No question about it — real estate prices are at bargain levels.  Many individuals seeking to recoup their stock market losses, or who are considering a career change, are seriously considering real estate as an investment opportunity.  However, despite the fact that rates are at historically low levels, lenders are still reluctant to loan money, and with the overall drop in appraised values, it is harder than ever to get an equity line of credit.  Even those with great credit scores find that lenders are reluctant to loan money for some of the more challenging types of investment opportunities, such as bulk REO sales, foreclosures, rehabs, and flips.  This is where you might consider using your retirement plan — your 401(k) or IRA - as an alternate source of funds.

First, you need to find a qualified IRA custodian who will allow you to invest in real estate, and not just “traditional” investments such as stocks, bonds or mutual funds.  A truly “self-directed” individual retirement account  (”SDIRA”) custodian will allow you to “self-direct” your retirement funds into “alternative” assets, such as real estate, notes and deeds of trust, and business opportunities.  This isn’t new - it has been available to investors since 1974 when Congress enacted ERISA.  What is new is the nature of investment opportunities that are available.

Several custodians offer the opportunity to use your SDIRA to invest in real estate, but there are restrictions and regulations.  The transaction must be arms length:  the account holder may not receive any direct or indirect benefit (i.e., commission); and they may not sell or buy property that is owned by a direct relative or themselves (i.e., you cannot purchase your mother’s house or buy a condo for your daughter while she’s attending college).  In addition, you may not make personal use of the property purchased with retirement funds.  Real estate investment property is generally ideal for using SDIRA funds.

With a SDIRA, your Custodian must control the disbursement of funds, and all proceeds (i.e., rental income or sale) must be returned to your IRA in order to maintain the special tax treatment provided for retirement plan accounts.  This means that all transactions must be processed through your SDIRA Custodian, which can result in fees and, in some cases, delays.  In some types of transactions, such as bulk REO sales, foreclosure sales, rehabs and flips, not only are there multiple transactions, but time is of the essence!

This is where a “Checkbook LLC” can help.  The process involves setting up a separate LLC funded and owned entirely by your SDIRA, and deposited directly to a checking account held in the name of the LLC.  As Manager, you would have the authority to issue checks to disburse funds for both minor and major expenses, pay fees, and generally manage the funds according to the time requirements imposed by the type of investments you are working with.  A classic example is the need for prompt disbursement when purchasing foreclosure property at the courthouse steps.

The “Checkbook LLC” is not for everyone, and there are some disadvantages when using SDIRA funds to invest in real estate.  The investor must be fully aware of and take special measures to ensure that the investments comply with the special restrictions, or risk losing the special tax benefits provided for retirement plan funds.  “Boilerplate” or “Internet” format LLC documents will often not be acceptable to SDIRA Custodians.  At the same time, don’t be fooled into paying thousands of dollars for unnecessary services, books and tapes.  Remember, your primary goal should be to invest your retirement funds in real estate, not gimmicks!  Always consult with a qualified professional, and take the time to learn more.

All types of investing involves risk, and investing in real estate is no exception.  There is no such thing as a “risk-free” investment.  You can learn to manage risk, and take steps to reduce risk – you cannot eliminate it.

According to conventional wisdom, higher risk is associated with higher rates of return.  New investors are encouraged to start with low yield, low risk investments until they get some experience.  This is good advice for two reasons.  First, new investors should take a cautious approach and determine their tolerance for risk.  Second, even a low, positive yield is better than a loss of your entire investment!

The most important step to managing risk is to identify and understand the risk factors.  Ask yourself “What could go wrong?”  One of the maxims of Murphy’s Law is that anything that could go wrong will go wrong.  Some factors are obvious – such as severe weather, vandalism, and tenants that fail to pay rent.  Other factors, such as changes in zoning laws or changes in local economic conditions, may be more difficult to predict but have equally devastating impacts on your investment.  The key to managing risk is to identify the factors and then develop a plan.

Get Educated.    If you are just getting started as a real estate investor, there is a lot to learn.  Unfortunately, most of the books in the bookstore and in the library were written and published before the recent housing crisis, and although they may provide some excellent background information, some of the methods they recommend are no longer applicable.  The best approach is to join a real estate investment association or club that focuses on education, not sales.  For a small fee, you can attend seminars and programs that will not only teach you some of the basics, but will highlight recent developments and trends.  Perhaps even more valuable, you will meet other people like yourself, as well as interact with experienced investors.

Make a Plan.   Consider both your personal and your financial goals, and develop a Plan.  A good Plan will focus on your goals.  Goals should be realistic.  Your plan should be flexible, and contain an exit strategy.  Your financial goals should support your personal goals, not the other way around!  Remember, good investment plans take time – there is no single perfect investment!  If an attractive investment opportunity comes along that does not conform to your Plan, you can re-evaluate your Plan, but don’t be too quick to abandon it.  The “deal of the Century” happens every week!

Due Diligence.  Every experienced investor will emphasize the importance of doing “due diligence.”  This means different things to different people, but in all cases, it involves learning as much about the proposed investment as you can before you write a check!  Some information is critical, whereas some is not.  It may depend on the type of investment, the location, or the structure of the deal.  Buying a single-family rental property involves different risk factors than joining an investment fund that concentrates on buying shopping centers.  The more you become educated about the different types of investment opportunities and the different factors involved, the better you will be able to narrow your focus and ask the right questions.

Research.  You don’t need to be a genius to make money in real estate investing, but you need to be smart.  And you can get smarter.  There are many different types of ways to invest in real estate – but keep it simple.  Only consider investments that you understand.  Talk to other investors, find out what can go wrong – learn from the mistakes of others.  Always double-check and confirm that you have the most current information, and don’t just rely on what someone says; fact-check.  Be careful to distinguish between facts and fantasy!  If the deal sounds too good to be true … it probably is!  Watch out for scams!

There are many sources of information – too many, in fact.  There are seminars, webinars, blogs, podcasts, more blogs, newsletters, podcasts, radio shows, and of course, the ever-present traveling real estate investment gurus who are coming to a convention hall near you.  Trying to sort through all of this can be overwhelming and time-consuming, not to mention costly.  Many of these so-called “free” programs are simply an opportunity to spend literally thousands of dollars buying CDs, books, and sign up for more programs.  Remember, your original goal was to invest in real estate, not CDs!

