tag:blogger.com,1999:blog-78010322031912449762024-03-12T22:23:54.542-04:00hRUBIK's hRAMBLINGSA blog dedicated to explaining the hows and whys and whats of real estate appraisal, with side trips into economics, human nature, and justice as they relate to valuation. <p>
<a href="http://www.hrubikappraisal.com">HRUBIK APPRAISAL SERVICES</a><p>
DISCLAIMER : I HAVE BEEN KNOWN TO MAKE MISTAKES. PEOPLE WHO TAKE MY ADVICE, OR USE THE INFORMATION I PROVIDE HEREIN, DO SO AT THEIR OWN RISK.James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.comBlogger91125tag:blogger.com,1999:blog-7801032203191244976.post-70890181318197908622017-11-15T23:34:00.000-05:002017-11-15T23:34:46.272-05:00After a DecadeIt was just over 10-1/2 years ago that I began this blog, partly in hopes that it might help build my appraisal business. I've had a lot of feedback from it, and even outside the comments I have been approached by people who said they appreciated some of the insights, but it never did provide any additional business that I was aware of.<p>
Now that I am on the edge of retiring, I may have the time to piddle with this again. Life has gone on, in fits and spurts, and as far as business cycles go, it appears that we are approaching another nose-dive in the real estate market, just like 10 years ago.<p>
I have to admit, my history is a bit checkered. In 2007, I had been released from my position as a reviewer with AMCO (now Dwellworks), because as a part-time employee they wanted to cut costs by having me shift from W-2 to 1099. Since that would increase my E&O liability far more than was comfortable, and I would have to sign a non-compete clause and I was only going to be part-time, I declined to go that route and was turned loose. I spent some time doing fee work, but the end of the bubble was upon us, and fee work was becoming scarce.<p>
In April 2008 I took a position -- it was through a temp agency -- with Old Republic Default Management Services as a BPO reviewer. They had lots of business, since there were scads of defaults going on. I worked there through October 2008, at which time I was told there was no more work for me, but when I applied for unemployment, OJFS found otherwise. I suppose that it did not help that I raised my hand and disagreed with their company attorneys that a licensed appraiser who would be reconciling BPOs was actually performing a valuation service under USPAP, and should comply. They said the key word was "price", I maintained that it was "professional opinion as an appraiser", and we had to part company. I got to collect unemployment.<p>
It wasn't much, and every time I took on a fee job, even for a day, I was off unemployment for a month. For a while things were getting a bit desperate. The work I was doing for the Federal courts was not very substantial, and fee work for lenders was nearly non-existent. In mid-2009 Fred Westbrook at Barry Ankney Inc took a chance and hired me for the 2010 Geauga County revaluation. <p>
For two years I wandered the backsides of Geauga County, spending my days checking the accuracy of the tax cards from the ground. I got to meet and talk to dozens of Amish farmers, and hundreds of homeowners and business owners. Some folks were hostile -- yes, I got death threats -- but most were interested in making sure their tax records were straight. I got to see the insides of factories and high security test facilities as well as campgrounds and multi-million dollar residential estates. Geauga County had it all.<p>
When the reval concluded, Fred offered me a job in the office as a residential reviewer. Actually, I was to be the start of the residential arm of LookingGlass.cc Ltd, the commercial appraisal management company run by Barry and his crew. Along with Fred and Barry, I would be working with Chuck Cather, my old boss from REAS, and with Dick Rexroad.<p>
Dick and I hit it off immediately. We just clicked as a team, honing our review skills. It only took a little over a year and we hung a sign over the door -- the Dick 'n' Jim School of Appraisal. That came about because our office co-resident, Pete Zendlo, was constantly ribbing us about all the teaching we had to do in order to get compliant reports from appraisers. I learned from Dick, he learned from me, and we developed numerous advanced insights through our discussions of all things appraisal.<p>
Dick retired at the end of last month. I have let Barry know that while I would like to keep working, I will be doing so on more of a part-time basis starting in January. Maybe I will have time to pick this blog back up and do some mentoring. Maybe not. I just had to stop by and see if I could still log in. Then I had to write something. Now I have to go. See ya.James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-8422546157154597192013-07-25T21:45:00.000-04:002013-07-25T21:48:43.518-04:00Look Out for Morty!<blockquote align=justify>I recently took part in a discussion where the topic was the ability of a lender to call a loan; in that specific instance, a businessman's line of credit. This discussion covered the reappraisal of mortgaged real estate. In a changing market, a lender may want to gauge the change in the degree of risk (lenders may require additional collateral or may reduce the line of credit if the value of the collateral becomes less than the loan amount), and also touched upon "due on sale" clauses.<p>
A typical mortgage deed might contain something like the following (which is the actual text from an actual mortgage):<p>
<blockquote align=justify>"<b>18. Transfer of the Property or a Beneficial Interest in Borrower. As used in this Section 18, "Interest in the Property" means any legal or beneficial interest in the Property, including, but not limited to, those beneficial interests transferred in a bond for deed, contract for deed, installment sales contract or escrow agreement, the intent of which is the transfer of title by Borrower at a future date to a purchaser.<p>
<i>If all or any part of the Property or any Interest in the Property is sold or transferred (or if Borrower is not a natural person and a beneficial interest in Borrower is sold or transferred) without Lender's prior written consent, Lender may require immediate payment in full of all sums secured by this Security Instrument.</i> However, this option shall not be exercised by Lender if such exercise is prohibited by Applicable Law.<p>
If Lender exercises this option, Lender shall give Borrower notice of acceleration. The notice shall provide a period of not less than 30 days from the date the notice is given in accordance with Section 15 within which Borrower must pay all sums secured by this Security Instrument. If Borrower fails to pay these sums prior to the expiration of this period, Lender may invoke any remedies permitted by this Security Instrument without further notice or demand on Borrower.</b>"</blockquote>
While the likelihood of foreclosure on a residential property due to the above clause is currently not very high because there are so many foreclosures clogging the market, an understanding of what is actually owned and mortgaged is frequently missing in the mind of a typical homeowner.<p>
The popular view of a piece of residential real estate is a plot of dirt with a house on it. While it is true that these items are useful, the actual real estate is something different. Some definitions are in order.<p>
<blockquote align=justify>
<b>estate</b> : A right or interest in property. Defines an owner’s degree, quantity, nature, and extent of interest in real property. There are many different types of estates, including freehold (fee simple, determinable fee, and life estate) and leasehold. To be an estate in land, an interest must allow possession (either now or in the future) and be differentiated primarily by its duration.<p>
<b>freehold estate</b> : An estate or possessory interest in land that lasts for an indeterminable length of time, such as for a lifetime or forever. Examples include fee simple (also called an indefeasible fee), defeasible fee, and life estates. The first two continue for an indefinite period and are inheritable by the heirs of the owner. The life estate terminates upon the death of the person on whose life it is based.<p>
<b>fee simple estate</b> : Absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat.<p>
<b>leased fee interest</b> : A freehold (ownership interest) where the possessory interest has been granted to another party by creation of a contractual landlord-tenant relationship (i.e., a lease).<p>
<b>leasehold interest</b> : The tenant’s possessory interest created by a lease.<p>
<small><b>Source: Appraisal Institute</b>, <i><u>The Dictionary of Real Estate Appraisal, 5th ed.</u></i> (Chicago: Appraisal Institute, 2010).</small></blockquote>
Typically, when the buyer and seller of a residential property reach a meeting of the minds, the transaction that takes place is a transfer of a fee simple interest in the land and improvements. Theoretically (within the limits imposed by government), the owner of the fee simple interest may sell off all the materials that make up the improvements, and/or all the dirt, rocks, water, oil, or other minerals within the bounds of the property to the center of the Earth and still have the fee simple rights to the empty space left. He would have sold all the "stuff" that was on his real estate, but not the actual real estate itself.<p>
This is one of the hardest concepts to pound into the heads of real estate appraisers, their lender clients, and the borrowers against the real estate. <i>What is being appraised for a mortgage loan is not the dirt and sticks (although they play a part in determining what is available for quiet enjoyment of the real estate) but the market value of the bundle of rights that belong to the mortgagor.</i> In fact, the FNMA/FHLMC forms used to report the appraisal clearly identify the Property Rights Appraised at the very top of the first page. In most cases, the lender is loaning money on the fee simple interest.<p>
This creates some interesting potential problems for the mortgagor. Note that the lender reserves the right to call the loan if any <b><i>interest</i></b> in the property is sold without the lender's prior written consent. Let's look at some scenarios.<p>
<blockquote align=justify>
Pitfall #1. Big Bean Gas Company is aggregating parcels for a drilling unit, and strikes a deal with a group of owners in a subdivision for rights to the shale gas under their lots. Selling the rights to any possible underlying gas is a reduction of the fee simple interest in the property; under clause #18 in the mortgage above, it could trigger an acceleration of the loan payback, including a demand for immediate payment in full.<p>
Pitfall #2. Joe Homeowner wants to move but can't sell his home due to the poor real estate market. He can, however, rent it out. He finds a perfect tenant, and signs a one year lease. The tenant now has a leasehold interest; the fee simple interest has been diminished (even if only for 12 months), and if the lease was entered into without the prior written consent of the mortgagee, acceleration is possible.</blockquote>
It is vital to remember that when a person mortgages real estate, he is signing a deed which gives most of his rights in the estate to the mortgagee in the event that a default situation occurs. It is a sale with a right of redemption. The mortgagor retains the rights to possession and quiet enjoyment of the estate, but those rights are only on loan from the new owner, the mortgagee, until the terms of the mortgage are complete. The rest of the rights to the estate may belong to the lender, and if the mortgagor attempts to take those rights back without the mortgagee's approval, it could be a trespass which could forfeit the entire estate to the mortgagee in foreclosure. When you borrow money, and grant a mortgage deed to the lender, be sure to carefully read the terms of that deed.
</blockquote>
James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-22046229676114084612013-02-09T19:10:00.000-05:002013-02-09T19:10:31.511-05:00<blockquote align=justify>I've long been a gadfly to those who think that cheap money, Quantitative Easing, and all the other Voodoo Economic Spells by the Fed Magicians are the solution to America's financial woes. It just does not make sense to me that anyone could possibly think that devaluing a currency can have positive future effects. Hence I was taken a bit by surprise by a recent article in the financial section of the Beacon Journal which not only shared my concern about the direct valueless money was taking us, but also put forward a clear warning of a possible side effect that had escaped my attention : the future impact on the secondary mortgage market.
In Scott Burns' blog post of 9/8/2012 <a href="http://assetbuilder.com/scott_burns/building_the_next_financial_crisis_one_loan_at_a_time">Building the Next Financial Crisis, One Loan at a Time</a> he concludes,
<blockquote>
"What’s worrisome here is what’s going to happen to the market value of all these mortgages when, and if, interest rates return to more normal levels. When that happens, the institution holding the mortgage will be holding a loan whose market value is far lower than it’s face value. <i><font color=red>Suppose, for instance, mortgage rates rise to 5 percent over the next 5 years. At that point a 3.5 percent 30-year mortgage that is new today will have a term of 25 years and an outstanding balance of $179,768 but its market value will be $153,627.</font></i><p>
That’s a loss of 14.5 percent, a loss that would wipe out the equity of most lenders. If mortgage rates rise to 6 percent over the next 5 years, the market value of the mortgage will be $139,390. That would be a loss in market value of 22.5 percent.<p>
The same holds true for shorter-term loans such as the 1.99 percent auto loans that are becoming common . Were interest rates to rise quickly to 5 percent, every $1,000 of new 1.99 percent five-year car loan would sink in market value to $928. That’s a loss in market value of about 7 percent, enough to threaten the solvency of the lender.<p>
Note that we’re not talking financial Armageddon and runaway inflation here. We’re just talking about a return to interest rates that are on the low side of what we’ve seen over the last 50 or 60 years. Indeed, for some readers this will be a case of “deja vu all over again”— rising mortgage rates would be a replay of what was experienced in the 1970s, an event that culminated in the thrift crisis, destroyed the thrift industry and produced a financial crisis that paralyzed the real estate industry for years.<p>
Can we find a silver lining somewhere in this dark cloud? You bet. <i><font color=red>First, let’s not fret about our financial institutions; they already own Congress and can take care of themselves. The silver lining is for younger families: higher future interest rates amount to a major wealth transfer. Lenders will lose, borrowers will gain.</font></i> Younger households may be able to recoup some of their losses from the last decade as home prices rise and the true value of mortgages declines."[Red italics are mine.]</blockquote>
As mentioned, THAT was something that had not occurred to me. What is unsaid is that the disaster is unescapable. The Fed's low rate policy cannot be maintained forever. Even without any substantial economic recovery inflation has begun to attack the daily budgets of American households and businesses. The day will come when rates will have to be allowed to rise in order to attract government bond buyers.<p>
On that day the collapse of the secondary mortgage market will regain front and center position. Woe on that day to the investor who has a portfolio heavy in financial stocks. Why do I not share Burns' optimism about the banks escaping again? Congress has heretofore shown no will to reign in the Fed, but in the face of a second banking collapse, it will not provide easy bailouts to that sector as it did in 2008. The mortgage derivative market is a house of cards built from worthless Federal reserve paper, and there is a hurricane brewing in the Sea of Inflation.
