Second, I want to acknowledge the hard work that keeps our doors open. Behind the scenes, working diligently and tirelessly is my wife Debi. What an amazing job she does! She is that wonderful voice that answers our phones. In addition, she develops our spread sheets and our tracking sheets; she takes care of our many mailings to our clients and students; and, she runs our books. She keeps our accounts serviced and our clients happy. She is able to maintain a great focus even while developing and growing her own E-Bay business. Visit her store on E-bay by typing in http://stores.ebay.com/DebiDr.

Next, there’s Cora Lee, our closing agent with Fidelity Title Services, LLC in Inverness, Florida. There has never been a transaction that I have brought to her that she could not close. I have heard so many lame excuses from so many other Title Companies as to why our transactions could not be closed. When we would bring them to Cora, she would always find a quick and easy way to close them. If you are looking for a no-hassle company to close your transactions, contact her at fidelitytitleservices@mindspring.com.

Next are John and Natalie Carey. They a top-notch husband and wife real estate team and close personal friends of ours. I have relied on them for over 5 years to provide me with advice and guidance on purchases and sales, and to bring me back to earth when contemplating some creative way of getting a deal to happen. John is a very sane voice in this chaotic world of post-bubble burst real estate. Visit their website at www.citrusinvestmentproperties.com.

Indirectly, I would like to thank my sister who has always served as an inspiration to me. Linda has developed The Dietrick Group LLC, a Lehigh Valley, PA, based full-service real estate advisory company that specializes in commercial appraisal, commercial/residential brokerage and private placement funding. She is a true success story. Visit her site at www.dietrickgroup.com.

There are countless others that we work with that I would also like to thank as well. Mr. & Mrs. “Krue” Krueger; Mr. & Mrs. Joseph Laurino; Mr. & Mrs. John Woodstuff; Mr. Fred Uhl; Mrs. Susan Bishop; Attorney Anne Raduns and her husband Dennis Owen; Attorney Mike Evans; all of our past and current tenants and clients and students. You all make my job fun and profitable.

OK, let’s get on with the newsletter:

So much has happened in the real estate industry over the last 2 years. Very few investors would have predicted 2 years ago, that we would be in this kind of a market today. I speak to so many people throughout the days and weeks in between our newsletters, and a common look most share is that “slack-jawed & dazed” look and a common question most ask is, “What happened!?!?”

I also noticed that their level of experience and their position within the industry (i.e. investor, real estate agent, mortgage broker, builder/developer/contractor, etc.) did not prevent them from being negatively impacted by the market collapse.

As a result of the rapid downturn in the market, and specifically the factors that have caused it, investors are suffering two major wounds:

1. They have been stuck with properties that they cannot sell, cannot rent and cannot Lease/Option without taking a major hit in their own wallets.

2. They cannot find properties that they can purchase like they did in the “good old days” and either “flip” them, rent them out with a Positive Cash Flow, or Lease Option them with a good front end and back end profit.

The primary reason this is occurring can be directly attributed to the sub-prime mortgage debacle that we see, hear and read about each and every day on the television, on the radio and in the written media. This mess has had a devastating impact on real estate investing that will be felt for years to come.

As a practical part of my real estate investing, I have learned that paying attention to trends and looking for warning signs can spell the difference between success and failure. Real estate is not only local; it is cyclical. And by knowing the signs of change, you can easily determine the current condition of any market and better predict where it is going. If you are not in tune with where the market is heading, you can end up holding the bag so to speak, with bad investments.

Recently I was invited to speak before a wonderful group of investors and real estate professionals who comprise the Marion County Real Estate Investors Association. I was asked to speak on the subject of Lease Options. I was initially apprehensive about talking on this subject, because I find the current state of the market to be counterproductive to the acquisition of properties that will actually work in a Lease Option strategy.

So I sat down at my desk to really think out the best approach to this subject. I couldn’t go before them and let them know I thought they were crazy for thinking about Lease Options. I thought I would start out with an analysis of the current market and provide a primer on real estate cycles and real estate bubbles. Certainly that would be interesting and informative and lively.

When I saw a man in the front row actually fall asleep, I knew that I had misjudged my audience. For the most part, they didn’t care how they got to where they were; they wanted to know how to get out. They didn’t care about finding new properties; they wanted to know how to get rid of the albatrosses they were left with when the dust settled from the bubble burst. It proved the old adage that when you are up to your eyebrows in alligators, you don’t really care who is responsible for not draining the swamp.

