News flash: Investing in real estate is risky

The real estate developer started marketing the community two years ago. Investors nationwide quickly bought in, taking out construction loans on the southwest Florida homes they were sure they could flip, turning profits of $30,000-plus.

The deal, however, has turned into the cliché "I’ve got some swampland down in Florida" situation. The properties are not amid a swamp, but many are
now effectively worthless. According to a story in today’s New York Times, 482 erstwhile real estate moguls are left with half-built houses and thousands of dollars in construction liens.

These kind of things happened long before the latest real estate boom-gone-bust. And the personal stories of these investors in speculative real estate aren’t unique.

But that’s exactly what makes them noteworthy. You’d think after all these years and in this age when we have access to more information than ever before, this kind of thing would not still be happening.

Sadly, however, people still do ill-advised things with their money. That tendency is underscored by this passage from the article that caught my eye: One of the contractors on the project "acknowledged that he had missed some obvious red flags, including the fact that none of the people having homes built ever checked on the progress." (Emphasis mine).

Now I know the tax code views owning rental property as a passive activity, but I also know if I had a big chunk of money on the line, I’d want to make sure things were proceeding as planned.

In the wake of the development’s troubles, the paper reports that "tension between the bank and the borrowers [is] running high." You think? Each side accuses the other of lax oversight, and are pointing fingers. Or at least getting their lawyers to point fingers.

My favorite quote in the story comes from the attorney representing about 100 investors. He said "it was wrong to blame the investors because they did not fully understand loan documents and other paperwork they signed." (Again, my emphasis.)

Say what? It’s not my fault. Don’t blame me because I didn’t know exactly what I was signing even though it was an official loan document involving tens or hundreds of thousands of dollars. Don’t hold me accountable because I didn’t fully read the paperwork and make sure I knew the precise terms and conditions involving all that money.

Here’s the ruling from Judge Kay: Get out of my courtroom immediately and take that lamea$$ excuse with you! And on your way home, make sure you stop and pick up some financial common sense!

The compassionate part of me does feel for these folks. Really. They’ve lost a lot of money. Many have unfinished houses, along with liens from landscapers, painters and other contractors. The few that have rentable properties are finding that with the cooling market, the houses are not bringing in enough cash to cover costs.

But the real life part of me is getting dizzy from all my eye rolling every time I think about that "I didn’t understand" excuse.

The lure of "real" investments: One of the Florida investors now left holding the bag says he has no regrets. "I would rather have a house that I can’t sell at the moment than a stock certificate," he told the paper.

Not me. While real estate can be a good money maker, the associated hassles are not for me. I don’t want to deal with renters, even reliable ones. I don’t want to have two property insurance and two property tax bills to pay every year. And I don’t want to mess with the added tax complications of owning rental property.

Personally, I’ll take the occasional market roller coaster ride down with my stocks and mutual funds. I’m holding onto them for the long haul, making them still a statistically good bet.

Some real property investors also don’t take into account the taxes they’ll face if they are able to successfully flip a house. Profits on a property held for a year or less are short-term capital gains that are taxed at the owner’s ordinary income tax rate.

If you’re considering picking up a bargain property in this slow real estate market, make sure you, unlike some of those [cough] "ill-informed" [cough] Florida development investors, know all the details of the purchase. And this story has tips on dealing with the tax issues when you are able to sell the place.