Interest Rates

The sensible person buys when interest rates are coming down. You cant do that at the moment because they are already as low as they have ever been. The next move has to be up. You never buy when interest rates are rising.

If you dont understand why I will explain.

The most important point about house prices is not the sale price but the cost. They are different. If a house price is £100,000, and you need an 80% mortgage, you are borrowing £80,000. The most important calculation you can do is to work out if you can afford the mortgage payments.

If interest rates are at 1%, and your bank is charging you 2% over base, then you will be paying 3% interest on the money borrowed. That works out to £2,400 a year. Add that to the repayment figure of the mortgage and that is your annual cost. If the mortgage is a repayment loan over twenty years you are going to have to pay £2,400 plus £4,000 every year to service and repay the loan. Total: £6,400.

If interest rates rise by 2% your total repayments for a year will be £8,000. That’s a heck of a difference. The crucial question is: how much can you afford? If interest rates go up you can afford less and therefore will not be able to chase up house prices.

Now look at the current situation. If interest rates in the UK are 0.5% your mortgage payments are piddling. No problem. Great news. But what happens when they rise? You get squeezed into default. There is a way round that. I’m sure you can work it out. If you cant you shouldn’t be in this business, but for those who are just starting out, here is the simple way to deal with the possibility of rising interest rates.

You take out a short term mortgage, say 15 years. If interest rates go up to a level you cant cope with, then you go to your broker and arrange for the loan to be adjusted over a longer term.

So, how about things right now? I have news for you. Interest rates will rise. They have to. Just look at the charts. I have them back to 1200. Is that far enough back for you? Look and enjoy.

Rates between 3% and 7% appear to be the norm. We will assuredly return to the norm sooner rather than later. Can you afford those rates? If not, you are heading for wipe-out.

That’s why the professional always buys when rates are high but coming down. Life gets easier that way. Buying when rates are low means things can only get harder. Which do you prefer?

The interesting thing is that when interest rates are high house prices tend to be low. This means if you start to buy as the rates come down you get two benefits; an increasing return on your investment as your mortgage gets cheaper, and so your expenses come down and therefore your profit goes up; and as interest rates come down houses generally become more affordable so people start to buy, and prices start to rise, so you clock up some capital gains as well.

Interest rates are geared to the rates the central government has to pay to borrow. It is interesting to watch the cost of government borrowing. If the government does not need to borrow then generally speaking rates can stay low. That is not always the case. Interest rates may have to remain high for other reasons, but I dont want to get too technical here. All we need to know is what is driving the rates at the moment, and how things are likely to pan out in the future.

We have recently seen what happens in Greece. They run out of money, so they have to borrow. Investors dont want to lend to a bad risk. They will continue to do so, but only if the return is attractive enough. That return is the interest rate. It goes up when times are tough. Greece’s borrowing costs went rapidly from about 3% to 23%. That would normally reflect in the rates governing all borrowing within that currency. However, Greece got bailed out by Germany and the IMF. All is well for the moment, but for how long?

What about the UK? The government’s borrowing requirement is very high. If there is a whiff of fear that the government wont be able to repay its borrowing, then interest rates will rise, and, as we saw with Greece, they can rise sbstantially very quickly.

One of the things we have to watch for is the probity of the government of the country we are invested in. That puts the USA right out of court. The currency will survive as long as it is the currency of last resort. That situation is likely to change drastically sometime during the next ten years. However, maybe the euro will implode first. Who knows? But one thing is certain, there are two ways governments can deal with their problems. I am ignoring the proper solution, which governments never take, and that is, to cut their expenses and run a tight economic ship.

The two popular alternatives are: print money and pay debts with that; or encourage inflation which reduces the value of the debt. Usually, the first alternative encourages the second in any case. (Strictly speaking, an increase in the money supply is the definition of inflation. There can be a delay in that supply feeding through to the market, and that is what is happening at the moment.) Controlling the level of subsequent price rises under these circumstances is well nigh impossible.

Have a look at what happened during the last cycle of interest rate rises:

Interest rates up to 15%. Excuse me, but that is financial suicide.

You have been warned.

Cheap Villas

Cheap Villas for sale in the Algarve

I know I have taken longer than expected but we are ready to go.

We already own a building site in a quaint Algarvean village just three miles from the sea. We have been offered an old manor house with some parkland just a little further down the road which we will be developing next. We have done a deal with another guy who owns land alongside a golf course on an island in Indonesia. And we have done another deal with a guy who owns hundreds of hectares of land between two rivers, and bounded by a fabulous white sands beach in North-Eastern Brazil.

