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Las Vegas Real Estate Update

In investing, there are once-in-a-generation opportunities. Going long government bonds and stocks in the early 1980s was one such opportunity. Buying commodities in the early 2000s was another. In the current economic environment, we believe buying real estate in distressed areas is the next big thing. One of our predictions from last year was that prices would converge nationally as domestic migration trends emerged. As Baby Boomers retire, we reasoned that they would flee high taxation areas with expensive real estate in favor of low taxation areas with cheaper real estate. As we enter the 2nd half of 2012, this trend has developed. Heres an article from the Wall Street Journal that expounds on these domestic migration trends. http://online.wsj.com/article/SB10001424052702304444604577340531861056966.html?mod=WSJ_hp _mostpop_read

As you can see from the chart above, the decline in real estate in expensive cities (New York City, Los Angeles, San Francisco) is accelerating relative to real estate in distressed areas like Phoenix, Las Vegas, and Miami. In fact, real estate prices are rising in Phoenix and Miami, which were 2 of the very worst

markets in America. Not all real estate in the U.S. is created equal; we are very bearish on real estate in expensive cities. Although home prices in Las Vegas are down year-over-year, we are still making exceptional returns, which stems in part because our focus is on lower-end properties with better appreciation prospects. In our view, higher-end real estate in Las Vegas is indistinguishable from real estate in expensive cities like New York City. Las Vegas real estate is down year-over-year because the decline is concentrated in higher-end properties. A decline in higher-end properties brings down the median home price in the entire Las Vegas market even though lower-end properties have already bottomed. It is critical to understand that this is a bifurcated market. The bearish reports about Las Vegas real estate dont make a distinction between property types, and this is a huge blunder.

Profits, Profits, Profits

The interesting thing about real estate is that the higher the cash on cash returns based on rents are, the higher the future capital appreciation is. The same phenomenon occurs in stocks. Warren Buffett gets aggressive in his purchases when dividend yields (think of dividends as rents) are their highest. He then profits from a combination of very high dividends and capital gains. At the height of the real estate bubble, people couldnt even cover their expenses with rents; in other words they had negative returns. What followed was an epic crash in home prices. These investors were greedy when everyone else was greedy, which is always a recipe for disaster. What we are trying to do is listen to Warren Buffett and be greedy when others are fearful. We are deeply immersed in the real estate market in Las Vegas and we can tell you that the fear surrounding the market is 100% unjustified. Home prices have declined to below pre-bubble levels, and at this point, 100% cash deals are returning more than leveraged deals would have 5 years ago. This is not conjecture- heres an example from a recent cash deal we closed.

Purchase Price: $29,000 Closing Costs: $853.97 Total Upfront Costs: $29,853.97

Fixed Expenses
Insurance: $19.58/month Property Taxes: $31.71/month HOA fees: $156/month Sewer fees: $15.83/month

Net Returns
Monthly Rents: $650 Monthly Expenses: $223.12 Monthly Net Returns: $426.88 Annual Net Returns: $5,122.56 or 17.2% In our previous report, we mentioned that the same home we bought for $35,000 could now be bought for $30,000 because of a combination of our new contacts and an increased knowledge of the market. Well we werent lying because the aforementioned deal is in the exact same community and has the exact same floor plan as the first home. As our knowledge increases, our returns will invariably increase as well.

Timing: Is This the Bottom?

Timing is everything in investing, and 9 times out of 10 it is probably wise to do the exact opposite of everyone else. So rest assured- we are very happy that reports continue to come out that Las Vegas real estate is somehow a bad investment. We want to quietly accumulate inventory and be positioned for the cyclical rally in real estate that is coming. In the interim, we are trying to bring in as many people on board to benefit from this investment opportunity that for whatever reason is hidden from the public. In regards to timing, the government has been our ally in many ways. For example, Assembly Bill 284 took effect in Nevada in October. This legislation makes it harder for banks to foreclose on homes by forcing them to file an affidavit before foreclosing and by increasing penalties on fraudulent documentation. This legislation has created a sharp decline in available inventory, which is a dream

