Can You Still Get Rich in Real Estate?
To succeed in a much tougher market, you've got to change your strategy--whether you're buying, selling or renovating
(MONEY Magazine) – Home sales are slowing. Condo prices are slipping. Sellers can't get their asking prices. And real estate bulls, including Columbia University economics professor Christopher Mayer, who not long ago argued that land shortages and rising populations would translate into ever-rising prices in "superstar" cities like New York and San Francisco, are now waving the caution flag. If you're buying real estate expecting a short-term gain, says Mayer, "you should be looking elsewhere."
Clearly, it's time for a rethink, and our 37-page special report will help guide you in that process, whether you're mulling over buying, selling, refinancing or remodeling a home or investment property. Or if you're just wondering, Is our house still worth what we think it is?
The short answer: It depends on where you live. If you reside in one of the past decade's boom markets along the coasts or in the Southwest, brace yourself. Prices there were powered by two kinds of fuel: low interest rates and the willingness of buyers to pay up for the American dream. That tank is almost empty. In Los Angeles today, the median dream goes for 10 times the median income. That's unsustainable no matter how creative banks are in coming up with new hybrid loans.
Mayer thinks that, with fewer people buying but plenty still hoping to cash out, prices in the most expensive markets could drop 15% in the next year, if mortgage rates rise another point. The forecasters at Fiserv Lending Solutions and Moody's Economy.com, who crunched the numbers for our 12-month nationwide forecast, aren't so pessimistic, but they're hardly Pollyannas. Prices will flatten in most ex-boomtowns this year, and next year will be worse, says David Stiff, Fiserv's chief economist. "A lot of markets--particularly those where prices have increased dramatically compared with income--will see drops by late 2007," he says. Those declines are expected to range from a few percentage points in Boston to as much as 20% in Miami and Las Vegas, says Economy.com's Mark Zandi. The more unhinged prices are from local incomes, the more likely a fall.
That doesn't mean, however, that real estate is about to crash across the U.S. First, if you live someplace that hasn't gone wild--think Atlanta or Philadelphia or just about anywhere in the Midwest or Texas--you'll see slower rates of increase, but losses aren't likely. "There are sizable parts of the nation's housing market that will be just fine," says Zandi.
Second, a strong economy and job growth should hasten a return to a normal housing market in which prices rise just a bit faster than inflation. Since World War II, notes Stiff, the housing market and the economy have moved largely in sync. Then, starting in 2002, the Federal Reserve's rate cuts in the wake of the tech meltdown and 9/11 kept home prices rising even as the economy stalled. "Now, as the housing cycle unwinds," Stiff says, "the rest of the economy will keep growing. That puts a floor under prices and will let housing and the economy sync back up." The caveat, of course, is that if the economy falters, housing will really start to look overvalued.
So what do you do? If you've got a place you like, a mortgage you can handle and no plans to move or build a new wing, relax. But if you're active in the market, or you soon might be, rethinking is indeed in order. Again, your strategy should depend on where you live. MONEY found owners, sellers and buyers making smart moves in three very different markets: Albuquerque, which is in the midst of a late boom; Atlanta, a steady if unexciting grower; and Providence, where the party is definitely over. Their stories follow.
CASHING IN ON THE LAST OF THE HOT SPOTS
Keep your head during a boom, and you'll keep more of your gains over the long run
In early spring a TV news report on KASA Channel 2 in Albuquerque noted that the housing market nationwide was slowing down, with mortgage rates and inventory rising and demand slackening. "Now with all that said, by all accounts here in New Mexico things are still red hot," quipped Greg Zanetti, a local financial adviser. "But we are usually a little behind national trends."
Indeed, Albuquerque missed much of the great bull market in houses. Between 2000 and 2004, median prices appreciated no more than 5% a year. But as other sunbelt cities are cooling, Albuquerque has started sizzling. Call it the rolling boom. As high home values price buyers out of one area, they move to new cities. Thus the San Diego bubble begat the Phoenix boom, and Las Vegas led to a bull market in Reno. Now those booms, and one in Santa Fe, have rolled into Albuquerque. "Even though our prices have gone up, we are still much more affordable than other areas," says Cathy Colvin, president of the Albuquerque realtors board.