Real estate investment associations and groups, such as SJREI, hold regular meetings that you can attend for very low cost, and provide an opportunity to meet and interact with other investors – both new and experienced.  They feature speakers who are experts on different aspects of real estate investing, and who often have their own programs that you can attend or subscribe to for more detailed information.  Since every person is unique, and because there are so many different types of real estate investment products available, you should sample a few of these programs to find out what suits you the best.

Consult with Professionals.  This may seem obvious, but many people wait until after they’ve run into problems to talk with a professional.  Real estate investments involve making critical decisions that involve legal, tax and financial consequences.  Working with the right real estate, tax consultant, financial planner, and attorney may cost money in the short term, but the results may yield substantial savings in the long run!  Often, you will be able to use information from a qualified professional over and over, making it one of the best long-term returns on your investment!  Getting professional advice is one of the most effective ways to avoid risk!

Evaluate, Re-evaluate, Modify.  As you learn more and gain confidence, you may choose to modify your Plan.  Make adjustments to keep your Plan realistic and achievable.  Establish a realistic timeline for your financial goals.  Modify your Plan to help ensure that your Plan reflects changing circumstances.  For example, the “hot market” condition that enticed you to consider investing in one area may have cooled off, or gone into decline as a result of a change in local conditions (i.e., closing of a major manufacturing plant; severe flooding; or substantial new housing construction).  Review your Plan and modify it as necessary to adapt to these changes.  Always have an exit strategy!

Take Action.  Invest, don’t spend, your money.  You will learn by doing, so get started!  Invest in real estate, not sales pitches.  Don’t wait for the “perfect, risk-free opportunity” – it does not exist!  Getting started is important.  But getting started on the right foot is even more important!

Easter is a time of inspiration — to look for the positive side of life.  The economic crisis and its impact has been devastating, and the doom-and-gloom forecasters tend to get the headlines.  Despite this, I know we’ve survived worse, and we’ll get through this as well.  On reflection, it occurred to me that the distinguishing characteristic of a healthy, vibrant society is the willingness of its members to help others; to volunteer their time for the good of the whole; to invest — time, talent and money — in the community.

This year - 2010 - marks the 100th anniversary of Scouting in the United States.  Founded in England in 1908, and promoting the principles of doing a Good Turn and urging everyone to Be Prepared, Scouting programs now involve over 30 Million participants in over 160 countries around the world.  Here, in Santa Clara County, we have over 4,000 adult volunteers who help leverage the small number of professional staff to provide quality programs, leadership training and opportunities for outdoor fun and activities for approximately 16,000 youth members.  In 2009, over 220 boys earned the highest rank in Scouting - Eagle Scout — an accomplishment achieved by only 2 out of every 100 Scouts.  As one of these 4,000 trained volunteers, I truly appreciate the sacrifice in terms of time and effort, but I also recognize the value of this collective contribution to my community.

According to studies by Independent Sector, the value of a volunteer’s time in 2008 was calculated nationally at  $20.25 per hour, slightly higher for California ($22.79).    It is estimated that each of the 4,000 adult Scout volunteers devote approximately five (5) hours a week, or around 260 hours per year, on average.  Each of the 16,000 Scouts contributes at least an hour per month on a service project, and each Eagle project involves approximately 100 service hours towards a community benefit.  Added together, Scouting in Santa Clara County generates more than 1,250,000 hours of community service, for a combined value over $28,487,000!

Of course, the dollar value  — at best, only a rough estimate — does not tell the whole story.  Serving by example, these Scout volunteers provide leadership and inspire others, by fulfilling their promise to follow the Scout Oath and Law, and to Do a Good Turn Daily.  Whether building a new trail or working with autistic youth, honoring Veterans or collecting food, cleaning a creek or restoring a public park, Scouts not only improve their community, they show others the true meaning of citizenship.  By their actions, these volunteers are investing in their community, and in their future.  For a historical perspective, you can review a brief summary of Scouting’s contributions to the Nation since 1910 here.

A Scout is Thrifty, which is the theme of this year’s Friends of Scouting campaign.  Scouts have been at the forefront of the Green movement since their inception.  This year, the Friends of Scouting campaign goal for Santa Clara County is a modest $784,500.  Yet, this money will be leveraged by the combined volunteer effort to produce more than $28 Million in community benefits this year alone!  $36 for every $1 donated works out to a really Good (Re)Turn on your investment!  So, Do a Good Turn, and make a contribution to Friends of Scouting — and help the volunteers and staff to continue their work serving the community.  You can donate online, or send a check.  For a copy of the Friends of Scouting brochure and donation form, click here.  Any and all contributions of any amount are welcome.  And even if you cannot afford to contribute money, think about what you can do to volunteer some time in 2010 to help your community.  Thank you.

Are municipal bonds going the way of subprime loans?  Will the threat of municipal bankruptcies adversely impact real estate values?  Should real estate investors be concerned?  Recent articles suggest the answer to these questions is a qualified “Yes.”  But while it may be too early to tell for certain, the forecasting dynamics are like predicting earthquakes — the proof of your theory may be a disaster of unprecedented magnitude.

The WSJ reported on 2/18 that cities around the country were evaluting the potential benefits of filing bankruptcy under Chapter 9, a seldom-used section of the Bankruptcy Code that provides limited ability for municipalities to file for bankruptcy protection.  There have been only 600 Chapter 9 filings since the provision was enacted in 1934.  One of the largest in recent history was Orange County, CA in 1994, but the current situation in Vallejo, California is grabbing the headlines.  There, the City has moved to used Chapter 9 to get out from under its union contracts with municipal employees, including police and fire personnel, and the issue is under appeal.  The WSJ reported that the City of Harrisberg, PA, with a population of only 47,000 — is facing $288 Million in debt and a $2 M payment due March 1st.  The San Jose Mercury News reported on 2/19 that the City of San Jose is facing a $100 M deficit, and a 15% cut in payroll across 6,521 employees would be necessary to avoid 550 layoffs.  San Jose is considering asking for a 1/4-cent hike in Sales Tax, a proposal with lukewarm support, but it would only raise around $30 M.

