Before you join the gold rush to buy investment properties in the burgeoning second home market, take off your rose-colored glasses and proceed with caution.
Only fools rush in.
The "wealth effect" you'd expect from real estate equity growth and rental income doesn't happen in a vacuum, and those expected returns can get sucked away by unexpected expenses, market conditions, and properties that simply aren't good investments.
"My quick bit of advise on this is, with the huge appreciation factors and the fact that real estate developers in this market have been on to this for some time now, be careful where you buy," said Christine Karpinski, investor and author of "How To Rent Vacation Properties By Owner" (Kinney Pollack Press, $26).
"As you would in any investment angle, be sure to do your homework to be sure what you are buying is indeed a good investment," she added.
Investors accounted for what's likely a record 23 percent of all home sales last year. All second home purchases -- investment properties, vacation houses, and retirement homes -- accounted for 36 percent of all home sales, and second homes now comprise 38 percent of the nation's entire existing housing stock, according to the National Association of Realtors' "2005 National Association of Realtors Profile of Second-Home Buyers" released earlier this week.
Residential real estate is the new "go-to" investment for numerous reasons.
Baby boomers lead the way, buying up second homes with equity wealth from existing homes. The group of Americans born between 1946 and 1964 and now aged 41 to 59, represent a population bulge of 75 million people who are redefining the second half of life. Many plan to remain active, work full or part time during their "retirement years," and stay put in their own home as they age, rather than move into a retirement home. For them, a roof over their heads generating a return on their investment and providing a tax shelter is a means to that end.
Tax laws, now exclude from taxes up to $500,000 in capital gains when you sell a home. That extra money can be rolled over into another home -- or two -- where additional tax benefits await.
The domestic segment of the travel market flourished after 911. The post-911 shift to what is perceived as safer domestic travel, rather than travel abroad, created a larger market for investment properties owners rent out. Domestic travelers often prefer to stay in the more homey environment of a home rather than a hotel, motel, or inn. Rates can be cheaper for larger groups and the less dense form of accommodations gives travelers a greater sense of security.
Stock market refugees who both lost, and made money before the dot com collapse found a safer more practical investment haven in housing because it's also a tangible asset. As an investment, second homes are just plain cool. It's a lot sexier to live, work, and play in an investment than it is to read stock market indices every day.
"With the WorldComs and Enrons of the last few years, people are looking to have more personal control over their investments. Real estate has often been used as a safe or "blue-chip" investment, because it seems to ride out the ebbs and flows of the market over the long term," Karpinski said.
In addition to the tangible aspect, real estate investments are more easily leveraged investments. That means a smaller percentage of the investment actually faces risk. Only $100,000 down, for example, gets a half million dollar investment. With even more risk, you can invest in real estate with virtually nothing down. Equity growth and the new mortgage market also makes the investment more liquid than ever. Pull out equity in San Diego one day and go shopping for a home in Chicago the next.
"There's no question about it. Whether purchased as second homes, primary residences, or as purely investment properties destined to be 'flipped' for a quick profit, real estate is a powerful, profitable alternative to the stock and bond markets," says Alfred Glossbrenner, co-author of the book/CD "How to Make Your Vacation Property Work for You!".
However, returns on any investment, especially real estate, are almost never over-night sensation, but long term obligations. Don't let recent run ups in home prices, or the growing flipping practice cloud your vision. Keep in perspective how the come-latelys looking for a fast buck in the stock market suffered when they tried to cash in on the already spent dot com era.
Real estate values can, and do fall. Protecting any investment with diversity remains the golden rule in personal investments.
"Investing in real estate is not rocket science, but it does take a lot of research, planning, and old-fashioned hard work," says investor Eric Tyson, who, with Robert S. Griswold, co-authored "Real Estate Investing For Dummies," (Wiley, $21.99).
While speculators take the riskier approach to investing by flipping properties -- buying and quickly reselling, hopefully at a profit -- most investors buy the property to hold for appreciation, rental income, or both.
With comments from other experts, here's what Tyson and Griswold offer as start-up tips for first-time investors holding onto properties.
Live within -- or below -- your means. You typically won't be able to tap investment returns right away and in many markets, you will pay some expenses (insurance, taxes, maintenance, upgrades, etc.) to own investment property even if you rent it out. Roll back your do-it-all lifestyle. Keep your current car a few years longer. Don't live in an expensive community loaded with amenities you'll never use. If you must travel, travel to the investment property, and use visits for do-it-yourself tasks that cut costs on maintenance and upkeep.
Put 20 to 25 percent down. Living frugally will give you the money you need for larger down payments, which give you the best financing terms and speedier returns on your money. Smaller down payments come with more expensive interest rates, private mortgage insurance, and other costs. While you should strive to use as much of the lenders' money as leverage to cover acquisition costs, too much leverage can be dangerous if the market turns on you and your debt expenses are too high to allow you to bail out without losing money.
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Pick a real estate team. Line up an investor-advisor, real estate agent, loan officer, tax specialist, attorney, and others who can assist you. An investment-smarts heavy team of professionals positions you to identify, and quickly close on the best investment properties.
Think small. Small residential properties like condos, townhomes, and small homes are easier to maintain and manage, and the initial capital investment is smaller, putting less money at risk. Consider larger detached homes multiplexes and larger multi-housing units after you've mastered one or a few smaller properties.
"A property with a successful vacation rental history can actually fetch a higher price than its competition. That's because the new owner isn't buying just a building or a condo, he or she is buying a small business with a proven track record," said Glossbrenner
Think location, location, value. Own property in up-and-coming areas with new development, the potential for growth and other factors that enhance finding and keeping good tenants. Properties in solid locations but in need of deferred maintenance, that is largely cosmetic, can be wise investments.
"There are some markets that are over saturated with new development. Avoid them," said Karpinski.
Conversely avoid "perfect" properties. Avoid new or fully renovated properties, unless they are in the path of progress or in a prime location -- say the first phase of an ocean front community. First-phase pricing is often favorable because of the pressure on the developer to pre-sell some homes before his development loan kicks in. Otherwise new properties may have already been squeezed by the current owner and further rent or value increases may be limited.
Buy close by. Buy within two hours travel time -- by car, plane, train or boat, depending on how you travel. Seek more distant investments only after becoming familiar with the market, regularly travel there for other reasons or find an property manager who won't cut deeply into your profit potential.
Take the glow off cash flow. Don't take the seller's or agent's word for it when it comes to the income and expenses associated with the property. Work a cash flow report from scratch based on your, or your team's research. Otherwise you have no way of truly knowing the investment value of the property.