Matt Costello’s Blog

State’s housing news much better than nation

Madison - Wisconsin housing sales decreased but prices increased in 2007, leaving Wisconsin’s real estate market in much better shape than many parts of the Midwest and the nation, according to the year-end analysis of existing home sales conducted by the Wisconsin REALTORS® Association (WRA).Wisconsin home sales declined in 2007 by 10.8 percent relative to 2006, but median prices actually rose 0.2 percent over the period to $164,000, according to the REALTORS®’ report. Sales in the Midwest were also down by a similar margin, falling 10.5 percent over last year, but sales nationally were down nearly 13 percent.

Another victim of the real estate bubble?

Not enough people want to live in downtown Madison?

Development that was underfunded?

Misunderstanding between the developer and his bankers?

YOU DECIDE.

 Below are the local press articles regarding the recent foreclosure filings against the developer of Metropolitan Place Phase II and his lending/funding sources.  Since word of this hit the media yesterday there has been a lot of speculation as to the cause of this foreclosure action.  Time will tell what truly happened.

I do know a few things:

1)  Development of a large residential condo tower is definitely different than developing a group of 4-8 unit buildings on the fringes of a city.  What I mean by this is on the fringe developments, the developer typically pre-sells 50% of the building before the lender will allow construction to start.  This lessens the risk of the market corrections, interest rate jumps etc…  In Metropolitan Place Phase II’s case, they had to build all 164 units at the same time with the hope that market conditions didn’t affect them too much in order to keep the lender happy.

2.  The market did shift.  The number of units available downtown increased tremendously and unfortunately pricing couldn’t be adjusted to meet the change in demand.

3.  A project with the size and scope of Metropolitan Place is enormous.  When completed and occupied the number of dwelling units between Phase I and Phase II is at 338 households.  Think about this in terms of single family subdivisons in the ‘burbs.  That large a subdivision would typically take 5-10 years to build out and complete.   This has created a small village on 1/2 of a city block!

4.  Finally, there’s talk of the courts forcing the project into receivership with a court appointed entity taking control of the project and it’s sales.  What might happen in this case is that prices on the remaining units could drop substantially to get them sold and sold quickly.  For those unit owners who have already bought, this is bad news in the short term.  If they needed to sell during this time frame, they’ll more than likely see a loss as they’ll be competing directly with new lower priced units.  Long term, however, they should be OK as once the remaining units are sold the market can take back over and units should sell at fair market rates.

5.  I don’t think it’s time to panic!   In fact the faster the developer can resolve this issue with its lenders the better off everyone will be.  It’s hard to sell real estate under the stigma of foreclosure especially when it’s a condominium development.  That hurts everyone both current owners and potential buyers.  A fast resolution, whatever that outcome may be, it essentially best in the short and long term.

Camp Randall Stadium Madison,WI - Sculpture by by sculptor Donald Lipski

It looks a bit like an eroding Washington Monument with a core made out of footballs.

The 50-foot obelisk was designed by sculptor Donald Lipski, who is evidently famous enough to convince people this was a good idea. Lipski named his work “Nail’s Tales,” which is a reference to Lipski’s college friend Nail.

Since the sculpture is honoring Alvarez, shouldn’t any obscure references in the title have something to do with Alvarez?

The words “art” and “football” are rarely together in the same sentence. Here’s a great example of why not. Almost universally derided when it was unveiled, this extraordinarily phallic piece was erected (hmmm…) in front of Camp Randall, home of the UW football team. Nobody seems to be too thrilled about it, with a great many people wishing the University had decided to honor Elroy ‘Crazylegs’ Hirsch instead.

When Should You Sell Your Investment Property?

The ultimate purpose of investing in real estate is to make money. I make this statement with no apologies, though it may sound greedy; however, real estate is just like any other investment — whose primary purpose (at least should be) is to build wealth. Thus — there should be a time in the future that the investor plans to sell.

With the Prime Directive of “buy low, sell high” laid aside, most investors grapple with when to sell. There are several sell points real estate investors should have in their business plans. Looking to the future, investors may want to sell after having reached one of the following benchmarks: the property has maximized its profit, you’ve located a better investment opportunity, the tax depreciation limit has been reached, or you’ve realized your wealth-building goals.

Maximized Profit

In most markets, there’s a time when the profit is maximized and your rate of return drops. If an investor fails to monitor the local economy, he may miss the optimum time to sell a house and lose profit. If you’ve tracked the cost of housing across the country, you’ll find that it has rarely dropped from one year to another. However, real estate is sold and held locally, thus the value of real estate may slide up and down more in a local market than when you look at it on a national scale.

I purchased my first investment property as a primary dwelling. Soon after the purchase, it dropped in value over the next several years by nearly 26 percent and lingered there for about six years. It finally recovered and I sold for a very small profit. To add insult to injury, the condos in that area have nearly tripled in value since then and are still growing. Was my selling choice good timing? It depends. Looking at the next benchmark demonstrates how to overcome bad timed choices.

Find Another Great Opportunity

Once I sold the condo, I moved into a property that was worth three times the value as the condo — and in the same time period, has more than doubled in value. Thus, my equity in the new property is much higher than the equity in the condo today — fortunately, my timing worked out. If various properties appreciate at the same rate and you have an opportunity to purchase the more expensive house — your rate of return will be increased by the value of the more expensive home.

