What is the deal with hedge funds?

All it took was a few high-profile losses from funds that invested in these subprime bonds for hedge fund managers and other holders to rethink how much their mortgage bonds were worth. And since many of these bonds were bought with borrowed money, lenders began asking for more cash to cover potential losses. Nervous hedge fund investors started asking for their money back. But as the market for these mortgage bonds dried up, fund managers had to sell stocks or other assets to raise money. That’s one reason the stock market saw such a sharp selloff this month.

But as the dust begins to settle, investors are still not sure if the storm has passed. Because hedge funds don’t have to report their holdings, it’s not entirely clear that the reports of big losses are over. Another big implosion could send the markets into another downward spiral.

It also won’t be known how badly banks that lent money to these hedge funds and pension funds and insurance companies that invested them have been hurt. The next round of quarterly earnings reports for big financial services companies aren’t due for another two months.

I am thinking of taking advantage of this downturn in the housing market and purchasing an investment property. I plan on renting out the property for several years until the market recovers, and then selling it for a nice profit. Is this a sound financial plan?
— Ron G., Stafford, Va.

It’s not a bad idea generally, but the Devil’s in the details. And it's not as easy as those guys on late-night TV infomercials say it is.

Investors call this "bottom fishing" — and it can be a great way to pick up bargains. The hard part is figuring out when to buy. It’s not at all clear that prices have hit bottom — or when that will happen. Some home builders and analysts say it could take at least another year for the market to recover. If you buy too soon, you’ll risk seeing the value of your investment fall soon after you buy it.

You’ll also need to finance this purchase. Lately, the mortgage markets have gotten very tight — especially for so-called “jumbo” mortgages (over $417K). So your financing costs could turn out to be high enough that you can’t cover your monthly mortgage payment with rent. If you wind up with “negative cash flow” (mortgage and other costs are more then rental income), it’s going to be hard to make money.

A lot depends on how much you put down. Most lenders these days are looking for a substantial down payment, especially for investment properties. The more you put down, the more likely you'll cover your mortgage payment with rent. But then you’re losing the return you could make on that down payment by investing it elsewhere.

Your plan also relies on the market “recovering” in such a way that you make a nice profit on the rising value of the property. There’s no way to know, but there are also no guarantees that the housing market will return to the rapid appreciation we all grew accustomed to earlier in the decade. Many of those now getting washed out of the market got hurt because they were relying on ever-rising prices.

Finally, no matter what trends you see in mortgage costs or housing prices, real estate really isn’t one big market: It’s a collection of very small markets that move in different directions at different times. In any market, there are always some properties being bought and sold at prices that will allow you to make money. But most sellers these days are still holding out and waiting for prices to continue to rise. So it may be very difficult for you to buy a rental property at a price that can make you money.

Real estate can be a good investment in any market, but in times like these you really need to do your homework. There may be money to be made, but there's also still a lot to lose.

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