Is it time to invest in foreclosures?

Firms are buying up foreclosed homes and renting them out, hoping to profit from the appreciation. Individuals can do better, if they can buy a foreclosure that justifies itself in rent alone.

Julie Jacobson/AP/File
Auctioneer Eddie Burks, of Williams and Williams Worldwide Real Estate Auctions, right, calling out bids during a foreclosure auction for three different properties in Las Vegas in 2011. Real estate companies have moved into cities like Las Vegas and Phoenix, snapping up hundreds and even thousands of properties and then renting them out.

Don't look now, but some of the real estate markets that skyrocketed during the housing bubble and then crashed are heating up again.

Median housing prices in Las Vegas were up 20 percent in 2012, according to the National Association of Realtors (NAR). Cape Coral, Fla., once the nation's foreclosure capital, saw 26 percent price appreciation last year.

The housing crash has spawned a rebound that has taken hold with a vengeance in some cities. A flood of investors are snapping up foreclosure properties, rehabbing them, then renting them out. And they aren't just individuals. Private equity firms and other institutional buyers – who once would have bought apartment buildings – are scooping up thousands of single-family homes that they plan to fix up and put on the rental market. Some of them plan to create real estate investment trusts (REITs) and sell shares to the public.

Should you invest in Ameri-ca's housing rebound?

"It's a very strong time to buy," says Sean Fergus, manager of research at John Burns Real Estate Consulting in Irvine, Calif. "The market has really turned." Through 2016, his firm is forecasting house prices in major markets such as Las Vegas, Phoenix, Atlanta, Chicago, San Diego, San Francisco, and Tampa, Fla., to climb 22 to 48 percent.

But rental real estate is tricky, even in times of low prices. "It pains us to say this, but there are going to be some failures, so it's probably important to know exactly what you're investing in," warns Oliver Chang, a former Wall Street analyst and now cofounder of Sylvan Road Capital LLC based in Atlanta.

Many institutional investors – what he describes as "macro house traders" – are counting on price appreciation to make the bulk of their money. They typically contract out the work of finding, rehabbing, renting, and managing the properties, aiming to clear a profit margin on rent of only 6 to 7 percent.

Mr. Chang's company, which he calls a "housing value investor," aims to make its money from rentals. It plans on keeping margins high by doing the rehabbing and management work in-house.

Whether you plan to buy a home or invest in one of the REITs expected to appear, you should figure out which strategy you're using.

The riskier course is to bank on price appreciation, says Ken Fears, an economist with NAR in Washington. For one, the big run-ups in places like Phoenix and Las Vegas look stronger than they are, because the mix of sales has shifted. Low-end sales are declining and high-end homes are selling in greater numbers, he says, which boosts the median price. Another reason a price-appreciation strategy is risky is that the best housing deals have already been snapped up in the hottest markets.

"If you're looking for that bottom in the market, you've missed it in those places," says Daren Blomquist, vice president at RealtyTrac, an online marketplace for foreclosures based in Irvine, Calif. "Those kinds of markets ... we consider picked clean by investors."

The oversupply of properties is gone from those areas.

The rental-first strategy is less risky, because the stream of monthly rental income should provide steady returns no matter what happens in the market, says Mr. Blomquist. "You have more of a cushion, even if home prices go down"

Where should you look for the best property deals? Seek areas that are seeing solid job growth but still have plenty of foreclosure sales. Typically, these lie in "judicial" states, where courts oversee (and thus slow down) foreclosures. Mr. Fears of NAR likes states such as Maryland, Pennsylvania, and New Jersey. RealtyTrac's list of best metros to buy a foreclosure includes Palm Bay, Fla.; New York; and Chicago (see chart). About half of all distressed properties lie outside major cities in major regions of the United States, Chang points out.

As prices rise, the window of opportunity for these purchases is limited to a few years, writes Paul Diggle, a property economist for Capital Economics based in Toronto.

"The very recovery that investors are driving," he says, "will eventually price them out of the market."

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