The delinquency rate for loans held in CMBS is the highest since the series began in 1997.  Delinquency rates for other groups remain below levels seen in the early 1990’s, some by large margins.

Between the fourth quarter 2009 and first quarter 2010, the 30+ day delinquency rate on loans held in commercial mortgage-backed securities (CMBS) rose 1.54 percentage points to 7.24 percent.  The 60+ day delinquency rate on loans held in life company portfolios increased 0.12 percentage points to 0.31 percent.  The 60+ day delinquency rate on multifamily loans held or insured by Fannie Mae rose 0.16 percentage points to 0.79 percent.  The 60+ day delinquency rate on multifamily loans held or insured by Freddie Mac increased 0.05 percentage points to 0.24 percent.  The 90+ day delinquency rate on loans held by FDIC-insured banks and thrifts rose 0.32 percentage points to 4.24 percent.

“Weakness in the economy has continued to weigh on commercial properties, which in turn weighs on the mortgages they back,” said Jamie Woodwell, MBA’s Vice President of Commercial Real Estate Research.  “Economic growth, specifically in areas of jobs and consumer spending, will be key to stabilizing the commercial property and mortgage markets going forward.”

Construction and development loans are not included in the numbers presented here, but are included in many regulatory definitions of ‘commercial real estate’ despite the fact that they are often backed by single-family residential development projects rather than by office buildings, apartment buildings, shopping centers or other income-producing properties.

The MBA analysis looks at commercial/multifamily delinquency rates for five of the largest investor-groups: commercial banks and thrifts, commercial mortgage-backed securities (CMBS), life insurance companies, Fannie Mae and Freddie Mac.  Together these groups hold more than 80 percent of commercial/multifamily mortgage debt outstanding.

The analysis incorporates the same measures used by each individual investor group to track the performance of their loans.  Because each investor group tracks delinquencies in its own way, delinquency rates are not comparable from one group to another.

Based on the unpaid principal balance of loans (UPB), delinquency rates for each group at the end of the first quarter were as follows:

.           CMBS:  7.24 percent (30+ days delinquent or in REO);

.           Life company portfolios: 0.31 percent (60+days delinquent);

.           Fannie Mae:  0.79 percent (60 or more days delinquent)

.           Freddie Mac:  0.24 percent (60 or more days delinquent);

.           Banks and thrifts:  4.24 percent (90 or more days delinquent or in non-accrual).

About MBA

The Mortgage Bankers Association (MBA) is the national association representing the real estate finance industry, an industry that employs more than 280,000 people in virtually every community in the country.  Headquartered in Washington, D.C., the association works to ensure the continued strength of the nation’s residential and commercial real estate markets; to expand homeownership and extend access to affordable housing to all Americans. MBA promotes fair and ethical lending practices and fosters professional excellence among real estate finance employees through a wide range of educational programs and a variety of publications. Its membership of over 2,200 companies includes all elements of real estate finance: mortgage companies, mortgage brokers, commercial banks, thrifts, Wall Street conduits, life insurance companies and others in the mortgage lending field. For additional information, visit MBA’s Web site: www.mortgagebankers.org.

Specialized Wealth Management

It seems that mistakes made by businesses and investors are always repeated again sometime in the future.  I have named this phenomenon “Short Economic Memory.”  Economic bubbles seem to happen every decade or so; where consumers are willing to pay high prices without concern for how those assets will sustain those prices.  Remember tech stocks with P/E ratios of 700?  Apartment buildings with 3% Cap Rates?  These bubbles “burst” when the underlying assets could not sustain the values that were paid for them.  The ensuing collapse caused some economic pain.

Is this the first time that it happened?

Of course not.  Everyone knows about the Great Depression of 1929 to 1933, but humans have been involved in trade for over 5,000 years.  Surprisingly, the internet has little information of economic conditions prior to the 19^th century, (perhaps further evidence of our “short economic memory,”) but a diligent search can reveal some details.  To paraphrase a famous quote; Those who forget the past are condemned to repeat it. In this article, I explore economic calamities of the past, and discover that the same problems have been recurring throughout history.

Inflation

Between 218 and 201 BC Rome helped to finance the 2^nd Punic War by degrading their coinage in weight and purity.  This devaluing of currency produced hyperinflation – rising consumer costs, and shrinking values for coins that are kept at home.  Five hundred years later, in 324 AD, overproduction of the Egyptian Denarii led to the same result.  In 1160, so much Chinese currency had been printed that it was worthless.  Emperor Kao Tsung reformed the currency with a new issue, but hyperinflation had returned by 1166.

Although every event, (such as the American Civil War,) has more than one cause, (slavery, a power struggle between the states and the Federal government,) there is usually one big cause.  For hyperinflation, it is deficit spending.  By definition, governments engage in deficit spending when they spend more money than they earn.  The extra money has to come from somewhere, so a country can either a) borrow money or b) print some more. Option a) may be the smarter choice, but one can only borrow so much money.  When a country’s credit is exhausted, it may need to print more money to pay its bills – and to pay its debt service.  The solution seems easy – don’t spend more than you have – but governments have been struggling with this concept for over 2,200 years now.

“Bubbles”

During 1719 in France, shares of the Mississippi Company rose dramatically in value among frenzied speculation.  The company had a monopoly on trade with the China, Southeast Asia, (then known as the “East Indies,”) and France’s Territory in the New World.  The company, for a myriad of reasons, could not sustain its share value and prices plummeted.

Everyone remembers the “dot com” bubble of the late 1990’s.  As mentioned earlier, this is when Price/Earnings ratios in the 700’s were not uncommon.  (A P/E ratio of 700 indicates that company is trading for that multiple of its annual income.)  To put this in perspective; if an apartment building with a Net Operating Income (NOI) of $100,000 was selling at a 700 P/E ratio then that would indicate a value of $70,000,000 – at a CAP Rate of 0.14%.

A famous example of “dot com hysteria” occurred with Qualcomm. (NASDAQ: QCOM)  This stock had ridden dot-com hysteria to a price above $500 per share – 25 times its value from a year earlier.  On December 29, 1999, a 28-year old Paine Webber analyst named Walter Piecyk issued his first-ever research report on the stock.  His evaluation was particularly rosy – he estimated that stock would hit $1,000 in 12 months.  As frenzied investors rushed to get in, the stock went from $564 to $659 on that day.  That marked the highest value that Qualcomm ever saw.  QCOM trades for an equivalent of $142 today; just 21% of what investors paid in 1999.

