Weigh the Value of Real Estate in Your Investment Strategy

More and more physicians are finding themselves intrigued by real estate these days. Over the past several years as stock market portfolios plummeted, many physicians found themselves actually living in their most profitable investment—their own home. The same conversation with friends and neighbors was repeated in areas across the country—giddy shock and pleasure at news of what the house down the street sold for. Rising home prices and low mortgage interest rates combined to produce a heady mix. It seemed everyone was refinancing, taking out a home equity loan, renovating, considering a move, or otherwise figuring out how best to take advantage of the market.

Money

Money

The June 2004 issue of was dedicated to this real estate phenomenon. Here are just some of the statistics unearthed:

Home prices grew an average 8% nationwide last year, according to Case Shiller Weiss. This year, the firm predicts a 6.4% rise. Geographic areas vary widely. The median price for a Manhattan apartment, for instance, reportedly grew 21% since just last year, while other areas in the United States grew a mere 2% to 5%.

• Interest rates were 8.7% in May 2000; they are currently around 5.9%.

Last year, $223 billion in new loans was taken out by homeowners based on their equity, according to Economy.com.

• Last year, $124 billion was spent in remodeling, according to Harvard's Joint Center for Housing Studies.

But what investment lessons are behind the statistics? Should physicians buy real estate? More importantly, can the market last? Or will those who invest now face losses when the party comes to an end? And what does all this mean for real estate investment trusts (REITs)?

Homeowner's Forecast

A report released on May 26 by the Washington, DC-based Homeownership Alliance took a long-term look at residential real estate. Entitled "America's Home Forecast: The Next Decade for Housing and Mortgage Finance," it predicted the following:

Home price appreciation should average around 5% a year from 2004 to 2013, but could be above 6% if supply constraints continue to tighten.

• Residential mortgage debt is projected to grow close to an 8.25% annualized rate by 2013.

"Home price growth that is in line with income growth is sustainable over the long run, even if home price appreciation outpaces overall inflation," explains Fannie Mae economist David Berson. "With the national unemployment rate below 6%, extremely low mortgage rates and economic growth accelerating, the likelihood of a decline in home prices at the national level is quite remote."

However, the commercial sector is another story. "Altogether, near-future prospects for good operating profits in commercial space markets are rather poor well into 2004," Anthony Downs, CRE, reported last November at the Counselor of Real Estate's Market Watch program, which serves leading real property advisors. Commercial real estate continues to suffer from a sharp drop in demand, Downs says, citing a GVA survey from mid-2003 that showed a 16.2% average vacancy rate for 28 downtown and 24 suburban markets in North America. Downs feels another commercial real estate boom is unlikely before 2006.

J. Michael Moody, MBA, president and cofounder of National Tax & Investment Seminars, the nation's largest sponsor of financial education programs for health care associations, is more optimistic. "Interest rates will probably go up this summer, but they've got a long way to go before real estate becomes unattractive," he comments.

Even if things do turn for the worse, Moody still feels that real estate has earning potential for the type of investing a physician would take on. "All markets are cyclical…in any economy you can find geographically specific opportunity."

Beyond Your Own Home

Money

So should physicians enter the real estate arena? Keep in mind that simply owning your own home gives you a fair stake in the market. As Jason Zweig reports in "There's No Stock like Home" in the June 2004 issue of , "According to the Federal Reserve Board's 2001 Survey of Consumer Finances, Americans have [on average] 27% of their assets in their own home— more than in stocks, mutual funds, and retirement accounts combined."

Effective Real Estate Investing Strategies

But what if you want to invest beyond your own homeownership? As the lecturer and author of , Moody has spoken with many physicians across the nation about this topic. "The response has been overwhelming… investing in real estate certainly has a mystique… people are really unhappy with what's been exposed on Wall Street during the past few years," Moody says.

