Who is Going to Help Us? I just listened to the Fed Chairman discuss with members of congress the possibilities for helping us avoid a recession. I must admit, I don't have much faith in congress or the FED figuring out a way to resolve this problem. Although there is some talk of co-operation between Democrats and Republicans to obtain a solution that both sides support, it doesn't look to me like it can happen. The Republicans want to stimulate business growth to provide opportunity and higher incomes to consumers and the Democrats want to send money directly to consumers. I have a sinking feeling that neither strategy can work. Its kind of like trying to cure a night of binge drinking and overeating by sending the binger to the hospital for a stomach pump and an enema. That sometimes works in drastic situations but the cure is often more traumatic than the disease. Sometimes you just have to change your habits and let the natural mechanisms take over. Let's face it. We've been on a binge fueled by cheap money and foreign capital inflows. We need to slow down and regain our health to regain the confidence of the investment community. Some people will lose their homes. A tragedy, no doubt but they shouldn't have bought big houses they couldn't afford. Some consumers will have to stop spending because their credit cards and home equity loans are at a maximum. This will mean job losses and business failures in a number of sectors, especially retail. Some large banks and investment banking firms will have to scramble to shore up declining balance sheets and several highly paid executives will lose their jobs along with clerical and service workers. Home builders will have to cut their plans to produce more housing inventory in a market with more resale and foreclosure inventory than it can handle. When the smoke clears, we will regain our health and, hopefully, learn to live within our means.

How Do We Handle The Slowdown. I have a retired friend who recently informed me that he has sold most of his stock positions and has 75% of his investment portfolio in a savings account. He says his main problem is trying to support his family on a 4% yield. I have news for him. As the FED continues to cut interest rates, that yield will drop to 2-3%. While we have raised cash in most of the portfolios we manage, we don't recommend moving to that much cash. In a market where you can find 8-12% dividends, moving totally to cash is not a strategy I can afford to follow. If we utilize a portfolio that produces adequate cash flow and we employ more prudent personal spending strategies, it is possible to ride out the market adjustment and have some cash available when the markets recover. I realize this post is short on detail. I'll get more specific on strategies later on.

TURN AROUND AND RUN LIKE HELL

A New Investment Strategy? Turn Around And Run Like Hell is the title of a book I received as a Christmas gift. It is actually, a compilation of war time battle strategies, not a book on how to cope with the recent market distress. You can go back to my post of May 15 entitled, Beware The Receding Tide, as proof that the current market situation is not a huge surprise to us. You can also look at my post of July 15 which makes the point that excess liquidity in the marketplace is causing investors to make some really stupid decisions. So if I anticipated the current correction, why didn't I sell everything and put everyone in cash to preserve capital to invest in anticipation of a turnaround when things change? The answer is that I wasn't positive that a downturn was coming, I didn't know when it would arrive, and I didn't know which sectors would suffer the worst. What we did was raise some cash by accumulating instead of re-investing dividends and selling those stocks that we felt were overvalued. We continue to follow these strategies. If we had known that the correction would begin this fall and that it would involve mostly financial stocks, we would have "turned around and ran like hell." We didn't and now it looks as if totally selling out at this point would result in giving up a lot of upside potential, which appears to us to outweigh the downside risk. For one thing, we continue to collect rich dividends, and for another we believe that a rebound in share prices has more potential than a significant decline. Selling out at market bottoms is exactly this strategy that causes the average investor to miss out on market rebounds.

So What Is Our Prediction For the Future? Short-term it appears that the mortgage and housing industries are a year or so away from a rebound. Financial stocks will remain out of favor and the good will suffer along with the bad. Our current portfolio of high-dividend stocks will languish; however, as more people realize that cash flow and intrinsic value are more important than the market perception of value, we should see a rebound in market prices. My investment strategy will be to keep an eye out for reasons that we might change what we are doing; however, it is highly unlikely that we will be tempted to "Turn Around and Run Like Hell.

BACK IN TEXAS

Back After A Long Trip. After flying to Denver to check on business, I got in my pick-up truck and headed Southwest to Arizona. I had a number of things to take care of such as scattering the cremated remains of my uncle on a mountain in Tucson and visiting my 88 year old father in Mesa. After that, I rode across the desert and back to the woods here in Southeast Texas. I'm glad to be back.

Is An Annuity In Your Future? If you read the financial press, you'll see many negative articles about annuities. Granted, the management/mortality fees are somewhat high and the surrender charges can be excessive if you cash in before the required 5-10 year holding period, Much of these disadvantages are the result of over-zealous sales tactics by some commission-driven sales people. Just like most other financial products, they are useful a number of circumstances and mis-applied in others. For example, I recently ran across a couple with 100% (almost $1 million) of their IRA money in a variable annuity. My opinion is that there are at least two things wrong with this scenario. 1. IRA's are tax advantaged instruments which allow the build up of earnings inside the annuity with no current taxation. Annuities offer the same tax deferred build up. Buying these instruments inside an IRA offers no additional tax advantages and the investor ends up paying excessive fees for services charges inside the annuity. While there might be some reasons for including an annuity in an IRA (I'm being charitable here), you never want to devote 100% of your IRA to an annuity. 2. The other flaw in this scenario is that your investments are limited to those offered within the annuity. While these can be quite broad, they are still a long way from being comprehensive.

