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Real estate fads burning out as market changes

When I was a youngster, Davy Crockett was the craze in toys for youngsters. I had a coonskin cap and plastic shoulder bag and felt like a real frontiersman. Imagine my dismay when a lady at the drugstore said that Daniel Boone would replace old Davy as the next icon. What’s wrong with Davy Crockett? Did Daniel Boone wear a coonskin cap, too? What’ll I do with all this stuff?

I didn’t embrace change well then and I still don’t. Better for me to find something that works and stay with it until something that is clearly better comes along. Bell-bottoms and monk strap shoes come and go. Jeans and boots are forever.

Along those lines, I don’t subscribe to investment fads either. Day after day the American economy is going to generate wealth and to own a house and a little piece of our economy is the ticket to success. Mutual funds trump buying individual stocks for people who don’t know what they’re doing which include most people. Buying an affordable house and paying off the mortgage while still gainfully employed fits me just right.

However, not everyone shares my enthusiasm for sticking with the tried and true. Some folks get caught up in the euphoria of the moment and pursue every fad that comes along, from diets to investments.

One such case is the hot real estate market of the past few years. Cheap interest rates and an ever-increasing population fueled the explosion in house prices. However, fads have a way of turning into foibles for the unwary, particularly toward the end of a boom. Such may be about to happen in some U.S. real estate markets.

Rarely have I seen so many rational people go so berserk over houses and mortgage financing. ARMs, interest-only and 50-year mortgage terms make it appear that we can buy more house than the traditional benchmarks indicate is prudent.

Ah, but those benchmarks may be valid after all.
Interest rates are creeping upward though they seem to have reached a temporary plateau. Lots of ARMs came with three-year or five-year guaranteed fixed interest rates.

Since those were so popular about five years ago, the fixed-rate terms are beginning to expire. Soon the reality of buying more house than one can afford through financial gimmickry may cause wailing and gnashing of teeth throughout the country.

Just about ever fad will eventually burn itself out. The trick is to be in on the front end and not be the last one aboard. Knowing when to bail out is tricky. Most people miss the optimum time to sell to a bigger fool and convert their wealth to cash before the inevitable downward slide begins.

One might incorrectly believe that I am opposed to real estate as an investment. Quite the contrary. Real estate is a dependable investment that should be part of most everyone’s portfolio. And, therein lies the problem.

Folks who have ratcheted the price of houses through the stratosphere weren’t adding to their portfolio from investment funds on hand. They were debting themselves beyond their ability to pay in hopes of reaping a quick windfall. That’s speculation, not investing.

Now comes the grim reaper, as he always comes after a superficial financial bubble. He’s ready to collect the rent and some of the renter can’t pay. It’s not a pretty sight.
How could all of this have been avoided? A few basic financial principles might be helpful.

1. Investing in real estate requires financial “staying power.” You’ve got to have the funds to hold on for years in the event a downturn if the market catches you mid-deal.

2. Don’t go in over your head. Calculate the worse case scenario of falling sales and higher interest rates and see if you can hang on. If not, let the deal go. Better to dodge the bullet than to bet your future on a fickle investment that could render you worse off than if you had buried your money in a jar.

3. Get some balance in your investing. Diversify across asset classes (stocks, bonds and real estate). Put your money into a broad range of financial assets and let the overall economy work for you. Be a player for the long term.

Why do we want such big houses anyway? Impress our neighbors? Reward ourselves? More room to store our junk? Beats me. My guess is that we want a castle to announce to an uncaring world that we’ve arrived.

Enjoy your castle while I go dig some money up in the yard.

Thought for the Moment

Pay attention to your enemies, for they are the first to discover your mistakes.

— philosopher Antisthenes (c. 445-365 B.C.E.)

Joe D. Jones, CPA (retired), is publisher of the Mississippi Business Journal. Contact him at cpajones@msbusiness.com.


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