Why the Real Estate Boom Will Not Bust: How to Build Wealth in Today's Expanding Real Estate Market by David Lereah

• Read an Excerpt

Read an Excerpt

PREFACE

Some of today’s hot residential real estate markets are beginning to cool down a bit. As predicted in my first edition, for the nation as a whole, the boom is winding down to a healthy real estate expansion. There will continue to be great opportunities to build wealth in real estate for the remainder of this decade. Some in the media and elsewhere claim there is a housing bubble, and that it will eventually burst, similar to the stock market bubble debacle in 2000. As I demonstrate throughout this book, their reasoning is flawed, a point I have driven home time and again on major business television networks like CNBC and CNN in recent years. Nonetheless, each year the naysayers come back sounding further alarms. Fortunately, given the reaction from the marketplace, few are paying attention.

I am not suggesting that real estate prices will post double-digit growth as they have in so many of our nation’s local housing markets the past several years. That is not a healthy market situation in the long run. Demand for homes needs to come more into balance with the supply of homes. The frenzied local real estate markets with 20 to 30 percent price appreciation over a couple of years’ time, and with multiple bids on a house that result in a sale price significantly higher than the price for which the house is listed, is neither sustainable nor desirable. One should not equate the word “boom” with this kind of frenzied market environment. Simply stated, a real estate boom is a healthy real estate expansion. And for a variety of compelling reasons I outline in this book, this healthy expansion has endured for about thir­teen years andpromises to continue for the remainder of this decade. Do not think that a slowing in price appreciation (from double digits) signals the demise of the real estate expansion. The fact is that residen­tial home sales could even have a down year without indicating an end to the expansion. You can’t post a record-setting performance year in and year out. From 10,000 feet in the air, a one-year dip is just a blip in the long-term expansion path. Stick with real estate investing for the remainder of this decade and into the next, and you will experience substantial and satisfying wealth gains.

The contents of this book are based on my twenty-plus years as a real estate/banking economist. You’ll find simple and easy-to-use information on how to successfully purchase, invest in, and maintain real estate. For those of you who want to actively monitor local real estate markets across the nation, I urge you to visit my new Web site: www.intelligentrealestate.com. This site will assist real estate investors in identifying value in local real estate markets while building substan­tial wealth in the process.

Perhaps the most important message of this book is that real estate doesn’t even need a boom to roar. Even when property sales and price appreciation settle back to more normal levels of activity, property returns still offer benefits that more traditional investment vehicles such as stocks and bonds cannot. I’m talking about the leveraging power of your real estate investments as well as the tax and other gov­ernment benefits bestowed upon property. Such benefits give real estate a “competitive edge” over stocks and bonds and other invest­ment rivals as long-term investments, even in a slower real estate mar­ket. In a boom, such benefits are even more powerful.


In my view, there has never been a better time to make real estate a bigger part of your long-term financial future.


Chapter One
The Opportunity of a Generation

The recent U.S. real estate boom has made money for an incredible number of households in America. In fact,in 2001 and2002, many economists (including me) claimed that real estate was the only sector propping up the economy and keeping it from a full blown free fall. Even as stock prices tumbled and businesses faltered, the real estate market continued to soar, with home prices rising steadily in most areas of the country. For most home owners, their house is far and away their biggest investment. This great rise in real estate values meant that home owners saw their household wealth increase substantially. Moreover, the savviest real estate investors have discovered how to profit from the boom in ways other than just owning their own home–through home improvements or renovations, buying rental properties, vacation houses, Real Estate Investment Trusts (REITs), and more. The performance of real estate as a financial asset has been astounding.

What you may not know is that opportunities still abound in U.S. real estate markets. And those opportunities will continue to exist throughout this decade and into the next. What we are seeing today is a phenomenon that takes place only once every other generation: a long-term expansion of the real estate market. And that is why you need to take advantage of this once-every-other-generation opportunity now.