What's The Real Benefit Of An Annuity? When I took my financial planning courses, the official definition of an annuity was "systematic liquidation of capital." Sound like a trip to Las Vegas? Translated into English this means that an annuity allows you to draw principal and interest from your investment at a previously agreed upon schedule. Viewed as an insurance, rather than an investment product, the real benefit of an annuity is that it offers a guarantee that you will be able to receive an income stream as long as you live. It insures that you will never outlive your income. For example, consider a 66 year old male with $300,000 in capital. This individual doesn't want to be bothered with managing his investment portfolio and doesn't want to worry about outliving his money. One alternative is to buy an annuity that would pay $2067 a month for life. If he lives until age 90, his total payments would be $570,492. Upon his death, payments cease and there is no money left for heirs. If a spouse is involved, there are other options, one of which is that, in return for a smaller income stream, there is also a guaranteed income for the lifetime of a spouse. In the case of a 63 year old spouse, the income would be $1,773 and the spouse would also be covered for her life. This is an oversimplified approach. I received these numbers from a web site, www.immediateannuity.com. While the site provides a quick estimate of the available benefits, there are other details to consider which are too cumbersome for discussion here.

There Are Obvious Disadvantages To This Approach. If the investor and spouse die in a flu epidemic during the first year, the insurance company gets all the money and the heirs get nothing. In addition, inflation would reduce the purchasing power of this income stream over the years. Theoretically, it is possible to receive this same income from an investment portfolio without forfeiting the principal at death. The main benefit of this approach is stability. You give your money to the insurance company and the game is over. You don't have to worry any more since your income is guaranteed for life. There are also a number of compromises. You could invest part of your money in this instrument and the remainder in other investments. This would enhance the stability of your return while the other investments would allow the possibility of capital appreciation and higher returns. The task is to choose the mixture of higher returns and stability that fits your income needs and risk tolerance.

The Holiday Season Is Upon Us. It is my objective to get one more post in before the holidays. If I don't, I would like to thank you all for your friendship and support over these years. While money is a major part of my life, it means nothing compared to the relationships that have sustained me for almost 70 years.

THE RETIREE PARADOX

Why Do We Put Ourselves Through This? The market is often a brutal place where we watch the value of our assets go up and down for reasons that we could never adequately understand, much less anticipate. Why not stay out of it and let the hedge funds and institutional investors knock themselves out? While this is an option for some of us, most of us need more income than we can squeeze out of a bond portfolio or government insured bank deposits. Herein lies the retiree paradox. We hate the market volatility but we can't derive enough income from so-called "safe investments." Consider the plight of a small businessman who sells a company for a half million in after-tax cash. Assume there is another half million in investment assets outside the company. A million dollars worth of investment assets puts him/her in the top 1% of retirees. Assume employment opportunities for a 60 year old former entrepreneur are limited and that the retiree wishes to stop working and live off social security and investment income. Further, assume that he/she has little tolerance for the ups and downs of the stock market. A "safe" investment will produce income at 5%, yielding $50,000 in before/tax income. When social security income becomes available, the retiree and spouse can get another $20,000-30,000 annual income for a total of $70,000-80,000 per year. It has been my experience that, although retirees in this category often tell me they need $5,000 per month in income, very few actually end up getting by on that amount. "Extras" like travel, home improvements, and helping out the kids often increase that amount by an additional $20,000-30,000 per year. In addition, declining purchasing power from inflation will sooner or later have a negative effect (although not as much as many financial professionals project). So what do we do?

Most of Us are Forced to Take Additional Risk to Obtain Higher Yields. This forces us into real estate or the stock market. The average annual return from the stock market is in the 10% range; however, we have been warned that 8-9% may be more realistic for the future. This would be satisfactory if we received this average return each year; however, a more likely scenario is a 15% return for one year and 3% the next. If the market is up when we need to make a withdrawal, we do well but if it is down we drain our capital so we have a lower investment base to produce income for next year. Studies have shown that retirees who need to withdraw from a down market for the first two years after retirement will have a substantial risk of running out of money during their life span. The main reason I established this blog is to offer people a solution.

