Wednesday, November 28, 2018

Can Appraisers Stay Relevant?

In May 2018 the feds have increased the De minimis threshold on commercial real estate loans from $250,000 to $500,000. This means federally related loans being made below $500,000 are not requiring a licensed appraisal. Likewise, the last quarter of 2018 brought another proposed De minimis change this time for residential properties. This proposed residential change is raising the de minimis from $250,000 to $400,000. As expected, appraisal organizations are outraged, Appraisers accuse federal regulators of recreating housing crisis conditions. Appraisal Institute president, Mr. James Murrett, MAI SRA said that increasing the appraisal threshold will “threaten the vital role” that appraisers have in real estate deals.

Here's the likely reason why the feds are easing appraisers out of the underwriting process. Licensed appraisers are required by USPAP (Uniform Standard of Professional Appraisal Practice) to appraise a property based on the collective market participant's value opinion within the context of the definition of market value. For example, this means if a specific property is in escrow for $375,000, has 5 backup offers for $375,000, other similar properties in the district are selling for $375,000, and verification of this sale coincides with the elements of the definition of market value, well its pretty obvious the collective market participants think the market value of this property is $375,000.  

Many appraisers, in all good conscience, will appraise this property with a "conservative" market value opinion below the $375,000 escrowed sale price if they feel this market is over heating. Their argument is because they "feel" it's just plain wrong to appraise the property at $375,000 that could possibly lead to disaster somewhere down the line like what occurred in the 2007 "great recession". What this type of appraisal opinion has led to is a conflict in the appraisal community between these "conservative" appraisers and anyone who, in their opinion, "rubber stamps" this $375,000 value example. 

This conflict between appraisers was intensified when many of these "conservative" appraisers were dropped from many lenders "approved appraiser" list because they were "blowing" the closings of these loans. When the "great recession" occurred, these blacklisted appraisers felt vindicated for their previous value opinion "feelings".  

Here is the "catch 22" for appraisers. Do we adhere to USPAP standards and reflect the value opinions of the collective market participants or do we "follow our conscience and feelings" and "dictate" a misleading appraisal value opinion in the face of market evidence to the contrary? 

In hindsight, appraisers that adhered to USPAP standards by neither over valuing or "conservatively" undervaluing the property as of the date of appraisal appeared to have nevertheless over valued properties once the market collapsed. Although they were not blacklisted from the lending community before the collapse, they were now vulnerable to wrath of blacklisted "conservative" appraisers; lawsuits by clients trying to claw back lost profits from the appraisers E & O insurance; and aggressive state appraisal licensing boards that, due to public outcry, felt a need to "protect the public good" by severely punishing appraisers that elected to reflect their market value opinions based on the collective market participants forecasts and opinions.

Its very difficult for an appraiser to defend previously appraised values, that have now collapsed, from other blacklisted appraisers that are now acting as "expert witnesses" in these "Monday Morning Quarterbacking" types of complaints.    

As a result, attempts to resolve this conflict has given rise to AMC's (Appraisal Management Companies) which are middlemen between lenders and appraisers. This policy grew out of the "conservative" appraisers complaint that lenders were pressuring appraisers to "hit" the right market value in order to close the loan. Most of the time, this market value opinion the lenders wanted "hit" was indeed the correct market value as reflected by the collective market participant opinions. The AMC attempt at "leveling the playing field" has actually exasperated the problem in the following ways:

  • Has increased the appraisal costs to the borrower because AMC's have to add their fee on top of the appraiser's fee. 
  • The AMC's fee has actually lowered the appraisers "customary and reasonable fees"
  • Has increased a draconian appraisal review process by AMC's and other review appraisers that inhibit the field appraiser from accurately reflecting the collective market participants pricing of a specific real estate property. This has led to excessive regulation and insufficient compensation complaints by appraisers. 
  • Has decreased the timely delivery of appraisals & customer service
  • Has created greater liability risks to appraisers even if they are following the rules and standards
  • Has increasing barriers to direct communication with lenders resulting in appraisal report acceptance and/or perceived report quality issues
  • Has delegated appraisal assignments to lesser-qualified appraisers
  • Has created a reluctance by appraisers to interact with clients out of fear of violating appraiser/client firewall
  • Has increased the wealth divide by punishing buyers and sellers that rely on financing when competing with cash buyers. This paves the way for cash buyers to snap up properties ahead of those buyers that have financing contingencies. These contingencies rightfully so have increased seller's risk of successfully closing the sale due to the buyer being denied the loan due to an unanticipated "conservative" appraisal opinion. 
  • Has discouraged the next generation of appraisers from entering the profession or existing appraisers from hiring them. 
  • Has lead to a shortage of qualified appraisers especially in rural locations. 