We are going to build our ultra modern villas on these plots of land, and they will be available for sale at silly prices.

The cheapest of the villas will be a two bed detached home, built from modern eco-friendly materials, and will be for sale for £50,000. You wont find anything as cheap and as good as this anywhere else on the planet.

If you want details, get back to me. I shall be making regular posts on this blog to keep you up-to-date on how things are going. Stay tuned.

Sell America

The US mortgage farce

I have been warning people to stay away from the US property market since 2005, and I suggested getting out of it during 2006. My views have not changed. In fact, the US market is shaping up for one heck of a mess.

We all know that a few years ago a few bright sparks decided they had discovered a great way to spread risk in the real estate and insurance markets. It all revolved around the highly dubious practice of selling mortgages in bundles of investment packages to pension funds. It was considered to be such a great wheeze that the lunatics who thought up the idea were given Nobel prizes.

The banks were going to sell on the mortgages so they weren’t really interested in whether the houses were worth what they sold for. They weren’t interested in whether the buyers could pay. All they were interested in was the commission fee for selling on the investment bundle.

Houses were built, buyers came along, mortgages were granted, the mortgages were bundled up and sold on to pension funds. Then came the housing crash.

Now the fun begins. Houses are now worth considerably less than the buyers paid for them. This means the investment bundle isn’t worth what it was sold for. That means the pension fund is sitting on a duff asset which is still depreciating. That means that people who have invested part of their income into that pension fund are looking at a lower return, and therefore a smaller pension. So much for risk being spread. That’s how it was spread. All over the planet. It was spread away from the issuing bank, which ought to have shoulder any risk, and onto ordinary people’s pension provisions, and those folks are now having to pay for the banks’ recklessness.

The banks did not do due diligence. The rating agencies gave the investments AAA credit ratings, and there was a whole lot of mis-selling.

As the houses are now worth less than the money owing on them there is no incentive for the buyers to carry on paying the mortgage. It is estimated that about 25% of all these under-water mortgages are in default, very often a strategic default. That means that although the buyer could pay the mortgage he sees no point in doing so, and just stops paying, thus living rent free in his nice new home.

This means not only is the underlying value of the investment asset going down, but the return on that investment has ceased, and the likelihood of the money ever being paid back has just taken a dive.

Generally, this should mean the bank forecloses on the non-performing loan. But hold on. The bank sold on the mortgage as part of an investment package. Which package was that particular mortgage a part of? Can it be untangled from the investment unit that was sold on? Very often the answer is ‘no’ or ‘dont know’.

So, now what? The bank may not be the right entity to foreclose as it has sold on its rights with that investment package. So who is going to foreclose?

A buyer who wants to stop paying his mortgage and stay in the house now looks to be in a very strong position.

That’s bad news for the banks, because the banks lent out the money and now they have another non-performing loan on their books. It’s bad news for the pension funds who bought the investment package. They now have only a remote chance of getting their money back. And it’s also bad news for rather a lot of pensioners who thought their pensions were safe.

This also means that we now have two more problems with US real estate. The first is, we have a locked-up market. These non-performing mortgages have put the sale of these properties out of the question for some time until someone can sort out who is entitled to do what. They have also put in doubt the legality of the sale of previously foreclosed homes. Did you buy one? If so I hope you took out title insurance. Even if you did, I seriously wonder when all the dust has settled whether the insurers will still be standing.

Apparently the banks hired people who knew nothing about the business to deal with the massive backlog of foreclosures. Many of these people were barely literate and now admit they didn’t know what a mortgage was, or what an affidavit was, and so on. This means the depositions that were the basis of the foreclosures are fraudulent.

In any case, how do you foreclose on a home when you can’t figure out who owns it because the original mortgage is part of a derivatives package that has been sliced and diced so many ways and then sold on that its legal ownership is often unrecognizable? Apparently no less than 65 million homes in question are tied to a computerized program called the national Mortgage Electronic Registration Systems (MERS), and that is often identified in foreclosure proceedings as the owner.

Wait a minute….. the computer program owns the house? I beg your pardon? Heck, I couldn’t make this up, could I?

Adam Levitin, a Georgetown University Law professor who specializes in mortgage finance and financial regulatory issues, was recently quoted on CNBC as saying….
The mortgage is still owed, but there’s going to be a problem figuring out who actually holds the mortgage, and they would be the ones bringing the foreclosure. You have a trust that has been getting payments from borrowers for years that it has no right to receive. So you might see borrowers suing the trusts saying give me my money back, you’re stealing my money. You’re going to then have trusts that don’t have any assets that have been issuing securities that say they’re backed by a whole bunch of assets, and you’re going to have investors suing the trustees for failing to inspect the collateral files, which the trustees say they’re going to do, and you’re going to have trustees suing the securitization sponsors for violating their representations and warrantees about what they were transferring.