Buy Cash Flow, Not Assets. Hence the title of this blog. If you are retired or planning to retire, your best bet is to start planting your "Cash Flow Garden." It doesn't matter how much money you have if you can't convert it to cash flow to fund your living expenses. The name of the game is to have cash flow from a variety of investments. This adds considerable flexibility since you can use the income in both up and down markets. You no longer have to worry about whether you will have to sell assets into a down market or whether your nest egg will last as long as you do. If you leave your nest egg intact and spend only the income, your risk of running out of money is much reduced. The market price of your portfolio can advance or decline but you can stay secure if your income continues.

The Recent Correction Brings us an Opportunity. The hardest hit stocks in this correction are those in the financial sector. We have sold some of our investments in this sector because we thought their income stream was in jeopardy. Others have been hit hard because they have had to reduce the value of their assets because of a rule that forces them to "mark to market" the value of some of their illiquid assets. While their book value has been reduced, their cash flow remains strong. If dividends continue at current levels, the market value will eventually return to previous levels. By searching a data base of these companies and selecting those with a high probability of dividend continuation, you can not only buy a strong dividend income stream that is likely to increase over the years, you will have a high probability of increasing market value in the future. In my end of October post, I listed five stocks that I believe have a high probability of producing a 9% dividend yield in the future. I did this not to recommend these stocks but to give you an example of some of the opportunities out there. My philosophy is similar to that of Dan Reeves, former Denver Bronco head coach. He said "Your offense has to take advantage of the opportunities the defense gives you. Similarly, your investment strategy has to be one of taking advantage of the opportunities the markets give you. This philosophy has served me well in the past and I will continue to use it.

AIN'T NOTHIN' YOU CAN DO ABOUT IT.

The Market is Not Treating Us Well. This reminds me of a story I heard recently about a man who was in the process of being tested for a position in the New York City police department. The final step involved an oral interview to get an idea of his overall knowledge of some of the situations he might encounter as a policeman. One question was what are rabies and what can you do about it. His answer was, "Rabies is Jewish priests and there ain't nothin' you can do about it. You might apply that answer to your participation in the stock market. While there is nothing you can do about the overall direction of the market, there are a lot of things you can do about your own investment portfolio. The problem is that many, if not most, of these are wrong. In a study of mutual fund participants, it was determined that very few of the shareholders did as well as the overall performance of the fund over a long period. The problem is that there are powerful forces that prompt us to do the wrong thing at the wrong time. Buying low and selling high is an objective that few investors achieve. Let's face it. Warren Buffet we ain't.



Beware of What You Read in the Newspapers. Even if what we read in the newspapers is mostly true, the papers are reporting history. Making your investment decisions with only his in mind, is like trying to drive your car with the rear view mirror. In the 90's we had a technological revolution in this country as the computer chip and the internet drove huge gains in productivity. It changed the way information is disseminated. Those changes are still taking place. If that is the case why did investors that lost money outnumber those who made money? Instead of the dot com era, why do most people call it the dot bomb era? You may recall that start-up companies with practically no sales and negative earnings became worth as much as Ford or General Motors. You couldn't pick up a newspaper without reading about a bunch of new dot com billionaires. Everyone wanted in on the act and they drove prices of those companies into the stratosphere. If you got in early and got out in time you made money but few people did. Now days you can't read the business section without reading of China, India, and some emerging market countries growing their economies at 8-9%. That was last quarter. What is going to happen next quarter? It isn't so obvious and those of us who think we know, don't know what we don't know.



Oil is Nearing $100 a Barrel. Let's sell our depressed financial stocks like Citicorp and Bank America and run out and buy an oil royalty trust like Prudhoe Bay Trust or San Juan Basin Trust. Before we do that, we might consider that, in addition to supply demand factors, the energy markets are heavily influenced by speculators who buy futures in these markets. Is oil really worth $100 a barrel or is the true value closer to the $60 a barrel level as reported by industry insiders? The point I'm trying to make is that the more publicity an industry segment gets, the more people want to devote capital to it. The result is that more and more investors flock to that segment until they drive prices to unrealistic levels. A sure fire method for sub-standard returns is to sell what is currently unpopular and put the proceeds into one that is currently popular. You might get away with it now and then, but you will make more mistakes than home runs. Remember Warren Buffet's adage. When the majority becomes aggressive, I get fearful but when the majority becomes fearful, I get aggressive.



Playing With the House Money. There is an old saying among Las Vegas gamblers that you are in good shape when you've won enough money to put your own money back in your pocket and play with your winnings (house money). That's what most of our clients are doing. If you've made a good return for several years, you have to expect that you may need to give some of it back when the market corrects. Of course, you can take your money out and wait until the correction is over but it is extremely difficult to know when to put it back in. Studies have shown that if you were out of the market for only a short time during a recovery, you would have lost more than 33% of the gain. The problem is, we don't know when that short time is.

