View of AZ Market - "Strategic Defaults"

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Overall Market Conditions: (statistical facts)
Activepropertieslistedforsale(Maricopa County Arizona)as of 4/01/2009 was 46,287, broken down as follows:

Listed sales price range	No. of properties listed for sale
$0 - $100,000	9,718
$100,001 - $200,000	14,387
$201,001 - $350,000	9,641
$351,000 - $500,000	4,286
$501,000 - $750,000	3,137
$751,000 - $1,000,000	1,732
$1,001,000 - $1,500,000	1,353
$1,501,000 - $2,000,000	760
$2,001,000 - $4,000,000	993
$4,001,000 - $5,000,000	101
$5,001,000 and higher	126

Properties listed as “pending and under contract”as of 3/31/2009

Listed sales price range	No. of properties listed under contract
$0 - $100,000	4,440
$100,001 - $200,000	4,255
$201,001 - $350,000	1,756
$351,000 - $500,000	453
$501,000 - $750,000	198
$751,000 - $1,000,000	176
$1,001,000 - $1,500,000	56
$1,501,000 - $2,000,000	17
$2,001,000 - $4,000,000	16
$4,001,000 - $5,000,000	3
$5,001,000 and higher	3

Sold properties in Q1, 2009 are broken down as follows:

Listed sales price range	No. of properties listed as sold Q1, 2009
$0 - $100,000	6,628
$100,001 - $200,000	6,589
$201,001 - $350,000	2,932
$351,000 - $500,000	819
$501,000 - $750,000	342
$751,000 - $1,000,000	120
$1,001,000 - $1,500,000	78
$1,501,000 - $2,000,000	38
$2,001,000 - $4,000,000	46
$4,001,000 - $5,000,000	3
$5,001,000 and higher	4

It is important to keep in mind that the sales statistics only capture activity as listed in ARMLS, the Realtors Database and other sales take place within many product pipelines, i.e. Trustee sales, REO sales direct from lender inventories, direct sales from home builder inventories, etc.
Average days on market for sold properties Q1, 2009:

Listed sales price range	Average days on market until sold
$0 - $100,000	76
$100,001 - $200,000	79
$201,001 - $350,000	97
$351,000 - $500,000	116
$501,000 - $750,000	143
$751,000 - $1,000,000	157
$1,001,000 - $1,500,000	148
$1,501,000 - $2,000,000	225
$2,001,000 - $4,000,000	210
$4,001,000 - $5,000,000	426
$5,001,000 and higher	419

On their face, these numbers don’t look terrible however we believe that 90% of the sold properties are properties that show up in ARMLS as either the cheapest active in their subdivision or within a group of between 1 and 3 of the least expensive active listings. Keep in mind that we are still experiencing over 7,000 listings a month combined cancelled and expired (see below) and the example above is sold listings only.

Cancelled and expired listings Q1 2009

Cancelled, and expired listings in ARMLS Q4, 2008
Cancelled listings totaled 12,790 for Q4, 2009 for an average of 4,263 per month
Expired listings totaled 9,041 for an average of 3,013 per month
Average per month DECREASE in the number of active listings per month as a result of cancelled or expired listings is 7,276 per month.

Our opinions about the listed data and how it relates to opportunities in the industry are as follows. Since our business is exclusively focused on the entrepreneurial Investor, all of our comments and prospective are geared towards for profit real estate trading activities:
Active listings: We believe that the current number of active listings (overall) in the market represented at 46,287 (Maricopa county only on 4-1-2009
) represents an oversupply of approximately 257%. We believe adequate supply in order to achieve a price stabilized market within which an investor to precisely predict the average days on market to sell an investment property is 18,000 active properties. The number of active listings has dropped from Q4 of 2008 the only reason to get intoxicated by that fact would be if it was anchored in a net decrease driven by properties being sold, and it does not appear that it is. The data shows that the real net decrease is driven by the average 7,276 listings per month either cancelled or expired, and if you net out the number of sold properties from that figure you see an average net decrease of approximately 2,000 listings a month which ties out almost exactly to the net decrease in active listings from the end of Q4 2008 to the end of Q1 2009 – so the summary is we believe there has been no measurable improvement in net absorbtion of properties offered for sale in the Q1 of 2009 even though the overall number of active properties is lower by approximately 6,000 listings and unless you believe that a Seller who “gives up” and removes their property from the market represents prosperity we don’t think there is any other explaination with merit on this point.
Pending and under contract properties: These numbers are generally somewhat deceptive due to the fact that we believe that as many as 50% or more of the properties listed as pending and under contract fall out due to the Buyers inability to obtain financing, and if the selling price eclipses the FHA lending limit cap we believe that the percentage of contracts that fall out is EXPONENTIALLY INCREASED due to lack of available financing.Sold properties: Sold properties on a monthly basis remained fairly consistent from Q4 of 2008 through Q1 of 2009. THE STAGGERING STATISTIC RELATING TO SOLD PROPERTIES IN Q1 OF 2009 IS THAT NEARLY 92% OF ALL TRANSACTIONS COMPLETED HAD A SALES PRINCE OF UNDER $350,000.
Supply – demand effect: It is widely accepted that values will not rebound or even completely stabilize until there is a meaningful vision and credible evidence of supply demand balance occurring. We believe that there are several components to this. First, we believe that a pricing bottom can be achieved without supply demand balance occurring and that a pricing bottom (value bottom) being established will lead to predictable selling timeframes (DOM) and a climate where speculative investors can purchase assets with a level of confidence that the market comparables that they utilized in making their investment decision will not be a moving target.
Inventory supply statistics:

