Posted on 06/23/2005 8:33:46 AM PDT by ex-Texan
Four points to ponder as you survey the landscape.
Whether you're fretting over it, considering speculating on it, or berating yourself for missing the boat, real estate is on everyone's mind these days.
Even if you don't live in one of the housing markets that Federal Reserve chief Alan Greenspan characterizes as "frothy," you've no doubt observed some pretty impressive appreciation in residential real estate prices in your own locale.
The fact that housing prices soared during and after the recent bear market for stocks cemented the view that real estate is a can't-miss investment to which the normal guidelines don't apply. But as any survivor of the dot-com bust can attest, the phrase "It's different this time," is one of the most dangerous in any investor's lexicon.
True, real estate will never be worthless (unlike, say, Pets.com), and stagnation is probably a more realistic scenario for real estate prices than is an all-out bust. (I don't know about you, but I don't plan to sell my house and move to an apartment, even if real estate prices could be getting overheated in my area.) However, there have been times when home prices fell sharply.
In the early 1990s, for example, many homeowners in Southern California and New England saw their home prices fall below the amount they still owed the bank on their mortgages. Thus, it pays to avoid getting caught up in this or any other mania and to think rationally about how real estate fits within the context of your portfolio.
Here are some factors to bear in mind as you contemplate the current environment for real estate.
Resist the Urge to Speculate
Okay, so maybe you're not gobbling up seven or eight homes at a time and financing them with risky interest-only loans. But that doesn't mean you're not speculating. If you're considering stretching your budget (and short shrifting other investments) to finance a larger home than you need or to pay for home improvements above and beyond what's standard in your neighborhood, you, too, are speculating. You're assuming that home-price appreciation will justify any and every home-related expenditure.
But that may not be a safe bet to make. Yes, residential real estate prices have outpaced major stock-market indexes over the past five years, and real estate has also proved its mettle as a diversifier for a stock- and bond-focused portfolio. Over the long run, however, housing prices have been every bit as cyclical as stock prices (click here for a nifty table depicting long-term appreciation and depreciation trends in some of the major U.S. housing markets) and have logged gains about 1 percentage point above inflation. Thus, it makes sense to hold real estate as part of--but not in place of--a well-diversified portfolio.
Get a Grip
"Real estate in (name your well-located hometown) will always go up," I hear my neighbors say.
Well, maybe it will. But many real estate market participants are assuming that real estate must be a good investment because you're likely to get someone to pay more for a piece of property tomorrow or next year than you paid for it today.
But that mindset--often called the "greater fool theory"--can be a dangerous thing, because it assumes that there's an infinite supply of buyers willing to step up and buy at any price. It also ignores the fact that real estate is like any other asset in that you can estimate its intrinsic value and from there decide how much you're willing to pay.
If you're considering making a real estate investment, you owe it to yourself to make a rational assessment of whether that property is over- or undervalued. For help, check out my colleague Craig Woker's excellent article from a few weeks ago.
Check Your Other Real Estate Exposure
Homes aren't the only type of real estate that has been soaring over the past several years--commercial real estate prices have also escalated, translating into higher prices for real estate securities such as REITs. Thus, it's a good time to check what real estate securities your funds own and consider reducing that weighting back as part of a regular rebalancing plan. (When you rebalance, you strip money away from the asset classes that have done well over the past year or so and put the money to work in those areas that haven't fared as well.) Remember: You don't have to own a dedicated real estate fund to have real estate securities in your portfolio; small- and mid-cap value offerings also frequently hold REITs.
Also be on the lookout for any homebuilding stocks in your portfolio, which will tend to rise and fall with the strength of the housing market. Such stocks have been superstar performers over the past several years but could be vulnerable to a downturn in the housing market or even rising interest rates.
Be Judicious About Taking on Debt
Much of the talk about a possible bubble in the housing market has centered around interest-only loans, which have enabled some real estate buyers to take on more debt than they might otherwise be able to afford. Such loans carry significant risks, however. For one thing, these loans usually carry adjustable interest rates, which would jack up the borrower's payments if rates were to rise. In addition, once the "interest-only" period is over, buyers who can't afford the principal payments could be forced to sell their properties at a loss. Thus, you're really doubling your bet that interest rates will stay low enough to prop up the housing market and that your income will grow to the point where you can afford your mortgage.
