- The Washington Times - Friday, December 11, 2009

Economic reports coming out over the last couple of weeks continue to be mixed. Some suggest that the economy is in the recovery mode. Others suggest we have a way to go. Mortgage rates fell before edging back up, but they remain at unprecedented low levels.

In the past few weeks, I have shared some sad stories in this column about folks who bought property at the peak of the market and are now sitting on real estate worth less than the mortgage balance.

Despite this, I have said that real estate has proven to be a good investment over time, but those who invest in real estate in hope of “flipping” the property for a quick profit are subjecting themselves to considerable risk. Amateur real estate investors who bought property with little or no money down during the peak are, indeed, in big trouble today. Here’s a sample of a classic conversation I would have during the first half of this decade.

Investor: I found a property in the District that I would like to buy as an investment. The purchase price is $400,000. Property values are going up by 20 percent a year. I’m going to rent the property for 12 months and then sell it for a big profit.

Me: OK, how much money do you want put down as a down payment?

Investor: I don’t want to put any money down. That’s stupid since I’m only going to hold the property for a year.

Me: Well, what if the market turns and you can’t sell it for what you expect?

Investor: Are you kidding? The market’s on fire. Help me arrange an 80 percent investor loan. I’ll take out an equity line on my primary residence for the down payment.

Me: An 80-percent investor loan will run about 6 percent, and the monthly payment, including taxes and insurance, will be about $2,200. The payment on your equity line will be another $400, making the carrying cost of the rental property $2,600 per month. How much do you think you can rent the property for?

Investor: Only about $2,000.

Me: This means you will have a negative cash flow to the tune of $600 a month.

Investor: I don’t care. I’ll be selling the property for $500,000 next year.

Me: Are you sure? Real estate can have cyclical downturns, just like stocks. Are you prepared to carry the property for longer than a year in case this happens?

Investor: I’m not worried about it. Are you going to help me with the loan or not?

You get the picture. These folks took big risks and lost.

Today, I would speculate that real estate is probably a pretty good investment if you are prepared to hold it for several years. Values have fallen below their lofty levels and interest rates are the lowest in 50 years.

However, mortgage financing is a lot tighter than it used to be. This is a good thing because it will protect amateur investors from themselves.

It will be interesting to see how the economy and real estate market evolve in 2010.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail at henrysavage@pmcmortgage.com.

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