Listed sales price range	No. of months supply based upon Q1 2009 Sales
$0 - $100,000	4.39
$100,001 - $200,000	6.55
$201,001 - $350,000	9.86
$351,000 - $500,000	5.23
$501,000 - $750,000	9.17
$751,000 - $1,000,000	14.4
$1,001,000 - $1,500,000	17.3
$1,501,000 - $2,000,000	20.0
$2,001,000 - $4,000,000	21.5
$4,001,000 - $5,000,000	33.6
$5,001,000 and higher	92.9

Q1 2009 produced similar results in this area when compared to Q4 of 2008 which are preventing a pricing bottom (value bottom) from being established, including:

• No sustainable reduction in the number of active properties listed for sale for a “good” reason
• Substantial builder inventories still unsold and heavily discounted
• An astounding amount of properties being recovered by Lender Beneficiaries at Trustee sale instead of selling to 3^rd party investors.
• REO (Lender recovered assets) being dumped into the market at reduced prices
• A very difficult and limited permanent mortgage market where the only reliable source for takeout financing isthe FHA, which has a maximum loan amount in MaricopaCounty of $345,250 at this time

Benchmarks to look for relating to supply-demand balance:We believe that there are certain events that to us, would represent credible signs of a value bottom either being established,or the expectation that one will be established in the near term, which are:

• The number of active listings for sale as represented in ARMLS drops below 40,000 and remains below 40,000 for 90 consecutive days AND Not as a result of expired or cancelled listings.
• The number of properties being noticed for trustee sale is reduced each month for 4 consecutive months. This would indicate some measurable “flow through” in this area, meaning we could make a reasonable assumption that lender recovered assets are going to peak, and pent up inventory would then logically, slowly decrease.
• Existing lender REO inventories have a sustained inventory reduction by 50% or more
• Existing builder inventories have a sustained inventory reduction each month for 4 consecutive months
• Recovered assets and REO properties “cycle” through the system
• The take out, permanent lending market begins to “”thaw out” and multiple companies are offering competitive loan products to the consumer for owner occupied properties

The Foreclosure market:
Having pioneered the use of the world wide web for the sale of foreclosure properties over 10 years ago we have an in-depth knowledge of the dynamics within that industry and we continue to track and analyze,in great detail, the activity occurring at Trustee sales.We also believe that the velocity of trustee sales have a very significant impact in market conditions.Specifically, we believe that key indicators are as follows:

• The number of properties being offered for sale (auctioned off) is unprecedented, commonly reaching or exceeding 1400 properties a day,and averaging 900 a day in Maricopa county alone.
• The pipeline of properties “in the system” scheduled to be sold at auction,but not yet sold is giganticAND INCREASING QUICKLY.We estimate the number of properties” in the system” at this time, scheduled to be sold at Trustee sales is 39,000, a 30% increase from Q4 2008. As stated above, Sales scheduled on a daily basis range between 900 and 1400 PER DAY.
• The ratio of properties that are sold to 3^rd party bidders vs. properties that receive no bids at the sale and are sold back to the Beneficiary or “back to Benny” is estimated at 95% back to Benny, 5% sold to 3^rd party investors, a slight improvement from Q4 2008 howeverproperties that require the 3^rd party investor to bid in excess of $200,000 get almost NO INTEREST at the sale.This is a very significant because properties that are sold back to the Beneficiary take an extended amount of time to “cycle” back into the system as active listings.Properties that sell to 3^rd party bidders generally re-enter the system as active listings within 60 to 90 days after the trustee sale assuming they are not occupied when sold at the Trustee sale.
• The prices being paid at Trustee sale by 3^rd party investors for properties auctioned averages 70% of current retail value provided the property needs only minor repair, “paint and carpet”. In instances where more substantial repairs are needed this percentage decreases rapidly.

