Everybody's an Investor Now
With Home Prices Rising, Investors Play a Risky Game of Anticipation

By Daniela Deane
Washington Post Staff Writer
Saturday, May 21, 2005

It feels as if Playboy's Playmate of the Month for May is speaking for the entire country.

Fort Lauderdale native Jamie Westenhiser, 23, told the magazine recently that she is ditching her modeling career to take up real estate investing.

In the magazine's May issue, Westenhiser poses in her lacy lavender baby doll, wearing nothing else except furry boots, leaning on a computer desk next to a stack of books with titles including "All About Escrow" and "Real Estate Principles." In her "playmate data sheet," she writes that her ambition in life is to have a "successful career in real estate."

Westenhiser and everyone else, it seems.

At the same time that the number of investors has skyrocketed, the costs of carrying an investment property have also spiked, especially in places where prices are climbing rapidly, as they are in the Washington area. That's making real estate investing more difficult -- and riskier -- than it has been in years. And the sheer number of investors has added to the concern about whether these price increases are sustainable.

"If you're an investor, unless you're smart, and you're lucky, you could get caught and burned," said Mark Zandi, chief economist at economic consulting firm Economy.com. "Some juiced-up markets -- and Washington is one of them -- are increasingly dominated by investors looking to make a quick profit."

A recent study by the National Association of Realtors showed that almost 25 percent of homes bought in 2004 in the United States were bought as investments. That's up a whopping 14.4 percent, compared with 2003. David Lereah, chief economist for the association, said the organization was surprised by how big the investors' share of the market had become.

"People are looking at real estate like it's another 401(k)" retirement plan, said Al Mansell, president of the association.

It's not hard to see why real estate investment is so alluring. From the beginning of 2000 to the end of 2004, home prices nationally rose 50 percent, according to the Office of Federal Housing Enterprise Oversight. During that period, the Standard & Poors 500-stock index, a broad measure of the stock market, fell 17 percent.

In the Washington area during that time, the increase in home prices has been even more dazzling -- 89 percent. And all anecdotal reports indicate that climb has continued so far this year, although the government hasn't released figures.

There is a problem, though: Because home prices have risen so dramatically here, the costs of owning an investment property, compared with the income it brings in, are getting out of whack.

Investors count on rent and price appreciation to make a long-term profit. Rents are traditionally used to offset the monthly costs associated with carrying an investment property, typically mortgage loans, property taxes, condo and homeowners fees, and maintenance. Tax breaks such as depreciation also make real estate attractive.

Some of these expenses, such as property taxes, have also risen significantly in this region as home values have increased. But while home prices and property taxes have soared, rents have largely stagnated over the past few years, although recently they've begun rising again. In some parts of the region, a rental glut has developed with many new rental units coming onto the market at the same time.

Many owners of larger apartment buildings aren't that worried about the future, though. They believe that rents are on an upward trend, and that demand will stay strong here, largely because of continued job growth and in-migration to the area. If interest rates start rising, which most economists predict they will, fewer renters will choose to become homeowners, thus strengthening the rental market.

At the moment, though, small investors here are finding it's hard to make the investment equation work on a month-to-month basis.

"The properties that are on the market now are so expensive that unless you put down a large down payment, you've got negative cash flow," said Robert Gratz, a lawyer and owner of several investment properties. "That's why I haven't bought anything recently. It costs money to own it and that's not a risk I'm willing to take."

To be able to afford to invest, some people are teaming up with family, friends and colleagues, according to agents who work with investors. They're also looking further out to less expensive areas or at smaller, cheaper properties.

David Fairweather, a local real estate investor and developer, said that even though "it's harder and harder for the smaller investor to find property where the numbers work," real estate investment remains the "best investment around for the person of average means."

He said prospective investors need to make sure, however, that they have the "financial wherewithal" to carry their investment. He said holding real estate for the long term, rather than "flipping" property for short-term gain, is the way to generate true wealth through real estate investing. However, he said, "an awful lot of people want to flip."

Banks have noticed the increase in investment buying and some have stepped up efforts to bring in investor borrowers, which takes the risk to a new level.

