How to Confront the Florida Housing Bubble

Whether you’re a homeowner or residential real estate investor, you probably have a high percentage of your net worth invested in your home or other properties. This can be a scary proposition, especially if you’re afraid that the healthy Florida home loan market will soon come crashing down.

Should you be worried about the real estate bubble bursting?

Today’s market is anything but typical. The Office of Federal Housing Enterprise Oversight reports that the average U.S. home increased in value by 13.4 percent between the second quarters of 2004 and 2005. In markets such as Florida, Nevada and California, the appreciation has been far greater.

As property prices continue to move higher, some economists and other observers are voicing concerns about price bubbles and the risk that prices in some markets experience deprecitation. If the drops are significant, the impact could spread beyond home prices and potentially slow the U.S. economy.

What is a housing market bubble?

Definitions of a housing market bubble vary, but the Federal Deposit Insurance Corp.’s perspective is often used. According to the FDIC, a local real estate market is considered a “boom” market when prices have appreciated by at least 30 percent in the previous three years. According to the FDIC, 55 of the 362 U.S. metropolitan markets met this definition in 2004, and those boom markets comprise 40 percent of the value of residential real estate in the U.S.

The past few decades have shown that it takes a significant economic event to reverse strong housing markets. For example …

Southern California’s price declines in the early 1990s were exacerbated by job losses in the defense industry and a national recession. But when that area’s technology industry slowed recently, property prices continued to increase based on sustained demand from homeowners and investors.

The Australian real estate market experienced a string of double-digit price increases in the early 2000s, as real estate became the investment of popular choice. The country’s central bank responded by raising interest rates, as the Federal Reserve Board has done, and the state of New South Wales imposed a transfer tax on the sale of investment properties in a bid to dampen property speculation. These efforts popped the bubble but didn’t cause a crash.

Home prices have been largely unchanged for the past year, although some major cities have seen slight declines. Property owners who cannot receive their asking price are pulling properties from the market, leading to a reduced supply even as demand falls.

What can you do in the face of a bursting bubble?

If your property value declines, your mortgage plays the most vital role in making up for any losses. Each Florida home loan type has a unique set of advantages and risks - and your specific circumstances and needs will determine which mortgage works best for you.

If you own property in a boom market and are concerned about a “soft landing,” however, you should consider a loan that requires regular principal payments. The logic is if you finance a property with an interest-only or negative amortization loan and subsequently need to sell during a market decline, you’ll face a loss that may require an outlay of cash.

Conversely, if you had been making principal payments during the life of the loan, you would have reduced the loan’s balance and softened the loss’s impact. The economic results will be essentially the same in either scenario, but periodic principal payments reduce the cash-flow impact of selling at a loss.

Real estate investors and homeowners who live in boom markets and plan to sell their properties within the next five years should monitor their local markets closely for signs of softening. But if you plan to hold your property for the medium or long term, the media’s obsession with national property bubbles shouldn’t be a cause for concern. Real estate prices move in long-term cycles, and property owners whose mortgages fit their financial circumstances will be in a good position to sit tight through the cycles.

Information is power. If you’re concerned about your exposure to a potential real estate bubble, consult industry insiders to discuss the options available to you. These experts will take a close look at your current Florida home lown or potential Florida home loan to make sure you’re not at risk of any substantial loss.