Smart Buying
Gems in the Rough
You can still make money. Just don't rely on market momentum.
By Jeffrey R. Kosnett, Senior Editor
From Kiplinger's Personal Finance magazine, November 2005
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With high gas prices, economic uncertainty after killer hurricanes and signs that the dizzying increases in home prices may be slowing, it's understandable if you're nervous about the real estate market. The Jeremiahs say that jumping in now is the equivalent of buying Internet stocks in early 2000.
We say, not so fast. Real estate is, after all, a local market, rich in exceptions to national and even regional trends. If you salvage an ugly duckling, adapt a building for a new use, or chance upon a neighborhood that hasn't been discovered yet, you can still make money on your investment. But you'll need to add value to the property, rather than rely on market momentum to boost the price. Or, as Atlanta financial adviser Robert Hockett puts it, "You make your money on the buy, not the sale."
Buying smart is vital. When interest rates rise, the resale value of speculative property, such as high-end condominiums in overheated markets, could plummet. You're better off with small professional buildings, apartments for middle-income rentals or retail space with established tenants.
In a slowing market, you also have to invest for the long term, not a quick flip. Ideally, your rental income should keep you ahead of your mortgage, taxes and expenses. You might be comfortable with a cash deficit that's small and temporary, but red flags should wave if you can't rent your space for enough money to put you ahead after a year or two. If that's the case, pass it up to seek out a gem in the rough.
Sweat equity
Shaker Heights, Ohio, is a choice suburb of Cleveland, where families stay put, homes for sale are usually snapped up quickly and property values grow steadily. So when Dominic Tropiano scanned a list of foreclosed properties scheduled for auction, he zeroed in on a four-bedroom house in Shaker Heights for $120,000 -- far below the $300,000 to $400,000 that the homes there typically fetch.
Before he put in a bid, Tropiano, a 26-year-old financial analyst and stockbroker, did some homework. He asked the bank about the house's background and learned that the property had been vacant for a year and a half. The bank was more interested in getting its money out than making a killing. Next, Tropiano recruited a partner with skills he lacked. Through a friend, Tropiano met John Tominc, 22, a carpenter and handyman. Over lunch one day the two decided they could work together as equals, with Tropiano arranging the financing and Tominc providing the muscle and construction know-how. Each contributed half the up-front money.
In October 2004, Tropiano won the auction with a bid of $132,000, which he covered with a 100% mortgage. When the pair got the title, they also received a few things they hadn't bargained for, such as a bill for $10,000 in unpaid taxes. Worse, when Tropiano and Tominc finally saw the interior of the house, "it looked like a war zone," Tropiano says. "Pipes were frozen. There were holes in the walls, and the fireplaces were blocked." The pair had 90 days in which to correct 120 building-code violations.
Their $50,000 credit line for construction allowed them to hire crews to work on wiring, plumbing, heating and air conditioning. But Tropiano and Tominc used their own evenings and weekends to tear down walls and clear debris, filling 13 Dumpsters. They paid an architect several thousand dollars to make their plans comply with Shaker Heights' design rules. As the work progressed, the young developers were able to increase their credit line.
By the time the house finally took shape, with new floors and windows, a larger kitchen and a big master bedroom that wasn't part of the original 1920 floor plan, the pair had invested a total of about $200,000. They plan to put the house on the market for about $320,000, a reasonable price for the neighborhood. Considering their time and labor, Tropiano and Tominc might not earn as big a profit as they had once hoped. But neighbors are thrilled to be rid of an eyesore, and the partners are ready for another project. "What we've done and what I've learned are indescribable," says Tropiano. "We wanted to do everything right."