CHAPTER 1: Introduction
It seems that real estate and the economy in general go through a
period of rapid expansion and then go into recession for several years
before the cycle is repeated. Even though such cycles are studied and
exploited by real estate investors, a deeper question remains. Are
such cycles natural or imposed, and if the peaks and valleys of such
cycles could be proactively managed, without government interventions,
to eliminate booms and busts in real estate?
This book provides the reader with data and logic to analyze factors
which cause booms and busts in real estate. It also discusses various
components of market cycles, and proposes a framework to eliminate such
booms and busts.
The first challenge in writing a book is to define the target audience
in terms of who will most likely buy it, and who will actually use the
information provided therein.
Each real estate transaction involves a buyer, a seller and a
financier. When a buyer purchases the property on the cash basis, the
buyer assumes the dual roles of buyer and financier. When a seller
provides owner-financing, the seller wears two hats. However, majority
of real estate is purchased by using other people’s money. The
financier assumes a risk of capital loss if any of the primary (buyer,
seller, and financier) or secondary (bank, real estate agent,
inspector, appraiser, etc.) actors were not diligent, properly
incentivized or honest enough while being involved in real estate
deals.
Martin Wolf of Financial Times explains the latest real estate fiasco
as, “It took foolish borrowers, foolish investors and clever
intermediaries, who persuaded the former to borrow what they could not
afford and the latter to invest in what they did not understand.”
Professor Darrell Duffie of Stanford University indicated, “The
picture emerges: banks often sell loans that are designed specifically
for an intermediation profit rather than a long-run investment
profit.” This is summarized by Mohamed El-Erian, co-CEO and co-CIO of
PIMCO, one of the largest investment management companies of the
world, as, “allowable activities too often exceed the ability of the
system to sustain them.”
And as late as the summer of 2007, even the largest banks did not take
corrective measures to stop the inevitable train wreck. The CEO of
Citigroup, Chuck Prince, said on July 10, 2007, “When the music stops,
in terms of liquidity, things will be complicated. But as long as
music is playing, you’ve got to get up and dance. We are still
dancing.”
Primary Audience:
This book is a “call to duty” for real estate entrepreneurs who are
uniquely positioned to take on the responsibility to save real estate
from the booms and bust cycles created by banks with the help of the
real estate brokerage industry. These banks and brokerages help
sellers inflate real estate prices which lead the whole nation towards
eventual busts.
Real estate entrepreneurs are fully adept in creating real estate
transactions which are win-win-win for buyers, sellers and financiers.
Such transactions may involve seller financing, lease options,
wraparound mortgages, master lease agreements, private mortgages, etc.
Banks make the most amount of money by originating new loans. A
majority of real estate brokers make money only when real estate
ownership changes hands. Some of the above-mentioned “creative”
transactions carried out by real estate entrepreneurs may not invoke
sale events. Real estate agents do not like that because the way the
real estate brokerage is currently set up, real estate agents’
livelihood depends on properties changing hands. The other
entrepreneur-managed transactions may prevent a mortgage event from
happening which robs banks from the opportunities to make money, and
banks don’t like that.
Note: For the sake of brevity, I will use the word “bank” to represent
a lending institution unless a distinction is warranted. I will use
“agent” to represent a real estate broker or salesperson. I will use
“entrepreneur” for real estate professionals who actively own, repair,
manage, and strategically liquidate real estate on full-time or
part-time basis.
There is no wonder that banks and real estate brokers keep the real
estate industry in certain operational mode, prefer that smart real
estate entrepreneurs stay out of the game, and only those willing to
execute expensive, straight-jacketed and bank-centric mortgages are
allowed to sit on the table. This is done to make sure that banks are
able to sell the mortgage “paper” to the highest bidder in the
secondary market. After reading a few early chapters in the book,
readers will realize that “exit strategies” and “secondary markets”
are the twin towers of constant upheavals in the capital markets.
The Community Choice in Real Estate Act prohibits banks from directly
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engaging in real estate brokerage and management businesses. Banks
rightfully proclaim, “We are not in the real estate business,” but it
does not prevent them from being “around” the real estate business and
creating havoc through their exit strategies and secondary markets.
