Boom Over, Investors Focus On Fundamentals, New Areas

Individual investors are shifting their focus to multiunit rental properties and long-term holdings. Read about the new rules for buying and selling real-estate as the market cools.
By: Ruth Simon: The Wall Street Journal Online
Battle-scarred mom-and-pop investors are still dabbling in real estate. But they are changing the rules of engagement.

During the housing boom, many individual investors went deep into debt to buy investment properties - rental homes and condos - in hopes of selling quickly. The goal: Cash in on soaring prices. They may have had little or no intention of being landlords for the long haul.

Despite the end of the speculative craze, a number of markets in the fragmented real-estate world continue to lure investors willing to adjust their expectations. One key move: As rents take off, buyers increasingly focus on multiunit rental properties instead of the single-family condos and homes that were popular during the housing boom.

Some investors are also shifting money into regions of the country where they expect prices to continue to rise, such as Texas, the Kansas City area and parts of North Carolina.

Developers are also crafting special promotions, such as guaranteed rental income for as long as five years. Deals like these are particularly common in Florida, but they are also appearing in other markets, including Philadelphia and Myrtle Beach, S.C.

Another major shift: Most investors are focusing on the fundamentals that guided the market before the housing boom, especially cash flow - the ability to actually make money from, say, rentals, rather than from quickly selling the property. They are sticking with properties that turn a profit (or at least break even) after factoring in interest payments, taxes and other expenses.

That is a change from the past few years, when speculators were willing to lose money each month in hopes of selling for a big gain.

"Making a minimum of $50 to $125 monthly on each house is what we're shooting for," says Wendy Kallberg, a recent investor in Newport News, Va., who has purchased four single-family homes and condos over the past year at prices ranging from $67,000 to $140,000.

"I'm not interested in flips," Ms. Kallberg adds. "In six or seven years, I will go and sell the property."

Big risks remain for investors in residential property. The National Association of Realtors reported that the median price of an existing home in October was down 3.5% from a year earlier, the largest decline since the group began collecting these data in the late 1960s. And a glut of unsold homes could continue to keep prices in check.

Many investors have fled. The number of borrowers taking out mortgages to buy investment properties was off more than 70% in the third quarter from a year earlier, says First American LoanPerformance, a unit of First American Corp. Meanwhile, investors' share of home purchases fell to 8.4% in the first nine months of this year from 9.5% a year earlier, says LoanPerformance. Five years ago, that share was less than 6%. (Figures don't include investors who paid cash or financed their purchases by tapping the equity in their existing home.)

Some of the biggest declines in investor purchases are in once-hot markets where speculators helped drive prices to unsustainable levels. In places such as southern Florida, Phoenix, Las Vegas, San Diego and Washington, D.C., "the numbers just don't make sense for long-term investors...unless they are able to buy at a strong discount," says Jack McCabe, a real-estate consultant in Deerfield Beach, Fla.

Still, demand for investment properties remains healthy in some parts of the country. In the Charlotte, N.C., area, investors have been snapping up raw land and developing it for builders who are moving into the area as other housing markets cool, says Wallace Perry, president of Coldwell Banker United, Carolinas region. Land prices are rising at 10% to 15% annually, nearly twice as fast as home prices.

In the Kansas City area, out-of-state buyers are fueling demand for small and midsize apartment buildings, says William Hargis, a broker in Overland Park, Kan., with Reece & Nichols, a unit of Berkshire Hathaway Inc. Investor demand has also been strong in many parts of Texas. "We're seeing a lot of people from other parts of the country" coming to town to buy investment properties, says Steve Hendry of Re/Max Associates of Dallas.

With home prices softening in many markets, some advisers are counseling clients to focus on multifamily and commercial properties. Homes and condos are "not the place for a person who wants to make good, solid real-estate investments," says Jim Lumley, a broker in Amherst, Mass., who has written about real-estate investing.

Small apartment buildings and commercial properties are "more stable" investments, he says. "You've got a number of people paying rent."

Anthony Reed, an agent with Long Realty Co. in Tucson, is seeing increased interest in commercial properties because asking prices for many residential properties "are unrealistic." Investors "expect the property to at least pay the mortgage with a 20% or 25% down payment," he says.

Yields on commercial properties have fallen over the past four years, but rent growth is strong as vacancy levels decline, says Youguo Liang, a managing director for Prudential Real Estate Investors, a unit of Prudential Financial Inc. "If you balance the two factors, it's not the best time and it's not the worst time," he says, adding that conditions "slightly favor investors."

The situation is bleaker for those buying homes and condos as an investment, says Mr. Liang. "They should have very limited expectations on appreciation going forward - probably 0% to 3% annually for the next five years," he says.

Many speculators who bought property during the boom may now be facing a tough choice. They can either lose a moderate amount of money each month while they wait for the market to rebound, or they can sell and take the pain all at once. Refinancing the mortgage could help under certain circumstances, such as when a borrower has an adjustable-rate mortgage that has reset to a higher interest rate. But for those who took out exotic mortgages with low monthly payments, refinancing may bring no relief.

Some investors keep their eyes out for special situations, such as properties being unloaded by people who took on too much debt or invested unwisely during the housing boom. Willam H. Lublin, chief executive of Century 21 Advantage Gold in Philadelphia, says he is now taking a look at two groups of properties currently owned by investors in financial distress.

As the market for homes and condos has cooled, some developers are unveiling special promotions designed to appeal to investors worried about cash flow. In Philadelphia, Maxwell Realty Co. is telling qualified investors who purchase units in two condo projects that the developer will pick up the difference if their rental income doesn't cover monthly operating costs during a two-year period.

Under the program, the developer finds a tenant for the property and is responsible for monthly mortgage payments, condo fees and real-estate taxes, provided the buyer puts 10% down.

In Hollywood, Fla., Kim Kirschner of Kirschner Realty International is working with several developers who have created similar incentive programs, designed to give investors "break-even or some type of [positive] cash flow for a two-to-three-year period."

Jeff McConkey, broker-owner of the Avista Group of Keller Williams Realty in Tampa, says he's working with several condominium developers who are offering a "rental-assurance" program that stretches for as long as five years.

But investors should approach such offers cautiously, advises Mr. McCabe, the Florida real-estate consultant. "We're seeing a lot of developers and builders right now...breaking their promises to buyers," he says.