So the direction and tempo of the talk changed to discussing their immediate problems. I don’t know if any one walked away with any specific solutions, but our talk went on for two hours, even though I was only permitted an hour. Regardless of the direction that our talk took on that evening, it does not negate the fact that those who do not learn from the past are destined to repeat it. And since I do not have that group of investors held captive in a hotel conference room any longer, I want to discuss what I started out to talk about that night.

A lot of investors are aware of the basic economic model for supply and demand: More demand pushes prices up and too much supply pulls them back down. What most investors do not know however, is that there are actually 3 separate and distinct markets that are work at the same time.

The first market is the Supply-and-Demand market we just mentioned. Most investors consider this market to be “THE MARKET”. There are two separate types of demands that you need to be aware of however:

1. Real Demand: that is the need and desire for housing on the part of buyers, who intend to occupy those homes. There is also the demand of investors for properties to be used as rentals, fix-up & resale’s; and, flips for quick speculation.
   

2. Artificial Demand: This is the demand for property that continues after the real demand has been satisfied and a bubble is growing, silently and dangerously. We have all been witnesses to this phenomenon. This is also what I call speculative fever.
   

There are two separate types of supply that you need to be aware of as well:

1. Real supply: this consists of a quantity of newly constructed homes and vacant/existing single family residences that approximately meet the real demand for an area. As an example, if 500 properties sell each year in your area, construction of 500 new properties (less existing properties that turn over) is considered a real supply.
   

2. Market-Response supply: this is created when an artificial demand is created. Developers continue building new units simply because speculators are lined up to buy in pre-construction phases, even though no real demand is going to be there to meet the supply once the units are actually completed. Owners of existing homes see the apparent growing market in new construction, and the fever spreads to this part of the market as well.
   

Next we have the Rental Market. We can gain a tremendous amount of insight into the health of the market in our area by studying vacancy rates. When rates are low, a strong demand for rentals is apparent. A strong rental market usually goes hand-in-hand with a real demand for existing / used properties.

The investor might assume that low vacancy rates are a symptom of a strong real estate market. Their inclination is to buy single-family homes and rent them out. They may be able to generate enough positive cash flow to cover their mortgage, with the underlying assumption that a strong rental market also influences real estate values. But what if property values remain flat? It’s likely that taxes will increase because the county will need to look for new revenues to pay for their services. Insurance premiums continue to rise due to environmental and bureaucratic influences. All this serves to erode the profitability of the investment, at least for the short-term. You quickly realize that no new demand is being created.

The third market in real estate is the Financing Market. This market is expressed in most cases in terms of “average mortgage interest rates”. When rates fell between 2001 and 2005 to historic low levels, the number of people who could qualify for first-time mortgages expanded quite rapidly. This created a real demand for single-family homes and in retrospect, was the beginning of this real estate cycle and the bubble that we recently witnessed. Inevitably, those low interest rates will eventually begin to rise. The market begins to slow. Historically, the rate of mortgage defaults begins to rise as well. Most mortgage defaults in the US result in foreclosure and as a result of borrowers losing their properties, the supply of homes increases. This is the beginning of a self-correction in the market.

There are any number of external influences that also affect value beyond these three markets. After the recent hurricanes ,construction costs rose significantly. Many people left the coastal areas for the interior and placed pressure on the available property inventory of these areas, driving up prices.

In certain cases, the increase in costs of non-real estate related products and services can have both negative and positive affects on property values. The increase in the cost of crude oil has a domino effect within our economy and has a huge impact on real estate.

As investors, we need to be aware of how real estate works within the overall economy, especially in our own area. You can’t turn on the TV news anymore without hearing the horror stories about the economy, the sub-prime market and the daily growth of foreclosure numbers. Mortgage rates are in a state of flux. Property values are plummeting. Lender requirements are tightening. Things are changing and changing quickly. These are national stories however and they are based upon averages. They may not reflect what is actually happening in your area. Watching these averages is dangerous because it tells you little if anything about what is happening locally.

Don’t assume there is only “one market”. Here are some guidelines for analyzing your local market.

1. STUDY PRICE TRENDS FOR THE PAST 5 YEARS. Be alert. Price trends look most promising just before a crash. Don’t think current price trends tell the whole story about where the market is headed.
   

