The Changing Real Estate Market

A housing downturn may be imminent, say economists and real estate investors alike — presenting problems for many people, but opportunities for others.

You’ve probably heard about the coming slowdown in the housing market for a very long time. Real estate is cyclical, and in the United States it has been in an upswing for at least five or six years, which is how long housing prices have exceeded the rate of inflation, says Susan Wachter, professor of real estate finance at The Wharton School at the University of Pennsylvania. That means it’s only a matter of time before we experience a downturn.

It’s hard to believe a downturn is really here. On March 1, the Office of Federal Housing Enterprise Oversight (OFHEO) announced that average U.S. home prices climbed 12.95 percent in 2005, despite rising mortgage rates in the second half of the year. That’s about double the historical average of 6.4 percent, according to Bankrate Inc.

But while the housing market is still appreciating, it’s appreciating more slowly. The Commerce Department announced on March 23 that new home sales tumbled 10.5 percent in February to an annualized rate of 1.08 million units, the biggest one-month drop in nine years.

That means properties are sitting on the market for much longer than they used to. You might expect that in California, where Bruce Norris of the Norris Group, a California-based real estate investment firm, says “we’ve gone from a three-month supply to almost a seven-month supply.” But examples are pouring in from all parts of the country. In Miami, at the Jade Residences at Brickell Bay, 117 of the building’s 352 units are reportedly on the market. And in Manhattan, at Donald Trump’s 120 Riverside Boulevard condos, more than 20 percent of the building’s 250 units are up for resale, according to The New York Times.

And increasing supply almost always leads to falling prices, says Norris. For the first time since the third quarter of 2003, one of the regions in the much-followed OFHEO index showed a four-quarter price decline: Prices in Burlington, North Carolina, fell about 1 percent between the fourth quarter of 2004 and the fourth quarter of 2005.

That may not seem like much, but economists see it as a foreboding sign — and it’s not just due to rising interest rates. “Housing valuations have become somewhat stretched in some areas over the past year,” says Josh Feinman, an economist with Deutsche Asset Management in New York. “Some cooling is likely.”

The slowdown will affect anyone who’s buying and selling property, of course. But real estate speculators — individuals who buy property with the intention of re-selling quickly, or flipping it, for a profit — are likely to suffer the most. That’s because they could be paying mortgages and maintenance costs on properties they can’t sell and can’t rent out for enough money to cover their costs. According to Redbrick Partners, a New-York real estate investing firm specializing in single-family homes, half of the rent an investor can potentially collect does not flow to the bottom line, because it gets eaten up by vacancies, taxes, maintenance, etc. And as supply has increased over the past decade, demand has decreased. Today, Redbrick Partners says rental yields on single-family homes have declined from 7 percent in 1976 to under 5 percent today. And Norris says that in areas of California, a $500,000 house would rent for just $1,400 per month.

There is some good news, however. First, the housing market often fluctuates in different geographical locations. Miami, Florida, is an often-cited example: The number of condos worth $500,000 or more for sale in Miami is reportedly twice what it is in Los Angeles, where the population is four times as large. “If you ask me if the housing marketing is going to experience a downturn, I have to ask you ‘Where?'” says Norris.

In general, the markets that have had the greatest appreciation over the past five years are most vulnerable to a downturn, say real estate experts. “When affordability is at an all-time low, as it is in California, where housing prices have appreciated 300% over past eight years, you lose velocity, or the ability to sell a house at a brisk pace,” says Norris. “And prices start to come down.”

As for specific areas that are likely to experience downturns, on December 16, CNNMoney.com reported that Las Vegas property values will fall by 7.9 percent in 2006 and another 5 percent in 2007; San Diego property values will fall by 3.4 percent in 2006 and another 5.7 percent in 2007; and Santa Ana/Irvine property values will fall 3.1 percent in 2006 and another 6.1 percent in 2007.

