Thursday, February 17, 2005

RESIDENTIAL REAL ESTATE

Mike Taylor of taylortree.com, "My Old Merrill Pal" and I had a good discussion about residential real estate rentals the other day. My wife and I have earned our living by renting our families homes, condos and commercial properties for the past 19 years. I generally discourage folks from entering the business unless they are ready to pay attention to the market and to work very hard. I discourage folks from investing in rental property unless they have substantial reserves, 25% or more of total property values in liquid investments. Real estate is typically purchased on margin. The old saw about the stock market is to never meet a margin call. Sometimes in real estate, one must meet a "margin" call to realize long-term capital gains.

"My Old Merrill Pal" who has extensive experience as an investment broker, investment advisor and CPA, made the following comments:

"I have experienced a little rental real estate investment in my own family and
commercial is far easier and more costly to enter than residential. What is enticing about residential is that it does not appear to cost
much to enter, but boy you can pay a lot along the way.

In a pro forma for any real estate investment today, you should consider, at
the least, these three things.

1) Operating expenses are never as low as you would think. I rented a single family house to
someone and in the lease was the requirement for the tenant to maintain the yard. The tenant did not maintain the yard and I paid a company to do the job. The margins were too thin to cover. There were other unforeseen expenses.

2) Rents do not always increase. I had to lower the rent to get a better tenant.

3) Put in your calculation rising interest rates, taxes and other costs. If you get a bank to fix
your rate, you can forget about rising interest cost but other costs will surprise.

My father-in-law, who suffered serious losses in the Texas 80's real estate
debacle ( actually a melt-down) told me one axiom I will always
remember.

You make your money in real estate when you sign the contract to
buy.


Never purchase with assumed growth rates in values to make your money.
Jack made much of his gains when he signed good purchase contracts."

"Old Pal" nailed the problems and the correct way to make money in real estate. Investors need to include "unknown" costs and they need to shop for the best price at the best time. Most investors need to build liquid investments first. After all stocks are cheaper than bonds and bonds are cheaper than real estate.

With the dollar at low levels, US property is cheap relative to foreign property. Resort properties are very hot. Big money is being made by those who buy and "flip" quickly. I know of beach condos that sold for $320,000 14 months ago and for $510,000 recently. Should the dollar continue to fall, a speculative blow off will occur in real estate. During the 1980's similar cycle, home building peaked in the mid 80's but foreign buyers continued to push up prices for another two to two and a half years.

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