Attorney Richard Kessler recently conducted a study in which he found “serious errors” in approximately 75 percent of the court filings related to home repossessions that he examined.

“Defective documentation has created millions of blighted titles that will plague the nation for the next decade.”

See what I mean about buying real estate in foreclosure in the US? See what I mean about having title insurance? See what I mean about the US property market probably being in a total mess for at least the next decade?

This situation leads to one more massive problem. Let me quote John Carney of CNBC:
“The most damaging thing that could happen to banks would be the discovery that they simply cannot prove they hold a mortgage on a house. In that case, the loan would probably have to be written down to near zero. Even for current loans, the regulatory reserve requirements would double as the loan would no longer be a functional mortgage but an ordinary consumer loan. Depending on the size of the “no docs” portion of the loan portfolio, this might be a minor blip or require a bank to raise new capital to fill the hole in the balance sheet.”

This all came from a wonderful theory about how to spread risk for which the inventors got nobel prizes. Spreading risk is one thing, but it sounds more like muck spreading to me.

As I have said before: welcome to the upside-down world of the new normal. You’d better learn to live with it. It is going to be here for some time.

Do yourself a favour: dont buy real estate in the US. And dont look at a chart of the US$. The currency is dropping like a brick. It’ll give you nightmares. Short term it’s down about 18%, long term it is down so much it is embarrassing. And god knows how far it will fall if we get QE2.

ROI

ROI


Let’s look at Return on Investment.

The most important calculation you can do is work out what is your return on investment. Let’s say you invest £50,000, and get an income of £7,000. Not good.

Two points here. The first is: what do you want to get as a return? The second is: what could you get elsewhere?

What are you going to use as your control? I look at a safe investment, and look to see how safe that investment would be into the future. At the moment I am invested in green oil which brings me in 13.7%. I could be invested, but have just sold, a bank share bringing me in 17% in dividends. And I have just been offered a guaranteed return of 30% on carbon credits.

I think I would have to say I would not invest in anything else that brought me in less than the lowest return I can safely get elsewhere. Can I get those returns in UK real estate? Yes, but only in an existing investment bought way back in the mid nineties. I cant get it on a new deal.

Sorry, that puts UK real estate out as an investment in one simple move. That was last decade’s deal. That was the old normal. It most certainly isn’t the new normal. Typical returns are about 7% for a lot of hard work and some risk. Not for me.

If I can invest my money into a company that does the work, brings me the dividend, and all I have to do is check that the money comes in on time, why should I hassle with houses and tenants?

But what about capital gain?

Let’s use a stupid, and incorrect piece of evidence. House prices go up on average 7% a year over the long term. That is not correct for several reasons, and I have charts going back to 1760 to prove that it is nonsense. Prices tend to move with inflation, and with bubble cycles. They also move in relation to the availability of finance. They also only move up to a maximum percentage of income. Once that maximum is hit they cant rise any further as there would be no money available to service the loan.

The bad news is that the maximum was hit a couple of years back. Further bad news is that for several years the rise was in excess of 7%, so common sense tells you that to keep to the average, prices must rise much less than that figure for some time to make up for the previous big rises.

Forget the nonsense about smaller families, immigration, shortage of houses etc. Those aspects have no effect whatsoever on house prices, never had and never will. After all, all those aspects didn’t suddenly disappear in 1990 and then suddenly reappear a few years later, did they?

I cover all these points in considerable detail in my book: The Property Investor’s Bible. You can buy it at http://www.property.org.uk/unique/book/index2.html

To realise a capital gain you need to buy low and sell high. Currently we are a little off a major high. You cant buy for capital gain at such a point in the cycle. At these levels prices must come down or stagnate.

Obviously a big factor in your return on investment will be interest rates, so in the next blog I’ll look at them.

…………to be continued

BMV

Things look good for the real estate market. Interest rates are low. You can get an 8% plus return on your investment. There are below market value deals galore all over the place. The banks are beginning to lend again. Prices are higher than they were a year ago. The worst is past. Things can only get better from here on.

Okay, do you actually believe that? Hmmmm….. Let’s pull this thing to pieces and look carefully at all the elements.

I’m going to deal with this in a series of sections.

