I was just talking with a real estate professional in Northern California about how precarious the market for residential homes is becoming. My friend is an elderly real estate broker that started selling real estate in the 1970s and now has over three decades in the industry. She has seen the prices of houses appreciate radically as well as drop precipitously over prior decades.



We were chatting about the hard money lenders who are lending at 70% loan to value ratios instead of 50% and just how deadly this could be financially. I explained that the reason these younger real estate professionals are lending at unsafe ratios is due to a type of money thinking I call “financial immortality.” This type if thinking is the tendency of human beings to extend what we know about the present into the future.

Think about it. When you get up in the morning you jump out of bed and walk a certain number of feet in certain directions and you get your usual food and sanitation needs taken care of. It's probably pretty much the same (if you are at home and not on the road) every day. You probably drive the same way to work every morning. You do pretty much the same activities each day to pull the pay check in or keep the business running. You generally assume that tomorrow is going to be much like today.

Your routine daily experience has taught you that if you do just a few things well which means pretty much the same way in a certain way you will get your money at the end of each month. In other words your daily routine is pretty static (doesn't change much) and to function in a static environment you need to have static thinking. Something that is static never changes and is immortal. The problem is that none and I mean NONE of our financial markets are static they are dynamic (change a lot). Worse yet when they change they often change a lot and really fast!

In order to survive as a real estate of stock investor you have to have dynamic thinking. Let me explain. I told you that there are hard money lenders in California that have been earning a good return. Hard money lenders start by either lending money to builders and rehabbers at the going rates for hard money funds which today are 15%. If they don't have money they will have people invest through them. The hard money lender pays his or her lender at a lower rate like 13% and keeps the 2% spread for managing the money.

The safety in the deal is making sure that the property is worth a lot more than the hard money loan amount when the project is finished. Many of them start lending at 50% of the value of the project (loan to value ratio abbreviated LTV). Once they get confident (static) with what they have to do to make money many are now lending a 70% of the value of the project because they can place more money in the market.

The problem is that many of these “financially immortal” thinkers don't remember when property values plummeted up to over 50% in some areas in the 1980s in California when the Keating scandal allowed Savings and Loans to lend at high LTVs and the real estate market collapsed when interest rates rose. Right now we have a combination of radical home price appreciation in markets like California where people have been accepting interest only mortgages tied to adjustable rates. The percentage of interest only adjustable rate mortgages in California is now over 40% where a few decades ago very few such mortgages were originated. Other states in this same predicament include Virginia, Arizona, and Colorado.

What few people today know is that interest only mortgages were a significant part of the problem in the great depression. In the roaring 1920's housing prices soared and banks begin offering interest only mortgages. When the stock market and banking system collapsed and up to one third of the U.S. population lost their job house values plummeted and people could not sell off their homes to get out of these bad mortgages. A flood of foreclosures ensued all because people were assuming the roaring 20s boom would just continue because they were using financially immortal thinking that that says “what goes up never comes down.” The people who were dynamic thinkers cashed out their homes in the 20s and thrived in the great depression because they were not carrying lots of debt. THAT IS WHY I TEACH THE ENORMOUS VALUE OF FREEDOM FROM DEBT TO MY STUDENTS!

If the market does collapse and you are a dynamic thinker you might do well scooping up great deals from the financial immortals in their dying gasps. By the way this was the same thinking that got so many financial immortals in the stock market in trouble. The financial immortals believed The lie Wall Street was pushing that the stock market would never come down during the final part of the massive bull market in the 1990s. The dynamic thinkers were able to smell the bull$%^# on all over Wall Street in 1999 and 2000 when all of the insiders were dumping their high priced stock they optioned for nothing on the heads of the financial immortals!