Times have changed the real estate game. Appreciation and tax shelters no longer pave the road to profits

The bookstores used to be full of them. Volumes that promised vast fortunes in real estate and told how readers could get rich on land and buildings. Titles like ``How I Made a Million in Real Estate'' and ``How Any Woman Can Get Rich in Real Estate'' claimed to uncover the secrets of prosperity through property. By and large, the secrets in these books could be boiled down to one word: inflation. Buy good property (if you had to borrow to do so, even better), wait for inflation to boost your portfolio and make your borrowed dollars even cheaper to repay, sell at a big profit, buy something else, sell at a profit, and so on. Soon, you'd be rich.

You don't see too many books like that around any more. Now there are more modest titles like ``How to Profitably Buy and Sell Land,'' and ``The Intelligent Investor's Guide to Real Estate.''

The titles have changed because the world of real estate has changed. Lower inflation, high commercial vacancy rates, an aging population, and constantly changing tax laws have redefined real estate investment, though they have not eliminated it.

``Americans have had a love affair with real estate since the Dutch threw the Indians out of Manhattan,'' says Michael Silverstein, executive director of Tax Shelter Investment Review, a Boston newsletter.

That love affair was cooled a bit by the 1984 tax act, which chipped away at the value of all tax shelters, particularly real estate, by increasing the write-off period from income property from 15 to 18 years. But even without that, there are other fundamental developments that have dramatically altered the real estate markets.

The ``baby boom,'' that ubiquitous demographic lump that has altered every part of society it has passed through, including education, commerce, and housing, is getting older. The age group which traditionally includes the first-time home buyers is markedly smaller now, reducing the demand for new housing. This has been offset somewhat, however, by the fact that many of the older baby boomers are buying their second homes.

Lower inflation has slowed the rapid appreciation that was once taken for granted as a part of home ownership. This, coupled with higher mortgage rates, has made home-buying less attractive or affordable for many people, pushing up the demand for rental housing, a demand investors and builders are just beginning to address.

Although the office market is overbuilt in many locations -- with vacancy rates in the 13 to 14 percent range -- some cities, like Boston, New York, and San Francisco, have vacancy rates ranging from 4.6 percent to 8.6 percent with rents that are the highest in the country. But this has caused some firms to move out of these central cities and head for the suburbs.

The amount of money available for real estate development is growing like a high-rise condominium being built with three shifts of workers. Pension funds, public and private syndicators, savings-and-loans and commercial banks, issuers of mortgage-backed securities, insurance companies, and foreign investors all seem to feel there are unlimited opportunities on real estate. This flow of cash has resulted in severe overbuilding in some areas, which has reduced or flattened rents. But, as a report by the Real Estate Research Corporation in Chicago says, ``money speaks louder than vacancy!''

Meanwhile, something called ``tax simplification,'' or ``tax reform,'' hangs ominously over the real estate market, with no one certain which, if any, of the proposals set forth by the Treasury Department last fall will pass and, if they do, when they will take effect.

Among other things, the proposals most affecting real estate would eliminate interest deductions on anything but primary residences, limit deductions for other types of interest to no more than $5,000 above passive investment income, repeal rehabilitation tax credits, end property tax deductions for all real estate, repeal the investment tax credit, and make any partnership with more than 35 partners a corporation.

``Right now the tax proposals are making everyone stop in their tracks and assess what they're getting into,'' says Dennis Dugan, director of the economic studies practice at Coopers & Lybrand, the accounting firm. ``Even if they passed, investment in real estate is not going to drop off the end of the earth. We'll have a better idea what's going to happen when `Son of Treasury' comes out in May.''

Sometime that month or early in June the Treasury is expected to issue a revised tax-reform proposal, sometimes also dubbed ``Treasury II.'' It will be partly based on comments received since the first one was issued, plus incorporating some of the provisions of the two major tax-reform proposals on Capitol Hill.

``I don't think there will be any major changes this year, but there will be some next year,'' predicts M. Leanne Lachman, president of the Chicago-based Real Estate Research Corporation. In the meantime, she says, some real estate investments, like private syndications as opposed to public limited partnerships, ``have come to a screeching halt.''

Other types of development are continuing, however. In homes and apartments, for instance, builders are still finding room to grow, though at a more cautious pace.

``We've seen an increase in contract sales where the customer comes in and orders the house they want, then the builder goes to work,'' says Robert Gough, an economist with Data Resources Inc. in Lexington, Mass. ``Builders aren't building on `spec' as much as they used to.'' Builders have ``gotten burned'' at least twice in the last 10 years doing this, Mr. Gough says.

One of the more attractive housing areas for builders and investors now is apartments. Here, demographics are working in their favor. According to the US Census Bureau, over 40 million people will reach age 30 during this decade. It expects household formations to average 1.5 million a year, creating a demand for 2.5 million housing units annually, when replacement needs and vacancy rates are added in.

However, since 1977 the housing industry has averaged only 2 million units a year, according to a study by Kemper/Cymrot Inc., a real estate investment subsidiary of the Kemper Group.

At the same time, the income needed to purchase a home has grown to burdensome proportions. Under the old standard, people were expected to pay no more than 25 percent of their gross income for housing, notes Greg Junkin, vice-chairman of the Balcor Company, a large real estate syndicator. ``Now,'' he says, ``You're talking about approximately 40 percent of net pay going to mortgage payments.''

Rents, however, are averaging about 20 percent of net pay, Junkin says. While this figure varies greatly around the country (as anyone who has tried to find affordable rents in places like Boston or New York can attest), it does mean there is a greater demand for rental housing in the country as a whole, which is good news for investors.

A key to successful real estate investing, the experts agree, is patience. As long as people are willing to hold on to their investments -- whether it be their own home or a limited partnership -- for at least four or five years, and as long as they are thinking more about income and appreciation than tax deductions, they should be able to find good places to put their money.

``As long as you're planning on staying in a home at least five years, chances are you'll at least break even,'' said Michael Brenner, chairman of Coopers & Lybrand's real estate industry services group, who offered some thoughts on other real estate investments.

A second home used primarily for vacations ``is a good idea if you want to have a place to go on vacation,'' Mr. Brenner says. ``There is concern about whether interest on a mortgage will be deductible. But apart from that, I don't think the economics of buying a vacation home makes a great deal of sense. If the area really takes off, you might come out OK should you want to sell.''

A combination vacation home and investment property, which you use only a few weeks or months a year and rent out the rest of the time, may be a different matter, he says. Although the Treasury's original tax proposal could make many of these properties uneconomic to own, those that aren't just ``breaking even'' by using expenses and deductions to offset income while their owners plan on appreciation, should fare better, Brenner says.

As for syndications and limited partnerships, these are still selling ``to a limited extent,'' he says. ``But they are taking two to three times as long to market.'' Again this is largely due to the Treasury proposal, which, he says, ``has cast a pall over the syndication market.''

``I'd say there will be some changes in the tax laws that will affect partnerships,'' Brenner adds. ``But I don't think they will be as severe as was proposed.'' He believes a reputable, income-oriented partnership will survive most changes Congress might make.

The biggest winners in all this uncertainty and tightening have been real estate investment trusts (REITs). Again, the Treasury's tax proposals have played a part, Brenner says, as has a continually growing menu of REIT offerings. Depending on your preferences, you can buy shares of a REIT that invests only in apartments, in participating mortgages, in shopping centers, retail stores, or any of these in specific parts of the country.

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