Access Wealth Strategies

(Author note: I wrote this post at the beginning of 2010 but it got lost in pending status until now.)

Every year, I see magazine articles or major websites that offer their best tips and strategies for the new year. Thus, I’ve decided to share my thoughts as well.

During this global “Great Recession” and related credit crunch, there are historic numbers of distressed assets on sale, and that includes more than just real estate.

Warren Buffett was talking about how great an investment distressed assets were back in 2008. In fact, he would buy them because he knew the long term value was higher than the current impared pricing. Listen to Buffett talk about what he would buy as much as he could in this video below.

The options available to Buffett are one thing, but what options are available to the rest of us?

• Perhaps you are a business owner who currently lease your store or shop space, then there are likely buildings you could purchase that could cost less than your current rent payment.
• If you want to invest in real estate, there are a variety of options. Certainly buying homes from wholesalers or the trustee sale auction is not too difficult.
• A more complicated deal would be to gather some investors to buy performing or non-performing real estate loans at a discount. The numbers I’ve seen are that non-performing loans are selling for 30% of face amount and performing ones are selling for 60%. If the loan ends up performing then you get a good return. If you have to foreclose, you may end up with a great return.
• Paper assets are also on sale. Earlier in 2009, stocks certainly crashed down to levels not seen for a decade. They could fall again.
• How about buying a business from an over-extended owner who needs to raise cash? Make sure it’s a business you know very well and want to own.

A very experienced businessman once told us he’d seen 3 different real estate cycles in the Phoenix area over 30 years.  During the prior cycle he saw people who drove in to town in a pickup truck and a decade later, flew out in their personal Lear jet. They had made millions from buying and selling real estate assets during the market downturn and subsequent rebound.

That’s the cycle we are in now.  What do you think about it? How are you going to capitalize on it?

In the first post of this series we looked at when to buy and sell: Buy when fear is rampant and sell when greed reaches all levels of society in the current market.

In the second post of the series we looked at what to buy.

Buffett already tells us to use price fluctuations to our advantage with the following quote:

Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.

So, how do we know when is the right time to buy and sell? What do the prices look like?

In general a long up-trend will end after asset prices are above the long-term valuation by a standard deviation or more.

Here are 3 good examples from recent experience:

• The technology-driven Nasdaq stock market peaked in March 2000 with the PE (price to earnings) ratio reaching 264 while the more mature Dow 30 index peaked at 42 when the 100-year average is only 14 to 21. In these cases people were paying a very high price for not very much earnings.
• During the residential real estate bubble which peaked in 2005, home prices in some bubble markets had climbed to twice their traditional price to rent ratio. Essentially prices doubled but rents stayed the same. This is unsustainable in the long term because people would eventually choose to rent when they can save so much money each month.
• During the commercial real estate bubble that peaked in 2007, the cap rates had fallen so low that instead of a traditional 10% cap rate, many markets were priced at a 7% or 8% cap. Some coastal markets were even in the 3-4% cap rate range. This was a time when interest rates were rising even above the cap rate — that implies the buyers were banking on appreciating prices only, not current cash flow.

Here’s an example from personal experience. In 2006 I owned some lower-end mid-tier quality rental units in the Dallas/Fort Worth area of Texas. The tenants earned about $25,000 per year and paid around $600 per month in rent.

In early 2006, one of my tenants mentioned to me that she wanted to start flipping houses! This was a clear sign that the last possible buyers had entered the market and the only place for the real estate market was to go down (which it ultimately did starting in 2006).

In case you are wondering, I already had this property for sale and fortunately it sold in March 2006 before the complete collapse of prices.

The summary of the past three articles in this series is to buy quality assets below their long-term conservative valuation at a time when the masses are selling in fear. A good paraphrase of Warren is Buffett to buy value when others are selling it — in other words, the asset is “on sale”.

You may also find these Motley Fool articles interesting:

• Warren Buffett’s Best Advice Ever
• Everything Buffett Needs to Know, He Learned Right Here.

A few weeks ago I interviewed Korbett Roberts from Benefit Concepts on the subject of life insurance.

Now life insurance may not be an exciting topic at first glance. However, getting a life insurance policy is one of the most important decisions you will ever make, which can greatly impact the lives of your loved ones far beyond your lifetime.

With the myriad of choices on the market today and conflicting advice from salespeople, it can be very difficult to identify what kind of life insurance you really need to properly protect your life’s work and your family’s lifestyle.

Korbett and his team at Benefit Concepts are experts in using life insurance as a strategic asset to serve a variety of purposes including estate planning, business succession, retirement cash flow, etc. for their clients, most of whom are affluent business owners with over $10 million in net worth.