Those of you who are home owners are already participating in the real estate boom to an extent. During the first four years of this decade (2000—2004), home owners and investors in residential real estate collectively enjoyed a $4.6 trillion increase in the value of their properties! That means, on average, each home owner experienced a $42,700 gain on their home in just a four-year period. And, of course, some home owners saw an even greater increase–as much as 70 to150 percent of the value of their house. In some high-priced areas such as Anaheim, California, households earned more than $200,000 over this period. That is a lot of wealth.

But not everyone benefited from this rise in value. Too many households do not own any real estate property. And of those who do, most do not realize the many ways they can leverage their investment and increase their stake in the real estate boom. Most home owners view their home as a place to live and have an emotional attachment (justifiably) to their homes. It is often difficult for these individuals and families to make sound, objective financial decisions about their homes.To them, home is a security blanket, a safe haven from an outside world plagued with crime and terrorism. From a financial perspective, they view their home as a large, tangible, appreciating asset, one that most expect to eventually sell and use the proceeds to purchase another home or to add to their retirement nest egg.

But there is so much more you can do to profit from real estate during a boom period. It does, however, require changing old habits. Home owners need to learn to separate their emotions from economics. What do I mean by that? Most home owners make home improvements that satisfy them emotionally but do not increase the value of their house (i.e., the pink carpet in a daughter’s bedroom, or the wet bar in the basement). Modernizing a kitchen or installing central and energy-efficient air-conditioning, on the other hand, can be effective investments that yield a substantial increase in the long-term value of your home.

In most cases, real estate is the largest financial purchase a household ever makes. It needs to be treated as an investment similar to stocks and bonds. Property ownership should be integrated into the goals and property ownership need to be thought of as a primary component of a household’s investment and retirement portfolios. Real estate can improve your ability to take care of your financial health. Think of real estate as a dynamic asset, generating monthly and/or annual returns. Home owners need to factor in these returns as they review the performance of their investment and retirement portfolios.

I will argue that over the next decade, some funds currently earmarked for stock and bond investments should instead be earmarked for real estate: home renovations/additions, second homes, rental properties, real estate investment trusts (or REITs), and real estate mutual funds. In the current boom, the benefits of real estate investing vis-à-vis stocks, bonds, and other income-generating assets should be obvious. First, the stock market (as of this writing) experienced a 10 percent negative return as measured by the S&P 500 Index over the past four years. Because real estate investments are usually far more leveraged than stock/bond investments (you pay a down payment, usually a small percentage of the full price),they generate much higher returns on average per dollar invested. Real estate also creates wealth more quickly through the combination of amortization schedules, tax deductions, rental income, and price appreciation, as I will show in the chapters that follow.

Why do I believe that the real estate boom will continue into thenext decade? While many real estate watchers like to attribute the boom to low mortgage ra t e s,that is only part of the story.And even ifmortgage rates notch up a percentage point or two,they will still remain historically low.What are the other factors at work? First,t e c h-nological advances such as automated underwriting and Internet-driven home listings have reduced home ownership costs and simplifiedthe process with which houses are bought and sold.Most important,a continued high level of demand for homes by baby boomers,their chil-d r e n ,and new immigrants buying their first homes helps to ensure that the boom will continue into the next decade.There is no real estate“price bubble.”The long-term fundamentals for housing remain excellent into the foreseeable future.

I believe that in years to come historians will see the beginning of the twenty-first century as the “golden age” of real estate. And I want to persuade you to take advantage of this historic opportunity. In the first part of this book, I will paint a clear picture of today’s real estate boom and explain why the boom will continue well into the next decade. In the second part of the book, I will show how you can profit from real estate with or without a boom. I spell out the financial benefits of owning real estate and offer specific strategies for investing available funds into real estate opportunities. In the final part of the book, I present the tools, information, and analysis you need to become a savvy real estate investor, and show how you can integrate your real estate investments into your overall investment strategies and financial planning goals and objectives.

