As the debate over the housing market heats up, you can’t help but see the similarities to the tech bubble of 2000. I base this on my own personal observation of human behavior in the real estate marketplace. First, I believe that many investors are entering the real estate market with lofty and unrealistic return expectations. They are ignoring all of the warning signs inherent to a market top, and plunging head first into speculative practices such as “flipping” properties and accumulating large amounts of debt by aggressively borrowing to buy properties. Secondly, I believe lenders are partnering in this lunacy by pushing risky loans with low payments that investors are finding hard to resist. Finally, the hottest areas in the country, such as California and Florida, are becoming grossly overpriced through speculative buying.
Similar to the tech crash in 2000, someone will be left holding the bag, and it could get ugly. While real estate has traditionally been a sound investment and will continue to be so into the future when done prudently, we are seeing a period of unsustainable growth that could wreak havoc on the speculative investor. Individuals are tossing caution to the wind (sound familiar?) with hopes of cashing in on the great real estate boom of the 21st century. We are now seeing lending practices such as 100% financing, no-interest adjustable loans, piggyback loans, and negative amortization loans. Both lenders and borrowers are banking on continued appreciation and inflated equity in order to refinance into safer loans in the future. But what happens if real estate values begin to decline and investors are left upside down, owing more than their property is worth? What about the possible payment shock if interest rates rise? Granted, this real estate boom has been rewarding for most anyone that owns a home, and savvy investors have been able to take advantage of the rapid appreciation we have experienced during the past few years. But it is getting late in the game and many of the real estate pros are getting out and beginning to liquidate their real estate holdings.
We find with our clients that real estate is and will continue to be a sizable portion of their net worth. Most have built a nice equity position in their homes, while others have diversified by owning commercial real estate either directly or indirectly through REITs or real estate mutual funds. These types of investments can offer both current income and appreciation and help bring added diversification to a portfolio. We believe this will be an important strategy going forward as baby boomers retire and continue to look for sources of retirement income. We also have quite a few clients who own second homes and rental properties, or have purchased land to build retirement homes. We will continue to caution them about pursuing speculative real estate that could damage their retirement plans. We stress that any real estate investment must have strong fundamentals and should be done within the context of the client’s overall investment strategy. As with any bubble, there will be plenty of opportunity for those that are patient and prudent. My advice is to look before you leap. Investing is different than speculating. Adhere to the lessons learned from the tech bubble.
David J. Huber, CFP