Is Now a Good Time to Invest in Real Estate?

A condominium sold just the other day in Newport for $185,000. It had originally been listed for $350,000 and is assessed for $305,700. 

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Did I catch your attention? Is this exactly the type of investment you’ve been scanning the real estate ads for?

There are plenty of enticing opportunities available in the wake of the 2008 market crash. But how do you know if real estate investing is right for you, and what types of concerns and criteria should you be familiar with before you take the proverbial plunge into rental property ownership?  In this blog, I will seek to provide information to help you decide your level of readiness for such a venture, and also address some concerns you should be aware of before you buy.

First, although I’m sure most of you are already familiar with how stock investing works, I’m going to quickly go over some basic “Investment 101” points in order to illustrate a few differences between investing in stocks and investing in real estate.

The Basics: Stocks vs. Real Estate

When you purchase stock as an investment, you purchase a share in a company that pays dividends or income on a quarterly basis.  The returns may not be high, but hopefully you chose a stock that will appreciate in value so you can see two types of return on your investment: dividends and appreciation.  Investment real estate works similarly in some ways.  You take some money and purchase a property that will bring you an income stream (rental income).  But unlike stocks, which ask nothing of you after your initial investment, real estate demands that you keep an eye on it – or pay someone else to do so.  Stocks don’t break down.  They don’t leak, rust, chip, or stain.  They don’t need mowing and plowing and routine maintenance.  They don’t complain about rental increases and the other stock’s yappy dog or high heels clacking overhead… et cetera, et cetera.

On the other hand, you can improve your property and thereby increase its value, which is something you can’t do with a stock.  A stock is a stock is a stock, and you probably have little direct influence over its worth, the way you do with your property.

Some Things to be Aware of Before You Buy

When buying investment property, I urge people to exercise caution.  You should definitely have structural/mechanical and radon/ hazardous materials inspections included as part of your purchase agreement. 

Make sure that:

• You are buying in a neighborhood that is attractive to renters
• The apartments are not in violation of the housing code
• The apartments are legal and registered with the city
• That apartments built prior to 1978 have current lead-safe certificates

Additionally, you may want to consider those things that need attention right off the bat – usually maintenance items that were deferred by the previous owner:

• Roof condition
• Foundation/ masonry condition
• Heating and plumbing maintenance and repairs.
• Kitchen appliances, counters, cabinets, floor coverings
• Bathrooms
• Paint and wallpaper condition

These expenses should be mentally added to your purchase price. 

If everything seems to be a go at that point, then you need to think about the care and feeding of your new investment ‘pet.’  I usually sit down and create a maintenance and repair plan and schedule. There is a lot to think about when you choose to take on an investment property, and you’ll be better able to anticipate future costs if you adopt a forward-thinking approach.  

Financials

Critical to the whole process is whether this purchase makes financial sense for you.  Meet with your accountant and do a cash flow analysis for the next few years.  Make sure that you factor in vacancies, repairs and maintenance, inflation, as well as the commissions you will pay for finding tenants.

There can be significant tax advantages to owning investment property.  Under President Reagan, when Congress decided to rein in some tax code abuses, it categorized rental property income as “passive.”  At the time, this characterization struck me as a wild misnomer.  Owning investment property is probably one of the most hands-on endeavors you’ll ever take on!

If you choose a good property in a good rental neighborhood and are able to do some repairs and improvements on your own, then owning residential real estate investment property can be very rewarding.  I know plenty of people who have been able to retire on the income that their properties throw off once they’ve finally paid down their mortgages.

There’s also another pretty clear benefit to owning real estate instead of stock: real estate is something tangible.  Even if the market goes down the tubes and your house is declared “worthless,” at least you can still live in it!  The floors and walls and roof are still standing to provide you with shelter.  The same cannot be said of a devalued stock certificate.

Commercial Investments: Good Idea / Bad Idea?

Investing in commercial real estate, by which I mean office buildings, retail stores, strip malls, destination malls, and industrial space, has its own set of advantages and drawbacks.  When you buy larger commercial properties (shopping centers, office building, etc.), part of the process includes a period of due diligence.  This is a time period, usually 30 - 60 days, where you can explore all the ins and outs of the property and have a number of thorough (and often costly) inspections. 

Commercial leases tend to be long term – sometimes decades – and the leases have built in escalators to allow for increased expenses in taxes, insurance, inflation, and annual building maintenance.  These are called “triple net” leases.  While the leases can be long term, the waiting period to find a replacement tenant can be painfully long as well.  For this reason, a commercial investor needs to have deep pockets.  If you want to get into commercial real estate investment, you need to be familiar with the culture and leasing specifics around each kind of commercial investment, or hire a property manager who has this expertise.

Because of the length of time that it takes to pay off a mortgage, a friend of mine once jokingly referred to real estate investing as a “dead man’s game.” But if you work hard to find the right investment property and invest within your means, I can assure you that this will not be the case!

What did the 2010 Real Estate Market look like?

At the end of each year, around the same time I’m working on those tedious tax preparations, I compile all the real estate sales data from Newport County and the bordering towns so that I can see the last year’s effect on the local market.

