Self-directed Investment Options in 401(k) Plans: Legal and Fiduciary Issues

Self-directed Investment Options in 401(k) Plans: Legal and Fiduciary Issues

By Pillsbury Winthrop Shaw Pittman LLP



What is a Self-Directed Option?


As an extension of the continuing trend toward expanded participant investment options in 401(k) and other defined contribution retirement plans, investment providers are marketing an option that provides participants access to brokerage accounts, from which they may elect to invest in a broad array of investment vehicles. These arrangements are generally referred to as brokerage windows or self-directed options ("SDOs").
If an SDO is adopted, a plan participant is allowed to transfer money from the plan's regular menu of investment funds to a brokerage's money market account. From that money market account, the participant then may choose to invest in any of the investment options available under the particular brokerage arrangement agreed upon between the plan's sponsor and the investment company (or companies). As a rule, investment fees in the SDO are the same as those charged for an individual retail investor-in other words, the fees are most often higher than the fees negotiated by the plan sponsor for the regular menu of funds.


What types of investments may be made available through an SDO?


Some of those marketing SDOs and some employees lobbying for them suggest that there should or need not be any particular restrictions on the types of investments that would be available by way of an SDO. This is incorrect as a policy and legal matter.
For the employee who says "this is my money and I should be able to invest it however I want," the response is that there are important distinctions between money in an employer-sponsored retirement plan-including the money contributed by the employee-and personal investments made with take-home pay.
If not for special tax rules enacted by Congress for employer plans, the value of an employee's plan account would be taxable to the employee as soon as it vested. Instead, if an employer plan satisfies the requirements of the Income Tax Code and ERISA, income tax is deferred on the contributions (except for employee after-tax contributions) and earnings until the payout date. These special tax benefits are provided by law to encourage employer-sponsored retirement plans. But in exchange for these tax benefits, plans must be designed to serve the public policies of ERISA. In particular, the primary public policy of ERISA is to ensure that employees have adequate retirement savings. Not surprisingly, then, an ERISA plan must be designed to minimize the risks of large investment losses. The employee has a choice, then: invest within a restricted universe using tax-deferred funds or invest within an unrestricted universe using after-tax dollars and paying tax on earnings currently.

Specific legal prohibitions and fiduciary rules impose a number of restrictions on the types of investments that may be offered through an SDO. These rules are discussed below in detail.


Background on ERISA section 404(c)

Most employer 401(k) plans and other defined contribution individual account plans are intended to be ERISA section 404(c) plans. Under section 404(c) of ERISA, if a plan provides for individual accounts and permits a participant to exercise control of the assets in his or her account, then the plan's fiduciaries may not be not liable "for any loss, or by reason of any breach, which results from such participant's, or beneficiary's exercise of control." To satisfy section 404(c), a plan must comply with detailed regulations about the characteristics of at least three "core" investment alternatives that must be offered and about investment rights and information that must be provided.
Many articles have been written about section 404(c) and I do not propose to go into detail on that subject in this article. Instead, I will assume that the plan for which an SDO is being considered does, in fact, comply with section 404(c). However, it is important to keep in mind that it is the Department of Labor's position that compliance is determined on a case-by-case basis and that any person claiming relief from liability under section 404(c) "will have the burden of proving that the conditions of section 404(c) and any regulation thereunder have been met."1

Potential liabilities associated with an unrestricted SDO
Although ERISA section 404(c) is itself worded broadly, the legislative history and regulations make it clear that the plan fiduciaries of a section 404(c) plan still retain significant fiduciary and other duties and liabilities 2 that restrict the range of investments that should be permitted under an SDO. In addition, certain Internal Revenue Code rules and other legal rules and practical considerations make restrictions advisable. These liabilities, duties and advisable restrictions are generally described in greater detail in this article, but they are first summarized below:
To avoid a breach of fiduciary duty by the plan sponsor, no investment should be permitted that would cause the plan to hold assets with "indicia of ownership" outside the jurisdiction of the federal district courts of the United States;
To avoid a breach of fiduciary duty by the plan sponsor, no investment should be permitted that is not permitted by the plan document or that would jeopardize the plan's tax qualified status;
To avoid a breach of fiduciary duty by the plan sponsor, no investment transaction should be permitted that could result in the loss of an amount greater than a participant's account balance;
To avoid breaches of fiduciary duty by the plan sponsor and other persons related to the plan, and the imposition of excise taxes on these persons, no investment should be permitted that would result in a "prohibited transaction" or that would greatly increase the difficulty of compliance with the "prohibited transaction" rules;
To avoid potential problems with distributions and IRA rollovers, no investment should be permitted if it is illiquid or not permitted for IRAs; and
The plan sponsor may want to prohibit investments that would generate unrelated business taxable income ("UBTI") for the plan.

Prudence in fund selection and retention

Compliance with section 404(c) only shields the plan fiduciaries from any loss or any breach that results from the plan participant's exercise of control over the assets in his or her account. The regulations point out that it is necessary to determine, in any particular case, whether a loss or breach actually resulted from a participant's investment decision, and state that relief for fiduciaries is available only if the loss or breach is the "direct and necessary" result of the participant's exercise of control.
In the Preamble to the section 404(c) regulations, the Department of Labor "points out that the act of limiting or designating investment options which are intended to constitute all or part of the investment universe of an ERISA 404(c) plan is a fiduciary function which, whether achieved through fiduciary designation or express plan language, is not a direct or necessary result of any participant direction of such plan." Therefore, "the plan fiduciary has a fiduciary obligation to prudently select such vehicles, as well as a residual fiduciary obligation to periodically evaluate the performance of such vehicles to determine, based on that evaluation, whether the vehicles should continue to be available as participant investment options."

While the Preamble language makes it clear that any choices the plan sponsor makes in designating investment options must be prudent (and the retention of those choices must also be prudent), it leaves unclear whether the prudent fund selection/retention duties are inapplicable if the plan sponsor places no limits on the investment universe of a section 404(c) plan. To date, no regulations or rulings address this point. It seems highly unlikely, however, that a plan sponsor could duck one of the most fundamental fiduciary duties in ERISA-the duty of prudent investment-by the simple expedient of making the inherently imprudent decision to place no restrictions whatever on the investment vehicles a participant may choose. In any event, as is explained further in this article, there is no doubt that the plan sponsor will want to place some restrictions on investment vehicles offered through an SDO. That being the case, the Preamble compels the conclusion that the fiduciary duties of prudent selection and retention of investment vehicles will apply to the SDO.

This conclusion immediately leads to the question: how is it is possible to fulfill this fiduciary duty if a very large universe of investments is offered through an SDO? This question also has yet to be answered in any regulations or rulings. A good argument can be made that the fiduciary duty applies to the selection of the SDO, not to the individual investments available through the SDO. The argument would be that the same standard should apply as applies under old trust law cases, since the law of trusts is supposed to apply under ERISA. Under old trust law cases, a trustee's prudence is judged on the entire portfolio, not on each individual investment, standing alone. That sort of analysis makes sense for SDOs, because a participant may well choose an investment that is a counterbalance to another investment and only makes good investment sense when viewed in the context of the entire portfolio. If this analysis applies, the sponsor would be required to make a prudent selection of SDO provider, carefully design the SDO with that provider and monitor the operation of the SDO to ensure that it operates as it is designed.

Even if the fiduciary duty of prudent investment selection applies to the individual investments available through the window, it would not be impossible to meet. The prudent-investor duty does not require that the fiduciary select the absolute best investments, but the fiduciary should be sufficiently knowledgeable about investments to make the types of choices that a prudent investment expert would make. As a practical matter, this would mean that the universe of SDO investment vehicles should be defined and limited. That would still mean that hundreds, or even thousands, of vehicles could be available, so long as they all satisfy specified criteria, such as one would normally find in a plan's investment policy. And the fiduciary would have to have a system to permit it to conduct periodic reviews to ensure that it eliminates investment options that do not meet these criteria or that fail to satisfy the investment performance standards of a prudent investment policy.

The following is a detailed discussion of the principal types of investments that should not or must not be offered through an SDO.

