The most interesting finding of the day was what appears to be a warzone (see photo!). It’s actually located in a very good neighborhood. The previous owners were investors trying to turn it into 2 properties but the building community wouldn’t allow it so they left this mess.

The bank is asking for 220,000 which of course is overpriced as always. I am going to check with someone I know who does building to see what the cost would be to develop the interior. If the bank would accept a much lower offer we could make it a 4 bedroom flat (it’s 100 sq usable meters), rent out each room for 350€ for a total of 1500 month. If we could get a fixed interest rate of 4% our mortgage would come out to less than 1200/month over 25 years (borrowing 160,000 to purchase and 60,000 to renovate).

Anyway, I’m a novice and this is just a rough estimate. It seems like it would be a fun project to learn from if the bank accepted a fair offer and the renovation could be done. In the meantime, the search continues. Now I’m going to start filtering out shady neighborhoods that I’m more familiar with from our visits.

I setup a Google Doc to keep track of properties and visits, also to keep tabs on the better ones to see if they are still around in several months and possibly cheaper offers would be accepted.

Years, months, and days much later I finally have something to say. We have begun work on our second company, the equivalent of an LLC for property holdings.

The banks are filling up with properties they have to get back out into the market, find buyers and get them off their books.

If you want to buy just any property, good luck! It’s nearly impossible to find financing in current economic conditions (where we are, in Spain). But if you want to finance a bank held property they are trying desperately to get of their hands they’ll give you 100% and in some cases even more.

This was confirmed by an agent we talked to yesterday who was showing us some properties. Our goal now is just to find the first. Get 1 property, no money down and make positive cash flow. It’s really a tall order; nevertheless, from the first 5 visits yesterday there were 2 that were decent, but still too expensive to reach our goal. The prices on the bank owned flats have really come down, but they need to be a little more desperate, bring them down a little more, for us to find what we need.

We learned so many things from all the mistakes we made on our first 2 purchases in France a few years (where we actually put a lot of money into them) ago that we’re determined not to repeat any of them. Here are some of our main things:

• Don’t just go for cheapest and often tiniest. When all is paid and done the property has to bring a cash flow that merits all the paperwork, management and expense for each individual property. Small properties generate the same work and similar expense to larger ones, even though they bring much less money.

• Buy close to home. Know the market you’re buying in, study it, get immersed into it. Real estate is not an investment, it’s a business. There are cheaper places but we’re working Madrid because we live here. Also, when you own something far way there is not much you can do but rely on a management company. Management companies only care about their bottom line, not yours. They don’t go out of their way to get your place rented in record time and they make more money when you change renters. Unless you have someone awesome to manage your property and make it a great investment, keep it close where you can do everything needed, when needed.

• Don’t lose money! Sounds obvious right? We’re not going to buy anything that will lose us money. It’s not worth it. Don’t buy rushed, or buy on a whim, be 100% sure you found a property that won’t lose money. There’s no point in investing in Real Estate otherwise. We’ve lost quite a bit on the first ones because we rushed into it and for other reasons stated here.

• Protect yourself. Always have insurance against non-paying renters.

• Use a business entity. This way your renters don’t know the people who own their property, they just see a business. This protects your privacy. If you get shady renters you’ll appreciate this more. Also having the property in an entity will protect your personal assets if you have business problems and on the other hand protect your property if someone sues you personally.

• Be sure to accurately calculate ALL expenses before buying. Mortgage, taxes, vacancies, community repairs, etc. Anything that can go wrong will go wrong; take this into account when doing your calculations.

• First check the building and the neighborhood. You can fix the house up but you can’t change the people that live there. If the neighborhood looks bad or the building looks bad forget it. You don’t want to own property in a building where the people who live there don’t keep it in good conditions.

Those are the main things of the top of my head. Now I know simply don’t invest in property to invest. Do it right or don’t do it at all.

Tomorrow we’re visiting more properties from another bank. Yesterday I discovered that one neighborhood was quite crappy that I thought was good. I’m anxious to become more familiar with the whole northern part of the city. We also picked up some insight from the person who showed us the flats. I’m sure each new person we deal with will bring something new knowledge. I’m looking forward to it!

People frequently go to the bank to see what they offer. You should never just take what the banks offer, negotiate! If one bank makes an offer take into another bank to see if they’ll better the offer. It’s not like walking into to Best Buy and purchasing a product, this is designed to be negotiable and if you just take whatever is offered it’s like burning money.

