The Mortgage Meltdown Fallout Continues

Reuters reports that American Home Mortgage Investment, a REIT, could no longer fund loans and may be forced to liquidate its assets. This comes after last Friday's announcement that it would not be paying its quarterly dividend to shareholders. The company is unable to fund $300 million of loans it already committed to make on Monday. It is expected to be unable to fund another $450 to $500 million in loans today. Shares of the REIT closed at $1.04 on Monday, down from a high of $36.36 in December. But this is the important part of the article:

"It is raising concerns about the whole mortgage market because American Home really didn't do anything in subprime," said Sam Rahman, a portfolio manager at Baring Asset Management Inc.

Stop and think about the full ramifications of this. On the personal level, how many home buyers are going to not be able to purchase their houses now because AHM can't fund the loans? How many shareholders have lost substantial chunks of money due to the drop in the share price - never mind the stopping of the dividend. And how many mutual funds had positions in this company and will also lose money? And all this from a company that had very little, if anything, to do with subprime lending and accounted for roughly 2.5 percent of the U.S. mortgage market.

And then there are the collateral effects. Mortgage insurers are getting hit. MGIC Investment Corp. and Radian Group Inc. said they were going to write off a combined $1.03 billion investment in the subprime mortgage arena. Add this on top of the other $1.4 billion loss I wrote about a couple days ago and we are starting to talk about some serious money. Does anyone still think this isn't anything to worry about? That it won't have ramifications in our broader economy? Just think about those people whose loans won't get funded. Their purchases will probably fall through. This may cause them to cancel the sale of their existing homes. Moving companies won't get hired, new furniture won't be bought, money stops changing hands. The effects trickle down.

So what's a real estate investor to do? If you invest in REITs or other real estate related stocks or mutual funds, take a close look at the company's portfolio and how much exposure they have to adjustable mortgages. Check to see how much cash they have on hand and how close they are to being maxed out on their credit lines. Check the rate of defaults and late payments on their loans. Are they rising? All this information is available in the reports companies are required to file with the SEC. If you prefer to invest in properties, now is the time to stick to basics - buy below fair market value (significantly below if possible because FMV can drop like a rock in some places). Be sure the property will positive cash flow when rented at or below market rates. Don't count on appreciation or tax deductions to turn your negative cash flow into a positive cash flow. Like all else, this period will pass, but you need to make sure you can weather the storm.