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.

Foreclosures Skyrocket

According to this report on CNN, the number of foreclosures rose 58% during the first half of this year. One in every 134 households is going into foreclosure. In Nevada, it's even worse - 1 in every 40 houses.

Louisiana Update

Another conference call for the Louisiana investment just concluded and it looks like TMG, the investment group that is taking control of this project, is giving us investors a pretty good deal. As usual, there are lots of details, but I'll try to keep it simple here.

Those of us that are currently on the first mortgage for the commercial properties in Louisiana have the following options:

1. Get cashed out. Your investment will be paid off and you'll get your money back.
2. Roll your investment into a new second mortgage. The second will be collateralized not only by the two buildings in Louisiana, but also a couple of other commercial properties in Houston (a strip mall and some apartment complexes). The second mortgage will be for about a year, although it is likely it will be refinanced and paid off early. (We will be guaranteed at least 6 months interest though.) The second will be at the same interest rate we are getting now (12%). In addition, we will be getting 4 points cash up front.
3. If we decide to stay in the investment, we will also get the option to convert our investment into an equity position in about a year (a "right of partnership of ownership"). The terms for this will be worked out later, but it is likely equity position holders will get monthly payments at 9% APR plus a preferred position on the investment, which means they will get their money back before anyone else when the places are sold. So even if everything goes south and the properties need to be sold at a loss, the preferred positions will have an excellent chance of getting all their money back. This is optional, so if we don't want to become equity holders, we don't have to. They expect to sell all the properties after an additional year for a profit of around $10 million dollars and investors could be looking at doubling their investment.
   

This whole deal is set to close the end of next week. The original investment was originally set to end in March, 2008 and this new one will expire a year from close of escrow. So if I decide to keep my money in the investment, I'll be paid 4 points to extend my investment by about 5 months. And that money will be paid upfront at the close of escrow in a week or two.

To me, this is a no-brainer. The slumlord who took over control of the investment will be gone. The new first mortgage holder will be TMG, the group that already has about $400,000 invested in the current second. The president of TMG also will be personally responsible for $1 million of the new mortgage and he is putting his personal residence up as collateral.

This investment is turning out to be pretty profitable for me. I had some months where there were no payments, but we are now current and have been paid late fees. So my return including the late fees is around 12.6%. Now I'll be getting another four points, which jacks the ROI for this year up to 16.6%. Then there is the prospect of getting 9% for another year plus a 100% or more return on our principle when the buildings are sold.

But technically, my ROI is infinite now, since my investment cash came from my HELOC, so it's not even my money I'm using. But it's just not the same to say my new ROI will be infinite-er :-)

Summertime Slowness

Nothing much seems to happen in the summer. Here in Arizona, it's just too hot to go outside and do anything and with vacations and family visits, it seems like real estate has taken a back burner for a moment.

My Louisiana investment has finally been brought current. Actually, more than current since I've already received the payment for August. That brings the mortgages up to date. The other aspect of this investment - buying out the old majority owner and possibly getting an equity share of this and several other properties - is still in process. I think escrow is supposed to close by the end of the month, but with a deal this big, I wouldn't be surprised if it took longer. No more details yet either, so I am not entirely sure how good of an investment this may be and if I'll want to stay in it or cash my money out and move to something else.

My tenants in Rental #1 still have yet to pay their $200 from May that they were mistakely undercharged by my management company. The tenants told the management company last Tuesday that they wouldn't have that money until August. If they have not paid everything by August 10, I've instructed the management company to evict them. Their lease is up on November 1 and I am 95% sure I will not be renewing their lease. It might cost more to evict them now than to simply keep dealing with their issues until their lease expires, but I would rather be trying to rent the place in August and September than in November and December.

The investors I was rehabbing and flipping properties for are evaluating their options right now. I think all the media coverage about the housing meltdown has got them a bit worried about flipping and they aren't sure if they want to keep doing that. They are looking into getting a rental property, perhaps something in the Payson area that they can rent out part time and possibly use for themselves other times, or perhaps just a straight rental somewhere in the metro Phoenix area.

Personally, I'm saving up my funds for my next REI purchase, which will definitely be a multi-unit property. I'm not saving as much as I'd like, mainly because I've been hit with a rash of big expenses lately (well, that plus a losing vacation to Las Vegas!), so I'm not sure when I'll be ready to pull that trigger. Just a few months, hopefully.

Subprime Mortgage Meltdown Begins To Gather Steam

The meltdown in the subprime mortgage market is gathering steam and beginning to be widely felt. Yesterday, Bear Stearns told its clients that two of its hedge funds were now worthless.

Bear Stearns, the nation's fifth-largest investment bank, began disclosing in March that the two hedge funds had sustained heavy losses tied to subprime loans extended to risky borrowers. At the time, its High-Grade Structured Credit Enhanced Leveraged Fund was worth about $638 million -- and now has no value.

Meanwhile, the larger and less-leveraged High-Grade Structured Credit Fund lost 91 percent of its value. It was worth about $925 million before taking on losses in March.

Ouch! That's a total loss of 1.4 billion dollars! At this is just at one firm - and a firm that was considered the "pre-eminent Wall Street firm dealing in mortgage-backed securities." And those funds were "High Grade", meaning they was supposed to invest mostly in "highly rated" securities. Wait until the other firms start reporting. Wait until more of these subprime mortgages have their interest rates reset in the next couple of years.