Booms do roll over, however. Housing prices in Phoenix, for example, could decline nearly 20% over the next 5½ years, according to Moody's Economy.com. So even if prices are still rising in your market, you'll want to make decisions with an eye to holding on to as much of your equity as possible once the easy gains have been made.
Go Where Land Is Scarce
Certain neighborhoods appreciate faster than others. In Albuquerque, expansion to the north, south and east is restricted by mountains, Indian reservations and an Air Force base. This helps explain why the little remaining land in already developed areas has increased in value more than some of the new developments to the west, says David Murphy, publisher of SalesTraq of New Mexico.
Consider the West River Valley, a small, highly coveted locale. It backs up to the Rio Grande and feels like the country, yet it's five minutes from a major mall. Robert and Heather Drager bought an acre there seven years ago. Still in their twenties at the time, they couldn't afford to build a house. So for four years they lived with their parents and house-sat for friends to save money. "Obviously, we really wanted this neighborhood," says Rob. In total they paid about $250,000 for their land and 2,000-square-foot house, about $100,000 more than they would have shelled out in Rio Rancho, a fast-growing community to the west. The sacrifice paid off. The Dragers' area has appreciated at more than double the rate of Rio Rancho. Today they wouldn't consider selling for less than $450,000, an 80% gain.
Other hot neighborhoods these days: city centers. Young professionals and baby boomers with suddenly empty nests are moving to downtown areas, lifting real estate values in the process. It's a phenomenon that's hardly unique to Albuquerque; it's happening in Philadelphia, Baltimore and Cleveland as well. Prices in Albuquerque's Nob Hill area have jumped about 30% since 2004, and that section of town was rising even when the rest of the market was flat a few years ago, according to local agent Linda DeVlieg. "This neighborhood is walking distance from shopping areas, restaurants and night life--even my work," says clothing boutique owner Emma Del Frate, 39, who's listing her Nob Hill home for $335,000 and has bought a larger, $500,000 house around the corner.
Finding the house proved difficult. Emma and her husband Victor, 38, searched the area for a year and a half with no luck. So they got inventive. In December 2004 they left a note on the front door of a house that looked attractive, asking the owners to call if they ever wanted to sell. The following summer they did. By year's end, the Del Frates were in serious negotiations. The house needs some updating, but the couple say they'll be conservative when it comes to renovating--no ripping out walls and relocating rooms. Which leads to a second strategy:
Don't Go Crazy When You're Remodeling
"Even in a rising market, you actually can over-remodel," says Everett Collier, president of the remodeling industry's trade group. Consider kitchens, which give one of the highest returns. According to Remodeling magazine, the average price for a minor kitchen remodel is $15,000. You recoup 99% of the cost at sale. When the price tag climbs to $82,000 for a high-end remodeling job, your return drops to 85% of the cost.
That's why Janine Archibeck and her husband Michael opted to work with their existing floor plan. "A larger master bathroom would have been nice," says Janine of her 3,700-square-foot home in Albuquerque's Near Northeast Heights area. But not for the price: at least $25,000.
Janine, 38, and Michael, 39, were certainly willing to invest in their architect-designed 1961 home, which they bought in 2002 for $320,000. In addition to replacing fixtures and appliances, and adding glass to brighten the place, the couple turned their backyard into a paradise that features a heated pool, a pool house and a canopy that shades a sitting area near the outdoor fireplace and grill. What they didn't do, says Janine, was knock down structural walls. "All the bathrooms are in the same place," she says. "We didn't have to move any plumbing." The Archibecks spent $190,000 on interior renovations and could easily have spent twice that had they decided to expand the home's footprint, says their architect, Jon Anderson. Today the home is worth at least $750,000.
The moral: Build a breakfast area or an apartment-size bathroom because you want one, not because you figure that in a fast-rising market, the more you spend the more you'll make. The boom will fade, and then your gains will depend on how wisely, not how much, you invested.