</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com4tag:blogger.com,1999:blog-7801032203191244976.post-74054745507501301082012-02-08T21:44:00.001-05:002012-02-08T21:47:37.138-05:00A Look at Disposition Value & Liquidation Value<blockquote align=justify><br />A common instruction in an engagement letter in these times might include wording such as:<p><br /><br /><i>"Please provide both the current market value and the disposition value based on a 9 month market period for the fee simple interest." </i><p><br /><br />As compliance reviewers, my colleague, Richard Rexroad, SRA, and I have noted on numerous occasions what appears to be total confusion among the ranks of appraisers as to what exactly is meant by "disposition value". Certainly, the definition of disposition value is easily found for, and cited in, their reports, but the summary statements that include their opinions of disposition value may be of marginal use -- or worse, no use at all -- to the client.<p><br /><br />To try to ascertain the resources available to appraisers for reference on the subject, a search was made of all media in the Appraisal Institute's Lum Library using the keywords <i>"disposition value"</i>. The search returned one resource, <b><u>Appraisal Institute Special Task Force on Value Definitions, June 1992</u></b> by Schultz, Featherston, Gibbons, LeGrand, and Parson. That work proposed definitions of disposition value and liquidation value, both of which appear to have subsequently been defined following their proposal. No further modern references could be located in the Lum Library.<p><br /><br />Perhaps the best starting point for the discussion would lie in examining the Assignment Type and Intended Use of the report. After the highjacking of the URAR form by Fannie and Freddie in 2005, and the hardcoding of the Intended Use ("The intended use of this appraisal report is for the lender/client to evaluate the property that is the subject of this appraisal for a mortgage finance transaction."), most residential appraisers gave no further thought to that matter. For the most part, the assignments were for either purchases or refinances; no other discussion of the intended use was needed.<p><br /><br />With the increase in inventory of REO properties and the periodic need to analyze the value of the collateral with a view toward asset disposition, lenders holding residential properties in their portfolios have been ordering large numbers of appraisals for the purpose of collateral analysis rather than mortgage finance. The AI Reports forms (which would be a much better choice for the task) have been ignored by the lending community. Appraisals for collateral analysis have been ordered, almost without exception, on the FNMA 2005 series of forms, most likely because that is what the lenders are most familiar with. <p><br /><br />Because the FNMA/FHLMC forms are intended to be used for mortgage finance rather than disposition of the asset, the change in Intended Use is in direct conflict with the hard-coded statement in the report, and very few residential appraisers (even among those holding various designations from professional associations) have seen fit to add language in the addenda to the report which will supercede the hard-coded verbiage.<p><br /><br />[<i>Note: The forms do state that "Modifications, additions, or deletions to the intended use, intended user, definition of market value, or assumptions and limiting conditions are not permitted.", and then two exceptions are cited. However, that restriction applies ONLY to the use of the form for a FNMA/FHLMC mortgage transaction. <b>The GSEs cannot prohibit the use of the form for other purposes; the key to their USPAP-compliant use in such situations is to adequately provide overriding verbiage in an addendum regarding the intended use, intended user, definition of value (and the source of the definition), assumptions, conditions, limitations, and certifications. </b></i>]<p><br /><br />This discussion does not purport to address all forms of deviation from the hardcoded verbiage in the FNMA/FHLMC forms, but appraisers using those forms for other than a mortgage finance transaction need to keep the above factors under consideration.<p><br /><br />When the assignment stipulates that the purpose is in the nature of collateral analysis for disposition of the asset, the client will frequently request either a disposition or liquidation value opinion along with the current market value opinion. In doing so, the client is first looking for the present value of the asset as though it had been offered on the open market at competitive terms with all other properties comparable to it. The typical exposure time for the subject must be analyzed and reported for the current market value. In that analysis, the appraiser will also be analyzing the market supply and pricing trends of competitive homes; all these factors are supposed to be summarized on page 1 of the FNMA report form. <p><br /><br />Development of current market value is a straightforward process for most residential appraisers. Their major concern with the neighborhood market trend information is to develop adequate adjustments for the comparable sales, based on their distance in time from the effective date of the report. When the assignment adds the requirement to develop an opinion of disposition or liquidation value, however, there will be an application of the trends to the stated marketing period along with additional consideration of the motivation of the seller.<p><br /><br />An examination of the definitions of these values is in order:<br /><br /><table frame=box rules=all cellpadding=5><tr><br /><td width=315 align=center><b>Market Value</b></td><br /><td width=315 align=center><b>Disposition Value</b></td><br /><td width=315 align=center><b>Liquidation Value</b></td></tr><br /><br /><tr><br /><td align=center>12 CRF 323.2(g)</td><br /><td align=center>Dict. of RE Appraisal (4th Ed)</td><br /><td align=center>Dict. of RE Appraisal (4th Ed)</td></tr><br /><br /><br /><tr><br /><td align=left><font size=small>Consummation of a sale as of a specified date.</font></td><br /><td align=left><font size=small>Consummation of a sale will occur within a <b>limited future marketing period</b> specified by the client.</font></td><br /><td align=left><font size=small>Consummation of a sale will occur within a <b><i>severely</i> limited future marketing period</b> specified by the client.</font></td></tr><br /><br /><tr><br /><td align=left><font size=small>Competitive and open market under all conditions requisite to a fair sale.</font></td><br /><td align=left><font size=small>The actual market conditions currently prevailing are those to which the appraised property interest is subject.</font></td><br /><td align=left><font size=small>The actual market conditions currently prevailing are those to which the appraised property interest is subject.</font></td></tr><br /><br /><tr><br /><td align=left><font size=small>The <b>buyer and seller each acting prudently</b> and knowledgeably.</font></td><br /><td align=left><font size=small>The <b>buyer and seller each acting prudently</b> and knowledgeably.</font></td><br /><td align=left><font size=small>The <b>buyer acting prudently</b> and knowledgeably.</font></td></tr><br /><br /><tr><br /><td align=left><font size=small>Assuming the price is not affected by undue stimulus, buyer and seller are typically motivated.</font></td><br /><td align=left><font size=small>The <b>seller is under compulsion to sell</b>, the buyer is typically motivated.</font></td><br /><td align=left><font size=small>The <b>seller is under <i>extreme</i> compulsion to sell</b>, the buyer is typically motivated.</font></td></tr><br /><br /><tr><br /><td align=left><font size=small>Both parties are well informed or well advised, and acting in what they consider their own best interests.</font></td><br /><td align=left><font size=small>Both parties are acting in what they consider their best interests.</font></td><br /><td align=left><font size=small>The buyer is acting in what he or she considers his or her best interest.</font></td></tr><br /><br /><tr><br /><td align=left><font size=small>A <b>reasonable time is allowed for exposure</b> in the open market.</font></td><br /><td align=left><font size=small>An <b>adequate marketing effort will be made</b> in the limited time allowed for the completion of a sale.</font></td><br /><td align=left><font size=small>A <b>limited marketing effort and time will be allowed</b> for the completion of a sale.</font></td></tr><br /><br /><tr><br /><td align=left><font size=small>Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto.</font></td><br /><td align=left><font size=small>Payment will be made in cash in U.S. dollars or in terms of financial arrangements comparable thereto.</font></td><br /><td align=left><font size=small>Payment will be made in cash in U.S. dollars or in terms of financial arrangements comparable thereto.</font></td></tr><br /><br /><tr><br /><td align=left><font size=small>The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale. </font></td><br /><td align=left><font size=small>The price represents the normal consideration for the property sold, unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.</font></td><br /><td align=left><font size=small>The price represents the normal consideration for the property sold, unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.</font></td></tr><br /><br /></table><p><br /><br />Standards Rule 1-2 requires that the appraiser identify the Intended Use of the appraisal. It seems to be a difficult thing for appraisers to ask clients, "What do you intend to do with my opinion?", yet that is critical to understanding how the problem must be approached. The appraiser cannot render a useful opinion of value without understanding the motivation of the participants in the market. We seem to clearly understand that a market value opinion will be used to make a decision regarding underwriting a mortgage loan. Sadly, there seems to be a failure to understand why a client would request a disposition or liquidation value; the client assumes we know, and we assume they understand what we are about to deliver.<p><br /><br />Let us step into the shoes of the lender with an asset which needs to be sold. The lender first wishes to know what his collateral is worth today -- the current market value. That value assumes that the subject has been on the market for its reasonable exposure period. In studying that exposure period, the appraiser will note the change in the market from the beginning of the exposure period to the effective date of the appraisal; that market change information will be critical in making adjustments to the comparable sales. <p><br /><br />Unfortunately for the client, he is holding the subject in his inventory today, without a sales contract. He realizes that in order to get a contract, he will have to market the property. He has certain parameters for market time. Let us assume that the market is slow and the reasonable exposure period for the subject might be 6 months. The client knows that it will take time to sell the subject; acting prudently (see the definition of disposition value) he is willing to extend the market time to a maximum of 9 months, and orders a disposition value based on a 9 month market period. What is he telling us he wants? Have we really learned the definition of the value type?<p><br /><br />Perhaps the client tells us his intent is to know what the property will be worth 9 months from now by asking for a disposition value based on a 9 month market period. That is a prospective value opinion which the appraiser will need to develop by adjusting the current market value for any anticipated change in the market over the 9 month period, <i>as well as his knowledge, <b>perhaps gleaned from anecdotal evidence in talking with sales brokers</b>, of typical discounts in the subject market when properties sell under compulsion</i>. Similarly to <i>forecasting</i> in a relocation appraisal, the 9-month disposition value thus arrived at gives the client a far end of a range (current market value is the near end) within which he can hope to sell the property during that time period. If an offer comes in within that range, the client now has a tool he can use to judge the acceptability of the offer. As the 1992 Task Force noted, in a declining market, the disposition value opinion would probably be lower than current market value, but in a rising market, it possibly could be higher.<p><br /><br />Development of a liquidation value opinion would follow the same general pattern, with a subtle difference -- the factor of <i>extreme</i> compulsion to sell, coupled with the facts that the marketing effort would be limited and the seller might not be acting prudently. In such a situation, the place to turn for the anecdotal market conditions would be the auctioneer who specializes in absolute auctions with no reserve. Such an opinion would need to be formed with the mindset that the specified market period for the subject would anticipate an absolute auction at its termination, with a view toward informing the client that any offer he received within that time period which fell into the range would likely be one to which serious consideration should be given.<p><br /><br />Nevertheless, regardless the trend of pricing in the marketplace, the anecdotal evidence will be crucial to the development of either type of value. There simply is not enough reliable statistical information readily available to the average residential appraiser for this purpose. The subjective nature of anecdotal data should not be viewed as lacking validity; the decisions behind the motivation and actions of the typical seller in disposition or liquidation scenarios are similarly subjective and valid. The appraiser is not being misleading as long as full disclosure of the kind of data source is made.<p><br /><br />What is not valid, and is indeed unethical, is to postulate an opinion of value without understanding the intended use of the appraisal, or acknowledging the conditions explicit in the definition of that value.<br /><br /></blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-50628534855714304152011-08-04T23:03:00.003-04:002011-08-04T23:10:57.542-04:00So Prove Me Wrong<blockquote align=justify>On Tuesday, after the nefarious Beltway Bozos passed <b>the largest debt increase in American history -- a 16.78% increase</b> which the greedy spenders will utilize to its fullest extent -- the stock market reacted with its sharpest loss in months. I said then that worse was to come; that the Asian markets at midday were down about 2%, foreshadowing a continuing Wall Street decline.<br /><br />Wednesday morning the slide from Tuesday afternoon continued until the afternoon, when the tide turned and the market began to rise. The Dow clawed its way back to +26 for the day, and I began to wonder what had happened. I think I know.<br /><br />Wednesday afternoon the heaviest volume came from heavy buying of Standard & Poor's industrial fund. That fund deals mainly in the 500 top industrial stocks on the exchange (most people have at least <i>heard</i> of the S&P 500). When money is pumped into the S&P 500, the fund managers must deal with it; they buy industrial stocks. This creates a feedback mechanism, driving the market ever higher. This feedback is enhanced by computer trading, since the computers are not programmed for fear. <br /><br />All you need is a catalyst, and it is my belief that the catalyst was the Fed's private member banks -- a sinking stock market was the opposite of what their political masters needed, so they began buying to shore up the market. Without doubt, the need for a "sucker rally" was also a powerful motivator. The industrials rose on the coattails of that buying.<br /><br />This morning the outlook was a bit bleaker. The Asian markets did not follow Wall Street; they continued to drop. Standard & Poors was the top loser of the day in terms of volume. Apparently the rallyers from Wednesday also got cold feet, and the sell-off began again in earnest. Traders wanting to retain relative liquidity are moving to cash in anticipation of rising interest rates. This is putting a strain on the banks, which, while paying minimal interest, are still being hurt by having to hold funds which they dare not place in the market. <br /><br />It is no wonder that instead of paying interest, banks are starting to charge large depositors a fee for holding their cash, as announced by BNY Mellon today. "The northern lights have seen strange sights...", but we are about to fall down the rabbit hole.<br /><br />I have digressed. Today, the Dow dropped over 500 points, down 4.31% in a single day. At this writing (10:30 PM Thursday here, 10:30 AM Friday in Hong Kong), the Hang Seng is down over 4%. It could rebound, but the threat of a weekend, and worries over the U.S. unemployment figures pointing upward, make an Asian rebound very tentative. <br /><br />So, to the geniuses in Washington, I say, the worst possible thing you could have done to our economy was to increase the President's credit card limit. Prove me wrong. I'm waiting.</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-39365339145745292462011-08-02T21:52:00.004-04:002011-08-02T22:06:15.945-04:00WHAT? No UP?<blockquote align=justify>There are some stunned people this evening who were jubilant that the House and Senate and President came together on a deal that would hopefully avert default. They were expecting that the stock market would rise and everyone would be cheerful about the wonderful new future we faced. <br /><br />But -- the market tanked. It lost 265 points, over 2%, for the day. This may seem counterintuitive to government figures, public employees, and newscasters, but there is a very logical reason for what happened. Unless I have misread what appears to be an obvious reaction, I predict that the next few days may show that it will continue to happen. In fact, as I write this, the Asian markets (on which the sun has risen and which are already in tomorrowland)are down over 2% -- a harbinger of tomorrow's Wall Street adventure.<br /><br />What the Washington Klutzes have done over the past several decades has been the steady erosion of the worth of the US dollar. In order to score political points by artificially generating an "economic recovery", the gummint, through the evil genies at the Federal Reserve, has held interest rates at levels that are artificially low. My question for some time has been, "If it costs nearly nothing to borrow a dollar, then what is that dollar really worth?"<br /><br />The panic over possible default was engineered by the Administration, the Fed, and the lapdog press, with the overt participation of the folks who make their living through usury -- the bond traders. In the last hours of the panic, there were those who moaned that if the US gummints credit limit was not increased, the gummint would not be able to pay its creditors.<br /><br />That fiction ignored the fact that the President, via the Secretary of the Treasury, has the responsibility of prioritizing spending. He has put a high priority lately on bombing Libya, but such a low priority on such things as Social Security and Medicare as to threaten that those latter checks might not go out if he didn't get his way.<br /><br /><b><i>The usurious bond traders were particularly worried. If the credit limit were capped at the current rate, there could be no new borrowing. Because they make their money on the commissions from bond sales, capping the credit limit might cap their incomes. They needed an influx of new borrowing.</i></b> <br /><br />There are unintended consequences to every evil under the sun. The US dollar, already weakened by the stupid Quantitative Easing policies of the Fed, is about to get even weaker. Currency inflation has one side effect that the markets understand, and that is, that when money is devalued through printing, interest rates must rise. <br /><br />When interest rates are held artificially low, and stock dividend yields outpace bond interest, stock prices rise due to higher demand. That was the scenario during the rounds of Quantitative Easing, and the reason for the interest in the stock market over the past year. I expect that this scenario is ending. Cheap money is risky money. Risk-takers demand higher compensation for higher risk, and interest rates are about to rise.