Underlying these stories is another looming crisis — the potential of an unprecedented disaster in the muncipal bond market.  Long considered a “zero-loss underwriting” market, the municipal bond insurance industry is looking closely at the situation.  In the near term, the threat appears moderated by technical factors under Chapter 9 rules, which allows special revenue bondholders to continue to receive payments, unlike the automatic stay provisions of Chapter 11.  But bond insurers are starting to set aside reserves, and some issuers are seeing their ratings drop.  If nothing else, it will make it more difficult — and expensive — for cash-strapped municipalities to raise funds.

What impact will this have on real estate values?  Already severely depressed by the current and looming inventory of foreclosed properties, real estate values have plunged, and even the most optimistic predictions acknowledge the recovery path is long and shallow.  But virtually every “Top-10-Best City” list for areas to live, invest, raise families, etc., is based on statistics that are heavily influenced by the level and quality of municipal services:  police and fire protection; crime rates, public parks and libraries; education and cultural activities; public transportation; bustling downtowns; and other similar criteria.

Here is where the picture gets darker.  Several articles cite a recent rise in crime in Vallejo as evidence of the hidden cost of filing bankruptcy, and the City has called for assistance from the Highway Patrol and surrounding communities.  But the State and local entities are themselves strapped for cash and resources.  San Jose has already made drastic staffing cuts in its Redevelopment Agency staff, and it’s clear that park and street maintenance efforts are on life support.  In short, every muncipal government in the United States is facing a budget issue as a result of the downturn in the economy, and their need to cut back services will further diminish the quality of life of their residents — and adversely impact the quality-of-life rating criteria typically used to rank them.  There aren’t many Mayors who don’t appreciate the irony — cutting back muncipal services, although essential to save money — will adversely affect quality of life and deter investment.  But filing bankruptcy could have even more drastic impacts — both tangible and psychological — which why no one wants to be the first.

There was a time, not too long ago, when the typical homeowner scoffed at the plight of the subprime loan holder, often blaming them for foolishly taking out a loan too rich for their income.  Very few homeowners, especially in California, ever considered the possiblity that their home value would decrease, and most people used to view bankruptcy or foreclosure as an extreme, last-ditch measure.  Even fewer had ever heard of a loan mod, and fewer still knew what a “short sale” was.  In a similar manner, local government officials do not want to be on the bleeding edge of trends, which is why they currently are doing all they can to resist using Chapter 9, just as so many homeowners once resisted the temptation to walk away from upside-down properties.  But if Vallejo’s “experiment” is upheld, and cities are unable to find new sources of revenue, the psychological barriers may be overcome by sheer necessity.  Bond insurers, investors, and Mayors are all watching closely.

Every successful real estate investor works with a team of professionals.  For those who are getting started, you should include a lawyer on your team, but start early.  If you wait until a situation becomes a crisis, the process can be confusing and could get very expensive.  Selecting the right lawyer can take some time and effort, but it will be worth it.

Even after going through a process of getting referrals from friends and colleagues, doing research on the Internet, and perhaps conducting a couple of interviews, you still need to learn how to make the best use of this valuable resource as a member of your team.  Many advisors promote the use of the “10 Question” approach – asking a series of questions before you hire a professional, such as a doctor, lawyer, financial planner, or other specialist.  These are often the same questions:  What is your experience? How long have you been doing this?  Have you handled cases like mine?  What is your success rate?  What do you charge?  How much will it cost?  What will be your approach?  Who will be handling the file?  What are my chances of winning?

These are all good questions, but I recommend a different approach – asking yourself a series of questions before you hire a lawyer.  Let’s face it – if you’re in trouble, you are not in the best position to bargain.  Imagine asking your cardiologist about his fees as they’re wheeling you into the emergency room.  In the real world, it is not always practical or advisable to negotiate with the ambulance driver or the roto-rooter man.

In order to make the best use of a lawyer on your team, you should ask yourself the following questions.  At all times, you will (or should) know more about your circumstances than your lawyer.  If you don’t know how you got into a dispute, or what you hope to achieve, how can you expect any professional to assist you? By asking yourself the following questions, you will find that you will be able to maximize the return on your investment in professional legal advice, and make the best use of the lawyer on your team.

1.  ARE YOU SEEKING KNOWLEDGE, JUSTICE OR REVENGE?

In other words, are you planning ahead or reacting to a legal problem?  If you are just getting started in a business or real estate transaction, a lawyer should be able to help you spot potential problems and provide useful guidance.  On the other hand, if you have been sued or recently experienced a breakdown in a business transaction, you need a lawyer who can help you review your options, and if necessary, take legal action on your behalf.  Unfortunately, most people wait until they need a lawyer instead of seeking advice before the need arises.  Consulting with a lawyer before circumstances force you to hire one can prove to be one of your most valuable “investments.”

2.  HOW DID YOU GET HERE?

If circumstances suggest you need to hire a lawyer, the first question you should ask yourself is “How did this happen?  How did it get to this point?”  Carefully and objectively review the chronology of events leading up to the dispute, and be prepared to explain to the lawyer what steps you have taken, if any, to resolve the matter.  Generally, disputes don’t happen suddenly.  Documenting the events will help your lawyer better understand the background and could save you significant amount of legal costs.

3.  IS THIS A BUSINESS ISSUE OR A LEGAL ISSUE?

A majority of disputes arising from real estate transactions involve primarily business issues rather than legal issues.  All dispute resolutions ultimately involve decisions that encompass elements of legal rights, fairness and equity.  A lawyer cannot make business decisions for you, but they can explain different legal strategies and consequences affecting your strategic planning and the “bottom line.”  The more the lawyer understands your business model, the better the chances the legal advice will be tailored to your situation.  Ultimately, you must make a decision, or it will be made for you.