SIGNS THAT A MARKET IS HOT OR NOT
In Las Vegas, sales are slowing, more homes are on the market and it's taking longer to find a buyer. That's the mirror image of what's happening in Albuquerque, where home prices look like a real bargain, at least for the time being.
SOURCES: Albuquerque Metropolitan Board of Realtors, Fiserv Lending Solutions, Greater Las Vegas Association of Realtors, National Association of Realtors, U.S. Department of Housing and Urban Development.
These markets came late to the party, and their good times are going to last.
SOURCES: Fiserv Lending Solutions, Moody's Economy.com.
BUYING, SELLING AND PROSPERING AFTER THE BOOM
Sure, a falling market is scary. But you've got more ways to handle it than you think.
Bill and Connie Smith have lived in five houses on the east side of Providence during the past 10 years. Along the way, and with little effort beyond packing and unpacking, they turned an initial $3,000 investment into $200,000. "Every single home we purchased we planned to stay in," says Smith. "But prices kept going up and so we would decide to cash out."
Last year, sensing a change in the market, they put all their profits into a $255,000 two-bedroom, two-bath ranch. "We almost rented but decided not to," says Smith, 42. "Now we're kicking ourselves. We could get something nicer for the money now."
An influx of Bostonians looking for less expensive nearby homes, combined with a revitalization of its downtown, made Rhode Island's capital one of the best markets in the country over the past five years. But in a scenario that's playing out in places like Las Vegas, Miami and San Diego as well, home values grew so much faster than incomes that people are priced out, especially now that interest rates are rising. As a result, home values will stagnate in Providence over the next 12 months, and then start dropping. "There's not the same rush to buy," says Providence broker Diana Kryston. Of course, some people have to buy or sell. What do you do if you're one of them?
If You're Buying, the Clock Is Your Friend
Look for properties that have been on the market for at least 90 days, and make your first offer at least 10% below the listed price. "Always remember to tell a seller or their agent that you have a lot to choose from," says Kathleen Corbett, an agent in Lincoln, R.I. "Let them know that you are seriously considering other houses."
Often the appraiser hired by a lender is motivated to inflate the price so the bank can make the largest possible loan. Make your offer conditional on getting an independent appraisal. Pay for it yourself. You want to be the client.
Remember that you can renegotiate right up to the closing. Even if the sellers won't budge on price, in a sleepy market they'll be more likely to make other concessions. That strategy worked for Benjamin Evans, 35, and Jennifer Stewart, 33, who bought a $262,000 four-bedroom colonial in the Providence suburb of Pawtucket in March. First, they persuaded the seller to pay their closing costs and agree to a contingency clause that allowed them to walk away from the deal if they didn't get a mortgage with a 6.2% interest rate or less. After the home was inspected, the sellers agreed to pay $1,000 to clean up radon and buy a one-year home warranty that covered the house and appliances. "During negotiations," says Stewart, "if we had 24 hours, we would sleep on it and get back to the seller within an hour of the deadline."
There's a decent chance that a stagnant market could be a falling one by next spring, especially if interest rates head up. So if you think you'll move again within a few years, consider renting. Otherwise, plan on staying awhile. Go for an extra bedroom if kids could be on the way. And get a fixed-rate mortgage to make sure your payments won't spike, leaving you unable to afford your house--or to sell it without taking a beating.
If You're Selling, Play the Price Game
Don't lose sleep deciding on a price. You're likely to list a bit too high at first. No problem. That mistake can end up being an asset later, as long as you're quick to readjust if offers are scarce. "When a buyer offers less than asking, you can turn around and tell them you have already lowered the price," says Julie Longtin, an agent in East Greenwich, R.I.
Go on realtor.com or local real estate websites to find out what other sellers in your area are asking. Visit local open houses to get a better sense of how your home compares with the competition. Talk to at least three real estate agents before you hire one, and be wary of being "highballed." An agent who tells you that he can get much more for your house than your other research suggests is wasting your time and could cost you money down the line.
