Real estate isn't exactly in the bubble that Nasdaq was in 2000, but that's only a little bit reassuring.
It's true that houses aren't going to disappear overnight like Pets.com and countless other dot-coms did five years ago. But you can still lose money in real estate, if you're not careful.
There are definitely signs of an overheated market out there. Among them are recent estimates released by the National Association of Realtors that more than one third of all homes sold last year were second homes. Furthermore, the vast majority of those were bought as investments and not for vacation homes.
New companies designed to help individual investors buy into the real estate market are cropping up about as fast as technology investment newsletters did in 1999.
Pro-real estate analysts have argued for years that real estate can't tank because everybody has to live somewhere. And it's true that a growing economy and a growing population point to a floor under home prices. But not everyone needs a second home, so the more speculation there is, the greater the likelihood of dashed hopes.
"After four consecutive record years, the housing market is due for a breather," says David Lereah, chief economist for the real estate agents' group. Concern about individual investors getting caught in a real estate meltdown caused several financial advisors recently to warn about the threats of imprudent investing.
"Real estate is an important part of a long-term financial plan, but it is not the 'silver bullet' that some people think it is," said Steven Lugar, a Dallas, Texas, money manager. "Most of the people who are tempted to dive into the deep end of the real estate 'pool' are individuals who already are flailing around without an effective ... strategy in place."
When setting a strategy, here are some points to consider.
— It's good to be invested in real estate, but not exclusively. If you already own your home, and you don't have a retirement account, build that before you buy a second home. Folks who held some real estate in with their tech stocks back in 2000 came out just fine. Those who own some stocks and bonds with their real estate today will weather future storms.
— Know the tax situation. Investors who earn less than $100,000 a year in taxable income have the most to gain by directly buying a second home and renting it out. By carefully following the tax rules, they can often deduct more than they earn on their homes on an annual basis.
There are rules that allow you to avoid capital gains taxes on investment property by living in it yourself for a while or by trading it for other property. If you do decide to own and rent out property, be fastidious about your record-keeping.
— If you're in a higher income bracket, or would rather own real estate indirectly, through a real estate investment trust or a mutual fund which buys many REITs, you'll have a higher tax burden. Those are good investments to put in tax-advantaged retirement accounts. If you want to buy real estate directly in your retirement account, look at programs such as the one run by Entrust Administration.
Realize that if you do this, you have to make sure you have enough money in the IRA to cover all the real estate costs involved, or risk jeopardizing the tax benefits of your IRA.
— Make sure you've got cashflow, can handle the long haul, and keep your emotions in check. Forget flipping, says Jim Gillespie, president of Coldwell Banker Real Estate Corporation in Parsippany, New Jersey.
You're a little late for the fast turnaround market, so expect to keep your new property for a while. And don't spend so much time worrying about the view from the kitchen sink window or the lovely marble fireplace. If you're buying to be a landlord, spend all of your time thinking about the roof, the furnace and the local school system instead. Make sure you have extra cash on hand so that, if you are the landlord when the roof goes, you can afford to fix it.
— Do as much of your own homework as you can and remember that old "if it sounds too good to be true..." rule. Some real estate agents are more knowledgeable and helpful than others, but not one would sacrifice a great, positive-cashflow deal just so they could give it to you. The more you can learn about your own market, the better off you'll be.
Coming to the fore are some companies that claim they will do your shopping for you. One, Redbrick Partners, is buying up portfolios of single-family homes, renting them out, and packaging them in investment partnerships. Another, Signil Wealth Network, says it's out there shopping for individual properties for investors who want to buy real estate but don't have the time or inclination to do their own market research.
It's true that experts know more about the markets than you do, but you'll pay sizable fees to both of these companies for the privilege of being able to buy real estate, hire property managers and trust someone else to make your deals for you. Some stock buyers who put their faith in brokers and financial planners last time around are happy that they did, and some aren't.
It will take some more time — like another market cycle? — to see whether those real estate pros pan out any better.
