The pros and cons of real estate development opportunities

Why international real estate continues to be a cornerstone of a solid investment strategy.

By Chris Marlin


Real estate has long been a cornerstone of all well-diversified investing strategies. What other investment comes with that most comforting of words - home?

In an age of a global economy and money virtually transferred around the earth in seconds, international real estate is as important for investors as foreign equities, bonds and commodities. Residential property can be a home, permanent or part-time. It can be rented for income for a time, then become the owner's home. It can be rented and then sold. The possibilities are endless.

You start with the same questions as for any other investment – what is your financial capacity to invest? What are your investment goals? How much can you tie up in a long-term investment? How can you maintain the investment? Trading opportunities, regulations and restrictions vary considerably from country to country.

Often, real estate investment starts with a home. For most Americans, it is their only real estate. Many buy a second home for vacations or residence in another city for business. As owners grow old, the home is an asset that can help pay for their care and comfort. It is the primary inheritance passed down to the next generation. So it’s a good thing U.S. homes hold their value well.

Other broad categories of real estate investment are commercial and industrial.  These are more complex and therefore more risky propositions than most residential real estate. They often involve corporate governance, high finance, extensive regulatory requirements and other challenges. You should proceed cautiously with any real estate dealings. Commercial and industrial require considerable knowledge and guidance.

You can invest in real estate without buying property. Real estate investment funds, offered by money managers and other financial services providers, allow investment without putting great sums at risk.  As with stock market mutual funds, regularly buying shares over time can become a substantial asset. Investors can buy corporate bonds that finance specific projects of large developers and stock in publicly traded development companies.


INVESTING IN RESIDENTIAL PROPERTY
Residential property fills one of the most basic humans needs and it can reflect our dearest aspirations and project our successes for the world to see. The most common American residences are single-family homes set on their own pieces of land, usually as parts of larger subdivisions or master-planned communities. Most are owned by their residents, but many places have a strong market for rental homes. Multi-family housing includes apartment complexes ranging from two stories to great towers into the sky. Townhomes are individual dwellings connecting to other units on either side, but none above or below. Apartments and many townhomes are rental units.

Many apartment-style buildings and townhomes can be condominiums, where condominium associations manage the large structure, shared amenities and other common elements, which owners have an interest in and a right to use. Condo advantages include: a nicer home or better address than otherwise might be affordable, shared security arrangements, freedom from yard work and exterior maintenance, and often homes at city center. Condos are particularly attractive to people who spend a lot of time traveling or have raised their families and want to escape yard and house maintenance or want resort-style living with swimming pools, fitness centers, tennis courts and other recreational activities.

There are trade-offs. Condo development is highly cyclical, so buying condo units strictly for investment can be risky. Condo owners are on the hook for monthly association fees for all amenities, whether they use them or not. They don’t have control of their home’s exterior appearance. They are subject to sometimes picky rules set by the condo association. When big unexpected costs arise, they are subject to special assessments in addition to condo fees. Buyers with children at home need to remember that some condos are better for kids than others.

REAL ESTATE ATTRACTING FOREIGN INVESTORS
U.S. real estate has attracted foreign buyers for decades. The historic stability of the American political system and reliable economic growth are the main attractions. By the roaring 20s, movies, radio, phonographs, newspapers and magazines were showing the whole world many exciting, romantic notions of American playgrounds for the rich and glamorous. Both the pleasure-seeking international rich and immigrants who saw opportunities for jobs and economic progress came.

Cell phones, transportation improvements, the end of the Cold War and computers and the Internet spread the news and opportunities farther and faster. China has quickly emerged as America’s leading peer and the two countries’ interchange and shared prosperity might define the world order for as long projected time.

It is important for prospective buyers to know they are not at the mercy of developers and real estate agents. When dealing for properties from afar, it is essential to check out, as thoroughly as possible, not only real estate agents, but also developers and homebuilders. Most states have regulatory agencies for construction with websites you can check to see if there have been complaints. You can go to county websites and find the county clerk or circuit clerk’s offices that have records of lawsuits that have been filed against developers. You can do newspaper searches or simply online searches listing the companies’ names.


"...BE AWARE OF ISSUES THAT WILL AFFECT THE PROPERTY'S VALUE OVER TIME - SUCH AS LOCATION, SCHOOLS, AND LIKELIHOOD OF FLOODING."


