Structure Real Estate Investing to Suit the Times

Physician's Money Digest, July 2006, Volume 13, Issue 7

In the 1978 hit movie Superman, the evil Lex Luthorhatches a sinister plot to seize control of ocean-frontproperty. In explaining his rationale, Luthor points outthat the price of gold will rise and fall, but one thingpeople will always want is land, "and they'll paythrough the nose to get it."

"Real estate has been a historically sound investmentfor years," says Doug Crowe, director of SpringBoardAcademy, a real estate investment institution. "The bubblethat is commonly talked about has to do with inflatedprices in very specific markets, regions, and neighborhoods.Anytime appreciation exceeds the market bylarge margins, there is bound to be a correction."

This highlights the importance of doing one's homework.Location is as much the key to successful realestate investing today as ever. Physician-investors arelooking for better lifestyles, and location plays a bigpart in quality of life. Therefore, doing your homeworkbefore investing in real estate is as important as doingyour homework before any investment you make.

Bubble Bursting

Despite all the talk about the real estate bubble bursting,there are many who do not believe a bubble evenexists. Jacky Teplitzky, executive vice president atPrudential Douglas Elliman, believes the normal laws ofsupply and demand are simply playing out. "I do notbelieve there is a housing bubble," Teplitzky says. "Thecurrent market is defined by me as stable; buyers arebuying, and sellers are selling. It is a much more normalmarket with a normal pace. Interest rates are still low,and the rental market is going up; therefore, it is a goodtime to buy. People have more options, as there is moreinventory, so they do not need to rush and make rusheddecisions. My prediction for 2006 is an appreciation inthe single digits, not double digits as 2005, but we arestill talking about growth and price increases."

Statistics from DataQuick support Teplitzky's assertion.The organization notes that in 2005, the medianprice for a single-family home rose 7.5% over the previousyear, the first time annual appreciation was less thandouble digits in close to 6 years. That's part of the marketsoftening that Teplitzky and others are referring to."We don't anticipate a housing bubble burst," echoesNanette Overly at Epcon Communities, a condominiumdevelopment firm. "We think it will be more of amarket adjustment as opposed to a severe decline or collapse.Real estate has always been a good investment,compared to other alternatives. Even in a more realisticappreciable market of 5%, that translates to a 50%return on investment, not to mention the tax benefits."

And even though interest rates are inching up, Overlysays great rates still exist. She admits that anytime ratesincrease, a percentage of the population gets pushed outof the market. But she points out that the largest percentageof buyers, particularly of condominiums, areover age 55. Many don't take a mortgage, or if they do,they come into the purchase with significant proceedsfrom the sale of their existing homes. Jonathan Agus,principal at CondoMax USA, agrees. He points outthat, "Interest rates are still at an all-time low. Withrental rates increasing, investorsstill have the opportunityto purchase propertiesfor a good price, rent them asthe property value increases,and sell them when the timeis right with very little out-of-pocketexpenses."

Real Estate Strategies

Selling your home is no easy task, says JanetLeavitt, a realtor with Coldwell Banker PrestigeProperties in Escondido, Calif. And if you're thinkingof selling your home on your own to take advantageof rising values and avoid paying a realtor fee, youmight want to think twice. According to a NationalAssociation of Realtors profile of home buyers andsellers, the typical sold-by-owner home went for$145,000 in 2005. That compares with $175,000 fora transaction by a real estate agent. In other words,notes Leavitt, even when paying a 6% commission inan agent-assisted transaction, the owner would stillrealize a net sale of $164,500, or about 15% morethan the owner who sold on their own.

Even if you've purchased your current primary residencewithin the last 4 or 5 years and have no immediateintention of selling, Crowe points out that thereare some important things to remember. "Keep inmind that someday you will be selling your property," Crowe explains. "Improve and modify to suit yourtaste and lifestyle, of course. But remember that yourhome will probably have a new owner one day, sokeep their needs in mind as you improve, remodel,and enjoy. Of primary concern is to remind yourselfthat it is your home first. Enjoy it. As an investor, Ialways have my assets pay for my liabilities. Myincome property pays the mortgage on my personalresidence. Therefore, I don't worry about paying offthe mortgage or accelerating the payments on myhome. That mortgage deduction is an important pieceof tax strategy. The equity we have in our house sitsidle, waiting in a home equity line of credit for thenext investment opportunity."

If you've purchased or plan to purchase a secondhome or vacation property, a lot depends on whetheryou plan to use the property yourself or rent it out. Ifit is a vacation property that you are going to enjoy,Crowe suggests you treat it like a second home anddon't worry too much about the investment grade ofthe property. The deductions you can realize and theenjoyment of it are your primary concern. As a long-terminvestment, any mistake you make in overpayingcan normally be recouped over time with appreciation.

