Investors who escaped the Oct. 19 stock market debacle with some money to spare may still be looking for alternatives. Some of them are considering real estate. But while the long-term record of real estate is good, there are more than a few uncertainties in the present environment for investing in property. First, tax reform changed most of the rules for investing in almost any type of real estate, except your primary home.
Second, the market's plunge may presage an altered economic scenario that would not be particularly good for real estate.
Some explanation of all this has come from publishers of investment books. In the last several weeks, several new books have come out that look at the new rules of real estate investing. All were completed before Oct. 19, so they reflect only the changes brought on by tax reform. But their timing couldn't be better, as people are thinking of trying something besides the stock market for a while.
``I certainly am not one that's going to be putting a lot of money into the market,'' Martin M. Shenkman says. ``The people I've talked to aren't doing it, either.'' Mr. Shenkman is the author of one of those books, ``Real Estate After Tax Reform'' (John Wiley & Sons, New York, $19.95). Shenkman is a New York lawyer specializing in real estate, tax planning, and tax shelter law.
Economic conditions that are not yet clear make it hard to see which properties will fare best in the next few years.
``Properties are going to suffer to the same extent as any other industry if the economy slows down,'' says Neal Ochsner, author of ``Common Sense Real Estate'' (Henry Holt & Co., New York, $18.95). ``If a company decides to expand, or if a consumer decides not to make a purchase, it's going to be reflected in the absorption [sales and rentals] of office space or the income of shopping centers.''
``On the other hand, there's going to be a great deal of money shifting out of the stock market looking for alternative investments. Real estate's always been considered a safe, stable investment.''
But now tax reform has taken what rules people did know about real estate and changed them:
Lower tax rates reduce the value of any tax benefits from real estate.
The 5 percent surcharge on the highest incomes affects affluent investors, who are the most likely to invest in real estate.
Longer depreciation schedules mean people won't be able to write off nearly as much of their investment each year.
New passive-loss rules mean that losses from so-called ``passive'' investments - like real estate limited partnerships - can be written off only against passive income, not against ``portfolio'' income (such as from stocks) or ``ordinary'' income (such as from salaries).
It's this last change that has caused most of the consternation among investors, Shenkman says. Now, investors are all looking for cash flow.
``It seemed like everybody was talking after tax reform that the only thing you need to be concerned about was cash flow, and appreciation didn't mean anything,'' he says. ``Appreciation is clearly a critical component of any real estate investment. You shouldn't invest in anything unless you feel it's going to generate some sort of appreciation. And that means the long-term hold.''
If there is any uncertainty in the economy, Shenkman prefers neighborhood or local shopping centers, with a grocery store, a hardware, or a restaurant as its ``anchor.'' Some of these are known as ``strip malls,'' and not all have done well, so location is especially important.
A potentially bad location, Ochsner says, is Manhattan residential property. The stock market's fall may have started a long-term contraction in the financial services industry, which would be reflected in higher vacancies, lower rents, and lower resale prices.
One way to find a good location is to have somebody else do it, but the average investor who rescued a few thousand dollars from the stock market isn't going to be trying a limited partnership. The best thing for these people is probably a real estate investment trust (REIT). These are similar to mutual funds, except they do not continually change their portfolio makeup.
Some REITs primarily provide income; others concentrate on appreciation, with less income; but most try to offer a combination of income and appreciation. These days, REITs are paying yields of 8 to 11 percent, with an appreciation rate of 2 or 3 percent a year. You can find REITs that specialize in strip malls, apartments, office buildings, or industrial facilities.
But finding a good REIT takes at least as much research as finding a good stock.
While a broker can come up with names of some REITs, you'll have to look at the prospectus, offering literature, and track record of the enterprise yourself. If you need help with the literature, a tax, legal, or investment adviser with experience in real estate can help translate the documents and may know something about the track record of the REIT sponsor, and can evaluate the location and quality of the properties in the REIT.
``The ultimate value of a REIT is the value of the underlying properties,'' Ochsner says.