Common Sense / By James B. Stewart
29/08/06

LET'S BE HONEST with ourselves: Aren't you just a little glad the real estate boom is over? No more bragging from self-congratulatory owners of property in the Hamptons, Las Vegas, or Miami Beach. No more tales of flipped condos. No more breathless tales of bidding wars and comparative sales.

I realized the end was nigh when the personal trainers at my gym were exchanging tales of the lots in Florida they were buying and selling like tech stocks.

Last week's figures for sales of new and existing homes, both showing sharp declines of more than 4%, make it clear that the long-anticipated real estate downturn has begun. The anecdotal evidence I've been hearing is that the situation in many markets is far worse than the data indicate, and got even worse this month. I realize that a significant downturn in any market causes hardship for some. I have a friend who moved to Florida and plunged into real estate speculation. When I spoke to him last week he sounded grim, describing a collapse that, at least in his immediate area, already has all the hallmarks of a hard landing. I hope he can extricate himself without too much financial damage. Tales of woe are mounting from the real estate industry, from home builders, architects and designers, empty-nesters and retirees hoping to cash out of big homes and move to smaller places.

There's no doubt that the real estate industry casts a long shadow, which is why some economists and policy makers are fretting about a slumping real estate market's capacity to drag down the whole economy.

But let's look at the bright side, too. I don't know that the real estate market during recent years qualified as a bubble, but it had many unhealthy economic and psychological effects. Soaring prices forced many people, especially young people buying their first homes and starting families, out of many markets, leaving them to look hopelessly at prices that streaked ahead of their buying power. It pushed too many people into dreadful mortgages, offering them the house of their dreams now at a price they couldn't really afford and will have to pay for eventually. It misallocated capital to construction for which there was no fundamental demand. And what good did it do all those people who boasted about their homes' sky-rocketing values? At least you could easily cash out of a tech stock and spend the proceeds, but real estate isn't liquid. Maybe you could borrow against it, but all that "wealth" was really worth little more than a good anecdote unless you decided to sell — and even then you had to buy something else at an equally inflated price.

Like the tech bubble, the rapid double-digit annual appreciation in real estate prices couldn't go on forever. I admit it went on longer than I expected or thought was healthy. It has clearly been cause for pervasive concern at the Federal Reserve, which helped fuel the boom with its super-low short-term rates. Surely Fed Chairman Ben Bernanke and his colleagues are pleased by a cooling of the market. The recent pause or possible end to rate increases seems well-timed to gauge just how cool it's become. Purging the market of excess speculation will no doubt yield some tales of plunging prices and hardship. But I wouldn't expect an out-and-out collapse, or even anything as severe as the downturn in the early 1990s. As Toll Brothers (TOL: 27.01, -0.25, -0.9%) Chairman Robert Toll said last week, there's no recession, long-term mortgage rates remain low, and there's still demand for housing.

This is a pretty healthy environment for housing, even if there are price declines still in store.

What does this turning point mean for investors? It's time to re-think my long-standing aversion to real estate and related investments.

Stocks of home builders like Toll Brothers and Pulte Homes (PHM: 30.75, -0.55, -1.8%) have suffered severe declines; expectations are so low that they seem good values for patient, risk-tolerant investors willing to wait for the market to stabilize. Some mortgage REITs, hard-hit by rising interest rates and fears of an overvalued market, have just begun to tick up. I still think it's early, since the extent of mortgage defaults won't be evident for a year or two. But REITs like Annaly Capital Management (NLY: 12.88, -0.12, -0.9%) and Newcastle Investment (NCT: 27.83, -0.21, -0.8%) (subjects of earlier columns) are both about 20% above their lows for the year. Other REITs, in my view, remain overvalued.

Property itself may also begin to be attractive, either as an investment vehicle or for your own use. In some markets, falling prices for condos compared with rents are beginning to make them attractive to yield-oriented investors who don't mind managing a rental property. And I'm hearing anecdotal evidence of some good buys on houses and land, especially in vacation and second-home markets. It's a paradox of falling real estate values that buyers balk at paying far less than they would have in a rising market, simply because they're afraid the value may decline further after they buy. All of a sudden they're market timers, aiming for an elusive bottom.

As usual, and especially for first-time buyers, I don't believe in trying to time the real estate market. If you like something, it fits your budget, and you plan to be there for an extended period, stop worrying about where prices are headed. Instead, be grateful you weren't buying a year ago.
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