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Is Real Estate a Good Investment Now?

By - 2009

After watching prices fall for years, people are asking, "Is real estate a good investment now?" Of course, like most classes of investments there are opportunities even in the worst of times. Even as the stock market crashes some stocks go up in price, after all, and even while some people lost money buying houses in the last few years, some made money. The better question, then, is "Which real estate investments are best right now?

Perhaps the worst kind of real estate investing is the purely speculative bets on rising prices. This is what we saw all over Tucson Arizona up until we moved from there in June of 2006. Homes had been appreciating at 20% annually for several years. many people began to buy them even if after rent was collected they lost $500 or $600 per month. After all, you might not mind paying out $7,000 in negative cash flow on a $200,000 house if you get to sell it for $240,000 a year later.

As we left town the bubble was about to burst. The fact that 11% of all houses sold were to speculative investors should have been a clue that much of the demand that drove prices higher was artificial. This kind of "buy and hope prices go up fast" investing is dangerous in the best of times.

Making Real Estate a Good Investment

On the other hand, if you were to buy a fixer upper at the top of the market, you could have made money even as prices fell. For example, suppose you bought a house that would be worth $200,000 when prepared, and because it was trashed you only paid $130,000. If all of your repair costs, holding costs and other expenses came to just $35,000 , you might have been looking at a $35,000 profit. Now, if prices fell by 10% and you could only get $180,000 for the home, you would still make $15,000.

Fixing and flipping a house can be a good real estate investment much of the time, even in a weak market. The key here is to buy right and move fast. Time cost money not only because of the interest, utilities and other expenses you're paying, but also because of falling prices.

Another way to make real estate a good investment now is to invest in properties that produce positive cash flow. If you are making money with it every month it doesn't necessarily matter whether the sales value of a house goes up or down. Let's look at a simple example to show how important cash flow is. Suppose you buy a home for $100,000 with a $10,000 down payment, and you net (on average) $150 per month for 30 years while renters pay off your mortgage. You'll have made $54,000. What if you bought in the one place where values dropped for thirty years and the house is worth only $60,000 now? You can pocket that too, and have made a total of $114,000 ($54,000 + $60,000) from your $10,000 investment.

What's more, rents probably went up. Though there are some places where property values have dropped for decades, I have not heard of a place where rents didn't rise in 20 or 30 years. Perhaps you are making $300 cash flow towards the end of the thirty years, and then when the loan is paid you are making an additional $600. Making $900 per month, or almost 11,000 annually on an original investment of $10,000 isn't all that bad, even if the home is worth 40% less. Cash flow makes real estate a good investment even during the worst price declines.

One more thing to keep in mind, since we all would rather have cash flow and appreciation: Not all areas are the same. We bought a small home in Colorado after leaving Tucson. We closed in June of 2006, which was close to the top of the market. A month ago, in June of 2009, we sold the house for 11% more than we paid. That only meant breaking even after all the costs of the sale, but it does show that the real estate market is not the same in all places nor with all types of properties. In many areas (including here) prices fell at the high end while staying the same or even rising on the lower-priced homes.

So is real estate a good investment now? It is if you make the right kind of investments and in the right places.

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