The New Investing Game
It is going to take more work to make money in real estate
What could be more fun than playing blackjack in Las Vegas? After a weekend gambling trip there three years ago, Ken Wu and Alan Koder figured they knew: investing in Vegas real estate.
So they started an investment club, borrowed money against their homes in San Diego, and plunked the proceeds down on two condos for about $120,000 each. Then they bought a townhouse in New Mexico, and Wu and a third partner purchased another house in Arizona.
At first, they thought they'd hit the jackpot, with prices in Vegas appreciating 50 percent in less than a year. But reality soon set in after one tenant stopped paying the rent, another caused $5,000 in damage before skipping out, and a third broke her lease after the air conditioner failed. Suffering negative cash flow and fearful that the resale market was beginning to soften, Koder pushed to sell the Vegas properties, while Wu argued they should sit tight.
Their predicament is hardly unusual. Egged on by double-digit annual appreciation and a bevy of gurus touting the latest make-millions-with-no-money-down schemes, a rush of hopeful real-estate tycoons bid up prices on properties from Vegas to Miami, where speculators accounted for as much as 70 percent of condo sales last year. But as many of those same people now rush for the exits, "the days of flipping properties for a fast buck are over," says real-estate analyst John Tuccillo.
That, of course, doesn't mean real estate has suddenly become a bad investment. Indeed, Tuccillo and others say the downturn in once hot areas means there are already deals to be had. "Fear and greed caused people to overestimate the value of their property on the way up," he says. "But that will also make them undervalue it on the way down."
Picky. Meanwhile, as is typical of housing downturns, investors able to hang on may find an upside: rising rents that could eventually turn negative cash flows positive. Current tight supplies of rentals in places like Los Angeles and Washington, D.C., aren't just driving up rents; "they also let you be more picky about who you rent to," notes syndicated real-estate columnist Robert Bruss.
Those who really want a high-quality tenant--and the chance to sell down the road--can also look for a renter interested in a lease-with-option-to-buy arrangement, in which renters who want to buy can lock in a price in exchange for an additional monthly payment or deposit. "They'll treat it like they own it," says Bruss. "And if they end up buying it from you after two years, you'll save yourself the hassle of putting it on the market and paying a sales commission."
That's not to say investors should plan on turning over a property so quickly. If your time horizon is much less than that, "you're not an investor; you're a speculator," says Bruss, who notes that typical real-estate cycles run seven years or longer. "And you'll get what you deserve."
For those willing to buy and hold, he says the surest way to make money in real estate in the current market is to find a fixer-upper that needs minor improvements. "Don't just buy a house and hope it goes up in value," says Bruss. "Buy one, and force it to go up in value."
Such a hands-on approach might have helped Wu and Koder, who were left holding the bag after one of the property managers they hired to look after their rentals failed to find new tenants quickly. "We were pretty naive about what it takes to be a landlord," Koder admits, "especially in Vegas," where renters tend to be more transient than they are in other cities.
That, however, hasn't soured the duo on real estate. While they decided in the end to sell the Las Vegas units--luckily, at a profit--they're holding on to their properties in Arizona and New Mexico, where they recently lowered the rent to ensure they got the best pick of tenants. "We're still cash-flow positive, but our stress has gone way down because we don't have to worry about it," Koder says of their new tenants.
Meanwhile, Wu and he are keeping an eye out to invest closer to home. "I watch the market on a daily basis," says Wu, who recently got his broker's license in San Diego. "The slowdown hasn't created any opportunities yet. But when it does, we'll be ready."
This story appears in the August 7, 2006 print edition of U.S. News & World Report.