Avoid fiduciary liability for maintaining the indicia of ownership of assets outside the United States

ERISA section 404(b) provides that it is a breach of fiduciary duty for a fiduciary to maintain the indicia of ownership of any plan outside the jurisdiction of the district courts of the United States. The regulations under ERISA section 404(c) provide that the requirements of section 404(b) continue to apply to a section 404(c) plan.
Congress enacted ERISA section 404(b) to protect plan participants against "runaway assets." It is fairly easy to imagine how a runaway asset problem could occur in an unrestricted SDO environment. Some business commentators have identified the Russian Republic as a hot business market, but one with risks because of the transition from communism to capitalism and widespread "gangsterism" in Russian society. A participant might invest in Russian business and might lose all or some of the investment because of illegal activity or for some other reason. If the "indicia of ownership" of the investment are not maintained within U.S. jurisdiction, then the participant could claim that it was a breach of fiduciary duty for the plan sponsor to permit the investment. In that case, the sponsor could be required to make up the losses, pay a civil penalty and incur liability for other equitable remedies.
In light of the fact that no ERISA section 404(c) protection is available to the plan sponsor in case of a violation of the "indicia of ownership" rule, the sponsor would want to ensure that no participant could direct his or her account to an investment that does not comply with section 404(b).3

Avoid fiduciary liability for making available investments not permitted by the plan document or that would jeopardize the plan's tax qualified status

ERISA section 404(c) protection is not available with respect to any instruction to invest in a vehicle that is not permitted by the plan document or that would jeopardize the plan's tax qualified status. Appropriate plan drafting could ensure that the plan-document issue does not arise. The sponsor would, however, want to ensure that any SDO does not permit investment in any vehicle that would jeopardize the plan's tax qualified status, such as a vehicle that has a high minimum investment amount requirement (such that it would cause the plan to fail the qualification requirement that rights under a plan be available on a nondiscriminatory basis).
Avoid fiduciary liability for permitting investment in a vehicle that could result in a loss in excess of a participant's account balance
ERISA section 404(c) protection is not available with respect to any investment instruction that could result in a loss in excess of the participant's account balance. 4 If the plan included an SDO, the sponsor would want to ensure that the participant is not able to invest in margin arrangements, commodities contracts, short selling and any other investments with a loss potential in excess of the participant's account value.

Avoid prohibited transactions

ERISA section 404(c) protection is not available for any investment instruction that would result in a direct or indirect:

Loan to the plan sponsor or any of its affiliates;
Acquisition or sale of real property that is leased to an employer of employees covered by the plan (or to an affiliate of the employer);
Acquisition of any employer security that is not a qualifying employer security (such as sponsor common stock); or
Sale, exchange or lease of property between the plan and the plan sponsor or any of its affiliates (other than the purchase or sale of a qualifying employer security or the acquisition or disposition of an interest in an investment fund managed by the plan sponsor or any of its affiliates).

To avoid potential fiduciary liability, the sponsor would want to ensure that the SDO would not permit a participant to make an investment that would run afoul of these rules.

In addition, regardless of whether an investment is problematic under the above rules, if it constitutes a prohibited transaction under the Internal Revenue Code rules, then the sponsor could be subject to prohibited transaction excise taxes.5 The Code prohibited transaction rules are similar to those listed above, but they include transactions between the plan and any fiduciary, the plan sponsor, an employee organization whose members participate in the plan and any person providing services to the plan, as well as some related persons (collectively, "disqualified persons"), and also include the following transactions:
Furnishing of goods, services or facilities between a plan and a disqualified person;
Transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;
An act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or
Receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.
Because of the so-called "plan asset" rules, adding an SDO can greatly increase the possibility that inadvertent prohibited transactions can occur under either ERISA, the Code or both. Under the plan asset regulations, 6 when a plan invests in an entity by purchasing a publicly-offered security registered under specified provisions of the Securities Exchange Act of 1934 or a security issued by an investment company registered under the Investment Company Act of 1940, the plan's assets are considered to consist of an interest in the entity, not in any of the underlying assets of the entity. If, however, the plan invests in other types of investments (which we will refer to as "nonregistered investments"), the general rule is that the plan is considered to invest also in the underlying assets, unless the nonregistered investment qualifies for exemption as an "operating company" or because equity participation in the nonregistered investment by benefit plan investors is "not significant." 7
This plan asset "look through" rule generally causes the managers of the look-through investment entity to become ERISA fiduciaries, and transactions involving the entity's assets to be subject to the prohibited transaction rules. For example, assume that a participant uses the SDO to purchase an interest in a real estate investment partnership that is not a registered investment, does not qualify as an "operating company" and in which investment by benefit plan investors does not satisfy the "not significant" test. The plan would be deemed to hold, not only a partnership interest, but also an interest in all of the underlying assets of the partnership. If it happened that the real estate investment partnership had an interest in real estate leased by the plan sponsor, the plan could have engaged in a prohibited transaction: the acquisition of real property leased by the plan sponsor.
Because of the complexities of the prohibited transaction rules, and the near impossibility of policing compliance if the plan holds nonregistered and nonexempt investments, the plan sponsor would want to ensure that the SDO only permitted participants to invest in registered investments and nonregistered investments that satisfy one of the exemptions that avoid the "look through" rule.

Avoid illiquid investments and investments not permitted by IRAs

Most plan distributions are made in cash or a combination of cash and sponsor stock. Thus, the distributions generally involve converting plan investments other than sponsor stock to cash. Despite this conversion requirement, most plans today can process distributions for payment on the same day that the distribution election is made. If an SDO is added to the plan, investments in the brokerage account would also have to be converted to cash and pushed back through the SDO window to the trustee for distribution. Usually, when a participant has an SDO through which s/he has invested only in mutual funds, it takes one or two extra processing days to convert the investment to cash and process the distribution. But if the SDO permits investment in a broader range of investments than mutual funds, the conversion may take even longer and may be problematic. If the investment is illiquid, how can it be converted to cash for distribution? What if a minimum required distribution must be made by the plan administrator, but assets cannot be converted to cash to make the legally required distribution? What if there is a substantial penalty for withdrawal or conversion? The sponsor may wish to establish investment guidelines that will ensure that any SDO does not permit illiquid investments or investments that impose substantial withdrawal penalties.

The sponsor should also consider the employee relations issues that may arise of the plan requires that all distributions be made in cash and/or company stock. Participants using an SDO may demand the ability to have SDO investments distributed in kind, which may increase the plan's administrative burden.

IRAs are not permitted to invest in life insurance contracts or "collectibles." 8 If these investments were permitted under an SDO, and rolled over in kind to an IRA, the rollover would be ineffective and would be considered a taxable distribution (at least as to the assets that may not be held by an IRA). If the plan permits, or may in the future permit, in-kind distributions of any investments other than company stock, the sponsor may wish to ensure that the SDO does not permit investment in life insurance contracts or collectibles.
Consider avoiding UBTI
Some investments, such as certain partnership investments, generate unrelated business taxable income under the Code, which would require the normally nontaxable trust to pay some income tax. It is legally permitted for a plan to have UBTI, but before investing in an UBTI-generating vehicle, the fiduciary should consider whether the after-tax return compares favorably with the before-tax return on more conventional investment vehicles. Since the nature of the SDO makes it impracticable for the sponsor to engage in this assessment, there is some question whether UBTI-generating investments ought to be permitted at all. If such investments were under consideration, the sponsor would also want to take into account the income-tax return and payment obligations that the plan may incur. These income tax obligations alone make most employee benefit plans reluctant to invest in vehicles that generate UBTI.
Other considerations
In order to maintain the plan's section 404(c) status, administrative procedures would have to be put in place to ensure that the information required to be provided to participants automatically and upon demand will be provided with respect to investments accessed through the SDO.
If participants are able to purchase sponsor securities through the SDO, SEC section 16 insider trading reporting and short-swing profits rules will come into play.
Administrative systems will be necessary to ensure that investments through the SDO are reported accurately and in a timely manner on the plan's recordkeeping system. These systems must also provide enough data for the designated party to ensure that information about the SDO is properly reflected on Form 5500 annual reports.

Plan assets are legally required to be valued at least annually. Only investments capable of proper valuation should be permitted and systems for ensuring that valuations are timely made must be put in place.

Additional participant disclosure and education may be necessary if the plan includes an SDO. It would be particularly important to convey information about risk factors and fee structures.
The sponsor should carefully negotiate an appropriate form of agreement with the SDO provider. In particular, the sponsor should ensure that the provider is liable for all consequences of any failure to satisfy the agreed-upon limitations on permitted investment vehicles and that the sponsor has the right to audit the operation of the SDO.

If an SDO is adopted, the sponsor must prepare plan amendments and revised communications concerning the SDO, including the different cost structure, the effect on the timing of plan transactions and any other relevant matters. If the plan is subject to the SEC prospectus requirement, then the plan prospectus must be updated and delivered in advance of implementation.

The sponsor should determine whether this arrangement will increase its fees for recordkeeping and other administrative services and or increase the cost of the plan's annual audit or inhibit reporting, recordkeeping and valuation.

Determine whether any dollar threshold for establishing a brokerage account would be deemed to discriminate against nonhighly compensated employees.

The sponsor would have to make arrangements with the provider to ensure that sufficient information is provided to the sponsor to permit it to fulfill its fiduciary duty of prudence concerning investment selection and retention.

