The Good, Bad and Ugly of Real Estate Investments
While many investors get a rise when it comes to the potential profits in real estate, that doesn’t mean all properties rise enough in value to justify the commitment.
“Some people buy real estate expecting it to appreciate a lot over time,” says David Reiss, a professor of law and research director of the Center for Urban Business Entrepreneurship at Brooklyn Law School. “But it can be risky – or even foolish – to pay so much for a property that you’re losing money on an operating basis just because you think it will appreciate.”
The wisdom in real estate, then, applies just as it would with stocks, commodities or any other investment class: The variables are many, the can’t-miss propositions few. So where should the savvy money go? And how does real estate fit into your overall portfolio?
Here, experts and observers weigh in on the essentials that should guide your decisions, as well as the ways to guide your financial forays toward success.
Know your market well. If you pay market price for an investment property, you probably won’t see particularly robust returns. “It will make a market return, and if you want to do better than that, you have to pound the pavement,” Reiss says. “Look for deals that are underpriced for one reason or another. And you won’t know which deals are underpriced unless you have a good sense of how properties are priced.”
Luxury homes may hold a key. In 2014, the S&P/Case-Shiller National Home Price Index for single-family dwellings rose roughly 4.5 percent. But Frank Symons, executive vice president and chief operating officer for the western region of Sotheby’s International Realty, reports that luxury homes appreciated 8 percent that same year. He cites Sotheby’s Global Luxury Residential Real Estate Report for 2015. “This is a healthy return on investment at a time when residential real estate is still recovering,” Symons notes. “As recovery continues, the rate of appreciation could gain momentum.”
Turnkey properties can unlock returns. With a turnkey investment, you’re buying a fully vetted, redeveloped property with tenants and a property manager. “It’s a lot like buying a take-and-bake pizza. All the ingredients are there, and all you have to do is buy,” says Scarlett Tassone, a vice president and mortgage banker with PrivatePlus Mortgage in Atlanta. The downside is that compared with other tenant properties, “they are not quite as lucrative and a bit more expensive,” she says.
Vacate vacation homes. Just because you can kick back at a recreational abode doesn’t mean profits will recreate themselves. “Vacation homes are nothing more than a whimsical retreat and a low-tier income option,” says Kurt Westfield, managing director of WC Equity Group, based in Tampa, Florida. “Seasonally, they do have the capacity to generate decent returns, but the vacancy and holding costs coupled with typically premium pricing tend to equate to a less-than-stellar rate of return.”
Give REITs a chance. A real estate investment trust is a company that owns, develops and redevelops real estate assets. “Publicly traded REITs and REIT funds offer liquidity and low investment minimums,” says Mike Papierski, national real estate practice leader at Northern Trust Company, based in Chicago. REIT mutual funds in particular offer high diversity. Just be aware that “performance tends to more closely align with stock market return and may not correlate with actual property values,” Papierski says. Overall, he recommends a 15 percent cap on real estate exposure in a portfolio.
Caveat rental. Yes, you can make money with rental properties. But if you have little experience in the game, expect a steep learning curve. “Bricks-and-mortar properties require expertise and intensive management, even with investment-grade properties,” Papierski says. “If the owner doesn’t have the expertise, he or she will need to hire someone to handle the leasing and day-to-day management.” And that fee generally runs between 4 and 8 percent of gross rents.
You might flip for flipping houses. In this form of investment, the goal is to get in short-term and sell properties at a markup. And while many investors make money this way, much depends on the neighborhood you buy and sell in, as well as hidden costs associated with renovating the property that can decrease its net return. “This type of real estate investment has more risk than owning rental properties,” says Rebecca Pavese, financial planner and portfolio manager with Palisades Hudson Financial Group in Atlanta.
Vacant property is a mixed lot. Vacant properties may hold tremendous potential in a neighborhood that’s gentrifying, or if the land sits in the path of a proposed water and sewage line. But investors will pay on both the buying and selling end. “As a development play, these have huge one-time upside,” Westfield says. “But the capital gains tend to be a hindrance. Personally, I avoid it.”
Increase your profit potential with an investment of time. Property development, management and administration often require an army of specialists. But if you’re adept at repairs, accounting or showing a vacancy to prospective renters, you can forego the fees associated with hired help. “Depending on your availability and your skills, these could be trade-offs that are worth making for you,” Reiss says.
It’s not just what you’re renting, but who’s renting. Veteran Atlanta Realtor William J. Golden, who works with RE/MAX Metro Atlanta Cityside, tells how his onetime rental home became a house of horrors. One tenant painted an entire room black; another housed a stolen motorcycle at the property. And when Mr. Motorcycle wasn’t swiping mail from wealthy locals, he allowed his buddies to squat there. Lesson learned? Vet your renters thoroughly and check on them frequently. “I swear that house was cursed,” Golden says. “Interestingly, we’d purchased the home from a psychic, so I wish she could have given us a heads up what was in store.”