Never take adjustable rate mortgages. You can’t plan a business or a household budget on a payment schedule you can’t control. While a low interest rate may look more attractive in the beginning, it can turn into a nightmare in the upcoming years. Just ask thethousands of underwater home owners or x-home owners from this last housing buuble.

Get advice from experts like your accountant or people you know in the industry who are current on the market.

Know everything possible about the property you are buying and its value. It’s much easier to get a good property financed than a bad one. The bank will be more flexible if it knows it can sell the property more easily if you belly up on your payments.

It’s not just in my neighborhood, it’s in the whole city. I always think to myself, “Man it would suck to be the owner of commercial real estate right now.” They must be taking some serious rental losses. If you own resident property it’s probably not great but people have to live somewhere.

I’m amazed at how stubborn property owners are. I browse the property listings periodically and there are property that have been on the market for rent for at least a year and they never lower the asking price, all the while the properties all around them empty out as well.

In the US , commercial real estate values are down 44% from their peek, if that’s any sign of what’s to come here.

This recession is going to be long and deep, at least here in Spain. Hopefully we can position ourselves to take advantage of it. In a few years, who knows, maybe there will be some great property, residential or commercial, ripe for the picking…  We have to keep learning and prepare the best we can.

Recently in the news in the states there has been talk about many new housing starts as signs of a recovering housing market. Although some experts say this is just an illusion. States subsidise the construction of houses to keep people working and hold up an illusion of an improving market and to help stabalize the economy.

Technically all Americans are subsidising housing as taxpayers are footing the bill for now completely government controlled housing agencies Fanny Mae and Freddy Mac. These organizations are STILL backing home loans. Fanny and Freddie (and FHA) could cost US tax payers approximatlely $1 trillion.

I heard several references to the ‘FHA’ in discussion about banks and mortgages so I looked it up. FHA stands for the Federal Housing Administration who runs programs to promote home ownership.

This association hands out what are called FHA loans. These loans are insured against default. If someone lends money to a borrower they don’t have to worry about losing money if the borrower can’t pay because the FHA will pay. The FHA charges the home buyer and upfront and monthly fee to cover its back when someone defaults.

I don’t mean to sound righteous but I think it’s totally unethical for anyone to walk away from their debts. If the people who bought the homes don’t pay for them, someone else will end up paying for them, and in most cases that falls on the rest of us with bailouts and money printing.

For years I ignored my school loans and they actually went to collection. The loans were from the US and I wasn’t even living there anymore and had no intentions of returning, so technically I could have escaped every paying them back. Nevertheless I got my !@##!! together and paid off the loans with a big monthly sum over a period of three years. It felt great to rid myself of that debt and it felt even better to live up to my obligations and do what was right.

60 minutes recently did a special on people walking away from their mortgages. The thing is, these people can actually afford to pay their mortgage but their houses are not worth what they paid. I’m not exactly crazy about what banks do to make money, but if I were a bank and I lent someone $300,000 for a house and instead of paying me my $300,000 back they give me an asset that is only worth $200,000. Is that right?

FICO is always an important factor banks (in the US) take into account for making the decision to lend or not. Scores tend to range from 300 to 850.

FICO is a bit simplistic and has some shortcomings. For example, anyone can request a credit card and promptly pay it off each month to raise their FICO score. FICO also doesn’t take into account the person’s income.

When the rating agencies (Moody’s and S&P) rated the safety of mortgage loans they asked for average FICO scores of all the parties the loans were made to, the average only needed to be around 615 to get an AAA rating. The big problem with the system is that there was a mix of very reliable lendees and very unreliable lendees. Taking an overall average was quite useless as there could be many people included in the bonds created with these mortgages that were not creditworthy, creating  great risk of defaults.

Nevertheless, the bonds were given high ‘safety’ scores as investments by the ratings agencies, which appears to have also made a big contribution to the whole subprime meltdown. After all, would financial institutions buy so many bonds if they were deemed risky?

I love this book, ‘the big short’, it’s giving me a much clearer vision of what happened in the housing market that sparked the financial crisis. It’s not too technical. It’s easy for someone like me to understand.

In Bakersfield, California a non-english speaking mexican strawberry picker with an annual income of $14,000 was lent $724,000 to buy a house!