Footnotes
1Section I of the Preamble to Regulation section 2550.404c-1.[^ back to article text]
2Several parts of this article discuss actions that could cause a breach of fiduciary duty. Under ERISA, if a fiduciary breaches his or her duty, a plan participant, beneficiary, other fiduciary or the Secretary of Labor may bring a civil action to enjoin the act or practice that causes the breach or to obtain other appropriate equitable relief. The breaching fiduciary is liable to make good to the plan any losses resulting from the breach and to restore to the plan any profits the fiduciary may have made through use of the plan's assets by the fiduciary. In addition, the fiduciary may be required to pay a civil penalty equal to 20% of any amount recovered from the fiduciary. Excise tax penalties may also be levied in case of a breach that is also a prohibited transaction, as discussed later in this article. (See sections 409 and 502 of ERISA.) [^]
3There is a major regulation expanding on, and providing for exceptions to, ERISA section 404(b). A discussion of that regulation is beyond the scope of this article. [^]
4Regulations section 2550.404c-1(d)(2)(ii)(D). [^]
5For each prohibited transaction, there is an excise tax of 15% of the amount involved. This accelerates to 100% if the prohibited transaction is not corrected within a short period.[^]
6Regulations section 2510.3-101. These regulations apply to the prohibited transaction rules under ERISA and the Code.[^]
7Under the regulations, an "operating company" includes a "venture capital operating company" and a "real estate operating company" that complies with extensive regulatory requirements. The regulations also set forth extensive requirements for determining whether benefit plan investment in an entity is "not significant."[^]
8A "collectible" is defined in Code section 408(m) as any work of art, rug or antique, metal or gem, stamp, most coins and any alcoholic beverage. Other tangible personal property may be designated as collectibles by the Secretary of the Treasury.[^]
© 1999 Pillsbury Winthrop Shaw Pittman LLP

MLS smacks down maverick website

June 21, 2008

MLS smacks down maverick website

By HAYLEY MICK



It was an antidote to Toronto's sprawling housing market: a simple website created by two self-described "computer geeks" to ease their first home search, and then help a city of frazzled buyers.

That is until this week, when the Multiple Listings Service - the reigning king of online listings in Canada - unleashed its lawyer on housing123.com and banished the new kids on the block.
"It was always this overhanging axe that was ready to fall," said Travis Fielding, the 31-year-old co-founder of the website, which allowed users to search MLS listings plotted on a Google map of local neighbourhoods.

After all, MLS has crushed upstarts before. Two Toronto-based sites, Realtysellers Ltd. and Realestateplus.ca, shut down in the past two years after run-ins with the Canadian Real Estate Association, which owns the MLS trademark. Housing123.com is accused of using its information without permission.

But some industry watchers say MLS may be losing this online turf war, as what's happening in the United States may soon happen here: Sites such as Redfin, Zillow and Yahoo Real Estate now carry the lion's share of new listings, while MLS is losing ground.

They say the MLS business model - giving people only a taste of a house and directing them to an agent for more - won't stand up against competitors that will give you every detail about a house and its surroundings, including local crime stats, school reviews and previous purchase prices, along with 360 tours and a break on the commission.

"They're basically saying, 'You know what? People want to search listings themselves,' " says John Pasalis, founder of Realosophy.com, a website that dishes details about Toronto and Greater Toronto Area neighbourhoods. "The problem in Canada is we can't do this because the real-estate boards don't allow us."

Adds Mr. Fielding: "I think they're stuck in the past."

The idea for housing123.com bloomed a couple of years ago after Mr. Fielding's friend and fellow software developer, Kevin Lai, became frustrated with his own home search. Sick of navigating MLS, and frustrated by an agent who missed good houses, Mr. Lai thought he could design a better system.

On his laptop, he basically created what is known as a "Google-map mash-up," which allows people to plot customized data (in this case, MLS listings) on top of a Google map application.
It worked so well that, just for kicks, he enlisted Mr. Fielding to help him take it to the public. It took about three weeks to work out the kinks, and they developed a way for the program to automatically add new listings. "On a scale of 10, it's probably like six," Mr. Lai, 29, says of the difficulty level. For their day jobs, he and Mr. Fielding design software for financial companies.
Since the site was launched 10 months ago, it averaged about 400 to 500 unique users per day, Mr. Fielding says.

Users appreciated its simplicity. House listings appeared as dots on a map of Toronto, which users clicked on to take them to the MLS listing. Houses were colour-coded by price so users could see which areas were pricey or affordable.

By contrast, MLS has no way to narrow a search to a neighbourhood. If you're looking for a Victorian in Kensington Market, you have to search in zone C-01, which covers Yonge to Dufferin, and Bloor to the Lakefront. (That includes the Annex, the waterfront, Kensington, Little Italy, Trinity-Bellwoods, University, the downtown core, and others.)

The search engine spits out hundreds of listings, and users are stuck flipping between MLS and Mapquest.

Still, the housing123.com founders knew it would just be a matter of time before MLS came knocking, because they were using listings that were the property of MLS.ca.

Last week, Mr. Lai received a letter from a CREA lawyer saying they had violated copyright laws. Remove the site, it said, or we'll sue.

"They were scraping data from our website," says Calvin Lindberg, president of CREA, which represents more than 94,000 brokers and agents. "It's something that we deal with on a regular basis. ... Obviously whenever we see it happening, we send a letter asking them to turn it off."
Since the site folded on June 15, dozens of users have voiced their dismay on a blog, urging the duo to keep going or seek legal advice. One user wrote: "MLS is brutal and your site made finding the right place in the RIGHT location a breeze."

By the end of the summer, MLS.ca will have a map component, Mr. Lindberg says. Beyond that, he says, the site does not need to be improved. "We've created a very effective and efficient system that the consumers love."

Others disagree. One simply has to look south to see the potential for informative sites, Mr. Pasalis says. Those sites, however, have only been made possible through tough legal battles. In May, the U.S. National Association of Realtors settled its antitrust case with the Department of Justice, giving online realtors - which have been offering fees that are significantly lower than traditional realtor rates - full access to the MLS database.

Mr. Pasalis says the onus should be on Canada's Competition Bureau, not individual entrepreneurs, to fight to ensure fair competition is allowed in Canada too.

For now, Mr. Lai and Mr. Fielding say they are dreaming up new projects. "At least we helped a lot of people find their dream home," said Mr. Lai, who is now in the market for a downtown condo.

The pair say they may revive their site, but only to post properties from individual sellers or brokers - not MLS. "We can't afford the lawsuit, that's for sure," Mr. Fielding says.

Days after his site folded, Mr. Lai and his wife bid on a downtown condo they had spotted using housing123.com - but no dice. His search has resumed on MLS.ca.©



© Copyright CTVglobemedia Publishing Inc. All Rights Reserved.

Prince William Co. Stiffens Illegal Immigration Crackdown

Posted to ABC News7 on:

6:23 pm Thu May 01, 2008 - MANASSAS, Va.


Prince William County (webnews) supervisors have made a key change to the county's illegal immigration policy, considered one of the most aggressive in the nation.

The board decided late Tuesday to direct police officers to question criminal suspects about their immigration status only after they have been arrested.

In October, the board directed police to check the residency status of anyone who is detained, no matter how minor the offense, if they believe the person might in the United States illegally.

Republican Supervisor Martin Nohe said Tuesday that the change in the illegal-immigration policy will limit the county's risk of a lawsuit.

Supervisors supported the change after cutting $3.1 million from the county's budget that would have funded video cameras in police cars to enforce the policy. Police had wanted the cameras to protect officers from allegations of racial profiling.

The change came before the board approved a fiscal 2009 budget of $893 million.

Prince William supervisors revisited the illegal immigration policy after Democratic Supervisor Frank Principi last week expressed concern about overly harsh enforcement.

Tuesday, he proposed a change that would have directed police to question a person's immigration status only after they have been arrested and taken to jail. He was the only supervisor to support it.

More than 100 people addressed the board for more than five hours Tuesday regarding both budget and immigration matters. Some asked the board to keep the illegal-immigration policy intact, while others urged supervisors to limit it.

"If [people] enter our country illegally, they should be deported, whether they are a criminal or not," said Walter Menz of Woodbridge.

Ruth Hellwig, a 45-year resident of Woodbridge, said, "it's dividing neighbor against neighbor ... even the children are discriminating against one another in the school system."

HOPE FOR HOMEOWNER ACT OF 2008

Hello Everyone,If you have questions about the new bail out from the government, here are some questions and answers:

Questions and answers about the Hope for Homeowners Act of 2008, passed by Congress last weekend to try to steer as many as 400,000 struggling homeowners away from foreclosure:

Q: What exactly will the legislation do?

A: It will allow those who qualify to cancel their old mortgage loans and replace them with 30-year fixed-rate loans for up to 90 percent of the home's current value. The FHA will insure a total of $300 billion of the loans over a three-year period.But the decision on whether to write such a loan remains up to banks, which would have to be willing to take a loss on the existing loans in exchange for avoiding an often-costly foreclosure.


Q: Who is eligible?

A: Eligible borrowers must have spent more than 31 percent of their monthly incomes on their mortgages as of March 1, 2008. The troubled loan must have originated no later than Jan. 1, 2008, and be on the borrower's primary residence. And the borrower's income must be verified.


Q: When does the program start?

A: It takes effect Oct. 1 and runs through September 2011, although the FHA isn't likely to have it operating at full capacity until next year.


Q: Since lenders can pick and choose which loans to refinance, how can consumers determine if theirs will be selected?