<br /><br />Classically, when interest rates rise, and their rate of return begins to exceed the rate of return for stocks, the market flees stocks and buys bonds. When savvy investors realize that everyone else in the marketplace will sooner or later get the same idea, panic selling sets in. Nobody wants to be the last guy to trade before the market hits bottom.<br /><br />I have been wrong before, and am willing to concede that I may not be entirely on the right track. I will, however, predict that the stock market is in for a decline to a sustainable level, at say around 8500, maybe a little lower. That will be caused by an expectation that cheaper money will be seen as higher risk with higher returns, with the gummint selling economic snake oil in an effort to charm bond buyers. This will lead to a drawdown in capital invested in plans to expand operations and payrolls, with an accompanying depression of the employment figures. <br /><br />The American people elected new Representatives who promised to hold to Tea Party principles. Instead, those Representatives appear to have been eating the Washington Establishment's magic mushrooms.</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-76479193873516156172010-10-15T08:34:00.002-04:002010-10-15T08:39:20.736-04:00The Rosy Crystal Ball<Blockquote align=justify>I've been too busy to publicly express my perspective on the economy lately but several items are making me curious as to how much manipulation the markets can handle before they correct themselves. The future, as presented by the US government and its monetary master, the Federal Reserve, appears quite well, and "market analysts" seem to be predicting a gradual strengthening which supposedly began when the "recession" ended over a year ago.<br /><br />I have often spoken out against the use of statistical correlation with regard to attempting proof of a concept. Correlation, however, allows visualization of a composite picture of events. Such correlation helps to avoid tunnel vision, where fixation on a particular goal blinds the observer to other inputs. The analysis of correlated events will then provide a view with more depth perspective, and add "color" to a "black and white" picture.<br /><br />The Fed has embarked on a course of <i>Quantitative Easing</i> (QE). QE is another term for printing money without increasing its backing. It "eases" the ability of member banks to lend money at low interest rates, and consequently, devalues the currency in which the money is issued. <br /><br />I have a question for the wizards : if interest rates are at a historic low, and yet the lenders are having difficulty interesting businesses in borrowing more (because the businesses appear wary of overextending themselves), what are the banks going to do with the additional currency? Will they, themselves, take the opportunity to purchase additional assets at low interest rates?<br /><br />A related area is the trend in consumer prices. If the Consumer Price Index has risen for the past 3 months at only fractions of a percent, this is perceived as a sign that inflation of the currency is under control. However, when the index rate for July and August combined was only 0.3 percent, yet the increase in August alone for fruits and vegetables (at the peak of harvest when prices should fall) was 0.4 percent, does this indicate that the composite index is understating the inflation of the core items which affect the largest numbers of consumers?<br /><br />Another area being watched is the trend in retail sales. One prediction which I saw, credited to JP Morgan Chase, was that retail sales would be up 0.6 percent in September, but if autos are excluded, would be up only 0.4 percent. Question : if retail sales are measured by dollar expenditures, and they roughly parallel the rise in consumer prices, does this indicate that they are in reality flat or even slightly negative?<br /><br />A third area being considered is the report on business inventories. The prediction (again attributed to JP Morgan Chase) is that the government will announce business inventories up 0.6 percent in August. This has been interpreted to mean that confidence is increasing. In view of the rise in consumer prices, coupled with the increase in retail sales roughly paralleling the price increases, could it also mean that perhaps people have stopped or slowed their buying?<br /><br />I don't know. I confess to being an amateur in matters of complex macrofinances. Nevertheless, there is something smelly that the newspaper has been wrapped around. Looking at only one part of the data could make me hopeful. Correlating the data makes me skeptical. </blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-71027561668637601442010-05-21T18:52:00.002-04:002010-05-21T18:54:17.803-04:00Change in OperationsTo my readers : I had to make a change in comment moderation due to a comment being placed which could have redirected readers to a website with questionable content. Sorry, but there are skunks in every woodpile, I suppose.James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-19591510823799523802010-04-10T00:07:00.002-04:002010-04-10T00:11:16.268-04:00Calling All Lollipops?<blockquote align=justify>My famous pessimism (OK, infamous, if you will) with regard to things economic when they just don't make sense got a jolt today with a FOX News article <a href="http://www.foxnews.com/us/2010/04/09/dows-trades-scarce-worrying-bulls/">The Dow's up but trades are scarce, worrying bulls</a> which pointed out that the DJIA has been rising while the trading volume has been declining. So I jumped into Yahoo! and pulled a graph:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhPyI_UmP0u5fMPNsKQ1-6JJCKbvNnHdDFfkiKKvRN-ltK2ZgjiivVKL8ezUm3y_resy5Uzs9khjLotDpNlEtDZtIkZsJ-5ZZiNuBo4eAm1rtodJXn1_Nwr_9l5p3o3N75itGeXe7zaKYE/s1600/z.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 238px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhPyI_UmP0u5fMPNsKQ1-6JJCKbvNnHdDFfkiKKvRN-ltK2ZgjiivVKL8ezUm3y_resy5Uzs9khjLotDpNlEtDZtIkZsJ-5ZZiNuBo4eAm1rtodJXn1_Nwr_9l5p3o3N75itGeXe7zaKYE/s400/z.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5458356114751957650" /></a><br /><br />Yup. The prices are up about 70% from last year, while the number of trades is down about 25%. You would think that if the market is recovering and prices are rising, there would be an increase in the number of players trying to expand their holdings.<br /><br />Do you smell something burning?<br /><br />A few commenters on the article want to pin the scam (yes, I do think there is an attempt being made to create a sucker rally) on the Administration, but I hesitate to go that far. Invoking Occam, I would tend to say that some of the major banks and fund managers are behind this phenomenon, hoping to draw broad enough support in the market to allow them to dump their more toxic assets on the unwary. <br /><br />The NYSE volume today was 4,511,569,000, of which 995,307,699 shares (22%) were Citibank (662,164,923), Ambac Financial (195,367,197), and Bank of America (134,825,884) -- the top 3 issues traded. This makes me deeply suspicious when almost 1/4 of the trades involved stocks which have negative P/E ratios and which are anticipated to pay no dividends. Remember that someone has to sell in order for someone else to buy, and it is the selling that first makes the buying possible; who is dumping these stocks? (I won't bother myself with who might be stupid enough to be buying them.)</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-50705169808505644812010-03-21T16:28:00.003-04:002010-03-21T17:04:43.857-04:00Open letter to Tim Crawford<blockquote>The following email was sent to the listed recipients. It seems that failure to listen to constituents is not a unique feature of the Beltway Gang. <br /><br /><blockquote align=justify>March 20, 2010<br />Open letter to Tim Crawford, <br />Summit County Council District 7<br /><br />Dear Tim,<br /><br />As a fellow campaigner in the past for addressing problems of representation in local government, I am appealing for your attention in the matter of the hostility that exists between the government of Summit County and the Barberton-Norton Mosquito Abatement District.<br /><br />As you are probably aware, the Barberton-Norton Mosquito Abatement District (MAD), organized under Chapter 6115 of the Ohio Revised Code, came into existence after the Barberton City Health Department (BCHD) ended its long-standing mosquito control program. Nuisance control of mosquitoes is not a mandated function of health districts, and the regular spraying for mosquitoes was considered a luxury that could not be maintained under the BCHD's limited budget.<br /><br />Both the Barberton and Norton City Councils were approached with the idea of forming a special sanitary district to reduce the population of biting arthropods under Chapter 6115. When neither council took action to form such a district, citizens from both communities circulated petitions and presented them to the Summit County Common Pleas Court as required by the statute. The Court agreed that formation of the special sanitary district would "be conducive to the public health, safety, comfort, convenience, or welfare" of the affected communities, and ordered that the Barberton-Norton Mosquito Abatement District be established.<br /><br />There have been complaints by certain disaffected persons that the organization and operation of the MAD, with assessments levied by the Board of Directors (BOD), is an example of "taxation without representation". Such an accusation is no more true than one which would state that levies by the State Legislature are also "taxation without representation". This is so because the landowners in the district are represented by the BOD, who are appointed by their elected officials. Those Directors are required to be residents of the MAD, and can be contacted by any landowner; the meetings of the MAD Board of Directors are also open public meetings at which the public can address the Board directly with its concerns.<br /><br />At the request of residents in surrounding areas, the MAD undertook efforts to expand. This expansion was opposed by the Summit County Health District (SCHD), which took the position that the activities of the MAD were an unnecessary duplication of the sporadic spraying done by the SCHD. In fact, the activities of the MAD are directed at nuisance control for the comfort and convenience of the residents; possible control of arthropod-vectored diseases are a secondary benefit from the standpoint of the MAD. The SCHD mosquito control program is oriented toward preventing outbreaks of arthropod-vectored diseases; the "comfort and convenience" of the residents is not emphasized by their program.<br /><br />Despite the different goals of these two entities, SCHD has actively and aggressively worked to eliminate the MAD. In the summer of 2009, the MAD sent out a survey to the landowners of Norton, and nearly a thousand of the recipients replied (22%) with postcards to Norton City Council, the vast majority of which were supportive of the MAD. They did not want their mosquito abatement program to end.<br /><br />As mentioned above, the landowners of Barberton and Norton are represented by the BOD. The political subdivisions in which the MAD is located (Barberton, BCHD, Norton, Summit County Executive, SCHD) are represented by the District Advisory Council (DAC). The Summit County Executive had a representative on the DAC from the beginning, and upon the City of Norton ending its agreement with the BCHD and contracting with the SCHD, the SCHD was entitled to choose a DAC member.<br /><br />It is my concern that neither of the DAC members representing Summit County are residents of the MAD. This situation, coupled with the antagonism of the SCHD toward the MAD, is a recipe for mischief. The citizens of Barberton and Norton are looking to you, our representative on the Summit County Council, and a resident of Norton who benefits from the work of the MAD, to protect our right to enjoy our property comfortably. <br /><br />Thanks for listening to an old Norton Neighbor.<br /><br />--Jim Hrubik<br /><br />cc: Dave Koontz, Mike Zita, Scott Pelot, Todd Bergstrom, Don Nicolard, Bill Mowery, Ken Braman, Brenda Hlas, Bob Genet, Kevin Coughlin, Tom Sawyer, Brian G. Williams, John Otterman, various Internet sites.<br /><br />Repeal 17 : Restore I-3<br />-------------------------------<br />http://www.linkedin.com/pub/james-c-hrubik-sr/12/7a4/a58</blockquote><br /><br />The MAD website is <a href="http://www.mosquitodistrict.com/">Barberton-Norton Mosquito Abatement District</a><br /><br />Angry messages can be sent to:<ul><br /><li><a href="mailto:crawfot3@nationwide.com">Tim Crawford, Summit County Council, District 7</a></li><br /><li><a href="mailto:mayor@cityofbarberton.com">Bob Genet, Mayor of Barberton</a></li><br /><li><a href="mailto:mayorkoontz@cityofnorton.org">Dave Koontz, Mayor of Norton</a></li><br /><li><a href="mailto:toddbergstrom@cityofnorton.org">Todd Bergstrom, Norton Ward 1</a></li><br /><li><a href="mailto:donnicolard@cityofnorton.org">Don Nicolard, Norton Ward 2</a></li><br /><li><a href="mailto:billmowery@cityofnorton.org">Bill Mowery, Norton Ward 3</a></li><br /><li><a href="mailto:joken5121@aol.com">Ken Braman, Norton Ward 4</a></li><br /><li><a href="mailto:mzitacc04@aol.com">Mike Zita, Norton At-Large</a></li><br /><li><a href="mailto:scottrpelot@netscape.net">Scott Pelot, Norton At-Large</a></li><br /><li><a href="mailto:brendahlas@neo.rr.com">Brenda Hlas, Norton At-Large</a></li></ul><br /><br />Let them know how you feel about spending City tax dollars to oppose the Mosquito Abatement District.<br /><br /></blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-72508663260256482272010-02-18T20:28:00.003-05:002010-02-18T20:39:52.696-05:00The Peter Principle is for Real<blockquote align=justify>Hmmm.<br /><br />The head of the UN Framework Convention on Climate Change, Yvo De Boer, is resigning that position to go to work for KPMG.<br /><br />KPMG. The company that was auditor for New Century Financial. <br /><br />You remember New Century? They went bankrupt because of their practices with respect to subprime mortgage lending. Then the bankruptcy court examiner accused KPMG of helping hide the accounting irregularities. To quote directly from <i><u>Final Report of Michael J. Missal, Bankruptcy Court Examiner</u></i> in re: United States Bankruptcy Court for the District Delaware, Chapter 11, Case No. 07-10416(KJC),<br /><blockquote>"The increasingly risky nature of New Century's loan originations created a ticking time bomb that detonated in 2007. Subprime loans can be appropriate for a large number of borrowers. New Century, however, layered the risks of loan products upon the risks of loose underwriting standards in its loan originations to high risk borrowers. For example, more than 70% of the loans originated by the Company had low initial 'teaser rates' that were highly likely to increase significantly over time. A senior New Century officer noted in 2004 that borrowers would experience 'sticker shock' after the teaser rates expired. More than 40% of the loans originated by New Century were underwritten on a stated income basis. These loans are sometimes referred to as 'liars' loans' because borrowers are not required to provide verification of claimed income, leading a New Century employee to tell certain members of Senior Management in 2004 that 'we are unable to actually determine the borrowers' ability to afford a loan.' Another common loan product offered by New Century that had a high degree of risk was the '80/20' loan, which involved two separate loans for the same transaction: a first lien mortgage loan with an 80% loan to value ratio and a second lien loan with a 20% loan to value ratio, resulting in a combined financing of 100% of the value of the mortgaged property. One Senior Officer of New Century noted in early 2006 that the performance of these 80/20 loans in 2005 was 'horrendous.'"<br /><br />"The Examiner has completed his investigation and files this Final Report, The Examiner recognizes that the subprime mortgage market collapsed with great speed and unprecedented severity, resulting in all of the largest subprime lenders either ceasing operations or being absorbed by larger financial institutions. Taking these events into consideration and attempting to avoid inappropriate hindsight, the Examiner concludes that New Century engaged in a number of significant improper and imprudent practices related to its loan originations, operations, accounting and financial reporting processes. KPMG contributed to certain of these accounting and financial reporting deficiencies by enabling them to persist and, in some instances, precipitating the Company's departures from applicable accounting standards."<br /><br />"KPMG contributed to these failings in critical ways. Among other inadequacies, KPMG failed to question or test certain important assumptions in a rigorous manner. The KPMG management team acquiesced in New Century's departures from prescribed accounting methodologies and often resisted or ignored valid recommendations from specialists within KPMG. At times, the engagement team acted more as advocates for New Century, even when its practices were questioned by KPMG specialists who had greater knowledge of relevant accounting guidelines and industry practice. When one KPMG specialist persisted in objecting to a particular accounting practice on the eve of the Company's 2005 Form 10-K filing -- an objection that was well-founded and later led to a change in the Company's practice -- the lead KPMG engagement partner told him in an email: 'I am very disappointed we are still discussing this. As far as I am concerned we are done. The client thinks we are done. All we are going to do is piss everybody off.'"</blockquote><br />Somehow that last paragraph seems like it could fit the whole Climategate fiasco with just a minor tweaking. According to <a href="http://www.foxnews.com/scitech/2010/02/18/climate-official-yvo-boer-resigning/">Fox News</a>, "De Boer's resignation comes in the wake of the continuing Climate-gate scandal -- a story that began with the leak of stolen e-mails from top climate scientists and led to revelations of sloppy science, efforts to suppress dissenting opinions and ultimately flaws in the U.N.'s top climate policy document. "<br /><br />The article concludes with, "De Boer said he will be a consultant on climate and sustainability issues for KPMG, a global accounting firm, and will be associated with several universities."<br /><br />Fitting.<br /><br />By the way -- those 80/20 loans that were made in 2007 and 2008 (and there were quite a few of them) -- are now resetting. Look for foreclosures to jump again toward mid-2010.</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-74201559955311702472010-01-31T20:52:00.003-05:002010-01-31T20:58:06.791-05:00How much is a dollar worth if ...<blockquote align=justify>As I write this (January 31, 2010), the media are reporting that the special inspector general at the Treasury Department, Neil Barofsky, who has been assigned to monitor the Troubled Asset Relief Program (TARP, aka <i>The Bank Bailout</i>), has today warned Congress that the problems within the financial system that created the market collapse are worse now than before the TARP began.<br /><br />Part of the reason for the alarm is the fact that the government has been borrowing to prop up the housing market, and, with the collusion of the Federal Reserve, has been holding interest rates at artificially low levels. A point will soon be reached at which the borrowing will have to cease, since the foreign lenders will realize that the risk levels have risen, and the subsidization will end. This will initiate another collapse in housing prices.<br /><br />I have a question : <b><i>How much is a dollar worth if it doesn't cost anything to borrow it?</i></b><br /><br />We can see that government intervention in the marketplace is rapidly leading the United States to bankruptcy. Rather than trying to expand spending, Congress needs to concentrate on how to best avoid foreclosure by the nation's creditors. <br /><br />If anyone thinks that the Chinese government (our major creditor) will simply roll over and forgive our debt, they need to study the tactics of the Tongs. The future of our country looks bleak, not because the people lack the willingness to work and pay their debts, but because the Congress has used the nation's credit card and gone over the limit.<br /><br />The spending on bailouts, foreign aid, and domestic programs must stop.