What are We Doing to Manage Risk in Our Portfolios? When we buy stocks, we buy into a business. Part of what we do is look at the underlying business in the companies we own. If the market price is up and we think the business value is down, we sell the asset. If the market price is down and the business is even or better, we try to find reasons for the price to be down. Is it do to an overall correction in the industry? Is the price following that of an industry leader? Are there some expectations of a future reduction in earnings? Does the price reflect a good earnings report that doesn't meet the expectations of analysts? If we can find no reason for the price to be down, we retain the investment but watch closely for reasons to sell at a later date. If, like most investments in our portfolios, cash flow from the investment is satisfactory, we try to place less emphasis on the market price and concentrate on whether or not the cash flow will continue. Sometimes we may sell a part of the investment and hold more cash than normal because we hope to buy some bargains in the future. You may recall that in March of this year, I wrote a post entitled : Awash In Liquidity. I postulated that this might mean "Awash in Stupidity." In other words, the markets are getting overvalued because there is too much liquidity. Since that time, we have been slowly raising the cash allocation in our portfolios. This has protected us somewhat, but not entirely, from major losses. We will continue to watch your money and ours in these turbulent times.

An Interesting Quote on the Aging Process. This one comes from Larry, the Cable Guy. "Inside every old person, is a young person wondering, "What the hell happened." It seems like only a short time ago, I heard better, saw better, and laughed more. What the hell happened?

FIVE STOCKS FOR INCOME

Got Cash? If you have some cash that you don't know what to do with, you may have more options than you think. Of course, you can always leave it in the bank but you will be lucky to get 5%. You can invest in the stock market but you will vulnerable to a major correction which could happen at any time. My strategy in these circumstances is to invest in stocks that produce an income stream. Don't need income to buy groceries, gasoline, etc? How about income to re-invest in the event of a market correction? During the major correction that occurred in the early 2000's, many saw their portfolios decimated as stocks that were overpriced returned to more realistic levels. There were bargains to be had at these levels but most investors had little capital to re-invest. Our income portfolios may have been down but the income stream continued and we had cash flow to re-invest in these bargains.

A Sample $45,000 Income Portfolio. The following is a sample portfolio of some stocks that I think are realistically, if not bargain, priced in the current market. These are higher income stocks which were punished during the recent credit crunch. While some companies in this category were corrected because the market thought they had little chance of continuing their dividend, my opinion is that the companies listed here have a good chance of continuing to pay their dividend. One caveat before I list these stocks: This is a sample portfolio and not necessarily one I would recommend for everyone. I would never advise your grandmother to put 100% of her savings into this. We are playing the probabilities here and those who can't afford the possibility of a major disruption should not take the chance. I should also call your attention to the fact that I did not do a comprehensive screen of all dividend stocks to pick out the best ones. Although, I do like these companies as evidenced by the fact that I either own some of them at present or have owned some in the past there may well be better ones out there. Do your own screen and due diligence before deciding you want to own this portfolio. Here is the sample portfolio:

1. 500 shares of Capital Source (CSE) @17.25. Cost is $8,625. Annual Income $1,200
2. 200 Sh. Am. Capital Strategies (ACAS) @41.4. Cost $8,280. Income $736.
3. 200 Sh. Bank of America (BAC) @47.48. Cost $9,496. Income $512.
4. 500 Sh. Permian Basin Trust (PBT) @ 15.69. Cost $7,845. Income $885.
5. 200 Sh. Kinder Morgan (KMP) @51.65. Cost $10,330. Income $704.

The total cost of this portfolio is $44,576. The annual income is $4037 or a yield of 9.06%. This is almost double what you can get in a money fund. Advantages are: 1. Reasonable diversification since the portfolio contains shares of the second largest bank on the country, business development companies, oil and natural gas royalty companies, and energy pipeline companies. 2. All these companies have a strong dividend payment history including a track record of increasing the dividend at least annually. 3. Growth in share prices.

Why Not Put All Your Money in This Portfolio? No matter how strong the company appears, you never know when the economy will throw you a curve like it did with Enron, Kmart, or American Home Mortgage. You need a bank account and other kinds of investments to make sure that under-performance of any company in this mix won't put you in the poorhouse.

It's Been a Busy Summer. Everything from personal illness to deaths in the family have kept me from accomplishing everything on my list this summer. We plan to leave this coming Wednesday for our winter home but we will be available by phone, fax, or e-mail. In addition, I am planning several trips back during the year. If you have issues that you think might need my attention, don't hesitate to call.

FED TO THE RESCUE.???

What Do the Federal Funds Rate Cuts Mean to You? Unless you were in some other country, you have to know that the Federal Reserve cut the federal funds rate by half a point at their most recent meeting. How will this cut affect you? As usual, the answer will depend on your financial goals and where you stand in your quest for financial independence.



Looking for a New Fixed Rate Mortgage? As I've said dozens of times, the Fed only controls short term rates. Long term rates can go up or down with a Fed rate cut depending on whether or not the market perceives the cut as inflationary. The immediate result of the rate cut was that long-term fixed rates increased slightly because of fears that the additional liquidity might help perpetuate some of the excesses of the past as consumers continued to borrow to buy stuff they really didn't need. Don't expect these rate cuts to help you get a lower fixed-rate mortgage.