A: Check with the bank or financial company servicing your mortgage, but it may be weeks before they make decisions concerning the new guidelines and assess individual loans.Even then, keep expectations limited."Servicers are going to be reluctant to take the government up on their offer," predicted Mark Zandi, chief economist at Moody's Economy.com. "The earliest they'll start taking them up on it is early next year. And even then it's likely to be modest."


Q: Is there anything a homeowner can do to improve chances of benefiting from the program, such as crunching numbers to make a case for the bank?

A: Not really. The best step is to keep up your payments as best you can.


Q: But doesn't this provide an incentive to NOT pay your mortgage, if you're barely keeping ahead of bills and are underwater on your house, so you can qualify?

A: No. If your situation deteriorates enough, the bank may reject any possible new loan."Turning yourself into a financial basket case is not going to work," said Dan Seiver, a finance professor at San Diego State University. "If you turn into a complete deadbeat, the servicer is going to just foreclose and dump it."


Q: So what should I be doing now besides trying to keep up with payments?

A: Talk to a local credit counselor and call the toll-free hot line of the Hope Now alliance — an industry group trying to coordinate a response to the mortgage crisis — at 1-888-995-HOPE. It is available 24 hours a day to provide mortgage counseling in multiple languages. Mary Thomason, director of resource development for The Impact Group of Atlanta, a housing counseling group, also suggests tracking expenses and income closely in order to be able to forecast your cash flow for the next six months and give yourself better control of your finances.


Q: If the banks and lenders refuse to write these loans, then what?

A: Public and political pressure may prompt them to participate. If not, and more people continue to lose their homes, Zandi says the next White House administration subject them to additional regulations or investigations if they remain unwilling to take on the risks.


Q: What happens if I'm able to sell my home after I refinance?

A: If you sell during the next five years, you must agree to share 50 percent of any profits from the resale with the government. What's more, homeowners can only retain equity gains based on a sliding scale. The homeowner would have zero equity from a sale in the first year, with the amount rising 10 percent in each succeeding year and capping at 50 percent from a sale in year five and thereafter. The equity must be repaid because the maximum amount on the new loans will be capped at 90 percent of the current market value, which automatically gives the previously troubled homeowner 10 percent equity in the home.


Q: Where can consumers find more detailed information about the plan?

A: There is a six-page summary of the housing act at http://banking.senate.gov/public/_files/HousingandEconomicRecoveryActSummary.pdf and the FHA's Web site at http://www.fha.gov is a place to watch for updated information. The entire 694-page bill is at http://www.house.gov/apps/list/press/financialsvcs_dem/hr3221_bill_text.pdf

DCLife Magazine

DCLife Magazine

PRO AND CONS OF THE 1031 EXCHANGE

October 1, 2007


Pros and Cons of the 1031 Exchange

By Neil A. OHara


How would you like to exchange one appreciated asset for another without having to pay capital gains tax? In the world of stocks and bonds, that only happens within qualified accounts like IRAs or 401(k)s. But it's a different story if your clients own business-related or investment real estate. Section 1031 of the Internal Revenue Code permits owners to exchange one piece of real property for another of "like kind"—a term broad enough to encompass anything from raw land to office buildings or mineral properties—without paying capital gains tax as long as they reinvest the entire sale proceeds in the new property.

A few restrictions apply, of course. The owner has 45 days from the closing of the sale to identify one or more replacement properties, and must close the new purchases within 180 days of the original sale. The owner can't touch the sale proceeds, either. The money has to go into escrow at a "qualified intermediary"—typically a bank or title insurer—pending reinvestment. A 1031 exchange works only if the real estate is held directly or as a tenancy-in-common (TIC), an undivided fractional interest in a property. Interests in a partnership or real estate investment trust (REIT) don't qualify. Nor does property used by the owner as a residence, which rules out vacation homes unless they are rented out.

In a hot real estate market, owners must take care not to flip properties in 1031 transactions. "If you trade too quickly the IRS may say you didn't buy the property for investment, but for the purpose of resale," says Steve Mastbaum, a tax expert and shareholder in law firm Greenberg Traurig's New York office. The consequences are ugly. The IRS not only disallows the tax deferral but also treats the profit as ordinary income rather than as a capital gain.

For people willing to accept the constraints, 1031 exchanges can lay the foundation for significant wealth. Stephen Wayner, first vice president at Bayview Financial Exchange Services in Coral Gables, Fla., has a client who put down $300 on each of two $3,000 lots he bought 33 years ago. Four exchanges later his net worth is $4.3 million—and he never put in another penny. Wayner says clients often use the tax-free proceeds of one sale for the down payment on a replacement, which allows them to buy more property and leverage the return.

IRS figures show a dramatic increase in 1031 exchanges in recent years. In 2004, the most recent year for which data is available, 219,675 individuals reported transactions, more than double the number in 2000. For partnerships, the transaction volume almost quadrupled to 47,928. Wayner says a whole new industry has sprouted since a 2002 IRS ruling permitted up to 35 people to join together as TICs to buy a piece of property and still qualify for 1031.

Patricia DelRosso, president of Inland Real Estate Exchange Corp. in Chicago, expects the growth to continue, as baby boomers who have spent their lives managing small real estate portfolios approach retirement. "They no longer want to deal with the three T's: tenants, toilets and trash," she says. "We can meet that need by offering a 1031 TIC exchange." While the owner still participates in decisions to sell, rehab or refinance the property, a management company handles collections and regular maintenance. DelRosso says a TIC exchange provides an opportunity to diversify, too. The owner can trade a portfolio of single-family rental homes for fractional interests in up to three replacement properties—a shopping center, an office building and a multifamily apartment complex, for example. Although advisors don't get paid directly from 1031 exchanges, suggesting a way for a client to defer tax builds credibility. And as William Fleming of PricewaterhouseCoopers' private company services practice notes: "People with these kinds of properties often have big securities portfolios."


(c) 2007 On Wall Street and SourceMedia, Inc. All Rights Reserved.

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U.S. residents to be fingerprinted

U.S. residents to be fingerprinted

By Tomasz Zalewski, Super Express, 28 July 2006.
Translated from Polish by Ania Milewska.

The U.S. Department of Homeland Security announced that greencard holders – permanent U.S. residents – will be fingerprinted at U.S. borders each time they re-enter the country. The new law is to go into effect in a few months. Since January of 2004, fingerprints (taken with a scanner and not with ink) and digital photos of all foreigners, with the exception of Canadians and Mexicans, visiting the United States have been taken at U.S. borders under the U.S. Visit Program. Snaring unlawful residents So far, close to 61 million people have been processed to determine the validity of their visas, to search for criminal records or for suspicion of terrorism. Anna Hinken, a spokesperson for the Department of Homeland Security, stated that fingerprinting permanent U.S. residents (who are not yet citizens) will help identify people who are using false or stolen greencards, which are easily accessible in the black market. Annually, about a million greencard holders cross U.S. borders, entering or leaving the country. It is estimated that about 12 million U.S. residents are greencard holders. Is it discrimination? The announcement of the new regulations has sparked protests by several pro-immigrant organizations. They claim that fingerprinting is discriminatory and is reminiscent of the requirement implemented after the 9/11 attacks, which affected males from the Middle East and South Asia, who had to register with the immigration authorities after entering the United States.


This article appeared in Edition 233 of Voices That Must Be Heard.

Translation © 2006, IPA, all rights reserved. Included by permisson of Super Express.

NEW VICE PRESIDENT

I have recently accepted the role of Vice President of Sales and Marketing for US Home Construction, Inc. We are both a Licensed Class (A) Builder, and an Architectural firm. The combination of these two important roles classifies us a Design-Build firm. The original General Construction company is about (12) years old. The old company was in need of a face lift and new management so US Home Construction, Inc. was bought and restructured recently. I am here because my goals as a real estate developer coincide perfectly with the growth strategy of the company. As a vice president I can keep the flexibility I need to assure success.



Find more photos like this on DCLife Magazine


My background enables me to provide:

• Accurate market consultation
• Marketing strategy
• Campaign Design
• SEM and SEO Comsultation
• Access to commercial lending

I think that I have a greater chance at becoming a top Real Estate Developer with such a strong relationship with a great Design-build firm.

_____________________________________________

FROM WIKIPEDIA

Benefits of Design-Build
It is important to note that the Design-build method, while not focused on saving the owner construction costs, nonetheless often saves the owner money on the overall project. The combined effects of carrying a construction loan (which typically carries a higher interest rate than permanent financing) and an earlier useful on-line date usually yields considerable overall profitability to the project and may make seemingly unfeasible projects into genuine opportunities.
The compression is an important aspect of the implementation of this system. Other attributes include:

• increased accountability by the service provider
• single source project delivery
• a value based project feedback system

Accountability
Rather than a parcelized level of responsibility of the classic design-bid-build, design-build provides an integrated solution for the owner or client. This moves projects away from the "finger-pointing" that is often commonplace in contemporary construction projects, and allows the owner to look to one entity with any questions or concerns.