1 Below Market Value
2 ROI
3 Interest rates
4 Market cycles

1 Below Market Value

Okay, let’s start with that hip phrase Below Market Value. Anyone who falls for this is sadly seduced by the new normal. If you get sucked into this you are, by definition, a sucker.

Let me remind you of the old normal. Market value is what something sells for at the time in the open market. Below market value is a value somewhere below what something sells for. Therefore, if you buy something at a certain value, that is what it sells for and therefore that is its market value. That means if you have fallen for this one you have bought at market value, not below market value. That’s a definition.

No-one who is in business sells something for less than it’s worth unless he knows something you dont. If he is advertising something for less than it’s worth you are being screwed because you are ignorant. You shouldn’t buy into the deal because it is advertised as BMV, instead you should do some essential maths.

Any deal advertised as BMV is so advertised because the seller has a problem shifting units. You shouldn’t buy BMV. You should buy below intrinsic value. If you dont know what that is, you need to go to my site, and buy my book which tells you how to value real estate. (http://www.property.org.uk/unique/book/index2.html)

You will probably also be told that the market value has been set by the bank’s valuer. That means you should be careful. Do you seriously mean to tell me that a valuer paid by a reputable bank (if there is such a thing) will value a property at less than what it is supposed to be worth? That means a bank is setting out to diddle itself by loaning a sum of money on a security that isn’t worth the amount of money loaned. Now, why the heck would a bank do that?

The reason is simple. The bank probably has a loan on the property. The builder/developer cant pay the interest. The bank needs to shift this non-performing loan. It hopes you will come along and get it off the hook. Do you want to do the bank a favour?

What’s that other little phrase the smiling salesman loves? Instant equity. Wonderful stuff isn’t it? Just what you need to build your portfolio. But, have you ever tried taking it down to the supermarket to buy a crate of wine? Instant equity indeed. Try taking it to another mortgage broker. Try looking at it in a year’s time. Try stacking up that price against a whole slew of second hand properties.

If property prices are stagnating or going down then where will your instant equity be next year or the year after? I know it’s the old normal to say this, but you should never buy a falling market. And if the market is rising no-one in their right mind would sell a property below valuation. Instant equity! Bah! There is no such thing. It’s panic-speak to get you to buy in a dodgy market.

Never mind chasing chimeras, work out the maths instead. Can you make money out of this deal? Is the money real or imaginary? Instant equity is imaginary. Cash flowing into your bank account is real.

Maybe the seller claims you can rent out this white elephant. Can you? Have you checked? If it’s in a tourist area the odds are you cant. Try renting out a property in Spain or Portugal or Bulgaria, or….. oh heck, any of the sad old places. You may be lucky, but do you want to build an empire on luck?

You should never buy something because it is listed as BMV, or chase instant equity. What you should do is work out intrinsic value. If you dont know what that is, buy my book, (http://www.property.org.uk/unique/book/index2.html) or take up a business you understand.

BMV. It is ad-speak. It is a concept designed to persuade idiots to part with money. Instant equity. It is ad-speak. It is a concept designed….. come on guys, wise up, use some old fashioned common sense. Buy the new normal at your peril.

………..to be continued

Surreal World-2

Let’s look at the USA. It is still the biggest economy on the planet. It is still a bastion of innovation and development. It still runs the world’s reserve currency. But it’s star is on the wane. It is busy destroying itself. It may take five years, it may take fifty, who knows? One thing is for sure, the future lies elsewhere. One thing is for sure, investing in the USA in any shape or form could well be a big mistake.

Let’s just look at a few salient facts.

The current government deficit has topped $13 trillion. That is a vast sum that can never be repaid. I dont even know how many noughts that needs, but it sure is a hell of a lot. I cant even imagine one trillion, let along 13 of them. Not satisfied with that, the government is thinking of taking on even more.

The Bush administration spent more money than every preceeding administration added together. That’s insane. The current administration has already exceeded that insane amount after only two years in office.

The current economy is running on the equally insane system which requires an expenditure of $2 to create $1.

The combined liabilities of the US government, which includes the future care for the old and infirm, runs to nearly $70 trillion. I’m sorry guys, but all of this has to be untrue. It has to be some silly nightmare story invented by someone with a very black sense of humour. But no, it is true. Ha ha. (Sorry about that hysterical laughter.)

Real unemployment in the US is over 20%. Allowing for under employment would take the figure even higher. The official stats say it is about 9.4%. Ha ha.

