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Harry Newton's In Search of The Perfect Investment Technology Investor. Harry Newton

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9:00 AM EST, Thursday, March 26, 2009. Smell the roses. Lay off rebuking yourself that you "missed" the 20% rise in the stockmarket since March 9. The chart is one thing. It looks gorgeous:

The reality is another. My friends tell me they're "playing" this market -- and consistently losing. They tell me they're "always" on the wrong side of the trade. When they expect stock prices to rise, they fall. When they expect them to fall, they rise. There are six problems:

1. No one loaded up on March 9 and consistently held. They' sold a little -- trying to lock in gains. They bought a little -- trying to make more gains.

2. Nobody knows how to respond to what Washington is doing or saying. Geithner is a goof. But sometimes (rarely) he hits a nerve. For the latest Washington nuttiness, try Paul Krugman's latest piece "Financial Policy Despair." Remember Krugman is the economist who hated Bush's economic polices and desperately longed for change. He got change. He's still not happy. He writes, "In fact, it (Washington) fills me with despair."

3. We're in a recession. This quarter's earnings are awful. A few more weeks and we'll see how really awful they are. Will the market climb through miserable earnings?

4. There are many shorts. And they're very jittery, one moment covering in a panic. The next moment loading up.

5. Every observer and his uncle is searching the "Confidence Indicators." If we get confident, stock prices will rise. For now, the indicators are mixed. For more, Click here.

6. And then there's the U.S. dollar. My friend, Mike O’Rourke, CMT's Chief Market Strategist writes last night

The attention and “concern” for the Dollar is remarkable. All of the sudden, everyone is worried about the Dollar weakening. From 2002 to 2008, the Dollar index dropped 40% and nobody seemed to care. From July 2008 to the beginning of this month, the index rose 25%, and even after the Fed’s push into quantitative easing, the Dollar is still up 17% since July. Until September, many, including us, believed the Dollar had all but lost its status as Reserve currency for the world. The crisis and the free market’s reaction to it proved us all wrong. We believe the Reserve currency status has been a significant contributor to the long term, unhealthy imbalances that the United States has created over the years. Notwithstanding our opinion, the free market has shown where investors run in times of fear. China’s (and Russia’s for that matter) call for a new Reserve currency based upon the Special Drawing Rights (SDR) of the IMF is somewhat unrealistic in the current environment. PBOC Governor Zhou noted that it could take a long time if adopted. Half of the western world is worried about the Euro holding together through this crisis, which makes it hard to believe that such a drastic change would even be considered now.

Given all this, there are brave souls out there. My friend and reader, David Gurgel, emails me:


By the time the NCAA finals are over, we will know if the recent rally is March Madness or the start of a recovery. I think the latter. Excuse the early email, but I watch the Asian markets as a I plan my investment strategy. I like Citibank and Shell Oil plus qqqq and spy.

So buy rental properties now? All of us are holding cash in anticipation of finding awesome investments, like "cheap" real estate. A reader sent me this piece from the It's worth reading. I haven't checked all his assertions.

Real Estate
Buy Rental Properties With Uncle Sam's Cash
By Christopher Grey

I don't make jokes. I just watch the government and report the facts. -- Will Rogers

Our government is unleashing an ocean of cheap financing in the hope of stimulating the economy and preventing further deflation of assets, especially real estate. Although most of this government largesse is going to directly benefit large financial institutions, private-equity shops and hedge funds, there are a couple of ways that smaller investors can directly benefit from it and get their fair share.

Fannie Mae (FNM) , Freddie Mac (FRE) and the U.S. Department of Housing and Urban Development are offering generous financing terms for the purchase of apartment buildings priced at or above $1.5 million.

In addition, the agencies will now buy the mortgage paper of investor-owned individual rental properties such as condos or single-family homes being used as rental properties, up to 10 properties per individual owner.

The irony of all of this cheap and easy financing for investors in rental properties is that the government is basically trying to replicate exactly the cheap and easy financing that caused the real estate bubble of a few years ago and the current crash.

What is different today is that the spread between the rate of financing and multiple of earnings on rental properties (or capitalization rate) has never been more favorable to investors. (A cap rate for an apartment property is calculated by dividing the current net operating income of the property by the purchase price.)

This is probably a once-in-a-lifetime opportunity for investors to generate current cash flow of 15% to 25% per year by locking in extremely favorable financing from the government to buy rental properties at a time when there are not enough investors willing to step up and buy these properties because of concerns about the economy and falling real estate values.