Second, wherever the housing market does cool, it isn’t likely to do so overnight, so sellers needn’t get desperate. Some individuals, of course, will have to sell — those who need to move because of a new job, or a divorce, for example. But others can take some time, as a softening or declining market often takes years.

Finally, it’s also important to remember that one man’s troubles are another man’s opportunity. Some of the best real estate investors buy when everyone else is selling. The theory: As prices decline, it becomes easier for investors to buy properties that create cash flow. They can take their time and negotiate lower prices; they don’t have to waive contingencies, such as appraisals and home inspections; and the income they can realize from renting the property is greater than what they’re paying for it.

In fact, for some investors, like Jonas Lee of Redbrick Partners, buying in a downturn is a way of business. Lee says in a January 22 CNNMoney.com article that his company has succeeded since 1993 by employing this strategy. The typical single-family home the company buys — usually in the downtown residential areas of rust-belt cities such as Baltimore and Philadelphia — costs just $80,000. He hopes a downturn in the housing market will give him even more opportunities to buy low.

Experienced real estate investors offer two pieces of advice, which vary depending on your plans for the property.

If you’re buying to sell, Norris agrees that buying low is a good idea, but you have to understand the real estate market first. “You have to be able to determine when a down market is about to switch and go up again, and buy then” he says. “A lot of time people will see the market softening and buy too early. For example, someone in California might see a house go from $700,000 to $625,000, think it’s great deal, and buy it. But three year’s later the place will be worth $500,000.”

If you’re buying to rent, Redbrick Partners suggests looking at urban single-family housing. According to the firm’s research, nationwide single-family housing returns have averaged 12 percent since 1976, and volatility has been low, with not a single year returning less than 6 percent. The key to success for small residential landlords trying to calculate the yield for a property costing $250,000 or less, according to Redbrick Partners co-founder Tom Skinner in an October 2, 2005, Chicago Tribune article, is “rent divided by two divided by price.” Typically, that gives landlords their yearly rental profit on a property to within 1 percent. It doesn’t account for any estimate of future appreciation or depreciation, but it is a pretty accurate measure for someone trying to determine if he or she will be make any money by buying a house and renting it out.

Active Income Through Passive Real Estate Investing

Many people avoid investing in properties due to the amount of time and energy it takes. After researching and purchasing a potential property you need to actively care for your investment either by becoming a landlord or managing the property. Real estate investment can be time consuming and limiting, how many properties can on person manage at one time? This is why investors who are looking at diversifying with real estate participate in passive real estate investing.

Passive real estate investing removes these headaches for investors who don’t want to deal with the day to day issues of property management. There are many different ways you can do this, each with their own benefits and disadvantages.

You can form a partnership, either general or limited and have the partner take the responsibility of managing the property(s) your partnership purchases. Real estate is an expensive venture that often cannot be achieved without obtaining financing. Pooling resources in a partnership allows participants to purchase more expensive properties with less outside funding. However you need to be able to trust your partner to take care of the properties and your best interests, and if neither of you are experienced in real estate investing problems can occur and you can fall prey to bad deals where income is lost. You can form a corporation which has more income pooling abilities and financial resources, but again you have to make sure at least some participants have knowledge in this type of investing.

Triple Net Leased Property is where you purchase commercial property and lease this property to a business owner who will run their business and take care of the property for you for a length of 15-25 years. This can benefit you and the business as long as the business cares for the property properly and is stable and pays on time. Careful research is involved in this type of venture to make sure you purchase the right property in the right location and also research prospective tenants before making an agreement with them.

Real estate investment trusts (REIT) are corporations that are formed to purchase investment in properties. These specially created companies are federally regulated to make sure they use their funds to invest in properties and distribute the profits among shareholders through dividends. These publicly traded companies provide benefits similar to owning stocks and help with a diversified portfolio. But the income they provide is taxable and cut into profits earned in this venture so that must be weighed carefully with the benefits.

