03 May 2008

US Property, May 2008


This week I will share some thoughts on US Property.

I'm enjoying my last afternoon in Southern Arizona. Tomorrow, Ben (from the February Snow Farm camp in NZ -- in photo above) and I will head north to Phoenix. Then on to Flagstaff and a repeat of the Canyon run. Monica warned me not to be a hero and JD's advice was to PB by "one second" so... I think my pals are telling me not to fry myself when we head to Phantom Ranch on Tuesday.

Next week, we follow the same route back to Boulder with one modification -- inserting a ride from Cuba, NM to Los Alamos, NM (the long way via Jemez). We drove that road to end our April trip and the climbing is too good to miss. Back-to-back centuries from Farmington to Los Alamos will put the final touch on my preparations for Epic Italy.

Dr. J was trying to figure out why the camps are so much fun and decided that the best aspect is the fact that we offer every camper an opportunity to challenge themselves on each day. You don't have to take the offer but it is there. Sharing those sorts of experiences with people is a lot of fun for us. We'll be running the Tucson camp again next spring as well as adding a mid-summer camp in Boulder. The camps tire us out but it is a "good tired" and provide me with a role to play as I age.

Come along next year and you can benchmark yourself against my Mount Lemmon time -- I do well on anything uphill over 20-miles...

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US Property
I told Monica that I was thinking about giving myself the week off from the blog and she suggested that I write about property. Perhaps, she was hoping that if I write my thoughts down then I might not have to act on them.

Here's a summary of the key articles that made it through my media filter this past week. Given that I was training an average of five-hours-per-day with the campers... you probably heard even more than me...

***Declines in median prices of over 20% in Sunbelt and Southern Californian locales.
***Pundits talking about further declines over the next six years.
***Unsold inventories double normal levels (Nationally).
***Continued write-offs and rights issues in the financial services sector.

Looks to me that both Mood and Money are heading down. Financial historians note that the property market is like a giant aircraft carrier... slow to turn but, when it does, tending to overshoot fair value.

I suspect that everyone in America knows someone that has had their house repossessed in the last year -- that is going to color all of our judgment as we hear more of these stories.

Towards the end of last year, I recommended that aspiring homeowners get their Net Asset Statements and Revenue/Expense budgets in order. Have you done this? In order to position yourself to take advantage of potential buying opportunities you need to have your financing, and finances, in order.

We are thinking about buying an investment property (not second home). Here are my criteria:

***Climate opposite to Boulder, CO
***Would enjoy using during vacant periods
***Less than 1% annual holding costs
***Forecast net yield (after all expenses) 10% over treasuries
***50% capital upside over a ten-year view
***Entry price less than $200 per sq foot
***Superior location in a prime destination
***No leverage purchase -- don't reach financially

Sound like a good deal? It does to me -- perhaps a bit "too good" for this stage of the cycle. To hit those numbers I would need a vendor to accept 15-40% less than their current asking prices. However, having done my homework, my bid price is 10% less than the most recent deal that actually completed and therein lies a tip...

Figure out what an asset is worth to you, prior to anchoring with the price expectations of the vendor


This is important all the time but even more essential in a declining market with constant negative information. By figuring out a price at which you are "unlikely to be wrong" -- you have a much better shot at being right over the medium- to long-term.

What are the signs that a target market might be poised for a large correction?

In this environment, I would look at the mortgage service cost relative to the cost to rent. Even with the recent corrections, many markets have rental costs that are fractions of the cost to own. Given large inventories of unsold homes, rental increases are unlikely. Given weak mortgage markets, mortgage costs are unlikely to fall. That leaves the most likely adjustment mechanism to be capital depreciation.

Potential buyers are building in expected price declines -- no one in the nation is expecting prices to rise. Most owners are holding depreciating assets -- we all HATE holding depreciating assets. At some stage, vendors will sell to remove the pain of a thousand paper cuts.

If you rent with a view to buying then negotiate strongly on early termination provisions -- the more Blue Chip your profile, the more aggressive you should be on all terms.

The ability to complete quickly will be seen as highly attractive by sellers. Vendors are going to get increasingly keen.

On the corporate lending side, I have not yet seen credit contraction in line with the capital that has been written off by the financial sector. I suspect that the front line banks are current preparing strategies for how they will deploy, preserve and recover capital over the next 12-18 months. When we start to hear about rising corporate bankruptcies then we will know that we've moved into that phase of the credit crisis.

Here are three things that I keep hammering into myself when I'm thinking about making an investment:

#1 -- I don't "need" to do deals (doing nothing is OK)
#2 -- I desire to make good investments
#3 -- Above all else preserve capital (for me, the time for "betting big" was 10-20 years ago)

Be prepared, attractive buying opportunities will present themselves to educated investors.

Until next week,
gordo

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