Between 2004 and 2008, we saw the effects of a real estate bubble.  Apartment complexes weren’t seeing CAP Rates quite as low as the previous example; but I did see some trading for 3% or 2% CAPs.  Investors, convinced that they were “buying for appreciation,” did not seem to mind paying $2,500,000 for $50,000 of annual income, (a 2% CAP). These buyers failed to remember that commercial properties are valued by the amount of income they generate.  Without rising income, the only way to sell a commercial property at a profit is through “CAP Rate compression,” or selling for a lower rate than what you purchased at.  At a 2% CAP Rate, however, it isn’t very realistic to assume that the rate would go lower.

The “Greater Fool Theory” is best described as “buying something not for what it is worth, but under the assumption that somebody else will pay still more for it.”  A business plan based on such a theory, rather than on solid fundamentals, is much less likely to succeed.

Invest Using Fundamentals

All of the economic disasters above happened when investors (or the bureaucrats in charge) decided that “the old rules aren’t valid anymore.”  Investors were told of a “new investment paradigm” where printing money at will is no longer a problem, or that companies should not be valued on their income; but by “mouse click.”  Although the way we invest; in mutual funds, limited partnerships, Tenant-In-Common properties, REITs, may have changed, the fundamentals of why we invest have not.

In any market condition, buying assets according to solid fundamentals in demographically attractive areas is always a great plan.

Christopher Miller is a Managing Director with Specialized Wealth Management in Orange County, California and specializes in tax-advantaged investments including 1031 replacement properties.  Chris’ real estate experience includes work in commercial appraisal, in institutional acquisitions for a national real estate syndicator, and as an advisor helping clients through over two hundred 1031 exchanges. Chris has been featured as an expert in several industry publications and on television, and earned an MBA emphasizing Real Estate Finance from the University of Southern California. Call him toll-free at (877) 313 – 1868.

On paper, two organizations may appear to be a perfect match. But bringing them together in the “real” world after a merger or acquisition can present opportunities and challenges, which can ultimately make or break a newly combined organization’s success in the future. Not only are companies uniting their strengths for a bigger and better organization, but they are also integrating different visions, practices, philosophies, cultures, leadership and employees.

The reasons why companies merge are clear. For years, they have done it for additional market share, to put the competition out of business, to buy the talent of another company’s leadership team and to increase product distribution channels. But once two companies merge, they must decide which employees to keep and which ones to let go, which vision to follow and which one to drop, and which practices to implement and which ones to set aside. That’s where the challenge really begins.

“Maximizing your business strategies with your staffing strategies after a merger is a challenge for both parties involved,” says Bill Wells, managing director in the Irvine office of leading human capital solutions company Lee Hecht Harrison. “When there’s a merger, one prevailing culture and leadership always takes the lead, and your remaining people are key to your success.”

For this reason, Wells stresses the importance of considering the cost of turnover-which can add up to $1 million for every 10 people who leave following a merger-then taking strategic steps to retain people needed to move forward. he also says that paying attention to employee behaviors and concerns is key. Studies show human resource executives spend at least one-third of their time dealing with leadership and personnel issues after a merger. “The consequences of alliances and layoffs can have lasting effects on the morale, productivity and ultimately the success of the company,” says Wells. “The right staffing strategy can definitely compensate for some of the negative impacts from a merger.”

A good strategy focuses on open communication at all levels of an organization and remains consistent, according to Wells. In fact, he suggests over communicating to employees during times of uncertainty so that they aren’t surprised by change and in turn take their talent elsewhere. “It starts at the top, never at the bottom,” he says. “A company’s leadership needs to decide what best practices to rely on after the merger and then hold steadfast to those moving forward. They should consider what culture and values they want to create and then go through the process of implementing those throughout the organization. The key is no surprises. Keeping employees in-the-know allows them to choose their behaviors, positive or negative, after the merger. They can choose to either ignore the changes taking place or embrace them.”

Although executives who work for acquired companies are often the first to go and have less say in these new strategies, Wells suggests that they do their homework and approach the situation from a position of strength. “They should make an effort to become involved in developing new organizational strategies and if that’s not an option, they should at least look at the acquiring company’s track record. They’ll be able to determine what processes the company has gone through in the past, how quickly they let people go, which people they let go, etc., so that they know what to expect.”

To minimize the negative blow of a merger, Wells also recommends evaluating the new team and reorganizing where necessary. One way to achieve this is for companies to recruit new talent from within by matching employee skills with the organization’s short- and long-term needs, and providing valuable training opportunities for employees. Companies should also be respectful in the way they treat employees who are let go. This might include providing severance packages that include outplacement services to assist out-of-work employees with taking the next step in their careers.

“By providing these services and treating people with dignity and respect, companies can restore trust and positive feelings toward the organization among those employees who remain,” says Wells. “If properly handled, these can also speed the transition of those who remain in the organization and get everyone back to work quickly and more effectively, which goes a long way in meeting the company’s long-term goals as well.”

About the author

Bill Wells is managing director in the Irvine office of leading human capital solutions company Lee Hecht Harrison.

About Lee Hecht Harrison

Established in 1974, Lee Hecht Harrison’s experience includes helping companies of all sizes effectively manage change, downsizing and internal career mobility. Lee Hecht Harrison is the flagship brand within the Adecco Human Capital Solutions division of Adecco S.A., the world’s largest HR solutions company with over 6,600 offices in 70 countries and territories around the world. For more information about the company and its recent research on HR topics, please visit Lee Hecht Harrison’s website at www.LHH.com.

Why invest in real estate at all?  After all, we could put our money into bonds and collect the interest.   Unfortunately, the value of a dollar decreases over time.  If a solid piece of real estate is our investment vehicle, its value will increase during its holding period while at the same time providing income.  Real estate’s down side includes the fact that it requires a considerable upfront investment, a constant positive cash flow and usually, it cannot be quickly sold.  On the other hand, about 90% of America’s millionaires made their fortunes in real estate, and 1031 exchanges allow for a deferral of taxes, so let’s look at some legal and financial aspects of these offerings.

