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Lies We’ve Been Told | By: Multiple Speaker(s)

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Lies We’ve Been Told
By Vena Jones-Cox

The longer I’m in the real estate business, the more I’m convinced that some of the “conventional wisdom” we hear day in and day out is incomplete, misleading, or just flat wrong. For example:

There’s such thing as “good debt”. In case you haven’t followed this philosophy, it goes like this: it’s OK to borrow money against income-producing or appreciating assets, but not against things that don’t create value or depreciate like cars, vacations, and other consumer goods.

In other words, that mortgage loan that you got to buy your house is ‘good debt’, because, in theory, that house will increase in value even as you pay down the balance on the mortgage. The loans you signed for to buy your rentals are equally ‘good’, because those rentals both increase in value and produce cash flow over the 30 years that you make payments to your lender.

In fact, the conventional wisdom is that it’s smart to leverage such purchases as much as possible—in other words, put as little money down as you can—and to spread out the payments over as long a period of time as possible, since this allows you to ‘afford more value’, which is another way of saying that your income will cover a larger loan if it’s a 30 year loan rather than a 15 or 20 year loan.

The first problem with the idea of ‘good debt’ is obvious to you if you bought real estate with a low down payment between 2003 and 2007. That real estate has NOT, despite what its ‘supposed’ to do, appreciated in value. In fact, if you paid 70% of what that property was worth in 2006, and put 10% down, and have made every payment on it for 6 years, you probably still owe as much or more as the property is worth today—and you’ve already made 20% of your mortgage payments.

Yes, I know, this is an unusual circumstance, and over time prices WILL rise to more than the 2006 value of the property before the 24 years remaining on the mortgage is paid off. Nonetheless, millions of Americans have lost or will lose their homes to foreclosure—or walk away from them—before this happens. And every one of them will have one thing in common: a mortgage.

Yes, I understand the ‘necessity’ of borrowing money if you want to buy a house. And I understand the value of leverage and long-term financing if you want to buy the house you ‘want’. But frankly, I’ve come to believe through my dealings with hundreds of people in short sale situations that if you can’t ‘afford’ to put 20% down and can’t ‘afford’ the payments on a 10 to 15 year loan on a home, you can’t afford the home.

And I’d have to say the same thing about traditional financing on a rental property. The availability of 100%, 30 year financing (and cash-out refinancing) on investment properties in the first decade of this century caused a lot of long-time, successful landlords to lose everything they’d built over the course of years.

Debt might be necessary for acquisition of real estate, but I think that our goal should be to pay that debt off as quickly as possible, NOT to string it out for as long as possible in order to maximize current cash flow at the expense of equity build up (and HUGE interest expenses, by the way).

Banks are motivated sellers. One of the “facts of life” I’ve been taught since I got my very first taste of real estate education is, “Banks aren’t in the business of owning properties. For every $1 in bad loans or REOs on their balance sheets, they have to keep $8+ in their coffers and not loan that money out—so they want to rid themselves of their short sales and bank-owned properties as soon as they can.”

That was then, and it might even be true again in the future, but at the moment, there are political and regulatory forces that are making it advantageous (and in some cases, even necessary) for banks to hold on to their inventory rather than sell properties for whatever they can get and move on.

Primary among these is the suspension of the “mark to market” accounting rules. Prior to the mortgage crisis and bank bailout, lending institutions were required to report bad loans and REOs on their balance sheets at the current market value rather than at the amount that the lender had invested in the property. Today, thanks to the suspension of these rules, banks continue to report properties and loans at their original value until they’re sold at a lower price.

So what, you say?

Well, think about a local savings and loan that has 40 “bad assets” in the form of properties they’ve taken back through foreclosures. Let’s assume that the loans that the S&L originally made on these properties were $100,000 each, on average. Those 40 properties represent $4 million in “assets” on the lender’s balance sheet.

Except that, thanks to over-lending, the drop in the market, and damage to the properties through vacancy and vandalism, those 40 properties may have a current value of just $1.5 million. Even if they haven’t actually been sold, the S&L has, really and truly, already experienced a loss of $2.5 million on those loans.

Prior to 2008, that institution would have had to recognize that loss already. But with the suspension of the mark to market rules, they can continue to claim higher values on their bad loans and REOs until such time as they’re actually sold for true market value.

The loss is already there, so why play the game of pretending it’s not? Easy—if all banks and savings and loans had to market their bad assets to true market value, hundreds of them would fall below the FDICs minimum requirements for net assets vs. liabilities and would literally be shut down by the government. And it’s not just the banks that don’t want this—it’s the government itself. A huge wave of additional bank failures would undermine the public’s faith in the entire financial system, not to mention requiring the underfunded FDIC to spend even more money making the depositors of those banks whole.

So, to come back to the “banks are motivated sellers” fallacy, here’s the reality: yes, it’s true that banks aren’t in the business of owning properties. It’s also true that they’re in the business of staying in business, and withholding properties from the market (or refusing to lower the prices to something that a reasonable person would actually pay) is a smart move under the current, crazy rules.

Does this mean you shouldn’t pursue bank-owned properties? No—because when REOs ARE released to the market, it means that the lender is ready to write down the asset, and they DO still sell pretty cheaply in most markets. It simply means that the 11 million+ bank-owned assets that are NOT on the market and are not available for you to buy, because the government has interfered in the normal operation of the real estate market and given a normally motivated seller a reason not to be.

Reprinted with permission of Vena Jones-Cox. To get more free articles and tips, subscribe at

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