As we saw in my previous Investment Property Case Study 2, south Santa Clara County real estate can now be purchased for investment purposes and have a positive cash flow from the income received from rent.  Not only will there be a positive cash flow, but there is great potential for gains in equity appreciation.  The home that will be analyzed here is an REO, i.e. bank-owned real estate.

The property chosen for this case study is 125 Bennett Street in Gilroy, a 12 year old home with easy access to Monterey Road. This is a 3 bedroom, 2.5 bathroom home on a 3600 sq.ft. lot.  The current list price of this home is $289,900.  This property has been on the market for 401 days and the beginning list price was $549,000.  I will make the assumption that the bank will accept $280,000 for the purchase of this home.

           

Here are the assumptions that I made:

• Monthly rent amount = $1900
• Purchase price = $280,000, 25% down payment = $70,000
• Loan:  5.5% interest rate with 1 3/4 discount points, 30 year loan, monthly payment = $1192, total acquisition cost = $5000 (including closing costs and points)
• Utilities paid by tenant
• Self-managed (no property management costs)
• 5% vacancy allowance
• Annual property taxes = $3500
• Annual insurance = $900
• Annual maintenance costs = $2800
• Investor’s federal tax bracket = 25%, California state tax = 9.3%
• Holding period = 7 years
• Annual appreciation:  4%
• Projected sales costs = 7%

Using the above assumptions, the property can be analyzed as an investment, taking into account tax depreciation, cash flow before and after taxes.  We will also look at the eventual sale of the property, looking at the total gain on the sale.

•  Income - Vacancy Allowance = Gross Operating Income = $21,660
• GOI - Operating Expenses = Net Operating Income = $14,460
• Subtract Mortgage Payments = $14,304
• ANNUAL CASH FLOW BEFORE TAXES = $156
• ANNUAL CASH FLOW AFTER TAXES = $1,990 (takes cost recovery (depreciation) into account)

Looking at my assumption of selling the property in seven years with a guess of 4% appreciation in value per year:

• Projected sale price in 2016 = $368,461
• Subtract cost of sale = $25,792
• Add 7 years of cash flow = $1,092
• Subtract remaining loan balance = $186,513
• CASH OUT ON SALE = $157,248
• Subtract initial investment of $75,000
• TOTAL GAIN ON SALE = $82,248

Please consult your tax advisor for more information regarding the tax implications of buying, leasing and selling investment real estate.

As we saw in my previous investment property case study , south Santa Clara County real estate can now be purchased for investment purposes and have a positive cash flow from the income received from rent.  Not only will there be a positive cash flow, but there is great potential for gains in equity appreciation.

Last month I looked at an example case study on a property in Gilroy and this month I will look at Morgan Hill.  The property chosen for this case study is 17230 Torrey Way located near the Morgan Hill City Hall.  There is a pool and spa in the backyard of this 4 bedroom, 2 bathroom, 1340 sq.ft. home sitting on a 7370 sq.ft. lot.  The current list price of this home is $359,900 and it is a bank-owned property.  This property has been on the market for 37 days.  Most likely the list price is a little high for this 52 year old home in an old part of Morgan Hill.  Therefore I will make the assumption that the bank will accept $325,000 for the purchase of this home.

Here are the assumptions that I made:

• Monthly rent amount = $2000 
• Purchase price = $325,000, 25% down payment = $81,250
• Loan:  5.5% interest rate with 1 5/8 discount points, 30 year loan, monthly payment = $1384, total acquisition cost = $6000 (including closing costs and points)
• Utilities paid by tenant
• Self-managed (no property management costs)
• 5% vacancy allowance
• Annual property taxes = $4062
• Annual insurance = $1000
• Annual maintenance costs = $3250
• Investor’s federal tax bracket = 25%, California state tax = 9.3%
• Holding period = 7 years
• Annual appreciation:  we’ll look at 3% and 4%
• Projected sales costs = 7%

Using the above assumptions, the property can be analyzed as an investment, taking into account tax depreciation, cash flow before and after taxes.  We will also look at the eventual sale of the property, looking at the total gain on the sale.