 This middlemen AMC solution has not protected the public in reducing the risks of inaccurate and/or "conservative" valuations. Nor has it reduced the risks of another collapse in property values in the near future. In fact, leading macro economists are predicting major valuation bubble formations are occurring in this country and all over the world for both residential and commercial properties. 

The exasperation of this conflict has also opened the door to the proliferation of "proprietary algorithms" big data, machine learning, and artificial intelligence types of valuation processes. These "black box" valuation solutions are being created and promoted by founders with little of no valuation experience. The reason they are called "black boxes" is because the valuation processes are not transparent in divulging their appraisal methodologies in arriving at the opinion of value. If you cannot transparently follow the appraisal process without asking the reader to take a "giant leaps of faith" to the conclusion of value, you are opening the door to massive incompetence and fraud. 

If there’s "proprietary algorithm" transparency, valuation experts will be able to better tell whether or not these processes are just junk science and/or do not adhere to  generally accepted appraisal standards and methodologies. 

Now you see why the feds are simply excluding appraisers from the process of buying and selling properties. By no fault of their own, appraisers have increasingly become part of problem and not part of the solution.   

The value industry's leadership and membership have to immediately make up their minds how best to proactively solve this conflict or, if they continue to stay on the defense, see their profession and services become increasing irrelevant. 

This solution first has to be in the best interest of the public and the world community, and second must have a place for all current participants to fairly participate at acceptable compensation for their services. Lastly, this solution must give all appraisers including "conservative" appraisers a way of quantifying and communicating their "feelings" of hidden risks without contradicting the collective market participants obvious market value conclusions as indicated in the previous $375,000 example.  
We think we have solved this problem for both residential and commercial properties and will be announcing this practical solution in the first quarter of 2019. We are a group of dedicated valuation experts with decades of experience in performing complex valuations and reporting. This solution will not exclude any of the current participants and will encourage the next generation of valuation experts in entering the profession. 

This solution will be used by designated and non-designated licensed appraisers; "conservative" appraisers, and appraisers that give greater weight to the collective markets determination of market value;   AMC's; lenders and other users of appraisal products; real estate brokers that provide valuation services; investors; developers; providers of risk analysis; and even the general public can use this solution in making better buying and selling decisions. 

This solution will actually speed up the underwriting process by reducing costs, reduce ineffective appraisal  regulations, and reducing the time it takes to prepare and transparently report the appraisal opinion.  

This solution does not throw out the "baby with the bath water".  Instead, it builds on the current appraisal process and generally accepted appraisal methodologies that are transparent and verifiable by the appraiser and recipients of the appraisal products. This solution for residential and commercial properties not only accurately and transparently derives a property's accurate current market value without bias, but also uncovers hidden risks previously undetected by the appraisal process. 
This solution does not exclude data scientists and other specialists in artificial intelligence, machine learning and blockchain technologies. These specialties can use their skills and talents in building upon the transparent foundation of the appraisal process that took decades to perfect. Their participation will add further risk reduction in helping to arrive at accurate and unbiased current market value opinions as well as reducing the risks of future market collapses due to previously undetectable bubble formations when the appraisal was performed. 
We welcome everyone's participation and opinions regarding this solution. Help stabilize economies,  encourages growth and promotes the well-being among citizens. By registering HERE   you will be the first to receives details of this innovative solution to a problem that has plagued our country and the world community for decades.  

Thursday, February 9, 2017


Want to know if your existing apartment complex is ready for a condo conversion?

As an MAI designated appraiser, many clients have come to me for an analysis as to whether or not their existing apartment complex is ready for immediate condo conversion. 

Recently, there has been a spike in interest from multi-tenant apartment owners and Realtors if the highest and best use of their property is for condo conversion. This interest is mainly due to rapidly rising housing rents, low interest rates and a lack of affordable housing supply for mainly first time millennial buyers.  

