Category — McMurdie's Real Estate Rules

HOW TO BUY FORECLOSURES and REOs/bank owned property is a hot topic today. Dozens of online websites offer, for a charge or monthly fee, foreclosure buying systems, foreclosure tracking systems, and foreclosure information.  I have purchased at trustee sales both residential and commercial properties for myself and clients. I can write with some authority on this subject for California buyers.

Newcomers to foreclosure buying and online information must be reminded this process is governed by California law. Foreclosure systems, procedures, or laws in other states now found online are not applicable in California.

This is a series of articles, Part I is buying bank owned property, real estate owned by a lender following a trustee’s sale foreclosure. Parts II-V will cover specific details of equity purchase agreements buying out the seller-in-foreclosure, tracking Notices of Default and Notice of Trustee Sale, investigation of property pending trustee sale, preparing for and bidding at the trustee sale, and post sale problem areas. [Read more →]

A SALE & LEASEBACK to a relative is the number one way to prevent foreclosure. Also known as a friendly sale, this technique allows a homeowner to give up only tax benefits until the market brings prices not only back, but higher. For details on how this technique works email Real Estate Blocks.

McMurdie’s Real Estate Rule No. 48: hold real estate through busts as the market will not only come back, but go higher. The preceding Rule is No. 47: real estate recessions can always be seen coming, sell all properties you cannot hold for at least three years of bust.

REAL ESTATE IN OUR URBANIZED post-industrial economy has become a complex subject often analyzed by highly educated real estate professionals.  But the basics of real estate are often overlooked leading to poor real estate decisions and bad advice. 

McMurdie’s Real Estate Rules are a fun tongue-in-cheek way of pointing out the logical basics of real estate.  The “Rules” are a humorous way of stating these basic principles for real estate owners and professionals.  The “Rules” are also easy to remember.

McMurdie’s Real Estate Rule No. 1:  land is worth what it produces. 

Reasoning.  What confusion revolves around this simple principle!  What is land that produces only rattle snakes worth?  Rattle snakes are not valuable.  Land producing rattle snakes today runs about $150 an acre.  Cheap.

Shelter is valuable.  Land has alternative uses.  Land can grow trees, wheet, cows, oil,  shelter, work space, parks, and freeways.  If land has a man made structure,  it is ”improved”.  A home on land for instance is a structural ”improvement”, as are the related streets, curbs, gutters, and utilities making the land more valuable as shelter.

The highest and best use of land, an appraisal term, describes maximum value of land and improvements.  Highest and best use is a basic real estate principle.  How much is an apple orchard worth?  Whatever the capitalized income value of the apple crop is worth at given time.  If the apple orchard is surrounded by industrial buildings then the land, converted to industrial building space, would be worth more.  But only if its use is converted.

For each use of land there is a corresponding range of values.  The lowest value is the immediate capitalized income value of its present use.  This is the immediate cash the land will produce.  The value of the apple orchard is the value of the crop of apples.  The future value of the apple orchard is its capitalized value.  Historically, people will pay approximately 3-10X the annual income of the land in cash for this future income value.  A buyer would get back the total cost of the land in income within 3 years.

For example, today real estate owners and professionals ask “What is the bottom of the housing market?”  Dumb question.  In a given area people need and pay for shelter.  If an owner is foreclosed out of their residential estate then bottom line they rent shelter.  For all “Yeh, but” fans, yes, people can move elsewhere and then shelter is worthless.  Generally they don’t. 

The lowest value for home shelter is its fair rental value.  This is the income value.  The “estate” price of home shelter may exceed its income value, but historically by not more than 20%.  When home prices rise to 50% or more over the rental income value then the ecomomic basic of the worth of land producing shelter is no longer economically sound.  The price to rent ratio is too low.

When a buyer can rent shelter for $2000 a month, and a mortgage payment for the same shelter is $4000 per month, renting is the optimum buyer decision.  Simple.  “Short selling” a home is well named.  Renting is cheaper than owning today.  Land is worth what it produces. 

How To Use Real Estate Rules.  McMurdie’s Real Estate Rules are fun simplifications of real estate basics.  The reason they’re called ”rules” is there are no actual real estate hard and fast rules at all!  Ha!  They’re reminders of basic principles.  There are, however, some basic principles of real estate economics, sales, law, construction, finance, and management that are useful.  The “Rules” restate these basic principles.

I have 30+ years experience and seven years of formal education in real estate.  Sometimes I like to have fun with the basics because people forget!  There are over 150 Real Estate Rules!  Over the next two months all 150 Rules will appear.  Be a real estate guru!  Learn all of McMurdie’s 150 Real Estate Rules!

McMurdie’s Real Estate Rule No. 2: there are exceptions to every rule!

A PROPERTY’S PRICE to rent ratio establishes its lowest market value. This month’s issue of Forbes (unavailable online) has an excellent article on this vital real estate fundamental. Both Realtors, buyers, and sellers want to know “how low can the market go?” McMurdie’s Real Estate Rule No. 78: the lowest value for any property is determined by what income it produces. Tract homes produce shelter, rent. Income value establishes the lowest price. Comparable sale value is the highest price.

How low can the residential market go? Down to the rental value.

If the list price of a home is $650,000, and its rental value is $2100, you don’t need a calculator to know rents will not cover expenses and mortgage payments.

Historically investors buy homes when cash flow from a rental, after tax deductions, is zero. No net after tax cash loss. This is simply because rental rates go up after a couple of years producing first tax benefits, and then actual cash income.

Traditional fix and hold investors have been out of the market for several years. The price/rental ratio has been to low.

Fix and flip has never traditionally worked. Fix and flip depends on double digit appreciation.

Fix and Hold investors improve on rental income returns by buying fixers, fixing to increase rents right away; getting tax benefits from repair deductions, and then obtaining net after tax income from the purchase the first year! Price appreciation is a secondary benefit.

Investors are in the market now, including Silicon Valley, but the price to rent ratio will need to go up before investors jump into buying rentals. Rental rates are going up. This will help. But here in Silicon Valley prices will need to decrease by 20% or more before knowledgable investors buy rentals.

My guess is that by Fall 2008 prices will be 20% lower, provided mortgage interest rates remain low, investors will then buy and flatten out the current Bear Market.

Remember McMurdie’s Real Estate Rule No. 126: Bears always come out and clean up the income bargains in the market.