Rental properties, however, are another story. "Becautious of renting out to others," Crowe warns."You can do this yourself or use an onsite managementcompany. Both approaches have their pros andcons. Scores of books have been written on the subject.Most of us have heard horror stories about problemproperties, tenants, and situations. However, thetruth is that any of us would be happy to have anincome property that had perfect tenants. The appreciation,depreciation, growth, and cash flow are out ofthis world. The onlyfactor to watch out foris problem tenants.That is where you shouldfocus your efforts: screeningtenants."

Watching Trends

Overly says that median pricing ofcondominiums is rising faster than that of detachedsingle-family homes, and sales of condominiumsare outpacing single-family detached homes inevery major market. The overriding factor is thatbaby boomers are moving out of their traditionalhomes and into condos, both in urban and suburbanlocations. Accordingly, condominium conversionsare rampant in many areas of the country."The displacement of so many apartment units andtenants will provide an opportunity for investors inthe coming years," Crowe explains. "New apartmentconstruction has been painfully slow, and thiswill add to the increase in value for apartmentproperties nationwide."

Crowe believes that if the condo conversion companyhas a solid track record, it's an excellent opportunityfor investment. However, he cautions potentialinvestors to make certain that companies have contingencyplans on the sellout of their projects and theirbanking relationships to weather any unexpectedissues. "Many developers, like myself, offer 20%,25%, and 30% returns on their projects for equityinvestors," Crowe explains. "This is an excellent placeto invest for the short and medium term. Small andmedium investment properties work very well for thelong term."

Commercial real estate, however, plays by anentirely different set of rules. The margins can beslimmer, the risk greater, and the rewards have thepotential to be massive. But Crowe cautions thatinvestors with full-time professions should not treadinto these waters alone. "REIT [real estate investmenttrust] funds and other opportunities that haveminimal risk are easier ways to work the commercialinvestment field," Crowe says. "The only exceptionwould be for a physician to invest in their own medicalbuilding. Owning and renting back to yourselfor your group is nearly a home run in any accountant'sledger. Every doctor should investigate owningand leasing back their own offices. Ask a savvyaccountant about this right away."

Nelson Zide, senior vice president of ERA KeyRealty Services in Framingham, Mass., says that theprudent investor can make a great deal of money inthe real estate market. But like any major investment,real estate investments must be approached cautiously.He suggests keeping real estate investments small,and recommends small residential properties vs largecommercial entities. The rationale, he says, is thatowning several small residential properties is lessrisky than having all of your money tied up in a singlecommercial venture.

Zide is also a proponent of using your own moneyfor real estate investments. "Ignore people who say,‘Don't use your own money,'" Zide says. "You haveto spend money to get into the market, despite theclaims of the ‘no-money-down'investment gurus yousee on TV. They are usually making money from thesale of books, tapes, and seminars, not from realestate. Once you have accumulated enough property,you can begin to leverage your investments withoutputting additional money down, but that takes time."

Al Woodward, CFP®, of Woodward WealthManagement, echoes those thoughts. He points outthat even though the national economic numbers arepositive, there are always individuals in communitiesacross the nation who are experiencing some level ofadverse financial pressure. Generally, these are thepeople who attend the no-money-down seminars, thecash flow seminars, or various forms of multilevelmarketing seminars. "These people purchase thecourse, normally with a credit card," Woodward says."They are amazed when the get-rich-quick programfails, even though in the fine print the promoter hasadded language that discusses the risk and points outthat the success examples they use are ‘extraordinary.'The only one who wins is the promoter."

Zide suggests the best way to get started is to setmoney aside monthly in a special investment account,not unlike putting money away for any significant purchase.That way, when you're ready to buy property,the money will be available. When you're ready tobuy, Zide recommends being conservative. His adviceis to calculate the value of the property based on itscash flow, not its value as a tax shelter. "Also, don't letyour personal taste or emotions get in the way of aviable investment," Zide says.

He also agrees that condo conversions are a goodstarting point because they are relatively inexpensive.Depending on location and other factors, a condo inthe $60,000 to $80,000 range should have 400 to600 square feet of living space and one or two bedrooms.These properties are low risk and low rent,attracting tenants even when markets are down. "Ifyou buy more than one unit, you can usually negotiatea better price," Zide recommends. "You haveleverage, as long as there is an opportunity to buyfrom others in the complex."

Whispers of a real estate market crash are justrumors. Crowe points out that the single-family homeremains the foundation for the average American's networth. That's a fact, he says, that's not about to change."Investing in only one or two additional properties peryear for only 5 years creates the opportunity for anyoneto become a millionaire," Crowe says. "Slow andsteady investing in modest homes and apartment buildingshas proven time and time again to be the path tosustainable growth, tax reduction, and amassing significantwealth."