Looking at Real Estate for the Long Run

• ByTim Melvin, RealMoney.com Contributor
• On 10:00 am EDT, Thursday October 1, 2009

Investing in real estate could make you rich over the next decade. The problem is that in the short run it could make you broke if you enter the market too soon. I think real estate prices have more downside in the short run, and it could be substantial.

I have talked a lot about the problems I see in this market. Option ARM resets, tax credit expiration and the huge shadow inventory all spell lower prices to me. I know prices have come down over the past two years, and I hear all the talk about housing affordability. I just do not think any of this matters right now.

Let me share a story a friend of mine told me yesterday to illustrate why it is too soon. He has a house for sale in one of the nicer sections of Brooklyn. The house has been on the market for 18 months. In that time, they have had several offers, all of which fell through for lack of financing. The get traffic, but offers are drying up. People are looking, but they are afraid to buy. They want to buy the distressed and foreclosed properties at ridiculous prices. A sale by a homeowner who just wants to sell a property is rare right now.

I know we saw an uptick in sales over the summer, but I wonder what happens now that the tax credit is out of play. Unless you are a cash buyer, you would need to have the house under contract by now in order to close before the credit expires. All this has accomplished is slowing the bleeding.

There is a percentage of Americans who have acted responsibly and saved their cash over the years and used their credit carefully. Those folks have been spurred by tax incentives to go ahead and buy. Much like Cash for Clunkers did in the auto industry, the tax credit pulled forward sales that were probably going to happen in the next year anyway.

The problems in the commercial market are also pretty well known. There is some thought that changes in the tax law may stop commercial from becoming a huge problem, but with the amount of debt that needs to be refinanced in the commercial market, it is probably not enough. Transaction volumes and prices are falling while vacancy rates are rising. Prices probably have further to go before a bottom is in sight.

Go for Quality

A lot of money is sloshing into Wall Street, looking to take advantage of distressed real estate. I think that is exactly the wrong approach to be taking for individual investors. When we get the next leg down in real estate, it is going to be time to buy, in my opinion. I cannot predict the exact timing, but I can say I am pretty sure we will see it, and I want to be ready to take advantage when it does. The time to prepare is before the battle.

At that time, why on earth should I compete with the Wilbur Rosses and Sam Zells of the world looking at the distressed stuff? The falling tide sinks all boats in a bad market. I plan to focus my real estate endeavors in the quality companies with assets of high quality that fall along with the market.

I also want to focus on land rich companies. After all, as Will Rogers observed, "They ain't making any more of it." Companies that I have talked about before, like Alico, St. Joe and Tejon Ranch are going to be compelling values if they continue to fall in prices. All of them own substantial tracts of land that could be developed or sold in the future.

I also want to look at the high-quality commercial property owners. I have talked in the past about W.P. Carey. I really want to own this stock at lower prices. The company owns and manages about $10 billion of real estate. It is a well-run conservative company that will do very well in a real estate recovery. It pays a generous dividend that been raised 34 quarters in a row.

Another high-quality company that catches my eye is Brookfield Properties. The company owns 108 properties encompassing over 75 million square feet of space including the World Financial Center in New York. The portfolio is in very good shape, considering the current economic backdrop. It has a 95% occupancy rate with an average tenant rating of A. The average lease still has seven years to go, and the average rollover rate for the next three years is just 4%. After the recent equity offering, Brookfield has over $1 billion of cash on the books.

Why am I writing about real estate when I believe the prices is going lower in both commercial and residential markets? The answer is that I am well aware that real estate is one of the best wealth-building investments in history. If I am right about market direction over the next few quarters, there will be a historic opportunity to make money. When I see a market or asset that has already dropped substantially and looks like it has a leg down left, it is time to start doing the homework.

Buzz up!