Boom or Bust

For those looking to invest in the real estate market?keep your eyes on the headlines. According to the Federal Deposit Insurance Corp. (FDIC), the number of areas across the U.S. with real estate booms shot to 55, increasing by nearly two-thirds last year. The FDIC warns, "these booms may be followed by busts".

"Boom" areas are defined as having inflation-adjusted prices at the end of 2004 that were up 30% or more in three years.

Of the 362 major metropolitan cities included in this study, over 15% were boom areas. This data, analyzed by the Office of Federal Housing Enterprise Oversight, more than doubles the peak of the 1980's booms and is the highest ratio of boom markets in 30 years.

As for "boom or bust", busts are rare. Only 17% of U.S. housing booms from 1978-1998 ended in busts, which are defined as a 15% or more drop in home prices over a five-year period.

What is making the market soar? Aside from inflation, the mortgage industry has to be considered first. Adjustable rate and interest only mortgages are growing in numbers and subprime loans now account for 10% of all mortgage loans.

With interest rates lower than they've been in years, borrowers can afford to finance an amount greater than the standard 80% loan to value. The percentage of loans exceeding 80% of the purchase price has grown to over 30%. If a borrower has an adjustable rate mortgage and the interest rates rise, their payments increase. If the market values drop, or bust and they have 90% or 95% loan to value, they owe more on the home than it is worth. But these are all "What ifs??".

In the markets with the highest number of "boom" cities, California with 21 cities has a high increase rate of 58% and Florida with 11 cities has a high increase rate of 54%. These two states alone account for 60% of the boom areas! With these numbers, would you purchase an investment property in Florida or California and flip it in three years for a possible return upwards of 50%?

Of course. A relatively sound investment. How much longer can the market withstand these price increases before it busts? Even history shows a period of time when the market stalls so that inflation can catch up. If you want to invest in real estate, carefully examine the history of the market you are purchasing in! If it has been booming like Florida and California, be careful how long you hold on to the property. If you notice the market is starting to drop, sell. Hold on too long, it may bust!

By Jason M. Rigler