</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-28792823169629380092010-01-25T22:52:00.004-05:002010-01-26T19:04:39.559-05:00Calling Sancho Panza...<blockquote align=justify>On January 22, 2010, the Akron Beacon Journal ran a story put together by staff writer Marilyn Miller which told of the request by a local man, Michael Karder, for government help to build wind turbines. In the article there is an implication -- "some companies inherit patents that create walls that stop new people from promoting their products" -- that his business cannot gain traction because someone else owns the technology.<br /><br />Just a bit over a week earlier (January 13), Beacon staff writer Bob Downing wrote a column about Karder's agreement with a European firm to assemble and market its wind turbines in the US. The windmill parts would come from China, the generators from Korea, and the assembly would be done in the Akron area. The major drawback, he claimed, was lack of financing, which he blamed on a tight credit market.<br /><br />All he needs is $60,000,000 to build the plant. (Ever hear the Kingston Trio song, "Tijuana Jail"?) The January 13 story states that there are 7 competing factories in the United States, with several more under construction and which are to open soon. Ultimately, he anticipates producing 600 wind turbines per year, with installation of about 1,700 of them offshore in Lake Erie. <br /><br />The articles paint glowing pictures of a future filled with new jobs for the Akron area, but as is typical of such populist fodder, they are light on details. Let's explore some rabbit trails.<br /><br />At 600 per year, and a reasonable lifespan for the project of 30 years (we will not at this point go into the details of why businesses are allowed to <i>depreciate</i> their assets, but suffice it to say that most of the time, when a factory is sold, it requires extensive renovations and modifications before the new owner can use it), the lifetime output of the factory can be anticipated to be about 18,000 windmills. One tenth of them are to go in Lake Erie, if various governments approve. Of course, Mr. Karder expects that he will also be able to manufacture parts for smaller wind turbines for the home electric generation market. Realistically, though, one would think the market for such turbines is limited, not because people don't want to try them out, but because of the layer of restrictions that exist now and will exist into the future. Try going to your local building department with a request to put one in your back yard and you will get a quick lesson in local government.<br /><br />Mr. Karder would like to borrow $60 million. For the sale of argument, let us say that he is allowed by a generous lender to amortize and pay off the loan over 30 years, like a home loan. Let us also assume that he would be able to borrow the money at 4% (current large portfolio 30 year commercial mortgages amortized at 30 years are at about 8.25%, but we will assume a <i>green</i> investor...). The total cost of the factory would then be about $103 million (and if he actually has to pay the market rate, $162 million). <br /><br />One other thing : Mr. Karder has purchased the patent rights for the wind turbines designed by his European partner -- "I have patent rights in North America, primarily the Great Lakes area." Does that mean that someone else owns the distribution rights in other parts of the country, and he is limited to the Great Lakes region? If so, his market is truly limited.<br /><br />If Mr. Karder's factory can actually produce the large turbines he envisions (2.5mW and up), he will face competition which ranges in price from $1 million to $2 million per mW installed. If he cannot successfully break into that market, and instead has to compete in the residential or small commercial market with the 100kW-900kW machines he plans to begin with, he will be competing at about $1,000 - $2,000 per kW installed. <br /><br />[It can be argued that the return on a wind turbine currently is somewhat better than break-even, with generation running in the neighborhood of $0.10/kW, and my current electric bill at just over $0.11/kW delivered. At that price, with an average annual consumption of 9800kW, I could save $98/year by buying a $25,000 wind turbine (I could probably get by with 25kW/day, but then I don't have an all-electric home). Some people prefer to concentrate on how much they will save regardless how much they spend.]<br /><br />There are some other factors which will also come into play -- the NIMBY factor (why don't the Kennedy's want a nice, clean, green windfarm blocking their view of Cape Cod?), licensing and zoning restrictions, air rights (if my windmill blocks your windmill and devalues your property, can you sue me?), and so on.<br /><br />The articles do not mention these things. They simply bring to the fore the fact that an entrepreneur wants the government to step in and help him set up a business. The POTUS, as reported by Ms. Miller, blamed the banks and the patent laws.<br /><br />What would really be helpful would be an explanation, by a banker, of the reasons why Mr. Karder, with $60,000 down, cannot get a $60,000,000 loan to build his factory. Is it that the bankers have examined the costs and determined that the risk is too great? Is that why he needs Federal dollars?<br /><br />For my part, I'd go nuclear. Our Navy has had nuclear powered ships cruising the globe for a half-century now, and each ship's power plant can easily provide enough electricity for a small city. At Las Alamos, the Hyperion Power Module was developed and will soon be deployed in Third-World communities around the world. Why Third-World? I will let you guess why Americans will not get the benefit of American technology.<br /><br />A year ago, I posted in another place,<br /><br /><blockquote><center><br /><b>Hyperion Fast Facts</b></center><left><ul><br /><li>Small -1.5 meters across, approx size of a residential “hot tub”<br /><li>Produces 70 MWt or 25 MWe, enough to power 20,000 average American homes or the equivalent<br /><li>Buried underground out of sight and harm’s way<br /><li>Transportable by train, ship, truck<br /><li>Sealed module, never opened on site<br /><li>Enough power for 5+ years<br /><li>After 5 years, removed & refueled at original factory<br /><li>Uniquely safe, self-moderating using a natural chemical reaction discovered 50 years ago<br /><li>No mechanical parts in the core to malfunction<br /><li>Water not used as coolant; cannot go “supercritical” or get too hot<br /><li>No greenhouse gases or global warming emissions<br /><li>Think: Large Battery!</ul></left><br />Think nuclear. (Nucular in some parts of the country.)</blockquote><br /><br />I would be willing to bet that any American city, or even a savvy investor, who wanted to borrow $60,000,000 to set up two power plants that would power 40,000 homes for $300/year would find a lender. Crunch the numbers. Reporters don't seem to know how to use calculators.</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-24592421313817538032009-12-08T00:09:00.002-05:002009-12-08T00:16:16.817-05:00Steady As She Goes<blockquote align=justify>While there has been some expectation that the Federal Reserve would have to begin raising interest rates to prevent inflation, the comments today by Ben Bernanke throw some cold water on that idea :<br /><br /><blockquote align=justify>"Though we have begun to see some improvement in economic activity, we still have some way to go before we can be assured that the recovery will be self-sustaining. Also at issue is whether the recovery will be strong enough to create the large number of jobs that will be needed to materially bring down the unemployment rate. Economic forecasts are subject to great uncertainty, but my best guess at this point is that we will continue to see modest economic growth next year--sufficient to bring down the unemployment rate, but at a pace slower than we would like.<br /><br />A number of factors support the view that the recovery will continue next year. Importantly, financial conditions continue to improve: Corporations are having relatively little difficulty raising funds in the bond and stock markets, stock prices and other asset values have recovered significantly from their lows, and a variety of indicators suggest that fears of systemic collapse have receded substantially. Monetary and fiscal policies are supportive. And I have already mentioned what appear to be improving conditions in housing, consumer expenditure, business investment, and global economic activity.<br /><br />On the other hand, the economy confronts some formidable headwinds that seem likely to keep the pace of expansion moderate. Despite the general improvement in financial conditions, credit remains tight for many borrowers, particularly bank-dependent borrowers such as households and small businesses. And the job market, though no longer contracting at the pace we saw in 2008 and earlier this year, remains weak. Household spending is unlikely to grow rapidly when people remain worried about job security and have limited access to credit. " Ben S. Bernanke, December 7, 2009.</blockquote><br /><br />Several weeks ago the Federal Open Market Committee issued the following 3rd quarter statement :<br /><br /><blockquote align=justify>"Investor sentiment toward the banking sector appeared to deteriorate over the intermeeting period. Bank share prices fell, with equity prices for large banks declining more than those for regional and smaller banks. Credit default swap spreads for large bank holding companies were about flat, but they widened for regional and smaller banking organizations. Market participants reportedly remained concerned about the earnings prospects for banks in an environment of weak economic activity and rising loan losses.<br /><br />Debt of the private domestic nonfinancial sector appeared to have declined again in the third quarter, as estimates suggested that household debt edged down and nonfinancial business debt decreased. Consumer credit contracted for the seventh consecutive month in August, reflecting declines in both revolving and nonrevolving credit; issuance of consumer credit asset-backed securities also fell."<br /><br />"The recovery appeared to be continuing and was expected to gradually strengthen over time. Still, most members projected that over the next couple of years, the unemployment rate would remain quite elevated and the level of inflation would remain below rates consistent over the longer run with the Federal Reserve's objectives. Based on this outlook, members decided to maintain the federal funds target range at 0 to 1/4 percent and to continue to state their expectation that economic conditions were likely to warrant exceptionally low rates for an extended period. Low levels of resource utilization, subdued inflation trends, and stable inflation expectations were among the important factors underlying their expectation for monetary policy, and members agreed that policy communications would be enhanced by citing these conditions in the policy statement. Members noted the possibility that some negative side effects might result from the maintenance of very low short-term interest rates for an extended period, including the possibility that such a policy stance could lead to excessive risk-taking in financial markets or an unanchoring of inflation expectations. While members currently saw the likelihood of such effects as relatively low, they would remain alert to these risks."<br /><br />"The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period." FOMC Minutes, November 3-4, 2009.</blockquote><br /><br />The information presented by the Fed seems to be that (1) interest rates will remain low for the foreseeable future, (2) despite the addition of significant amounts of cash (stimulus money) into the banking system, banks are still reluctant to loan the money, and (3) there is an "underutilization" of available financial resources. I believe the Fed is well aware of the danger to the banking system that is posed by these conditions.<br /><br />Money is a tool of commerce, and like any other tool, is also a commodity. It is necessary to provide a conduit for exchange of goods and services. The value of those goods and services are subject to relative supply and demand. Rapid communications, enhanced transportation facilities, and better education have opened the way for competition in US domestic markets for goods and services produced in developing countries. Workers in those countries are likely to have lower demands for wages and benefits, and production in the marketplace shifts toward lowest cost and highest profit.<br /><br />Consumption of goods and services in the US has changed. Prior to the financial market collapse, most American economic activity was undergirded by credit extended, to a large degree, on real estate, in markets which had been overdeveloped. The housing supply in the United States still exceeds demand; this is the reason for the decline in real estate prices and the large numbers of vacant dwellings that can be found in every major American city. To give an example, Census 1990 tables show that Summit County, OH had a 1990 population of about 515,000 with 211,500 housing units. The 2006-2008 projection tables indicate a population of 543,600 (up 5.6%) with 242,700 housing units (up 14.8%). Housing unit growth outstripped population growth in the county by nearly 3:1 over a decade and a half. When the smoke cleared, there were 8% fewer people per house in 2006-2008 than in 1990. Despite the increase in supply, predominant prices had risen from $60-75K to $100-150K in that time period. While this appears to fly in the face of the law of supply and demand, the underlying cause of the anomaly was the availability of easy credit and lax underwriting guidelines, coupled with a change in behavior whereby homeowners borrowed against anticipated future increases in home value in order to subsidize lifestyles that were beyond the means of their ordinary incomes.<br /><br />Mr. Bernanke's concern about underutilization of the available financial resources is valid. It needs to be recognized, though, that no matter how one might want to demonize the bankers for not making credit more readily available to consumers when the rates are so low and the cash is so plentiful, they are being prudent. In fact, considering the current excessive overcompensation of American workers (by developing world standards), they are also being prudent in not lending to commercial enterprises to stimulate production, since the market for overpriced American goods is shrinking (and this despite the contraction in our balance of payments ratios).<br /><br />The Fed's concern with respect to their policy possibly leading to "excessive risk-taking in financial markets" is valid. Supply and demand drives lending as well as buying (alas, how many times people have been warned that when they mortgage their home, they are selling it to the lender for the term of the mortgage!) and a shortage of mortgage funds in the conventional market always seems to bring out the unconventional lenders with a correspondingly higher interest rate to compensate for the increased risk. While the "official" interest rates promulgated by the Fed may be low, desperate borrowers may be willing to pay a premium for the use of money provided by unconventional lenders willing to gamble, a situation which could lead to an even more serious economic, or possibly even social, collapse further down the road.<br /><br />Another serious consequence has to do with the nature of the banking business itself. Banks do not make money on deposits, they make money on loans. The wild profitability of banks during the period 2001-2005 was related to their profligate lending practices. If they do not lend money, they make no profit, and investors shun unproductive assets. The banks themselves may raise interest rates -- this is seen already in the credit card industry -- and once again expose themselves to inordinate risk-taking. Or, they may be replaced by other institutions. I would be willing to guess that in some parts of the country Islamic banks are starting to take up the slack. When reinforced by the power of money, Sharia Law puts on a very attractive face. But be aware; the situation in Dubai is instructive. There is a reason why slavery and debtors' prisons still exist in lands that utilize that type of economic structure.</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-91408312385790322502009-12-02T22:33:00.003-05:002009-12-02T23:53:34.603-05:00Dumping Workfiles<blockquote align=justify>Visitors to my basement at one time were treated to the sight of dozens of file storage boxes stacked there. The majority of those appraisal workfiles dated from my tenure as a staff appraiser from 2003 - 2004. USPAP requires that a copy of the appraisal and the workfile be retained for 5 years from the effective date of the valuation. After that the files can be discarded, but the rules governing client confidentiality have to be followed. As a result, when the files reach their fifth birthday, I use them to heat the house.<br /><br />While going through the boxes (yes, I do glance at the reports to make sure I do not inadvertently destroy something which should be retained) I found the following peer review done by a third appraiser regarding my appraisal of a home and the value opinion provided by another appraiser retained by a litigious borrower:<br /><br /><blockquote align=justify>"November 4, 2004<br /><br />I have been asked to review two appraisal reports that were completed on this property. The first report was completed by James Hrubik based on an interior viewing of the home on February 12, 2004 and the indicated opinion of value was stated as $33,000. A second report was completed for a different client by <i>Appraiser X</i> based on an interior viewing of the home on August 18, 2004 and the indicated opinion of value is stated as $70,000. For this review I viewed the exterior of the subject property and all comparable sales used and have attached photos of these properties and a location map to this review. Please note that approximately six months have transpired between the effective dates of these reports and I am therefore unable to confirm if the condition of the home had changed in this period of time.<br /><br />For this review, I surveyed the Akron Area MLS and public record information. The MLS describes this neighborhood as Southwest Akron and is Area SUM34. Per the MLS there had been a total of 93 sales of single family homes of all property ages and styles in the twelve months preceding the effective date of Mr. Hrubik’s report. The price range was $3,000 to $134,900 with nearly 2/3 of all sales ranging between $3,000 to $30,000, and many were described as being ‘Bank Owned’. The median price was $21,500 and virtually every sale between $71,900 to $134,900 was described as being a ‘New’ home.<br /><br />The report completed by Mr. Hrubik provides a neighborhood description that states this is an urban neighborhood with property price ranges between $10,000 and $125,000 with a predominant price of $40,000. The age range is described as being from New to 100+ years with a predominant age of 80 years, which is reasonable and consistent with MLS data. Mr. Hrubik selected three sales for his analysis that were offered in the MLS and I was able to verify the sale price and property features as reported based on the MLS descriptions and public record information as follows:<br /><br />Comparable #1: 643 W. Thornton sold in 9-2003 at $30,000 after being listed at $32,000 for 54 days. The property descriptions are consistent though Mr. Hrubik fails to report that this home was reported to have a finished basement rec room with wet bar and a negative adjustment could have been included. There was no prior sale or listing of this home in the previous 36 months.<br /><br />Comparable #2: 987 Laurel Avenue sold in 10-2003 at $29,500 after being listed at $32,900 for 119 days. The property descriptions are consistent with the data sources noted. Though there was no prior sale of this home in the 36 months prior to the date of value, the home had been offered for sale in the MLS on two previous occasions, once at $49,900 for 184 days until the listing expired on 2-14-2002 and again at $39,900 for 92 days until the listing expired on 7-31-2002.<br /><br />Comparable #3: 994 Celina Avenue sold in 10-2003 at $33,530 after being listed at $34,900 for 122 days. The property descriptions are consistent with the data sources noted. There was no prior sale or listing of this home in the 36 months prior to the date of value.