Single Source
Instead of having several contractors and consultants, an owner has just one entity to deal with. Design revisions, project feedback, budgeting, permitting, construction issues, change orders, and billing can all be routed through the design-build firm. This single point of contact allows a certain degree of flexibility for the owner. Most design-builders will leverage that flexibility for the owner's benefit by continually refining the construction program to maximize the owner's value at the completion of the project.

Value-based project feedback
Typically, in order for a contractor to bid on a project, very specific details relating to the methods and materials must be given to avoid any ambiguity and to make an "apples to apples" comparison of bids. In a design-build context, the owner, the owner's other consultants, and the design-builder can work together to determine what methods and materials will maximize the owner's value. In instances where marginally more expensive materials, designs, or construction methods might yield a higher return on investment for the owner than those of lower cost, the owner is free to adjust the project's program without having to re-bid the entire project.

Editor's Letter: Too Far, Too Fast

January 1, 2008
Editor's Letter: Too Far, Too Fast


David Bodamer Editor-in-Chief Retail Traffic Magazine


The meteoric ascent of Centro Properties Group from a company few were familiar with a decade ago to a firm that controls one of the 10 largest portfolios in the United States always seemed too good to be true. It turns out, it was.

While Australian capital has long had a prominent presence in the U.S. (names like Westfield, Macquarie and Galileo come to mind), Centro's rise was somehow different. It collected properties as if they were stamps, amassing more than 700 in a matter of years through portfolio deals and outright acquisitions of companies. In the process it leapfrogged past firms with decades of experience owning and operating properties in the U.S. market. And 2007 provided the firm's master stroke: the acquisition of New York City-based New Plan, one of the oldest and largest retail REITs in the country.

A few months ago I had the chance to sit down with Centro CEO Andrew Scott when he was in New York attending an investors conference. One of the things I asked is how the company was able to move so far so fast. He pointed to the superannuation funds in Australia whereby every worker puts 9 percent of their money into retirement accounts. And a preference there has always been to invest in commercial real estate.

In Australia, however, the vast majority of investible real estate is already owned by funds like Centro. As a result, Australian firms have to be aggressive abroad in order to invest their funds.

Scott said that Centro constantly had money streaming in and was able to move from acquisition to acquisition without seemingly ever taking a breather to absorb the new properties. He even hinted that there might be more deals for the firm in the offing this year. As it turns out Centro's growth wasn't just the result of those funds. In reality, it was carrying an extremely heavy debt load, with much of that short-term financing stemming from its aggressive acquisitions strategy.

Now it's looking at billions of dollars worth of maturing debt that all needs to be paid back (or refinanced) by February 15. The initial reports coming out of Australia are that no bank is willing to do that unless Centro dramatically decreases its leverage levels. The only way it can do that is to sell assets quickly. And that creates a whole other problem.

Centro's fall is proving doubly painful because investors in U.S. retail REITs have gotten spooked by Centro's rapid fall. They are worried that U.S. REITs have followed suit and dumped REIT shares in the days after Centro's announcement sending many companies to new 52-week lows. That may hamper some REITs' ability (or willingness) to jump in and buy Centro's portfolio, especially if it would require them to take on more debt — something that's extremely tricky in the current environment.

In the end, there's a strong argument that Centro's problems are the result of bad timing and a too-aggressive strategy. It seems highly unlikely that other firms will face similar issues since no major retail REITs have similar leverage levels or are looking at the amount of debt maturing in 2008 that Centro faced.

But it also shows that getting a handle on the credit crisis may not be as easy as we thought a couple of months ago either.

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VIEW A TYPICAL SEM CONTRACT

Consultant:
Eugene Smith, Jr.
27 Danbury Street, S.W.
Washington, D.C. 20032
Email: corporate@mestizomedia.com
Phone: 571-276-9683

Goals

Develop an online marketing strategy and a viable plan that will enable client to efficiently attain targeted registered contacts within twelve months. Consult for Web site enhancement to compliment online marketing strategy. Customize a Client Response and Management system. Coordinate prospect delivery to account managers, and develop a tracking system to monitor account manager effectiveness. Facilitate Customer Service, Retention and Sales Training (Soft Sales).

Duration of Services
The typical term of the consulting engagement is three months. Consulting will automatically continue in one-month increments unless another agreement is made between the parties, or it is cancelled. Either party may cancel the agreement provided 15-days written notice (email is acceptable).

Project Management Services
During the term of the engagement Consultant will oversee Client's online marketing program, make recommendations, react to Client input and decisions, and in approved cases act on the behalf of Client on various aspects of the program. Consultant is responsible for maintaining a timeline and working with sub-contractors to keep the project on schedule. The project includes several components as further described below, including Marketing Strategy, Search Engine Optimization, Web Site Enhancement, Online Marketing Planning, and Branding Strategy.

Marketing Strategy
• Consultant will apply online marketing knowledge and Internet technology
expertise to Client's ideas and business objectives to develop a plan that will achieve specific and measurable results toward the desired goal.
• Consultant will offer advice and additional ideas during regular discussions with Client.
• Consultant will create and maintain a central document that outlines specific elements of the plan and seek Client approval.
• Consultant will create a timeline to ensure elements of the plan are being acted upon.

The marketing strategy will be the first deliverable of the consulting engagement. All elements of the original marketing strategy will require approval by Client. Any future deviations from the original plan will require written approval by Client.

Search Engine Optimization Services
Consultant coordinates efforts of professional SEO firms to expeditiously make necessary changes to the site(s) to achieve better search engine rankings. During strategy development phase;
• Consultant will work with Client to identify keywords that will be targeted for high ranking.
• Consultant will be responsible for obtaining at least two competitive bids for any sub-contracted work. This may include additional SEO services and/or Media services. Because of industry contacts and relationships, Consultant may be able to obtain services on a wholesale rate and pass along the savings.
• Consultant will communicate to contracted firm the target list and monitor the results.
• Consultant will negotiate with contracted firm to efficiently build upon existing site infrastructure to avoid excess cost. Some Web site development work may be needed for SEO to be successful.
• Consultant will maintain communications to ensure project stays on schedule.
Web Site Development Services
SEO and adding functionality to the Web site(s) necessitates Web site development work. Using the Client approved marketing plan;
• Consultant will provide an itemized list of pages, applications and possible enhancements. Client will approve list.
• Consultant will develop the pages, or recommend that certain work be sub-contracted. Client will decide if work will be sub-contracted.
• Consultant will be responsible for obtaining at least two competitive bids for any sub-contracted work. Because of industry contacts and relationships, Contractor may be able to obtain services on a wholesale rate and pass along the savings.
• Consultant will maintain communications with web development firm to ensure project stays on schedule.

Online Marketing Planning and Execution
Concurrent to the work previously described, consultant will;
• Develop an online marketing plan that will achieve the defined goal.
• Communicate aspects of the plan to Client for approval.
• Negotiate the best rates and obtain insertion orders from selected advertising vendors.

Because of industry contacts and negotiation skills, often Consultant will be able to arrange CPA (Cost-Per-Action) deals that carry less risk for the Client.
• Implement approved elements and track effectiveness.
• Provide feedback on campaign successes and failures.
• Develop tracking mechanisms to determine effective CPA.
• Optimize marketing plan toward lowering CPA.
• Provide pacing reports and projections related to progress.

Intangible Services
There is an intrinsic value associated with the Consultant's unique qualifications, experience and know-how. Whether measured in cost savings, additional revenue, increased efficiency, alternate business opportunities, brand recognition, improved conversion rates, speed to market, or other business development improvements, by contracting services the Client acknowledges additional benefits not specifically identified in the agreement.

Fees
A retainer fee for work described in this proposal is determined to be $18,000.00, with payable upon acceptance of this agreement. A Schedule of Payments is expressed below under “Payment Terms & Conditions”. Subsequent months, pursuant to the automatic renewal clause under "Duration of Services" are per month at a rate of $7,000.00, payable no later than the fifth day of the month in which services are to be rendered.

Consultant will charge a campaign management fee based on 10% of the total cost of any advertising insertion orders that are negotiated and accepted by Client under this agreement. This fee is similar to, but lower than the standard advertising agency commission rate of 15% and is only applied to advertising orders made during the term of this agreement, which are negotiated on behalf of Client, recommended by Consultant, and accepted by Client. Campaign management fees are billed at the end of the month in which the order is accepted, payable within 15 days or no later than fifteen days prior to the end date of the engagement, whichever is earlier. An incentive-based prospect management fee of $100.00 per successfully captured account.

Payment Terms & Conditions


Schedule of Payments
$9,000.00 (equivalent to 50% of the retainer fee) Due by June 22, 2007
$4,500.00 (equivalent to 20% of the retainer fee) Due by August 10, 2007
$4,500.00 (equivalent to 20% of the retainer fee) Due by September 21, 2007
Due to the intangible nature of the services rendered, Consultant expects timely payments. All fees billed under the terms of the agreement that remain unpaid for twenty-five (25) days after the invoice date will be considered a default by Client. At that time all services will cease until the balance is paid in full. If payment is not made, any outstanding deliverables will be rendered void. Consultant will pursue delinquent fees to the fullest extent possible under the law.