•  Income - Vacancy Allowance = Gross Operating Income = $22,800
• GOI - Operating Expenses = Net Operating Income = $17,738
• Subtract Mortgage Payments = $16,608
• ANNUAL CASH FLOW BEFORE TAXES = $1130
• ANNUAL CASH FLOW AFTER TAXES = $3,090 (takes cost recovery (depreciation) into account)

Looking at my assumption of selling the property in seven years with a conservative guess of 3% appreciation in value per year:

• Projected sale price in 2016 = $399,709
• Subtract cost of sale = $27,980
• Add 7 years of cash flow = $21,630
• Subtract remaining loan balance = $243,750
• CASH OUT ON SALE = $149,609
• Subtract initial investment of $87,250
• TOTAL GAIN ON SALE = $62,359

Looking at the same 7 year holding period but with a 4% average annual appreciation:

• Projected sale price in 2016 = $427,678
• Subtract cost of sale = $29,937
• Add 7 years of cash flow = $21,630
• Subtract remaining loan balance = $243,750
• CASH OUT ON SALE = $175,621
• Subtract initial investment of $67,500
• TOTAL GAIN ON SALE = $108,121

The increase in annual appreciation from 3% to 4% increased the gain by $45,762. 

Please consult your tax advisor for more information regarding the tax implications of buying, leasing and selling investment real estate.

There are currently 19 active listings of single family residences (SFR) located in Morgan Hill, CA on the Multiple Listing Service priced $400,000 and under.  These prices were unheard of in 2005 and 2006, and, while those higher prices are long gone now, they will be back.  Smart buyers are taking this opportunity to purchase their first home or an investment home.  Many of these investment homes are cash-flowing positively due to the low interest rates currently available to investors.

A home in a nice east-side Morgan Hill neighborhood came on the market yesterday.

1420 Kelly Park Circle is a 3 bedroom/2 bathroom, 1299 sq.ft. home on a 5,227 sq.ft. lot.  This is a bank-owned home (i.e. usually smoother transaction than a short sale.)  The Kelly Park Circle community has an HOA pool/spa and the association fee covers many amenities for approximately $193/month.  This neighborhood feeds into Nordstrom Elementary School.

Homes in the Kelly Park Circle neighborhood sold in the mid-$600,000s during the peak of 2005 and 2006.  For more information on this home or other residences in our South County area, please contact me.  I am also able to lead you through an investment analysis to determine if any property will suit your needs.

As I mentioned in my last post, I showed a lot of bank-owned residences in Los Banos on Friday.  One thing that struck me was that for the most part (with a few exceptions), the properties were in good condition.  Out of the ten that we saw, at least half of them had been freshly painted and new carpet was installed.

This goes against what most people think of when they consider the condition of REOs and short sales.  But the condition of these homes is sometimes ”turn-key”, meaning that you could move into the home and not have to do anything.

In the south Santa Clara County cities of Morgan Hill, San Martin and Gilroy, there are currently 346 distressed residential properties that are either REOs (bank-owned) or short sales.  See my previous post that defines the meaning of these types of sales.  These homes range in price from $1,999,999 for a short sale at 12895 Ales Place in San Martin,

to $104,900 for a bank-owned townhouse at 7759 Murray Avenue in Gilroy:

Both of these properties appear ready to move into.

If you like the prices of the distressed properties that are on the market now but are reluctant to even look at them because you are concerned that all distressed properties are going to be terribly damaged, please reconsider.  As your agent, I can weed out the properties that are in poor condition and only show you the properties that require very little work to make them habitable.

I have many great repeat clients and two of them have called me within the past week to help them in locations other than Santa Clara County.  I suggested to each of them that they may want to use a Realtor who is located closer than I am to their property sale or purchase, but both sets of clients insisted on working with me.  And who am I to refuse?!  Not only do I know that I can do a “way beyond expectations” job for them by doing a lot of research up front along with the excellent service I always offer, but I also get to spend time with some wonderful people and help them achieve their real estate goals.

The first call came from some previous clients who asked me to do our sixth transaction together.  They’d like me to sell some investment property they have in Santa Cruz.  I sold this home to them several years ago.

