Beat the bubblicious real estate market

Timely guidelines
Another worrisome trend: NAR reports that 36 percent of home sales in 2004 were second homes. Of those, the number of people reporting that they made the purchase primarily as an investment climbed from 20 percent in 1999, to 64 percent in 2004. That's a sign a lot more speculative buyers have come into the market, and that could be fueling a real estate bubble in some areas.

If you're thinking about putting more of your assets into real estate in 2005 — whether you're a first-time buyer, looking for the retirement home of your dreams, or still think you can make good money investing in real estate — here are some guidelines for maneuvering in what's likely to be an overheated market this year.

First, realize that you may be getting in late. “The best real estate investing was done three to five years ago,” says Geordie Crossan, a financial planner in Westlake Village, Calif. When it comes to the purchase of a second home, he advises clients to consider whether they're already overexposed to real estate in their portfolios — much the way investors were overexposed to tech stocks in 1999. “If your real estate holdings are more than 75 percent of your total equity, you need to look at building up some other assets,” he says.

‘Not an ideal strategy’
More second-home buyers today are blurring the lines between vacation and rental properties, justifying the purchase by planning to rent it out and figuring it’s sure to appreciate. But if you're really looking for an investment property, do the math. Rental income minus expenses should produce a positive cash flow, says Gayle Henderson, an agent with RE/MAX Excaliber in Scottsdale, Ariz. “Some buyers are willing to live with a shortfall if they think prices will appreciate rapidly, but that's not an ideal strategy,” she says.

MORE COVERAGE Luxury homes slip closer to Earth A billionaire's 'statement house' The fed's take on real estate 'Of course, there's no bubble' The wrong time for REITs?

Another good rule of thumb: In the research phase of shopping for a new home, compare prices of comparable properties that are for rent and for sale. If the local market is getting bubblicious, it may be far cheaper to rent than to own. In that case, if you expect to sell in less than five years, it may be worthwhile to rent. This could be especially true if you're vacation-home shopping. For your primary residence, long-term, it's always better to own, says Kelly. “Just be very patient and make sure you're buying something that is actually worthwhile.”

How so? The old maxim — find the worst house in the best neighborhood — still applies, real estate agents say. “Location just can't be substituted,” says Henderson. “In a premium neighborhood, chances are you have less risk of loss and more opportunity for gain.” Look for excellent schools, good public services, and low taxes, even if you pay more for the house because of them. A paper soon to be published in American Economic Review, finds that property values are rising fastest in communities with strict zoning laws and well-organized neighborhood groups, mainly because that keeps available supply of new homes down.

MORE FROM BUSINESSWEEK

BusinessWeek Section Front

Experts Talk About FOMC Minutes, GDP, and Home Prices Stock Picks: Hewlett-Packard, Analog Devices Stocks Fall on Economic Data Checking the Health of the Housing Recovery Stocks Gain on Home-Sales Data Unions, Business Oppose Tax on 'Cadillac' Care Wall Street: Is It Good to Apologize for Greed? Stocks Slip on Dell Earnings Apple's Schiller Defends iPhone App Approval Process Dell Stock Gains May Slacken BusinessWeek Section Front