If you hate the idea of a full-service broker and a 6% commission, make sure you can be patient. Selling via a discount broker may take longer in a cooling market. Another option: Cut a deal with a full-service agent. A soft market has a way of making brokers more flexible.
Don't count on the broker doing all your marketing for you. Tell your neighbors that you're selling. They can be the best advertising tool you've got. Longtin even suggests putting fliers in the mailboxes of the 50 closest houses. The folks down the block aren't buying, of course, but if they like your house, they're sure to mention it to that friend or family member they'd like to have closer.
And make sure buyers like your house. Jeff Lima, who sold his three-bedroom ranch in Pawtucket in February, credits his quick sale--he got three offers the first weekend--to the landscaping work he paid for and the energy he expended cleaning out closets, emptying his basement and sending boxes of stuff to neighbors and friends. Lima sold for $650,000, slightly above his asking price and a big jump from the $379,900 he paid four years ago. "More than anything else, the prep work is what sold the house," says Lima. "And that cost nothing." In a falling market, where your profit margin is being squeezed, that's a great return on investment.
SPRUCE UP THE PLACE
DIY FIXES Sweat equity, and the cost of a few supplies, can pay off big when you're getting ready to sell.
BIG JOBS These improvements will help you sell your house quicker, and you'll likely get back more than your outlay.
SOURCES: Clemson University, National Gardening Association, Remodeling magazine, RenovationExperts.com, U.S. Department of Energy.
TOUGH TIMES AHEAD
Once-hot markets that are now unaffordable will slow this year. Over the next six years, they'll be falling by as much as 19%.
NOTE: Projected peak-to-trough decline over the next six years (periods vary). SOURCES: Fiserv Lending Solutions, Moody's Economy.com.
GETTING THE MOST FROM A GO-SLOW MARKET
When big gains don't come easy, you need to get more particular about what you own
The bird's-eye view of metro Atlanta tells you what you need to know about local real estate: Houses are big and there's plenty of raw land. Throughout the South, easy land combined with easy terms and a growing population to lift prices modestly and fuel demand for ever-larger homes. You could do okay selling to a newcomer, and it was easy to trade up.
Now that the economics of housing are changing, that might not be enough of a strategy. Here are the new rules:
Buy Quality, Not Quantity
In a market like Atlanta, which saw average appreciation of only 4% a year during the height of the boom, stretching to buy the biggest McMansion on the block isn't going to pay. As higher interest rates erode buyers' purchasing power and prices weaken at the high end of the market, "the further out and the larger you build your home, the longer you'll have to wait to see a return on your investment," says Philip Rassel, head of the Atlanta division of Metrostudy, which analyzes housing markets.
Nationwide, Americans' desire for bigger homes seems to be weakening. The size of the average new U.S. house has stabilized in recent years at 2,430 square feet after three decades of steady expansion, according to the Census Bureau. And the American Institute of Architects reports that luxury kitchen appliances and upscale bathroom fixtures are becoming must-have features for new homes. Out: formal dining rooms.
The glut of big houses has some homeowners, like Mark Miller, 45, and his wife Christine Schneider, 42, thinking that this is a good time to cash in. "If you push up supply too much, prices have to come down," says Miller. The couple, who have a daughter, Josie, 3, bought their 4,100-square-foot home in suburban Marietta from Schneider's parents six years ago for $450,000. Today they figure they can sell it for about $700,000, and plan to do so before the market softens. "A big chunk of our net worth is tied up in the house. We want to capture that gain," Schneider says. After they sell, the couple expects to spend about the same amount to build a smaller, more energy-efficient home in a neighboring community where they can walk to stores and restaurants. "We could drop 1,000 square feet easily," says Schneider. "I don't believe in having space we don't use. It's expensive to heat."
Downsizing, of course, isn't for everyone. If you own a supersize home and can afford to maintain it, enjoy. Just keep in mind that it may take longer than you think before you can sell for a big profit.
Invest for Income, Not Capital Gains
In a market where investors can no longer count on much of a return from a quick flip, being a landlord is the name of the game. But only if the numbers work. "Your money should come from paying down your mortgage and the cash flow the property produces," says Gary Eldred, author of The Beginner's Guide to Real Estate Investing, "You're looking at total return, not just appreciation."