Non-construction offerings, the most common, usually range from three to twenty years. This may include revitalizing a building while it is being used for income.  Raw land with an offering time of three years or less usually means that the site will be going through the entitlement process wherein the required permits and reviews are completed by officials before construction begins.  Consider what your ideal time limits would be for your investment because typically there may be little market for the long-term investments once they have closed.  If need be, the sponsor would typically first offer the property to the investors in that same property, then to their other investors and finally, the selling agent may offer it to their clients, so it would not be a speedy process if the property had to be sold.

Let’s use as an example a hotel that needs refurbishing and has a (capital) cost of $16,345,000.  If the cap (capitalization) rate looks at how quickly the property will pay for itself, then we can adjust the other factors involved to find our desired return.  Net cash flow /  Purchase price = Cap rate.  With a purchase price of $16,345,000, the net cash flow has to be about $1,144,150 annually to get near a 7% capitalization rate.  Investors, however, like to keep their cash equivalents, so, just as in buying a home, they may use a mortgage or leverage when partaking in an offering.

If an offering has 35 or less participants, it need not go through the SEC’s registration process, so that is the most common offering provided.  For a 35-member offering, each investor would have to take on a minimum in leverage and supply equity (cash) totaling $467,000.  The PPM (private placement memorandum) may also specify how the leverage and equity are to be split.  The PPM also usually states a minimum purchase amount for each investor, but let’s stay with the $467,000 mentioned above.  It then gives a dollar amount for the equity and debt.  For instance, it might require $210,150 in equity and $256,850 in debt (leverage), which translates to 45% equity and 55% leverage as a minimum investment.  Leverage gives the investor a larger slice of the pie with a smaller infusion of equity.  Sometimes a single investor is limited to an amount 10 times the individual subscription amount.  However, the fewer the investors, the less time and personnel the offering company has to allocate to the endeavor.  About 6 months ago, a sponsor put out an offering with a 10% return, and one quick investor supplied the entire $12 million total for the 3-year period before any other broker-dealers could get PPM out to their clients.   The sponsors could offer that return on New York property and they also liked having to deal with only one client.  Some investors take larger slices if they feel the offer is a good one, or if their 1031 exchange amount is larger than the minimum, so having all 35 allocations go to 35 different investors is rare.  Also, while the investor may keep to the 45-to-55 percent ratio, as long as they meet the minimum requirement, they can invest the amount they want.  At the end, this may leave an amount less than the minimum.  Therefore, there is usually a statement that says the offering company, in its own discretion, may accept an offer less than the minimum.

Our next step is to look at whether the operations will provide the advertised cash flow.   For the startup, a Sources and Uses of Funds statement, found in the PPM document,  should be present to show funds received from the loan and the investors (sources), and its deployment (uses).  Uses may include reserves for ongoing operations – an important hedge against the unknown.   The first Sources and Uses statement is about the startup, that is, the leverage and equity supplied by investors.  There may be a projected Sources and Uses statement  that shows the final year when everyone is cashed out.  There should also be Cash Flow Projections for each year of the investment with cash-on-cash returns as a percent and reserves at the end of each year.   The Debt Coverage Ratio is used as a criterion for further lending, should that be necessary.  It is the annual net cash flow divided by the annual debt service.  If the ratio is 2, then it has 2 times more net cash than the required debt repayment or leverage, and therefore can comfortably cover its mortgage payments.  If there is or are pages about assumptions, it may seem very conservative, almost to a point that seems as if business will never be better than at the start of the operation.  This conservative outlook is championed by auditors so as to keep everyone’s expectations within reality.

Be sure to look at the terms of the loan.  Can it be prepaid, and if so, when?  An inabililty to prepay the loan and/or a defeasance that works against prepayment might adversely affect the tenants in common’s ability to sell the property, if need be.  If there will be a mezzanine loan (short term) or a refinancing, is the interest rate reasonable?  Review all the fees and compare them to the other offerings.  Don’t be afraid to ask about anything that isn’t clear.  The offering companies have specialists who put the deals together and are ready for questions.  Formatting your questions in an e-mail will give you time to first review it for clarity and omissions.  There is often a section on how a 1031 exchange will work with the IRS code, accompanied by denials that it will work for everyone (or anyone).   UBTI and the Alternative Minimum Tax may also be covered.  Once you have submitted all your questions and received answers from the sponsors, be sure to show it to your tax or investment advisor.  They sometimes have a different take on the situation.

Companies, more and more, are setting up a Special Purpose Entity as a Delaware LLC for each buyer, whether or not the buyer has a trust or other protective vehicle they planned to use in the title.  Spouses are considered to be a single member for this purpose.  This is referred to as “a single member limited liability company intended to be bankruptcy remote (“SPE”)”.   Its purpose is to securitize a commercial mortgage and at the same time keep the investment and investor out of anyone else’s bankruptcy.  To do that, it has to meet certain requirements which are not usually in a trust or other personal document.   For more information you can bring up “SPE”  on Google to get a more complete definition, or request a copy from us to be e-mailed or U.S. mailed to you. The offering company may pay for the initial setup or roll the cost into the buyer’s upfront fees.  The buyer usually pays the annual Delaware fee thereafter (about $125), and the bill is usually mailed to the investor from the State of Delaware.  This is an additional layer of protection for the investor and therefore the offering company.

Some investment firms include in their PPMs a list of all their offerings in the past with their dates and financial data as part of the list.  If this is not provided in the PPM, be sure to ask for it from your agent or broker-dealer.   The offering company is a stranger to you and as a careful investor this is one more step in allocating your funds wisely.

Kevin A. Williams, President of North Global Securities, is currently the Managing Director of North Wealth Management Company, LLC.  He has allocated his talents to the institutional investment services arena for over 15 years.  Kevin earned a Bachelor’s Degree in Economics and also holds the following securities registrations: FINRA series 6, 7, 24, 63 & 65 industry certifications and is licensed by the California Department of Insurance.

