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.
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.
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 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 1990’s, 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.