4.  HOW MUCH IS AT STAKE?

This is usually among the first three questions a lawyer will ask you.  The answer helps the lawyer to understand the nature of the dispute and assess the amount of resources that might be required.  Every client should understand the importance of doing a cost-benefit analysis before going forward with expensive legal strategies.  Under the American judicial system, recovering your legal costs and attorneys’ fees is the exception to the rule.  If you feel you have been wrongfully sued, or are seeking your “pound of flesh” from a former business partner, seeking justice or revenge can be very, very expensive.  Legal disputes can end up costing hundreds of thousands of dollars and could result in a person losing their career, their marriage, and sometimes their sanity.  A good lawyer who is looking out for your best interests will help you to carefully evaluate all consequences of a proposed legal action.  Be realistic when evaluating the relative costs versus the benefits of your legal strategy.

5.  CAN YOU MAKE BETTER USE OF YOUR TIME AND MONEY?

Litigation can take up a lot of time and cost you lots of money.  You should make your decision on the basis of what is best for you in the long term.  What outcome is most compatible with your long-range plans?  If you have suffered a loss of money in a transaction, consider the “hidden” cost of trying to recover the funds, such as the amount of time you will have to spend searching for documents, attending depositions, and preparing for trial, not to mention attending a lengthy trial in some cases.  You should consider how you could use this time to better advantage – perhaps making more money than you lost!  You should evaluate what you can learn from the experience, and put that knowledge to good use.  Do the math – and consider the return on investment.

6.  HAVE YOU DONE YOUR HOMEWORK?

Before you hire a lawyer, do your homework.  You know more than anyone about your case and the circumstances.  Thanks to the Internet and many excellent publications like Nolo Press, you can educate yourself about some of the relevant law that may affect your situation.  It is rarely a good idea to represent yourself, but learning more about the law will help you ask the right questions when you meet with your lawyer.  Since most lawyers charge by the hour, doing your homework will save you money.  A better understanding of the legal process will also help you make better decisions about your case.  Doing your homework can yield a valuable, tax-free free return on your investment.

7.  WHAT WOULD YOU SETTLE FOR?

One of the first questions a lawyer should ask their client is what they would be willing to accept to settle the case.  Clients are often skeptical – why think about settlement when they have a good case?  The reason is simple – there is no such thing as a guaranteed outcome.  More importantly, our legal procedures make it mandatory for parties involved in litigation to make a good faith effort to resolve the dispute through “alternate dispute resolution” procedures, such as mediation and arbitration, before going to trial.  There is absolutely no way to know for certain how a Judge or Jury will decide your case after a trial, and the post-trial procedures for challenges and appeals can go on for years (yes, years).   If you want to have any control over the future of your case, you need to consider settlement.  In fact, most cases can be settled before any litigation is commenced.  Over 90% of all cases filed in Court are settled before going to trial, and many more are settled within hours of commencing the actual trial.  Bottom line:  the sooner you can settle a dispute, the less it will cost in terms of time and legal fees.

8.  HOW COULD THIS SITUATION BEEN AVOIDED?

At some point, usually after you receive an invoice from the law firm you hired, you will ask yourself how the dispute could have been avoided in the first place?  Obviously, it would be better to know the answer before you get into difficulties, but hindsight tends to teach us the value of foresight.  Consulting with an attorney before you commence a business or real estate transaction could be the most valuable use of your time and money.  Because lawyers see lots of problems after they’ve occurred, they can usually provide some good guidelines on how to avoid them in the first place.  CAVEAT:  You cannot prevent litigation, but you can take steps to reduce the probability that it will occur.  The sooner you ask the question, the more benefit you will gain.

9.  WHAT IS THE BEST WAY TO PROTECT MY ASSETS?

There are many, many books and seminars available on the topic of “asset protection.”  Most of these are sold on the premise that you could “lose everything” in a lawsuit.  Novice real estate investors are frightened into spending thousands of dollars for all sorts of “asset protection” schemes that, in the long run, are often useless and unnecessary.  Selecting the correct entity for your business model, whether it is a C-corporation, an LLC, a limited partnership, has important consequences for accounting and tax issues, and in some cases may serve to provide you with an added degree of privacy.  But the two most important steps you can take to protect your personal assets are (1) good management practices, and (2) insurance.  The combination of these two factors work together to resolve almost all types of legal challenges, and as noted above, most cases settle before any judgments are handed down.  Statistically, the probability of anyone “losing everything” as a result of a lawsuit is extremely small, yet some people invest more money in asset protection schemes than they invest in real estate!

10. WHEN IS THE BEST TIME TO TALK TO A LAWYER?

Now. Really – now! If you’ve already made a decision to get involved in a business or real estate transaction, or want to get started investing in real estate, you need to have a lawyer on your “team” of professionals to consult as you go forward.  For the cost of an initial consultation, you could learn a lot about where your plan may need further review, what risks you may not have considered, and key questions to ask your investment partners before you proceed any further.  It may be the wisest investment of your time and money that you’ll ever make!

Many people would like to invest in real estate.  Housing prices have plummeted; rates are at historic lows.  You can actually buy cash-flow investment property in California!  It’s a great time to buy real estate.  But how do you get started?

There are several ways to invest in real estate.  You can buy investment rental property, or purchase in an interest in an investment company.  You can buy single family homes, apartment buildings, REOs, fixer-uppers, or even raw land.  Or, you can purchase tax liens, options, or notes.  Thanks to the credit crunch, you can also invest by loaning money secured by real property.  There are several strategies, such as:  “buy and hold,” “leveraging,” “flipping,” “wholesaling.” for maximizing profit:  flipping, “buy and hold,” leveraging, wholesale contracts.    For the new investor, it’s like learning a new language.  There are literally dozens of books and articles in the library, the bookstore, and on the Internet - it can seem very overwhelming!

A word (or two) about risk.  All real estate investing involves risk.  There is no such thing as a “risk-free” investment.  You can learn to manage risk, and take steps to reduce risk - you cannot eliminate it.  Each individual has their own personal risk tolerance level.  While getting started, consider what would happen if you lost your entire investment.  As you gain experience and confidence, your tolerance for risk will probably increase, along with your ability to reduce the risks inherent in any investment.  An important element of risk management is to avoid problems, whether they are of an economic or legal nature.