Because of the volume and degree of Borrowers in default, it is very apparent that Beneficiaries with significant portfolios (CMO’s, CDO’s and Wall Street related pools of mortgage capital generally managed by “services”) have been slow to react to borrower defaults, and it is not uncommon for the Beneficiaries to take no meaningful action to recover property from borrowers in default for up to 1 year. Because of this, we believe that the pipeline that can be gauged by the number of Trustee sales actually existing within the system i.e. Recorded notices of Trustee Sale) does not represent the depth of the looming problem, and we believe that the actual number of properties which will appear in the system within by the end of Q2, 2009 may be as much as 50% higher than what can be accurately predicted.
We mentioned “strategic defaults”in our Q4, 2008 report and we are seeing this segment dramatically increase. We define a strategic default as a Borrower who continues to have the ability to make the payments ontheir mortgage obligation, but makes a “business decision” to stop making payments because the value of their property (primary residence) has dropped so far below the price they paid for the property that continuing to make the payments becomes financially imprudent. The Borrowers are willing to sacrifice their credit report in exchange for prospect of “throwing good money after bad”. We are seeing a significant number of strategic defaults in the higher end property market, which historically has been more insulated from significant foreclosure activity. Price stabilization and a “value bottom” does not help these borrowers as the only motivation they would have to continue to make their payments would be credible signs of value recovery, which we have not seen at this time and do not expect to see until at least Q3 of 2009 or later.
As a follow up the asset backed securities (CDO’s and MBS’s) comments from our Q4, 2008 report, we are less optimistic now than ever about a good result in this area and the enevitable impact on values and price stabilization is incredibly difficult to predict. When we first heard about the “bad bank” idea that the Obama team was contemplating we believed that it was the only viable proposal to date since the traditionally the US Government will accept repayment over a long period of time at a modest rate of return. When we learned that the “bad bank” plan was scrapped and replaced with a plan to “partner” with private capital to “clean up illiquid assets on bank balance sheets) our enthusiasm turned to fear since we all know that the partners and managers of hedge funds and private equity firms will require the highest possible returns over the shortest period of time which will directly impact the prices they are willing to pay for these securities. The Obama plan is to offer NON-RECOURSE financing to the investor on these securities in attempt to reinforce respectable offers at fair discounts to face value. We will see how this shakes out over the next several months, but on its face we believe it’s going to be a bloodbath in terms of discounts of the securities, and a windfall for institutional investors with liquidity at this time, and that will have a significant negative impact on price stabilization and value recovery.
Opportunities:
We believe that current market conditions actually offer savvy investors a multitude of opportunities at almost every level, provided the obvious risks are “priced in” to the purchase price.

Specificinvestmentmodelsthatareworking:
Fix and flip:

The “fix and flip” business model has been thawing out after a lengthy period of being out of favor with the investor community. Our observation is that this segment represents meaningful opportunities provided the end user retail price point is specifically limited to properties within the $0 to $250,000 and if retail price is under $200K it’s even more viable. The most favorable pricing points will continue to be directly tied to the FHA loan funding cap and as the cap moves so will the prosperity in that area of the market. The average days on market (DOM) is somewhat predictable for properties in this pricing category and a critical element of any fix and flip model is predictable DOM, especially if the model is a leveraged model.
Rentalportfolios:
We still like this segment with a 36 to 60 month investment horizon. Interestingly, some of the best opportunities here might be in perimeter markets, where 3/2/2cg frame stucco cement tile roof properties can be bought at Trustee sale for $50K and rent for $900 a month. We believe this is an excellent time to either begin to build, or add to an existing rental portfolio. The key is light leveredge and picking a community that is not destined to become a ghost town.
Buy and hold:
If you have the “stomach” for it we actually think there are some excellent buy and hold opportunities in the high end market. This would require light to moderate leverage and a minimum 24 month investment horizon and a more moderate ROI requirement.
NewConstruction:
At this time we are not prepared to endorse any new “spec” construction activities.