2. COLLECT REGIONAL ECONOMIC INFORMATION. Study the local economic factors that will affect supply and demand. On what is your local economy based? Is the general population made up of retirees and snowbirds? What are the statistics on job growth, median income, demographic make-up of the job force, etc. You will see growth trends that will aide you in making competent decisions as to your timing.
   

3. NEW CONSTRUCTION RATES AND POPULATION GROWTH TRENDS. Don’t overlook new housing starts when determining the health of the market. Many investors simply look at the inventory of existing homes. We are currently seeing a glut of new construction on the market for drastically reduced prices. Those that can’t be sold are being offered for rent. How can investors who purchased existing properties at the peak of the buying and price frenzy, possibly compete with new construction being offered for $60.00/SF?
   

4. EMPLOYMENT AND POPULATION TRENDS. Is the local population growing or shrinking? Are jobs coming into the area or are they leaving?
   

5. LOOK BEYOND PRICE. The specific factors that determine long-term real estate prices include:

   1. Mix of Population.

   2. Climate.

   3. Traffic patterns.

   4. Crime statistics.

   5. Primary economic centers.

Are there any new businesses, tourism or manufacturing facilities planned in the relative near future, and in the converse; are any shutting down or moving to other areas?

In a classic description of economic supply and demand, it’s a simple model that explains why prices rise and fall.

1. DEMAND FOR REAL ESTATE RISES. When more people want properties than there are properties to be sold, it is a clear sign that the cycle is starting and is in an upswing. Pay attention to the following indicators:
   

1. Time on Market. The shorter the time, the greater the sign of growing demand.

2. Price Spread. This is the percentage difference between the asking price and the final sales price. The lower the percentage, the stronger the market.

3. Trends in Inventory. If there is less than a 6 month supply (calculated by dividing homes for sale by the average monthly closed sales) you have a healthy market.
   

2. DEVELOPMENT FOLLOWS DEMAND. When demand begins to rise, developers and contractors respond by increasing development activity and new home starts.
   

3. DEMAND LEVEL BEGINS TO SLOW DOWN. In an orderly market, demand reduces simply over time. In a bubble, it happens quickly and speculators find themselves holding over-priced, over-leveraged and over-valued properties. If you know what to look for, you can spot the signs that the market is slowing, simply by tracking the 3 indicators we previously discussed. (Time on Market; Price Spread; Trends in Inventory)
   

4. SUPPLY EXCEEDS DEMAND. Development does not always slow down just because demand is slowing down. The tendency is to continue building a long as prices are rising. This phase seems to always take the inattentive speculator and developer by surprise.
   

5. DEVELOPMENT ACTIVITY SLOWS OR STOPS. When supply overtakes demand, developers either tend to slow down or stop. Many tend to think that the ever-growing price trends will continue indefinitely. These developers either stop or they go bankrupt.

6. DEMAND CEASES AND THE MARKET HITS BOTTOM. At the bottom of the cycle demand reaches an all time low due to over-supply. This is the end of the demand-supply cycle and the beginning of a new one. Price levels end up being very close to where they were before the cycle began. This happens because the demand was artificial.
   

This was a classic cycle. Let’s take a look at the cycle when it is driven by a bubble, more like what we have just gone through. There are five distinct phases to every bubble:

1. ECONOMIC CONDITIONS IMPROVE OVER THE PAST. Bubbles don’t grow spontaneously, but are reactions to the larger economic cycle. Tax cuts and reductions in interest rates spark the economy. Indicators such as productivity and employment improve, adding the overall sense of prosperity. Experienced investors recognize the cyclical nature of real estate.
   

2. OVER-INVESTMENT STARTS AND GROWS. Lower interest rates and liberal lending policies are viewed as sparks to the economy, even though they are also evidence of the expansion of debt in the form of mortgage lending. The media gets on board and reports on a national level that “times are good and getter better”.
   

3. CREDIT IS CURTAILED NEAR THE TOP. Interest rates are the primary culprit in the growth of a bubble. Rates are lowered to generate economic growth and more mortgages are written. This expands the real demand for housing. This is all spoiled when the developers and builders, along with the speculators meet that real demand with an oversupply. As the bubble intensity grows, it is aggravated by a reversal in interest rates due to an increase in mortgage defaults.
   

