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Larry MacDonald

The bargains and pitfalls of buying U.S. real estate Add to ...

The collapse of the U.S. housing market has been epic. Home prices remain 30 per cent below the peak of May 2006, as measured by the S&P/Case-Shiller Home Price Index.

Unlike stocks, bonds and commodities, U.S. real estate has not had a big run-up in prices since the crash of 2008. It's one of the few asset classes where bargain hunters might still be tempted to jump in. The values are even more enticing for Canadians due to a gain of more than 30 per cent in the loonie against the U.S. dollar since 2004.

"These are the best buying prices I have ever seen for U.S. houses," declares Bob Keats, a financial planner since 1981 and author of The Border Guide: A Canadian's Guide to Living, Working and Investing in the United States (now in 10th edition). "Canadians are able to buy one-third more than they could have a few years ago."

The savings may even be greater. The housing affordability index calculated by the National Association of Realtors (NAR) in the U.S. is showing a huge improvement: in the third quarter of 2010, it was nearly 50 per cent higher than the average level in 2007. Not only did tumbling house prices contribute, but so did a slide in mortgage rates from 6.5 per cent to 4.75 per cent.



Snapping up bargains in Arizona



Jim Chuong, a Toronto-based sales rep for Novartis Pharmaceuticals Canada Inc., has been out shopping for U.S. investment properties since the fall of 2009. He has made several purchases since his first in early 2010.



After an intensive screening of regions in the U.S. sunbelt, he narrowed his focus to Arizona. A key selection criterion was low crime rates: with the help of crime data published on the websites of most U.S. cities, he found that Arizona neighbourhoods were among the best for having both low crime rates and low house prices.



"I'm finding rental condominiums for sale in Arizona at $50 per square foot in decent neighbourhoods, with little property or violent crime," he notes (all dollar figures in U.S. currency). "That's as much as one-tenth the cost in Toronto."



Also appealing were the choices for registering title. The state had an ownership option known as "community property with rights of survivorship," which allows Mr. Chuong's estate, in the event of his death, to pass on U.S. properties to his wife with little tax hassles.



As well, taxes and insurance costs are low in Arizona. Annual property taxes, as Mr. Keats confirms, are under $1,500 for a $200,000 house - less than half the taxes levied in fiscally challenged Florida and California. There are big savings on home-insurance premiums too, compared to earthquake- and hurricane-prone Florida and California.



Mr. Keats, formerly from Vancouver and now living in Phoenix, favours Arizona too. For retirees, single-detached houses with swimming pools and backing onto golf courses can be found at prices ranging from $150,000 to $200,000 - near major metropolitan areas, close to amenities.



Mr. Keats feels confident in a housing rebound. "There is an influx of approximately 40,000 people into the Phoenix/Scotsdale area every year thanks to growth in industries such as tourism, defense and aerospace," he explains. "That should in due course absorb the surplus of houses on the market."



Keep risks in mind



"You know what they say about real estate. It's all about location, location, location," says Rachelle Berube, a Toronto-based property manager who writes the Landlord Rescue blog. "Because of the local nature of markets, you really have to do your due diligence."



"A friend bought a house in Florida for $60,000, which seems like a great deal compared to Canadian houses," she continues. "But in Florida that price is still $10,000 above the average in the area. My friend also found out she can't work on her own house; there is a rule that only U.S. citizens can do repairs or renovations on houses in her area."



Getting to know the market before buying is especially important in the case of investment properties. "If the tenant stops paying, or the property manager is doing a lousy job, it's hard to address these things when you are thousands of miles away. You'll have to buy many properties in the same area to make a flight worthwhile. I personally prefer to own rentals close to where I live so I can get to them easily."



"If you have a lot of money to throw around, or are really good at research, the risks may be acceptable. But there are so many variables that could go wrong because of details specific to the location and cultural differences."



"Examples are very high vacancy rates, high crime rates or a lousy local economy where tenants don't have jobs and can't pay rent. In Phoenix, vacancy rates are close to 20 per cent and there are condo developments in which no one can get a mortgage -- which drives prices down. Title problems with properties in the U.S. also pose a serious risk."



"Here's another illustration. A couple bought a foreclosure at an auction and moved into the house. Later, they were shocked to receive an eviction notice. It turns out they had bought the second mortgage and did not really own the property."



"If you are going to buy in the U.S., take the time to really know the area, and avoid tour bus trips sponsored by real-estate brokers to see foreclosures, and areas marketed to foreign buyers. You absolutely don't want to be part of the buying frenzy."



Other caveats



Many Canadian residents pay cash for U.S. properties, often by refinancing their Canadian properties. This approach not only avoids the currency risk of paying off a mortgage taken out with a U.S. bank, but tends to have comparatively good lending rates. On the other hand, the rates are "floating" and could rise faster than fixed-rate mortgages, cautions Mr. Keats.



Taxes - including those levied on capital gains earned at time of sale, withholdings on rental income and estate taxes - need to be factored in. Furthermore, registering title can cause unpleasant surprises. One of Mr. Keats clients, a recently widowed lady from Calgary, had to hire probate attorneys in three U.S. jurisdictions to clear her deceased husband's estate; these costs could have been avoided had the right title been used.



Housing market still under pressure



The market is not "hanging onto the temporary momentum caused by the homebuyers' tax credits," reports David M. Blitzer, chairman of the Index Committee at Standard & Poor's. Over the four months to August, the year-over-year increase in the 20-City S&P/Case-Shiller Home Price Index decelerated from 4 per cent to 1.7 per cent.



The inventory of unsold houses suggests U.S. housing prices could remain weak well into 2011, if not see further discounting. According to NAR data, unsold houses total nearly 11 months of supply, well above the norm of five to six months. Downward pressures on house prices would thus seem to be in effect for most regions of the United States.



Foreclosure data is nothing to cheer about, either. The recent scandal over banks' questionable processing of foreclosures led to a slowdown in the number of "underwater" properties coming to market. But once the banks straighten out their operations, the rate of foreclosures for sale should ratchet up.



Meanwhile, shoddy and dubious practices at banks have raised questions over the ownership of not just foreclosed properties but also millions of mortgages that were securitized. Many would-be buyers could be put off by the uncertainties -- although title insurance is available for that risk, observes Mr. Keats.



U.S. housing should eventually recover, but it may not happen until well into 2011. Nevertheless, as seasoned value investors like Mr. Chuong know, exact bottoms in markets are hard to predict in advance. If you have the financial resources, skill set and perseverance to cover all your bases, buy the bargains when they arise and wait out any dips in prices that might occur after purchase.

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