Will The Cut Make Your ARM Loan More Manageable? Several financial columnists have written that these rate cuts won't help lower the foreclosure rate. The fact is they might make a difference in some cases. ARM loans usually adjust based on some margin over the one-year treasury. This is a short-term index and should drop when the Fed cuts rates. The standard one year ARM adjusts at 2.5-2.75% over the index. This means that your next adjustment should leave you in the 6.5 to 7% range. Hardly a disaster. If you have one of the sub-prime ARMs, the margin can be as much as double that. Even though your adjustment may be a half point lower than before the cut, the margin is so large that it will still cause a major trauma to most borrowers.



Got a Home Equity Line of Credit? Most of these are based on the prime rate which should decrease dollar for dollar with a Fed cut. If your loan was at prime, or 8.25%, it will drop to 7.75%. This means that a borrower with a $100,000 loan should see a payment reduction of about $500 per year. Funny, how it seems that many borrowers hardly notice a reduction of that magnitude but scream like they were shot when rates increase that much.



Going to Open a Savings Account or Buy a CD? In general, you will find it difficult to locate decent rates on your cash accounts. Banks will quickly lower what they are willing to pay for funds after a Fed rate cut. This is at a time when the average rate on bank money funds is less than 1% and demand savings accounts often pay 1-2%. If you shop diligently and are willing to do business at a bank not necessarily located in your town, you will be able to beat these averages but even aggressive banks will gradually lower rates on funds they have on deposit. Brokerage money accounts will also pay lower rates as a result of the Fed cut and we need to remember that these funds are not insured like bank funds. Although no one has ever lost money in these funds, its not impossible, particularly when we have a credit crunch like the one we recently experienced.

Looking to Buy Stocks? The effect of the Fed cut on the market was immediate with the Dow rising more than three hundred points the day of the cut. At this point, the market is near an all time high as the cost of leverage decreased and liquidity levels increased. Good news for those who are in the market? Remember my recent post about liquidity breeding stupidity. Lower rates encourage bad behavior as consumers borrow to buy items they don't really need, home buyers are willing to bid up the price of homes because monthly payments are low, and investors chase higher yields with little regard for risk. Now is the time for conservative investing. One opportunity appears to be high-dividend stocks which have taken a disproportionate hit in the recent correction. This will require considerable due-diligence since some stocks dropped for a reason. High dividends are never attained without risk. A portfolio of high dividend stocks must be carefully managed to avoid those stocks where the risk outweighs the return.

Is The Recent Cut Good or Bad? While investors obviously thought the cut was good, I question the wisdom of adding more of what caused the problem in the first place. Cheap money isn't always cheap in the long run. The strongest advice that I can give anyone is to borrow only when necessary. It's not a bad time to reduce your overall debt level. Be careful not to over spend your income. Another severe correction is not out of the question.

A FEW QUICK COMMENTS

I'm not posting as often as I would like. So many times I've heard retirees say that they don't know how they ever found time to work. I'm not exactly a retiree but I now understand that comment. I used to go to the office every day. I attended to day-to-day affairs and had numerous meetings with clients and potential clients. I don't do that any more. I don't know where the time goes except that I am certainly more diligent with health issues and exercise schedules. Of course, I still meet with clients and occasionally potential clients but I no longer actively market my services or that of the company. Anyway, I plan to post more often in the future by just speaking my mind and not being so critical of what comes out.

I Attended the Exchanger Meeting Yesterday. I also had lunch with several old-timers who have observed many market cycles in this town. Now is not a good time for a real estate agent that spends most of his or her time collecting residential listings and trying to market the same. We all agreed on that. But we disagreed somewhat on the signals that indicate we are in a good market for investors. As I mentioned in my last post, we are evaluating some residential investments here and there. The signs I look at are the rental market and the amount of inventory for sale. These are somewhat positive in that vacancy rates are low, indicating high tenant demand relative to the supply of rental units. Inventory levels are still high which means that buyers have a lot of choices. Foreclosures are high which means that there are numerous properties that have to be sold (although many lenders haven't figured that out yet). You can sometimes cut a good deal on pre-foreclosure property by convincing the lender to take a short pay off to save the hassle of foreclosure. The trick there is to find some one in the lender's office who can make a decision. I guess I still think your best bet is to find a foreclosure property already listed with an agent so you have someone who already has a contact with the proper representatives in the lender's office. According to one of the old timers at yesterday's breakfast, another quick measure of whether or not the market is nearing a bottom is monthly rental rates near 1% of the purchase price. This means a $120,000 property that rents for $1,200 a month. The average isn't quite there yet but careful screening can locate a property here and there. We are going to continue researching these markets. More on this soon,

TIME TO BUY AN INVESTMENT PROPERTY???