  They now have some very fortunate tenants living there from UCSC who are lucky enough to live in a beautifully remodeled home with a lovely backyard.  This home has a wonderful floorplan with 4 bedrooms and 2 1/2 bathrooms.  The choices in colors and finishes are incredible.  Look for it on MLS sometime early next week.

So yesterday I had lunch at Cafe Sparrow in Aptos (so delicious!) with the Santa Cruz clients.  Life is good.  Then today, I trek off to Los Banos with my investment buying clients.  Life is still good.  I hadn’t been to Los Banos in a while and it has grown into quite a city.  Many new businesses and nice housing developments.

My clients and I both did a lot of research on the city regarding investment property prior to our house tour today.  I talked with several people who gave me first-hand accounts on the excellent rental market in Los Banos.  My clients and I saw 10 homes today that met their criteria:  5 years or newer, 4 bedrooms, and priced under $150,000.  Homes meeting the age and bedroom criteria in 2005 would have been selling in the $400,000s.  We found some homes that may fit the bill for my clients.  We’ll see how the REO negotiations go….

Most of the homes we saw in Los Banos were bank-owned homes and, although this home pictured above was also bank-owned, most of them had dead grass in the front yard, and no landscaping at all in the back yard.  And most appeared to be in good condition, with a few exceptions.

Obviously, I travel far and wide for my clients.  If you need help anywhere in the Bay Area, I can help you with advice, with agent referrals or with my very own expertise!

RealtyTrac, an online foreclosure marketplace, contains nationwide foreclosure information and is a good source for finding out what is happening with distressed properties locally.  RealtyTrac shows that Gilroy currently has 446 bank-owned properties and 295 pre-foreclosure properties (one where the owner has received a Notice of Default.)  As a comparison, Morgan Hill has 154 properties that are bank-owned and 163 pre-foreclosure properties.  So, all-in-all, Gilroy has 424 more properties that are in some stage of foreclosure than does Morgan Hill.  These include commercial properties, but the vast majority are residential.  Even San Martin has their fair share of bank-owned homes.  According to RealtyTrac, there are 154 bank-owned properties in that small community.

                                                  

However, both Gilroy and Morgan Hill are seeing a majority of the sales that are occurring are “financially distressed” sales, meaning either bank-owned or short sales.  See my blog post from September 8th for the description of short sales and bank-owned properties:  http://southcountyrealestatetoday.com/2008/09/08/a-brief-primer-on-distressed-properties/

The Multiple Listing Service shows that in the past month, there were 77 residential listings in Gilroy that went under contract.  Of those that did, 58 were either bank-owned or short sales.  In other words, just over 75% of the recently sold homes in Gilroy were financially distressed.

And in Morgan Hill, there were 40 residential listings that went into contract in the past month.  Of those, 27 were either bank-owned or short sales.  That would be just over 67% of the recently sold homes in Morgan Hill that were financially distressed.  Still a very high number.

And, finally, San Martin has had two sales in the past month - both were short sales.

Even with all of the buzz in the media regarding short sales and foreclosures, I still have people asking me basic questions regarding the difference between a short sale, pre-foreclosure, foreclosure and REO.  So if you are completely educated on this topic, you might want to go onto my next post because this post will be just going over the basics on these topics.

The first step that a financially distressed homeowner should take is to call their bank and ask to speak to the loss mitigation department.  They should ask for someone who can help them with a forbearance agreement or a loan modification agreement.  Remember, the lender doesn’t want to foreclose but would prefer to work on options that would allow the homeowner to stay in their home.

Should these agreements not be obtainable, the homeowner should explore selling their home as a short sale.  A short sale happens when the unfortunate situation arrises where the owner must sell but their mortgage amount is greater than the amount that they can net on the sale of their home in the current market.

Why do banks accept short sales?  Simplistically, they do because the mortgage is in arrears, the property may be in poor condition, the homeowner has suffered a hardship (must be proved), the area or neighborhood has depreciated, or the bank simply has too many REOs (bank-owned) properties on their books.