Kevin can be contacted at North 1031 Exchange, 4667 MacArthur Boulevard, Suite 220, Newport Beach, CA  92660.  Toll Free:  866-700-1031 or Kevin@north1031.com

The most common mistake that many beginning real estate investors make is that they pay too much for property. Fact is overpaying for property is often cited as the number one reason why so many newcomers fail to make it as profitable real estate investors. That’s because most beginning real estate investors are woefully undercapitalized, and they don’t have the deep pockets that are needed to subsidize their overpriced real estate investments.

For many neophyte investors, paying too much for their first investment property usually proves to be a very costly and fatal mistake, and marks the beginning of the end of their foray into real estate. That’s why it’s imperative that you learn how to accurately estimate the current market value of potential investment properties! As far as I’m concerned, it’s the single most important aspect of the entire real estate investment business!

A Fast $15,000 Profit for Knowing the Value of a Condemned House

I once bought a real estate option on a filthy, neglected, run-down, but structurally sound house in a neighborhood-in-transition in Winter Park, Florida, a suburb of Orlando, that had been condemned for building, safety, health and fire code violations. This place looked like something right out of downtown Baghdad, Iraq! It had what code enforcement inspectors commonly refer to as accumulations of every type of debris, garbage and junk known to mankind! The property’s owner lived in Westerville, Ohio, and wanted the steady stream of threatening letters from the Winter Park Code Enforcement Board to stop.

I had done my homework, and knew the property was worth at least $110,000 after it was cleaned up. I ended up paying $500 for a one-year option to purchase the house for $75,000. It cost me $2000 to have all of the accumulations removed from the property, and the house, driveway and walkways pressure washed. Three weeks later, I sold my real estate option agreement for a $15,000 profit! This never would have happened if I had been clueless about how to estimate property values. Since I had an accurate estimate as to how much the property was worth in its current condition, I was able to negotiate a below market purchase price that was based on the property’s filthy, neglected, run-down non-marketable condition, and not on how much it might have been worth after it had been cleaned up.

No Kelly Blue Book for Real Estate Investors to Look Up Property Values

Sadly, there’s no Kelly Blue Book equivalent for real estate investors to lookup used property prices in, so you’re going to have to learn for yourself how to estimate the current market value of potential investment properties. However, thanks to computers and the Internet, in most real estate markets it’s not that difficult to get a rough estimate of a property’s current market value. This is especially true for real estate investors located in counties where all property ownership, sale and tax assessment records are available online.

The Definition of Market Value

The Appraisal Foundation’s Uniform Standards of Professional Appraisal Practice, defines market value as: “The most probable price a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the sale price isn’t affected by undue stimulus.”

The Difference Between Assessed Value and Appraised Value

The difference between a property’s tax-assessed value and its appraised value is as follows:

1. Tax Assessed Value: Tax-assessed value is the value established by the local taxing authority for a parcel of land and the improvements placed upon the land for property tax purposes. For example, in Florida, owner-occupied single-family houses are generally assessed at around seventy percent of their fair market value by county property appraisers.

2. Appraised Value: Appraised value is the value estimate given to a property by a licensed property appraiser using accepted appraisal methods for the type of property being appraised. For example, the accepted appraisal method to accurately estimate the fair market value for an owner-occupied single-family house is the comparison sales method where a property’s value is based on the recent sale of comparable properties within the same area.

The Three Common Methods Used to Estimate Property Values

The three most common methods used by property appraisers to estimate property values are the:

1. Comparison Sales Method: The comparison sales method bases a property’s value on the recent sale prices of properties that are within the same area and comparable in size, quality, amenities and features.

2. Income Method: The income method is used to estimate the value of an income producing property based on the net income the property produces.

3. Replacement Cost Method: The replacement cost method is based on what it would cost to replace the improvements on property using similar construction materials and construction methods.

The Comparison Sales Method of Estimating a Property’s Value

The comparison sales method of estimating a property’s value is based on the recent sale prices of properties within the same area that are comparable in size, amenities and features. In order to be accurate, sale price adjustments must be made for comparable properties that have been sold at unrealistically low prices or on overly favorable financial terms not readily available to the buying public.

The Income Method of Estimating a Property’s Value

The income method is used to estimate the value of an income producing property based on the net income the property produces. Under the income method value is calculated using a:

1. Capitalization Rate. The capitalization rate, or cap rate, is calculated by dividing a property’s annual net operating income by its purchase price.

2. Gross Rent Multiplier. The gross rent multiplier, or GRM, is calculated by dividing the purchase price by the property’s monthly gross operating income.

Watch Out for Owners Using Fuzzy Math

A word to the wise: when you read a property’s income and expense statement, you should always go under the assumption that the owner is probably practicing fuzzy math by fudging on the numbers, and telling little white lies to back them up. Also, use a monthly income and expense analysis worksheet like the sample copy below, to cross-check everything that’s listed on a property’s income and expense statement in order to reconcile the statement with receipts and tax returns against what’s shown on:

1. Schedule E (Supplemental Income and Loss) of the owner’s latest federal income tax return.

2. The property’s latest annual tax assessment income and expense statement on file at the county property appraiser or assessor’s office.

3. All of the rental agreements for the past year.

4. Water, sewage, solid waste, gas and electric bills for the past year.

5. Repair and capital improvement bills for the past year.

The Replacement Cost Method of Estimating a Property’s Value

The replacement cost method of estimating a property’s value is based on the cost of replacing the improvements on the property minus the cost of the land to estimate a property’s value. Replacement costs are calculated on a per square foot basis by dividing the total number of square feet in the building by the per square foot construction cost. For example, a two thousand square foot convenience store that cost $375,000 to build would have a replacement cost of $187.50 per square foot, $375,000 divided by 2000.

How to Get Free Building Replacement Cost Estimates

You can usually get a free building replacement cost estimate by calling a local independent insurance broker who represents insurers that specialize in providing property and casualty insurance coverage for residential and commercial buildings. When you call a broker, tell them that you want a replacement cost quote. Property replacement costs are calculated by using a replacement cost formula that’s based on the property’s geographical location and its:

1. Street address.

2. Age.

3. Type of construction.

4. Number of stories.

5. Type of roof.

6. Current use.

7. Heating and cooling system.

8. Square footage.

Use the Eight-Step Approach to Estimate a Property’s Current Market Value

Use the following eight-step approach and the current value worksheet on the following page to get a rough estimate of a potential investment property’s current market value:

Step # 1: Log onto your county’s property appraiser or assessor’s Web site to obtain the tax assessed value of the property under consideration.

