White Hot Residential Markets May Cool Down in 2005

The sentiment among residential real estate investors in recent years has been marked by great exuberance, and rightly so.  Residential real estate markets across the country have been on fire since 2000.  Reuters reported today that the value of the average home in the United States increased nearly 50 percent over the past five years, while the average gain in many communities on the east and west coasts has been closer to 100 percent over this period.

Increases in values in recent years have encouraged a great deal of speculative activity among investors in many markets, which has added fuel to the fire, so to speak.  A New York Times article published earlier this week refers to a report by the National Association of Realtors that nearly a quarter of the homes sold in 2004 were purchased primarily for investment purposes.  In many markets, it has been common for investors to purchase a unit under construction with the goal of reselling the unit for a profit before construction has even been completed despite the negative tax consequences; investors reselling within a year of purchase are subject to a 35 percent federal short-term capital gains rate instead of a 15 percent rate.  In one condominium development project in Miami Beach in 2004, for example, 130 of 280 units were purchased and resold before a single resident moved in.  Increased demand driven by this speculative activity has been a factor encouraging developers to undertake new projects at accelerating rates. 

Rising interest rates will likely temper the overall demand for residential property over the next couple years. As the cost of borrowing money increases over time, the amount of money that an individual purchaser can afford to borrow decreases, unless the increase in his salary makes up for the added cost. And it is the increase in salaries in an improving economy that gives Alan Greenspan confidence that rising interest rates will not lead to outright residential market collapses.  However, as the Reuters article referred to above reports, even an upbeat Greenspan recently warned that a slight average decline in home value is hardly beyond the realm of possibility. 

Unlike securities markets which are international in scope, real estate markets are extremely localized; values in one neighborhood may be on the rise while values in another part of town may be falling for various reasons.  One must therefore be careful not to make overly general predictions. 

That having been said, in residential markets with many new homes currently under construction and a relatively high percentage of homes owned by speculative investors seeking to realize a profit in the short term (i.e. in markets such as Miami Beach), prospective purchasers should be very cautious in times of rising interest rates.  In these markets, future supply appears positioned to greatly outpace demand.  And as so many stock market investors and Yankees fans learned the hard way in 2001, the fact that you cannot remember losing does not mean you will not lose.

Comments

[Home Remodeling Ideas]

so you mean residential real estate is no longer good?so ehats the new trend when it comes to houses?