Equity in a note has almost replaced yields as the primary force that Note Buyers use to determine a note's value. In today's market a Note Buyer has to anticipate what happens in the event of a default more than ever. Therefore equity is king. We have heard the term "equity", but many do not understand what equity really is. As a result you can make big mistakes when purchasing or selling property, as well as notes. Equity is something we can brag to our neighbors, list on a balance sheet, and even borrow against it. But equity is a mythical figure until cash is pulled out. Equity can be destroyed or created virtually overnight by forces outside your control. I have seen "equity" go from $70,000 to a negative figure in a period of 6 months, vice versa. In many areas of the country, this is happening today.

What is equity? Equity is defined as the difference between the amount of encumbrances and the fair market value of the property. ( I always liked that term, fair market value. What is "unfair" market value.) This definition is true no matter if you are a Note Buyer or real estate buyer. For example, say you own a property that has a $50,000 first lien, a $10,000 second lien, and a $2,000 city lien. You say the property is worth $100,000. Your equity would then be $38,000. ($100,000 minus the total encumbrances of $62,000) The encumbrances can easily be calculated by just adding them up. Want to build up quick equity, just pay down the debt quickly. In THE NOTE PROFESSOR NOTEBOOK, I have a chapter on "Building Equity Fast with Good Terms". It is merely knowing how to structure notes correctly.

Let's continue. If the property is worth $100,000. Hang on, for a minute. Who decided the property was worth $100,000? (Ever hear of ARV? Who decides the value? ) "I got it from the tax rolls", you say. Are the tax rolls reflective of market value, or is it only an opinion of value based on politics as a basis to bring in revenue? I think we can all agree that the tax rolls are the least reliable method of determining the market value of property.

Others will say, "There are several on the same street that are for sale for $100,000, and mine is as good as theirs. The key word is "for sale". They are not selling, but are "for sale". If something is not selling, is this market value, or the fantasy of a seller.

"I paid $90,000 for the house, so it should be worth $100,000", is another statement I often hear. What does what YOU paid for a property have to do with how much it is worth today? From the other side of the coin, if you paid only $10,000 for the same property, is it now worth only$10,000 because you got a good deal? REMEMBER: What you paid for something has nothing to do with market value.

Along the same lines, when property in the "market" is saturated with foreclosures, some will say, "My property is not in foreclosure, so it is worth more because I do not HAVE to sell." What is being ignored is while you might not HAVE to sell, the buyer DOES NOT HAVE TO BUY at your price.

Here is another often heard statement, "The house across the street appraised and sold for $100,000 a couple of years ago, so mine ought to be worth the same". Was this a refi or lender appraisal? We all know in their eagerness to fund loans, lenders would instruct appraisers to inflate the price of the house to get the loan funded. Thus, the subprime bust was formed.

Have you ever seen this happen in your market? You have an appraisal of $100,000, and houses all in the block for sale at $100,000, but nobody is buying. Although you have appraisals, tax rolls, factored in what you paid for your house, but your house is not selling. Is the house really worth $100,000.? Have any of you rehabbers experienced this situation? Are you beginning to see what I am saying about equity and its relationship to market value? Equity depends on a subjective view of what the market value is. YOU, might believe your property is worth $100,000, but if the buyers do not believe it to be true, your house will not sell.

Have you ever heard that it is a "buyer's market" or "seller's market"? Remember this if nothing else from this article. It is ALWAYS a buyer's market. At times buyers are willing to pay more than other times. You will have a "hot" market or "cold" market, but it is always the buyers who determine if the market is "hot" or "cold", not the sellers. When buyers are buying there is a hot market. When buyers are sitting back and not buying, it is a cold market. It is that simple.

Are there elements that enhance "buyer's markets". Of course. Remember, the price of real estate is directly proportional to the funding available. When money is easy, market value of real estate, and therefore equity will rise. What happens when the availability of money decreases? We need only to look at today's market to understand that in many areas, equity was "wiped out", almost overnight.

Summary: Do not be misled to believe "equity" in your property is something tangible. Equity is a mythical figure. It only becomes real when you cash out. We note buyers realize this and will adjust our offers accordingly. This is one reason I suggest to get a strong down payment. The more equity in your note, the more valuable your note to Note Buyers.

If you have questions about how to structure notes, or would like to convert your note to cash, please contact me. Contact Me.

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ECONOMIC SYSTEMS

I received two emails on my most recent Economic Observations article which are excellent examples of the some of the confusion on whether actions taken by our politicians are "good" or "bad". The first email was trying to convey that Obama is a socialist on one hand, while on the other hand, the second email was expounding that Bush is a fascist. Watching the "experts" in TV and print debate whether or not we are a socialistic country, whether Obama is a Marxist, or Bush is a fascist is a mere exercise in academic quibble. The problem in the "debates" is nobody will define terms. My opinion as to why definitions are never given is because definitions would distract from whatever political message is being conveyed. However the pundits use terms as if everybody is in agreement. On the rare occasions where a term is given a definition, the debate deteriorates even further when one side or the other will attempt to apply the "pure" meaning of a term like socialism and fascism when defending their favorite politician or political party.

