Published June 30, 2005

Real estate continues to shine in the hearts and minds of Californians. In fact, for most people their home is their largest investment. Many people think that real estate is a safe investment. And why not, according to the Office of Federal Housing Enterprise Oversight, last year alone Californians experienced a 25.4% growth in the value of their homes. Overall, we’ve experienced a 107% increase in home values over the past five years here in Sonoma County. One certainly can’t argue with the recent results.
On the flip side, let’s contrast these housing gains to the five year performance we’ve seen with the three major stock market indices. Looking up historical returns on Yahoo, I compared the market close on June 12, 2000 with the close on June13, 2005, the Dow, the S&P 500 and the NASDAQ returned negative results of 1%, 17% and 45% respectively. This simplified view leads us to believe that investing in any other vehicle besides real estate is a foolish thing to do. However, real estate has its risks as well.
A major factor that has helped to sustain the real estate market is the combination of low mortgage-interest rates and the availability of interest-only loans. Currently, in the San Francisco Bay area more than half of all home buyers have opted for an interest-only loan. I estimate that a borrower with a $500,000 mortgage can save as much as a $1,000 a month by having an interest-only mortgage instead of a traditional 30-year fixed mortgage. If these “cheap” loans aren’t enough, a final barrier of entry has also been scrapped-- the traditional 20% down-payment has become a thing of the past. More than half of all mortgage loans are completed with less than 20% down. For many young Californians these conditions have provided the opportunity for entry into the real estate market.

Why do I suggest caution? The looming possibility of interest-rate hikes plus the frenzy to enter the market before rates go up has helped to fuel the rising prices, causing many economists to fear we have a real estate bubble. I’m not predicting that the California real estate bubble is going to burst, and even if it does, most agree that we’d see no more than a 10-20% correction. I do suggest that buyers give careful consideration when making a purchase, and even more so, when purchasing for speculation or rental. If interest rates rise, many homeowners may find that they can’t afford the increasing payments, necessitating the “cashing out” of their equity. This may happen quickly, because as interest rates rise buyers will be priced out of the market. So, when you may need to sell you won’t be able to and if you’re leveraged 90 or 100% you could find yourself upside down.

As a financial planner, I spend a lot of my time and energy working to reduce risk within my clients’ portfolios. More and more this includes considering the percentage of their assets their home equity represents. It’s important to become educated about the risks associated with home mortgages and develop a contingency plan. It’s only prudent to consider the possible downside of your real estate investments and to make your decisions based on data not on whim. This way, if the bubble bursts, or begins to leak, you will be ready.

—Stephen Bossio is the principle of Magnum Financial
(Smart Money + Good Thinking) and can be reached by phone at 707-996-9664 or sbossio@sammonsrep.com.
Stephen offers securities through Sammons Securities Company, LLC Member NASD and SPIC.