Bloodhound News:
A storied home in Story...

We first heard from Ronan Doyle on January 18, 2004. He was relocating to Phoenix from Atlanta (having lived in New York City and Suburban Connecticut, among other places) and wanted a home of distinction – preferably an historic home.

We had just rewritten our business plan, and Ronan was the first real test of the Bloodhound idea, a different way of doing real estate. The home depicted above, 1102 West Culver Street, Phoenix, was the home he ended up buying, and the web site we built for his home search is still featured on the BloodhoundRealty.com home page.

We love Ronan, and we've loved this house since the first time we saw it. Ronan is moving on, to a great new job in Boston, and he has entrusted us with the sale of this incomparable home.

Did we mention that we love it? Do you doubt this? Visit the web site we built for this home. Cathleen took dozens of photos and Greg wrote hundred of words describing them. If Ronan-on-the-way-in was proof of the Bloodhound idea for buyers, then Ronan-on-the-way-out is a Bloodhound tour-de-force for sellers.

You can see this house – if you hurry. Cathy is holding it open today, Sunday, from Noon until 2 pm. If you're in the Phoenix area, we've love to have you stop by.

The power of bad advice...

We are very rigorous about facts. Gut feelings may have merit. Personal experiences and anecdotes may resound with the ring of truth. But when you make an assertion, you should be able to back it up with some sort of argument. The farther that argument strays from independently verifiable fact, the less likely we are to believe you. You may be as right as rain, as right as the mail, but if you can't back up your claims with facts, they are doubtful at best.

This makes reading the newspaper less than fun – although it can be very funny. Further down we'll talk about Three Little Bears who sold their homes out of an unreasoned fear of Goldilocks, but for now we want to talk about the investment costs of bad advice.

Saturday's Arizona Republic has a lengthy article about the effect real estate investors had on the market in the Valley of the Sun over the last year, and the impact they may yet have in the near future. The article is filled with one undefended assertion after the next, and none of that really matters. Even here, they wrap fish in it.

Here's a laundry list, by no means comprehensive, of undefended claims:

• Investors accounted for at least 25 percent of all Valley home buyers last year, according to property records and real estate agent reports. ["Real estate agent reports" are anecdotes, and no one looked at all the property tax records.]

• Frank Nothaft, chief economist for mortgage giant Freddie Mac, said investors accounted for 30 to 35 percent of all home sales in metro Phoenix last year. [Based on what data?]

• Nationally, the rate was 23 percent. [Based on what data?]

• Las Vegas, where investors have started to pull out and cause home prices to dip in some new neighborhoods, had a higher rate than the Valley. [For what it's worth, Las Vegas is faring very well in the aftermath of its surge – a claim we can document.]

• As home prices have flattened, many investors have tried to find renters instead of buyers for their properties. [Assuming the consequent: The underhanded argument being slipped in here is that they weren't buying to hold and rent in the first place.]

• If people keep moving to the Valley as projected, most investors should be able to find people to lease their homes. [Vacancy in rental housing is fairly low for the first time in years; we've always been a soft rental market, but that may be changing.]

• A slowdown in home-price increases isn't necessarily bad because it keeps metro Phoenix from following California cities such as San Diego and San Francisco, which are losing jobs and residents because of high housing costs. [This is a steamer trunk full of assumptions with no room left over for any documented facts.]

• Most market watchers believe the most-speculative investors have already cashed out of metro Phoenix's housing market, moving on in search of the next big deal. [This might be true, but how could it be measured?]

• The number of home buyers acknowledging that they are buying houses as investments fell in December. [Their 'acknowledgment' would be on the Affidavit of Value, which is already understood to be of dubious value, since many investors, on the advice of their lenders, say they will be owner-occupants or second-homeowners.]

