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What novices need most: A reality check
If you think real estate is a sure thing, it's time for a little refresher course on risk.
August 22, 2005: 1:47 PM EDT
By Gerri Willis, MONEY Magazine
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NEW YORK (MONEY Magazine) - Tired of hearing about your not-so-bright cousin's latest real estate flip? Jealous that your mother-in-law's profits from the ancestral family split-level are big enough to buy a semipro baseball team?

The hell with all the bubble talk. If so many people are making money in real estate, how hard can it be?

Actually, pretty hard. With nearly 25 percent of buyers now describing themselves as investors, you'll face stiff competition for properties -- and tenants. Lots can go wrong. Let me count the ways.

1. It's risky. Got it?

Whether your goal is to build (or renovate) and sell quickly or to be a long-term landlord, you'll obviously suffer if the local sales or rental market sours. If your hot flip prospect flops, you could be saddled with a monthly mortgage you thought you'd be rid of long ago.

"When the bubble pops, there may be no one left to flip to and you will get stuck," says Mark Weiss, co-author of "Streetwise Landlording and Property Management."

Bubble or no bubble, you'll cut your investing risks -- and up the odds of making money -- if your plans include patience and fortitude.

2. It can be far more expensive than you imagine.

Investing in property can make buying a primary home seem like biking with training wheels. For starters, landlords are tightly regulated in some cities and counties.

(In Milwaukee, for example, you need a license to rent a home to more than four unrelated adults.) Insurance costs are often higher than for residential real estate.

And tax issues -- especially property taxes -- can add all sorts of wrinkles. In Yorba Linda, Calif., property taxes soared 107.7 percent between 2000 and 2004; in Alexandria, Va., they rose 86.2 percent. Increases like these can soon gobble up any rental profits you had counted on.

3. Your numbers may never add up.

Many newbies tap their home equity to invest, so a misguided move can prove disastrous. If you hope to buy, renovate and sell in short order, you need to reality-test your assumptions.

Start by getting comparable prices for homes in the area where you'd like to invest -- specifically, get a price range for homes that are as nice as what you believe your renovation special will become. Add in your anticipated appreciation for the period you plan to hold the property.

Compare that total with the sum of the following: the price of the median house or multifamily home in the neighborhood you've targeted (you can get these from a real estate agent); closing costs for buying and selling; renovation costs; holding costs (such as taxes, insurance, utilities and landscaping); plus a decent profit (10 percent of the value of the entire project is reasonable).

The two totals should be fairly close. If your renovation costs put you over the top of nice homes in the area, walk away.

4. Remember the L word: Location.

Wise investors rely on long-term appreciation to fuel gains so, just like a home buyer, you'll want to seek properties that are likely to see the best appreciation -- those close to good transportation, shopping and schools. You can make all the fixes you want, but if your investment is poorly located you'll pay the price.

Look around: Are neighbors reinvesting? Also, focus on places where the number of rentals is low compared with owner-occupied homes. Ideally, rentals should make up no more than 5 to 10 percent of the overall housing stock in a neighborhood.

This can help ensure that your property retains its value if lazy landlords fail to keep up their holdings. And when you do find something that seems worth buying, bring in a contractor or a home inspector to make certain the problems you're facing are only cosmetic.

In the end, real-world assumptions get you the kinds of returns that last and can be built upon. And maybe even impress the not-so-bright cousin.

Watch out for:

  • Rental overload Is the area's housing stock more than 10 percent rentals? Careful: Lazy landlords can drag down your property's value.
  • Renovation costs If your plans for a fixer-upper put you over the price of nice homes in the area, you may never recoup all your costs.
  • Property taxes Few things gobble up anticipated rental profits faster than soaring property taxes.

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Click here for more real estate investing stories.

Are you cuckoo for condos? Click here to learn more.


Gerri Willis is host of CNN's Open House. Write her at real_assets@moneymail.com.  Top of page

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