It happened without a sound. If only it were possible to hear the real estate bubble burst, then maybe the downturn in the housing market wouldn’t have caught quite so many people off guard.
And the outlook remains rather grim. At the current rate, it would take nearly a year to sell all of the unsold homes that dot the nation’s landscape. It’s a real worry for homeowners thinking about the basic economics of the situation: The glut of supply will only continue to depress home prices. Indeed, the residential real estate market is on shaky ground.
All of this has made it challenging for real estate investors looking for stability. Many homeowners who were unable to sell their homes have unexpectedly become landlords. At the same time, owners of investment properties have been rejiggering their approach to evaluating investment options. With a slew of former homeowners entering the rental market, many landlords are able to demand higher rents.
Take Patrice and John Hopkins who have owned investment properties since March of 2005 and done quite well. A year ago, the couple pocketed a $45,000 profit from the sale of a 2.3-acre piece of land in Fredericksburg, Virginia, that they’d purchased a year earlier. The parents of two daughters–Amari, 8, and Alexandra, 2–they are ready to reinvest. But now that the housing market has taken a hit, the couple is moving with caution.
Actually the couple would like to undertake a rather big project. They’re looking to purchase as many as 10 townhomes that they will rent out. Patrice and John, who reside in Triangle, Virginia, and have an annual household income of $225,000, want to spend no more than $130,000 per property. They’re also weighing participation in the federal government’s Housing Choice Voucher Program (often referred to as Section 8), which allows low-income families to lease affordable, privately owned rental units and would provide the Hopkinses a guaranteed income stream.
Yet even at a modest price point for each property, they’re still making sure that they’re performing the necessary due diligence to ensure that they’re not paying too much. After all, foreclosures have climbed, partly because investors who bought at the top of the housing boom with an adjustable rate mortgage were unable to charge rents that covered their reset interest rates. In May, foreclosure filings were up 48% from the same time last year, according to RealtyTrac Inc.
The key, Patrice says, who works as a social worker in Woodbridge, is to find the highest quality investment property that would guarantee positive cash flow. Because there’s a glut of unsold town homes and foreclosed properties in the northern Virginia market, she and John, an engineer, plan to take their time and find the most advantageous deal. “We want a mortgage we could still pay if we weren’t able to rent it out and that wouldn’t interfere with our other financial responsibilities,†Patrice says.
The Hopkins family could very well get their wish. In many markets, properties can be bought at deep discounts, either from owners who can no longer keep up their mortgage payments or from banks that have taken back properties that have gone into foreclosure.
Time to Buy?
Despite the alarming numbers, many professionals are encouraging people to enter the market. If you have some financial flexibility, you might consider becoming a landlord. “This is the best time in about a decade to invest in real estate,†says Lisa Betts, president and CEO of Capleon Properties L.L.C., a real estate brokerage firm in Brooklyn, New York. Interest rates are low (at the end of June, the average on a 30-year, fixed rate was 6.62%, according to Bankrate.com) and properties are selling, in certain markets, for half of what they would have sold for a year ago. Foreclosures continue to rise and banks are itching to get rid of homes seized from troubled borrowers, properties known as real estate owned, or REOs.
Obtaining financing for REOs isn’t impossible, either. Investors just need to be armed with more cash than they may have needed a few years ago. Some banks are asking for as much as 30% down, says Betts. You could, of course, qualify for a bigger loan if the selling price is at a huge discount to its current value, some experts say. But many banks might be reluctant to grant any sort of loan if the condition of the home is poor.