Even if you're not speculating with exotic mortgages, it's still a good time to be judicious about taking on any mortgage-related debt. Soaring home prices mean that even those who have lived in their homes for a short period of time have built up a healthy amount of equity that banks are all too willing to let you tap into. Do so with care, however. Yes, home-equity loans and lines of credit can be a decent way to finance necessary purchases or to make improvements that put your home in line with others in your neighborhood, as the interest from these loans is tax-deductible. But real estate prices have already enjoyed a big runup, meaning that appreciation in your home's value won't always offset your borrowing costs. Meanwhile, many market watchers argue that investors will be lucky to see single-digit stock- and bond-market returns in the coming decade. Against such a backdrop, it's tough to call any debt "good debt."
Soon that sucking sound will be so loud it will be deafening.
All the people tied into adjustable rate mortgages or interest only loans will be screaming the next time Greenspan decides to cool inflation by adjusting interest rate upward.
I love living in Ohio where real estate prices historically climb an anemic 3-4% annually...
What do people THINK is gonna happen when they buy a 1200 square foot sh*tbox in San Fransicso for 600 grand?
The obvious routinely escapes many in the masses fixated on greed and long time warm-fuzzies.
Actually, my mortgage company did a purchase in Pacifica for $660,000 that was 1145 square feet...it was a dump though-looked like a big square booger.
It's not just California! I purchased my home outside of Houston in 1992 for $188,000 and it's a fairly modest home compared to many in the area.
Today the appraisal folks have it valued at $352,000! My taxes alone are almost $1,000 per month all because of the home re-finance situation. What people did not realize was that the tax assessor gets to revalue your property based on the appraisal you get in order to refinance. They value your property at the APPRAISAL amount NOT for the amount of the loan you take out. When your neighbor refinances you become subject to increases in your appraised valuation as well. I've lost several neighbors because they could not afford to stay in their homes. I'm only in mine because I protest my valuation every year, but I will not be able to stay here much longer at the current rate of increase of 10% per year.
"You won't find 1,200 sq ft in S.F. that cheap."
I considered moving out there, back in 99 before the bust. Interviewed in late summer, and was actually sitting in the airport waiting for my flight back east when the bubble started to burst. Never seen so many long faces in my life, looking at the tickers going across the bottom of the tv screens in the lounge. I looked at houses, out a ways since I'm something of a country guy... found a crappy little ranch, 1200 square feet, needed every repair imaginable but was the only thing I could even envision myself living in that I could possibly come close to paying for. It was $325K. Partial view of the Pacific, in Half Moon Bay. Any idea what this would price out at, today? More than double that, I'm sure. I'm also sure that I'd have been out of a job in very short order, had I accepted, so any appreciation would be water under the bridge in any case.
I have a friend who got caught by a 'short term fluctuation' in Los Angeles commercial real estate. The bottom fell out of the market in the 1990's. Soon his office building was 'upside down' in a falling market. Then he lost tenants who decided to move away from the problem and his vacancy rate jumped from 5% to 15% and then to 25%. It took him ten years to get back to square one. In the meantime, many other commercial property owners were forced into foreclosure because they could not pay their debt. My friend was paying out of his pocket each month to hold onto his great 'location-location' property.
oh, I don't know. I was born in Ohio. Whole family is from Ohio. And I'll take a catbox in San Francisco over the Ritz in Springfield Ohio.
I think you'll enjoy this thread.....
Yet another doom and gloom RE article? This is laughable.
I can see mortgage-atoriums coming for those poor unfortunate souls who didn't sell fast enough.
BUMP
All we do is close and fund the loan. Doesn't matter where the house is-we have a nationwide HUD license. The buyer lived and worked in California.
Property taxes are the worst kind of tax anyway...what is it-you're RENTING your property from the government, essentially...
I'm immediately suspect of any person who uses the word "always" or "never" when discussing economics, generally and investments, specifically. BTW, how does real estate compare to the S & P 500 since 1920?
It's not just California! I purchased my home outside of Houston in 1992 for $188,000 and it's a fairly modest home compared to many in the area.
Today the appraisal folks have it valued at $352,000!
What's really going to shock everybody is that when the collapse comes, the Houston house is going to go to $130K or less while the San Francisco house will hardly move at all. The reason? Asian and European money flowing into desirably located (and exchange-rate cheap) US real estate. Those folks don't want to live in Houston. ;)
Sounds like another case of taxpayers taking another pocketbook hit from local and state governments needing more tax dollars by raising property taxes based on hyped up appraisals.
I just paid my elderly mother's phone bill. Her use was $19.00 --- her taxes $9.91 (3 of 5 being itemized federal taxes).
Grrrr
Nah. It's DISGUISHED as a RE thread. Actually, it's a CA bashing thread.
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