Is This a Good Time
To Invest in Real Estate?
by Terri Cullen
July 3, 2002 -- Bubble be damned! Judged by the response to last week's column about buying real estate at the top of the market, residential real estate appears to have plenty of air left in it. Indeed, many readers seem determined to buy real estate, not only as a place to live but as an investment -- even as they fret over when the bubble will pop.
In this heated housing market, that's not necessarily a bad call. If you buy and hold an investment property and rent it out over an extended period of time you'd be hard pressed to come as close to a "sure thing" with any other type of investment. The average annual return for apartment investments, including price appreciation and rental income, over the past 20 years has been around 12%, according to the National Council of Real Estate Investment Fiduciaries, an industry trade group in Chicago. That compared with an average annual return of about 9.5% for stocks and 5.1% for bonds, found in a recent study by the National Center for Policy Analysis, a public policy research group in Washington, D.C.
But financial reward doesn't make landlording easy. If you're serious about purchasing property as a long-term investment and renting it out as a source of fixed income, here are a number of things to consider.
Worth The Hassle?
Being a landlord is hard work. I'm talking "raising teenagers hard."
"People looking at investment property have to understand they're going to be playing the roles of customer-service rep, human-resources counselor, maintenance and repair person, accountant ... there's just a lot of different hats they need to learn to wear before jumping in," says Frederick Prassas, senior vice president of the Institute of Real Estate Management in Lacrosse, Wis. "That first 2 a.m. phone call from a tenant with an emergency is a real eye-opener."
Approach investment property as you should any equity investment: Do your due diligence. The IREM offers dozens of online education courses on its Web site designed specifically for professional real estate managers that are now opened up to the public. Three comprehensive courses include an introduction to single-family homes and small residential properties ($145 for nonmembers), basic budgeting and accounting for investment-property owners ($245 for nonmembers), and risk-management techniques to preserve property and profit ($260 for nonmembers).
Once you're finished with the reading room, it's time to bone up on your math. The lure of a steady, monthly income may seem less enticing when you consider taxes, maintenance, insurance, plus fees to caretakers -- such as property managers, rental brokers, landscapers, painters, and carpenters or repairmen.
For example, a home in Ogunquit, Maine, a resort town near Kennebunkport, can bring $20,000 a month for summer rentals, but you'll pay a 20% to 30% for local real-estate brokers for each renter they find you, $400 a month in housekeeping and $75 a month for insurance. Property tax nibbles off another $500 a month.
That brings you down to around $13,000. Now factor in the hidden maintenance costs -- not just minor repair and upkeep, but large expenses that invariably will come down the road (any investment-property owner will tell you that road is shorter than you think). How many more years are left on that roof? How soon will the water-heating system need to be replaced? Are your kitchen appliances all about the same age? Then they may have to be replaced around the same time.
Finally, renters often can and do steal, deface and destroy property -- sometimes accidentally, sometimes not. Homeowners' insurance policies will cover most of the damage, but deductibles and ever-increasing premiums add up.
Add in the additional $3,000 to $5,000 a year you'd likely pay on these unforeseen hidden costs and you've just cut that $20,000 down to about $12,500, or 38% less.
How Big Is Thy Bubble
If you're still prepared to embrace the landlord title, you need to hammer down whether your region is the best place to buy right now. As my last column noted, many parts of the country are still seeing double-digit home-value appreciation ... some in less than one year. Sales of new and existing homes continue to be spurred on by low rates, aggressive mortgage lending, the tax advantage of homeownership, and the sharp selloff in the stock market.
How quickly your local housing market will cool and when depends on many factors, the most important of which is the health of the local economy.
"I've followed about 100 markets over the last 10 years and I've seen the same patterns again and again," says Ingo Winzer, president of Localmarketmonitor.com and editor of the National Review of Real Estate Markets in Wellesley, Mass. "What happens in overpriced markets depends very much on what happens in the local economy."
For example, Houston's housing market has suffered from rising energy prices and Enron-itis, while in Silicon Valley and San Francisco there are far fewer dot-com millionaires around to drive already steep housing prices even higher. In New York City, the swooning stock market is undermining real-estate prices, with many would-be buyers delaying their purchases in the hope that prices will fall further.
Based on the outlook for the regional economies and other factors, Mr. Winzer sees bubbles building in Boston, San Diego, Fort Lauderdale, Fla.; Detroit and Oakland, Calif. But if you're looking for homes in Syracuse, N.Y., Hartford, Conn.; Dallas and Charlotte, N.C., you're likely to find a bargain in the months ahead as demand cools, he says.
One way to gauge the economic outlook for the region in which you're looking to buy is to track job growth. The Bureau of Labor Statistics' Web site offers a helpful tool here. Its "State and County Employment and Wages" section includes a screen that allows you to track job growth by county (in section 3, scroll all the way to the bottom to select "all industries"). Another screen, found in the agency's "Local and State Unemployment" section, will show you whether unemployment is on the rise in that county.
"What you want to avoid and be most careful about are investing in places where the real-estate markets are overpriced and employment is dropping," Mr. Winzer says. "Those are the markets which have the highest risk for an eventual drop in prices."
A Tenant's Market
Historically low rates have spurred many long-time renters to embrace homeownership in equally impressive numbers. So if you're looking to purchase an investment property with the intention of renting it out, know that the pool of prospective tenants may be much smaller than it was three years ago, at the start of the current housing boom.
"Low interest rates, which are helping to boost the environment for home ownership, have really taken a toll on the apartment sector," says Paul Puryear, managing director of real-estate research at Raymond James Financial Inc., St. Petersburgh, Fla.
The stock-market meltdown and weaker job market also are boosting vacancy rates nationwide, as would-be renters take the low-cost route of rooming together to share costs, or the no-cost route of moving back in with mom and dad.
Vacancy rates for apartment buildings managed by institutional investors rose to 8.91% for the first quarter of 2002, up from 8.16% during the fourth quarter of 2001, according to the National Council of Real Estate Investment Fiduciaries. This is the highest vacancy rate for apartments since 1991.
A smaller pool of renters means you'll be competing with other landlords for similar, and perhaps even larger properties, which may limit what you can reasonably charge tenants.
How to tell whether there's a tenant shortage in your area? The U.S. Census Bureau's Web site offers stats on vacancy rates for 75 of the largest metropolitan areas up to 2001. A quick check of data tracking vacancy rates show Buffalo, N.Y., Birmingham, Ala., Columbus, Ohio, Las Vegas, and St. Louis, Mo., among the cities with steadily rising vacancy rates, while Los Angeles and Fresno, Calif., and Milwaukee, Wis., all have seen vacancy rates decline.
Population growth also can determine whether you'll have difficulty attracting tenants. Check out the Census bureau's population growth estimates for your region. You'll want to avoid any market where population growth is below 1% or declining.
Email your comments to rjeditor@dowjones.com.