<br /><br />All three sales are in close proximity, similar in age and living area, and were within six months of the effective date of value and are therefore considered relevant and reasonable. Each was listed for sale with a professional Realtor and had adequate market exposure in the MLS.<br /><br />As noted, I was also provided an appraisal report completed by <i>Appraiser X</i> for a different client and have found a number of significant deficiencies with the report. The neighborhood is described as being ‘Suburban’ rather than ‘Urban’. The neighborhood price range is stated as $50,000 to $90,000+ with a predominant price of $60-75,000 which clearly contradicts MLS data for this neighborhood. In addition the age range is 60 to 100 years which does not include a significant number of homes in this market that are much less than 60 years old. <i>Appraiser X</i> fails to provide the FEMA flood zone information which leads me to question if she had adequate data sources for this community. The land value estimate of $15,000 is not reasonable for a site of 32’ x 132’ in this urban setting as this is more than 50% of the total sale price of nearly 2/3 of the reported sales in the MLS as noted above. Finally, <i>Appraiser X</i> provided three sales in the market analysis that were non-MLS transactions. The data source stated (Auditor’s Office/Exterior Inspection) does not provide information regarding any terms of sale, property condition, or if the transaction was at market and arm’s length. Other concerns regarding these sales are as follows:<br /><br />Comparable #1: 817 Raymond is reported to have sold in 4-2004 at $72,000 per public record information. <i>Appraiser X</i> states that there was no prior sale of this home in the preceding 36 months. However, this home was offered in the MLS at $20,000 in 1-2004 and transferred to SMB & A LLC in 1-2004 at $14,000. The home then was sold in 4-2004 at $72,000 with terms and conditions of the transaction not known nor is there verification that the home had been restored for this purchase. <i>Appraiser X’s</i> failure to disclose the previous recent sale is a violation of USPAP and leads me to question if this was actually a ‘flip’ transaction.<br /><br />Comparable #2: 1006 Nathan is reported to have sold in 11-2003 at $67,000 per public record and seller. <i>Appraiser X</i> fails to disclose that the <i><b>[n.b. - I deleted this buyer-seller relationship disclosure for retention of confidentiality]</b></i> and is likely biased toward the transaction. Failure to disclose this relevant information regarding the seller is considered misleading as a typical reader would assume this was a verified and unbiased transaction. There was no prior sale or listing of this home in the 36 months prior to the effective date of value.<br /><br />Comparable #3: 640 W. Thornton is reported to have sold in 2-2004 at $75,000 per public record, The data source can not be used to verify the terms and conditions of this transaction nor the condition of the home at the time of its sale. However, upon my exterior viewing on November 3, 2004 this home appears to have been vacated and at least one window is broken which again leads me to question the reliability of this sale. No other sale or listing in the preceding 36 months was found in data sources for this property.<br /><br />It is highly unusual for a qualified appraiser to not utilize the MLS as a primary data source for this established urban neighborhood in the city of Akron, which leads me to question if <i>Appraiser X</i> had adequate experience or resources to have accepted this appraisal request.<br /><br />For the purposes of this review, I also surveyed the MLS for active listings in the subject’s neighborhood to help establish a reasonable upper limit of value for homes of similar vintage.<br /><br />Currently, a property at 388 Raasch Avenue is offered for sale at $45,000. This home is described in the MLS as being completely renovated including newer drywall, carpet, furnace, A/C, windows, roof, kitchen with oak cabinets, newer bathroom. The home is reported to have been built in 1925 and offers 1128 sq ft living area, which would be competitive with the subject. As noted, this home has yet to sell and has been on the market for over 200 days. It is my opinion that this active listing provides some helpful insight into this neighborhood for homes that are renovated to this degree.<br /><br />For these reasons I am of the opinion that the value as reported by <i>Appraiser X</i> is without merit or support. The neighborhood description does not accurately reflect the reality of the predominant sales activity in this market area. The use of questionable or unreliable sales data without utilizing the MLS in this market, or seeking assistance from someone with access to the MLS, leads the reader of the report to unreasonable conclusions and for this reason the report is misleading." </blockquote><br /><br />I remember that incident well, as I was required to sit beside my client's attorney as we faced the borrower and his counsel. That is how I managed to get a copy of the review. Also, because the report was involved in litigation, it and all pertinent files need to be retained an additional five years beyond the settlement of the dispute.<br /><br />The rest of the story? The borrower (who wanted to borrow about $60,000) claimed my client would have made the loan had the borrower been a member of a protected group. <i>Appraiser X</i>, whose office was 60 miles away, was brought in to make the case that I had significantly undervalued the home and that my client had utilized it in an attempt to prevent the loan. It is of interest that I was not named in the suit; there was nothing in my report which could have been interpreted as bias. I just had not come up with the correct number, and my client trusted my judgment.<br /><br />No mention was made anywhere in the proceedings that the tax appraised value of the home was only $30,750. My client settled out of court by agreeing to hire a fourth appraiser who managed to appraise the subject property for about $45,000, thereby allowing the client to loan the borrower the tax appraisal amount and still stay within Federal guidelines.<br /><br />To my knowledge the second appraisal was never submitted to the Ohio Division of Real Estate for review; protection of <i>Appraiser X</i> was possibly a part of the settlement. Now you may have a bit more insight into why the banking industry was in need of a stimulus in 2008.</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-38793802066834132422009-11-26T17:19:00.007-05:002009-11-29T19:35:01.533-05:00Time Flies<blockquote align=justify>It has been several very busy months since the last post. I have been busy gathering and verifying tax card information for the Geauga County Auditor in order to provide an updated database for the 2011 reappraisal in that county. In doing so, I have been logging experience hours in non-residential appraisal work, to be applied toward my application to sit for the General Appraiser certification exam.<br /><br />Meanwhile, while not intending to do so, I have failed to provide a follow-up on the query that was the subject of the last post. I received the following reply (in part) to the information I sent to the troubled borrower:<br /><blockquote><i>Jim,<br /> <br />Thank you for the information and your thoughts. I will certainly take your advise</i> [sic]<i>. I noticed that remodeling averages are from 65%-77% depending on the project which certainly shows the appraisal was estimated much lower. I understand what the auditor's records show but they came in here and documented 4 bdrm and 3 full baths. Are we paying for an accurate appraisal? Two more questions 1) how is land value figured? And replacement cost per sq ft? Our insurance company has it much much higher. I'm just trying to wrap my mind around this as to why it came in so low. We had this same thing happen before were</i> [sic]<i> the first appraisal came in much lower 50-60000. We spoke with Chase and explained everything and they issued another appraisal. The appraiser who came out has intimate knowledge of our area in fact he explained the his mother is a Realtor in this area and he knows the value. It came in at $399,000.</i></blockquote><br /><br />I never did email the man back, but my notes on my thoughts have been cluttering my desk for the past 5 months, so here goes.<br /><br />First off, the last few sentences of his email are very troubling to me. If, during the original loan's appraisal process, the value came in $50-60K less than what was "needed", and the bank sent out a second appraiser who "knows the value", I, as a very suspicious, untrusting, and experienced reviewer tend to immediately class the second appraiser as one who could also "hit the value", whatever it took. Sorry, I have not just one noid, but a paranoid where these matters fall.<br /><br />Is the borrower "paying for an accurate appraisal"? I suppose that is a very nuanced question. By law, the client is the bank. The borrower pays for the appraisal, but the bank is the intended user. Certainly the bank should be interested in a well reasoned and factually supported opinion of value, but the words "accurate" and "opinion" do not belong in the same sentence without some other explanatory verbiage. The facts should be accurate, and the opinion should be unbiased. <br /><br />Certifications 1, 4, 7, 9, 11, and 12 of the FMNA Form 1004 (3/2005) address the accuracy and adequacy of the data used in the analysis. Adjustments may be difficult in a declining market with a scarcity of sales, and the appraiser must use his best judgment. Much more attention is also being paid now by lenders to geographic competency (Certification 11) -- where does the appraiser live and normally work, and is he truly familiar with the market? <b><i>n.b. -- it should be recognized that an appraiser <u>can</u> become extremely competent in a market at some distance from his normal base, but the onus is on the appraiser to prove such competency in both his choice of data and the resulting reasoning.</i></b><br /><br />As to the value of the land, there are three normally accepted methods for determining land value (the value of the land as vacant and unimproved). The first is market sales comparison. Examination of recent sales of vacant buildable parcels should provide the appraiser with information to form an opinion of value for the subject parcel. The subject parcel had 2.65 acres; the borrower cited a 1 acre lot selling for $78,000. That would be a very poor comparable in a built-up area like the City of Solon; more comparable sales would be vacant residential lots between 2.5 and 3 acres in size, and such sales would be extremely rare. The $5750 adjustment for site size would be the appraiser's opinion of the <i>contributory</i> value of the site size difference; the important thing there is support for the site value which the appraiser is supposed to detail on page 3 of the Form 1004. That support is required by FNMA, regardless whether the Cost Approach is completed. (We'll discuss that a little further on.)<br /><br />The other two commonly used methods for determining site value are <i>extraction</i> and <i>allocation</i>. Allocation is fairly simple and is built into most models for AVMs and CAMA. In its simplest form, when the cost to build the house, new, is calculated, a percentage figure is multiplied by the cost to give a land value. In its most reliable form, the percentage is derived from market studies of builder costs, and is adjusted internally for positive and negative land features. In practice, however, it is often a "pluck from air" (PFA) figure and, within assessment records, frequently produces hilarious results. (Sorry, but I have in mind a lot in the City of Akron which had an old house on it. The year the house was demolished, the lot was valued by the Auditor at $8,000. The next year, with a new house -- built with government grant money and not at all a market-driven project -- on the lot, the tax appraisal land value had jumped to $20,000. The mean and median price of housing in the neighborhood was unchanged. Such is the magic of carelessly applied allocation.)<br /><br />Within built-up areas with few vacant land sales, extraction is the third commonly used method for determining site value. To properly do a land value extraction, sales comparisons must be run on a number of recent sales of homes where significant details of their quality and condition are known to the appraiser. The appraiser must do a Cost Approach appraisal of each of the comparable homes (comparable in this context being more applicable to the characteristics of the land than the houses), with great care taken to account for all forms of depreciation that might have affected those homes. The resultant depreciated cost of the improvements is then subtracted from the raw sales price to indicate the contributory value of the land under the home. Unfortunately, while many appraisers cite extraction as their method for determining site value, it is my experience from looking at their reports that a good many of them either have no idea what they are about, or they are incredibly lazy.<br /><br />In general, FNMA does not require the Cost Approach to be completed on the Form 1004 unless it is the appraiser's opinion that it is needed to provide support for the reasoning behind the value opinion. Appraisers generally use cost tables to determine the cost to construct the home using current methods and materials, and then apply estimates of depreciation (physical, functional, and external) to arrive at a depreciated cost of the improvements. This is then added to the site value figure to indicate a market value for the home. In theory, it works if an honest site value is used and if all three forms of depreciation are properly accounted for. Lenders want to see the Cost Approach used because they feel it is a shortcut to providing a figure for which they can require the borrower to supply an insurance policy. Most appraisers are now including a disclaimer that the costs "are not to be considered indicative of insurance replacement costs", this despite the fact that the form requires them to check that the costs are either for reproduction or replacement.<br /><br />An insurance appraisal is generally not a market value appraisal. Insurance policies are written to allow property owners to recover the utility of their asset if it is fully or partially destroyed. Replacement cost per square foot, for insurance purposes, must include the costs involved in removing any debris from a damaged home, and then reconstructing it to its former usefullness. This means that no depreciation can be entered into the process, since the home, when the owner again takes up residence in it, will be restored to "new" condition. The replacement cost may be, and usually is, far more than the market value of the home. If the home is purchased for $100,000, but is of such age and design and condition that to rebuild it to modern standards would cost $200,000, the borrower may only be required by the lender to insure it for the purchase price. If it burns to the ground and must be rebuilt, the insurance company will only pay the policy amount. The borrower will have to come up with the rest. If he cannot qualify for the additional loan amount, or does not have the cash, he may have to default on the original loan. Consequently, homeowners should have their houses independently appraised for insurance purposes, and under no conditions should they rely on a market value appraisal for insurance value uses.<br /><br />There is one final thing cloesly related to the above which needs to be mentioned and which will make me <i>persona non grata</i> in some circles. The gentleman who originally wrote to me acknowledged in his rejoinder that <i>"I noticed that remodeling averages are from 65%-77% depending on the project"</i>. A dirty little secret is that this also applies to new construction, albeit to a lesser degree. Just like a new car, which loses value the instant it is driven off the dealer's lot, in a stable market, a new house depreciates, possibly 5% - 15% depending on where it is located, the instant the buyer signs the contract with the builder. The practice of selling new homes with 100% financing is still occurring, but it is not politically expedient to suggest to FNMA that new home buyers should be required to put down 20-25% of the purchase price in cash. Especially not with the government trying to stimulate the economy by offering tax incentives in a market that is in significant oversupply.<br /><br />Hi-yo, Silver! Away!</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-73361130111231530362009-06-12T13:32:00.004-04:002009-06-12T13:49:21.651-04:00Comparing Oranges to Oranges<blockquote align=justify>I get some interesting questions from time to time. While I cannot directly address the concerns some people have about home value (the instant I utter my opinion of value, even orally and/or "off the cuff", I have done a certified appraisal and am required to submit to the person receiving the opinion (even though a client relationship may not exist) a signed certification. So, I have to be careful. Still, as I said, some of these things are interesting and bear a little research.<br /><br />Here is a sample, dated today:<br /><br /><blockquote align=justify><i><br />Jim,<br /> <br />We just had an appraisal completed, which feel $105,000 short of the appraisal completed 11/07 KeyBank. We understand the market trend in today's economy. However we live in an area that is still maintaining a good home value- Orange Village. The appraiser used comps that are 3 bdrm 2 to 1 full baths 2 car garage and the homes are 48, 53 & 35 years old which our is 30. Also our home sits on 2.65 acres heavily wood lot and the comps are 1.65, 1.48 & .35 not on wood lots. We have put 62,000+ in home improvement in the last 2 years, Pella windows & all entry doors & sliding door, new boiler, new hot water tank, new roof, remodeled kitchen, new built in appliances, porcelain floor, 2 full baths taken down to the studs granite & silestone vanity tops porcelain tile floor and shower, all new interior doors, closet doors, all new light fixtures interior & exterior, new carpet, baseboard, interior paint through out.<br /> <br />With all that said he noted $15,000 in home improvements and a few windows replaced all but 5 windows have been replaced. He adjusted the replacement sq. ft @ $79. The acres he gave $5,750 for adjustment, 1 acres lot in Solon is selling for $78,000.<br />He appraised our property @ $291,000 which we needed $347,000. Why didn't he use comps that are apples to apples not apples to zucchini ? QuickenLoans will not order a second appraisal even through I was able to give them comps that just sold last month @ $380,000 which was built the same year close to the acreage and 4 bdrms & 3 full baths. We have lost our 4.375% rate lock and have no recourse. And our $500 lock rate deposit. What happened????? Can you shed any light on this and suggestions? <br /> <br />Thanks for your time.</i></blockquote><br /><br />Curious George being a monkey, I did a little look-see in the MLS and sent the following reply :<br /><br /><blockquote align=justify>Thanks for the query.<br /><br />I assume that you are referring to the home at --- Road, 44022. The Cuyahoga County Auditor shows that the home is a 2436 sf ranch, on about 2.65 acres, built about 1979 with 3 bedrooms, 2 full baths, a half bath, full basement, and a 3-car garage. The tax appraised value for 2008 was $292,400, including the tax appraised land value of $68,400.<br /><br />You need to realize that the lender will be looking at the same public records information, and underwriters are currently being very conservative.<br /><br />I cannot address specifics in your question since I do not appraise in Cuyahoga County and cannot claim competence in that market area. There are, however, some very general items that you might want to look at.<br /><br />You imply that only three comparables were used. I am finding that I have to use from 5-9 comps on the grid, including 1 or 2 active listings to show the market trend. Because of the scarcity of sales, the first three comps may be "ugly" due to the need to keep their sales dates within 6 months; it is not always easy to "bracket" under tough market conditions.