Back in February of 2008, we tried to purchase a house in Bellevue. We called it the "blue house". It was an older dare I say run-down house in an older neighborhood. The seller thought it was worth a lot more than I did so we didnt get the house.

The thing that stuck with me though was the neighbors. We met a few of the neighbors and I think about one of the couples from time to time. They thought the asking price was a fair one because they had just paid the same amount for a smaller house a few blocks away as an investment property.

The husband was an engineer. They were well educated and had steady jobs and were raising kids. These were people who were fully capable of doing math and showing some common sense. I get very nervous when I meet people like this who just bought "investment" properties.

I tried to delicately ask: Is the rent on that house enough to cover the mortgage?

They were happy to talk about it. The rent was not covering the mortgage but that was ok with them. "It would pay off in the long term."

I think about them from time to time.

I wonder if they have figured out by now that a short-term loss is never a long-term gain in real estate.

If you are starting a business, you invest money up front and expect a loss until your revenue grows enough to make your money back. But that model only works win a business where you get revenue growth which is not how real estate works.

With real estate, you pretty much know from the start what your revenue will be and if it is less than your expenses there will never be a long-term gain. You are basically buying a bankruptcy which is why its so important to stick with properties that are priced to cash flow.

Yes, from time to time I think about that family and the thousands like them.

How long can they keep it going?
How long before they want to get out and cant?
How long before they are forced to get out or go bankrupt?

And it wasnt just individuals. Lots of "professionals" got caught up in the same problems with their own investments.

what do you do when income is less than expenses?

First you try to raise your income but that is hard to do in rental property.

Generally there is a lot of supply out there. If you jack up prices on your tenants, you a) piss them off and b) push them into moving. (That's what happened to us.)

If there are a lot of rental choices out there, the tenants leave and it will be hard for you to replace them. So you drop your prices or offer intro rates to fill your unit. That is the time when you decide ANY money is better than no money.

If you cannot solve the problem by raising income, you cut expenses. You take your rent checks and you spend as little as humanly possible. The first thing you cut is the stuff people wont notice immediately - maintenance and repairs. Then you cut management and staff.

The result for renters is more problems and less service.

A friend of mine is renting the bottom unit in a "luxury" building. Her unit has been flooded twice. First time a toilette backed up in the unit above her. The second time the unit two levels above had a pipe freeze and burst. Instead of wrapping the pipes, management had to deal with damage to two apartments and storage units.

I would expect to see a lot of problems like this at larger apartment complexes as well as a lot of desperation to fill units because there are a lot of new units coming on the market.

If things are REALLY bad, you cut your biggest expense: your creditors. You take the rent checks and you stop paying your mortgage.

Its been a few months now and there is a steady stream of stories about renters who paid their rent and end up getting evicted because their landlord didnt. It is sad but I would expect to see even more of it in 2009.

And I expect to see problems in commercial property too. Just this last week the WSJ warned of a huge wave of commercial property defaults on the horizon. I would expect to see problems with any property that changed hands in the past 2 to 5 years.

Its funny to think back 6 to 9 months ago and look at what people were saying about investing in real estate and economy in general. What a different world it will be in 2009.