Option to Amend
This agreement may be modified at any time provided both parties agree in writing, to any modifications. Consultant will require that any changes of significance be made on a dated copy of this agreement, with acceptance indicated by original signatures. Other changes may be made through email correspondence at the discretion of Consultant.

Search engines that may be included in testing are, Google Adwords, Yahoo! Search Marketing (formerly Overture), FindWhat, Mamma.com, Enhance Interactive, Kanoodle, E-Pilot, among others.

Upon ratification of this agreement, the term of this consulting engagement will commence on the second Monday following the date of endorsement of all parties involved.

Lehman raising $6B in capital, expects $2.8B loss

June 9, 2008

By JOE BEL BRUNO
AP Business Writer

Lehman Brothers Holdings Inc. on Monday confirmed fears on Wall Street that the credit crisis isn't quite over, and it left investors to wonder if other major investment banks face the same set of risks.
The nation's fourth-largest investment bank said wrong-way trading moves and risky mortgage-backed securities plunged it into a nearly $3 billion second-quarter loss. It marks the first time Lehman was unable to post a profit since going public in 1994.
Its stock fell nearly 9 percent and helped drive a broad sell-off in bank and brokerage shares.
Lehman's top executives, who have repeatedly assured investors that their books were safe, will fund the firm's survival by raising $6 billion of fresh capital. It is a move many of Lehman's competitors have already been forced to make.
The announcements, made before the official June 16 release date of Lehman's results, were an attempt to calm a market still badly shaken by the near collapse of Bear Stearns in March. Analysts were disappointed that Lehman's loss was much deeper than they expected, and felt it could have an impact on rivals.
"There is a broader element to all this," said David Trone of Fox-Pitt Cochran. "Management considered this to be an aberration, but I think you'll see similar results in form and structure, just the magnitude will be smaller."
Sanford C. Bernstein analyst Brad Hintz, a former chief financial officer of Lehman, said one concern is the $130 billion of mostly residential and commercial real estate assets the firm sold during the quarter. Those sales triggered billions of dollars of gross mark-to-market adjustments — or accounting changes to the value of assets — since the beginning of last year.
He believes that if those prices are deeply discounted, it would set a precedent that could hurt rivals like Merrill Lynch & Co., Morgan Stanley, and Goldman Sachs Group Inc. "There could be a modest domino effect," Hintz said. Those companies have also had write-downs of mortgage-backed assets, with Merrill taking a heavy enough hit that it lost its CEO. Goldman is believed the be the strongest of the Wall Street companies.
Further, Lehman's investments to hedge against troubled assets on its books backfired, and CFO Erin Callan said they "were significantly impacted" during the past few months. She said the highest point of the market's disruption this year was in March, but conditions have eased since then.

Lehman said it expects to lose $2.87 billion, or $5.14 per share, for the period ended May 31, compared with the $1.3 billion, or $2.21 per share, it made in the year-ago period. Analysts had expected the company to report a loss of just 22 cents per share for the period, according to Thomson Financial.

CEO Richard Fuld said he was "very disappointed" in the quarterly results. However, he believes the additional capital — raised through an offering to yet unnamed investors — will help keep the company whole amid continued market turmoil.

There had been market speculation that Lehman was seeking outside investors to offset losses during the quarter and fortify its balance sheet. Some analysts felt the firm's balance sheet was the closest of all the Wall Street firms to Bear Stearns, which narrowly avoided bankruptcy in March through its government-sponsored sale to JPMorgan Chase & Co.

But so far, Lehman appears in better shape — and possibly has generated more confidence among investors — than Bear, which was badly undermined when panicky customers withdrew their money from the investment bank. Moreover, after the Federal Reserve helped engineer JP Morgan's buyout of Bear, investors have felt more secure that the government is unlikely to let a big investment bank fail.

Lehman is expected to raise capital by selling to mostly American investors $4 billion of new common shares and $2 billion of three-year mandatory convertible preferred stock. The convertible stock is required to be turned into common shares by the end of the three-year period.

The firm was under pressure after David Einhorn, who runs the hedge fund firm Greenlight Capital, vocally and publicly raised questions about Lehman's earnings during the first quarter. He said the company has not disclosed all of its losses, and felt Monday's announcement was only the start.

"Lehman is raising $6 billion that they said they didn't need to replace losses that they said they didn't have," he said in an interview. "Since the credit markets actually improved this quarter, such losses primarily reflect losses that might have been taken in prior quarters. A preliminary analysis of the pre-release and conference call suggests that there are still unrecognized losses on the balance sheet."

In addition, Lehman's stock sale will significantly dilute outstanding shares. As of March 31, Lehman had about 553.6 million shares outstanding. The common stock offering would add about 142.9 million shares, while the conversion on the preferred stock would eventually add as many as 71.4 million more shares.

Lehman shares fell $2.81, or 8.7 percent, to $29.48. Moody's Investors Service and Fitch Ratings both cut their ratings on Lehman, exacerbating the decline.

In this Jan. 24, 2008 file photo Chairman and CEO of Lehman Brothers, USA, Richard Fuld speaks during a working session at the World Economic Forum in Davos, Switzerland. Lehman Brothers Holdings Inc. on Monday said it will raise $6 billion in new capital to shore up its balance sheet after saying it expects to post an unexpectedly large second-quarter loss of nearly $3 billion. (AP Photo/Virginia Mayo, file)

Banks Facing Up to Reality of Diminished Values

By Jim Freer

This year, reality is sinking in at many community banks that have high ratios of noncurrent land development and other real estate loans.

"They realize," said Kingsley Greenland, chief executive officer of the Boston loan-sale adviser DebtX, "that the values, not just of the loans but of the collateral, are not going to come back any time soon."

Thus, many such banks are looking to sell some of these loans — a change from their previous strategy of continuing to restructure weak credits while trying to delay writedowns.

Some are turning to advisers like DebtX that market bank loans to institutional investors.

Others are speeding up their real-estate-owned sales, provided the discounts are not too steep on undeveloped land and stalled housing tracts. Their goal is to sell properties this year rather than incur tax liabilities and other costs as they wait for a housing market rebound.

The $7 billion-asset United Community Banks Inc. in Blairsville, Ga., began that strategy last year because "we cannot predict when prices will start reversing," said David Shearrow, executive vice president and chief risk officer.

Some bankers and advisers expect a new round of banks' and their holding companies' setting up "bad bank" subsidiaries to hold noncurrent loans and REOs.

One example is BankAtlantic in Fort Lauderdale, Fla., which in March transferred $101.5 million of noncurrent loans to a newly formed asset workout subsidiary of the $6 billion-asset parent, BankAtlantic Bancorp.

Almost all the loans were so-called land bank loans to Florida residential developers whose builder clients did not carry out deals to buy lots after the housing market began to soften in late 2006.

Alan Levan, the chairman of BankAtlantic and its holding company, said using an entity that is not part of the bank adds flexibility for timing loan sales. The subsidiary could become a joint venture partner in some developments after the housing market begins to rebound, he said.

Meanwhile, some banks are turning to traditional-style auctions, complete with bidding and the hammer falling, to unload housing construction loans and undeveloped properties.

J. Durham & Associates in Albany, Ga., is to hold the first in a series of Atlanta-area auctions of bank-owned commercial real estate properties and undeveloped land in late June.

Many publicly traded banks are among those that have decided to sell loans and REOs quickly — rather than face the prospect that prices may still be falling late this year and into 2009.

Analysts and investors "are comparing these banks to their peer groups and asking, 'How are you managing your nonperforming assets and REOs?'," Mr. Greenland said. "A way to stay ahead is to not wait to foreclose but to sell the loan before it gets to foreclosure and mitigate your losses."

A growing number of banks are taking a "pay now rather than pay later" approach to selling loans and accepting discounts, said Christopher Marinac, the director of research at the Atlanta investment bank FIG Partners.

DebtX, which also sells nonproblem loans to institutional investors, sold loans for about 100 banks last year.

That total could double this year, Mr. Greenland said.

Cowlitz Bancorp. in Long-view, Wash., with about $500 million of assets, has been selling real estate and commercial loans through DebtX since 2003.

Its latest DebtX sale was an acquisition and development loan to a developer near Portland, Ore., for which it received "just under 50 cents on the dollar," said Cowlitz president and CEO Richard Fitzpatrick.

The single-family home project stalled because several builders had backed out of contracts to buy lots.

Cowlitz might have spent three to five years trying to sell the project if it had taken it through foreclosure, Mr. Fitzpatrick said.

"We sold, received some cash, and moved on," he said.

Still, in sales before this year, including some of nondistressed loans, Cowlitz had gotten "north of 85 cents on the dollar" on some DebtX sales.