Finding properties that net a positive cash flow is nearly impossible in pricey coastal markets like San Diego or New York City. But it can be done in a non-bubbly one. And landlording looks especially attractive in fast-growing sunbelt cities such as Atlanta, Austin and Raleigh, N.C. In Atlanta, says local agent Gwen McKinley, three-bedroom starter homes can be had for under $200,000, and demand for rentals within easy commuting distance of office parks is high. When Roswell, Ga. residents Calvin and Beatrice Shaw, both 45, purchased their first rentals last year, they looked for properties in South Atlanta, in a new development close to several highways. The Shaws, who have a daughter, Morgan, 18 months, purchased two small three-bedroom homes for $130,000 each and rented them for $1,100 a month. That's enough to easily cover the mortgage payments of $750 a month plus about $150 worth of insurance and property tax costs. "The idea was to find properties that paid for themselves so we could hold on to them for many years," says Beatrice. They plan to keep buying.
Before you let tenants sign a lease, check them out. Joan Farbstein Kaplan, who owns four rental properties in Atlanta, learned that lesson the hard way. During a slow period for rentals, Kaplan, 44, who buys single-family homes in the $250,000 range and prefers middle-income professionals as tenants, rented one of her homes to college students. "A neighbor e-mailed me saying he had called the police 11 times in one month due to noise and commotion! My husband and I had to call a meeting with the tenants, pleading with them to stop having band practice and parties at home," she recalls. So check credit and references. And ask about amplifiers.
Finally, keep enough cash in the bank to cover costs if you can't rent the property for a few months or need to make unanticipated repairs. A management firm that maintains the property and finds renters will charge 5% to 10% of your rental income, but avoiding landlord hassles might be worth the squeeze on your profit margin. After all, in a slow-climbing market, you'll likely be holding on to this property for a very long time.
SLOW BUT STEADY
Prices in these cities have risen at a moderate rate, and growth is forecasted to more or less maintain the same pace.
SOURCE: Fiserv Lending Solutions, Moody's Economy.com.
89 What's Next for Home Prices
Forecasts for the 100 biggest markets
96 Get Real
Author John Reed debunks the "advice" of real estate gurus
98 Rate Hike Survival Guide
Escape plans for boom-time buyers
107 Boosting Value in Any Home
Three renovations that added value in their own way
118 The Best Addresses
Sixteen websites that save you time and money
122 The House That Swallowed Don and Shelly Cruz
A family's dream home--and financial nightmare
WHY HOME PRICES HAD TO SLOW DOWN
Rising prices, and now rising rates, have made homes harder to afford...
MORTGAGE PAYMENTS AS PERCENTAGE OF INCOME
...even as the number of houses for sale continues to rise...
12-MONTH CHANGE IN NUMBER OF HOMES FOR SALE
...so price gains are moderating, and more markets will fall in '07 and '08.
SHIFT IN HOME-PRICE GROWTH FOR THE TOP 100 MARKETS
NOTE: Median annual mortgage payment with 20% down and a 30-year fixed-rate mortgage. SOURCES: Fiserv Lending Solutions, Moody's Economy.com, National Association of Realtors, U.S. Census Bureau, U.S. Department of Housing and Urban Development.
WILL YOUR RENTAL PROPERTY PAY?
Run the numbers to make sure you'll at least cover annual expenses.
Yearly rental income 
Less estimated vacancy rate (5% to 10%) [-]
MORTGAGE AND PROPERTY TAXES
ESTIMATED MAINTENANCE COSTS (repairs, upkeep)
HOMEOWNERS ASSOCIATION AND/OR MANAGEMENT FEES [-]
Plus tax savings from depreciation (cost of the property ÷ 27.5 × your tax rate) [+]
Equals profit or loss [=]
They kept down costs on their renovation, adding upgrades but not moving walls or pipes.
They persuaded the buyer to pay closing costs, clean up radon and throw in a home warranty.
They're building a portfolio of rental properties in the Atlanta area that they'll hold for years.