Step # 2: Search your county’s property tax rolls for recent sales of three to five properties that are comparable in size, amenities and features, and located within two miles of the property under consideration.

Step # 3: Carefully analyze any comparable properties that you find, and make sale price adjustments for differences in amenities, special features and the property’s physical condition.

Step # 4: Verify the income and expenses that are listed on the income and expense statement of the property under consideration.

Step # 5: Analyze the property’s income and expenses for the past twelve months to estimate its net operating income potential.

Step # 6: Calculate the property’s capitalization rate by dividing its potential operating income by the estimated value that you derived from analyzing recent sales of comparable properties in step number three.

Step #7: Estimate the property’s value by multiplying its net operating income by the capitalization rate you came up with for the property.

Step # 8: Calculate the cost of replacing the improvements on the property using the same building materials and method of construction.

ANSWER:  A landlord seeking to pursue an eviction, known as an unlawful detainer, must name and serve every adult known to be living in the rental unit with the unlawful detainer summons and complaint.  An adult such as you who was not named is not subject to the judgment for possession that the landlord apparently obtained against your sister and husband, which in turn generated the writ for the sheriff’s notice.  The only exception is if you were separately served with another paper known as a “prejudgment claim of possession” form which requires you to immediately take certain actions to protect your rights.  However, you are asserting here that you weren’t served with any papers.  To be sure, you should probably go to the office of the clerk of the superior court that issued the judgment and writ to make sure there is no declaration of service listing you as a recipient of these documents.  If there is no claim you were previously served, you can file a post judgment claim of possession in the same superior court, pursuant to California Code of Civil Procedure Section 1174.3.  There is a specific court form for this purpose.  You will be required to pay a court filing fee or else obtain a fee waiver under the “indigency” standards.  Once you file the claim, the sheriff cannot proceed with the physical eviction against you until the court has resolved your status.  A hearing on your claim will be set quickly, although the time will be extended if you also deposit the equivalent of 15 days of rent for the unit.  Without explaining the legal technicalities, we can tell you that the landlord will eventually be entitled to remedy the mistake of failing to name you and to proceed with the eviction.  However, filing the claim may give you some leverage to negotiate a resolution with the landlord either on your own or through your local mediation program, for example to allow you time to vacate or to allow you to become an acknowledged tenant pursuant to a new rental agreement.  You should contact a fair housing agency in your area or call Project Sentinel at 1-888-324-7468 for more information.

Question:  I recently answered an ad for a vacant apartment.  I have a pet Chihuahua so I was only interested in a community with a pet friendly policy.  When we toured the property, the rental agent would only show me available units on the first floor.  When I asked about units on the second and third floor, he told me that pets were only allowed on the first floor.  Isn’t it discriminatory to restrict pets to only one part of a building?

Answer:   Landlords have broad discretion to allow or prohibit pets in a rental complex, including the right to limit tenants with pets to certain units with the overall community.  Landlords can also impose reasonable rules on pet owners including limiting the size or type or number of pets allowed without being in violation of any laws against discrimination.  The answer is different if your pet is a companion, service or support animal prescribed by a treating physician.  A service animal performs a task or tasks for the disabled tenant to help the tenant perform normal living activities.  A companion/support animal provides emotional support for a tenant with a psychological disability. Under the fair housing laws, a companion, service or support animal is not a pet.  A landlord would not be able to limit the location of a companion, service or support animal to certain units in the complex, such as the first floor.  If a potential tenant meets the applicant financial screening criteria, the landlord must allow the companion, service or support animal as a reasonable accommodation to the tenant’s disability, if the tenant makes a written reasonable accommodation request. The formal written reasonable accommodation request should be accompanied by a support letter from a treating physician.  The treating physician does not have to disclose the actual disability, but must certify that he/she is a physician,  is treating the tenant for an eligible disability, and that part of that treatment plan includes the services of either a companion, service or support animal.  Landlords cannot charge a pet deposit for the companion, service or support animal but can impose reasonable rules to assure proper supervision of the animal’s activities.  Please contact Project Sentinel for assistance in writing a formal reasonable accommodation request at 1(888) FAIRHOUSING.

Rent Watch is provided by Project Sentinel Questions may be sent to Rent Watch, 1055 Sunnyvale-Saratoga Road #3, Sunnyvale, CA 94087. Copyright © 2002, Project Sentinel. All rights reserved.

If a property owner has a growing number of properties, it’s inevitable that a day will come when they ask, “Should I outsource the day-to-day operations of my business to a property management company?”

Deciding when to outsource and which company to hire is one of the most important business decisions a property owner can make. Choose wisely, and an owner will be rewarded with the peace of mind that comes with responsible property management. Choose incorrectly, and an owner will be working harder after hiring a property management company.

Whether an owner has one or one hundred properties, it’s important to consider whether or not they’re prepared to hire a property management company. Handing over the management of property is a major decision. Before making that choice, owners will want to make sure they understand the following:

• The implications of self-owned management;
• The pros of outsourcing management to a third party;
• The corresponding cons; and,
• The alternatives to outsourcing.

Let’s take a look at each consideration in detail.

What’s Involved in Effective Owner Management?
Owning and managing property require two different skill sets. Unfortunately, many property owners purchase property not knowing the full responsibility that management entails. Before a person jumps into purchasing rental properties, they’ll need to understand what is going to be required of them.