Official stats say inflation is on the floor. But then, official inflation does not include basic things like food. Unfortunately, food prices in the US have risen on average about 30% over the past year. Official figures do not include real prices of consumer goods. They are “adjusted” for so-called improvements. Some wonks in a government office somewhere in Maryland are employed to work out what the new improvements would have cost in some pre-cock-up currency value, and to subtract that figure from the real cost, and prove that the item for sale costs less than it would have done some years back if it hadn’t been improved. That new figure then proves there is no inflation.

Come on guys, I couldn’t make up this stuff, could I? And dont ask me if that white rabbit that just went by looking at his watch was real.

Of course, US real estate is still on the way down. The figures dont show the true picture because in no less than 22 states the banks have stopped foreclosures, so the figures dont actually look so bad. Instead the houses are now simply on the zombie list. After all, you cant have monsters about. So let’s hide them under a convenient stone.

Despite all that house prices are still going down.

But the recession is over. Ha ha!

………………to be continued, or read the whole article in my newsletter on the Unique Property Site.

Rutland

I turned off the M1 at Leicester. My daughter lives in the wilds of Norfolk, so I made for the A47. It’s a very pleasant road, not over burdened with traffic. Suddenly I noticed a sign to Oakham. Hold on, isn’t that the county town of Rutland?

I had obviously crossed a county boundary and I was in England’s smallest county. With all my criss-crossing of England over the years I must have missed Rutland. I turned left and drove down a small road, past a large lake, and into the town of Oakham.

It’s a small place with a population of about 10,000. The castle is reduced to earthworks plus the great hall. This dates from 1180—90. The building is attractively ornamented with Romanesque architectural details, including six carvings of musicians. The outer bailey of the castle, still surrounded by low earthworks; it is now a park with a bandstand. Some deep hollows in the park are the remnants of the castle’s dried-up stew ponds (fishponds).

Traditionally, members of royalty and peers of the realm who visited or passed through the town had to pay a forfeit in the form of a horseshoe. This unique custom has been enforced for over 500 years, but nowadays it only happens on special occasions (such as Royal visits), when an outsize ceremonial horseshoe, specially made and decorated, is hung in the great hall of the castle. There are now over 200 of these commemorative shoes on its walls. Not all are dated and some of the earliest (which would doubtless have been ordinary horseshoes given without ceremony by exasperated noblemen) may not have survived. The earliest datable one is an outsize example commemorating a visit by King Edward IV in about 1470. The horseshoes hang upside-down: while this is generally held to be unlucky, in Rutland this was thought to stop the Devil from sitting in the hollow. The upside-down horseshoe motif appears in the county council’s arms, and on the local Ruddles beer labels. Recent horsehoes commemorate visits by HRH The Princess Royal (1999), HRH The Prince of Wales (2003) and HRH Princess Alexandra (2005).

Interestingly we have a beautifully converted chapel for sale in Rutland. Have a look at the Church page on the Unique Property site.

Welcome to the Surreal World-1

Things are not going well in the world. Some folks would have you believe that we are out of recession and that things are slowly getting back to normal. That is not so. The real problem is that we live in a surrealist world run by lunatic governments.

Let us have a look at a few of the problems and the way they are being treated.

The first problem is that the developed countries have run up too much debt. You will note that the American government chose to treat this very serious problem by running up even more debt. It doesn’t take a child of six to work out that that is idiotic in the extreme. However, we have nobel prize winning economists telling us that is the answer.

We have even just had one such strange person claim that going to war and killing lots of people is one way of sorting out the current economic mess (Krugman).

I dont know how one deals with this sort of thing. When supposedly sane intelligent people are lauded because they speak unbelievable claptrap, we have a serious problem.

What people with any grasp of sanity would agree with a peace prize being awarded to someone who is running two wars and is threatening a third?

What is happening here is that we now appear to inhabit a world similar to the one Alice found at the bottom of the rabbit hole. We now have a problem with language, meaning and sanity. If we are to survive we must learn to cope. We must start to use language in the way the folks behind the Iron Curtain had to back in the dark days of the cold war. We must adopt a form of translation so that we can understand the surreal-speak used by our totally mad politicians. In short, we now need to start reading a subtext into any (mis)information we are given.

This is all very distressing. What can I say to a visitor lately arrived from foreign parts? “Welcome to the surreal world”? “Welcome to the rabbit hole”? “How do you like my new home, in a tent in the grounds of the local lunatic asylum”?

I shall try to remain sane. Who knows, if we try hard, maybe we will come through this.

……………………………….to be continued
(or read the complete text on my newsletters page)