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Steve's note:Contributing today's essay is my friend and legendary investor Chris Weber. In his most recent issue, Chris addressed the question...

Is It Time to Buy Florida Real Estate?

By Chris Weber, editor, The Weber Global Opportunities Report
Saturday, September 15, 2007

I think it is still too early to buy Florida, in general.

There have been some large price declines in some areas. For instance, in Lake Worth, close to where I used to live (and still spend some of each winter) in Palm Beach, I just heard of one house, which had been on the market as high as $799,900 finally selling for $450,000. That's a decline of nearly 44% from the asking high. On that same street, another house which had an asking high of $750,000 recently sold for $436,050, a nearly 42% decline.

But my rule for buying real estate – especially property that you are not going to live in yourself – would strike people as pretty stark. I ask myself, "Would the return I get from rent – the net return after all the taxes, insurance, and other expenses – be at least 10% a year? Would it even be much higher than the rate I could get on T bills, eurodollars, etc?"

I was recently offered a small apartment building in another part of Florida – Bonita Springs, between Naples and Ft. Myers. I know the place because relatives used to rent there.

The average rent is about $900 per month. That's $10,800 annually. The apartments had been on the market for as high as $325,000 a piece. Similar ones in the area had actually sold for around this price at the peak about two years ago. The sellers have put the price down to $199,900.

Now, does this price make sense? Assuming I'm just paying cash and have no mortgage interest payments to make, the gross amount I would get based on that asking price works out to an annual return of 5.4%. But this is before federal income taxes, Florida property taxes, insurance (it is on a canal that leads to the sea), and general maintenance.

Even if I could write off some of this on taxes, you'd conservatively have to reduce this 5.4% return by at least one third. That reduces the return to 3.6%... and I think I am being quite generous. It would probably end up being less. Indeed, I'd be surprised if it were much over 2.5%. And then you get the headaches of being responsible for repairs, etc.

Of course, most people don't think in these terms. They have bought based not on numbers like these, but in the firm belief that they could resell the property at a much higher price. What is happening has put a big dent in that belief.

I told the seller that I would not pay more than $100,000 per unit. At that price the gross would be 10.8%. Of course, I could try to get more rent, but with the demographic in apartments like these (retired people whose prime income is their Social Security payments), there is very little room to raise.

And my net, even if the seller accepted my offer, would be a percentage return around what I could get by staying in safe cash instruments, which come with none of the maintenance worry.

So I'm saying that even at that drastically reduced offer (which the seller laughed at), I still would not rush to buy. Maybe I would, but it is not certain. What would the buying price have to be to get a net return of 10%? I'd say around $75,000. That would give a gross return of 14.4%.

But an apartment that had been as high as $325,000 being sold at $75,000? That's a price reduction of 77%. Impossible? Well, during Japan's real estate crash of the 1990s, property ended up selling for as much as 90% from peak prices.

The seller in this particular case has had no offers at all, other then mine. I actually did not want to give it, but he kept asking me. My intention was not to be a "vulture," but to come up with a number that made some kind of sense on a financial return basis.

I think we are facing years where one cannot count on higher prices in Florida real estate. Now this doesn't mean that you can't get good prices even now. But you just can't expect to turn around and resell at a higher price within a period of several years. And if you are buying for income, the average prices are still much too high for me.

Too many sellers are holding out for prices that are not going to be met. The process just needs time to become more realistic. How much time? The aftermath of the last huge boom in Florida real estate needed 30 years (1920s to 1950s) until prices got back to peak levels.

Let's hope it doesn't take that long this time.

Good investing,

Chris Weber

Market Notes


In late 2002, the stock market was in the midst of a 50% decline, recession still lingered, and the number of corporations defaulting on their loans was near historic highs.

A horrible time to loan money to the world's shakiest companies, right?

Wrong. Turns out, when business conditions look absolutely terrible, it is the absolute best time to loan money to shaky companies in the form of high-yield bonds (also called junk bonds).

As our chart of the week shows, if you had bought an index of these high-yield bonds back in the panic conditions of November 2002, you would have earned roughly 21% per year for the following two and a half years. The spread of high-yield bonds over safe government bonds was an enormous 10% back then.

Right now, the spread is only 4.5%. The red arrows show that you don't make money when the spread is so low. History tells us to wait for much gloomier business conditions to make high-risk loans. Only when companies are desperate for cash do you make extraordinary returns.

-Ian Davis

Stat of the week


Percentage decline in the price of crude oil from its 2006 high to its January 2007 low.

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