Still, he cautions that real estate investing is a tricky business that shouldn't be entered into based on a tip in the hall, as it requires lots of homework. "Real estate is not for everyone… there can be an awful lot of risk… spend your time before you spend your money… education is the key," Moody says.

Moody sees several advantages to real estate investment. Besides equity growth and appreciation, they include:

• Tax benefits. Benefits include deductible interest, deductible operating expenses, and the 1031 exchange in which taxes are deferred on the sale of property.

Ill liquidity. Real estate cannot be quickly converted to cash. "The time and patience of real estate forces us to go slowly and methodically…it forces us to be a long-term investor," Moody says.

• Control. Unlike stock ownership, you can have more control in terms of making physical improvements, raising rents, etc. "Control is an immense benefit," Moody says.

However, Moody brings up several disadvantages to real estate, including:

• Ill liquidity. This point, mentioned as an advantage, can also be a disadvantage, because you shouldn't look to real estate for short-term cash flow. Along these lines, "there's no single answer for how long to hold a property," Moody says. But the investment goal should always be kept in mind. "Visualize the end at the beginning," he comments.

Time commitment. The more control you want, the greater the time commitment. Tenant issues, in particular, can be a major disadvantage.

• Government influence. While the government may offer real estate advantages tax-wise, it can create headaches elsewhere. Prepare yourself for building permits, ordinances, environmental laws, zoning, and more.

Still interested? Moody recommends that physicians begin the process by reading books and networking with commercial brokers and other physicians who have invested. Often, a physician's greatest drawback is the time requirement. As a result, many decide to partner, putting up the capital and making strategic decisions, while playing a more passive role in daily details.

Of course, this doesn't mean falling prey to anyone looking to make a buck. "If you're going to partner, find someone who is ethical, competent, and has a track record in investment property," Moody says. Equally important is putting it all on the table from the outset—your expectations, what you hope to achieve, and what sort of risk you are willing to take on. "I think it's real imperative that if physicians are going to invest in real estate, they don't quit their day job. It's a marathon, not a sprint," Moody comments.

Right Type of Real Estate

Interestingly, a physician's best real estate investment may be what they already consider as a second home—their office building. "There's some really attractive benefits," Moody says. "A growing number of physicians are doing this." After all, if you're writing a rent check every month, all those benefits of ownership are going to someone else. According to current tax codes, Moody says it makes the most sense to acquire the building personally, then lease it to the practice. In this way, you own an appreciating asset and are creating a stream of personal income, as well as a tax shelter.

Despite the incredible growth in housing, Moody isn't a fan of owning a vacation home as an investment—unless it's located in a highly desirable area. This is because the sole financial benefit of vacation homes is typically only from appreciation. Also, you can only write off the home as an investment property if you rent it out the great majority of the year—leaving you and your family a highly limited time to enjoy it.

REIT Income Option

Of course, there's another way to invest in real estate that's not so personally risky. A REIT is a company that owns—and in most cases, operates— income-producing real estate. According to the National Association of Real Estate Investment Trusts (NAREIT), Congress created REITs in 1960 as a way to give anyone the ability to invest in large-scale commercial properties. Today, there are approximately 180 publicly traded REITs in the United States with assets totaling $375 billion.

To be considered a REIT, a company must distribute at least 90% of its taxable income to shareholders annually in the form of dividends. Historically, the NAREIT Equity REIT Index has frequently outpaced the S&P 500, Dow, and Nasdaq over the past 30 years. However, after several great years, REITs reportedly plummeted about 15% just this past April. But many still see them as a sound investment because they add diversity to a portfolio, recommending a REIT allocation between 5% and 10%. In fact, IBM will add a REIT fund to its $22 billion 401(k) plan on July 1. "I'm a big believer in REITs," Moody comments. "They ought to play a role in a portfolio." To learn more about REITs, including performance statistics, visit www.na reit.com.

For more information on Effective Real Estate Investing Strategies by J. Michael Moody, visit www.financial-healthcare.com/start.html.