Chapter 2
Why The Real Estate Boom Has Wings

I believe the real estate boom or expansion will continue into the next decade, generating trillions of dollars of additional household wealth. Usually in the forecasting business, the best we can hope for is to be fortunately right or intelligently wrong. Most of us are usually intelligently wrong. No one can predict the future with any regularity and accuracy. But I have a great deal of data and market observations to support my case. The Japanese have a proverb: “He who can see three days ahead will be rich for 3,000 years.” That is why I feel compelled to tell the story of a sleeping industry that awoke in the early 1990s and has been spreading its wealth ever since. It is the story of the Great Real Estate Boom of the twenty-first century.

A Boom Was Born

In the early 1990s,the real estate markets were just recovering from the housing contraction of 1990—91.Home sales were sluggish. Homeprice appreciation was relatively weak. Mortgage rates were hovering above 10 percent–double-digit territory. Mortgage origination volume (i.e., the dollar amount of mortgage loans) averaged a relatively modest $500 to $600 billion per year.

People purchased homes to live in–pursuing the American dream of home ownership. Homes were viewed as large assets that were not easily transferable but provided shelter, security, and a roof over one’s head. Purchasing a home leads to pride of ownership, which in turn generates social benefits such as reducing crime and improving the quality of life in communities across America.

Real estate was rarely mentioned in the same sentence as investments such as stocks and bonds. Earning a competitive return and building meaningful wealth was just an afterthought for most house-holds purchasing real estate. Only the wealthy–the real estate moguls–made serious money in the real estate markets. But even they had incurred large losses in the early 1990s,as a consequence of the 1986 Tax Reform Act,which literally crippled the commercial rea lestate marketplace and sent commercial real estate values plummeting.

But something happened in late 1991 that changed the face of the real estate markets forever. Mortgage rates began to drop. Some households called their lenders to “refinance” their mortgage loans to the lower rates. The idea was to take advantage of the lower interest rates and lower their monthly mortgage payments. If you were paying 10 percent interest on a $100,000, 30-year mortgage loan, your monthly payment was about $877 per month. If you could refinance the mortgage loan at 8 percent, the monthly payment would drop to $733 per month, saving you $144 per month or $1,728 per year. Lenders were very receptive to the increased refinancing volume, since they earned fee income for providing the “refi” opportunity in a low-interest-rat eenvironment. By early 1992,the real estate markets were experiencing a major refinancing boom.

Falling interest rates also made homes more affordable, increasing home buying across the nation. Existing home sales grew a robust 10percent in 1992 and 9 percent in 1993. Mortgage origination volume, consisting of both refinancing mortgage loans and purchasing mortgage loans (taking out a mortgage to purchase real estate), totaled $800 billion in 1992 and reached the astounding $1 trillion origination mark in 1993.

But the events behind 1992 and 1993 were not solely the result of people refinancing and purchasing homes in record numbers. The other part of the story was that the mortgage lending companies, settlement providers (e.g., title insurance companies), and real estate agents were able to process the record refinancing and home purchase volume without significant delays and bottlenecks. Somehow the real estate markets had evolved under the radar screen to service double and triple the volume of just one to two years prior. Moreover, the costs of purchasing and/or refinancing a home dropped precipitously, permitting the housing markets to expand in unprecedented proportions.

As they say, the rest is history. Some ten years later (2003),the real estate market found itself in uncharted, record-breaking territory. Mortgage originations, which began at a modest $560 billion in 1991, totaled almost $4 trillion in 2003! Similarly, existing home sales grew from a modest 3.1 million homes sold in 1991 to over 6 million homes sold in 2003, a 100 percent increase in the number of existing homes sold in the nation in just over a decade’s time. Our nation’s largest sector of the economy doubled in size in just over a decade. Imagine the manufacturing sector doubling in size, or the automobile industry producing 32 million vehicles rather than the 16 million vehicles it produces today. It was an astounding accomplishment. How did this real estate boom happen? How did it get started? There were six major developments influencing the real estate markets during the past decade that jump-started the boom:

1.Mortgage rates dropped to generational lows.
2.Housing finance innovations lowered home ownership costs.
3.Home listings were centralized on the Internet.
4.Minority home ownership became a government priority.
5.Demographic influences (e.g., the maturing of the baby boom generation) strengthened housing demand.
6.Real estate became a safe haven for household wealth.