Unfortunately, a majority of real estate entrepreneurs are ill advised
by self-serving real estate “gurus” who teach “secret” techniques
which either make them the laughing stock in front of banks and real
estate brokers or may just be outright illegal in certain situations.
This leaves the entrepreneurs in an uphill battle against
well-financed banks and well-entrenched real estate brokers.
Banks deals with real estate as a collateral to be dumped if a bank
ends up stuck with it. For a real estate agent, real estate is like a
commodity not much different from barrels of oil for an oil trader.
There is a mutually beneficial relationship between banks and agents.
This relationship inflates housing prices, only to be deflated
periodically. It is not in anyone’s interest to keep this cycle of
booms and busts going. Stable housing is good for the whole nation,
and the entrepreneurs are in a unique position to help the nation get
rid of these booms and busts.
Real estate entrepreneurs interact with real estate as a business.
Many a time they buy what consumers can't buy or don't want to buy and
the banks don't want to lend against. They improve the housing lot,
and provide decent housing to millions of Americans. They rescue real
estate after builders, agents and banks have screwed it up, yet one
more time, by creating an oversupply of residential and commercial
properties, inflating prices through Multiple Listing Services (MLSs),
and expanding and shrinking availability of credit for real estate
transactions.
Late-night TV and Internet and late-night TV "gurus" are part of the
problem of making real estate entrepreneurship look like fast-buck
con-menship. Some entrepreneurs, who chose to set their sights low
will benefit from this book to find alternate, efficient and
cost-effective ways to fund their deals. Others, who set their sights
higher, will join a nationwide movement to enable the richest country
in the world avoid real estate booms and busts by restructuring how
real estate transactions are carried out.
Secondary Audience:
The secondary audiences of the book are those who have money available
to invest as cash or in their retirement accounts, but are seeking
non-Wall Street, asset-based investment opportunities. This book will
help them understand various aspects of real estate investing, such
as, how to evaluate real estate as an asset class, how to evaluate
income properties, how to evaluate real estate entrepreneurs, and how
to get into investing relationships with those entrepreneurs for
mutual benefits.
General Audience:
The general audience of the book is anyone who wants to make sure that
their children and grandchildren don’t experience real estate booms
and busts the same way they, their parents and grandparents had to
endure.
This book will discuss how booms and busts are created by banks, how
current bank underwriting decision-making is flawed, and how the
collateral-centric approach to real estate lending is needed in place
of paper-centric, pain-centric and borrower-profile-centric
approaches.
This book will make a case of why people, with cash and retirement
savings, should look at real estate as a reliable asset class instead
of traditional investment vehicles promoted by banks, insurance
companies, and Wall Street.
This book will discuss how we can “revive the economy”, as President
Obama envisions, by making the dollar travel, far and wide, through
real estate. Entrepreneurial real estate professionals can play a key
role in reviving the economy if Private Money is available to them.
A large number of people own real estate; free and clear. I will
discuss how equity can be leveraged to lower the cost of real estate
transactions by reducing “toll collectors” who make real estate
expensive for all of us thus leading us to the next bust.
Finally I will put it all together to propose a real estate lending
environment where real estate changes hands, monitored, and
risk-managed, to provide fixed income to those who need secure and
predictable passive income; and create massive income opportunities to
the others who want “to build a new foundation for lasting
prosperity,” as suggested by the new President of the United States.
Private Money lending as proposed in this book, is an alternate
investment strategy for lenders, and a flexible financing source for
borrowers. Lenders can choose to be conservative, and generate fixed
income through long-term mortgages. They can also choose higher
returns through short-terms bridge loans. In this environment, equity
is cherished, preserved and leveraged. Accountability is individual
but the environment helps individuals make the best use of the equity.
Legal instruments exist to deal with eventualities, but not to exact
vengefulness. In this environment cross-collateral and co-borrowing is
encouraged to make real estate accessible to anyone who loves real
estate as an asset class.