The Death of Real Estate Is Greatly Exaggerated, Again

“The darkest hour is that before the dawn.” – Euripides

Like it or not, we are entering a time when a growing number of properties will be unloaded at bargain-basement prices and a handful of investors will make a fortune.

Let me explain…

The last time real estate died was in the late ’80s. The Tax Reform Act of 1986 took away tax shelters that had been key drivers of investment. Accelerated depreciation was gone, capital gains tax rates became (usually higher) income tax rates, and passive income losses (such as from rental income) could no longer be used without limit to offset active income (such as wages from your job).

Suddenly, many investors stopped buying, others dumped properties at bargain prices, foreclosures rose, and a bear market in real estate began that, in some categories and markets, would last almost the next 10 years.

The late ’80s and early ’90s were particularly tough on office space and apartments. Overbuilding took place in many markets in the first half of the ’80s thanks to the 1981 Tax Act, a big incentive for builders. So the 1986 Act – taking away many incentives – was a major flip flop.

As a result, some landlords offered “concessions” of 25 percent or more of the nominal lease … just so they could show lenders they were getting the rents needed for comfortable debt coverage. In reality, they were getting far less, and foreclosures rose in the commercial sector too. In the words of Sam Zell (CEO of some of the largest real estate investment trusts in the country), the goal for real estate companies was to “survive to ’95.”

In residential real estate, there was no nationwide bear market, but markets flat-lined in much of the country. In some markets, aggravating factors led to prolonged slumps.

The plunge of oil prices in the second half of the ’80s led to a 21 percent drop in Houston residential real estate in three years. In New York City, housing prices fell after the stock market crash of 1987. They wouldn’t surpass their pre-crash levels for good until 1998. In Los Angeles, big employment cuts in the aerospace and defense industries in Southern California led to a 21 percent decline between 1989 and 1997. Adjusted for inflation, the fall was about 40 percent

There are lessons to be learned from this period – both of caution and of opportunity.

On the cautionary side, never listen to anyone who says real estate always goes up. Markets can fall, and bubble markets can fall hard. So always buy cash flow, always buy value, and always buy with a large margin of safety – so that your expected income could fall 20 percent or more and you wouldn’t be forced to sell.

Never forget that real estate is local. Even while markets like LA, NYC, and Houston were hurting, other markets continued to post steady appreciation. That especially applies to today, where many formerly hot markets are deflating and many value markets are experiencing strong demand and steady price appreciation.

Finally, whenever bubble markets do implode, there is plenty of opportunity for value investors.

Remember the Resolution Trust Corporation (RTC)? The government agency was formed to dispose of nearly a half-trillion dollars of distressed assets in the wake of the failure of many Savings & Loans. Much of what was sold were the distressed loans themselves, but it also included over 300,000 pieces of real estate. And many investors made fortunes as many properties were sold for 50-60 cents on the dollar or less.

Similar events are unfolding today. A rising number of mortgage loans are in arrears and foreclosures are on the rise across the country. You may end up helping to pay for some of these problem properties even if you don’t buy them. That’s if the government opts for another taxpayer-funded bailout of loose-money lenders as it did in the late ’80s and early ’90s.

So you might as well consider buying some of these properties before they end up on the courthouse steps, save a property owner from foreclosure, and pick up some cash-flow properties at good prices in the process.

I happen to live in one of the worst bubble markets in the country, South Florida. Not only did prices practically go vertical in the first half of this decade, but property taxes have soared as grasping government officials are now assessing at full “market value.” At the same time, insurance has skyrocketed in the wake of a record number of hurricanes in 2005 and 2006.

Yet because I never “chased the market” and insisted instead on buying undervalued, deep-cash-flow properties, my properties are doing fine. More important, in the coming year, I expect to uncover some extraordinary opportunities even in this market.

At the same time, I continue to invest outside my area – in select value markets in the west, southeast, and mid-Atlantic states. In fact, these markets are benefiting from an exodus of investors and homeowners from the bubble markets. And, given a growing number of telecommuter-friendly jobs and a steadily rising pool of baby boomer retirees, this flight from expensive to affordable should be a strong one for decades to come.

When the going gets rough, smart investors know now is precisely the time you’ll find diamonds in the rough.

[Ed Note: Justin Ford has invited some of the most successful real estate investors he knows to join him in Miami May on 18th-20th. They will reveal the strategies they feel will make the most money in 2007 and 2008. For the most part, these are investors who started with little or no money and have gone on to make millions. They include Dave Lindahl on apartments, Ray Alcorn on commercial properties, Marko Rubell on pre-foreclosure marketing, Steve Cook on wholesaling, Thom Phelan on 1031 exchanges and using self-directed IRAs to buy and sell real estate, Alan Cowgill on private money, and more.]