SHOULD YOU INVEST IN REAL ESTATE?

Some Things You Should Know. There are a lot of things you should know before you invest in real estate. Probably the first of these is that virtually every one should invest in this area and part of the puzzle is to pick the investment vehicle that is right for you. While I have discussed most of these at one time or another I will confine this discussion to direct ownership as opposed to more passive investment vehicles such as real estate investment trusts (REITs) or tenants in common (TICs). There are also several property types from single-family homes to office buildings. Take my word for it, unless you are an experienced, high net worth investor, now is not a good time to venture into commercial properties. While you might buy one of these at a bargain price, it may be difficult to find and retain tenants to provide rent to cover operating expenses and debt service. Unless you have adequate reserves it might be difficult to hold on to the property until a strong market cycle allows you to sell at a favorable price. In the final analysis, the single-family market seems to offer the best combination of return and safety. We will confine the rest of our discussion to single-family home investment.

Is This A Good Time? The financial press is filled with articles that tell you that housing prices still have a considerable distance to fall before the market stabilizes. Is this true? In reality no one, including me, knows. To make things even more difficult, there is a tremendous difference between various regions of the country. In addition, there is a difference between different regions of the state, and even between different regions of a given metropolitan area. If you read national publications, the most common theme is that housing suffers from two major difficulties. 1. Excessive inventory of houses for sale and 2. Negative equity. This places a burden on sellers. There is heavy competition from other sellers and it is impossible for even desperate sellers to offer their property at a bargain price if that price is significantly lower than the amount owed on the property. If you offer a seller $150,000 for a property in which he owes $200,000, chances are he doesn't have $50,000 to pay out of pocket in order to sell the property.

Where Are The Opportunities? Despite all the negative publicity about housing, there are some opportunities for those willing to seek them out. The main opportunity in the Metro-Denver area is strong tenant demand. Investors sometimes forget that it is tenants that drive the investment market. Five years ago, real estate prices were increasing rapidly, and my phone constantly rang with investors looking to diversify out of financial markets into real estate. I informed most of them that high vacancy rates made it too risky to invest in real estate at that time. Now the situation is reversed. In Denver, the vacancy rate for single-family housing is less than 4% and for apartments the vacancy is in the 6% range. Our experience tells us that such low vacancy rates provide pressure on rental rates making future rent increases more likely.

Interest Rates Are Low. Although credit requirements are strong and fewer buyers can qualify for loans, those who can qualify will find rates favorable. Lenders are motivated to make loans to buyers with good credit, stable income, and higher down payments. Although there are always seminars about buying real estate with none of your own money, it is only the more entrepreneurial buyers who should venture into these areas. One thing to remember is that low down-payment financing adds a lot to your risk. You have to make those mortgage payments even if your property is vacant and the value of your property is below your acquisition price.

Housing Starts are Low. In most areas of the country, builders are producing little in the way of new inventory. This makes it more likely that any excess inventory of properties for sale will eventually be absorbed. Further, since it takes awhile for builders to re-enter the market, it is unlikely that this situation can rapidly reverse itself. In the early 1990's when the supply-demand balance began to reverse it took over a year for building to pick up. In the meantime those who owned houses were able to take advantage of very high appreciation rates. Unless you are in an area that is chronically depressed, this situation is likely to recur.

Some Initial Steps. 1. Know your finances. If you have a portfolio of financial assets and ample liquidity to provide for emergencies, this market might be favorable for you. 2. Know your market. Evaluate the market you are considering. If there is a very large inventory of properties for sale and few recent sales, don't buy unless you know the rental market is strong. The quickest way to evaluate the market is to find out how many properties have sold within the past year. Divide that number by 12 to determine the average sales per month. Then divide the total number of properties for sale by that number. This will tell you how long the current inventory will last. If there are 12 sales during the past 12 months, that means during the average month, 1 property sold. If there are 36 properties for sale, the inventory would last for 3 years or if there are only 2 properties for sale that means a 2 month supply. Our experience shows that when the inventory is more than a year supply, the market is depressed and less likely to appreciate. When there are less than 6 months supply, market values should be increasing. 3. Study the rental market. How many properties are for rent? What is the asking price. Don't be afraid to call on some of the properties being offered to find out the asking price.
4. Take a look at what's available. Look at a few properties, estimate the rental income and expense, figure out what your debt service will be and determine your potential cash flow. If it doesn't show at least 4-6%, look at alternative ways to finance or pass on the deal. If there appear to be some opportunities, check with a lender to make sure you are qualified for financing and proceed with caution.

This Is Scratching The Surface. I will go into more detail in a later post. In this very difficult investing environment, you can't afford to ignore opportunities to improve your situation. I think real estate may offer those opportunities.