Armed with advice from investment seminars and how-to-do-it books, many people who once only dreamed of investing in real estate are seeking income-producing properties. They are busy acquiring houses to rent, small apartment buildings and such commercial properties as warehouses.
"We're getting more buyers with $150,000 or $200,000 to invest, usually groups of three to five relatives or friends who have pooled their assets," says Larry Young, executive vice president of the Forrest D. Olson real estate investment unit of Coldwell, Banker & Co., a diversified Los Angeles real estate concern.
Real estate appeals to investors because properties often appreciate faster than the inflation rate. Buildings can be depreciated for tax purposes, and the deduction can be used to shelter income from the property or from other sources.
Most important, real estate acquisitions can be financed largely with borrowed cash. Through such "leveraging," the buyers have the opportunity to increase greatly the return on their investment.
Real estate has its risks. With currently high interest rates and prices, it isn't uncommon for the cost of mortgage financing and other expenses to exceed the initial rent that can be gotten from a property, says John T. Reed, editor of a real estate investment letter. The buyer may have to "carry" the property through the early years until market conditions permit increases in rent, he says.
Many buyers are willing to do so because they are betting that inflation will continue to push up real estate values. To provide a margin of safety against possible market downturns, however, investors should try to buy properties that have a positive cash flow Reed says. Quite simply, the income should exceed the expense.
For the many first-time investors who put their money into residences for rent, Reed says that duplexes, or houses divided into living quarters for two families, often are better buys than single-family homes "because the relation between price and income is more sensible." Where a duplex might be priced at eight times its rental income, he says, a single-family house might have a multiple of as much as 15.
Whatever the risks, investors haven't been deterred from plunging into income-producing properties. Here is how some have fared:
In 1978, Marcia Johnson-Reid, who directs a neighborhood development program for a Chicago bank, and her husband Bruce, an architect, bought four "two flats." Each contains two two-bedroom apartments. They paid $11,000 apiece for them with financing from a local savings and loan association.
The couple contracted for electrical and plumbing repairs in the turn-of-the-century structures. They put in wood cabinets themselves, sanded the floors and painted. They also managed the properties. "The winter before last, we were over there every other day with a blowtorch to keep the pipes from freezing," Marcia Johnson-Reid says.
Tenants of the Johnson-Reids, who pay $100 to $175 in monthly rent, include a computer programmer, an architect, a plumber and two welfare families. The couple is selling one of the flats for $26,000, or a 13,000 profit after repair expenses. "Prices in that neighborhood have begun to accelerate of late," Johnson-Reid says.
Another investment by the Johnson-Reids didn't work out as well. In February 1979, they and three partners acquired a 13-unit apartment building for $75,000. A professional property manager was told to make repairs and to clean up; the cost for that was to be recovered through rent increases.
"We thought we could just sit back and collect money," Johnson-Reid says. But the building had undesirable tenants and high turnover. "We went there one day to find out why and discovered the manager hadn't done as he was told," Johnson-Reid says. "He thought, mistakenly, that we didn't want to spend any money on upkeep. There was a failure of communication. So we fired him."
Meanwhile, two partners pulled out, and early this year the others sold the property for $82,000. The gain on the purchase price was more than offset by repair costs. "We all should have gone in with a detailed plan for rehabilitating the building and better cost estimates. And we should have managed it ourselves, at least initially, until we got to know the building and the tenants."
In southern California, John Litsch, owner of a machine shop, has been buying land in an industrial park and putting up small buildings for the last several years. Six of the buildings are leased to manufacturers. But Litsch says he hasn't been able to raise rents fast enough to keep up with rising costs of land and building materials. "Rents should be 40 cents to 50 cents a foot," he said, rather than the 22 cents to 25 cents he is getting.
Nonetheless, he said the annual return on his investments is more than 20 percent because of sharp appreciation on his property.
In Croton-on-Hudson, N.Y., Peter Franzoso, a hairdresser, and his brothers recently sold an 83-unit apartment building they had owned since the early 1960s. "We weren't making any money," Franzoso said. "Our maintenance costs went up faster than our rents. But a lot of the tenants are on Social Security and couldn't afford higher rents. We felt sorry for them."