Why do short sales get such a bad rap in the real estate market?  Because of the time that it takes for the seller’s bank to agree to the contract price.  This can take 30 to 90 days (I’ve seen longer.)  Most buyers lose patience and look for another home to purchase.

What do banks require from the short seller?  The package must contain, in addition to several other items, the most recent mortgage statement, hardship letter (for job loss - pink slip, for divorce - divorce filing, for excessive debt - consumer credit counseling, for illness - a letter from their doctor, for death - a copy of the death certificate, for a job transfer - the relocation order), completed financial statement, three months bank statement, three months pay stubs or P&L statements, two years past tax returns and current asset statements.  If this is incomplete, the process will be delayed that much further.

If the short sale is unsuccessful, foreclosure is the next step.  A foreclosure is the legal process of selling property to satisfy a defaulting borrower’s debt.  The preforeclosure process has several steps:  Notice of Default given to homeowner, Notice of Trustee Sale setting the auction date, the Trustee Sale auction, and the Trustee’s Deed which transfer the property title to the highest bidder or to the beneficiary (the bank).

The timeline for a foreclosure begins with the Notice of Default (NOD) recorded.  On Day 14, the NOD is mailed to the borrower (homeowner).  At this point in the preforeclosure timeline, some buyers may offer to buy the mortgage from the owner.  Some owners are not accomodating and may not allow any inspections of the home.  Also the burden is on the buyer to check whether any liens are on the property.  On Day 91 the Notice of Trustee’s Sale is recorded and mailed.  Day 115 is the deadline to cure default and Day 122 is the Trustee’s Sale.

There is no right to withdraw an offer made at the Trustee’s Sale.  The buyer is responsible for any liens on the property.  The minimum bid at the Trustee’s Sale covers the loan balance, accrued interest and the fees and costs associated with the foreclosure.  These days, most often there are no bids on many of the properties due to the high minimum bids. At that point the bank becomes the owner and the house becomes a Real-Estate Owned property.

Short sales and foreclosures effect a distressed homeowner’s credit rating differently.  Although there are not definite amounts that the scores will be lowered and these numbers may be optomistic, a general rule of thumb is that short sales will lead to a loss of 80 to 100 FICO points and that it will take approximately 18 months for the short seller to be able to buy real estate again at a decent interest rate.  A foreclosure will lower the credit rating by about 250 to 280 points and it will take approximately 36 months after going through foreclosure to be able to purchase a home with a mortgage that has a reasonable interest rate. 

(Title quote from Charlotte Perkins Gilman) 

I currently have three offers out on short sale properties.  Banks are taking forever to respond to these offers.  One offer was submitted on March 1, 2008, one on March 30, 2008, and one was just submitted on May 5, 2008.  I don’t have a response on any of them.  Thank goodness my clients are aware that they will have to be extremely patient while waiting for a response from the seller’s bank (or banks if there is more than one loan on the property.)  But, in the meantime, new properties are coming on the market, and the sellers and the banks may lose what offers they currently have on the table as buyers are always looking….

Anecdotally, the banks don’t seem to realize the value of the Realtors who list the short sales or those who represent buyers who make offers on the short sales.  Banks want to severely cut our commissions.  From what I understand regarding short sales versus foreclosures/REOs, banks would be much better off financially if they would work with the Realtors in a timely manner, pay our full commissions and get these short sales closed.  The banks’ losses will be much greater if these short sales work through the foreclosure process and end up as REOs.  And with the way the system is working currently, it is very probable that the majority of short sales will become REOs.  Ironically, once the REOs are listed on the MLS, the seller, i.e. the bank, usually offers 3% commission to the buyer’s agent.

Gretchen Merrick, CRS, GRI Phone:408-892-9015 DRE#:01317499 Intero Real Estate Services gmerrick@interorealestate.com Featured Listings 16868 De Witt Ave Morgan Hill, CA 6 BR | 4.50 BA $0 More Details 1845 Silverwings Ct Morgan Hill, CA 4 BR | 3 BA $1,025,000 More Details 2220 Liberata Dr Morgan Hill, CA 5 BR | 6 BA $2,595,000 More Details

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