There is not enough room here to explain everything you need to know about real estate investing, but a few pointers will help you get started.  I strongly recommend new investors should attend real estate investment seminars, talk to other investors, and read books and articles on real estate investing.  Learn the language.  Consider a low-risk, short-term investment and try it.  You will learn more “by doing” than anything else.

First Step:  Make a Plan.  The most important step is to consider both your personal and your financial goals, and develop a Plan.  A good Plan will focus on your goals.  Goals must be realistic.  Your plan should be flexible, and contain an exit strategy.  Be sure to have a Plan before you write your first check!

Your financial goals should support your personal goals, not the other way around!  Determine where you want to be in a few years down the road:  in a new home; retired; or not worrying about the kids’ college tuition.  Your financial goal should be to earn enough to help you reach your personal goals, plus a little extra for emergencies.  Remember, good investment plans take time - there is no single perfect investment, despite what some promotional ads try to make you believe!

Second Step:  Do your Research.  You don’t need to be a genius to make money in real estate investing, but you need to be smart.  And you can get smarter.  Again, I recommend that you attend real estate investment seminars (like SJREI) and talk to other investors.  Warning: Be wary of motivational seminars that try to sell you investment products, books, software programs, and CDs.  Listen.  Learn.   But don’t buy everything they sell -or say!   Invest in real estate - not gimmicks!

Remember, there are many different types of ways to invest in real estate.  Focus on those that you understand and are comfortable with.  When you are getting started, avoid complicated schemes, and stick to simple.  Achieving a level of comfort and success with one type of investment activity or another requires practice and patience.  Smart people learn from their mistakes.  Really smart people learn from other people’s mistakes!  (Hint:  everyone makes mistakes.  Try to make small ones, not big ones!)

As you learn more and gain confidence, you may choose to modify your Plan.  Make adjustments to keep your Plan realistic and achievable.  Establish a realistic timeline for your financial goals.  Modify your Plan to help ensure that your Plan will remain current and relevant.  For example, you might choose to modify your plan to invest out of state, or to team up with other investors.  The key to survival is adapting to a changing environment, and a smart investor must be prepared to adjust their investment strategy in response to changing economic conditions.  Remember: It is important that your Plan include an exit strategy.   In addition to doing Research on your strategy and a more specific investment proposal, you should develop a reliable “team” of professionals you can rely upon for timely, relevant advice.  Most successful investors have a team of tax specialists, real estate agents, attorneys and other professionals they work with on a regular basis.  They are often well-worth the cost of their services.  You can use the knowledge you gain from your professional advisors over and over.  The rate of return on your investment in professional advice is priceless!

Other steps to take:  Research the market and local conditions.  Fact-check information you get at seminars.  Remember: If it sounds too good to be true, it probably is!  Don’t rely on obsolete  information.  A lot has changed in the past two years - check the dates.  Learn as much as you can about the local market, demographics, and conditions.  Get local information:  use the Internet, but don’t rely on what you see online.  Find local newspapers, churches, and realtors, and talk to someone “on the ground.”

Finally, as part of your research, don’t forget to make sure the investment is consistent with your financial and personal goals.  If not, STOP.  Ask yourself:  “Will this investment get me closer to my financial goals?”  If the answer is “No,” step back slowly from the checkbook!  If you don’t have enough information to answer the question, you need to do more Research, modify your Plan, or find a new investment.

Third step:  Action.  Invest, don’t spend, your money.  If your ultimate plan is to make money investing in real estate, invest in real estate - not in sales pitches.  Remember, there is no such thing as the “perfect” investment. When getting started, it is okay to proceed slowly and deliberately, but you need to proceed.  Take a deep breath, get going, and keep an eye on your exit strategy!

Getting started is important.  Getting started on the right foot is even more important!

“You’re going to lose everything you own,” the speaker solemnly warned the audience at a recent real estate investment program.  “We live in a very litigious society,” he continued; “you need asset protection.”

Real estate investors, as a group, will flock to hear speakers talk about the need for what is commonly known as “asset protection.”  They will spend hundreds, if not thousands of dollars setting up elaborate business entities (the LLC - “Limited Liability Company” - being the most popular), in an effort to avoid “losing everything.”  Ironically, many new investors spend more money on “asset protection” than they do on real estate.  Sometimes they end up with all sorts of asset protection entities, but no assets to protect.

There is a more rational and practical approach to asset protection.  Setting up the correct business entity to allow you to achieve your real estate investing objectives is both important and necessary.  The correct entity will allow you to take full legal advantage of tax benefits and provide a structure for running the business.  Properly established and registered, the entity will allow the investor to work with investment partners, obtain financing, and provide a basis for determining the relative percentages of ownership and allow for succession and continuity for a successful operation over a period of time.  And yes, the entity will provide a measure of “asset protection” for the benefit of the principals, if the entity is properly established and capitalized, and has complied with the appropriate level of corporate formalities.

However, no form of entity is a substitute for good risk management.  The fundamental components of a good risk management program are (1) good management practices, (2) adequate insurance coverage, and (3) regular review and oversight.  For real estate investing, good management practices include using the services of a reputable, licensed, professional property management company.  The relatively small cost (usually 6 - 8%) will be more than justified by the savings from avoiding disasters.  Good management includes proper screening of tenants; regular and thorough inspection of the investment property, arranging for prompt and competent repairs, and if necessary, timely initiation of eviction proceedings.

In addition to standard form “all risk” fire insurance policies, adequate insurance coverage should include, where appropriate, flood, earthquake and other forms of disaster coverage.  I recommend that tenants be required to carry renters insurance, which can cost as little as $12 per month, but will cover the tenant’s personal belongings, relocation costs (if necessary), and injuries sustained by their guests.

Last, but not least, good risk management practices includes regular review and oversight.   “File and Forget” is not a smart way to manage anything.  Prudent owners make sure they manage their property managers, and take steps to ensure that their expectations are met.  Do not just sit back and hope the checks roll in every month.  Be proactive. Pay attention.  Ask questions.