• The percentage of new homes selling to investors dropped from a high of 11 percent last January to 5 percent at the end of the year, according to the Information Market, a Phoenix-based data firm. [This would be during the span of time when investors were banned from virtually all new home subdivisions. The surge in resale values was caused by this ban, but the builders had no problem selling all of their available inventory to putative owner-occupants – all of which puts the lie to this whole thesis.]

• About 18 percent of all used homes were selling to investors in December, compared with a high of 20 percent in September. [And yet, somehow, the annual figure runs to 25%, 30% or even 35%, when the monthly high was 20%. Don't worry, though: There's no documented support for the monthly figures, either.]

Understand, many or even most of these things, plus many other assertions we've left out, might be true. The problem is that none of them are defended by reference to independently verifiable fact. We do an enormous amount of work with investors, and we could give you a very precise run-down of our own numbers. But we can't think of any way to document some of the more hyperbolic claims made above. Until we are proved wrong, we will presume that all of these numbers are spun from whole cloth.

Anyway, the essence of the article is that the market-wide run-up in values was essentially caused by investors. We had challenged an earlier iteration of this claim, and evidently someone went back to try to buttress it with some hand-waving evidence.

The problem is not that it's the-world-will-end-Tuesday wrong, the problem is that it cannot be wholly right. The house we started this newsletter with is up more than $230,000 – that's 87.5% – in just two years. This was not caused by investors. There are no short- or long-term 'speculators' in luxury historic homes.

At the other end of the food chain, our feeling is that a whole lot of investors were very badly advised in the recent frenzy. We turned away dozens of potential clients who were insistent on buying exactly the wrong thing: Duplexes, slum properties, in-fill lots, etc. None of these are necessarily bad investments, but they are horrible buys for passive investors living out-of-state.

The next level of bad advice is the idea of 'speculation' in itself. Real estate is a long-term investment. It is possible – in any market – to make money on short holding periods, but this requires a huge amount of concentrated effort. If it's not your full-time job, you're probably losing money.

On the other hand, operating from better advice should produce healthy long-term results regardless of short-term vicissitudes in the marketplace. These are figures from our investments web page:

In the following table, we're looking at the same one real $225,000 house in five different down payments with two different assumptions about average appreciation over the next eight years. This is a real house that we sold recently, with all costs, taxes, rents, etc., being based on the real numbers. We've held rents flat (at $1,050 a month) and vacancy high (at 10%), even though, in the long-run, rents should go up and vacancy should go down. We are extremely rigorous about real-life numbers, so you know exactly what you're getting into. If anything, we want for our numbers to be more pessimistic than reality, so that your real results turn out to be happier news than our projections.

If you click on the down-payment percentages in each scenario, a five-page spreadsheet will open showing you every last fact and projection leading to our conclusions. CFBT is your projected annual cash-flow before taxes. CFAT takes account of the cash-flow after you have deducted losses and depreciation from your tax liability. Yield is the net annual after-tax return on your initial outlay. Since you will probably be selling your investment properties by IRS Section 1031 tax-deferred exchange, your actual Return and Yield numbers could be higher; this is a topic to discuss with your tax professional.

What this table makes abundantly clear is that positive cash-flow, except with a very hefty down payment, is very difficult to achieve. But because our annual appreciation rates have been so high – and because they show every sign of exceeding appreciation in other markets – if you can make that down payment, or if you can absorb a negative cash-flow from other sources of income or with a negatively-amortized loan, your ability to build long-term wealth in the Phoenix residential real estate market is tough to beat!

These are projections, not facts. But they're projections based on a rational apprehension of the underlying facts of this particular real estate market.

The fact is, the Republic has been running scare stories about real estate investments in the Valley for 18 months and more. In that time, we have worked with dozens of investors, none of whom have failed. Most of them have been hugely successful, and a few are up a half-a-million-dollars or more, all in that same 18 months. Needless to say, in the anecdote-driven world of the Republic, their experiences go unreported.

What does all this prove?

Simply this: Phoenix is, has been, and will continue to be an excellent market for residential real estate investment – provided you do it our way, buying and holding newer homes in high-appreciation areas.