Click to listen below to this informative 2-part interview which covers a surprising array of creative uses of life insurance that you may not know about.

Part 1 of this interview (28 min.) covers:

• Life insurance in a nutshell
• Some examples of the benefits of owning a life insurance policy
• What kind of protection is there from law suits and creditors?
• Term vs. permanent
• What kind of tax benefits are there?
• Getting cash flow via a policy loan
• How can a business benefit from purchasing life insurance?
• How does life insurance fit into estate planning and keep your estate out of costly and public probate?
• Why you should be concerned about your state’s estate taxes
• What are the disadvantages of buying and owning life insurance?

Part 2 of this interview (24 min.) covers:

• How to choose the right life insurance agent for you
• What questions should you ask an agent before working with him or her
• What are the most common mistakes people make when purchasing life insurance?
• What is the most important thing to get right when purchasing a policy?
• What is life insurance portfolio analysis and why is it critically important especially if you have purchased a policy in the last 3-4 years?
• How Benefit Concepts helped a client turn an unneeded policy from a $250,000 annual expense to a $2 million gain
• What does it mean to “leverage” life insurance?
• What are some ways to fund a life insurance policy without using current cash flow?
• How to compare a life insurance policy performance to other investment vehicles to know you’re putting your money in the right place?

To learn more about this topic or ask follow up questions, contact Korbett Roberts at Benefit Concepts.

Please comment below and tell us how you liked this interview and how we can make it better.

In Part 1 we discussed why the market is ripe for hard money lending, now let’s look at why hard money lenders are willing to fund deals traditional lenders reject.

Hard Money Lenders Can Charge Much High Interest Rates

Hard money lenders demand much higher interest rates (10-18% or 2-3 times higher) than banks do because they fund deals that do not conform to bank standards.

Banks have very specific standards because they are highly regulated and need standardized systems to make many loans. In contrast, many hard money lenders are individuals or small groups who are willing to work in narrower markets with niche products.

It’s All About the Asset / Collateral

If you could own an asset (e.g. real estate) that is worth $200,000 for only $100,000 (getting it for half price), would you do it?

Hard money lenders provide short-term loans (usually 6 to 18 months) based primarily on the value of the hard asset (such as real estate) that is collateral for the loan. In contrast a traditional lender bases the loan on the borrower’s ability to repay with the collateral as a secondary factor.

The two best quotes I’ve heard from hard money lenders are:

“Only lend if you’d rather have the asset.”

“Drive by the asset and think: do I want to own this?”

The “asset” referred to above is real estate, typically a single family home. Now think from the hard money lender’s perspective: You’re making a loan based on the asset, so what’s the worst thing that could happen?

Answer: The borrower defaults and does not pay you back.

So what happens when a hard money loan is defaulted upon?

If the hard money lender has properly recorded a first lien on the property / collateral, then the lender can follow the legal procedure to foreclose on the property – i.e. the hard money lender becomes the owner of the property which was the collateral for the loan.

Let’s see how the math works out in an example:

Imagine a new home bought in 2005 for $400,000 (inflated price in the bubble) and is now worth $200,000 (realistic market price today). The home owner who owes more on the home than it is worth today and who lost their job in the recession has stopped paying the mortgage and been foreclosed upon.

A flipper can buy this home at the trustee sale auction for say $120,000. The flipper buyer gets a hard money loan for 80% of the purchase price, or $96,000, and pays the remaining $24,000 cash himself.

So, assuming the home is really worth $200,000 (realistic price a retail buyer would pay today), the hard money lender’s basis in this property ($96,000 loan amount) is roughly 50% of today’s retail price ($200,000)!

That is a VERY secure position for the hard money lender.

So, in the “worst” case where the borrower defaults on the loan, the hard money lender gets to own the asset that’s worth $200,000 today for only $96,000 (ignoring fees and other legal costs).

How to Win Even If You Lose!

Hard money lending in this market is lucrative because you get to “win even if you lose”:

(1) If the borrower pays you back with interest as promised, you’ve received double digit yield on your money in a short period of time (6-18 months). This is an attractive yield compared to 0-3% on bank CDs and not much more for corporate bonds.

(2) If you “lose” and the borrower fails to pay you back, you can take ownership of the collateral property for what amounts to about half the current market value (e.g. $200,000 property for $100,000).

So, as a hard money lender, you can receive a double digit yield in most cases AND have the security of making even more money if the borrower defaults and you get the property at a cost below the REO or trustee sale price.