In many situations, the apartment owners can possibly have readily available condo buyers by converting their existing rental tenants that currently reside in their buildings. When these renters realize it is cheaper to buy their unit then to continue renting, it becomes a win/win situation for both the landlord and tenant. 

Even if this built-in demand exists for your property, how do you know if condo conversion isn’t your best exit strategy as opposed to just selling the property as an apartment complex? 

The only way to tell if condo conversion is your best option is by conducting two separate appraisals on the property. The first appraisal assumes you will sell the property as it exists as a fully leased apartment complex at stabilized occupancy and at current market rents. This appraisal indicates the property’s current “as is” Market Value. 

The second appraisal assumes you will convert the apartment complex into a condominium complex and sell each condo to individual buyers until all are sold out. This appraisal indicates the property’s current “as is” Bulk Market Value. 

Whichever of these to “as is” values is higher represents the property’s highest and best use. Even if you don’t intent on converting your existing apartment complex into condos, you should always sell your property based on its highest and best use corresponding value. 

If your property’s current “as is” Bulk Market (as a condo conversion) is higher than the property’s “as is” market value (as an apartment complex), sell for the higher value. Don’t leave any money on table! Your buyers are condo converters NOT apartment investors, in this case. 

The problem apartment owners have in selling their property is determining what the highest and best use of their property might be. To hire an MAI appraiser, like myself, would involve two separate appraisals as indicated above. This would cost several thousand dollars and possibly take weeks to complete. 

If you choose to have a professional appraiser prepare both appraisals, you will only receive the reports one time indicating values as of the date of the appraisers inspection. If appraisals indicate condo conversion, you will have to pay the appraiser to update the appraisal as more reliable data becomes available to you as you start the conversion process.  

To appraise the property as a condo conversion, the appraiser or property owner must know the following major components of value. 
  • Cost and time it will take to entitle the property for condo conversion 
  • Individual condo retail selling price points 
  • All cash competitive property yield based on the risk of the project
  • Entrepreneurial profit needed to entitle and sell out the project
  • Costs and expected time it will take to sell all the condos (absorption rate)
  • Temporary rental income and expenses as complex is sold out as condos
As the apartment owner, you might already know many or all answers to these questions. Even if you not sure, a “best guess” will give you a rough idea of your property’s “as is” Bulk Market Value if converted to condos. If this value is significantly higher than your property’s “as is” market value as an apartment complex, you might want to further explore condo conversion as the highest and best use of the property.

Through technology, there is now a way for you to personally solve these problems, fast, inexpensively, without bias or appraiser mistakes, and be able to update the appraisal as more verified data becomes available. You can even keep monitoring the progress of you condo conversion once you commit to proceed.   

This technology was created by certified MAI designated appraisers using generally accepted appraisal processes and financial modeling that would normally cost you thousands if prepared by professional appraisers.  

With this recently developed cloud based technology, there is a way you can obtain by yourself both the initial “as is” value for an apartment complex and the “as is” Bulk Market Value for a proposed condo conversion. 

For more information, press HERE and take a look at a sample appraisal report you can generate yourself for appraising your property as an apartment complex. Or, Press HERE and take a look at a sample appraisal report you can generate yourself for appraising your property as a condo conversion. 

Taking advantage of this new technology gives you an early advantage in this rapidly emerging condo conversion trend. By receiving more information about this new self help procedure, you will be given access to MAI designated appraisers that can answer all your questions. 

Monday, February 6, 2017


Here’s how to successfully break-in using stunning new technology

Just out of college, I was determined to build my wealth in real estate.  It was daunting when faced with the bodies of knowledge I had to master in order to be successful, i.e. investment analysis, appraisal standards, brokerage, financing, risk analysis, construction management, financial feasibility, market studies, etc. 

After getting a real estate license my freshman year of college and selling houses in-between semesters, I started interviewing successful developers and real estate investors of income producing properties and subdivisions. 

The most constructive advice I received from many of my interviews was “you’ve got to make your money on the buy not the sell”. This cryptic sage message wasn’t exactly clear to me and I pressed them for explain more in detail. They told me this advise entails a body of knowledge that only comes with professional training and experience. 

So, my junior year of college, I started working for a local MAI designated appraiser with the intent on gaining the professional training I needed. After two years of appraising single family houses, I was promoted to a commercial appraiser when I graduated from college. Now I had better access and information due to my appraising commercial developments, major remodeling projects, and subdivisions at various stages of development. 