I remember a couple years back a guy named Casey Serin appeared on Rich Dad’s insider videos to explain how he managed to buy 7 properties with no money and nothing down which he was planning to flip for profit. At that moment we had reached the top of the bubble and there were no more buyers. Now he was stuck with these 7 expensive mortgages and facing serious financial problems. I wonder how he is doing now. Hopefully he is working his way out that mess and doing better. We e-mailed back and forth a few times and he seemed like a pretty nice guy.

The lesson was never to speculate (at least not invest on the sole basis of expecting the price to go up) , always invest for cash flow or monthly returns.

Compound interest is the theory pf adding accumulated interest or earning back to the principal.  Other terms used interchangeably with compound interest rates include annual percentage rate, effective annual rate, and effective interest rate.  Compound interest generally prevails in finance and economics.  It is worth mentioning that there was time in human civilization when compound interest was considered as the worst type of usury.  Compound interest was extremely condemned by Roman law in addition to common laws of other countries.

The word “yield” signifies a rate of return that is derived from compounding, reinvestment, or varying market value of a security.  Two factors have great effect on compounding: the periodic interest rate; and the frequency with which the interest is compounded.  The frequency of compounding is generally annual, semi-annual, quarterly, monthly, or daily.  The periodic interest rate is simply the interest to be charged for each period.  A nominal interest rate is an annual rate that has not been “adjusted” for compounding.  For example, if Mr. Li invested in real estate in Hong Kong in January of 2008 with an initial capital of $10,000 that pays a yearly interest rate of 4% that is compounded quarterly then the table below shows the value of his property at a given quarter

The yearly interest rate is 4%, which also represents your nominal rate since it has not been adjusted.  To obtain the periodic rate for quarterly compounding, divide 4 (interest) by 4 (number of quarters in a year) and you get 1 or the quarterly ROI.

When an interest is earned by an investor it is converted into a capital.  The process of compound interest entails reinvestment of capital; the dollar earned for each quarter is reinvested.  On March 2008 Mr. Li earned $100 which was added to his initial investment making his new capital for June 2008 $10,100 and so on.

Checking how often interest is compounded is a smart thing to do before deciding to invest in any real property.  Obviously, the more frequent it compounds, the faster you reach your financial goals.  These are basic information you have to know if you seriously intend to maximize the full potentials of your investment.  Also, it can save you with so much troubles and headaches in the future.

The most basic computation in evaluating the rate of return for a real property investment is the simple interest. Calculation of simple interest consists of 3 elements: principal, rate, and time. The principal is the initial amount of investment. The rate, also referred to as rate on investment (ROI), is the interest rate of your investment at a given period of time.

Let me give you an example, Ms. Anne has decided to invest his bank savings worth $10,000 to a newly developed, residential district in Detroit, Michigan. The property consultant mentioned an annual interest rate of 7% after 2 years.

Principal = $20,000 Rate = 5% Time = 2 year

Simple Interest = Principal x Rate x Time

= $10,000 x .05 x 2

= $1,000

In 2 years time, your $10,000 investment will earn $1,000. Your property’s value then will be principal plus interest or $11,000. Obviously this is a simple scenario using simple interest. What if you have 2 property investments that need proper evaluation? Referring to Ms. Anne’s case discussed above, she decided to add more money so that her total annual earned interest will reach $1,500 or 7.5% of initial investment (instead of $1,000). If she expects the interest rate to increase to 9% how much additional money does she need to achieve her target?

Using the same formula:

Simple Interest = Principal x Rate x Time , since we have 2 investment periods, then

Simple Interest (period 1) + Simple Interest (period 2) = Simple Interest (total) , or

Principal x Rate x Time (period 1) + Principal x Rate x Time (period 2) = Principal x Rate x Time (total)

Substituting the values from the table:

(20,000 x .07 x 2) + (2 x .11 x y) = (20,000 + y) x .10 x 2

Solving for y will give you the value of $16,666.67. This means that Ms. Anne has to invest an additional of approximately $16,700 to attain her target.

Another computation frequently used in financing and economy is the compounded interest. Simple interest has lower yield or future value since the interest earned in compound is reinvested as capital. Knowing the fundamental interest calculation can help you make better offer to your clients. The properties you are selling can become more appealing if you can give them an idea how much it will worth after a period of time. If you are on the other side of the negotiation, you can evaluate the property on your own and even verify claims and assertions on a certain investment.