How To Profit In Today’s Real Estate Marketplace

The financial headlines during much of the past two years have been largely negative if not hugely negative, but in the generalities of the day we sometimes look past a basic reality: Opportunities for real estate profits are still out there.

The folks I have in mind are small real estate investors, individuals who have a few properties here or there, enough to impact their balance sheets, standard of living and monthly income.

I bring this up because for all the recent financial news, many small investors have done fairly well. Indeed, on the basis of cash flow a number are no doubt asking, “downturn, what downturn?”

The idea is not that small real estate investors are somehow immune from the declining prices seen in most markets, rather the point is that they don’t particularly care because they’re not selling or refinancing every Tuesday. Their interest in real estate is surely tied to values and they certainly would like to see them go up, but it’s not a day-to-day thing.

What does pique their interest is income today and income tomorrow. They’re long-term holders of real estate, people who like monthly checks.

“Lost in the headlines about falling real estate prices and slowing sales is a baseline reality,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the leading online marketplace for foreclosure listings and data. “People have to live somewhere. Most people like to live indoors. The need for good indoor space is how long-term investors fill their wallets.”

Sales Versus Rentals
The traditional focus of real estate has concerned sales and sale prices. This makes sense because real estate sales are a major financial transaction for most buyers and sellers and they also have important implications for local communities — builders and brokers make money, lawyers collect fees, furniture sales increase and local governments collect lots of taxes.

Rentals are different. Rather than buying and selling with some frequency the idea is to buy and hold. For how long? Well, in some cases for decades and generations — remember that estates can be used to shelter assets worth $3.5 million in 2009, and that’s in addition to the marital exclusion.

While some investors favor condo units because much of the maintenance is done by the condo association, others prefer single-family houses because such properties are largely self-managed by tenants. Whatever the case, in the realm of investment real estate someone with one unit and someone with 20 are both known by the same title: Landlord.

As with any group, within the landlord community there are both saints and sinners. Sinning landlords seek to maximize profits while skimping on repairs and upkeep. Saints have a different view.

Good landlording means going for the long-term. The goal is not to maximize monthly rentals, it’s to maximize cash flow and income streams over time. At first this may seem contradictory, but a landlord who seeks the highest possible rental rate is also likely to be a landlord with vacancies.

Vacancies set off lots of problems. First, there’s the central matter of no income. None. Zero. Given a choice of a high rental rate and one monthly vacancy every year or two — or a lesser rental rate and no vacancies, savvy small landlords would much prefer the stable income approach. Why? Because they have steady and ongoing costs in the form of taxes, mortgages and other expenses whether a property is rented or not.

Second, vacancies make plain where paint is needed, where new appliances are required and where damage needs to be fixed. Such repairs cannot be deferred when a home is empty and prospective tenants are weighing your place or somewhere else.

Third, it costs money for ads and takes investor time to fill vacancies.

Tenants
It follows that to attract tenants a landlord must offer not just a property, but a property that is well-maintained and attractive, a place where people want to live.

Given that you have a very nice property for rent it follows that you want a good tenant. What’s a “good” tenant? In basic terms there are three criteria:

  • The tenant has a visible source of income in a field which is likely to continue. In other words, somebody with tax returns, pay stubs and the ability to keep earning.
  • The tenant must pay rent each month, every month, in full and on time. This is an absolute business necessity.
  • The tenant must be a good steward of the property. He or she must be willing to keep the water filter up to date, trim the hedges and do some minor labor. Why? Because it makes the house a better place to live, and that’s good for both landlords and tenants.

Cash Flow
Home prices in most areas have taken a beating during the past year, but that’s not why small landlords are interested in buying more property, including perhaps foreclosures. Instead, the reason is this: While home values have fallen rental rates have been remarkably stable.

How can this be? Easy. People have to live somewhere. As the number of local foreclosures has increased, mortgage lending standards have tightened so that sales have been pushed down, and the population has grown, the demand for good rental units has remained steady — especially for owners with nice properties.

A new report issued by Reis, Inc., shows that among 9.5 million rental units the vacancy factor increased 0.4 percent during the last quarter of 2008 to 6.6 percent, while rental rates dropped 0.4 percent.
 
How bad are such results? Relative to what’s going on in the world not bad at all. Let’s look at some comparisons:

  • Stock market investors lost “about $7 trillion” and the Dow was down 33.8 percent in 2008 according to the New York Times.
  • The S&P/Case-Shiller Home Price Index showed that home values in 20 major markets dropped 18 percent in 2008.
  • The National Association of Realtors reported that a typical existing home sold for $181,300 in November — down 13.2 percent from November 2007 when the median price was $208,800.

Economics
Given tall tales of instant real estate profits it’s useful to look at the economics of what really happens with a long-term investment approach.

The National Association of Realtors says that the typical single-family home sold for $89,300 in 1988. Twenty years later the typical existing home sold for $181,300 as of last November.

Yes, it’s true that November 2008 home values were down 13.2 percent from November 2007, but for long-term owners it doesn’t much matter because they’re not selling. Not only have typical cash values risen substantially since 1988, the more important point is that rental rates have gone up and largely stayed up.

How To Take The First Step
Wall Street is fond of telling people that past performance does not guarantee future results and the same is surely true for real estate. If long-term investing seems attractive, that’s great — but it’s not a sure deal.

If local real estate seems better or at least more understandable then investing in pork belly derivatives, insurance products without reserves or investment advisors without a conscience, then the first step is to buy nothing. Instead, take your time and learn about your local market. Are rentals in demand? Is the population growing or shrinking? What about the job base? Speak with real estate brokers, investors and real estate attorneys. Ask about local rules and regulations. Study local foreclosure lists and look for properties near you. Get information from your local economic development office. Read some books — and not the ones that promise great riches overnight.

See what’s on the market — including homes which have been foreclosed. Such properties are often available at discount and with financing, two qualities which should interest would-be investors.
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Peter G. Miller is the author of the Common-Sense Mortgage and is syndicated in more than 100 newspapers.

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