<br /><br />You also need to remember that cost is not the same as value. You may want to take a look at Remodeling Magazine's <a href=http://www.remodeling.hw.net/2008/costvsvalue/national.aspx>Cost vs Value Report </a>. <br /><br />I performed a search of the MLS looking for sales only in Orange. In 2006, there were 33 sales with a median price of $307,000, in 2007 there were 24 sales with a median price of $348,875, in 2008 there were 27 sales with a median price of $260,000, and for the first five months of 2009, there were only 5 sales with a median price of $165,600. While the MLS does not show all the sales that have taken place, it does show the brokered sales that most likely have occurred with adequate market exposure and can be used to form a value opinion which meets the FNMA definition of "market value". The statistics show the actual trend in prices for brokered sales in the Orange market.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmjkhkutBX1gm0L7mleoDZXo18k36_8TV6kp8xeSxYYnZeNapQbBlUOdUbu5fpYloZhhNhOizpWI7TgMeMjRMGn8tAyuMYBqXfE8mCW8yyxvcMinUcnGScf6MvnIS3lkjQ7hUPkshDTpQ/s1600-h/Picture+2.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 131px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmjkhkutBX1gm0L7mleoDZXo18k36_8TV6kp8xeSxYYnZeNapQbBlUOdUbu5fpYloZhhNhOizpWI7TgMeMjRMGn8tAyuMYBqXfE8mCW8yyxvcMinUcnGScf6MvnIS3lkjQ7hUPkshDTpQ/s400/Picture+2.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5346495672793042770" /></a><br /><br />I would suggest that you examine the appraisal report done in November 2007. You have implied that the value opinion was $396,000, or about $162/sf. There was a home which sold at 28700 Jackson Road on 4/26/2007 for $290,000 ($120/sf). That home was a 2413 sf ranch on 2.55 acres built in 1962. While it did not have a basement, in my opinion it would be a logical candidate as a comparable sale even though it might have to be heavily adjusted for that feature. In fact, examination of the MLS sales data shows that even in 2007, with a much higher median price than now, there were very few single-story homes in Orange that sold for more than $130/sf.<br /><br />You may want to write a letter to the Ohio Division of Real Estate expressing your concerns, and forward to them copies of both appraisals for their review.<br /><br />Sincerely,</blockquote><br /><br />Without a doubt this homeowner is feeling the pain of current market conditions on his financial situation. He may be under the impression that all is well in his neighborhood, but there are very few locales where real estate prices have not dipped. I have been tracking the MLS statistical reports for the entire state since 2003 (via the updates published in <i>Ohio Realtor</i>) and for the first 4 months of 2009, the median sales price across the entire NEOHREX MLS area is down more than 21% from the same period in 2008. I don't think we have hit bottom yet, either. My opinion.<br /></blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-42618061918081528602009-04-02T19:23:00.002-04:002009-04-02T19:39:16.492-04:00Oy! Such Enthusiasm!<blockquote align=justify>On November 23rd I wrote,<br /><br /><blockquote align=justify>"I have several very bitter disagreements with the tax thieves. One has to do with their desire to strangle the taxpayer. The term "mark to market" is now getting some attention, but it is an old IRS tactic that was adopted by the people who invent accounting rules. According to the IRS, if the market interest rate is 5%, and I loan you money at 1%, you must pay income tax on the 4% I did not charge you. The accountants were forced by this tactic to come up with a definition of "fair value" that relies on the current market price, even for assets which a taxpayer does not intend to sell. If I buy stock at $1/share on December 30, 2008, and it goes to $2/share on December 31, 2008, and back down to $1/share on January 2, 2009, I have a gain of $1/share for the 2008 tax year, even if it was not realized. For a cash basis taxpayer, there is no effect, but for an accrual basis taxpayer, there is an imaginary taxable gain of 100%. This is the result of "marking the value of the asset at current market price". The tax must be paid in 2009, and you can take a write-off for the imaginary January 2 loss in 2010. IRS will use your money, interest free, in the meantime.<br /><br />When "mark to market" is applied to assets that are being held for income generating purposes, the decline in the market price of those assets can cause catastrophic effects in the credit ratings of companies. That is why so many lenders and insurance companies are now in a credit crisis. That is why throwing money at the problem will not help. The rules have to change. I advocate that "mark to market" be used only for assets actually traded, and "value in use" be given more emphasis where accrual accounting is utilized. IRS will not be happy with such a concept."</blockquote><br /><br />Note that I qualified the conditions for change; that "mark to market" be used only for assets actually traded. <br /><br />Yesterday (April Fools' Day), bowing to pressure from the banks and the politicians, the Financial Accounting Standards Board (<a href="http://www.fasb.org/pdf/fsp_fas141r-1.pdf">FASB Issues Staff Position 141(R)-1</a>) revised the rules regarding "mark to market". It is a lengthy read. The market has reacted quite positively today to the release of the statement. I have very strong doubts that many of the market participants have read anything beyond the news headlines about the statement.<br /><br />Of interest to an appraiser is the following :<br /><br /><blockquote align=justify>"<b>8. If the acquisition-date fair value of an asset acquired or a liability assumed in a business combination that arises from a contingency cannot be determined during the measurement period, an asset or a liability shall be recognized at the acquisition date if both of the following criteria are met:<br /> <br />a. Information available before the end of the measurement period indicates that it is probable that an asset existed or that a liability had been incurred at the acquisition date. </b>It is implicit in this condition that it must be probable at the acquisition date that one or more future events confirming the existence of the asset or liability will occur. <b><br /><br />b. The amount of the asset or liability can be reasonably estimated. <br /><br />Criteria (a) and (b) shall be applied using the guidance in Statement 5 and in FASB Interpretation No. 14, Reasonable Estimation of the Amount of a Loss, for application of similar criteria in paragraph 8 of Statement 5."</b></blockquote><br /><br />Remember, an appraiser is one who provides an <i>opinion</i> of market value, while an accountant (or a computer program) provides an <i>estimate</i> of market value. Estimates can be prepared in the complete absence of consideration of the market participants, but opinions must consider what the market participants are actually reacting to.<br /><br />The following disclaimer was also of interest [my bolds for emphasis]:<br /><br /><blockquote align=justify>"<i>This FSP was adopted by the affirmative votes of four members of the Financial Accounting Standards Board. Mr. Linsmeier dissented. </i><br /><br />Mr. Linsmeier dissents from issuance of this FSP because it fails to provide guidance in two key areas, and, therefore, he does not believe the FSP will be operational. <b>First, this FSP requires that an acquirer recognize at fair value an asset acquired or a liability assumed in a business combination that arises from a contingency if the acquisition-date fair value of that asset or liability can be determined during the measurement period without providing guidance as to how to make this assessment.</b> This assessment drives the key differences in the accounting prescribed by this FSP and, if not clear, is likely to raise significant application and comparability issues. Statement 157 provides guidance on how to determine fair value in active and inactive markets and in the presence of both observable inputs and unobservable inputs, which might suggest that fair value should be able to be determined in many, if not most, circumstances. <b>Mr. Linsmeier is concerned that without providing guidance on how to make this determination assessment the Board is being unclear about its intentions, introducing significant judgment in the application of this FSP that will not result in consistent reporting across enterprises.</b> <br /> <br /><b>Second, this FSP does not prescribe in detail how an asset or a liability arising from a contingency initially recognized at fair value in a business combination would be measured subsequent to its initial recognition.</b> This FSP only requires that an acquirer develop a systematic and rational basis for subsequently measuring and accounting for such assets and liabilities depending on their nature, suggesting in the basis for conclusions to this FSP that methods be developed similar to those prescribed in Interpretation 45. While not stated in this FSP, the Board in its deliberations leading to this FSP generally agreed that Statement 5 does not provide appropriate guidance for the subsequent accounting for an asset or a liability arising from a contingency initially recognized at fair value in a business combination. In addition, the majority of the Board did not support subsequent accounting at fair value for those assets and liabilities. <b>The failure to make these tentative decisions authoritative in this FSP and the failure to provide further guidance on the subsequent accounting similar to Interpretation 45 are likely to result in multiple methods for accounting and reporting for identical assets acquired and liabilities assumed in a business combination subsequent to their initial recognition at fair value, causing significant comparability issues for financial statement users across enterprises. As a consequence, Mr. Linsmeier believes this FSP fails to provide sufficient guidance to permit financial statement issuers and their auditors to consistently apply the guidance in this FSP and, as a result, financial statement users will not be provided useful and comparable information about the financial statement effects of assets acquired and liabilities assumed in a business combination that arise from contingencies.</b> "</blockquote><br /><br />The Appendix to the statement includes the following items:<br /><br /><blockquote align=justify>"B28. The Board acknowledges that this FSP does not provide investors, creditors, and other users of financial statements with some information that would have been provided had Statement 141(R) not been amended. However, because this FSP will continue to require that an acquirer disclose the amount of the asset or liability recognized at the acquisition date and the nature of the contingency, investors, creditors, and other users of financial statements will receive more information than they received under Statement 141. The Board believes the changes to Statement 141(R) made by this FSP were necessary to address operational issues raised by various constituents that could have resulted in significant costs to preparers.<br /><br />B32. Differences also exist between the disclosures required by Statement 141(R), as amended by this FSP, and revised IFRS 3. For an asset or liability arising from a contingency recognized at the acquisition date, this FSP requires that the acquirer disclose the amount recognized and the nature of the contingency. For contingencies that are not recognized at the acquisition date, this FSP requires that the acquirer include the disclosures required by Statement 5 in the footnote that describes the business combination. For contingencies in which there is at least a reasonable possibility that a loss will be incurred, Statement 5 requires that an entity disclose the nature of the contingency and give an estimate of the possible loss or range of loss or state that such an estimate cannot be made. Revised IFRS 3 carries forward the existing disclosure requirements in IAS 37 and requires an acquirer to disclose the reasons that the fair value of a contingent liability cannot be measured reliably, if applicable. For recognized contingencies, the acquirer is required to disclose (a) a brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits, (b) an indication of the uncertainties about the amount or timing of those outflows, including major assumptions made about future events, where necessary, to provide adequate information, and (c) the amount of any expected reimbursement and the amount of any asset that has been recognized for that expected reimbursement. For unrecognized contingencies, unless the possibility of any outflow in settlement is remote, the acquirer is required to disclose the nature of the contingency and, where practicable, (1) an estimate of its financial effect, (2) an indication of the uncertainties relating to the amount or timing of any outflow, and (3) the possibility of any reimbursement. Under IAS 37, entities also are required to disclose changes in the carrying amount of a contingent liability, including the reasons for those changes. "</blockquote><br /><br />The market rally today was said to be a result of investors hoping to see financial stocks show improved profit conditions as a result of application of this rule. While this rule will help in situations where assets held for income production are being analyzed, I would have to agree with Mr. Linsmeier that there is insufficient guidance with respect to supplying investors with information where assets which have defaulted or are in danger of default are being valued. In particular, the downward price pressure on the housing market has, I believe, been understated because the statistics being analyzed have not been adequately filtered to reflect market value as perceived by buyers. <br /><br />Once the idea sinks in that this is not a cure for the mortgage portfolio devaluation problem, we may see some "morning after" regrets. Choking on furballs is always a danger when one partakes of the hair of the dog which bit him.</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-25281310860075376432009-01-27T23:54:00.008-05:002009-01-28T00:30:22.799-05:00If Congress Were Serious... Or Even Semi-Intelligent...<blockquote align=justify><br />Is there intelligent life on Capitol Hill? How many fingers do those weird politicians have, and can they use them to count? Has the concept of a zero made it into their culture?<br /><br />First they conjured a few hundred million to bail out some banks. Then they had seven hundred billion added to the pot. Let us write that on the blackboard, students.<br /><br />$700,000,000,000. Seven hundred billion. The number of seconds that have elapsed since Julius Caesar was assassinated (44 BC - 2009 AD, 2052 years): 60 seconds/minute x 60 minutes/hour x 24 hours/day x 365.3 days/year x 2052 years = 64,765,059,840. If you spent $10/second for 2052 years, you would still not have spent $700,000,000,000!<br /><br />The Honorable Lunatics voted in October 2008 to spend up to $700,000,000,000 to bail out the failing banks. $350,000,000,000 remains unspent, and there is a strong push by the Obama Regime to have Congress add another $850,000,000,000 to that. Because there is no way the Loyal Opposition can halt this juggernaut, within a short time there may be $1,200,000,000,000 in the pig-trough (that is $100/second for over 380 years, or since the time the Pilgrims landed here).<br /><br />Let us do this another way. We all remember story problems from high school math. According to the US Census Bureau estimates for 2005-2007 (Table B25087) there are just over 51,000,000 US housing units with a mortgage. Of those, about 23,639,036 (46.2%) had mortgage payments over $1500 per month. The data from the Census Bureau is tabulated below; the upper mortgage payment amount was assigned at $6000/month for calculation purposes. I added the fourth column to arrive at the estimated mean monthly mortgage payment for each category. The final figure of $88,531,316,700 is taken to represent the average monthly US mortgage payment total.<br /><br />(Sorry about the formatting. I am still trying to figure out why Blogger screws up simple html formatting)<br /><br /><align=left><br /><b>TABLE B25087. <br />MORTGAGE STATUS AND SELECTED MONTHLY OWNER COSTS<br />Universe: OWNER-OCCUPIED HOUSING UNITS<br />Data Set: 2005-2007 American Community Survey 3-Year Estimates<br />Survey: American Community Survey</b><br /></blockquote><br /><center><br /><TABLE border=1><br /><br /><TR><br /><br /><TD COLSPAN=4 ALIGN=CENTER><b>United States</b></TD><br /><br /></TR><br /><br /><TR><br /><TD></TD><br /><TD ALIGN="LEFT">Estimate</TD><br /><TD ALIGN="LEFT">Margin of Error</TD><br /><TD align=left>Mean Payment Subtotal</TD><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">Total:</TD><br /><TD ALIGN="RIGHT">75,072,666</TD><br /><TD ALIGN="RIGHT">+/-172,605</TD><br /><TD></TD><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">Housing units with a mortgage:</TD><br /><TD ALIGN="RIGHT">51,164,197</TD><br /><TD ALIGN="RIGHT">+/-123,611</TD><br /><TD></TD><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">Less than $200</TD><br /><TD ALIGN="RIGHT">25,783</TD><br /><TD ALIGN="RIGHT">+/-1,536</TD><br /><TD ALIGN="RIGHT">$2,578,300</TD><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">$200 to $299</TD><br /><TD ALIGN="RIGHT">126,355</TD><br /><TD ALIGN="RIGHT">+/-2,860</TD><br /><TD ALIGN="RIGHT">$31,588,750</TD><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">$300 to $399</TD><br /><TD ALIGN="RIGHT">381,877</TD><br /><TD ALIGN="RIGHT">+/-5,296</TD><br /><TD ALIGN="RIGHT">$133,656,950</td><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">$400 to $499</TD><br /><TD ALIGN="RIGHT">822,717</TD><br /><TD ALIGN="RIGHT">+/-7,688</TD><br /><TD ALIGN="RIGHT">$370,222,650</td><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">$500 to $599</TD><br /><TD ALIGN="RIGHT">1,376,810</TD><br /><TD ALIGN="RIGHT">+/-10,365</TD><br /><TD ALIGN="RIGHT">$757,245,500</td><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">$600 to $699</TD><br /><TD ALIGN="RIGHT">1,947,454</TD><br /><TD ALIGN="RIGHT">+/-12,985</TD><br /><TD ALIGN="RIGHT">$1,265,845,100</td><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">$700 to $799</TD><br /><TD ALIGN="RIGHT">2,462,599</TD><br /><TD ALIGN="RIGHT">+/-12,073</TD><br /><TD ALIGN="RIGHT">$1,846,949,250</td><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">$800 to $899</TD><br /><TD ALIGN="RIGHT">2,855,941</TD><br /><TD ALIGN="RIGHT">+/-15,590</TD><br /><TD ALIGN="RIGHT">$2,427,549,850</td><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">$900 to $999</TD><br /><TD ALIGN="RIGHT">3,069,593</TD><br /><TD ALIGN="RIGHT">+/-16,378</TD><br /><TD ALIGN="RIGHT">$2,916,113,350</td><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">$1,000 to $1,249</TD><br /><TD ALIGN="RIGHT">7,679,899</TD><br /><TD ALIGN="RIGHT">+/-30,119</TD><br /><TD ALIGN="RIGHT">$8,639,886,375</td><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">$1,250 to $1,499</TD><br /><TD ALIGN="RIGHT">6,809,133</TD><br /><TD ALIGN="RIGHT">+/-24,825</TD><br /><TD ALIGN="RIGHT">$9,362,557,875</td><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">$1,500 to $1,999</TD><br /><TD ALIGN="RIGHT">9,848,125</TD><br /><TD ALIGN="RIGHT">+/-36,793</TD><br /><TD ALIGN="RIGHT">$17,234,218,750</td><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">$2,000 to $2,499</TD><br /><TD ALIGN="RIGHT">5,648,279</TD><br /><TD ALIGN="RIGHT">+/-21,249</TD><br /><TD ALIGN="RIGHT">$12,708,627,750</td><br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">$2,500 to $2,999</TD><br /><TD ALIGN="RIGHT">3,233,753</TD><br /><TD ALIGN="RIGHT">+/-16,491</TD><br /><TD ALIGN="RIGHT">$8,892,820,750<br /></TR><br /><br /><TR><br /><TD ALIGN="LEFT">$3,000 or more</TD><br /><TD ALIGN="RIGHT">4,875,879</TD><br /><TD ALIGN="RIGHT">+/-16,814</TD><br /><TD ALIGN="RIGHT">$21,941,455,500</td><br /></TR><br /><br /><br /><tr><br /><TD colspan=3 align=center><b>Mean Total Payment</b></td><br /><TD ALIGN="RIGHT">$88,531,316,700</td><br /></tr><br /><br /></TABLE><br /></center><br /><br /><blockquote align=justify><br />Based on the above, $1,200,000,000,000 would pay all of the mortgage payments for everyone in the USofA for about 13.5 months. However, it has been projected that only 10% of the mortgages in the country are likely to default. Since the depression is gathering steam, that is likely an underestimate, but if one could assume that a successful solution could be applied within, say, 6 months time, the default rate might be held to no more than 25%.