Real Estate Investors Face a National Paradigm Shift
par·a·digm
1. One that serves as a pattern or model.
paradigm \s for investing
As real estate investors our world has changed.
Our paradigm has shifted. Once American Investors were the kings of leverage. 10% percent down, 20 % down, 25 % down were the currency that was used to purchase real estate. Today banks require 30% to 40% down to obtain a loan, plus enough cash to make payments, for upto twelve months, should the property not have a positive cash flow.
Investors are in shock. We cannot close deals that would have been assembled 12 months ago.
- As sellers we are faced with a dearth of buyers. We ask ourselves, who has the cash to pay the bigger down-payments? We really don’t want to consider lowering our sales price.
- As buyers we are faced with sticker shock. Where are we going to get the money to increase our down-payments? Where are we going to come up with the significant asset requirements that banks are asking for?
Brokers are scrambling to reassess the market place.
Leverage has been a motivational factor in the ability of brokers to close deals. Let’s look at some comparison numbers for the purchase of a fictional apartment property.
“The Arbors”
|
2008 |
2009 |
|
| Sale Price |
$3,700,000 |
$3,700,000 |
| Down-payment % |
25% |
40% |
| Down-Payment $ |
$925,000 |
$1,480,000 |
| Loan Balance |
$2,775,000 |
$2,220,000 |
| Purchase Price per unit |
$52,857 |
$52,857 |
| Term Years |
30 |
30 |
| Interest Rate |
7% |
7% |
| Monthly Payment |
$18,462 |
$14,770 |
| Net Operating Income |
$270,742 |
$270,742 |
| Annual increase in expenses and income |
4% |
4% |
| Annual Debt Service |
$221,546 |
$177,237 |
| Year 1 Cash Flow Before taxes |
$49,197 |
$93,504 |
| Cash-flow as a percent of down-payment and closing costs ( Year 1) |
4.10% |
5.30% |
| Loan to Value Ratio |
25% |
40% |
| Debt Coverage Ratio |
1.22% |
1.53% |
| CAP Rate |
7.32% |
7.32% |
| Average 7 year Cash on cash return |
7.31% |
7.33% |
| 7 year pretax IRR |
14.89% |
12.73% |
| 7th year estimated cash return after taxes |
9.01% |
7.87% |
| 7th year cash return after taxes |
$108,322 |
$137,745 |
What becomes immediately obvious is that your cash return is higher, but you have invested more in a down payment and used up more of your valuable cash for the down payment.
Are larger down payments good for real estate?
Maybe.
Consider this.
In this unsteady market place we will be seeing an increased number of businesses laying off employees and reducing their size. Some of these businesses’ employees will not be able to pay their rents or mortgages. This means that commercial and residential investments will be facing higher vacancy rates. With a higher down-payment there is less risk to the investor and the financial institutions. This makes for a safer long-term investment.
What is the impact in the market place?
- There is cash in the market place that experienced investors have been saving. These players are looking for the “great deals” to invest in. There will be some great deals in selected market places and these bottom fishing investors will end up with properties at a very low price. At the same time many of these deals will need to be refinanced, and cash will need to be injected into them.
- The first deals that will end up in foreclosure will be the deals that were challenging to begin with, and made them fall out early. A good example is the 40 unit apartment property, located in the suburbs with only 20 parking spaces. Not enough for tenants and visitors. A project destined for continued failure.
- Those investors that have cash will need to satisfy themselves with smaller deals. These deals will take longer to close and will take additional time and energy to speak with multiple financial institutions in order to find a banker willing extend a loan.
- Banks are afraid to lend, because they need to increase their liquidity. They do not want to be one of those swallowed up by the FDIC.
- Sellers have to reduce their pricing or hold on for a while. With higher down payment requirements there are fewer buyers willing to buy at the higher price points.
- In general there may be a short term reduction in the number of deals closed. Until banks have sufficient capital available to continue to make loans, those deals that are closing will look to the owner for carry – backs and assumptions of existing financing to get deals closed,
- Businesses that are making money and need to expand will have trouble getting the cash they need from their banks to pay for the purchase of a new building. Many of these businesses will choose to lease in order to manage their near term expansions.
- Those businesses that are seeing a reduction in income will downsize and try to sell their properties, in the form of sale leaseback investments, to hold on to the property and to generate some cash. Retail tenants specifically will begin to negotiate with their landlords for rent concessions, that will enable them to survive during these trying times.
Summary
In the next twenty-four months sellers will have to get used to a reduced sales price for their product. CAP rates will be increasing as sellers become more motivated to sell their properties. In any case it will take longer to complete a transaction unless the seller has the ability to carry paper on the deal. Larger down-payments will give banks the security they are looking for with their loan portfolios.
Buyers will need to continue carefully analyzing their purchases.
The big question is; have we reached the bottom of the market? I suspect that this depends on more and continued government intervention to stabilize business, the financial environment and employment. This recession will be overcome as businesses small and large adjust to demand. In the short term, we will feel pain, in the long term, our country will be stronger. Buyers with cash need to be looking now: there is opportunity in the market place.
Tags: 2855 E Hayes St, bank owned assets, carbon monoxide detector laws, claim, cliff hockley, Job Fair, Low vacancy rates, Multifamily Investors, real estate transactions, reo, repairs, residential, rules, short sale, tenants save money
This entry was posted on Tuesday, March 10th, 2009 at 12:06 pm and is filed under Articles, Bank Owned, Investing, Sales & Leasing. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.