• Knowledge of landlord/tenant law. Familiarity with the state laws that govern the landlord/tenant relationship is a must for any property owner. If owners aren’t comfortable with their level of knowledge or experience in this area, they could be leaving themselves open to lawsuits and fines. For example, the federal Lead-Based Paint Hazard Reduction Act requires the disclosure of lead-based paint and hazards before the lease of most units built before 1978. Owners can face a $10,000 fine if they fail to do so. Airtight contracts and leases are also extremely important for protecting owners from lawsuits and recouping lost costs.
• Time and expense spent visiting properties. Rental properties are going to require regular visits to check on the condition of the property, perform emergency maintenance or show vacant units. If owners’ properties are far away from home or each other, they will spend a lot of time in transit. If owners attempt to self-manage too many properties, they run the risk of spending all their time performing routine visits instead of managing the company.
• Responsibility for repairs and maintenance. A landlord needs to have a diverse range of skills to perform maintenance themselves. At the very least, a landlord needs to have basic plumbing, electrical, carpentry and landscaping skills to properly maintain a property. If they’re not well-versed in these areas, they’ll be spending revenue on repair services. While family members and friends can be labor outlets, relying on such help comes with inherent risks.
• Effective tenant screening. An owner will quickly need to become good at weeding out problem tenants during the screening process. If an owner only has a few units and has to replace a problem tenant a few times a year, their profit is likely going to drop dramatically. Credit checks, employment verification and collecting references are key in this process.
• Ability to deal with difficult tenants. Even if landlords screen tenants thoroughly, they will inevitably interact with unhappy or unruly tenants. Whether the tenant is simply unhappy or in violation of rules and facing eviction, a landlord needs to stand firm in the face of adversity and enforce the rules of the lease. If they’re not able to confront people, a property owner risks being taken advantage of by tenants. In the most extreme cases, landlords may even need to rely on lawyers or courts to settle issues and pay hefty fees.
• Good property management software. If an owner is managing a decent number of units, they’ll want to invest in software to manage their properties. Investing in a robust property management system has the ability to increase efficiency by:

o Accepting rental payments online;

o Performing credit and criminal background checks;

o Decreasing advertising costs by automatically posting units to popular listing sites;

o Automatically reminding tenants to pay their rent;

o Eliminating poor record keeping by automating certain processes; and

o Creating letters and tax forms automatically from pre-existing data.

A solid property management system can be a good tool to have, especially for a novice property owner.

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Seems like every time I turn around, there is another state or federal program threatening to fine me into poverty in the event I don’t comply with some new requirement.  The most recent seems to be this EPA rule regarding renovation repair and painting.  I’m an owner of a fourplex, built in 1968, what does a guy like me have to do to stay solvent and out of jail?

ANSWER

The latest iteration of the EPA’s 2008 implementation of the Lead Safe Practices legislation requires that after April 22, 2010, property owners who renovate, repair or prepare surfaces for paining in pre-1978 housing or space rented by child care facilities must be certified and follow lead safe work practices required by the EPA’s Renovation, Repair and Remodeling rule.  There is a form involved, training, and of course a fee, and yes penalties for non compliance are severe.   Not all housing built prior to 1978 contain lead, in fact only 24% of homes built between 1960 and 1978 contain lead, 69% of homes built between 1940 and 1960, and 87% of homes built prior to 1940.  The lead safe maintenance practices are required unless your property has been tested and certified to be lead free.  For many owners, it may be less burdensome and more cost effective to hire a certified inspector or risk assessor to determine if the property has lead or lead hazards.   After April 22, 2010 ensure that your contractors are certified in lead safe practices, and follow the lead safe procedures.  Expect to pay a little more for prep, performance of any repairs, and clean up.  As any disturbance of six square feet of interior space, twenty feet of exterior space, will invoke the practices requirements, it will be an issue that all owners and contractors must be very familiar with.  You can get complete information at  www.epa.gov/lead/pubs/renovation.

QUESTION
One of my residents is taking advantage of me.  Lately he’s been deducting a portion of his rent because he claims to have fixed things in the apartment, and he thinks I should reimburse him for his efforts.   I just saw his most recent rent check and it’s $118 short.  Seems like he had to replace all of the faucet washers because one was apparently leaking and he doesn’t want to waste water.  Not only did he charge me for the three washers, but he thinks he’s worth $85 an hour for his time.  Had he told me, or my handyman, the problem could have been easily corrected in about twenty minutes.   This is the third time he’s done it this year. Can he do this?
ANSWER
No.  Your tenant is abusing a remedy that is provided to residential tenants in California.  Under certain extreme circumstances, a tenant may make repairs and deduct those out of pocket expenses from his rent.  The defect must be a serious dilapidation that renders the rental unit uninhabitable, and the tenant must provide the landlord notice of the dilapidation and a reasonable opportunity for the landlord to fix the problem.  Generally thirty days is deemed a reasonable time, but some defects, such as a defective heater in winter, will require the landlord to respond quicker.   If the defect is serious, and the landlord fails to correct it, the tenant may then “repair and deduct” the cost of repairs from the next rental installment.  This remedy may only be invoked twice in any twelve-month period and may not exceed the monthly rent.  Your tenant would not be entitled to deduct his costs for replacing the faucet washers under the repair and deduct theory because the defect isn’t a serious dilapidation and he failed to give you prior notice.  As such, the resident is in default and you could serve him with a three-day notice to pay rent or move out for the amount improperly deducted.

QUESTION
I’ve been on the receiving end of several small claims actions recently claiming that I withheld more of the security deposit than I was rightfully entitled.  After going to trial on a couple, it seems like there isn’t really one correct way to do it, seems like each judge that heard my cases had a different opinion as to how much I could rightfully deduct for certain items.  Can you give me some guidance that will keep me “out of court?”
ANSWER
Disposition of security deposits upon move out is one of the most litigated issues in civil court.  It is important that you understand what may rightfully be deducted from the deposit and what may not.  Civil Code Section 1950.5 provides that a landlord may deduct unpaid rent, cleaning and necessary repair charges in excess of “ordinary wear and tear.”  But the code does not adequately define “ordinary wear and tear,” which is the reason for the differing opinions from different judges.  There are certain guidelines that most courts follow.  Most courts agree that paint should last three years, and carpet should last seven.  Any damage that is tenant caused that shortens these expected life spans would be chargeable to the tenant.  Scratches, holes, or unauthorized painting of the walls would also be recoverable.  Ordinary wear and tear following a one year tenancy would normally include a couple of picture nail holes in primary walls, vacuum scrapes along certain baseboards, minor dust build up in out of the way areas, and minor traffic wear in the carpet.  These would generally not be allowable as deductions.  But ordinary wear and tear would not include repair or removal of numerous lag or anchor bolts, grease spots or stains in the carpets, or scratches or holes in the walls.  An accurate move-in and move out checklist plus pictures will definitely improve your chances of prevailing in court.  If you are claiming carpet replacement, cut out and save a sample of the damaged carpet as evidence at trial.   Remember, if you are deducting more than $125 for damage and cleaning, you must include copies of your receipts and each receipt must state the name address and telephone number of the vendor who provided the service.