The bad news is, the news in the newspaper is almost always bad. But the good news is, it's almost always wrong.

How to profit by bad examples...

If you want some really bad real estate advice, look no further than The Arizona Republic. Somehow or another, reporter Judy Nichols found three people who suffer from the notion that renting is better than owning their own homes in high-appreciation neighborhoods. Only two actually pulled the trigger and sold their homes, but, as every newspaper reader knows, three random anecdotes are no mere phenomenon but a certifiable trend.

Witness:

Kurt Nishimura is taking a calculated ride on Arizona's real estate wave. He sold his home in the Willo neighborhood, believing its value has topped out, and is renting an apartment in the Arcadia area for a year, hoping to buy something after the wave has crested.

The Willo is the most popular of the historic districts downtown. Well-restored Willo homes are avidly sought. People cruise the streets slowly, watching for real estate signs to be posted so they can get their bids in first. I am not making this up.

The rate of appreciation in the Willo consistently eclipses the baseline appreciation rate for the Valley. It's not hard to understand why: The supply is fixed and finite and the demand is unlimited. The rest of Mr. Nishimura strategy is also daft, but selling a home in the Willo because he expects its value to go down is particularly addle-pated.

But how about Tom Connelly, "president and chief investment officer for Versant Capital Management"? He "recently sold his house near a mountain preserve in Paradise Valley and is renting an apartment near 24th Street and Camelback Road." What was he thinking? This again is a house that will consistently beat the market. Connelly has a strategy, though. Unfortunately, it's based on securities trading, rather than real estate: "I think that in 12 to 36 months things will go down, way down."

Wanna bet?

Gene Cohen wanted to make the same dumb mistake, but in the end he was just too complacent. He's hanging onto his Willo home for all the wrong reasons. In due course, he will celebrate his inertia.

There is another article in the Republic asserting that 20% of Americans think the only way they could save $200,000 is to win the lottery, so I suppose we shouldn't be surprised that Ms. Nichols was able to find three seemingly well-heeled gentlemen who are so clueless about basic economics.

For example, Mr. Nishimura wants to wait until interest rates go up before he buys another house. His expectation is that houses will be much cheaper. This will not be the case, but his monthly payments could easily be 25% higher.

This is all very simple calculator math. Any of these men should be able to do it, as should Ms. Nichols. On the one hand, they're going to give up at least 10% a year appreciation on their homes, probably much more, along with the mortgage interest deduction and all the other benefits of owning versus renting – most notably the future leverage value of that accrued appreciation. And on the other hand, they're going to pay a lot more for a lot less when they finally realize that real estate does not work like the stock market.

But if all that is true, what are we to make of these three stooges? Are they really that dumb, or are they concealing other motives?

Could it be that Mr. Nishimura really didn't like the hassles of being a homeowner, so he sold his home and justified it with a bogus economic argument? Could it be that Mr. Cohen is embarrassed that he loves being a homeowner so much? Given that Mr. Connelly telecommutes to Minnesota, is it plausible that he might have wanted a zero-maintenance residence?

We'll never know, because Ms. Nichols didn't drill down to the underlying emotional reasons for selling, for which the purportedly 'logical' reasons may simply be a cover.

On the other hand, it could be they really are as clueless as they come off.

Either way, they have reaffirmed my already strong belief in the long-term value of investing in rental housing.

Who says there's nothing to be gained from reading the newspaper?

Can good advice
drive out the bad?

We hate the dismal state of real estate investment advice so much that Greg is writing a book to show how to do it right in the Phoenix market. On the one hand, some investors are so afraid of losing nickels that they leave baskets full of dollars behind. And on the other hand there is always Chicken Little, constantly foretelling doom. It never rains in the Valley of the Sun, and for that reason, among others, it is raining soup here, and will be for many decades. Together, we're going to build a better soup bowl and have ourselves a feast.

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