This year, Cowlitz took possession of another home building project near Portland that it is marketing itself — again willing to accept a discount rather than absorb several years' holding costs.

Some banks with problem loans and their borrowers are turning to private lenders, such as Forman Capital in Delray Beach, Fla.

Forman Capital's lending in Florida and other states has been on nondistressed commercial properties.

Now, with the number of noncurrent bank loans growing, CEO Brett Forman said his company will consider buying distressed housing development loans. Mr. Forman and other private lenders have more flexibility than banks in structuring loans, including those for distressed debt.

Data from the Federal Deposit Insurance Corp. show the market for distressed bank real estate debt has grown.

From Dec. 31, 2006, and Dec. 31, 2007, the industry's noncurrent ratio for all real estate loans grew from 0.80% to 1.71%. The noncurrent rate on construction and development loans soared from 0.71% to 3.15% during those 12 months.

Among banks with assets of $1 billion to $10 billion, the noncurrent ratio for all real estate loans rose from 0.67% to 1.53%, and from 0.76% to 3.05% on construction and development loans.

The FDIC had not released its first-quarter industry data by press time, but if earnings reports of publicly traded banks are an indication, the numbers are likely to get worse. Many community banks' quarterly earnings included significant increases in noncurrent loans to home builders.

United Community Banks reported that its ratio of nonperforming assets to total assets rose from 0.56% at the end of last year to 1.07% at March 31. Its noncurrent loans and REOs are primarily for housing construction in the Atlanta market.

United has been able to sell REOs aggressively because it exceeds all measures required for being considered well-capitalized, Mr. Shearrow said.

Writedowns have ranged from "0 to 20%" on sales of completed projects and "anywhere from 15 and 20 to 50%" on lots and undeveloped land, he said. Buyers usually are local developers and individuals, he added.

United uses its own staff to find buyers and tries to get properties off its books within 90 days of foreclosure. It prefers to foreclose and sell properties rather than try to sell problem loans before they reach foreclosure. In addition to being behind on loan payments, housing developers often are owed money by subcontractors and have liens, Mr. Shearrow said.

Setting up a subsidiary for problem loans is another strategy that requires a bank to exceed well-capitalized levels, said BankAtlantic's Mr. Levan.

The bank and its holding company satisfy the requirement. The holding company added to its capital in March by selling 2.1 million shares of Stifel Financial Corp. for $82.2 million and used much of the proceeds to buy loans from the bank.

"As opposed to being concerned about capital at the bank level, we can be more creative in working with borrowers and in completing foreclosures as the case may be," Mr. Levan said.

Steven Fritts, the FDIC's associate director for risk management policy, said the agency is not hearing much about banks setting up "bad bank" affiliates. Still, he said, "It can make sense to isolate those assets. It allows loan officers to focus on developing new business."

State laws on corporations and Federal Reserve and Office of Thrift Supervision rules on holding companies are what Mr. Fritts calls the "dominant legal drivers" for setting up such subsidiaries.

Taking foreclosed properties to auction is an alternative to managing them in a bad bank setup.

The Martin Realty Advisors in Alpharetta, Ga., and joint venture partner J. Durham & Associates have recently been advising several banks in southeastern states about auctions. "This is at an early stage," said Joe Durham, the president of J. Durham Associates. "We will start seeing more banks realize that they need to sell now because the markets are not getting better."

Mr. Durham said the first auction featuring bank assets will include undeveloped land, stalled condominium projects along the Florida Panhandle coastline, and stalled single-family projects around the Southeast.

Those kinds of properties are prominent as collateral for loans that DebtX sells in an online bidding process to more than 3,500 institutional investors. Mr. Greenland said he anticipates vacancies rising at numerous "marginal shopping centers," and that loans on retail properties could be the next to falter.

DebtX's business includes a five-year agreement with the FDIC, signed last year, to sell real estate assets that are in receiverships.

ON THE PATH TO BECOME A PRIVATE ANNUITY TRUST

COUNSELING CLIENTS

What strategies can planners suggest for clients who already own multiple homes in overvalued markets? If the bubble has not deflated in your area, you might counsel clients to sell their second homes if they want to get top dollar.

"We have a client who just sold a vacation home and an adjoining lot in Tahoe," says Stone, referring to the area around the lake that spans the California-Nevada border. "He wasn't using it enough to keep it, and he got a good price: $1.2 million." The price was so good, in fact, that the client would have had an $800,000 gain and a steep tax bill. "To defer the tax, we suggested this client sell the property to a private annuity trust," Stone says.

In this arrangement, the real estate is sold to a trust, which in turn makes a sale to a third party. The trust then reinvests the proceeds and pays lifetime income to the original owners as well as any balance to designated heirs. This way the client can defer income tax on the sale, effectively provide the heirs with a basis step-up and remove any funds left in the trust from the seller's taxable estate. But there are potential gift tax consequences, depending on the seller's age and the cash flow paid by the trust (see "Going Private," below).

Another tax-effective move is for clients to sell their primary residence and move into what had been a second home. The $250,000 home-sale exclusion ($500,000 for married couples) would shelter gains from the sale as long as the seller had lived in the house for at least two of the previous five years. If the clients decide to sell the former vacation home after living in it for two years, they would qualify for another $250,000 or $500,000 tax break.

"A married couple I represent did this recently, moving from the San Francisco Bay area to Tahoe," says Jane Williams, chief executive officer of Sand Hill Advisors, a wealth management firm in Palo Alto, Calif. "They sold their primary residence and moved into their vacation home." Williams works with many people who are experiencing a major life transition, such as a divorce or the death of a spouse. "The family home, which is often a major asset, can be an expense rather than an income-generator," she says. "For people with more real estate than they can maintain, we encourage downsizing."

Inflation first aid: Gold, oil and real estate

Inflation first aid: Gold, oil and real estate
By ROB CARRICK Globe and Mail Update
The arch-enemy of all investors is threatening a comeback after a long time away.

Inflation hasn't been a top-of-mind consideration for investors since the early 1990s, and today it's hardly noticeable. But there's growing concern that soaring prices for oil and food products are within the next year or so going to push the inflation rate higher than we've seen it in years.

This edition of the Portfolio Strategy column is all about inflation-proofing your portfolio, which is more problematic than you may think. Some investors automatically look to real-return bonds if inflation's a threat, but there are good reasons to avoid them. Gold and commodities are classic inflation defences, but neither is any sort of a bargain right now.

The first thing you need to understand about inflation is that it's a global phenomenon, even if the cost of living here in Canada in March was just 1.4 per cent ahead of where it was a year earlier. The inflation rate in the United States in March was 4 per cent, and other regions are comparable or worse.

“In Europe, inflation is running over 3 per cent, and in the emerging markets it's on fire,” said Alec Young, an equity market strategist with Standard & Poor's in New York. “In Russia, you've got 12 per cent and you've got 8 per cent in China. It's accelerating.”

Expect the usual carnage if inflation flares up here. The bond market will be hammered as interest rates rise, and the stock markets will struggle. The trouble for stocks arises from the fact that inflation makes investors more conservative about what they're willing to pay for a company's shares. Price-earnings ratios tend to fall, and that means lower share prices.

The market sectors that buck this trend are the ones that are based on gold and commodities such as oil and gas, metals and fertilizer. The psychology here is that commodities are hard assets that hold their value when prices are rising.

When the inflation rate surged into double digits in the 1970s, commodities were the place to be. The problem with commodities today is that they've already experienced a gigantic runup in price. In fact, rising oil and fertilizer prices are key reasons why inflation is globally on the rise. The price of crude oil, for example, has jumped about 75 per cent in the past year to its current range of around $116.

“Traditional inflation hedges don't look like attractive bargains right now, so the past may not be prologue this time around,” Christopher Davis, an analyst with the Chicago-based research firm Morningstar, wrote in a commentary this week.

Mr. Davis suggested a dollar-cost-averaging approach for getting into commodities, where you make small, regular purchases every month or quarter. That way, you get to take advantage of the sort of pullbacks we saw this week in oil and gold prices. Long term, there are commodity price forecasts out there that make a case for buying at current levels. Last month, CIBC World Markets issued a widely quoted forecast that crude oil prices would rise to $200 (U.S.) a barrel over the next five years, and that gasoline prices would jump to $2.50 (Canadian) a litre.

Be prudent when adding commodity exposure to your portfolio. Many Canadian investors already have substantial exposure to oil, metals and gold through their mainstream equity funds, exchange-traded funds and individual stocks. Both sectors together accounted for 47.8 per cent of the S&P/TSX composite index as of March 31.

Gold is the classic inflation hedge because of its intrinsic value, but S&P metals analyst Leo Larkin believes the price is heading lower in the months ahead. The price of gold surged 32 per cent last year and another 23 per cent in early 2008 to a peak of $1,030 (U.S.). It has since fallen to the $855 range, and Mr. Larkin said it's possible it might decline to $730 at worst.

From there, Mr. Larkin expects gold to head sideways for six months or so before mounting a comeback that could see it revisit the highs of earlier this year. “If inflation is kicking up, I don't see why ultimately it wouldn't surpass the old highs maybe some time in mid-2009.”