Getting the Most Out of Real Estate Investing Forums

Real estate investing forums can be a great way to locate new business partners and stay abreast of current market trends. Whether a newbie investor or seasoned pro, participating in social networking provides opportunities to learn new strategies and share ideas with like-minded people.

When joining real estate investing forums it is best to learn how the forum works before engaging in conversation. Read through the terms of service to determine how information should be provided. Many investment forums allow members to include a forum signature with a link to their website. Others prohibit the inclusion of sales pitches or affiliate marketing schemes.

It is a good idea to network with forum moderators and group leaders. Take time to connect with other investors and offer helpful information when possible. It is also a good idea to learn how to spot a professional investor from a scam artist. Unfortunately, many scammers lurk in social forums, so never give out personal information or buy products from those you have not developed a strong relationship with.

It is best to stick with reputable and well-established investing forums. The Internet can provide results on the top investor groups. Many types of online investing forums exist. Some focus on buying and selling distressed properties such as foreclosures and bank owned homes. Others focus on creative finance strategies or earning profits with cash flow notes and land contracts.

As a private investor, I participate in several investing forums. I recommend joining one or two groups to get a feel for how things work. Find the most knowledgeable investors and build relationships with them by asking questions or commenting on their forum posts. Share information and resources you have.

Popular Investing Forums

CREOnline is a good place for newbies to start their learning journey. This forum covers a wide range of topics including: creative financing strategies; locating discounted properties for sale; Section 8 landlord certification; managing cash flow when multiple properties are owned; and real estate and landlord tenant laws. Membership is required to participate in forums, but is offered at no charge.

REI Club offers a wealth of investing advice and information. The forum includes topics ranging from how to become a real estate investor to protecting investment properties. REI Club offers an extensive section dedicated to real estate marketing. Investors can learn the process for buying bank owned foreclosures and discover numerous seller-financing options.

Bigger Pockets has earned the reputation as the premier real estate investing forum. Featured on CBS News, U.S. News, and Newsday, along with receiving positive PR in several print publications, Bigger Pockets offers a wealth of information and resources to investors at all stages of their career.

Sound Real Estate Investing Advice

Real estate prices are governed by a huge number of factors. Therefore, real estate investing advice is not like a sure shot prescription about how you should invest. Rather, it is a broad set of guidelines that will help form your own thumb-rules. The most important real estate investing advice is that investment in real estate should never be confused with speculation. Here are a few aspects that you might want to consider before you put your money into real estate.

Real estate investment is like any other investment. It is more like investing in Treasury Bonds or Mutual Funds. You get returns on it even when you continue to hold on to your investment. In property/real estate investing, the gain could be two-fold. If the property you hold is in a sought-after neighborhood, it would most likely fetch you a good rent. While you keep getting the rent, the prices could rise and give you the added return.

A typical property estate investor has the financial muscle and staying power. Such an investor does not get carried away by small, short term gains and instead concentrates on the big picture. An annual return of 6 to 8 percent of the invested amount is considered decent. Anything above 10 percent is a big bonus.

In the case of speculation, you enter when the price is low and exit at a higher price. The assumption is that prices will continue to rise, and that is not always the case. In fact, the last decade has seen a big slump of over 70 percent in many of the otherwise booming economies. The best bet in the case of speculation is being able to spot developing neighborhoods, especially residential, and to invest early.

In addition to the property estate investment and speculation discussed above, there is an interesting alternative. The real estate investor buys property that is not in the best of conditions, does it up in line with the current trends and then sells it for a substantially higher price. The unique selling point in this case is that the new buyer does not have to spend time, effort and money in getting it done. In one sense, this is an investment because you will still command a good rent till you get a buyer.

In the case of commercial property estate, the returns are naturally much higher. However, there are two points that need to be considered. Number one, the investment required is huge, depending of course on the size of the property and its location. The other important factor is that movement can be pretty slow. Do not expect businesses to relocate every other year. So, while the income in the form of rent is likely to be fairly high, the prospect of earning money through price appreciation can easily be years away.