More Look to Real Estate To Pad Their Portfolio
By RUTH SIMON
Staff Reporter of The Wall Street Journal
From The Wall Street Journal Online
December 14, 2004 -- A growing number of Americans are buying real
estate as an investment, driven by the combination of low interest
rates, rising property values and tepid stock-market returns.
Investors accounted for 8% of mortgages used to purchase homes in
the first eight months of this year, up from 7.5% in 2003 and 5.7%
in 2000, according to an analysis prepared for The Wall Street
Journal by LoanPerformance, a San Francisco-based firm that tracks
the performance of 46 million mortgages monthly. It's the largest
investor share since at least 1986, according to the firm. The
number of mortgages used to buy investment property may actually be
higher since those figures don't include loans taken out to buy
second homes that are used by the owner but may also provide rental
income.
The demand for investment property is particularly apparent in
rapidly appreciating markets, including Las Vegas, Arizona and parts
of California, according to LoanPerformance. But it's evident in
other markets as well: In Miami, speculators account for as much as
80% of the preconstruction purchases of luxury condominium units,
according to Mark Zilbert, an associate with Esslinger-Wooten-Maxwell
Realtors.
In one new South Beach condo building, ICON, roughly half of the
apartments were bought by investors and then resold before the
building's official opening this week, according to the developer,
the Related Group of Florida.
The steady upward appreciation of housing prices has provided a
sharp contrast to the stock market's performance during recent
years. Median home prices climbed 7.7% during the third quarter from
a year earlier, with many coastal markets posting double-digit
gains, according to the National Association of Realtors. For the
five years ended Sept. 30, median home prices rose 39%, versus a
loss of 13% for the Standard & Poor's 500-stock index.
Investors helped drive up housing prices in Las Vegas
Those gains have attracted many individual investors. "It seems like
investing in real estate is a wiser decision than putting [the
money] into a stock market or savings account or savings bonds,"
says Kelly McDonnell, a recruiter for an educational testing company
in Amherst, Mass. Ms. McDonnell is currently shopping for a
two-family duplex she can rent out and then, she hopes, sell for a
profit in a few years.
But investors betting on double-digit gains could end up
disappointed. Falling interest rates have helped fuel the recent
rise in home prices, but rates are more likely to rise than fall
going forward. Already, there are signs that the housing market is
cooling. The 7.7% increase in median home prices during the third
quarter, while still above historical levels, represents a decline
from the 8.9% annual gain posted in the second quarter, according to
the National Association of Realtors.
One alternative: real-estate investment trusts, which buy and then
rent out shopping malls, apartments, office buildings and other real
estate.
REITs give investors access to a diversified mix of properties and a
hefty dividend without the management headaches. Already this year,
investors have poured a record $5.17 billion into funds that invest
in real estate, according to AMG Data Services in Arcata, Calif. The
inflows, which cover the period through a week ago today, exceed the
record $4.75 billion that poured into real-estate funds in all of
2003.
Though considered a relatively safe investment, REITs can also be
volatile. REIT prices fell roughly 20% during a six-week period this
spring after a strong jobs report raised fears that the Federal
Reserve would be more aggressive about raising interest rates. That
would have made yields on REITs less attractive.
Prices have since rebounded, but whether REITs can maintain their
upward trajectory is a matter of debate. They currently trade at
roughly 19 times adjusted funds from operations -- a commonly used
measure of REIT earnings -- well above their historical average of
12 times adjusted FFO, according to Mike Kirby, a principal with
Green Street Advisors, an independent REIT research firm. The
average yield on a real-estate fund is now 2.8%, according to
Morningstar Inc., down from about 4% three years ago. "On a pure
valuation level, it's hard to make the case that real-estate funds
are a good buy now," says Morningstar senior analyst Dan McNeela.
Still, some analysts say that REITs remain attractive for investors
with a long-term time horizon. Mr. Kirby expects REITs to generate
long-term returns of 9% a year.
Investors snapped up units in ICON, a new luxury condo in Miami
Beach, well before the building was completed.
Investors interested in owning hard real-estate assets range from
first-time speculators to wealthy individuals. Erik Friis, a San
Diego attorney, started buying San Diego real estate in the late
1990s, then set his sights on Arizona as prices in California
climbed. "It came to a point where there weren't any properties that
made sense to buy," says Mr. Friis, who recently sold a small
apartment building in San Diego and used the proceeds to buy a
24,000-square-foot shopping center in Tucson.
In Long Beach, Calif., there's "more of a demand than ever for
investment property," says Richard Gaylord of Re/Max Real Estate
Specialists. "The problem is that inventory is so low that I'm
pulling my hair out trying to find them stuff."
Many buyers are new to real-estate investing. In Tucson, "people who
never looked at real estate as being part of their investment
portfolio...are either acquiring residential income property or
participating in partnerships," says Rosey Koberlein, president of
Long Realty Co.
In Warwick, R.I., broker Ron Phipps says many investors are opting
for properties with good locations, even if a high purchase price
means they won't cover their costs for the next few years, Mr.
Phipps says. Others are buying investment properties that may
eventually be used by a child or aging parent.
Real-estate purchases are becoming increasingly popular among people
with $1 million to $10 million in assets, says Kevin Ruth, a senior
vice president and director of financial planning at UBS AG's UBS
Financial Services unit. In the Wisconsin Dells resort area, condos
that double as second homes and rental properties "are going like
hotcakes," says Michael Dubis, a financial planner in Madison, Wis.
The rise in investment purchases has caught the attention of many
who track the housing market, including Federal Reserve Board
Chairman Alan Greenspan. In a speech before America's Community
Bankers in October, Mr. Greenspan noted that purchases of
single-family homes for rental or use as second homes have grown in
recent years, though he said they still accounted for less than 11%
of total home-mortgage originations in 2003.
Some housing experts worry that investor demand has helped fuel the
recent gains in home prices and could accentuate any downturn as
interest rates rise and demand slows. The country is experiencing
"investor-driven price increases in certain markets. ... And these
markets could soften as investor demand wanes, as it inevitably
does," Fannie Mae Chairman Franklin Raines said in a speech last
month.
The perils of betting on short-term profits has been particularly
apparent in Las Vegas, where speculators helped push prices up
nearly 54% in the past year, the highest growth rate ever measured
in a metropolitan area, according to the National Association of
Realtors. When a falloff in sales and traffic led a handful of
builders to cut prices this fall, the reductions "hit investors
hardest," says Larry Murphy, president of SalesTraq, which tracks
the Las Vegas real-estate market.
Owning real estate, meanwhile, isn't as simple as purchasing a stock
or a bond. Investors need to be ready to handle late-night calls
about broken water pipes and faulty heating systems -- or hire
someone to manage these and other headaches. Management fees often
run 5% to 10% of gross rents. Moreover, rising housing prices are,
in many cases, making it tough for investors to cover expenses --
such as mortgage payments and property taxes -- through rental
payments.
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