An inflation-resistant sector you can buy into now at cut-rate prices is commercial real estate, which is mainly represented in the stock markets by real estate investment trusts. Recent financial market volatility has made investors leery of REITs on a global basis, and concerns about slower economic growth are a problem as well.

Here in Canada, the S&P/TSX capped REIT index is off about 18 per cent over the past 12 months. However, CIBC World Markets issued a report earlier this month saying the selloff of Canadian REITS belies some strong underlying fundamentals such as low vacancy rates and only a trickle of new properties hitting the market this year and next.

While the stock markets are averse to inflation, bonds are strongly allergic. Rising prices will goad central banks into increasing interest rates, and that always sends bond prices lower. Your best bet, says BMO Nesbitt Burns fixed income strategist Michael Herring, is to invest in short-term bonds. They'll hold up better than long-term bonds in a rising-rate environment.

The obvious bond choice for the year ahead would seem to be real-return bonds, which adjust their semi-annual interest payments and the amount you receive on maturity to account for higher inflation. But Mr. Herring advises against real-return bonds because they're a suspect value based on current prices. “My point of view is that people are overpaying for the inflation insurance that real-return bonds give you.”

Another thumbs-down for real-return bonds comes from Sheldon Dong, fixed income strategist at TD Waterhouse. He doesn't recommend them for retail investors because they behave like long-term bonds and thus have a tendency to be disturbingly volatile on a month-to-month basis.

“I've never been a big proponent on these things,” Mr. Dong said. “Most people own stocks, and most people own oil. That's their inflation protection right there.”
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CHAPTER TWO OF ACCLAIMED BOOK BY REAL ESTATE INVESTOR JAMES BEST

How Not to Get Started!

Before we get started in the nitty, gritty details, I thought I should share some background information on myself with you so that you might have a better understanding of how I approach real estate investing. I used to be a CPA with a large accounting firm and hated every minute of it. Every Sunday night, I would have a pit in my stomach with the thought of having to start another work week. My job in the accounting firm was to go audit our clients’ financial statements. So every day I would go to work at companies that didn’t really want me there. I was an auditor. Nobody likes an auditor.
While auditing these companies, I started to feel like I was on the sidelines watching them make things happen. My clients’ companies were making things happen. They were in the game. I felt as if I weren’t really in the game. I was just checking the score. Who likes to sit on the sidelines? The fun is in the game.
Ever since college, I knew that real estate investing was very profitable. I kept thinking that real estate investing would be a great way to earn a living without having to sit behind a desk all day long. So, like many people, I bought one of those so-called "get rich buying real estate" systems from a TV commercial. I won’t name any names, but if you turn on your TV very late tonight, I would be willing to bet you will find a new version of the same commercial running on some channel. I read every book I could find on how to buy foreclosed homes and sell them for a profit. I can honestly say that I tried everything recommended from these books and tapes. This book has been written with my blood, sweat and tears of real estate investment. As an investor, I have learned from my own real life experiences. As a real estate broker, I have learned from countless clients that have invested in real estate using different approaches.
The approach to investing that we have moved toward over all of these years has been working so well because of the underlying philosophy, which I will explain in detail throughout this book. It took a lot of mistakes to realize why investing in real estate was so challenging. Here are some of my mistakes….

My First Try to Make Money…

I found out through the school of hard knocks that Get Rich in Your Spare Time really meant spending a whole lot of time making not so much money. One of the books that I read recommended that I go find sellers that would sell their home to me and act as the bank. So, in essence, I should buy their home and they would receive monthly payments from me over time instead of their full sales price at the time of sale. With this approach, I supposedly wouldn’t need a bank and could buy homes without having a down payment. The truth was that the only people willing to accept this arrangement had homes that were garbage. In the late 1990’s and early 2000’s mortgage interest rates became so low that there has been a huge supply of home buyers. Because there are so many buyers, home sellers can get their full sales price without having to take any risk by accepting monthly payments. The real estate market in general over the last few years has been a seller’s market. This means that in most cases the seller calls the shots. If interest rates go into the double digits again, I suspect that these techniques might be more profitable because the market will become a buyer’s market.

CHAPTER ONE OF ACCLAIMED BOOK BY REAL ESTATE INVESTOR JAMES BEST

Are You Ever Going to Be Able to Retire or
Are You Going to Mop Floors at McDonald’s?


Have you ever walked into a fast food restaurant and noticed a Senior Citizen mopping the floors or cleaning the tables? I have, and it really breaks my heart. Do you think that the Senior Citizens who are mopping the floors dreamed of the day when they could retire and then work at McDonald’s to earn some extra income? Can you picture them in their 20’s, 30’s, 40’s and 50’s just waiting for the day when they could start at McDonald’s?
I am presenting this on the funny side, but it is a serious point for you to consider. The Senior Citizens you see working are not working because they want to. (Well, some of them probably do want to.) My mother retired a few years ago and has a part-time job because she likes to meet new people and see old friends at work! The majority of Senior Citizens are working because they have to. The reason they have to work is because their monthly income isn’t enough to cover their monthly living expenses.


Do you want to mop floors and clean bathrooms when you hit your golden years? If not, then consider this:

If You Ever Want to Retire in Your Life,
You Better Start to Create Passive Monthly Income Today
What is guaranteed to you in today’s world? Is your job secure? Are you guaranteed to get Social Security or your pension at work? Will the stock market continue with hardly any growth? Study after study has shown that Social Security will run out of money. The reason is because the baby boomer population will go from working and paying to Social Security to retirement and collecting Social Security. The number of people still in the workforce paying into the plan will not be enough to cover all of the outgoing payments made to retirees.
Look at Enron! Thousands of employees’ retirement accounts disappeared over night. Don’t think that you will be safe. The biggest problem that I see most people make is to rely on one income. Relying on one of anything is very dangerous to you. If you are relying on your 401(k) and the stock market crashes, you are going to suffer. If you are relying on Social Security and it runs out of money, you are going to suffer. In fact, many people rely on just one income from their job. What happens when the company downsizes and your one income goes away? Never rely on one of anything. It is far too risky.


You really need to protect yourself from the danger of “one” by creating other multiple income streams. By having 20 income streams coming to you each month, you are not as dependent on any one of them. This book is about building passive monthly income streams that you can live on to ensure your financial security and independence.
When I say passive income, I mean money that you receive every month from your investments. Understand that it takes some work to set up passive income streams. However, once your income streams are set up, you simply have to manage them.
In this book, I will show you how to create on average $58,004 in profits from buying just one single-family home for investment.
Let me ask you a very serious question:
If all you did was invest in two single-family homes and never did any other investing for the rest of your life, would you be better off financially?
Well, I know the answer and you know the answer. It’s actually a silly question; however, the majority of people never ask themselves this question. If you kept your job and had two rental properties that would be three income streams you would have coming to you. As you will see shortly, it is actually many more income streams. Each income stream you create is added financial protection for you and your family.
What is the best investment your parents ever made? Many of you will say that your parents’ best investment would have to be their homes. The next logical question then becomes, what would your parents’ life look like, if they had bought two rental properties 30 years ago? What would the life of the Senior Citizen working at the fast food restaurant be like today had they invested in real estate earlier in their lives? Would they still be mopping the floors and cleaning ketchup off of the tables?
I don’t want to see you cleaning floors; instead, my goal with this book is to motivate you to just invest in a few single-family homes. That’s it. I know that if I can give you the encouragement and tools to get started, you can dramatically change your future. If you take the ideas in this book and continue to buy two homes a year for the next 10 years that would be fantastic! The focus is for you to get started today and build monthly passive income so that you can live life on your terms and not be dependent on any one income stream.
Think about this:
If you were to invest in just one single-family home today and keep it until your retirement, you would increase your net worth by $411,613. You would have a monthly income from this one home in excess of $1,330. (A $100,000 home appreciating at 5% a year for 30 years would
be worth $411,613.) And that’s a conservative example. It could be much more in a market experiencing soaring appreciation.



Just a few homes purchased now could make you a millionaire in retirement. By owning real estate as an investment, you are not relying on Social Security or your employer’s pension. If you are lucky enough to receive Social Security or a pension, super for you! Treat it as a bonus. However, by owning real estate, you are guaranteeing your future financial security and not just hoping for the best.
The amount of income you create from your real estate investing is completely up to you. In fact, how quickly you can achieve financial independence is entirely up to you too. One of my client members, Joe Mercadante, was able to achieve financial independence in seven months at the age of 34. You can create as much income, or as little as you want. The choice is 100% yours.
The reason I am able to say this so confidently is because I have some clients that only create $15,000 on one property and don’t do anything else. I have other clients that create $30,000 on one property and then repeat the process over and over again on other properties.
You see, building your wealth is simple, but it’s not easy. The thought of buying two homes and renting them out is simple. But actually doing it is not easy.
That’s where this book comes in. This book will help you make the simple, easy!

Copyright 2008