To understand why rental properties are such a good buy today, let's start by looking at how they traded historically. In supply-constrained markets such as Los Angeles, apartments have generally sold at cap rates -- the inverse of a price-to-earnings multiple -- of between 3% and 8% of the purchase price in good neighborhoods during the past several decades.

A couple of years ago, cap rates were mostly around 3% to 4% of the purchase price, which is the equivalent of a 25 to 33 multiple of earnings, even though interest rates were higher than today. People were very optimistic about rents and real estate values a couple of years ago.

Today, people are very pessimistic about both rents and values. Cap rates are generally closer to 8% today in good neighborhoods, which is the equivalent of a 12.5 multiple of earnings. These numbers not only include operating expenses but also capital replacement reserves for these properties.

Also, because Los Angeles has some form of rent control in most areas, the current rents at these rental properties are substantially below market rents on average. Many properties have average in-place rents that are 30% to 40% below current market rents. What this means is that even if market rents decline somewhat because of a weak economy, average rents at these properties and income should continue to rise because the spread between current and market is larger than the potential decline in market rents.

At today's interest rates, an investor who is an experienced real estate operator meeting certain net worth and liquidity tests can borrow about 75% of the purchase price of these apartments from Fannie or Freddie or HUD at around 5% fixed for seven years.

Ten years is typically the maximum loan term, but the seven-year loan is better because of the current slope of the yield curve and programs offered by Fannie. If you're not an experienced real estate operator or don't have sufficient net worth or liquidity to meet the requirements, you can still take advantage of this attractive financing by investing as a limited partner with an experienced real estate operator.

Experienced real estate operators can be identified in your local market or other markets in which you want to invest through licensed real estate brokers at any of the major national firms such as CB Richard Ellis (FNM) , Cushman or Grubb and Ellis.

At those loan terms, the initial cash flow to the investor would be 17%, and for the reasons explained above, that cash flow is very likely to increase over time. Further, the loans from Fannie, Freddie and HUD are typically non-recourse, meaning that the investor is not personally liable to repay the loans. The lender will look only to the property as collateral for repayment unless there are so called "bad acts" such as fraud or a bankruptcy filing by the owner.

It gets even better. As a direct owner of rental properties, the cash flow you receive is partially sheltered from income taxes by depreciation. Depending on your personal tax bracket, the 17% pre-tax cash flow yield from the example above could be substantially higher on an after-tax basis.

Lastly, these properties can often be purchased at a large discount to replacement cost, which is the cost to build new apartments or other multifamily housing such as condos. This discount to replacement cost further increases the chance of an increase in the value of the property in the future.

For investors with a higher risk tolerance, there are even better cash flow opportunities in rental properties located in markets like Phoenix. Historically, cap rates in Phoenix have ranged from about 5% to 10%. Cap rates are higher, which means that income multiples are lower, in Phoenix vs. someplace like Los Angeles because the supply of housing is not as constrained, and there is no rent control, so rents are always close to market. At the peak of the real estate market a couple of years ago, cap rates in Phoenix were mostly in the 5%-6% range because of investor optimism.

Today, cap rates are sometimes 11% for similar rental properties. Although there is still some potential that the income at these properties could decline because of economic weakness, a significant amount of that decline has already happened during the past two years.

If you buy at an 11% cap rate, borrow 70% of the purchase price from Fannie, Freddie or HUD at 5.25%, which is available for Phoenix properties, your initial cash flow to the equity is nearly 25%. Even if the cash flow declined by 10% after you buy the property, your cash flow to the equity would still be 21%.

As previously mentioned, these pre-tax cash flow yields will be even higher after adjusting for the tax benefits of direct real estate ownership, and there is also likely to be future appreciation because of lower cap rates in the future and the large discount to replacement cost at which these properties can be purchased today.

If you compare these two opportunities for direct ownership of a multifamily property to owning a public apartment REIT such as Equity Residential (EQR) , owning the REIT shares doesn't look very attractive.

Even at these depressed share prices, EQR's common stock pre-tax yield is only about 10% vs the 17% to 25% yields in these examples. Also, the investor does not receive any additional tax benefit from sheltering income by owning REIT shares.