Over the years, I Learned how developers “made money on the buy” by using time consuming financial spreadsheets to lessen their risk of financial loss (this was before computers!). 

After receiving my MAI appraisal designation, I personally began developing and remodeling commercial real estate. I used the secrets I learned in my professional training as well as the secrets I coaxed out of the successful developers in which I had appraised their proposed projects.  

Even when computerized spread sheets became available, the task of “crunching the numbers” before I purchased a property for development or remodeling was tedious, time consuming and mistake prone unless I heavily reviewed my work. 

As an appraiser, I continued my appraisal practice charging clients enormous fees to produce these kinds of investment analysis to early stage developers with proposed projects. Client projects ranged from:

  • Developing income producing properties or subdivisions (including condo projects) from vacant land

  • Remodeling or finishing existing income producing properties or subdivisions (including condo projects)

  • Purchasing existing income producing properties that presently were NOT at stabilized occupancy and/or market rent(s)

  • Purchasing existing income producing properties that were presently at stabilized occupancy and at market rent(s)                            

Now technology has advanced to such a advanced degree that complicated investment financial spreadsheets are available on-line. Software developers have refined the user experience making these once complicated models easy to use and easy to interpret the results. 

All the financial models have been constructed and reviewed to meet generally accepted appraisal standards. I just wish I had access to this technology when I was first starting out in commercial real estate. It would have saved me years of professional training and experience needed to create these models myself. I could have avoided the many financial mistakes I made over the years keeping me from fast tracking my present net worth and financial independence. 

If you’re starting out in commercial real estate or even if your a seasoned pro, take a look at the technology advances that have recently been developed for CRE by pressing HERE.  Not only will this technology save you thousand of dollars in professional fees for in early stage investment valuation and analysis, but will also prevent you from making critical financial mistakes. You will also be able to constantly update your analysis with a single click of your mouse as more reliable data becomes available and economic conditions change. 

This technology will enable you to “make your money on the buy, not the sell” by providing you the initial and on-going game plan for your proposed residential or commercial project or purchase.  

Here’s the best part. Even if you hire a professional appraiser or analyst, they cannot indicate to you if your property’s current market value or proposed finished market value has entered a dangerous bubble. 

No matter what your property’s current market value might be, automated investment analysis and machine learning can now tell you if your property’s current or proposed value is in a bubble. This new value sustainability feature uncovers hidden risks that, until now, have never been available to the general public and unsuspecting buyers. 

Click HERE to see examples of sample reports of automated investment valuations and analysis for various property types at different stages of development. No matter if your a buyer/seller, developer, remodeler, broker, lender or investor, you will eliminate the severe learning curve, expensive initial professional costs, and the excessive time it takes to receive a similar report from a professional.  You will also avoid the hidden risks of real estate bubbles that have never been available before. 

Remember, with proper planning using this new technology, you will be making your money on the “buy” not the “sell” similar in a way the most successful developers plan their proposed developments and commercial property purchases. 

Tuesday, October 4, 2016

Warning To First Time Condo or Single Family Buyers!

Is your SFR & condo’s sale price or market value in a bubble and going to collapse during the current economic cycle?

Millennials currently thinking about buying their first condo or single family house witnessed the collapse of residential values in the mid 2000’s economic cycle.  

Many of you potential buyers are wondering if this is a good time to purchase in our current economic cycle. In many markets, entry level condos and single family housing prices have reached their pre-recession price levels. 

How do you know if you’re purchasing that specific condo or single family in a localized serious bubble as many economist are warning? If this is the case, your purchase price will collapse and possibly leaving you with more mortgage than house value. 

On the flip side, your purchase price might be an awesome buying opportunity with more upside then you or the market realizes. 

You’re the first generation to have access to a free financial modeling technology that solves this important buyer concern. This software was created by experienced licensed credentialed appraisers and financial analysts. 

To use this software, you simply…

  • Answer four basic questions about your possible condo or SFR purchase. 
  • Insert the asking price or market value of your property. 
  • Print out an easy to read report explaining the hidden risks.  

To get your free customized report, press HERE to receive a login and password to this cloud based software. You will also receive a free training video explaining how the software works. 