Let's Think About A Real Estate Investment. Is it time to buy something? If you are looking for a definite answer, you won't get it here. It depends on where you are in your quest for financial independence, what other kinds of investments you own, your cash flow needs, your stress and risk tolerance, and the current market conditions. Since all my readers are different, I will confine this column to the pros and cons of current market conditions in Denver, Colorado.

We Have Ample Inventory. There are many properties available and you have many choices. There are numerous motivated sellers who stretched themselves too thin in an attempt to buy all the house they could afford. Some are investors, some are lenders, some are owners who need to move for business or personal reasons. As the mouse pleaded, "Forget the Cheese, just let me out of the trap." If you are going to buy, you will need to sift through a number of deals to find one that will offer you an opportunity for profit.

There are Fewer Investors. Up until the last year or so, investors looking to diversify their portfolio and take advantage of the strong demand for housing were lining up to buy properties that they could remodel and sell for a profit. It was possible to borrow 100% on an investment property at very low initial interest rates. Investor demand has slowed as both neophyte and experienced investors found they could no longer count on selling remodeled properties for a quick profit. The financial press devotes headlines to "The Real Estate Bubble" and touts Denver as "The Foreclosure Capital of the Nation." If you are looking for a good deal today, you will no longer find a multitude of investors driving up prices.

Rates are Still Low and May Well Go Lower. You may not find lenders lined up to offer you 100% investor financing but long-term fixed rates are still low and likely to go lower. If you are willing to put 20-25% of your own money into a deal, you will still find a host of lenders willing to offer you rates that are only slightly above recent historic lows.

Rental Demand Continues to Improve. This is the most important factor in long-term investment success. Last year when we made a commitment to increase our property management, we entered a market where virtually anyone could borrow 100% of the purchase price of a new home. This meant more buyers and fewer renters. The few renters left had horrible credit and were virtually guaranteed to give you an unfavorable landlord experience. That situation has improved as vacancy rates have fallen and rents have gradually begun to increase. As an investor, your risk is highest in markets where tenant demand is low and investor demand is high. Under those circumstances, you will likely find it almost impossible to get a good deal on a property and, after your purchase, you will find it difficult to get a competent tenant to provide income to pay operating expense and debt service. We are just emerging from such a market and your odds for success are definitely improved.

So What's Not To Like? We can buy properties at below replacement cost, finance at low rates, get tenants to pay holding costs, and we have a high probability of increased rents in the future. Why aren't we encouraging our clients to get out there and buy? The answer is that we may not have turned the corner. The unfavorable supply/demand balance and future foreclosure risk is such that things may continue to worsen before they start to improve. In the 1987-1991 cycle, those who bought too soon found their properties continued to depreciate for some time before the real turnaround. Our position is that we should begin to look for some good deals and buy when we are able to locate opportunities. During the next few weeks, we will evaluate some potential purchases and contact those buyers on our list when we find a deal worth making. If you want to be on our list, give us a call. In the meantime, keep an eye on this blog for reports on some of the deals we are locating.

SLUGGING IT OUT.

Sometimes You're The Windshield, Sometimes You're The Bug. I've been the bug lately. The markets have been difficult with exceptional gains one day followed by exceptional losses another. In general, the trend has been down especially in some of the high dividend issues we've emphasized. The main culprit has been fear in the sub-prime mortgage market. While this is only a relatively small segment of the mortgage market, the overall market is so large that problems in even a small segment can run over into other sectors like banking, real estate, and construction. Delinquencies among borrowers who obtained these sub-prime loans have been running around 10%. As I posted last March, this is a prime example of stupid lenders and stupid borrowers with greed being a prime motivator. Its hard to identify the main culprit in this fiasco. Investment bankers were driven by greed as they earned huge fees by packaging these loans and selling them to investors willing to take risks they didn't understand in order to get above market yields. Most of these investors should have known better. Borrowers bought houses which were outside their affordability range because they could borrow almost all the purchase price at initial interest rates below market. When these rates increase to the true market rate, the natural consequence is delinquency. Neither the borrower nor the lender has a clue as to how to deal with the consequences.

A typical example is a transaction I participated in three years ago. The borrower received a loan of 101% of the $290K purchase price. After occupying the property less than a year, the borrower stopped paying and moved out after 3-4 more months of free occupancy. The lender did nothing for several more months and then filed foreclosure proceedings. After finally gaining title to the property in a foreclosure sale, the lender did nothing for several more months before finally putting the property on the market and selling it for $40,000 below the loan balance. The lender suffered a large loss made even larger by delaying action recover possession and locate a buyer to mitigate the loss. Anyone who has tried to contact a lender in an attempt to purchase a foreclosure property knows how inefficient they can be.