QUESTION
I’m getting conflicting advice about whether or not I must rent to some one that does not have a valid social security number, nor an official picture ID.  Seems like all the Fair Housing guys say I ‘cannot discriminate’ and that I must rent to all, regardless of whether or not the prospect can prove who he is, or verify his tenancy history, or his ability to pay the rent.  I have been following that advice for years, and now have a building full of undocumented people, that I could never find in a million years if I ever had to collect from them.  I want to take my building back, and only rent to persons that qualify, that have verifiable identities and credit, and are good credit risks.  What are my rights?
ANSWER
Our industry has passively allowed this erosion to occur over many years.  Many landlords have looked the other way, in favor of the quick rental, the cash payments, the full building, the reduced confrontation, we’ve taken the easy way out.  Landlords have been wary of lawsuits claiming discrimination, and have believed the bullying taunts and threats from the tenant and immigrant rights activists, that we have just taken the easier and less confrontational course of allowing it to happen.  We blame our government for not addressing the illegal immigration issue; republicans, conservatives and business want cheap labor; while democrats, and  liberals want cheap votes.  We blame employers for hiring, and our ‘welfare state’ for creating the magnet that keeps drawing.  Landlords are part of the problem as well. By succumbing to the short term temptation of the quick rental to the unverified, the undocumented, we are contributing to the problem.  Many landlords are realizing that rather than just complaining, they can be a part of the solution.  Landlords have absolutely no obligation whatsoever to rent to an individual who is unable to independently verify his identity, his past tenant history, and his ability to comply with the terms of the rental agreement, including his financial ability to pay the rent.  Our system of society is built around a numeric social security or tax identification number.  Our life history, good and bad, is reported more often than not, into a data base that is organized by, and sorted by the social security or a tax identification number.

QUESTION: Can you remind me of my obligations regarding renting to a prospective tenant that is also a registered sex offender?
ANSWER
Your tenant screening criteria should be applied consistently to all applicants.  In general your screening criteria should review and verify 1) the prospect’s financial ability to honor their tenancy obligations, 2) that the prospect has a positive prior tenancy and credit history, 3)  that the prospect has not been evicted previously, and 4) that the prospect will not place other persons, or the owner’s property, at risk of harm.  When evaluating a prospect with a criminal history, determine the nature and extent of the conviction, by requesting an explanation from the prospect, or by requesting a criminal data base report.  A conviction for a violent crime against a person or property is a serious offense that would enable an owner to decline a prospect.   An applicant who falsifies the application by stating that he was not convicted, when he actually was, can be declined for providing false information on the application, provided all applicants who falsify information are treated the same.  In this age of violent criminals in our midst, and astronomically high recidivism rates, it is more important than ever that we know who our residents are, and keep the ne‘er do wells out of our communities.

The foregoing is intended to provide general information, not specific legal advice.  You should direct specific inquiries to your attorney.  Stephen C. Duringer, Esq. is an attorney specializing in landlord tenant law, evictions, judgment enforcement, and asset preservation planning.  His firm, the Duringer Law Group, PLC, with offices in Anaheim Hills and Lake Arrowhead, is one of California’s largest and most successful landlord tenant law firms, representing landlords exclusively throughout Southern California.  The firm may be reached at 714.279.1100 or 800.829.6994 or 877.387.4643.  Visit www.DuringerLaw.com for more information.

The Chilean earthquake was 550 times more powerful than the Haiti earthquake, yet there was more property damage to buildings from the Haiti earthquake, not to mention so much more human loss. The Haitian earthquake was a shallower earthquake, 8.1 miles deep as opposed to about 21.7 miles for the Chilean earthquake. Haiti’s quake was only 13.7 miles from its Port Au Prince capital, compared to the Chile earthquake, which was 200 miles from its Santiago capital. Perhaps the biggest factor though in explaining the difference in resulting devastation is that Chile’s building codes are much stricter than Haiti’s. Chile has a long history of earthquakes including the world’s largest recorded earthquake of 9.5, which occurred in 1960, so Chile knows all about earthquakes and how to prepare for them.

Worldwide, there are nearly two earthquakes each day that are strong enough to cause property damage, death and injury. Fortunately, most of these earthquakes occur in unpopulated areas.

On April 18, 2008, these words from the U.S.G.S. newsroom rattled more than a few nerves closer to home:

California has more than a 99% chance of having a magnitude 6.7 or larger earthquake within the next 30 years, according to scientists using a new model to determine the probability of big quakes.

The likelihood of a major quake of magnitude 7.5 or greater in the next 30 years is 46%-and such a quake is most likely to occur in the southern half of the state.

That alone was enough to jolt many owners into checking for earthquake insurance rates.

But the companies that rate insurance companies, notably A.M. Best, Inc., have become much more stringent and conservative in their rating methods, following the 2008 financial meltdown. In order to avoid having their financial ratings downgraded, insurance companies offering catastrophe coverage are now under more pressure to either purchase more reinsurance to bolster protection for their existing portfolios, or restrict the amount of coverage they can offer. Some carriers have even withdrawn from the market.

The trend in earthquake coverage in California is toward ever increasing prices and less availability. For example, in 2008, the pure premium for a policy I placed for two six-unit apartment buildings was $5,050. In 2009, for the same coverage, the premium jumped to $7,460, a 47% increase. Prices in 2010 are higher, not lower. The volatility of commercial earthquake insurance quotes is such that quoted rates are only offered for five days.

There are several factors that affect earthquake insurance rates:

Insured Value-The price of insurance is directly proportional to the amount of coverage purchased.

Year Built-Due to stronger earthquake codes in more recent years, carriers charge less for newer buildings than buildings constructed prior to 1976.

Location-There are several major territorial earthquake zones that insurance companies use to determine their starting rates. Properties that are located close to a major fault are charged higher premiums than those areas located further from seismic zones. Geological characteristics are also taken into consideration, such as whether the location has a high water table is built on loose soil, or is built on bedrock.