SINGLE-FAMILY RESIDENTIAL OPPORTUNITIES
Americans love single-family homes. Though most Americans have lived in cities and suburbs since the 1920s, a fundamental part of what has been referred to historically as the American Dream is owning your own home. For most people, this is a vision of a home and yard on a small patch of land.  The U.S. constitution declared, over 200 years ago, that Americans have the right to life, liberty and property. The country has been zealous about the protection of property rights ever since.

Local governments and developers began dividing tracts of land into standard-size blocks and splitting the blocks into small standard-size, numbered lots in the 19th century. National subdivision standards appeared in the 1920s. After World War II, prosperity, new materials,  construction techniques and design innovations brought booming subdivision and suburban development. It is still going strong.

Homebuilders add almost 540,000 new homes a year. Nearly 10 times that number of existing houses get new owners. About 65 percent of American households own their homes. Americans and their government prize home ownership so highly that the U.S. is among the few nations where homeowners may deduct from taxes interest paid on mortgages, reducing the interest outlays by about a third. There have been large government programs to help veterans, low-income families, minorities and other groups buy homes.

When buying a home, you need to be aware of issues that will affect the property’s value over time – such as location, schools, and likelihood of flooding. However, the overriding question is: How much can I afford to spend on housing? Financial advisers say it’s good to stretch a bit – determining what current expenses you can realistically cut to invest more for the future.

Buying more house than you can pay for can be a very bad investment. Would you be budgeted so tightly that loss of a month’s or six weeks’ pay could put you in crisis? Do you know how much insurance, taxes and utilities will require? Have you considered costs of lawn and routine home maintenance? Will the new location raise commuting costs? Will you have money for emergencies?


THE MARKET OF NEW HOMES
New homes get most attention because of their impact on the economy. New housing is one of the nation’s major economic indicators. They bring great demand for construction materials, multitudes of skilled workers and appliance and furniture sales. New housing developments bring new schools, churches, shopping centers, automotive-related businesses, dry cleaners, plumbers, medical practices, handymen and all other enterprises of modern urban and suburban life. 

In 2016, 536,000 new U.S. single-family houses were sold, up 12 percent from 2015, according to the National Association of Realtors. The median price – the point at which exactly half sold for more and half sold for less – was $322,500.

Their greatest advantage? Everything is new. They are built to current building codes. They incorporate contemporary ideas of comfort and style. In the electronic age, that includes more power – more wiring and outlets. Kitchens are better-designed, better equipped, and, often, larger. Bathrooms have more of higher-quality amenities. For four decades, there has been a steady emphasis on improving energy efficiency, and for the last two, on ecological sustainability.

The advantages of new are not limited to modern comforts. Maintenance costs are low. Well-established, reputable national and regional developers guarantee this with dependable warranties on structures and equipment. For many homeowners, newness and the calendar are investment tools. They buy a home, do the basic upkeep and enjoy it. When enough time passes for its value to increase, but not so much that they’ve had to pay for major replacements, they sell and buy another house. Lifespans of roofs, heating and cooling systems and major appliances provide guidance as to when to make such moves.


"MOST NEW HOMES ARE IN SUBDIVISIONS, ONE HOUSE AFTER ANOTHER, NOT PLANNED COMMUNITIES..."


A home that cost $75,000 in 1980 would have sold for $230,000 in 2016, according to the Case-Shiller Index, a Standard & Poor’s measure. And the U.S. Bureau of Labor’s separate Consumer Price Index showed that $75,000 in 1980 dollars had the spending power of $236,000 in 2016.  When you consider that in addition to the appreciation in value, owners got good housing or received rent income for 36 years – that’s quite an investment. Those who financed the houses with mortgages got back about a third of their interest payments by way of tax deductions.

National homebuilders and many big regional developers enhance the eventual pay-off of new houses on the front end, using the power of big scale and big capital. They keep watch on U.S. metropolitan areas to identify high potential for the long and intermediate growth. They buy large, impressive tracts in such areas before they are hot properties. Seldom do they spend large sums piecing together high-priced parcels into acreage for a development. 

They negotiate large bulk deals on everything from gravel to roof tiles to dishwashers and lower infrastructure costs per residence with savings on materials and completing projects with minimal interruption. When construction on homes and community amenities starts, one crew starts on a structure, finishes up and moves to the next, while another crew comes after them to do its work, and so on. When undertaking specialty projects, they are amenable to economy of scale.  In economic downturns, they can keep work going to meet our commitments. Time passes and trees and shrubs grow, owners put their stamp on their property and planned communities mature into distinctive neighborhoods with their own character.