But what about “asset protection.”  What if something “bad” happens, the tenant sues, and the investment property is in your name and not buried under an onion’s worth of layers of special entities?  What can happen?  Indeed, what DOES happen?

First and foremost, the type of liability that owners need to be concerned about involve claims resulting from personal injury, either to the tenant or their guest.  Injuries can range from a sprained ankle caused by a crack in the walkway to serious brain injury (or death) resulting from a collapsed balcony or similar structural failure.  There are also potential claims based on acts of discrimination, for example, but in terms of monetary damages, the “big ticket” issues usually arise from personal injury cases.

In such cases, the first and best line of defense is good property management, as discussed above.  In terms of avoiding catastorphic loss, investing in good prevention can yield a very high rate of return!  The next line of defense is your insurance policy (or policies), which should include comprehensive general liability coverage.  In the event of a claim, the insurance company will provide legal counsel and will pay for investigation and other costs arising from the incident.  If early settlement does not resolve the issue, and the matter proceeds to litigation, your insurance company is most likely under an obligation to provide a defense in most cases.  There are general exceptions, such as for willful or deliberate acts, and specific exceptions, such as where the policy does not cover certain types of loss unless a special “rider” has been obtained; i.e. flood, earthquake, etc.

Statistically speaking, it would be extremely rare if you found yourself facing a full-blown lawsuit with a prospect of a large jury verdict that might exceed the limits of your insurance coverage — the type of catastrophic “lose everything” outcome that promoters of “asset protection” programs use to sell their services.

Let’s look at the reality — not the hype.  It is fairly well established that close to 90% of all lawsuits that are filed will settle before going to trial.   So, if your insurance company has not been successful in resolving the claim and the plaintiff (i.e., your tenant) proceeds to file a lawsuit, the probability of the matter going to trial before a jury is 1 in 10.  Arbitration, mediation and other forms of formal dispute resolution are mandated by most State rules governing litigation.   In California, the parties are required to participate in a Mandatory Settlement Conference the week before the start of trial.  Statistics vary, but in one County, the Court noted that one-third of all remaining cases settle at the Settlement Conference, usually held on the Wednesday before the start of trial; another one-third settle on the Friday before trial, and a percentage settle even after the jury has been seated.  Again — as a statistical fact — very, very few cases make it all the way to the end of trial.  And even after the Jury renders a verdict, there are appeal procedures, that work to modify the outcome.  Many headline-grabbing jury awards are often reduced — drastically — by these types of procedures.

Real estate investors should consider the actual threat of “losing everything” in considering how best to protect their investment and their personal assets.  Sadly, many new investors spend more time focused on so-called “asset protection” measures than they spend doing their due diligence in relation to the investment itself.  Investors pay money to set up elaborate LLC entities only to find themselves locked into a bad investment with other partners they did not take time to know.  If one added up all the personal injury jury verdicts that exceeded insurance policy limits over a 10-year period in the United States, I wonder if the total amount would come close to matching the losses caused by Bernie Madoff and his scheme.

This is not to say that forming a LLC or a C-Corporation is not a good idea.  Properly done, the appropriate business entity provides the means to manage your investment assets, entitles you to certain tax benefits, and manage your investment partners.  But a business entity should never, ever be a substitute for good management practices.

Is the glass half full or half empty?  Or is it the wrong glass?  On October 8, Treasury Secretary Geitner announced that the Administration’s loan modification program was on target to help 500,000 households avoid foreclosure.  On October 9, a Congressional TARP Oversight Panel released a crtical report that predicted the Administration’s program would, “in the best case,” prevent “fewer than half of the predicted foreclosures.” (NY Times 10/10/2009).  Who’s right?

The problem, of course, is that no one really knows.  The program, which requires completion of a three-month “trial” period for a homeowner to qualify for a “permanent” loan modification, is still in the infancy of the implementation period to provide any meaningful statistics.  According to the NY Times article, as of September 1st, only 1.26% of trial modifications had become permanent, and the plan had produced only 1,711 “permanent” loan modifications.   Many of these so-called modifications involve only a short-term reduction in rate with no reduction in principal, and leave the homeowner upside down with no hope of qualifying for a refinance.  With many Option ARM loans due to reset, and thousands of new homeowners who just entered the market to take advantage of the 3.5% FHA down payment and the $8,000 tax credit, the stage is set for a new wave of delinquencies if the job market continues its current trends.

Another problem is the so-called “shadow inventory” - the homes that should be on the market at a trustee or foreclosure sale, but are not.  The evidence is empirical but not necessarily reliable.  Stories abound of homeowners who have not made their mortgage payments for months, but who have yet to receive a Notice of Default fromt their lender.  Perhaps some lenders are waiting to see how their first round of “trial” modifications play out.  In some cases, the sheer volume of applications has overwhelmed the loan servicers, forcing delays stretching into months while the applications are “under review.”

Bruce Norris recently attempted to calculate more precisely the extent of this phenomenon, noting that the number of Trustee Sales had dropped despite the ever-increasing number of delinquencies.  In July, 2009, he reported the number of Trustee Sales in California had dropped to slightly more than 17,000, compared to almost 29,000 in July of 2008.  Based on the number of deficiencies, the number of Trustee Sales should have been almost three times as many - 52,700!  Running the numbers over the past year, comparing delinquencies vs. trustee sales, Bruce Norris calculates that there are approximately 306,329 additional homes that should have gone to trustee sale in California.  If the rumors about delinquent homeowners who haven’t even been added to the list are even partially true, the discrepancy would be even higher.  And if the best the Administration’s Plan can hope to achieve is “less than half” of the predicted foreclosures, the prospects for success are indeed dismal.  Any grade less than 50% would not be considered acceptable under any circumstances.

Rising unemployment, overwhelmed and untrained loan servicing agencies, and a continuing refusal to provide adjustment for actual market value, are all ingredients for failure.  Add a few scoops of Option ARM resets, continuing chaos in the appraisal system, and a whole new crop of FHA-backed minimum-down mortgages to the mix, and you have the classic recipe for a catastrophe.  On the national level, the conflicting statistics only generate fuel for debate over policies and programs.  But at street level, families and neighborhoods continue to suffer from the collapse of a complicated securitized mortgage marketing scheme that should not have been allowed to take over and replace a more fundamental but functioning system.