The Fed Comes To The Rescue? The market reacted well to the Fed's lowering of the discount rate from 6.25 to 5.75% last Friday. Does that mean the crisis is over. Not exactly. For one thing, not a lot of money is borrowed through the discount window. Although it is sometimes the most visible to the public, the most utilized rate controlled by the fed is called "the fed funds rate." For now that rate remains steady at 5.25%. The Fed will probably lower that in September but they may decide to hold it where it is depending on the reaction of the markets between now and then. My opinion is that the Fed needs to be exceptionally cautious since the liquidity they poured into the system over the past 2-3 years is at least partially to blame for the situation we find ourselves in at present.

Where Do We Go From Here? Despite the fact that we have been managing our portfolios cautiously this year, many of our high dividend portfolios have been hit harder than the rest of the market. We are concerned about this but we hardly ever sell stocks because the market opinion of value changes. We are the first to bail out when we see a fundamental change that makes a stock less valuable but reacting to market hysteria is seldom conducive to sound wealth management. The good news is that September and October should see some substantial dividend payments. We can either hold this cash is a hedge against volatile markets or invest in some of those issues that we think have been adversely affected by the current correction. It is my opinion that the current correction has been healthy and not unexpected. Much of the selling has been due to aggressive investors who were heavily leveraged and forced to sell to meet margin calls. My advice is to keep a bit more cash and look for bargains that almost always exist after a correction such as the one we've just experienced.

BRUTAL MARKETS.

Liquidity Breeds Stupidity? Just a few weeks ago I quoted a so-called expert who said that the current attitude that says "the markets are awash in liquidity" should really be changed to "The markets are awash in stupidity". As of the past week or so, you could eliminate the awash in liquidity statement. Investors are leaving the real estate and stock markets and the result is a large price drop in many sectors. In my post of May 15, entitled "Beware the Receding Tide", I warned that markets do not increase forever and we should be prepared for a correction of some sort. While we followed our own advice, we were unable to avoid experiencing a reduction in many, if not most of our accounts. In fact, some of our income generating accounts dropped more than the others because of the panic in the higher yielding real estate and business development companies. One of my favorite companies, American Capital Strategies, dropped from the high 40's to the high 30's, a drop of about 20%. That's the bad news. The good news is that the dividend appears to be stable and likely to increase over the next few months. It is not the company that's changed in value, it's the markets perception of the value of the income stream produced by the stock. My plan is to re-invest the next dividend in the purchase of more shares. At the current price the dividend rate is almost 10%. I will keep some cash in case better opportunities arise in the future. I am somewhat pleased that we had this correction. Too much liquidity in the market actually breeds stupidity as investors, unhappy with the yield on cash equivalents, scramble to find higher yields and over-pay for risky investments to improve their yield. It will be an interesting time on the markets these next few weeks. We will watch closely and try to get some idea of the next good opportunity.

Real Estate Close to the Bottom. In my May post, I also mentioned how difficult it has been to find good real estate investments. I promised to study some of the market statistics and try to give you some idea of when we might expect a turnaround. The statistic that has interested me most is the number of building permits being issued, particularly in the condo/townhouse market. The condo and townhouse markets usually fall first and further than single family markets. One reason for this is that homeowner associations can rapidly become insolvent when foreclosures are high. Owners in foreclosure, become delinquent in their dues and lenders who gain title to the property after foreclosures, more often than not, do not pay dues either. This forces an increase in dues for, even minimal, maintenance. This results in more foreclosures and the cycle continues. There may be some investment opportunities here but investors who jump in too early may find that the cycle doesn't end as soon as they anticipated. One statistic I try to watch closely is the number of new building permits being issued. When new construction is insufficient to keep up with an increasing population, the oversupply of inventory begins to diminish and prices can stop declining and begin to increase. This brings me to a discussion of the trend of building permits over the past few years. Single-family permits increased slightly in most of the years since 2001. Condos and townhouses dropped drastically from 18000+ in 2001 to 5700 in 2004 and 2005. Front range statistics for the first four months of 2007 shows a reduction in single-family permits of 45%. Attached housing decreased by 15%. The overall population is increasing by 1.4% per year or about 66,000, Net in-migration is steady at about 27,000 per year statewide. Sooner or later, population increases will force a turnaround in the market. I don't claim to know exactly when that may be, but I do know that now is a better time to buy a residential real estate investment than in 2005. We will continue to watch the statistics and try to determine when to enter these markets.

One of My Heroes Died Last Week. My Uncle John passed away quietly during the night. He was a gunner on a B-24 during WWII and survived 30 bombing missions. Over half of the planes in his unit were lost during these missions. He received the Air Medal and the Distinguished Flying Cross. We were buddies since I first met him 62 years ago. We hunted and fished together until he became too old to tramp the fields and Alzheimer's took away virtually all his mental abilities. We are losing those WWII vets at a rapid pace. As far as I'm concerned those who are left are a national treasure.