You’ll be able to make the right buying decision regarding your proposed purchase within 30 minutes once you receive this information. 

Using this information will help you…
  • Realize you’re making an awesome buying decision, or
  • Negotiate a better sale price, or
  • Decide to cancel your purchase and wait for the next cycle to begin. 

If you decide to purchase the property, you can continually monitor the property’s market value indicating the prime time to refinance or sell at the top of the market.  

Your e-mail will remain confidential and will never be given to sales people or spammers.  We sincerely want you to make the best decision BEFORE you buy instead of regretting your purchase AFTER a bubble burst.  

Sign up now! Press HERE and give yourself the peace of mind that you’re making the right investment to one of life's biggest financial decision. 

Sunday, October 2, 2016

Trump: “We Are in a Big Fat Ugly Bubble”

Trump: “We Are in a Big Fat Ugly Bubble”

“There seems to be some perverse human characteristic that likes to make easy things difficult.”  Warren Buffett

In the first presidential debate, Mr. Trump stated, “We Are in a Big Fat Ugly Bubble.” His reasoning is the Fed’s irresponsibly in holding down interest rates that are creating real estate and other asset bubbles. 

Mr. Trump knows real estate bubbles can occur in some property types and locations due to supply and demand imbalances and/or misappropriations of one or more of the following economic balances:

  • The annual all cash risk rate’s (property yield) present value was accurately applied to the anticipated benefits expected by the buyers during their ownership. 
  • The market rent or market rent benefit (if owner occupied) was in the right proportion with the users demographic household annual income for residential properties, and also in the right proportion with the users demographic business annual income for commercial properties.  
  • The property’s market rent expectation increases kept up with actual users expected annual income increases.  
  • No irrational speculative expectation of the property’s future selling price appreciation was factored into the property’s beginning market value sale price. 

What Mr. Trump was referring to was the first bullet point. This economic balance states the property’s all cash risk rate (annual expected property yield) must be in sync with the actual risks being taken. This annual yield includes the expected ending sale price expectation. 

Investors and valuation experts base this all cash risk rate on alternative investments with similar risks. Due to artificially low Fed interest rates, many property’s current market values are being inflated due to lower going-in and going-out capitalization rates that are use to calculate a property’s current market value.  

These cap rates are being lowered leading to higher property values because buyers are leveraging (financing) the sale prices with artificially low interest rate loans. The resulting buyers annual equity yield appears to be competitive with alternative investments with similar risks. 

Without comparing a property’s current market value to its current fundamental value, the market will be unaware the property possibly has entered a dangerous bubble. 

If property values are in an ugly bubble, then Mr. Trump is correct that any interest rate increases by the Fed will have an adverse effect on property values. 

To see if your specific commercial or residential property is in an ugly bubble, there is a simple solution. 
  • First, have your property professionally appraised with an opinion of the property’s current market value. The traditional appraisal process uses comparable sales and data in deriving a property’s current market value. 
  • Second, have the property appraised based on its current fundamental value. This type of analysis uses the above four economic balances to appraise your property. A trusted real estate advisor can easily accomplish this for you using a new software ( You can even use this software yourself with minimal training and cost. 
This software automatically inputs your property’s current market value and compares it to the property’s current fundamental value. If your property’s current market value is significantly above your property’s current fundamental value, your property is in an “ugly” bubble.  

This means you are buying or holding the property at the top of a bubble cycle. The property’s current market value, in all probability, is not sustainable during the current economic wave cycle (approximately a seven year cycle). 

Conversely, you will have a great buying or holding opportunity if your property’s current market value is approximately equal or below its current fundamental value. 

In our bubble infested markets, it is now more important than ever to know your property’s current fundamental value as it relates to its current market value. This type of new analysis advises you when to buy, when to sell, and flushes out hidden risks that until recently were undetectable until the bubble burst.   

Tuesday, September 27, 2016

Warren Buffett’s “Value Investing” Secret Formula is a Solution to Solving Real Estate Bubbles (Part 2)

“Real knowledge is knowing the extent of one’s ignorance”, Confucius

In part 1 of this series, we discussed how Value Investing paradigm for the stock market has created enormous wealth for investors like Warren Buffett. The use of Value Investing made sense in evaluating trades do to the volatility and “corrections” that periodically occur.

