Housing investments require close eye on costs

When the economy slowed business for homebuilder Kevin Clingan – owner of Kevin Clingan Home and Design – he devised away to find the silver lining in a bad housing market.

During the summer, he bought a single-family house in central Springfield to fix up and rent. With real estate prices down and time on his hands, he felt the time was ripe.

“I had a bit more free time on my hands than in past years. I liked the thought of having some income later in life without having to go out and hit it 7 to 6 like I do now,” Clingan said.

With that house rented, he’s now in the midst of renovating on a second central-Springfield property and envisions ultimately owning about 10 by the time he hits retirement age.

“I don’t plan to own a hundred of them or anything like that. I just want a few for some income. Right now, the way the market is, it’s good if you’re willing to do (the work) yourself,” said Clingan, who is 50.

Ripe with opportunity
Clingan’s hunch that Springfield is a good place to get into the rental business was supported in September’s issue of Forbes magazine, which named the Springfield metro area ninth best nationwide for housing investments. The ranking was based on research conducted by Local Market Monitor, a real estate research firm based in Cary, N.C.

The company analyzed data, including second-quarter 2010 home price changes, for metropolitan statistical areas with populations of at least 400,000. The company also considered population growth 2000–05 and three-year home price forecasts to make its top picks for the best housing markets for investors.

According to Local Market Monitor’s research, housing prices in the Springfield MSA dropped 3 percent, the home price forecast was 1 percent and population grew 8 percent 2000–05. The Forbes article defined the investing “sweet spot” as a market where population was increasing pre-recession, strong job growth is expected in the next three years and home prices are at or near bottom. Raleigh-Cary, N.C., led the list with a second-quarter home price change of -3 percent, a three-year home price forecast of 0 percent and 2000–05 population growth of 18 percent.

Bob McCroskey, owner of Bob McCroskey Real Estate and several residential income properties, said that while there likely hasn’t been a stampede for investment houses since the report came out, he agreed that low market values and low interest rates make now a good time to buy. The overnight average on a 30-year fixed rate mortgage was 4.3 percent as of Oct. 5, according to Bankrate.com.

“Rightfully so, (potential investors are) probably studying more on their decision because before, supposedly if you bought it, there were no problems. It was going to inflate immediately and you were going to be way ahead,” McCroskey said. “Well, that isn’t reality.”

Return on investment
McCroskey recommends potential investors do their homework and be realistic about the expenses involved.

“You need to have a professional show you that house and show you what the houses that compare have gone for recently in the neighborhood. Some houses that are foreclosed or in distress may go for less,” McCroskey said. “It’s not like they’re all alike.”

“You look at a few homes then pick one out and you make sure it’s a good house. You know what the problems are in it, and you can buy it and fix it up,” McCroskey said.

Clingan is keeping an eye out for such properties for future investments.

“A lot of these homes that were worth $50,000 and $60,000 were foreclosed on and you can buy them in the 20s or teens even. Eventually they’ll be worth back in the 40s or 50s … so now is not the time to flip a house,” Clingan said, referring to the practice of buying a house, fixing it up and selling it at a profit. But even those so-called bargains can be money pits, said Kirk Heyle, owner of Heyle Realtors and Counseling Services, LLC, and the owner of about 100 residential income properties.

The problem comes when a homeowner finds out he or she is about to be foreclosed on and either neglects the property or blatantly damages it. Keeping a tight lid on the cost of fixing up a property is critical to making money off of it, regardless of whether it will be rented or sold, Heyle said.

The best investment properties are those that need some work, but not extensive – or expensive – kitchen or bathroom repairs.

“It’s just cosmetic,” Heyle said.

Clingan said renovation costs are in the forefront of his mind when he’s looking at a property.
“If they can’t pay back in a very few short years, I’m not buying them, plain and simple,” Clingan said.

“The payback is the first thing: How much do I need to do it? Being a builder, it helps me estimate how much I think I need to do these,” he added. “You have to be careful. You could put $20,000 or $30,000 in this house before you know it.”

Clingan keeps costs down by searching for bargains on materials and doing the labor himself. He works to make the properties attractive to quality renters.

Market demand can affect rental income potential, in that if there are more renters than properties, prices can go up, but if there’s a glut of properties and few renters, it will drive down rental rates. Industrywide, however, McCroskey said capitalization rates – determined by dividing income by expenses – are used to determine rental amounts. Landlords now are realizing between 9 percent and 10 percent on their investment properties, he said.

McCroskey said keeping costs down is important for potential landlords to remember.

“When you rent a house, it gets dinged, it gets lived in. I usually try to make my rentals as spiffy as possible for a little amount of money — you paint them and whatever,” McCroskey said. “But people come in and say, ‘This is a lot nicer than a lot of rentals I’ve seen.’”

If a person is intent on a flipping a home, however, the ante is upped considerably.

“The secret is, the kitchen and the bathroom is something you can trick out and make more money on,” McCroskey said. “If you’re going to sell it, you want it to be just like it was featured in the magazines: gorgeous and people fall in love with it and want to live there. You kind of want that for a rental property, but they just want to live there, not live there forever, necessarily.”

Potential investors also need to be aware of expenses that might not immediately come to mind, Heyle said, citing property taxes, rental upkeep and the expense of checking out potential renters.

Contacting employers, running applicants through Missouri Case.net to check for legal entanglements and running a credit check all take time, Heyle said, but he noted that the investment is worth it. Going through these steps can help minimize the risk a tenant will tear a place up or run off without paying rent.

“It is a lot of work, and if you make a mistake, you get stung and they can just trash you,” Heyle said.

Despite the risks, Clingan is forging ahead with his plan to add eight more properties to his holdings.

“It seems like a better risk than some of the other things that are out there. When you get to be 50 … you look at taking less big risks,” Clingan said.[[In-content Ad]]