Though housing prices continue to rise in many parts of the country, real estate investors can still lose money. So we asked the pros for some tips on tapping the real estate market at a time when the alternatives — stocks and bonds — have gone from sizzle to fizzle.
As investors seek shelter from a vicious bear market in stocks, and bonds paying low single-digit returns, real estate has been a big draw. For individual investors who can’t spare the down payment to buy property directly, real estate mutual funds have been especially hot. Through August of this year, some $2.7 billion has flowed into real estate mutual funds — up from just $18 million for all of 2001, according to Bear Stearns.
Individual investors have also turned to real estate investment trusts, or REITs. These companies invest in a portfolio of properties — everything from shopping centers and movie theaters to hotels and apartment buildings — and are listed on major exchanges and trade like stocks.
As the stock markets have slumped, REITs have been paying big returns — up roughly 15 percent last year and posting single-digit gains so far this year.
Still, some analysts think the days of big REIT returns may be numbered — especially if the economy remains weak. Lehman Brothers analyst David Shulman is among those who think it may be a bit late in the game to jump into REITs
“Investors might be becoming a bit too complacent about the durability of the high yields now being offered by REITs,” he said in a research report last week.
Individual REITS are also tough for individual investors to analyze because they hold dozens of different properties — each of which is financed with its own complex loan package. Sorting out which REITs are investment bargains is a full time job.
So many first time real estate investors are turning to individual properties — buying a house or small, multi-family property and renting it out. For those who can’t afford to go it alone, real estate investment clubs have become a popular way to pool capital and expertise. These groups also help improve members’ chances of finding a property that makes sense as an investment, according to Mark LaNore, president of the in Portland, Ore.
“It’s not a very easy thing to find bargains in real estate because a lot of people are looking for exactly the same thing,” he said. “We’ve seen a lot of cash go from the equity market to the real estate markets.”
QUESTIONS FOR THE INVESTOR
While finding the right property can be tough, the profile of a successful investment is pretty simple. You need to be able to buy a property cheap enough to cover financing, insurance, maintenance and other costs with rent — and have a little money left over every month. Though real estate also offers the potential for capital gains if your property appreciates in value, the Golden Rule of real estate investing is to make sure your property is “cash flow” positive.
But analyzing a real estate investment isn’t necessarily easier than deciding which stocks to buy: you’ll need to ask a different set of questions, such as:
1) Are there liens on the property?
2) Can you make improvements you have in mind without running afoul of local zoning laws?
3) Is that 20-year-old, abandoned underground fuel oil tank now considered an environmental hazard? (Don’t forget to check for termites.)
You’ll also need to make a thorough inventory of the costs involved in buying, improving and maintaining the property — everything from landscaping to property taxes. And remember to factor in your time — for everything from screening tenants to supervising repairs. You may want to hire a management company to handle those chores for you, as long as the fees don’t turn your positive cash flow negative.
Even then, there are plenty of risks you won’t be accustomed to if you’ve been an investor in stocks or mutual funds.
“The biggest pitfall is a tenant who doesn’t pay the rent,” said Wayne Damsta, a real estate broker at Century 21 Gemini in Wayne, NJ. “That erodes your positive cash flow for as long as it takes to remove that tenant, which can take months.”
Finding good tenants isn’t easy these days. In many parts of the country, record low mortgage rates have converted a lot of potential renters into homeowners, sending vacancy rates rising. So before you start looking at listings of houses for sale, study the rental market carefully and see how much houses are renting for.
If you’re looking for quicker returns, you might consider buying an older, run-down property and fixing it up. Finding a good candidate may be tough: cheap mortgage money has also fueled a renovation boom, leaving fewer and fewer older houses to fix up. But you won’t have to worry about the costs and time involved in managing the property.
“That always works in real estate, if you can take ‘C’ property and make it a ‘B’ or a ‘B’ property and make it an ‘A,’” said Brian Lancaster, a real estate analyst at Wachovia Securities in Charlotte, N.C. “But you have to some creative talent to do that.”
If you decide that you have neither the creativity to renovate a fixer-upper nor the time and patience to be a landlord, consider investing in your own home. If you’re not already a homeowner, mortgage rates may have finally fallen enough to make a house affordable — especially if you buy a two-family house and rent the other half. Even if you already own a home, consider taking the money you’ve stashed in a money market account and invest it in your house — by paying down your mortgage.
“A lot of people are taking money out of the stock market and putting it where they’re probably getting 1 or 2 percent maximum,” said Lancaster. “One of the nicest things you can do is pay off your debts. Just paying down mortgages makes a lot of sense.”
For example, if you’re paying 6 percent on your mortgage and getting 2 percent from a money market, you’re losing 4 percent.
But if you’re carrying credit card debt with double-digit rates, start there first. At least your mortgage payments are tax deductible.