Up until around 1970, Value Investing innovative techniques for real estate were not created and were unnecessary because property market values, cost of production, and fundamental values were in sync with each other.  Since then, in many residential and commercial markets, property current market values and their associated costs of production have significantly detached above these properties current fundamental values.

This “Margin of Loss” gap creates a hidden risk that market participants are unaware of until the real estate bubble burst. By that time the financial damage has occurred. This damage does not just impact the property buyer, as in the case of our stock market example, but rather the whole “food chain” that made loans, purchased loans, and bought financial instruments collateralized by these loan. 

The time is right to innovate a Value Investing strategy for real estate. “Margin of Loss” gaps are appearing in unsuspecting real estate types and locations around the country mainly due to: 
  • Globalization and “hot” money flowing into real estate from other countries. 
  • Loose money lending standards and misguided political policies.  
  • Investors taking greater risks in search of higher investment annual yields due to low annual yields of risk free alternative investments.
  • The markets “Irrational Exuberance” and speculation regarding a property’s forecasts.
  • Unsustainable market rents due to unresponsive bank lending for development projects that are needed to keep up with normal supply and demand for certain property types.   
Any one of these “causes” will create a “Margin of Loss” gap between a property’s current market value and its current fundamental value. The reason being is because these “causes” throw off the economic balances that were bullet pointed in Part 1 of this series. 

The trick to protecting yourself in these situations is to know exactly how big this gap might be, if any,  for your specific property using a Value Investing analysis BEFORE you buy or lend. 

So how can Value Investing techniques be used for real estate? You currently can’t buy this information from a valuation expert or trusted advisor. The valuation industry has not adapted  this new technology and continues to only give their opinion of the appraised property’s current market value. As previously indicated, this current market value of a property could have significantly detached from its fundamental value creating a wide “Margin of Loss” gap. 

Valuation experts reflect the market’s expectations by using recent comparable sales and other market metrics. Built in to these comparable sale prices and other market data are the market’s forecasts. If these comparable sale prices are not reversed engineered into the market’s forecasts, valuation experts and their clients will be unaware of any imbalance between the four economic balance bullet points indicated in Part 1 of this series. 

In these volatile changing times, we are still making buying and lending real estate decisions solely based on a property’s current market value opinion derived from comparable sales. In addition, we are not even analyzing the market’s forecasts that make up the property’s current market value opinion. Lastly, by not using Value Investing technology, we cannot see how dangerous the markets forecasts might be until we know the exact “Margin of Loss”, if any, between the property’s current market value and its current fundamental value. 

By continuing to value property in a “Vacuum” is analogous to “rearranging the deck chairs of the Titanic”. No matter how many accurate current market value opinions you receive on any given property, the results will be the same if a large “Margin of Loss” gap is not detected and the property is purchased or used for lending purposes. 

The general market of buyers and lenders cannot be expected to learn and create complex financial models, complicated algorithms and computer coding, and learn generally accepted appraisal standards needed to create a competent Value Investing paradigm technology.     

So a team of valuation experts, coding developers, web designers, and financial mathematicians were assembled to create a Value Investing Software for Real Estate called Valuexpose. This recently launched cloud based product was designed so that even the novice can learn and perform a Value Investing analysis on any property type and in any physical or economic condition.  

We are currently assembling a team of early adapters to train and use this product at no charge.  
Message me and I will send you a login and password to gain access to the software. Also, free training will be provided through a Udemy™ on-line training course specifically designed for the Valuexpose software. We are limiting the early adapters to 100 users that will receive a free lifetime membership at no charge for their feedback. 

The Dodd/Frank financial reform, tighter lending standards, limiting supply, low interest rates, and government guarantees have done nothing to stop bubble formations. As a matter of fact, these “reforms” are actually fueling new and more dangerous bubble formations. These formations are occurring in various property types and in various locations. There are thousand of different types of bubbles forming all over the country. “One bubble size fits all” is a misconception.

Please comment and share this post to keep the conversation going in solving the real estate bubble problem. Become an early adaptor of this new technology that takes investment analysis to the next level and standard of care. 

Warren Buffett’s “Value Investing” Secret Formula is a Solution to Solving Real Estate Bubbles (Part 1)

“Price is what you pay, value is what you get”, Warren Buffett

According to Mr. Buffett, current market value is the “Price” you pay for a property. This price can significantly differ from the same property’s current “Value”. By “Value”, Mr. Buffett is referring to “Fundamental Value”. 