BACK IN COLORADO

We Made It. Two relatively easy days of driving and we're back in Colorado. I have a to-do list as long as my arm but I'll be taking it one day at a time. Anyone needing an appointment can call the office and talk to Susan at 720-449-0200. If you want to try to reach me directly, the best number is 303-693-9610.

This will be a relatively short post since it is 11:15 PM. I am still trying to get a feel for this market. It appears that interest rate sensitive stocks are not doing well. Probably because a lot of folks are waiting for more rate increases on short-term bank deposits. I've been seeing some four to five per cent money market accounts advertised on the internet. Some of them from Banks. One such ad was from Capital One Bank with a 4.75% money market account. No minimum deposit was required and you were allowed 3 checks a month in the minimum amount of $250. I stopped by the Beaumont Texas branch to make a deposit but they told me that rate was an internet special and they were only offering 1.5%. Might as well keep the money under the mattress.

I've been watching a number of friends hit age milestones. My oldest grandson just turned 20. One of my best clients just turned 60, and my brother-in-law is turning 60 in September. I keep remembering that I turn 70 in January. One bit of encouraging news comes from an e-mail newsletter by Steve Goodier at lifesupportsystem.com. He reminded me that Churchill wrote a four volume masterpiece entitled The History of English Speaking People at the age of 82. Tolstoy and Goethe also finished major works at that age. Steve says you are too old when you have nothing left to give. Thanks, Steve I needed that.

HEADING TO COLORADO

Time To Leave This Place. We have been in Texas since mid October and I have not been able to spend much time in Colorado. The remodel of our townhouse is pretty well finished and things should be back to normal soon. I am anxious to catch up with clients and friends that I have spent little time with during the past year. I plan to stay in Colorado until I see everyone who wants to see me. Call our office or send me an e-mail if you need to contact me.

The Markets Have Done Better than I Have Expected. While this is a true statement, it hasn't applied as much to many of the things we are putting our money into. This is because most investors have decided that the FED will not lower rates any time soon. Short term rates have risen to more appropriate levels and long term rates have followed. Many of our investments are geared towards producing cash flow and these have dropped slightly because investors can now get more respectable yields on short term bank CD's and money market funds. Our investments continue to produce better cash flow than these short-term instruments but the market perception of the value of this cash flow has diminished. In reality, I believe these cash flow investments are now more realistically priced. While I thought they were over-priced in the past, I did not try to sell at the high point with the objective of buying back later at a lower price. While this is theoretically possible, I don't believe you can add much to your return by trying to micro-manage and outguess the market. My philosophy is to purchase cash flow and pay less attention to the market price than the stability of the income stream. Occasionally, when the price seems more than the intrinsic value, it may be appropriate to take some profits and re-invest in areas that appear to be less over-valued. The key is not to bet the farm on any one sector. At this point, it is probably wise to buy stocks in some of the banks like US Bancorp, Wachovia, and Bank of America. These pay dividends in excess of 3.5 to 4,5% and have a track record of dividend increases. It appears that there are some opportunities for capital gains there. Incredible as it may sound, it appears that the markets may have under-estimated the potential for some of the energy stocks like Texaco and Exxon. Because the perception was that current high levels of oil and natural gas would probably not hold, investors have been paying less for a dollar of earnings than the potential for future profits justify. I am moving more capital into these issues.

Are We Placing Too Much Emphasis on Cash Flow? A recent article,by a well-respected financial writer states that we should be paying less attention to dividends. His point is that, while dividends are nice, it's total return that really matters. In other words, you can get by with low, or even no, dividends as long as the value of your portfolio continues to increase. From the point of view of wealth building, this is true; however, the characteristics of the individual investor are of paramount importance. I am sure many of you are tired of hearing me say this, but if you need a check to fund your living expenses next month, you don't want to be depending on selling appreciated shares to obtain your funds. While dividend checks are by no means guaranteed, they are several orders of magnitude more reliable than capital gains. Younger investors with good job stability, high incomes, and high tax brackets may be well served by zero dividend portfolios but those of us who utilize our portfolios to fund our living expenses, can ill afford to be at the mercy of market fluctuations. I am not totally against selling shares now and then to obtain income but it is much more convenient to own stocks that provide dividend income. An additional benefit to high income portfolios is that we have income to re-invest when the market suffers a down turn. The main point to remember here is that both cash flow and capital gains are important and neither is more important than the other. The ideal portfolio is one that fits the needs of the individual investor. There is no one-size-fits all solution.

The Age Thing Getting You Down? It some times bothers me that I am turning 70 soon and have less time left than I have already used. My best friend from grade school through college was recently ordained as a priest in the Episcopal Church. A major accomplishment for a person less than one year from a 70th birthday. He didn't sit around and worry about getting old. He went out and did what he wanted to do. I think that's a valuable lesson for all of us.