Generally, if it’s a residential property it’s going to be a different set of rules than if it’s an investment property. The lending criteria have tightened up both for home purchases and investments. As an example, now it’s almost impossible to get a 100% loan for investment properties. A bank will not finance a project that is uninhabitable, which is sometimes the case, says Larryette Kyle-DeBose, author of The African-American Guide to Real Estate Investing (Amber Communications Group; $14.95). “You want to have six months of payments in the bank and a credit score of 680. They don’t want to end up taking anything back.â€
But Sibongile West, a real estate agent in Los Angeles, suggests that those who plan on buying real estate as an investment right now “really need to have a five-year commitment at a minimum to realize a gain.†The main reason is that the current housing market is still considered volatile and buyers should still be cautious. In Southern California, for example, she says the real estate market tends to cycle for between five and seven years, meaning for that length of time, there is either more demand for homes than there is available supply, or that there are more homes available than there are viable buyers.
Develop a Strategy
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Having this understanding can help you devise a safe investment strategy, Elliott adds. You’ll know what kinds of houses to buy,what types of neighborhoods to target, and even how many properties you will need to reach your long-term goals. Reading books, joining an investment club, and finding a mentor are also useful tools.
Elliott argues that becoming a landlord these days is a lot more complicated than it used to be. Section 8 rules have changed, for instance, and prospective landlords should make sure they know about tenant and landlord housing laws and regulations in their state and county. One popular Website, Mr-Landlord.com, offers tips to do-it-yourself landlords, rental owners, and managers. Other useful sites with a variety of resources are Landlord.com and TheLPA.com, which stands for the Landlord Protection Agency.
Advice from a Pro
Lester Zeigler, a landlord who also runs a home inspection business and owns 31 rental units in New Orleans, carefully mapped out a strategy before he began acquiring properties. During the early 1990s, the 42-year-old Brooklyn native moved to the Big Easy after visiting and seeing how affordable the rents were. Zeigler quit his job as a customer service representative for a bank and soon after purchased an $82,000 two-family home. He lived on one side and rented out the other.
Empowered by the success of his first venture,Zeigler and his wife, Yolanda, soon embarked on a quest to acquire additional homes–two-family buildings and larger.They had a clear plan of execution to help them weather good and bad markets: Keep a financial reserve of about three months of rent per unit, in case of a hardship; agree to do month-to-month leases, so they can easily get rid of problem tenants or increase or decrease the rent at their discretion; and try to maintain an 80%occupancy rate in order to turn a profit.
The Zeiglers currently own $2 million worth of real estate, which generates about $360,000 annually. Before Hurricane Katrina Zeigler held adjustable rate mortgages that were as high as 12%, but now he sticks with fixed-rate mortgages with rates of about 8.75% or less. The storm damaged all his properties, ultimately costing him$800,000 to renovate, upgrade, and redo the electricity and plumbing in all the units. Although most of his insurance costs have doubled, Zeigler has been able to pass those costs on to his tenants, since his average rents have gone from$450 to $650 or more post-storm because of housing shortages.
Zeigler still says that because he devised a clear investment strategy from the outset–to buy and hold–he’s less affected by the turbulence in the current housing market. Declining values don’t concern him, for example, because he doesn’t plan on selling his properties anytime soon.He can also pass along any extra costs to his tenants. If an adjustable rate mortgage was about to reset, sending his monthly mortgage payment higher, he could at some point raise his tenants’ rent, Zeigler says.
Evaluating a Deal
Still, experts say there are many factors involved when determining if an investment property is a good deal.Do extensive comparable research so you know what similar homes are commanding in that area. (Areal estate agent or an appraiser can do this for a small fee, which experts say is worthwhile since it’s currently hard to ascertain value with so many foreclosures.) You also need to evaluate the neighborhood; you can do that by driving around the area at night to get a feel if families with children would want to live there. Check out foreclosure rates, along with job growth in the city, to gauge how those rates could continue to affect the area.