<br /><br />The current economic crisis was begun by a collapse of the sub-prime loan market, and spread to the prime market due to fear in the investment arena that further lending would not be secure. IF the government were to somehow guarantee that NO mortgage would be allowed to go into default (in effect, guaranteeing that the investor would be paid for his risk, mortgage lending would once again be viewed as relatively safe and profitable.<br /><br />As much as the above plan would sell every man, woman, and child in the country into slavery to the off-shore lenders who would once more be emboldened to loan in the American housing market, it would be far more sensible than the current balloons being floated that have to do with judges being able to re-write the terms of loans. It would also lend itself to being implemented as a refundable tax credit, paid in advance, and as such, would offer almost immediate relief (at least as soon as the rules could be drawn and the forms printed). Finally, while it would not deliver any pots of money to the scum-bag bankers that got us into this mess, it would directly benefit the general population, and, in restoring confidence to the money markets, would ultimately create jobs, allowing people to work themselves off the program over time.<br /><br />Details would have to be hammered out; cut-off dates (I would suggest rescuing only loans made prior to 1-20-2009), tax refund rules, possible upper limits to payments (the current regime made a big campaign point of not giving tax breaks to the RICH), and restrictions on passing the bailout to third parties, are items that would have to be fought over.<br /><br />If a worst case scenario of 25% potential default (25% of all mortgages needing such insurance), the bill would come to roughly $265,593,950,100 per year. There would be enough in the pig-trough to pay one-fourth of all USofA mortgages for about 4.5 years. That should be sufficient time to get over our economic sniffles, and would guarantee a resounding re-election for BO & Company.<br /></blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-49551187128027748232009-01-16T16:06:00.004-05:002009-01-16T16:23:17.874-05:00How Much is that Dollar in the Window?<blockquote align=justify>Some more wizardry by those who flunked Econ 101. There is a sense of panic out in the vast, snow-covered American hinterland (yes, I am including New Yawk, Warshington, and Lost Angels in hick country) with regard to what "money" is currently able to buy. This Reuters article is an interesting read, just for the nit-picking possibilities : <a href="http://www.reuters.com/article/vcCandidateFeed2/idUSTRE50D3GM20090116">Inflation slows to half-century low in 2008</a><br /><br />"WASHINGTON (Reuters) - Inflation slowed to a half-century low this past year and industrial output fell for the first time since 2002, data showed on Friday, as the recession deepened toward year-end, raising the specter of deflation." ...<br /><br />"Weakening activity worldwide has depressed commodity prices, pulling headline inflation down sharply. However, core U.S. inflation, which strips out volatile food and energy costs, is also slowing increasing the risk of deflation." ... <br /><br />[Notice the blurb about food and energy costs? Are we talking industrial commodities, like steel? Today, on the Chicago Exchange, July 2011 wheat is up 19% over March 2009 wheat. December 2011 corn is up 21% over March 2009 corn. December 2009 lean hogs are up 13% over March 2009 lean hogs.]<br /><br />"'Deflation is just around the corner,' said Meny Grauman, an economist at CIBC World Markets in Toronto. 'With the U.S. economy roughly one full year into a deep recession, the prospect of deflation is a concern for another time, especially on a day when the U.S. government has decided to inject billions more into the U.S. banking system.'" ...<br /><br />[Huh? Run that past Barney Frank again...]<br /><br />"Deflation is usually described as a dangerous spiral of falling prices causing economic contraction as consumers hold off purchases in the hopes of even lower prices. Mounting job losses, falling household wealth and tight credit conditions have forced consumers to hold back on spending, limiting businesses' ability to raise prices and encouraging some to offer heavy discounts to lure customers." ...<br /><br />[ummm -- whose description? A politician's or an economist's?...]<br /><br />"Analysts said the data illustrated the urgent need for a massive fiscal injection to turnaround the economy. President-elect Barack Obama and Congress are working on a package of spending and tax-cut measures to stimulate demand." ...<br /><br />[Analysts? Banking analysts?...]<br /><br />"'There is little hope of a near-term revival in manufacturing without a huge fiscal stimulus program implemented with a sense of urgency,' said Roger Kubarych, an economist at Unicredit Markets and Investment Banking in New York." ...<br /><br />[Ah. Question answered.]<br /><br />"The Fed has dropped benchmark interest rates virtually to zero and with little firepower left on that front, is concentrating on pumping money into troubled credit markets to try to restore lending, hoping to spur activity and beat back incipient deflation risks." ...<br /><br />[Yes. We must borrow until we are back on a sound economic footing. Just trust them, don't think about it.]<br /><br />"Core prices, which exclude food and energy items, were flat for the second month in a row in December. On a year-over-year basis, core inflation rose 1.8 percent, the smallest increase since December 2003 and still within a range Fed officials would be comfortable with." ...<br /><br />[Lets see : spending is down, prices are still rising (but not as slowly), and we are ignoring the rapidly increasing cost of (food commodities) what people are still buying. Makes sense to reporters, I guess.]<br /><br />I have a question. Is there anyone in these "think tanks" that is not politically motivated? We have a period in time in which the Federal Reserve, at the urging of the government, has gone berserk printing money backed only by the 'full faith and credit of the United States'. This is a Wizard of Oz moment in time, or maybe the emperor's parade is passing and I'm the little kid. (Do fairy tales have a basis in reality?)<br /><br />Congress, please stop the nonsensical pretense at solving the current economic woes. The explanation for the problem is simple : if you eat too many plums, you get diarrhea. If you are sitting on the toilet, suffering from diarrhea, and feeding yourself plums as a means of curing yourself... do I paint an understandable picture?<br /><br />Tim Harford (of <i><u>Undercover Economist</u></i> fame) has written an interesting post : <a href="http://www.slate.com/id/2142241/">The $10,000 Light Bulb …</a> ; he states, "The official inflation rate tries to compare the price of a typical bundle of goods today with that of a typical bundle of goods in the past. But we do not consume the same goods today as we did in the past. How many Walkmans in an iPod? The question has no sensible answer, but an answer, nevertheless, is codified in the official inflation rate."<br /><br />The sad truth is that <i>measures</i> of inflation or deflation [note <i>measures</i>!] may have no real impact on people other than the political necessity to tie increases in entitlement programs to some fictional explanation; the need to exclude food and energy costs arose when the need to limit the costs of government handouts became apparent. That is why you have an "official inflation rate", and why it is important to politicians and the bankers who pull their strings.<br /><br />Actual inflation or deflation has an impact on real people, but mostly when it affects precisely the items excluded from the most prominent measures -- staple items like food and energy. The new $100 trillion Zimbabwe note (released today) is a case in point; in a country where a loaf of bread cost $30 billion (last week, anyway), and $10 billion, $20 billion, and $50 billion notes (released last week) are no longer enough, you have to make the bill bigger to sucker somebody into accepting it. Would you spend $22 million for a single sheet of toilet paper? (Oops -- last week's price, more expensive this week. Actually, if I were a Zimbabwean with Internet access and a Swiss bank account, I would try selling some of that money on e-Bay -- accepting payment only in Swiss francs -- to collectors in other countries!!!)<br /><br />I will reiterate. Inflation of currency is the deflation of its value caused by printing more of it without any material backing. Declining prices of goods is not deflation; it is the refusal of buyers to spend inflated money on items for which they have no perceived need. As a result of the criminally profligate printing activities of the Federal Reserve as abetted by the government, we should begin to see, within a 3-6 month period, astronomical increases in the costs of food and other staple goods. Buy your garden seeds early. The only deflation 'real Americans' have to worry about is in the purchasing power of their dollars.<br /><br />Now for our story problem. Senator Boozhwa has economic diarrhea from eating too many political plums. If poo-paper is $22 million per sheet (last week), how much will it cost the Senator to flush America down the toilet before the next election? [Hint : $800 billion will not be the final number.]</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-24614627123020609562008-11-23T00:08:00.002-05:002008-11-23T00:23:21.824-05:00Commercial Break<blockquote align=justify>This past week I was prompted by Mickey Axlebender Thirdson to pontificate on deflation, since people were talking about it but did not seem to know what it meant. Of course, if one is speaking of pneumatic tires, deflation causes a "flat", and if one is talking about a bore (as in, politician who won't shut up) the term has no meaning since the bore is a boor and cannot be embarrassed sufficiently to become deflated. However, when one is speaking about economics, then the common sentiment is that deflation is when prices go down.<br /><br />It is a bit more complicated than that, though. Perhaps we need to look first at "inflation", which everyone thinks they understand. We will need a place to stand on if we are going to move the Earth, saith Archimedes, and that place in economics will be a standard medium of exchange. Gold comes to mind quickly, as does the cost of a loaf of bread. The USBuck has been taken to be the standard for the past half century (yes, Virginia, there was a time when other currencies were considered the standard -- see "pieces of eight", for example) and the rise of the Euro notwithstanding, foreign investors have rallied back to the dollar recently because, relative to what is happening in the rest of the world, and in spite of US economic woes, the USBuck is still the most confidence-inspiring piece of paper afloat.<br /><br />Inflation is generally seen to be a process whereby prices are rising. There is a need to understand <i>why</i> prices rise. In a rational economic world, prices rise due to a rise in demand relative to a decline in supply. In other words, people are bidding for something, and the competition drives up the price. There are multiple intertwining factors in action, however. One factor is the item being purchased, and another is the perceived value of the currency used. In other words, the USBuck is a commodity in trade. In general, the more USBucks there are in circulation, the less valuable they become, and the more of them are required to barter for the item being purchased. When the government creates more USBucks, to the buyer, the USBuck has become less valuable, and to the seller, the item being sold has become more valuable. Inflation in the price of the commodity being sold, where the demand for the commodity has not increased, is actually caused by <i>deflation</i> of the value of the currency used in trade.<br /><br />So, we flashback to Jimmy Stewart in "It's A Wonderful Life", and we see him instructing Momma Dollar and Poppa Dollar to hide in the safe and create lots of little dollars. Unwittingly, Frank Capra was commenting on the reason why FDR was unable to solve the problem of the Great Depression with all of his programs. They all tended to create little dollars.<br /><br />Entrepreneurial buzz is full of the concept of "creating wealth". Wealth is "created" when a product, for which there is a demand, is produced. Too much of the "wealth creation" that has taken place has simply been fabricated through artificial accounting constructs. One popular method has been to provide seller financing of a piece of real estate. The seller needs money and is looking for a buyer, and the buyer has no money and wants the property, so the seller "creates" the money by allowing the buyer to make payments over the life of the contract. There is risk involved, and the seller compensates for the risk and charges interest (the time value of the money) to make up for the fact that he cannot use all of the sales price right away (opportunity cost has to be compensated for). The money used to make the payments (USBucks printed by the Federal Reserve) was originally intended to be used in direct exchange for goods and services without any adjustment for lost opportunity costs. Because the terms of the contract are now competing directly with the interests of the private banking system (the Federal Reserve), feedback in the economy forces the Federal Reserve to print additional USBucks to protect its own position. Money has been "created". This does not necessarily lead to a decline in the value of the USBuck <i>IF</i> there has been a corresponding increase in the total goods and services being traded and in the number of buyers of those things. Unfortunately, as has been pointed out in prior posts, there is a huge oversupply of housing (the most common wealth creation venue under the above scenario) and the net effect of the increase in USBucks has been to lower their value in trade.<br /><br />Deflation is commonly taken to be the situation when prices are falling. Why do prices fall? Prices fall either because there is too much "stuff" for sale -- no demand for the "stuff" -- or because the number of USBucks available has declined. If there are fewer USBucks, then the demand for USBucks rises, and the buyer is entitled to get more "stuff" for fewer USBucks because of the relative value. To look at the backside of it, deflation caused by a reduction of the number of USBucks in circulation is actually <i>inflation</i> in the buying power of the USBuck. My opinion -- William Jennings Bryan, with his "Cross of Gold" speech, was a blithering populist idiot who did not seem to realize that the alternative to crucifying the farmer with the gold standard was to suffocate the rest of the country with worthless paper.<br /><br />Sad to say, it appears that just now the deflation in the worth of the dollar is coinciding with a deflation in the worth of the goods and services in some sectors of the economy. There are too many houses; about 10% of the total housing stock should be bulldozed and returned to cropland or some other productive use. There are too many cars (particularly cheaply made, breakdown-prone, high-priced, gas-guzzling ones) -- a fact easily illustrated by the lack of car sales having very little impact on whether or not Americans are still getting to wherever they want to go. There are too many mortgages that were made at below-market teaser rates and which will default as the rates reset to market and the borrowers can no longer afford to pay.<br /><br />The government response has been fantastically stupid. Instead of listening to economists, the Congress and Senate chose to listen to every plaintiff whose ox had been gored, especially the Federal Reserve bankers. In the blink of an eye, the Federal Reserve was allowed to create $700,000,000,000 of new BailoutBucks, a move which cheapened the money in everyone's pocket overnight. Prices should have shot upwards, but one other factor was at work -- the machinations of the Infernal Revenue Service.<br /><br />I have several very bitter disagreements with the tax thieves. One has to do with their desire to strangle the taxpayer. The term "mark to market" is now getting some attention, but it is an old IRS tactic that was adopted by the people who invent accounting rules. According to the IRS, if the market interest rate is 5%, and I loan you money at 1%, you must pay income tax on the 4% I did not charge you. The accountants were forced by this tactic to come up with a definition of "fair value" that relies on the current market price, even for assets which a taxpayer does not intend to sell. If I buy stock at $1/share on December 30, 2008, and it goes to $2/share on December 31, 2008, and back down to $1/share on January 2, 2009, I have a gain of $1/share for the 2008 tax year, even if it was not realized. For a cash basis taxpayer, there is no effect, but for an accrual basis taxpayer, there is an imaginary taxable gain of 100%. This is the result of "marking the value of the asset at current market price". The tax must be paid in 2009, and you can take a write-off for the imaginary January 2 loss in 2010. IRS will use your money, interest free, in the meantime.<br /><br />When "mark to market" is applied to assets that are being held for income generating purposes, the decline in the market price of those assets can cause catastrophic effects in the credit ratings of companies. That is why so many lenders and insurance companies are now in a credit crisis. That is why throwing money at the problem will not help. The rules have to change. I advocate that "mark to market" be used only for assets actually traded, and "value in use" be given more emphasis where accrual accounting is utilized. IRS will not be happy with such a concept. It is not an accident that a recent Federal tax court decision (10/30/2008) ended in a ruling that disallowed a value for the cost of a historic facade restoration in New Orleans. IRS argued that only sales comparison should be used, and that cost and lost income should not be considered. "Judge James S. Halpern ruled that the court would not supplant its responsibility to assess an expert appraiser's reliability by accepting USPAP as the defining standard of reliability, stating that federal rules of evidence only require that expert testimony be based on reliable principles and methods." (Appraiser News Online, November 19, 2008, Vol. 9, No. 21/22). In short, the IRS can ignore Congress and make things up as it goes along.<br /><br />Deflation? The horse is out of the barn, but it's a mule. There are too many USBucks running around out there. The politicians are planning to print more in an attempt to "stimulate" the economy. There is too much "stuff" for sale, and the only way out of the rabbit hole is to either reduce the amount of "stuff", or reduce the number of USBucks. Meanwhile, back at the ranch, prices will continue to go down, and the country will suffocate in excess USBucks.<br /><br />Too simplistic? If I have to cut my throat, I would rather do it with Occam's Razor.</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-84502059856633875502008-11-21T02:11:00.003-05:002008-11-21T02:16:09.249-05:00A Rent Survey<blockquote align=justify>Well, I guess I'd better get started on this.<br /><br />First, we need to do a rent survey, to see what investors are asking in the Akron area. Checking the Akron Beacon Journal for November 20, 2008, we find 241 rental ads running and 43 single-family homes for rent that we can identify by address. Using the Auditor's website, we fill in the missing data -- sometimes the bath count, always the GLA, separating out attic finish (which may contain a room used as a bedroom, but which many investors seal off as a liability concern), and checking for a garage.<br /><br />The rent survey follows:<a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiswj6D8bpDgCGdQkySx8B3eAUMr53CNbw6hsmCM4Ru68LZzE-4WmvuX-lZ6GwSHrvlo7BFeUltAh-ZEDQwyPh2hsws10ULsOgNlxkLDWb_ZQnfFKOrco8sF0KogjyV5AHaltSBvgxf-JY/s1600-h/20081120+rent+survey.jpg"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 309px; height: 400px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiswj6D8bpDgCGdQkySx8B3eAUMr53CNbw6hsmCM4Ru68LZzE-4WmvuX-lZ6GwSHrvlo7BFeUltAh-ZEDQwyPh2hsws10ULsOgNlxkLDWb_ZQnfFKOrco8sF0KogjyV5AHaltSBvgxf-JY/s400/20081120+rent+survey.jpg" border="0" alt=""id="BLOGGER_PHOTO_ID_5271005573599759954" /></a><br />It appears that on average, there is a $37/bedroom difference between a 4-bedroom rental and a 3-bedroom rental, and about a $92/bedroom difference between a 3-bedroom rental and a 2-bedroom rental. It also appears that the 2-bedroom rentals, being smaller and possibly easier to maintain, return a higher rent/square foot ($0.63) than the others.