Many years ago, Mr. Buffett understood this economic foundation and created a process of basing his purchasing decisions on a property’s fundamental value called “Value Investing”. You see, Mr. Buffett knew the laws of economic business wave cycles revolved around fundamental values.  

Using this formula mainly for stocks, he successfully purchased an interested stock if the stock’s fundamental value was greater than the market’s asking price (called current market value). The difference between these two values in this buying scenario is called the “Margin of Safety”. 

Mr. Buffett’s formula for arriving at a property’s fundamental value (also called Intrinsic Value) was based on an the company’s fundamental economic expectations in the future. This formula  stripped away any of the market’s “exuberance” speculation and other “irrational” forecasts. Mr. Buffett’s formula also allowed him to input his own risk tolerance to find those stocks with the greatest “margin of safety”. 

This Value Investing paradigm is used by the most successful stock and company investors like Mr. Buffett. The vast majority of investors are picking stocks solely on the prices of what competing stocks are selling for. Even if the an interested stock’s price is below what competing stocks are selling for (comparable sales), the selling price could be significantly above the stocks current fundamental value without the buyers knowledge. Although this stocks selling price appears to be a “bargain”, in reality it is most likely a “suckers” purchase as the value always falls towards its fundamental value over time. 

With “sucker” purchases, the only person that loses when the stock slides towards its fundamental value is the purchaser. What if commercial banks started loaning 75% to 80% of the buyers stock’s purchase price? Ever worse, what if these banks sold these loans into the secondary markets that had government guarantees against loan losses from any cause? What if these secondary markets bundled these loans into financial instruments and had them AAA rated by Moody’s or S & P? Lastly, what if these financial instruments were sold to retail investors and retirement funds?

Without the buyers, banks and rating agency knowing what the stock’s fundamental value was when purchased, this whole “food chain” could be vastly underestimating the risks they are taking. 

Fortunately, this type of “food chain” for stock does not exist and consequently places the risks solely on the stock buyer. If stock advisors don’t factor in the these risks in advising their clients, indirect losses can occur to the advisor if the clients don’t use their services again. 

Traditionally, real estate has been considered a tangible asset made up of land value, construction materials, labor costs, and developers profit. The “rule of thumb” was that the  current replacement costs, less any depreciation, of a finished property was considered to be the property’s fundamental value. 

This “rule of thumb” worked well when real estate values and their cost to produce did not change very much from the years between 1900 and 1970. This was because the balance between a property’s cost to produce and the property’s market value selling price were roughly the same during those years. From 1970 to 2006, the housing price index went from 20 to 180 before crashing back down to 120. Commercial market values followed this same trend over the last 100 years. 

Actually, the property’s market value was not made up of the cost of production but rather the markets forecasts of the benefits they will receive once the property was purchased. It just so happened market value and the cost of production were the same during those years because of these four economic balances that existed. 

  • The annual all cash risk rate’s (property yield) present value was accurately applied to the anticipated benefits expected by the buyers during their ownership. 
  • The market rent or market rent benefit (if owner occupied) was in the right proportion with the users demographic household annual income for residential properties, and also in the right proportion with the users demographic business annual income for commercial properties.  
  • The property’s market rent expectation increases kept up with actual users expected annual income increases.  
  • No irrational speculative expectation of the property’s future selling price appreciation was factored into the property’s beginning market value sale price. 

During this time period, the forces of supply and demand did not significantly impact any of the above four economic balances. Consequently, property market values stayed in close proximity to the property fundamental values. These economic forces kept new development costs of production in check and economically feasible. 

Stay tuned for part 2 in this series that will explain how residential and commercial real estate’s economic forces have gotten out of balance in some property types and in some US markets. The lack of synchronization with rational forecasts of just one of the economic forces can cause a significant detachment between a property’s current market value and its current fundamental value called a real estate bubble. 

In these circumstances, no matter how accurate your property’s current market value might be, even if you can buy the property below this market value, you might be buying a “suckers” purchase without knowing the property’s current fundamental value.    

This series of posts will propose a solution as to how you can economically protect yourself in this volatile real estate market. The answer is a Value Investment paradigm for real estate using advanced technology.  Please comment or share this post to start the process of solving devastating real estate bubbles.