scenario. In the 2nd half of 2012 or in 2013, a wave of cheap homes will hit the market, which is when we will get very aggressive. Until then, we can accumulate capital and pounce when the time is right. The bottom line is that whoever purchases property in Las Vegas right now will most likely double or triple their money in 5 years if they are leveraged with a mortgage. Now before you roll your eyes in disbelief, note that this is a forecast we made about gold 5 years ago to widespread skepticism. So please allow us to explain why these returns are possible. Leveraged Deals While the returns on all-cash deals are robust, leveraged deals aka deals utilizing conventional mortgages- yield the best returns by far. If you know what you are doing, leverage is a powerful tool. Generally in a period of rising inflation, you want to be a debtor and pay back fixed loans with devalued dollars. This alone would make it an excellent time to take out a mortgage. But mortgage rates are also near all-time lows, which in conjunction with inflationary trends make it perhaps the best time in history to take out a fixed 30-year mortgage, period. Leverage serves to exaggerate both the upside and the downside. When leverage goes wrong, you get the financial crisis of 2008; when it goes right, you make returns that dwarf anything you could receive in conventional products. Nonetheless, even in a doomsday scenario, the downside in this type of investment is incredibly low.

As you can see from the above chart, the breakeven point in a leveraged deal in 5 years would be a sales price of $13,101. This would be a 55% decrease in our homes value over a 5 year period. Suffice it to say that this is a very unlikely scenario.

Investment Options
The best proof that we are true believers in this thesis is that we continue to put our own capital into these deals. We have no doubt that we will receive multiple on our investment over a 4-5 year timeframe. Anyway, there are several investment options available that we feel cater to all types of investors. 1st Option: Promissory Note We are now offering a note at 8% (previously 4%, but the returns were seeing are better than we expected) which is effectively collateralized by the property we purchase. With savings accounts yielding less than 0.5%, this is a great option for conservative investors. Based on the deals weve already explained, you can see that 8% will be easily attainable. In the worst case scenario, we have the option of selling the home we purchased and repaying the loan that way. This is the most conservative investment.

Option 2: All Cash Deals Option 2 is the second most conservative option because we are not taking out a mortgage on the property. Option 2 is basically the deal that was explained in page 2 and 3. We believe annualized returns of 10-15% are very conservative, and investors should expect something closer to 20% when we account for appreciation. In these type of deals, we will be taking 16% of the equity upfront in exchange for finding, purchasing, managing, and ultimately, selling the property. We need at least 3 years under this type of deal to see the investment through. 5 years is the preferred time frame for us.

Option 3: Leverage Deals Option 3 is the least conservative, but this is relatively speaking. We believe an investment in U.S. government bonds is much riskier, yet 5-year notes are yielding less than 1%! That being said, we realistically believe we can achieve 40%-80% returns annually when all is said and done. In this type of deal, the home would be purchased under the investors name, and subsequently transferred to an LLC with all of us as partners. We are only taking 10% equity in these deals, and in certain situations we will also put up capital (we put our money where our mouth is). So for example, if

the down payment is $10,000, we can put up $5,000 while the investor puts up $5,000. The equity split would be 45% ($4,500) to 55% ($5,500) since we are taking 10% ($500) of your equity.

If you read our first report, you know that pretty much all our forecasts came true. While we were bullish on Las Vegas real estate then, we are, quite frankly, even more bullish now. We are admittedly in the minority in our bullish stance on real estate in Las Vegas, but this is no reason for concern. At key turning points, you by definition need to be in the minority. In 2007, we were in the minority in sounding the alarms that a financial crash was coming, including in real estate. Now we are in the minority in expecting a massive rally in real estate. As we said before, in investing you should generally do the exact opposite of the crowd. The bullish call on real estate really comes down to this: Our government is running huge deficits that are unsustainable, and even with balanced budgets, the interest payments on our debt will rise exponentially (probably to $1 trillion annually by no later than 2020). Governments have historically always defaulted on their debts, with the exception of Romania in 1980. When our government defaults, capital will rush to assets like real estate. We think a de facto default on our debt will occur no later than 2016-2017. We strongly believe that the time to be positioned in Las Vegas real estate is 2012, and early 2013 at the latest. We hope we have made a compelling argument in favor of Las Vegas real estate based on real deals we have completed. Time is running out on an investment that has already proven to be very compelling. P.S. This is a somewhat simplified explanation of why we believe real estate in Las Vegas is a profitable venture. There are many more variables we are considering that make us absolutely positive that a significant rally is coming in distressed markets. If you would be interested in a more complex argument delving into cycles, currencies in the floating exchange rate system, etc., just let us know and well write something up.