Let's put things into proper perspective. There are two and only two ways to organize an economy.
1: Free voluntary exchange of values (goods and services)
2: Central control (politicians) of some sort of the production and/or distribution of goods and services. In this issue I am going to discuss central control method of organizing an economy that will put things into perspective, as well as show the errors made by both those trying to defend the Democrats and the Republicans economic policies.

We need to start by acknowledging that no society has ever had a "pure" economic system. This is where the confusion, and often the deviation from reality comes into play.

For example, those who cry, "Obama is Marxist", will point to certain actions like taking over banks and attempting to take over the health care system. Academics and pundits who favor Obama will come back with, "Obama is being forced to regulate, and wants to form a 'partnership' with business to cure all the economic woes, while maintaining private property". Others cried, "Bush was fascist" while his defenders would exclaim, "There is no comparison with Mussolini and Bush". Both arguments are correct and incorrect. Why? Because defenders and critics alike are applying "pure" definitions to their arguments.

Central planning of any economy falls under the umbrella of "collectivism". Collectivism can be defined as:
1 : a political or economic theory advocating collective control especially over production and distribution; also : a system marked by such control
2 : emphasis on collective rather than individual action or identity.
From an economic standpoint, notice the phrase, "control over production and distribution".

Now let's look at a dictionary definition of "socialism":
1: any of various economic and political theories advocating collective or governmental ownership and administration of the means of production and distribution of goods
2a : a system of society or group living in which there is no private property
2b: a system or condition of society in which the means of production are owned and controlled by the state
3: a stage of society in Marxist theory transitional between capitalism and communism and distinguished by unequal distribution of goods and pay according to work done.

As in collectivism, central control over the production and distribution of goods and services is a condition for socialism. Therefore, socialism is a "branch" from the tree of collectivism. There are many forms of socialism; ie. Russian socialism, Christian socialism, democratic socialism, German socialism, national socialism, scientific and utopia socialism, European socialism. All have the common thread of central control of production and distribution.

Now let's examine the doctrine of fascism. Here is a dictionary definition:
1: often capitalized : a political philosophy, movement, or regime (as that of the Fascisti) that exalts nation and often race above the individual and that stands for a centralized autocratic government headed by a dictatorial leader, severe economic and social regimentation, and forcible suppression of opposition "Severe economic regimentation" means government control of production and distribution of goods and services, does it not?

Are you noticing that both socialism and fascism contain common economic concepts; the control of the means of production and distribution of goods and services? Does it make any difference whether the government owns the means of production and distribution such as in North Korea, Cuba, and much of Europe, or whether the government controls the means of production and distribution while giving the appearance of private ownership as in Nazi Germany, Mussolini's Italy, FDR's New Deal, European socialism, or even here at home in America where politicians regulate and control industries?

Some forms of collectivism are more desirable to live than others. For example, living under FDRs economic fascism is more desirable than living under Hitler's form of fascism. Or living under Great Britain's and Europe's form of socialism is much more desirable than living under N. Korea's or Stalin's form of socialism. None have a "pure" system. Yet because of economic laws, all systems based on collectivism will witness the same fate..eventual economic collapse. It is insanity to believe that economic systems based on the same principle will have different results.

When the government (collective) takes control of the means of production and/or distribution of goods and services, no matter what form, the economic results will be the same. Why? Because when central planners, no matter how good their intentions disregards economic laws of supply, demand and marginal utility, the price system becomes distorted and at best continual shortages result where eventually consumption exceeds production. It makes no difference whether you call it socialism, fascism, "the third way" or communism, if free market principles are abandoned and collectivism is embraced in whatever form, only the degree of collectivism determines the time of economic collapse. For example, Castro's Cuba embraced rigid controls of the means of production and distribution which resulted in immediate poverty. On the other hand USSR tried to "industrialize" its rigid form of collectivism which lasted only 70 years. Our economy is embracing collectivism more and more. We are witnessing the results.

In summary, do not get caught in the trap of trying to define Obama's or Bush's economic policies with a "pure" definition of socialism or fascism. No system is "pure". Acknowledge the fact that fascism, socialism, communism, mercantilism, and feudalism, are but different branches from the tree of collectivism, but must obey an economic axiom: CONSUMPTION CANNOT EXCEED PRODUCTION.

If you would like to attend a short, inexpensive half day seminar to learn economics in easy to understand laymen terms, and how it relates to today's environment, please contact me with a short note give me an idea of what you would like to understand.

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