May 2005©
By Marc Singer & Neil Sosler
It seems that real estate has consistently been the top investment choice over the past few years. Some of our client’s personal homes have more than tripled in value over the last 5 years. The belief seems to be that there is no end in sight; real estate can only keep going up. As financial planners, we have seen this kind of excessive run-up in valuations before, and there is no happy ending.
What Has Caused the Large Increase in Real Estate Values?
The real estate market, like any other, is driven by supply and demand. When market dynamics favor one of these forces over the other, large changes in value can be observed.
Recently, both market drivers have favored increases in real estate values. Demand has been strong due to low interest rates (if people can afford more, they will buy more), the weak dollar, and the strong purchasing power of foreigners. Supply has been tight due to the dwindling amount of land in South Florida. Also contributing has been the poor performance of the stock market for 2000-2002 when many people shifted their assets from the market into more expensive homes.The confluence of these events has created a boom in South Florida real estate values.
The relevant question today is: can these factors all last? The dollar looks to remain weak; that may keep foreign demand for South Florida real estate strong. No more land is being created to alleviate the supply issue. However, interest rates are rising. This may be the most important factor when it comes to real estate valuations. At an 8% mortgage rate instead of 5% rate, real estate is worth 38% less due to higher payments.
An 8% mortgage can only pay for 62% of what a 5% mortgage can.
What Can Be Done To Protect Against Losses In Real Estate?
Regarding your primary home, there is little one should do. Buying and selling your home should not be dependent on the ups and downs of the real estate market but rather on personal quality of life issues. If you plan on staying for 5 years or longer, you should be able to ride out any market volatility.
If you own investment or speculative real estate, now may be the time to consider cashing out. One of the first things to avoid in this market is over-leveraging your holdings. We have heard of stories where people are using their home equity lines of credit as down payments for second or third investment properties. If real estate values stop going up (guaranteed at some point) or even decline (possible), there will be many people with large mortgages to service and shrinking assets to collateralize them.
Herd Mentality
When a lead article in the Miami Herald has a headline that reads: “Long lines of would-be buyers showed up to get a head start on buying condos” it might be time to rethink the fundamentals of the housing market. People line up for $50 concert tickets, not a chance to buy $400,000 condos. It is this type of herd mentality that leads to investment bubbles. As most people who have lived in Florida for over 30 years can tell you, the real estate boom and bust cycle is a long term tradition.
Conclusion:
Any diversified investment portfolio should include real estate assets. However, in a rising interest rate environment, real estate will be one of the first asset classes to be affected. Whatever your feelings are about the direction of the real estate market, consult with your financial advisor to make sure you are not overexposed in this sector.
Singer Xenos is an established wealth management firm specializing in physicians with $500,000-plus in investments. We manage over $500 million in assets such as retirement plans, annuities and personal accounts, with an emphasis on wealth building and protection from malpractice claims. Both Worth Magazine and Medical Economics named Singer Xenos one of the Top Financial Advisors nationally for physicians. Physician Asset Advisor and Singer Xenos do not provide legal advice.
Coral gables / Ft Lauderdale / Tampa / orlando 888.289.0060
