NEW YORK -- Anyone under 40 was raised with the "knowledge" that property values always go up. Half a decade of localized housing depressions -- in the Farm Belt, the Rust Belt and the Oil Patch -- have not dislodged that fixed idea. Not, at least, from the minds of those whom the depressions haven't touched.
Just a few months ago, a major consumer magazine pictured two grinning investors standing in front of their rental duplex. The caption read, "No one ever loses money in real estate." Last month, in another magazine, I read about a couple who had just bought a rental house as an investment for their children's college education. The monthly rent didn't cover their expenses, but they expect to sell in eight years at a large enough profit to pay the tuition.
Beam me up, Scotty, I'm on the wrong planet.
Small rental properties may break their owners' hearts in the slow-growth markets of the 1990s. That's because so many buyers still overpay for real estate, even in post-depression markets such as those of Houston and Dallas.
A prudent landlord charges enough rent to cover all of his out-of-pocket costs, plus at least 5 percent to 10 percent. You need that cushion to build a reserve for unexpected repairs, or to carry the mortgage during any month when the property isn't rented.
But many landlords with small properties rent them at a loss. They cover their costs with other income and gamble that they'll earn it all back when the property is sold. An investor who insists that rents cover his costs usually will be outbid by a speculator who will pay the costs out of his own pocket.
The income-tax laws still make it appealing to bid high. As long as you have some management role in the property, you can use up to $25,000 of your real estate investment losses to shelter other income if your adjusted gross income is $100,000 or less. Partial deductions apply up to income levels of $150,000.
But it may no longer pay to take losses each year on a bet that you'll sell at a jackpot price. Even if the value of your property rises, it may not rise enough to recover all your costs and pay a return commensurate with the risk.
Condominiums, in particular, are often poor investments, says author and real estate professional Andrew McLean. Builders are constantly putting up new units -- typically more than the traffic will bear.
How do you make money in real estate today? By seeking out niche investments where you see value that others don't, says John Reed, publisher of Real Estate Investor's
Monthly in Danville, Calif. Among the niches that you might exploit:
* Buy one-bedroom houses. They sell cheap but rent dear, because tenants love them. You can charge enough rent to cover expenses.
* Buy a house or duplex that is going to be torn down. Try to pay $1,000 or less. Hire a professional to move it to another lot. With the best of these deals, you can sell for twice the money you put into the property.
* Buy a house whose problem traumatizes the seller -- such as asbestos or a bad foundation. The problem may not cost as much to fix as the seller believes. If you buy at a low enough cost, you can make the repairs and still guarantee yourself a good profit.
* Find a person who's renting a house with an option to buy at a low price but can't afford to follow through. Buy the option, take the house and resell it at the full market price.
If all of this sounds like work, it is. But that's what it takes to make money in real estate today.
1990 Washington Post Writers Group