These companies understand the other side of the coin and don’t stray far from the successful business models they develop. Some large developers focus on master-planned communities – making sure the different elements work together as a pleasant and dependable whole. For example, instead of residential streets that simply have stop signs and empty into city streets and highways, they can plan street systems to handle traffic flow and promote safety for motorists and pedestrians. Developers can aside beautiful spaces for community enjoyment and route streets to accentuate the beauty of terrain. Landscaping can be unified for public areas.

Most new homes are in subdivisions, one house after another, not planned communities, tying directly into city streets or county roads and other public infrastructure. Some developers focus on relatively small tracts in specialized projects that maintain the character of long-established communities. This is expensive and higher-risk development and it usually takes strong, old local ties to make it work. When they succeed it strengthens the core of cities and improves the market for all of us.

Sometimes, long-desired tracts become available only after a city’s growth has reached or surrounded it and developers buy it for upscale homes with prices high enough to cover the land costs.  Some developers work at the other end of the spectrum, on less desirable land, with smaller houses on smaller lots and fewer amenities. These are important, creating opportunities for young and moderate-income people to buy homes that will help direct their financial and social future.


THE MARKET OF EXISTING HOUSES
Last year, 5.49 million U.S. homeowners sold their houses. The median existing house price (50 percent of houses sold for more and 50 percent for less) was $232,000. This includes homes ranging from a small, two-bedroom, $15,000 house in rural Idaho to a $50 million mansion in Malibu, California. Sellers are generally doing well. Using national statistics from Zillow, an online real estate market, The Economist echoed the other studies for the past 36 years. Home prices rose gradually from 1980-2000. Over those two decades, houses appreciated enough to offset the high inflation of the early 1980s. Prices picked up from 2000-04.  

In 2005 and 2006, prices took a steep turn upward and remained high through most of 2008.  In fact, the 2005-08 figures describe a textbook speculative bubble, the first in many decades. It was followed by a bursting of the bubble that lasted about the same length of time. In 2012, prices started climbing again and have continued at a strong pace, but gradually enough to minimize chances of another major bubble. Houses bought at peak rates before the financial crisis have largely recovered their dollar value, but have not yet appreciated enough to cover the inflation of the past eight to 10 years.

Benefits of buying existing houses include: established neighborhoods, schools and community amenities in place, and buying a house without paying current prices for everything. If the roof is good for another 15 years, the heating and cooling system for another five or six years, and so forth, you can spread replacement costs out rather than pay for everything new now. In addition, some buyers don’t want or need some of the high-tech wiring and gadgetry and prefer to install what they want.

INVESTING IN MULTI-FAMILY RESIDENCES
Multi-family properties can be excellent investments. A basic approach is the duplex, where the owner lives in one side and rents the other. It’s the same concept as reducing housing costs by getting roommates, but more formal. It requires sorting through such details as how much of the mortgage interest qualifies for the income tax deduction, how much is a business expense, and how much upkeep cost can be counted as a business expense. Again, realism about finances is key. You’ve got to be prepared to make repairs in the renter’s unit promptly. An accountant, a plumber and an electrician can be your best friends. Some investors start out with one duplex and do well enough to buy other nearby properties.

With large apartment buildings and complexes, finance and relations with City Hall are much more complicated and capital intensive. As a rule, leave it to the professionals. We are seeing more mixed-use and mixed-income developments, particularly in and near urban cores. They help cities deal with affordable housing problems by including units that sell or rent at less than market rates. Commercial developments make life easier for residents. They can be tailored to help cities deal with issues specific to them and will become increasingly important.

Many categories of real estate creates an abundance of investment opportunities.  Finding the right kind of real estate for you will likely take time, diligence and careful planning.  And American real estate appreciates in different ways than the amazing appreciation seen in Tier One Chinese cities over the last couple of decades.  So, you have to moderate your expectations.  But the security of investing in residential real estate in the United States continues to make the U.S. the most attractive market in the world for global real estate investors, year after year.


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About the Author
Chris Marlin
Chris Marlin
Asset Manager

Chris Marlin is founder and president of Lennar International, a division of one of America’s largest homebuilders, Lennar Corporation. He focuses on foreing direct investment via home sales, as well as matching foreign capital with Lennar’s varied real estate interests. He is a frequently requested international speaker, and is a member of the Association of Foreign Investors in Real Estate, the U.S. Global Leadership Coalition, and the Brookings Institution’s Metropolitan Leadership Council.

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