DiscountedNon-PerformingNotes:
We observed a VERY SIGNIFICANT increaer in the number of completed transactions in this segment in Q1 of 2009. The model requires a high degree of expertise in values, especially in land values and commercial real estate values since those are the typical types of collateral involved. It is also helpful or even a requirement to have a comprehensive knowledge of the bankruptcy system since many of these borrowers will seek the protection of the bankruptcy court prior to surrendering an asset. Light leverage can work In this model but the most successful models are 100% equity based. The most successful investors in this space also typically have relationships in place and credibility is very important in capitalizing on any opportunities in the space.
PropertyPipelines:
Trustee Sales:based upon our personal relationships with almost all of the major buyers of Trustee Sale properties we believe that the completion in this space is at a 10 year high.
As referenced previously, expect to pay approximately 70% of current market value when attempting to purchase at the Trustee sales. Unless your model is structured to compete at a very high level with the professional Trustee sale investor, we recommend buying though a professional wholesaler, preferably a “fixed price” wholesaler who will generally deliver the best value.
Pre-foreclosure:A successful pre-foreclosure model generally depends upon the utilization of significant equity in the subject property to be used as a part of the tools to solve the Borrowers problem. Since significant price deflation has occurred generally across all markets, we do not see any enthusiasm for a pre-foreclosure model at this time. The approach has changed over the last 24 months to include a short sale solution in order to make any pre-foreclosure activity economically viable so there is a varied skill set necessary for success in this space.
Short Sales:This area of the marketplace continues to be overcrowded with “experts” most of whom never even heard of s short sale 24 months ago, but in spite of that the segment has become so large it can’t be ignored by any serious investor. Clearly, there is opportunity in this space, but relationships and patience rule the day. We have seen the velocity of these transactions increase in Q1, 2009 and we expect that to continue.
REO Packages:We have not yet seen significant increases in this area in Q1 2009 with a few predictable exceptions. Buyers in this space are generally subject to a bidding process that promotes the “biggest fool” theory and we regularly communicate with the most prominent buyers of package transactions, almost all of whom report being “priced out” by competitors who are willing to pay significantly more for these assets than a prudent investor would be willing to pay. In spite of that, transaction velocity (actual transactions that close) are few and far between. We believe this will improve on Q3 of 2009.
ARMLS:We are seeing a very disturbing trend in this space. Legitimate investors who are making “value added” offers on properties listed for sale on ARMLS are getting our-bid on those properties by “wheel spinners” who try to tie up properties and then “re-trade” the sellers at or near the closing date by substantially lowering the price. This is causing extreme frustration on the part if the legitimate investor with cash in hand and also creating a false sense of demand for these properties. This problem should to some degree be self correcting over time as Sellers realize that it is a waste of time to accept any offer that is contingent upon anything.

Pricing,valuations,marketbottomsandouropinion ofwhatisimportantandwhatwastesyourtime:
Our opinion of the marketplace remains unchanged for Q1, 2009. We track the predictions of a wide variety of industry experts, statistical data and market trends. We do not think anyone is capable of predicting a “market bottom” and more importantly, we don’t think that it is a requirement of a successful real estate investment business model.
We also don’t think a “price appreciating” market is necessary to operate a successful real estate investment business model. The more important component is to be able to reasonably predict the minimum amount that the property will be worth between the time of purchase, and 12 months into the future. What this requires is price stabilized market, no a price appreciating market. Our investors are almost always buying properties significantly below current market value, so if current market value is neutral, their model still works.
We analyze pending sales but don’t think they matter muchother than making Seller and Broker “feel good” about potential spikes in activity, which is a generally short lived euphoria most of which don’t actually close escrow due to some form of pricing re-trade or the Buyers inability to obtain financing to close the transaction.
We pay a lot of attention to closed transactions andas you can see we “micro analize” closed sales in very narrow increments. In our opinion you can find tremendous prosperity in any market and the path to this as we see it is looking at all pricing segments independently of each other. When you do that, the areas of prosperity become very clear.
We monitor the number of active listings for sale but just looking at the overall number, month over month or quarter over quarter (which is what we find most people doing) won’t get you much useful information about overall market conditions.The increases or decreases in active listings for sale are all driven by some other factor, and understanding those “drivers” and how they impact the number of actives are the most important component of this analysis because those drivers actually do relate to the overall state of market conditions.
We also very closely monitor the number of lenders in take out loan marketplace.At this time, you can count the number of lenders making consumer take out loans on one hand, and the number of permanent take out lenders making investor loans on two fingers. Because of this, we strongly endorse investor business models where the core product is able to be retail priced at or below the FHA lending limit amount, which will offer the investor a real take out source for their end user buyer. Even if demand returns aggressively during the next 12 months the extent to which the demand can be met and transitioned into sales will be directly related to the variety and availability of mulitple sources for take out financing, to the point where there is an actual competition for borrowers in this space.