What most homeowners facing default fail to grasp is that the investors who hold or control their mortgage have absolutely no incentive or interest in “saving” the homeowner from default.  All that matters is the value of the Note, and in any particular situation involving a portfolio consisting of hundreds or thousands of individual Notes, which in turn comprise security for an investment held by shareholders, the decisions whether or not to modify the terms are made — not for the benefit of the individual homeowner — but purely and simply on the basis of the impact on the value of the portfolio overall.  Complicating this process are multiple layers of IRS, SEC and similar regulations and restrictions that limit the extent to which the portfolio managers can make adjustments without putting the shareholders — or themselves — at risk.  As it is, the best a lender can tell a homeowner in distress is that they will do a “charge off,” effectively shifting the financial burden for the loss from the lender to the borrower.  While it sounds like a huge break if the lender “forgives” a $100,000 Note, the lender gets to write off the loss against other gains, while the homeowner faces the prospect of a $40,000 tax bill via a Form 1099.

There are solutions out there.  Modifying the tax codes and restructuring the securitized mortgage market dynamics would take too long and would offer little in the form of timely relief.  I like Bruce Norris’ concept of returning to the days when an investor could buy a property by assuming the existing loan.  It would be a simple transaction, and return control of the housing market to people willing to work to make it succeed, instead of faceless institutional speculators amassing unmanageable volumes of security instruments that bear little relation to the properties they represent.  Investors would be permitted to manage their risk more directly, and more importantly, homeowners would have the opportunity and the incentive to participate in the process for a successful outcome.  It provides the opportunity for a classic “win-win” that would save families, preserve neighborhoods, and restore communities.

In a recent article published on September 18 in Forbes Magazine, “Where Home Prices are Hitting Bottom,” author Francesca Levy attempts to make sense out of recently compiled housing price data produced by a Mountain View research firm, Altosresearch.com, in effect trying to explain where and how different Metropolitan Statistical Areas (MSA) would be hitting “bottom.”  The data focused on whether the number of homes selling at a discount had declined or held steady.  Presumably, if the number of homes selling at a discount was declining, the argument could be made that the housing market in that specific MSA was close to the “bottom” — and a signal to investors to buy.

Four days previously, Ms. Levy had authored another article in Forbes, entitled “Where Home Prices are Likely to Rise.”   In that article, Ms. Levy reported on a housing price forecast produced by Moody’s Economy.com.  As reported, Moody’s calculations were based on long-term demographic and economic fundamentals, changes in income and population, and supply and demand.  Overall, the prediction was for a nationwide 16.08% decrease in prices by the end of the year, but by 2014, prices “will have nearly reverted to their pre-2009 state.”

For San Jose, the article says that the five-year forecast calls for a 23.04% jump in prices; however, that will follow another 25.14% decrease within the next year!  Housing markets in Texas will not see much of a climb, but then they also won’t experience much of a decrease.

As I’ve fondly quoted Yogi Berra:  “Making predictions is difficult, especially about the future.”  The Forbes articles make for interesting reading, and the online graphics are impressive.  But the “small print” caveats continue to provide the harsh reality check.  No one knows the full extent of the number of homes that will go into foreclosure, whether Congress will extend (or increase) the first-time homebuyer’s tax credit, scheduled to expire on November 30 of this year, and certainly no one knows if the banks will relax credit and start making loans again.  FHA, which has been providing a substantial number of loans, recently announced it has to tighten credit due to low reserves.

All of this makes for interesting reading, but one has to question where it takes us.  There are a number of unprecedented anomalies that makes me wonder if the forecast models are valid.  At least one real estate expert noted recently that there were over 2 million excess housing units in California — a shocking number given the number of programs designed to address housing shortages in this State.  California recently hit 12.2% unemployment.  Add to this a “shadow” inventory of properties that have not yet been foreclosed, due either to voluntary moratoriums or deliberate efforts to control inventory.   The Wall St. Journal reports there are approximately 1.2 million homes where the foreclosure process has not begun, even though the mortgages are more than 90 days past due.    The repercussions on local governments across the country have yet to be fully felt, let alone measured, yet are causing unprecedented cutbacks in services.   Ultimately, the entire process will come down to buyers’ ability to purchase homes, whether as first-time buyers taking advantage of tax credits and other incentives, or property owners selling their existing property and moving up.  Without jobs, this simply will not happen.

Therefore, I question what it means to say that housing prices in any specific MSA will rise or fall over any projected time period, given the current turmoil in the market, particularly the inability of the typical person to borrow money.  At the special Norris Group event held on September 11, 2009, “I Survived Real Estate 2009,” the various speakers were remarkably eloquent if not cautious.  David Kittle, 2009 Chairman of the Mortgage Banker’s Association, and John Young, Vice President of the California Builders Industry Association, along with other panelists, were quick to point out that for every new home purchase would result in an additional expenditure of $7,500 for furnishings and supplies, and noted that Congress is considering a $15,000 tax credit.  They claim that if enacted, this would result in over 400,000 home purchases, significantly reducing the backlog of troubled inventory.  Interesting concepts, and worthy of consideration as a means to jump start the economy.  But such a move by Congress, if enacted, would definitely throw another wrench in to the forecasting models.

It’s easy to be a skeptic, and I won’t claim to know of a better methodology or model.  But I would caution investors to adopt a healthy dose of skepticism when reviewing the ubiquitous “Top Ten Cities” lists as a basis for making an investment decision.  Concentrate on cash flow, a strong and diverse job market, and local conditions.  A good cash flow investment in a bad market will be a better investment than a negative cash flow investment in a good market.  An outdoor enthusiast once told me, “there’s no such thing as bad weather - only bad clothing.”  A corollary maxim would probably be that “there’s no such thing as a bad market — only a bad deal.”  Good gear can get you through the worst of storms.  A good deal will beat a bad market.

Investors need to look deeper into the background information provided by these articles, and REALLY understand the dynamics and demongraphics.  Communities with diverse economies and industries will fare better than those without.