<br /><br />Our investor may possibly want to concentrate on 2-bedroom homes, which will likely fit his purchase budget more easily as well.</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-18655300272526735372008-05-08T21:06:00.004-04:002008-05-08T21:17:45.607-04:00Second Base<blockquote align=justify><br />Realizing that improved real estate is a depreciable asset (have you ever filled out Form 1040, Schedule E?), an honest investor who truly wishes to get a return on an investment in rental real estate should first get a handle on the meaning of capitalization. In case you were wondering, that has a good deal to do with the term <i>capitalism</i>, which is a dirty word to some people who think that failing to properly capitalize a venture is a virtue.<br /><br />Capitalization refers to the ability to reasonably compare the costs of an asset to the benefits that derive from owning it. Accountants are familiar with the concept, but most amateur real estate investors, sad to say, are not. Even Jesus warned about the dangers of failing to capitalize ventures. I won't tell you where He said that; you have to look it up for yourself, but it is there and He was very clear about it.<br /><br />An investor who has no start-up capital is on shaky ground. I know, having started several businesses on shoestrings and losing my shirt because I was undercapitalized. Therefore, we will give our hypothetical investor the tidy sum of $10,000, and see what he could (maybe <i>should</i>) do with it.<br /><br />There is a basic formula for calculating the income produced by an investment : Income = Rate * Value. If we consider putting the $10,000 in the bank at 0.2% interest (which is about what some banks are paying right now on savings accounts and CDs), then the annual income (simple interest) on $10,000 would be R * V = 0.002 * 10,000 = $20. That is not much of an incentive for saving. It is one of the reasons why intervention by the Federal Reserve, lowering interest rates to stimulate the economy, will ultimately have disastrous effects. The only people who will win that one are the bankers, who get to use every one else's capital virtually for free.<br /><br />Our investor could put the money into the stock market. There are many solid mutual funds that have been paying 8%-12% per year. What is important to look at, though, is the mix of the annual return from those funds. How much is due to dividends paid by the companies that the fund invested in, and how much is due to capital gains that the fund earned through stock speculation? If the latter has been a very high percentage of the annual gain, the new market economics may soon make that fund much less appealing than one which derives a higher percentage of its gains through dividends paid on annual production.<br /><br />In the end, all solid gains come from the production of goods and services. Rental real estate is a service which produces places in which people can live. The rates of gain from those things are regularly published. For real estate investors, the Appraisal Institute publishes the <i><u>Korpacz Real Estate Investor Survey© National Market Indicators</u></i>, which is a gold mine of data on current capitalization rates for various types of real estate.<br /><br />An example would be the Overall Cap Rate for Apartments for the 4th quarter of 2007 (3.5%-8%, with a mean rate of 5.75%), or the Residual Cap Rate for Apartments for the 4th quarter of 2007 (4.5%-8.5%, with a mean rate of 6.58%). These are rates obtained by surveys of market participants; they are the rates that are being reported by serious investors in this field. They are also bellweathers for the economy in general, since any inflation rate (driven by artificially low interest rates) that exceeds the mean cap rates for a class of investment makes it economically foolish to hold that investment class.<br /><br />Our investor also must study the care and feeding of his investment. We will assume he wants to buy a house and rent it out to generate income. He would like to have the largest gains possible, but he is a young sprout of 35 years, and would like to make an investment that he can still be drawing income from 30 years from now, when he retires. For this reason he prudently seeks a rate of return that appears supported by professional investors in his investment class.<br /><br />Our investor will buy a house. Out of the gross rent, he will pay a mortgage, taxes, insurance, and anything that is needed in the way of maintenance. When he is ready to pass on, he will have not only earned an income over a lifetime, but will also have built an equity position. That equity position, however, should be considered a windfall bonus if it turns out to be a gain that beats the inflation rate, because in order to maintain the property, he will have to make further capital improvements over the life of the investment lest it depreciate through negligence to the point where it would be worth less than the original purchase price and also possibly lose its income generation potential.<br /><br />Our investor will start with $10,000, and hope to match the Overall Cap Rate for Apartments (about 6%, or $600 in annual net gain). For the sake of simplicity, we will stick with the short term implications, fully realizing that as his equity position increases, the theoretical yield should also rise. The fact that the monthly payments on the loan will remain constant (we will assume he goes the full 30 years without refinancing) make a short-term analysis more realistic. <br /><br />Next time we will help our investor choose his investment property.</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com3tag:blogger.com,1999:blog-7801032203191244976.post-19227370918888614672008-04-02T17:35:00.002-04:002008-04-02T18:01:21.404-04:00Finding the First Corner<blockquote align=justify><br /><center><font size=big color=red>Fable of the Day</font></center><br /><br /><blockquote>An old man watched a young boy tease a bear that was tied to a tree with a rope. Each time the bear would rise, the boy would back off. Each time the bear would sink back down, the boy would poke it with a long stick. The old man asked, "Sonny, what do you think you are doing? If that bear gets loose, it will tear you and everybody else in the neighborhood to shreds."<br /><br />"No worry, old man." says the boy. "I'm just playing the stock market."</blockquote><br /><br /><center><font size=big color=red>.........................................</font></center><br /><br />We proceed with my underlying claim that an investment whose value is based solely on the ability to "flip" an asset is on shaky ground.<br /><br />The <a href="https://www.efanniemae.com/sf/formsdocs/forms/pdf/sellingtrans/216.pdf">Fannie Mae Form 216 (Aug '88), Operating Income Statement</a>, is a frequently neglected tool that should be included with any appraisal of a 1-4 family income residence and critically scrutinized. The biggest problems (at least from my perspective) center around the facts that:<ul><li> most appraisers have no real-world experience or training in the maintenance and operation of a residential rental</li><li> most appraisers lack the experience to adequately address the need for periodic repairs to real property, and,</li><li> as a result, appraisers using the 216 generally accept borrower estimates or simply PFA to fill in the blanks.</li></ul>When this is followed by a reviewer or an underwriter who may not have been adequately trained to spot inconsistencies between the appraisal report and the 216, the Monthly Operating Income developed on the 216 will provide an unrealistic or even fraudulent indication of the property's net income generation potential. Fannie Mae requires this form to be properly filled out and submitted with every Fannie Mae 1025, Small Residential Income Property Appraisal. <br /><br />The 216 should also be completed for every single-family appraisal (Fannie Mae Form 1004) where the home is to be used as a rental. It usually is not, however, because loan officers do not want to pay the additional fee most appraisers charge to do extra work, and in any event, it is easy to get around by simply claiming that the home is to be owner occupied. Unfortunately, there is no space on the forms to indicate whether the borrower already owns a dozen single-family homes within the county. (Such information is embarrassingly easy to find and is sometimes very difficult to hide, but has nothing to do with the valuation of the subject property. The amount of fraud seen by the average appraiser is incredible, but reporting it can be hazardous to his business. Maybe I should post a few war stories?)<br /><br />If the subject property is a single-family residence that will be used as a rental, the <a href="https://www.efanniemae.com/sf/formsdocs/forms/pdf/sellingtrans/1007.pdf">Fannie Mae 1007 (8/88), Single Family Comparable Rent Schedule</a> should also be filled out. This will provide an estimate of the subject's gross income potential, as of the appraisal date. In general, the rent comparables used in the Fannie Mae 1025 will be used for the same purpose if the property is a 2-4 family rental.<br /><br />The front of the 216 is used to project the anticipated income and expenses for the next 12 months. It is sometimes necessary to survey income property owners to get a feel for what is typical in a given neighborhood; quite often the subject property's owner will underestimate his actual expenses. The form carries this statement :<blockquote><br />"If the appraiser is retained to complete the form instead of the applicant, the lender must provide to the appraiser the aforementioned operating statements (n.b ' actual year-end operating statements for the past two years'), mortgage insurance premium, HOA dues, leasehold payments, subordinate financing, and/or any other relevant information as to the income and expenses of the subject property received from the applicant to substantiate the projections."</blockquote><br />In over 20 years of residential appraisal practice, I have never had a lender provide that information. I always had to acquire it from the applicant, the property owner (if it was a sale), or market surveys. Many borrowers treat a request for such information with an attitude of offense, and market surveys are time-consuming because the competition in the rental market makes landlords treat such information as proprietary. It is, nevertheless, critical data, and on more than one occasion I have had to conclude that the projected Net Operating Income shows that the landlord's business is not viable. Once that happens, you have a very unhappy investor, who will never again willingly give you data about his investment plan. You also will have a very unhappy loan officer, who will try to guarantee that you never again get an appraisal order from his company.<br /><br />So, what is so difficult about this Form 216? For one thing, is asks for items like projected vacancy and the "customary expenses that a professional management company would charge to manage the property". Those two items alone can sink the NOI. The second page, though, is the real killer. On page 2 is the Replacement Reserve Schedule. Many investors will ask, "What is THAT?". THAT is what causes many of the investors in my market to lose their investment.<br /><br />Even assuming that the rental is unfurnished, and the tenant must supply stove and refrigerator, items like dishwashers, furnaces, central air units, and water heaters need periodic replacement. It is not unusual to see an appraiser indicate on a form that a home has a Remaining Economic Life of 40-50 years (hey - would you make a 30 year loan if the REL was 30 years or less?). Let us suppose you are talking about a duplex, with two of each. Assuming the equipment is brand spanking new the day of the appraisal, in a 50 year period the investor will need to buy and install two furnaces, four central air units, eight water heaters, and eight dishwashers. That is based on average life expectancies for those items. He will also need to re-roof the building at least once, and, based on my experience and the experiences related to me by local investors, will need to totally replace the flooring -- carpet and vinyl -- about nine times. Assuming he sells it at the end of the fifty year period, on that schedule, all of the replacement items would be needing to be replaced at that point, and he would be selling a building in need of updating.<br /><br />The Replacement Reserve Schedule provides an amount that should be set aside <i>each month</i> to have money in reserve to complete the repairs that will be required over time. A wise lender would require an escrow account for those items, but using that criterion, I have never done business with a wise lender. Those figures are totaled and transferred to page 1 and added to all the other expenses to give the Total Operating Expenses. The numbers are then reconciled: the Total Operating Expenses are subtracted from the Effective Gross Income and divided by 12 to give a Monthly Operating Income. The Monthly Operating Income is then reduced by the Monthly Housing Expense (P & I on the mortgage, hazard insurance, property taxes, MIP, etc) to give a Net Cash Flow. If this form were completed honestly and properly, the percentage of loans made on residential rental real estate would plummet. In most cases, the only way to generate a positive cash flow is to reduce the amount that is to be borrowed, since that is usually the largest single monthly expense. This calls for a bigger down payment, and would spell the end of cash-out refinancing of most rental properties.<br /><br />Next time we will look into the case of the honest investor who wants to actually get an income from real estate rental property, and expects to hold the property for a lengthy period of time.</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0tag:blogger.com,1999:blog-7801032203191244976.post-8088020710080535082008-04-01T11:36:00.001-04:002008-04-01T11:43:15.291-04:00Cornering a Market<blockquote align=justify>As a review appraiser, one of the biggest problems with appraisals of residential investment properties -- rental homes -- has been the lack of careful attention by the appraiser to the actual return on investment anticipated by the investor. If the investor were putting money into a stock, he would surely be interested in whether that stock was likely to earn money and pay dividends. The investor would look at the money in hand, examine the alternate choices (i.e., bank interest, other stocks, bonds, state lottery, etc) and see what rate of return could be expected. That caution has been lacking in recent decades, as investors look at stocks from the standpoint of their possible resale value (buy low, sell high) rather than their income generation potential (long term gain through dividends).<br /><br />When it is realized that the entire rationale for the existence of the stock market is the generation of capital for start-up and expansion of a business enterprise, the prostitution of the market by those who use the change in stock price as their sole reason for participation should give shareholders and directors reason to very seriously consider the potential negative consequences of going public with the stock, for, at that point, the financial stability of the company becomes hostage to the perceived profit-taking ability by the market at large.<br /><br />The real estate industry has been taken over by this same mind-set. It was the anticipation of a quick profit by the property "flippers" that drove the real estate bubble, much the same way that stock "flippers" have driven other "bubbles" in financial markets. The "flippers" made their money by buying low and selling high. Just as the stock market attracted non-traditional investors, the real estate market attracted "flippers" across the spectrum. It was not unusual during the bubble years for Average Joe to buy a house, live in it for a year or so, then sell and buy another, making a small (sometimes large) profit and moving up in the world. Indeed, there is nothing wrong with that kind of approach to real estate. The problem arises when Other Peoples' Money (OPM) enters the equation. <br /><br />If you have a few spare shekels of your own, what you do with them is your own business. You can engage in risky economic behavior because it is YOUR money. If you went to the local bank and said, "I would like a personal loan so I can buy some lottery tickets, and I will offer the tickets as collateral", any rational banker would either throw you out or die from laughter. (That is not to say that if you looked hard enough, you could find an irrational banker.)<br /><br />The basic underpinning of the study of economics is an understanding of the relationship between supply and demand. That relationship is never perfect; it is always in flux. Today I demand eggs for breakfast, tomorrow I demand cereal. What I pay for breakfast today is determined by how many eggs there are to be had, and how many other people want eggs. If eggs are scarce, and many people want them today, I may have to pay the California Gold Rush price of $100 per egg today, and if everybody wants cereal tomorrow, the guy who wants to sell a dozen eggs tomorrow may not get $1 for the whole dozen. Supply and demand; the market works in cycles and despite the claims of experts, is unpredictable because it involves the perceived wants and needs of people, and every day brings a new itch to be scratched.<br /><br />Therefore, if I go to the bank to borrow money for an investment, the banker wants to know what the value of that investment will be over the life of the loan. He wants to know if it will be a winner or a loser. If I want to invest in Pet Rocks, he wants to know if they produce dividend income, or if they have good resale potential. For that reason, few sane bankers will loan money for an investment in a day at the horse races, or even an investment in the stock market. Such gambles are heavily regulated.<br /><br />When the public fell for the canard that residential real estate was a good investment, most people failed to recognize that what they were falling for was a property flipping scheme, and not a dividend stream investment. The mantra was that real estate never goes down in value, therefore it was "safe". It was thus felt that using OPM was legitimate for property "flipping", whether done by investors who had that as their sole objective, or by Average Joe, who just wanted to make a profit when he sold his house.<br /><br />Enter government social engineering. Very few economists are elected to Congress. This is also a result of the Law of Supply and Demand, but I will leave the reader to figure out what I mean by that. Official government policy for several decades has tried to maximize home ownership, without regard to whether the new homeowners understood their responsibilities. This has resulted in lowering the equity barrier for entry into the real estate market, and the lowered requirements have been extended even to non-owner-occupied dwellings. <br /><br />In previous years, it was believed that a loan to value ratio of 80% was a reasonable risk, and borrowers with less than 20% down were required to purchase mortgage insurance, either through a GSE (FHA insurance) or through private mortgage insurance (PMI) companies. The insurance was then used to guarantee the repayment to the lender in the event of default.<br /><br />Because of the common belief that values were increasing (based partly on government indexes that measure the buying power of the dollar) the property "flipping" could continue as long as a higher resale price could be obtained by the investor. Little real attention was paid to the actual return <i>earned</i> on the investment. This was where the Operating Income Statement -- the Form 216 -- should have been of greater concern. It is also where the use of Gross Rent Multipliers (GRMs) lead to false impressions of value.<br /><br />Enough for now, I have other things that must be done at the moment. The investment idea that I am toying with will be developed over the next few posts.</blockquote>James C. Hrubik, RAAhttp://www.blogger.com/profile/09076226281030823151noreply@blogger.com0