401(k) Letting You Down? Try a Foreclosed Home
David and Michelle Haisley of Fort Wayne, Ind., weren’t happy with the performance of their retirement funds, so they made another investment—a foreclosed home for $27,000. David, a heating and air-conditioning technician, worked on the house before it went into default, then decided to make an offer when he saw it listed at about a third of the price of surrounding homes. The Haisleys found tenants for the house, who pay $900 a month, giving them an annual return of more than 20 percent. They plan to buy another foreclosed home if they can find the right deal. “It’s an income stream for us, and when it’s time we’ll sell it and make more money than we could from our 401(k),” says David. “There’s nowhere for prices to go but up, so it seemed like a pretty safe bet.”
As the housing market recovers, individual investors like the Haisleys are returning to real estate investing. “The typical small-size mom-and-pop investor has two or three properties, looking at it as an income supplement,” says Lawrence Yun, chief economist at the National Association of Realtors.
Investors are becoming more comfortable with real estate after the six-year housing slump, which brought prices down nationwide by 35 percent, according to the S&P/Case-Shiller Home Price Index. Many remain skeptical of stocks, even as the Standard & Poor’s 500-stock index has more than doubled since falling to a 12-year low in March 2009. “I’d rather buy real estate than gamble on the stock market or get almost no return from putting my money in a bank,” says Barton Wallace, a real estate investor and broker in Hingham, Mass., who owns four rental properties. “I don’t have any problem getting tenants.”
Wallace, who turned to real estate four years ago when she couldn’t get a full-time job, says she has clients who tap retirement accounts to buy foreclosed homes. They transfer money into self-directed individual retirement accounts that allow them to make their own investing decisions, with returns going back into the accounts.
Investors bought about 66,780 homes in August, the highest number since the beginning of the foreclosure crisis, according to data compiled by Bloomberg from the National Association of Realtors. About 90 percent of those homes went to people with fewer than 20 properties, Yun estimates. “Most of the demand is from small-scale investors who live in the community,” he says. “It provides a decent rate of return for them because rents are rising and prices are still low.”
The average U.S. rent rose to a record $1,086 a month in the third quarter, a gain of 3.3 percent from a year earlier, according to MPF Research. The vacancy rate fell to a 10-year low of 8.6 percent in the second quarter, according to the U.S. Department of Commerce. There are about 40 million rental units in the U.S., compared with 75 million owner-occupied homes.
A $125,000 home will yield about 8 percent a year if a tenant pays $1,200 a month in rent and monthly carrying expenses are $400. That formula doesn’t account for the time a landlord may spend responding to disgruntled tenants and repairing burst water pipes, broken furnaces, or leaky roofs, says Paul Diggle, a real estate economist for London-based Capital Economics. “Small-scale investors may actually run at a loss on rental housing if their sweat equity is accounted for,” he says.
Yovaldi Venter, a first-time real estate investor, says she plans to buy a foreclosed property using money from her retirement funds. Her target: a duplex on the south side of Jersey City priced at $60,000, a fifth of what it went for in 2008 when it last sold. It would provide “a stream of income for now, with the possibility of selling it when prices come back,” she says. Gary Hippensteel, who is getting yields of about 10 percent on six rental properties in Indianapolis, says he didn’t want to keep his money in a bank because it earns so little. “People want the safety of having a tangible asset,” Hippensteel says. “While it’s still subject to volatility in the overall economy, you at least have an asset that people will need.”