Substandard & Poor

On Friday 5^th August Standard & Poor (S&P) downgraded America´s credit rating from AAA to AA+. On Monday 8^th stock markets across the globe took a huge dive. On Wed 10^th, the Fed Reserve announced that it would keep interest rates at virtually zero for another two years, producing even more schizophrenic reactions from the markets.

Who´d want to be a trader in an environment like that?

Witnessing these crazy reactions makes me very grateful to have time on my side. Torcana, and the majority of people reading this newsletter have a huge advantage over the professional money managers who are having minor heart attacks on a daily basis.

Unlike them, ordinary investors don´t have to report to shareholders every quarter. They don´t have to engage in accounting trickery to make balance sheets look good. They don´t have to explain their every move or consider every action in terms of how it will be perceived by others.

That makes a big difference over time. When professional money managers base their decisions on what might happen tomorrow or next week, an ordinary person can do very well by just staying calm and planning a year or two ahead.

Personally, I don understand the violent reaction from the markets to the downgrade from AAA to AA+. No new information was released by S&P - they were just acting on what everybody knew already. It´s also crazy to think that the US was less credit worthy on August 5^th than it was couple of weeks prior when politicians were flirting with a default.

That being said, a stock market correction has been predicted for several months now. Markets have been too frothy for too long. Perhaps the protracted political bicketing over the debt ceiling and subsequent downgrade was simply the emotional trigger needed.

Ironically, the market reaction to the downgrade of American debt has been to purchase ever more amounts of American debt. They won´t earn any income from these assets - the yield on a two year treasury bond is a miserly 0.19%. However, the money managers happen to be very worried this month and that means running away from risky assets and choosing the liquidity and safety of treasury bonds.

Economists will say the market is rational - that´s a misleading way of putting it. A market will mirror the emotions of people within it, and they seem to be wildly emotional these days.

Real Estate Gold?

Gold is viewed as a safe alternative to government bonds and equities, and the price of gold is sky high as a result. Buying anything when prices are at record highs seems dubious to me, especially an asset like gold which produces zero income. I know one client who is doing the opposite - i.e. selling the gold he bought 5 years ago when it was just $600 an ounce (it´s over $1800 now).

Why run to gold? Why not run to an asset class that has already been stripped down to record lows, that offers a regular income, has an intrinsic value and has consistently acted as a hedge against inflation? Real estate is looking very compelling at the moment.

Florida - A brief insight into how we source real estate deals

Both the owners and employees of Torcana spend the majority of their working days watching the ebbs and flows of the Florida real estate market, particularly in Orlando. A lot of empirical knowledge has been built up over that time, and because we are on the ground meeting sellers every week, we have an edge when it comes to finding, analyzing and marketing new deals on a monthly basis.

Every time new figures are released about the Orlando property market, I get more and more convinced that the distressed market sector bottomed out some time ago. The inventory of high quality properties in Orlando is critically low because the absorption rate from sales far outstrips the new supply from regular and distressed sellers.

Consider these three facts from an official Orlando Realtors Association July report:

1. Since January of this year, Orlandos median sales price has increased by 23.3 percent.

2. First-time homebuyer affordability in July increased to 167.61 percent. That means the average first time buyer is earning 67% more than the minimum needed to purchase an average home.

3. Total inventory July 2010: 16,563. Total inventory Jul 2011: 10,349

If you´d like to read the full report, please click here.

How much should you be spending?

Most buyers want to purchase at the lowest possible price. However, price must be balanced against quality. An inconsistent rental income and an uncertain exit strategy will quickly sour a deal that seemed too good to be true.

In good times and in bad, the lowest prices will always be available in low income areas with poor transport links, low owner occupancy, high levels of foreclosures, high levels of delinquencies on community fees and lots of deferred maintenance.

Chasing a low purchase price with a high rental yield is what I consider to be a "too good to be true" strategy. Your rental income isn´t going to be very reliable in these kinds of areas. Tenants here are less creditworthy, less responsible and more transient. This will lead to high vacancy periods, high management fees and high repair costs. Finding a profitable exit strategy for that kind of property five years time will be difficult if not impossible.

The best investment locations, in good times and in bad, are those closest to the best schools, jobs and amenities where young families and professionals rent, live and buy property. For these reasons, they will never be the cheapest properties on the market, but they will certainly be the most stable.

A person seeking a reliable rental income and a solid exit market should choose properties with the following characteristics:

• FHA financing available to owner occupiers
• Low foreclosures levels
• High owner occupancy and low vacancy levels
• Low levels of delinquencies and deferred community maintenance
• A satisfactory HOA reserve to cover future maintenance work
• Close to quality schools and major employers

Junk mail filter

If you are receiving a dozen emails every week with deals that all look great - just ask the seller to confirm the above and you´ll very quickly find out which ones are duds.

The six bullet points above are obvious, anybody could come up with them after a few minutes thought. The trick is finding properties that match these characteristics and securing them at a competitive price. That´s not so easy and not many people are doing it.

There are different levels of risk in real estate, and plenty of ways to earn a living from it. Not everybody will agree with my take above. That´s ok - one size doesn´t fit all in this game.

However, if you happen to agree with me that the most viable strategy is to buy in locations where people pay their rent and bills on time, where the amenities are well maintained, and where banks are already lending to owner occupiers, then you´re going to love our next product launch.