"Some banks have just recently come up with interest-only loans and new adjustable-rate programs for investors to help them manage the increases in home prices," said Steve Calem, a mortgage broker in Bethesda. "They're giving better interest rates on investment properties than they used to. I can even do 100 percent financing on an investment property now, something that was just not possible not that long ago."

Economist Zandi said investors in hot markets such as Washington are "increasingly taking on more leverage and more exotic mortgages in order to purchase homes."

It's precisely that kind of borrowing that has some people worried.

"For me, that's way out there on the risky limb," said John Silvia, chief economist at Wachovia Corp., one of the nation's largest lenders. "Interest rates are moving up and the economy is slowing down. We don't have the same conditions as two years ago or even a year ago. Investing is much riskier than it was even just six months ago."

Zandi said: "Big major lenders don't see this as a positive development. Those who are in this industry for the long run don't want to see the market implode."

Federal banking regulators publicly warned this week that many lending institutions were loading up on high-risk loans. Government officials told lenders to be careful about home-equity loans and lines of credit because rising interest rates may make it harder for people to repay those loans.

Realtors group economist Lereah said tapping equity built up in primary residences is one of the most popular ways for middle-income Americans to finance investment purchases.

Mortgage broker Calem said if an investor has good credit, banks will do "no-document" loans, where a borrower's ability to repay the loan is judged solely by his credit history rather than on income and assets.

Price appreciation is a big part of real estate investing. "Let's say you're taking a loss of $300 a month on your cash flow, but appreciation is 15 percent on a $400,000 investment. You're making $60,000 a year in appreciation, but you're losing $3,600 a year on cash flow. Which is better?" asked investor Fairweather, who said he controls or manages hundreds of investment properties.

At some point, price appreciation is likely to level off. Historically, real estate tends to appreciate just a bit over the rate of inflation, providing property owners with a steady, but not spectacular, return on investment.

The rapid run-up in prices of recent years has led some to wonder whether a "bubble" has formed. And numerous economists point out that the number of investors is contributing to the climb in prices -- and some say that a big increase in investors could be in itself a sign of potential instability.

If prices fall, investors are considered more likely to sell their properties than owner-occupants. And a lot of properties could come onto the market at the same time, the reasoning goes.

"Everybody can't sell all together," economist Silvia said. "Somebody has to be buying. There's absolutely a chance that a whole bunch of people will try to sell at the same time. The game can change very, very quickly."

But is it true that investors always try to bail quickly if prices flatten?

Some local investors say they would sell if the market turned; others insist they plan to hold onto their investments.

"I'd want to sell while it's still a seller's market," said Kitty Bernard, an agent with Coldwell Banker Residential Properties in Reston who has teamed up with several colleagues to invest. "I wouldn't want to wait until it reverted completely to a buyer's market."

Tom Papadopoulos, a commercial real estate broker who also owns several residential investment properties, takes the opposite view.

"I'm a keeper," he said. "Why would I want to sell? As long as I have a tenant, I don't have any reason to sell. Real estate is about buying and holding. The way you make real money in real estate is to keep your properties for the long run."

Even though it has become a lot more expensive to invest-- and often involves negative cash flow each month -- there are still plenty of Washingtonians out there buying, according to agents, builders and loan officers.

Sarah Petusky, 28, and her husband, Matt, 33, who are the parents of a baby, are two recent buyers. They bought a $200,000 three-bedroom townhouse in Columbia late last year. For the down payment, they drew on a home equity line on their house in Olney. They rent out the townhouse, but are taking a loss of "a couple hundred dollars a month," Sarah Petusky said.

"We think the situation will turn around with values increasing," she said. "Our townhouse has already gone up about $30,000 in value."

Petusky said she and her husband would like to buy more investment properties, although they might have to look farther out than Columbia to afford the properties.

"We do my husband's 401(k) and we have IRAs," said Petusky, a stay-at-home mom. "Our townhouse is doing a lot better than any of those. We just look at it as another investment. It's probably the best investment we have, though."

© 2005 The Washington Post Company