As an attorney, I see the end result of bad investment decisions.  As an investor, I’ve made a few of my own.  Naturally, I wonder how these mistakes could have been avoided.  Would a better understanding of the psychology of investment decision-making  decision process help the investors avoid unnecessary losses?

Dr. Meir Statman, who holds the Glenn Klimek Chair as Professor of Finance at Santa Clara University Leavey School of Business, has written extensively on the topic of behavioral finance.  In a recent (Aug 23) article in the Wall St. Journal, “The Mistakes We Make - and Why We Make Them,” Professor Statman highlights the emotional impact of our tendency to avoid the “pain of regret.” Professor Statman theorizes that the tendency to hold onto a losing investment longer than necessary is caused by the need to avoid facing the reality that the investment has lost value.  As a result, the investor loses even more, even to the point of holding onto the investment until it has become worthless.  Professor Statman also notes the human tendency of investors to focus on realizing gain, which sometimes leads investors to sell a good investment prematurely.

In the WSJ article, Professor Statman provides eight “lessons” as a guide for investors to control these otherwise “normal” human tendencies that tend to adversely affect investment decisions.  He notes that “most investors are intelligent people, neither irrational nor insane.” But, the study of behavioral finance shows that we are subject to emotional influences that cause us to make decisions that are sometimes smart, and sometimes stupid.  “The trick, therefore, is to learn to increase our ratio of smart behavior to stupid.”

Most of Professor Statman’s examples focus on investments based on the stock market, which provides a convenient laboratory for studying reaction to changing conditions on a fairly rapid basis.   Would these rules apply in the world of real estate investments, where the valuation is based on different criteria, and the frequency of changes in value — at least in relative terms — is much much slower.  I would theorize, however, that the emotional factors are at least as strong as those associated with the buying and selling of stocks, in most cases.

Professor Statman’s lessons and his examples are worth reading.  Briefly summarized, he cautions against attempting to time the market; not to mistake hindsight with foresight; don’t let the fear of the pain of regret make you hang onto a losing investment too long; don’t just focus on success stories; avoid being driven by fear or exuberance; recognize happiness comes from gains in wealth, not levels of wealth; and to distinguish loss of wealth from loss of ego.  Professor Statman argues for diversifying your portfolio and using dollar-cost-averaging as a smart strategy to reduce regret and avoid losing your mind.

How could these lessons be applied to real estate investing?  The first lesson — avoid trying to time the market — is counterintuitive.  Aren’t you supposed to “buy low, sell high?”  In real estate, as in the stock market, there is a tendency to chase the market; to follow rumors and hype.  Following the herd is obviously a bad strategy for many reasons, but time and time again, you’ll hear someone say “So-and-so said on CNBC that Las Vegas/Miami/Phoenix was going to be the next hot market.”  Worst yet, people will claim to avoid chasing rumors, but pay thousands of dollars to so-called real estate “gurus” who will divulge a “secret” to the audience, and off they go.  Unless you are adding to an already diversified portfolio, chasing the “next best deal” is simply foolish.

Confusing hindsight with foresight is common, but could be disastrous.  Professor Statman states that “Hindsight error leads us to think that we could have seen in foresight what we see only in hindsight.”  Yogi Berra put it bluntly:  “Making predictions is difficult, especially about the future.”  A forecast is just a prediction, and investment involves making an educated judgment about the future.  Just because a particular author or speaker claims to have made an accurate prediction does not guarantee that their next prediction will be any more successful.  Statistically, each new flip of the coin presents a 50% chance of heads or tails; success or failure.  The danger here is overconfidence.

Professor Statman, an expert in the field of behavioral finance, notes that ‘Emotions are useful, even when they sting.”  The tendency to avoid the pain of regret leads to hang onto a poorly performing investment with the false hope that it will recover, rather than face the actual loss that will result when the investment is sold or abandoned.  He urges investors to not “cry over spilled milk,” and start thinking about today and tomorrow; and not focus on regret.  Hanging on to a losing investment only postpones the inevitable and magnifies the pain.

Another lesson involves what Professor Statman refers to as “confirmation error,” whereby we focus only on successes, and look only at evidence that supports or confirms the favorable outcome.  By way of example, Professor Statman notes it is human nature to focus on the miniscule, statistical probability of winning the lottery, and ignore the fact that the vast majority of participants lose.  In any truly diversified real estate investment portfolio, there will be both winners and losers, and within the range of winners, there will be both big and small returns.  The question will be whether the winners, taken as a group, outweigh the total losses, for a net gain, but human nature is such that the focus will be only on the one, super-successful investment deal in the entire portfolio, and the tendency to mischaracterize the entire portfolio as performing at the level of the single biggest performer.

Professor Statman makes the seemingly obvious observation that one should not base their investment on either fear or exuberance.  Again, he cautions against trying to “time the market,” and resist the temptation to be motivated by either a fear of losing your shirt, or the exuberance of jumping on the bandwagon.  Similarly, he advises investors not to lose sight of your goal.  Professor Statman says a stock market crash is like an automobile crash.  The key is to focus on whether you can drive to the garage, or need a tow truck.  I would add whether you need an ambulance.  The point here is to recall what goal you were trying to reach, and evaluate what you need to do after the accident to get back on track.

Last, but not least, Professor Statman is a strong advocate of dollar cost averaging.  This strategy is well known as applied to the stock market, where the daily price fluctuations and unpredictable nature makes it almost impossible for the typical investor to outguess the market, so making regular and consistent purchases will balance out the “per share” cost over time, and hopefully reduce the regret factor.  Here, I will take a leap and suggest that Professor Statman’s “lesson,” applied to real estate investing, would argue for building a diversified portfolio of different types of real estate investments in different geographical markets, as a hedge against a total failure should any one type of real estate or any particular market suffer a significant decline in value.

The bottom line is we need to learn to increase the ratio of smart decisions to stupid ones, and recognize that the latter are often the result of emotional factors that we failed to recognize or control.  Doing one’s due diligence, fact-checking, and staying focused on your personal and financial goals, are all important considerations for the real estate investor.