As a public company, EQR's stock is also subject to many other issues for an investor such as Sarbanes-Oxley, more expensive overhead and management costs, short-sellers driving down the shares via various trading strategies, negative impact from inclusion in the REIT index, and potential misalignment of interests between the managers and the shareholders.

EQR also has a much more complicated and risky capital structure as far as its corporate debt and preferred stock vs. an individual apartment building.

Many investors will not be able to understand all of these risks, as recently happened with General Growth Properties (GGP) , which has seen its share price collapse nearly to zero primarily because of issues relating to its capital structure and unrelated to its properties.

Further, this more complicated capital structure means that the investor is not getting a similar direct benefit from government financing that you can get from buying apartments directly. Yet another risk with REITs that will be difficult for investors to evaluate is the quality of earnings and the assets in the portfolio of a public company. The additional liquidity that you get from having a public security does not compensate you for the much lower yield and other costs and risks involved.

There are obviously other risks of direct ownership, including asset selection, market selection, due diligence and other property-specific issues such as evictions of tenants and bad debts. Finding good-quality apartments buildings for sale and evaluating those investments can be challenging for individuals with no real estate experience.

However, this process is actually easier than trying to understand the balance sheet and portfolio of a national REIT. Investors who want to pursue these investments should start by contacting apartment sales brokers and mortgage finance brokers in their local area.

Alternatively, all of the issues relating to asset selection, underwriting and due diligence can be handled by professional real estate operating and management companies that will typically invest their own capital alongside the limited partner investors so that there is no potential for a misalignment of interests.

If investors want to own rental properties for cash flow and appreciation, this is potentially a great time to do it through direct ownership that takes advantage of attractive government financing.

The spread between apartment cap rates and fixed-rate financing to buy them has never been wider. It is very likely that this spread will narrow either because of higher interest rates or lower cap rates in the future. In either case, this should be a relatively good time to buy if investors want to achieve solid current cash flow returns and upside potential.

Christopher Grey is a managing partner and co-founder of Third Wave Partners, a leading restructuring adviser, distressed situations expert and turnaround operating company focused on the real estate industry. Previously, Grey was a managing director in the California office of Emigrant Realty Finance, the real estate group of Emigrant Bank, a New York-based financial institution with $17 billion of assets. Founded in September 2005, the California office of Emigrant Realty Finance completed and managed on balance sheet $2.5 billion of debt investments.

Grey is a founding member of the Capital Markets Forum II of the National Association of Office and Industrial Properties and the Stanford Real Estate Network. He is a graduate of Stanford University with a degree in economics and holds a California real estate broker's license.

Whatever happened to Sarah Palin's $40 billion gas pipeline? The answer is not very much. But the story, from the latest Portfolio magazine is fascinating. Click here.

Are we over-retailed or what? I go to I search for nearby FedEx locations. It asks for my zip (presently 92253). This is the answer I get:

Based on your search criteria, there are 500 locations near 92253. ...

My YouTube audio doesn't work. The video works fine on your Windows PC or laptop. But the audio doesn't. I'm guessing you've checked "Sounds" under Control Panel. The problem probably to do with your firewall settings. Click on your firewall settings. Turn them off and on. Something will loosen up. Then reboot. For YouTube's solution, click here.

Stockmarket savvy.
+ Every time one guy sells, another one buys, and they both think they're smart.

+ A long term investment is a short term investment that failed.

And then there was the baby born in the high-tech hospital. It was cordless!

Enough of this idiocy.

My son, Michael and his girlfriend, have arrived to spend a few days with us before going back to grad school. Last night I took them to smell the orange blossom in the 70 degree cloudless night in California's gorgeous Coachella Valley.

This column is about my personal search for the perfect investment. I don't give investment advice. For that you have to be registered with regulatory authorities, which I am not. I am a reporter and an investor. I make my daily column -- Monday through Friday -- freely available for three reasons: Writing is good for sorting things out in my brain. Second, the column is research for a book I'm writing called "In Search of the Perfect Investment." Third, I encourage my readers to send me their ideas, concerns and experiences. That way we can all learn together. My email address is . You can't click on my email address. You have to re-type it . This protects me from software scanning the Internet for email addresses to spam. I have no role in choosing the Google ads on this site. Thus I cannot endorse, though some look interesting. If you click on a link, Google may send me money. Please note I'm not suggesting you do. That money, if there is any, may help pay Michael's business school tuition. Read more about Google AdSense, click here and here.