Real Estate Is Tempting, But Be Careful Out There

Published Sunday, February 7, 2010 at: 7:00 AM EST

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With real estate prices stabilizing or improving in many parts of the country, you may be thinking about jumping in to this market as an investor, perhaps in the interest of diversification and asset allocation. After all, the mantra is “buy low, sell high,” right? However, there’s another old saying that also applies: “Look before you leap.”

First and foremost, you need to determine if you should be buying real estate at all given the various management, liability, cash flow, and other issues associated with it. A simpler and often lower risk alternative could be to purchase shares in real estate investment trusts (REITs), which usually invest in commercial real estate rather than houses but which are more liquid and easier to manage within your overall portfolio. You could also buy stock in construction firms, housing suppliers, or other companies likely to benefit as real estate rebounds.

If you can tolerate the risks and responsibilities of buying a property and can do so while maintaining sufficient diversification in other assets, be sure to consider the following factors.

All real estate is local. Prices may (or may not) have hit rock bottom in terms of the national average, but that doesn’t mean the carnage has ended in your neck of the woods. While home prices stabilized in most areas of the country during the second half of 2009, overbuilt areas and those facing the highest unemployment levels continued to see declines, most notoriously in Las Vegas and Detroit.

To determine whether your target market has a good chance of seeing prices recover, take into account the current number of foreclosures on the market, how sharply prices rose during the good times, and economic factors such as local employment. Regions with relatively stable job markets and that didn’t experience the most extreme booms may recover value more quickly.

What’s the foreclosure rate? To determine the level of foreclosure turmoil in your target community, you need up-to-date information, and the only way to obtain that is to contact local organizations that have the pulse of the community. These groups include the Association of Realtors, Mortgage Bankers Association, city or county housing departments, and state agencies that deal with housing, banking, or economic development.

Ask for figures that let you compare the current level of foreclosure with past figures. The bigger the difference between past and present, the more influence higher foreclosure rates are likely to exert over home prices in coming months and years.

Buying a foreclosed home. Banks will sometimes sell foreclosed homes at a significant discount in order to clear them off the books. But buying distressed property carries extra risks. These steps can help you limit the danger.

  • Make sure the house you’re considering is located in a neighborhood with good schools, low crime, and a steady job market. Homes in troubled neighborhoods may not recover value quickly, or at all.
  • Do a title search to find any liens on the property or back taxes that may be owed.
  • Get the house inspected. Foreclosed homes are notorious for sustaining damage from previous occupants and for a general lack of maintenance.
  • Favor homes that a bank has placed on the market after paying off taxes and other debt and making repairs. Buying at auction can be riskier, because you’re likely to know little about the home.
  • Look at recent home purchases in the neighborhood to make sure you aren’t overpaying. While foreclosures often offer bargains, home prices have plummeted so rapidly that sometimes even distressed properties turn out to be overpriced.
  • Get preapproved for a mortgage, because lenders are especially nervous about making loans on distressed properties.
  • Consider other factors, such as an area’s demographic trends, the likelihood that local or state taxes may go up, whether the area is prone to flooding or other natural disasters, and insurance costs.

While it may be tempting to plunge into today’s housing market as an investor, it’s a rough-and-tumble arena, and buyers are subject to a wide variety of sometimes hidden risks. We can help guide you through the process, working to minimize risks and maximize results.

There are special risks associated with REIT investments including but not limited to: * The value of the units or shares of the trust will fluctuate with the portfolio of the underlying real estate properties. * Redemption will be at a price which may be more or less than the original price paid for the units. * There can be no assurance that the issuer will maintain a secondary market for REITs. Therefore, there is the risk that a REIT investment may be illiquid. * Special risks of investing in real estate including market risk, company risk, real estate investing risk, real estate securities risk, interest rate risk, small-cap risk, credit risk, income volatility risk, prepayment risk, extension risk, and foreign investment risk.

This article was written by a professional financial journalist for Advisor Products and is not intended as legal or investment advice.

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