Come On In, The Water Is Freezing

Roger Schlesinger
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Posted: Apr 14, 2008 8:59 PM

This is the first of a three-part discussion on the real estate market as we know it in these United States. I believe that the market is offering everyone a unique opportunity while pessimism reigns. However bad it looks, for those who understand that money is made in most investments when you “buy right” not “sell right,” the timing couldn't be better. If you are of the belief that the real estate industry will not return to its former growth mode and instead languish with problems for decades to come, this article and the following two are not going to dissuade you, and you might find it better to read something else. Having said all that, let's get on with it.

The title of this piece testifies to the fact that you need some extraordinary courage to do what I find perfectly normal: buy real estate in a down cycle. I will spend the rest of this column showing you why it really doesn't matter when the real estate market turns—this year, next year or in three to four years—because you cannot find yourself in better shape. The vehicle that will put you into that shape is a 15-year loan. Guaranteed!

Those who can only force themselves at the bottom of the cycle find that they either never buy or they change their parameters. Wall Street wizard and presidential advisor Bernard Baruch said, “Only fools and liars buy at the bottom and sell at the top.” The problem with insisting on buying at the bottom is that it will take about six months after the bottom is hit before you know that you’ve seen the low point. Those six months plus the time you’ve spent waiting for the bottom are too precious to lose. So drop the ball and chain that is holding you back from making a spectacular purchase and begin your search in earnest. You have an optimal chance of doing something that doesn’t come along that often: buy a piece of real estate without much risk and with tremendous upside potential.

Let us begin with the three most famous words in real estate: location, location, location!

Simply put, you need to be where the growth will occur, first and foremost. There are superior areas, good areas, fair areas and poor areas to choose from. Forget about the superior areas and the poor areas and concentrate on the remaining two: good and fair. Superior areas are too expensive and poor areas are a time challenge with the possibility of never recovering in a normal lifetime.

Once you have picked the area, you need to find a property that is undervalued because of overbuilding or excessive speculation, not because it has physical problems. Then make your purchase and watch the magic begin. If you buy a house for $375,000 and put $37,500 down, your new 15-year loan will be $337,500. Here is what you need to know:

• The payment will be around $2800 a month (including mortgage insurance for two years).

• In a little over four years, you will have paid off 20% of the balance.

• In nine years, you will have paid off half of the loan.

• And because it is a 15-year loan, that is when the entire loan will be paid off.

You will have paid approximately $425,000 in retiring your $337,500 loan. The difference between the two numbers is primarily interest which is tax deductible.

Now let's look at the house. Suppose you didn't come close to the bottom and it dropped another 10% when you bought it. Then because it is a really tough market, it took two years to begin moving up in value. At the end of two-and-a-half years, your house is worth $337,500, but at that time you only owe $299,000 so you still have some equity. Now for the good part. If your house goes up approximately 2% a year over the next 12.5 years, which is well below historical growth, your house will be worth about $425,000 or equal to the gross amount you paid over the 15 years. This turns out to be a wonderful savings account because your equity is now $425,000 as your loan is paid off. You also had free rent during the entire loan period.

This might be the best way to approach the purchase of real estate in this market. But one way for everyone doesn’t generally work. The next two columns will give you some alternatives that might suit you better and make the idea of purchasing real estate in this market a little more palatable.

Take any other number for appreciation and you will find that the investment moves from good to great and then to spectacular. The magic is your belief in the American dream, your knowledge of how loans work, and your good sense to put them tog