Example: A condo at $100,000 appreciates by 15 percent per year for four years, resulting in a gain of $74,900. A single-family dwelling valued at $250,000 with the same appreciation rate, however, ends up with a gain of $187,251. Do I even need to ask which was the better investment?

Maximized Depreciation

Real estate investors are allowed to depreciate their properties for 27.5 years while they have the house as a rental. Depreciation can add losses to your income on paper and thus, reduce your tax burden. Only the improvements (house, sheds, etc.) are depreciable, not the land. The IRS allows depreciation for up to 27.5 years for most investors, according to IRS Publication 946 - How to Depreciate Property. Once you’ve hit the maximum depreciation, some of your tax benefits disappear and it may be time to find another investment property. When you purchase another property, the 27.5-year timeline begins anew.

Cash Out

Finally — the ultimate reason for all of this investing, collecting rents, fixing leaky roofs, and broken hot water heaters, is to create wealth. At some point, you’re going to want to cash out the house so that you can send your kids to college, buy a retirement home with cash, take that round-the-world cruise, or whatever you want or need, to take care of.

As you approach investing, be sure to begin with the end in mind — thus understanding when you need, and should sell to maximize profit.

When Should You Sell Investment Property?

If you believe what it says, late night TV is full of great ways to invest in real estate. Most investors — they seem to suggest — are looking at big paybacks with no money down. That’s unlikely, like going to the store to buy a watermelon and offering to pay for it with a paperclip (a highly-unlikely feat which my daughter successfully managed to do this summer at camp).

It takes forethought and preparation to be successful in real estate. You also need to realize that buying real estate is investing and with investing there is risk: If you don’t know what you’re doing, you can make a costly mistake.

Choosing Your Investment

Beginning investors should start with small projects, just like Walter from Hawaii. He’s been involved in real estate for more than 12 years and invested in various two- to seven-unit properties. Properties — both commercial and residential — in good locations have made money for him. The properties he purchased in marginal locations, with high leverage down payments and extensive tenant turnover have not worked out for him.

Walter started with a duplex, which he later refinanced to buy a four-plex. He painted and put a new roof on the four-plex, then sold it for a seven-plex. He also bought a four-plex with one-bedroom units. He renovated the units and installed new siding, but in the end, he was lucky to receive a return on his investment.

Living in Oregon, he was far away from his investments in Hawaii and could not pay enough attention to the renovations. One moral of the story is that fixer-upper investments — like real estate investments generally — work best if you live nearby and, if possible, do the work yourself.

Other factors hampered the success of his investment, such a market more suited to two-bedroom units rather than one-bedroom units. As to Walter, he learned more with each investment and he also learned to be conservative.

Whether you’re looking to purchase a house, duplex, 50-unit apartment project, or commercial property, you need to carefully review the property’s economics. Are the rents used in your projections realistic? Are the expenses correct? Can you live with the cost of investment mortgage financing? What happens when you have a vacancy? Is there enough cashflow to cover it?

Are you putting money aside in a reserve account? How much money do you have to spend on repairs? Some investors believe that they should never repair a property. Unit inspections in occupied units will uncover problems that can be solved while the tenants are still living there and while there is cash flow, rather than waiting for a vacancy.

The West Coast and the Sun Belt are currently better bets than investing on the East Coast. Larger cities tend to be better investments than small towns because there is a larger potential pool of tenants and buyers. Communities located on freeways also tend to be more attractive as investments because they have good access to metro areas. Vacation destinations or towns that are economically diversified will be more stable as well.

Another client had 13 houses in the 1980’s and lost them all. So he went back to being a painter and started all over again one house at a time. His goal is to have 20 houses for retirement. He adds bedrooms, renovates, upgrades, and paints them, and then he either sells them so he can buy two more or holds them.

Planning an Exit Strategy

Remember that the economy, interest rates, layoffs, job opportunities, and construction trends impact every investor. Watch the trends and speak with local brokers, appraisers, investors, and real estate attorneys.

An investor always needs an exit strategy, preferably more than one, when he or she buys property. You need to have a vision showing when you will sell, if you will take the money and pay taxes or complete an IRS 1031 tax deferred exchange. Is your plan to have enough money for retirement? Are you going to pay off the property or refinance it and use the proceeds to buy another investment?

And what if values decline?

If you live in a depressed marketplace you need to decide if the weak economy will last a long time or if the area will pull out of it. This information is critical to your exit strategy. If you cannot find a buyer when you’re ready to sell, then what? Structure your mortgage without prepayment penalties, or make sure that your loan can be assumed. Check what the loan assumption costs will be and if financing terms will change with an assumption. Remember banks structure loans to benefit their bottom line and financing can be very hard to assume or refinance. It pays to research financing options before you make a final decision, and interest rates should not be your only focus.

You have to think ahead and be prepared for a range of possible events. For example, you invest with your best friend and her husband, but she gets divorced and needs the funds out of the investment to pay off her husband, what would you do? Another variable is your health or your family’s health: Will you may have to liquidate the real estate to pay bills?

Your exit strategy will help you make a better decision as you invest into the future. Plan your goals ahead. No one is forcing you to buy. Pick your time, and pick a property you can live with into eternity. Worst case, if the market does not move the direction you expect and the value does not go up, at least your tenants are paying off the loan.

Welcome to Matthew Costello’s Blog! This blog will provide you with valuable information, tips, and general insight into the real estate market in Madison.