“I try to find areas that are planning to build a SuperWal-Mart, because [the company] only puts up those properties in areas of growth,†says author Kyle-DeBose. “You want to get in front of the growth.â€
You also have to factor in the rental market, because maintaining a high occupancy rate is key to a successful investment. Look through the newspaper to find out about rents of various types of apartments. Some real estate agents suggest calling up existing landlords with units for rent to see what they’re asking. Some investors have a formula for determining if they’ve stumbled across a good buy. “I call it the ‘MAO’–the maximum allowable offer,†says Elliott,who runs the Atlanta real estate investment club. “I look at acquisition costs, renovation costs, plus 15% to 20% of the purchase price for holding costs. You add all that together and that will give you the maximum allowable offer to make. If you pay over and above that, you won’t get a sufficient return on investment.â€
Entering the Foreclosure Market
One of the most popular ways to find a deal is through the foreclosure market, which you can tap into at several points.One is the pre-foreclosure stage,when the owner still has the property but has missed a few mortgage payments.This situation can be uncovered through public notices about homes in default and through various Websites. RealtyTrac, for instance charges users $49.95 for information on properties in all three stages of foreclosure: the initial notice of default, the notice of an upcoming trustee sale or sheriff ‘s sale, and the notice of bank repossession. But this is a competitive space–it’s not unusual for homeowners to get multiple letters, flyers, postcards, and even door-hangers on a daily basis while their properties are in foreclosure, says Rick Sharga, senior vice president of marketing for RealtyTrac Inc.
Another option is a real estate owned property. If you’re buying an REO, the foreclosure process has already occurred and the bank owns the home. Investors can find out about REOs through real estate agents who specialize in them. But a caveat with REOs is that lenders and the companies that service the loans for these properties are now overwhelmed by the number of properties coming back and can’t respond to an offer as quickly as a buyer would like. In addition,
banks may not want to hold on to these properties, but they’re also not willing to give them away for pennies on the dollar, says RealtyTrac’s Sharga. Lenders also try to get rid of homes through auction, but novice investors shouldn’t attempt this method, experts say. You often have to show up at the auction with enough cash to buy the property on the spot, often can’t inspect the home in advance, and the current owners might very well refuse to leave.Websites such as USHomeAuction.com and RealtyBid.com promote auctions and, in some cases, do online auctions of homes nationwide.Of course, some investors might be inclined to sit out a while longer so that they can get an even better deal in the event the market worsens. But real estate experts warn against this. At this point, it’s any man’s guess. â€If one waits just for prices to bottom out, it doesn’t guarantee that interest rates will be low with good terms,†says West, the Los Angeles broker. “But if the buyer purchases now and just rides the cycle, even if the property lowers in value at some point, it’s not a realized loss unless the buyer sells it while the market is down.â€
Homeownership Contest 2008
Though the housing market is hitting a rough patch, to say the least, the road to greater wealth still starts at home. In every issue of BLACK ENTERPRISE, the Black Wealth Initiative section highlights our Declaration of Financial Empowerment, which begins with Principle No. 1: I will use home ownership as a foundation for building wealth. It’s a critical starting point because home equity (the value of the home minus the mortgage debt) constitutes the largest share of household net worth–some 32.3%, according to a 2000 census report.
Given the real estate headlines, it might be tempting to remain on the sidelines and put off home ownership for another day–but don’t count yourself out. You too can find your way to solid ground and a home of your own. Enter the 2008 BLACK ENTERPRISE Home ownership Contest and win a cash award toward the purchase of your first home. Last year, Elena Borneman won $10,000 toward her mortgage on a $140,000, three-bedroom home.
Contest entry forms will be accepted from July 14 to Aug. 29, 2008. Entrants must be planning to purchase a home by the end of this year and qualify for a mortgage. Applicants are also required to write a brief essay discussing their journey to home ownership. To enter, go to blackenterprise.com/homecontest.
States with the Most Foreclosure Filings, May 2008
1. Nevada, 118
2. California, 183
3. Arizona, 201
4. Florida, 228
5. Michigan, 353
6. Georgia, 378
7. Colorado, 388
8. Massachusetts, 406
9. Ohio, 410
10. New Jersey, 467
Source: RealtyTrac
# = Ranking No. below ranking signifies1 foreclosure for every X homes.
This story originally appeared in the July 2008 issue of Black Enterprise magazine.