Construction Type-While concrete and brick buildings are saints in a hurricane, they are much more expensive to insure against earthquake. Frame buildings generally cost less to insure and replace than their less flexible counterparts.

Height-The taller a building stands, the higher the rate will be. There is more stress created on taller structures.

Parking-If a building has tuck-under parking, it will be difficult or costly to obtain earthquake coverage. Tuck-under parking is reputed to have caused the Northridge Meadows apartments to collapse during the 1994 Northridge earthquake. Subterranean parking may also increase cost or restrict the ability to purchase coverage. If there is soft first floor parking, where there is a substantial open area in the perimeter walls, this is also viewed as an additional hazard by carriers.

Purchasing too little coverage can result in your policy becoming revalued from replacement cost to “actual cash value,” following a claim. This means that depreciation would be deducted away from your claim. But on the other side, overinsuring is not only expensive, but packs a second punch of significantly increasing the deductible that you pay. Unlike fire insurance which has set deductible amounts, an earthquake insurance policy uses a percentage of the policy amount as a deductible. Buy the lowest deductible you can.

If you have an older building and can provide proof of retrofitting to current building codes, you may be able to save money on premiums and more importantly, qualify for coverage in an ever tightening marketplace.

It is important to consider business income coverage if the carrier offers it. A building that has been condemned by the authorities following a major earthquake is not producing any income but still produces lots of expenses!

Building ordinance coverage is also very important. With ordinance coverage, you avoid arguments with the carrier if your building is only partially damaged but you become obligated to demolish the remaining structure. This coverage also assures that you will be adequately reimbursed for the cost of replacement upgrades that meet current codes.

If you are inclined toward purchasing earthquake coverage, now is the time to act. Waiting will not only cost you more — it may even prevent you from finding available coverage.

About the author
Eric Paulos is a Certified Insurance Counselor, apartment owner advocate, licensed California insurance agent, author and speaker. Eric Paulos Insurance Services caters exclusively to the apartment owner community, offering insurance and risk management services. Contact phone: 800-974-6787 Fax: 800-959-9603, Email: eric@apartmentins.com. Visit www.apartmentins.com for 24 hour a day, 7 day a week online quotes. Download free money-saving articles and reports. Apartment Management readers are also invited to log on for a free subscription to Eric Paulos Insurance Services’ monthly apartment insurance tips & bulletins.

Instigated by the slowing economy, and aggravated by some high-profile corporate bankruptcies (think Circuit City and Mervyn’s), retail centers are seeing dramatically higher than normal vacancy levels today.

Since commercial properties are valued based on the amount of money they generate, a GOOD property with temporarily low occupancy could represent a bargain purchase.  Lower prices today provide an opportunity for investors.  The business plan is simple here – buy when income (and value) is lower, and sell when it’s higher for a profit.

Why is GOOD emphasized in that paragraph?

That word is emphasized because it is a crucial point.  Missing that point could be the difference between a successful investment and a big loser.  A good property may have lower occupancy due to today’s slow economy.  A bad property has lower occupancy because it’s a bad property.

Good retail properties are located in growing areas populated by residents with disposable income.  These properties are well-maintained and have ample parking with good street visibility and easy access.  Such properties are in submarkets with lower vacancy rates, and significant barriers to entry.  A lower vacancy rate and higher barriers to entry mean less competition among landlords for tenants.

While a good shopping center may have all of the above characteristics, a bad center only needs one or two of the following drawbacks:
The site could be in a place (think Detroit) where population and/or disposable income is shrinking faster than normal.  The building may be in physically poor condition, or may suffer from functional obsolescence.  This term describes buildings that no longer, (or never did in the first place), have features that your target tenants desire.  An extreme example is a structure without an air-conditioning system, (they do still exist out there.)  More subtle are properties that lack adequate parking or ADA compliance.  The site could have environmental issues, such as soil contamination, or the building could just be too small for today’s users.  For example; the larger grocery stores of the 1930’s put smaller grocers out of business, but a modern supermarket needs to be 5 times larger.

An example of a building that never appealed to tenants in the first place is a two-story retail strip center.  Such properties are not often very successful in the United States, due to decreased visibility and impaired access.  One exception seems to be predominantly Asian neighborhoods.  These centers are thriving in cities such as Monterey Park and Rowland Heights.  That two-story strip center may have a vacant floor on top because nobody will ever want it.  Buy multi-story strip centers outside these areas at your own peril.

How I Prefer to Invest in Retail Centers
A good grocery-anchored retail center here in California could cost $15 million or more.  Even for wealthier investors, such a purchase could represent a substantial portion of their net worth.  I prefer to invest using various partial-interest options available in the market.  Using such offerings can allow an investor to create income and appreciation potential without putting $8 million down.  An investor can use such an offering to buy an interest in a single property, or one in a portfolio of retail centers.  The second option allows him to spread his risk among many assets, rather than put “all his eggs in one basket.”

If buying retail centers sounds interesting to you, then perhaps it is worth learning more about.

Securities are offered through Private Asset Group, Inc.  Member FINRA/SIPC. 3070 Bristol St. Suite 500, Costa Mesa, CA 92626. 714-545-5002. Specialized Wealth Management and Private Asset Group are not affiliated.  This document does not constitute an offer to sell, nor is a solicitation of an offer to purchase securities.  Any such offer shall be made solely pursuant to a Private Placement Memorandum.  All investments have MATERIAL RISKS. Past performance is never an assurance of future results.  Investors must read the SPONSOR’S Memorandum paying particular attention to the section on RISK FACTORS before they invest and for further disclosures about terms, risks, etc. Please consult a qualified tax advisor for specific tax issues.

Christopher Miller is a Managing Director with Specialized Wealth Management in Tustin, California and specializes in tax-advantaged investments including 1031 replacement properties.  Chris’ real estate experience includes work in commercial appraisal, in institutional acquisitions for a national real estate syndicator, and as an advisor helping clients through over two hundred 1031 exchanges. Chris has been featured as an expert in several industry publications, and on television, and earned an MBA emphasizing Real Estate Finance from the University of Southern California. Call him toll-free at (877) 313 – 1868