I had a hunch that 2010 would be different from its predecessors, and it turned out I was right.  When I took a look at the pages of analyses coming off my printer, I noticed a number of significant changes on Aquidneck Island in the last year.  According to the MLS records for all types of property being sold, both average and median sale prices are up slightly over last year.  The number of properties sold has inched up as well.  When I look at number of properties sold each year, it’s clear that the low point occurred in 2008, but the low price point seems to have occurred in 2009, which makes sense.  Sellers lower their prices after their property hasn’t received significant activity in a while.

There was also a change in the type of property that sold.  Single-family homes, which have always been our best seller, dropped a bit from 365 sales in 2009 to 360 sales in 2010.  At the same time, the number of condominium sales, which has slipped severely since its high in 2003, has risen almost 25% over last year’s number and is almost back to 2007 levels.  Multifamily homes, a very popular commodity in 2009, dropped 13 properties this last year

While any analysis or chart is just a snapshot of past reality up to a certain date, it is fun to imagine that it can give us insights into the future of the market.  What it can do is show us where we have been and what current market looks like.

I have additional graphs, which divide the market into price ranges: properties sold below $400k, in the $400k to $1 million range, and above $1 million.  These are the multicolor area charts below.  From the chart, “Aquidneck Island Number of Sales Distributed by Price”, it is clear that the number sold under $400k has dropped, while the middle range has taken up the slack.  An interesting view of the market is the comparison of this chart with the chart that follows showing the total dollars spent on the purchases in each category of home: the “Aquidneck Island Sales Dollar Distribution by Price.” In this chart, you can see that buyers in the middle and high categories spent almost the same amount of total dollars on their purchases and were only exceeded a little by the total dollars spent on properties sold for under $400,000.

To sum things up, we reached a marked sales bottom in 2008 and have moved up since then and we may have reached our low price point in 2009.  The middle part of the market that really took a hit in 2008 has reentered the game in the last year.  Condominiums are being recognized as a great value due to the pricing pressure they have felt in last couple of years, and sales reflect that. 

All in all, I suspect that 2010 will continue this trend.  In light of these indicated price increases (however slight), I would say that if you are thinking of buying a new home or investment property don’t wait!

Investment Real Estate vs. Home Ownership

“Owning your home is a smart investment.”

I hear people say those words all the time, and whenever I do, I think that whoever came up with that phrase didn’t really know what they were talking about.  A distinction needs to be drawn between investing in real property and home ownership. They are not the same thing!

A young acquaintance who analyses bonds for a living mentioned a discussion he’d had with his father recently.  Being a father myself, my ears perked up.  He said that his father was investing in gold.  I said, “What’s the problem with that?  Plenty of people invest in gold.”  He said that gold is not an investment because it doesn’t throw off an income stream; rather, it’s a hedge against inflation.  It occurs to me that owning your home might fall into the same category, with one major exception.  If you want to exchange gold for currency or another investment, it is a fairly easy matter.  If you want to exchange your home’s equity, it’s a much more cumbersome process.  You either need to sell it and find somewhere else to live, or refinance it and take on additional debt.

Investment is defined as: the investing of money or capital in order to gain profitable returns as interest, income, or appreciation in value.   The important part here is “in order to gain profitable returns.”  The only way to see a return on your home as an investment is when your home is liquidated, i.e. sold.  (If you mortgage or remortgage your home you can get cash out, but at a premium that must be paid back with interest.)

Case in point: a few years ago, some people were convinced that it was okay to purchase more home than they could afford because they viewed their home not only as shelter, but as an investment.  It seemed as if all property was constantly increasing in value, and that they would have a home that was always worth more than what they paid for it.  I think we’re all well aware of the consequences of that type of thinking! 

Most homes fall into the expense category; they usually are not income generators.  When you take out a home mortgage, you are paying both the interest to the bank plus some of the “principal” or cost of your house.  Over 20-30 years you will pay this amount fully, and by that point, your home will have a lot of equity.  So in a sense, your house is your “live-in” piggy bank, your mortgage as the savings mechanism that causes you to build equity.  During the time you’re paying it down, you have to earn money to pay taxes, insurance, utilities, repairs, and interest. Buying a home only really pays when you are able to retire your mortgage.  Then your cost of living goes down – but you still have to pay to live.

There is one situation that fits the “home as an investment” criteria.  Some people – often young people – will buy and live in a multi-family homes.  This makes the property more affordable, because the rental income is counted as additional income for their loan qualification.  Instead of buying a $150,000 single family home, they might be able to purchase a $250,000 two-family home.  Ideally, in a rising market, the rents rise and pay more of the home’s expenses, and the property appreciates in value.  Additionally, since the loan they are paying is larger, their equity grows at a faster rate.  Of course the downside to this is that in a declining market, rents can go down and ownership costs can increase.  This is why it is important to make sure that you plan and save so that you can handle the “rainy day” cash flow if things go wrong such as your mortgage rate or taxes increase, your water heater dies or your rents go down.

Over the long run, values and rents typically increase in good areas.  The first home my wife and I bought was a two-family home.  The rent we received on our first floor, one-bedroom apartment ended up paying most of our costs after a few years of ownership, which made our living expenses more affordable.  We also put a lot of ‘sweat equity’ into that home and increased its rental value.

This is an example of how your home can also be an investment.  Multifamily homes  bring with them the burdens of being a landlord, but they can really pay off in the long run.

HAPPY NEW YEAR TO OUR “AT HOME IN NEWPORT” READERS!!