4. A BUBBLE IS RECOGNIZED BUT SPECULATION CONTINUES. Speculator enthusiasm is infectious. In light of obvious facts and media reports, the tendency of the un-trained or impetuous investor is to continue to speculate.
   

5. GROWTH STOPS SUDDENLY. At this point we see subtle changes in the market. Newcomers and amateurs enter the market. There is a mind set amongst inexperienced investors to only begin selling when everyone else begins to sell.
   

6. PRICES FALL. The bottom has fallen out of the market; foreclosures become epidemic; the market is flooded with over-leveraged properties; Short Sales flourish; the market begins to correct leaving an economic landscape strewn with victims.
   

Markets tend to act in a predictable manner. They change in predictable manners as well. Knowing how to read the signals can improve your timing.

1. DEVELOPMENT ACTIVITY STOPS MAKING SENSE. Developers encourage a belief in a strong market because they need buyers for their properties. Speculators need other speculators willing to pay higher prices for properties. Real estate agents (far from being experts) are motivated by commission earnings and will always tell prospective buyers that the time is right to buy today! The need for a healthy market clouds judgment.
   

2. SPECULATION INCREASES NEAR THE PRICE TOP. When a speculator enters the market, it is usually the result of recognizing an immediate opportunity. That’s only good and wise business. However, there is a tendency for speculators to continue “speculating” long after rational thinking has passed. The speculator loses sight of the risk factors involved in short-term real estate, especially in cases where supply far exceeds the demand.
   

3. MARKET STATISTICS TURN NEGATIVE. Look to the fundamentals. In real estate, the fundamentals include new permits for development, sales levels and time required to complete a sale, deep discounts, and a growing inventory accompanying higher prices.
   

4. LENDING STATISTICS BECOME OMINOUS. Liberal lending policies back-fire. In an attempt to stimulate economic growth, lending requirements become very lax and the secondary market proliferates. Prices are driven high as it truly becomes a sellers market. Defaults become more prevalent and usually end in foreclosure.
   

There are four universal truths that apply to real estate.

1. VALUE DOES INCREASE WITHOUT REASON. You need to determine if the growth in a properties value is driven by a real or an artificial demand.
   

2. THE REAL ESTATE MARKET IS NOT LIKE THE STOCK MARKET. The stock market is highly liquid and transactions are executed quickly and for little cost. Stocks are not leveraged; they are usually paid for in cash. Stocks have no tangible value, but represent a partial ownership in a corporation. Real estate is the opposite. Because of these differences, it is unwise to apply stock market assumptions to real estate.
   

3. GREED AND FEAR DOMINATE SPECULATION. Once you know this, you are better able to apply logic to your approach to purchasing. When prices tumble, most people are afraid to invest in real estate. However, that is precisely the time when great bargains can be found on the market.
   

4. FUNDAMENTAL ANALYSIS WORKS IN ALL MARKETS. When analyzing real estate, the fundamentals are essential. The value of property is based upon comparable sales, the cost of replacement, the income approach based upon rental rates and the rates of divergence of these factors. They all help to identify the health of the market.
   

OK, now that I’ve painted this really ugly picture of the landscape of the current market, you might be asking ourselves, “Maybe we should be doing something else with our time and money?”

Well I have mixed feelings about those questions, but the bottom line is “We are real estate investors!” and “We buy houses” damnit!!! And if we are good real estate investors, we find ways to work in any market and still make money.

These are precarious times and I personally believe we have not hit bottom. All the indicators that I have seen tell me that prices (on our portion of the market) will be returning to prices like those we were seeing in 2003 and early 2004. But we need to be careful. Buying too high now, will have an impact on your future profits.

I personally follow a strategy espoused by Warren Buffet:

“When people are greedy, be afraid; when people are afraid, be greedy!”

It’s not necessarily the sellers you should be looking at for that “fear”. It’s the lenders. When the lenders who are taking back these properties by the thousands finally understand the extent of their problem, they will be afraid…very afraid. Look for signs. When they begin calling you back with regard to your short sale offers, rather than you calling them and leaving countless un-returned messages…that will be a sign. I see it happening now.

I believe we are at the very edge of the next great opportunity in the real estate cycle. We are not at the bottom yet, but very close. I advise that you occupy your investing time working with distressed properties and owners (through foreclosures and short sales) until the market corrects itself and inventories begin to drop. Don’t wait too long however. Please take this long newsletter to heart and practice the analysis techniques that will help you gauge your timing and involvement.