How to Find the Riskiest Housing Markets

Risk is all relative, but when it comes to real estate investing, how do you take the temperature of local markets so that you know which may be overheated and headed for decline — and the real value of a property?

This quandary is the subject of a Bloomberg Media column by John Wasik, who looked at rates of increase in home sales, the number of unsold homes, and the percentage of speculators making purchases… before concluding they may not be reliable measures.

These above factors are popular gauges, but for prospective buyers, may not be accurate signs of whether a buyer is getting in at the peak of the market, or the level of risk involved. What you need to really understand the situation is a comprehensive, inside look at housing activity. Home price figures give you a shallow view of the housing market.

The Office of Federal Housing Enterprise Oversight (OFHEO), for example, reported June 1 that U.S. prices rose 2 percent in the first quarter, down 1 percentage point from the previous quarter, for an annual rate of 8 percent.

Yet a slower appreciation rate doesn’t necessarily give you an insight into which markets are headed for a gradual easing, a decline or outright crash. From the OFHEO numbers, we know that the highest-growth markets were St. George, Utah, Naples, Fort Myers and Lakeland, Florida, and Phoenix-Scottsdale, Arizona.

As you are surely aware, the meteoric rise of the South Florida housing market has been well documented. Appreciation in those areas ranged from 36-38 percent over the past year. Do these cities pose any more risk to investors than Boulder, Colorado; Monroe, Michigan; or Anderson, Indiana, where prices fell by 0.12 to 3 percent?

HomeSmart Reports of San Juan Capistrano, California, may have a better diagnostic tool for examining property-market risk. HomeSmart evaluates conventional figures like sales trends and property values, then combines that data with lender-monitored information like property and neighborhood characteristics, local market trends, flipping and defaults.

It’s critical to know how many people are defaulting on home loans and to monitor the amount of speculation in a market. If housing prices become unaffordable for most buyers, the local economy goes south or prices are largely driven by flippers — speculators who turn over properties in a heartbeat — that’s essential information.

“Much of the normal market risk has been absent, or at least obscured, the last three years because of the strength of the real estate market,” said Mike Ela, HomeSmart’s president. “Now that sales are slowing and appreciation rates are coming down, risk is re-emerging.”

The company estimates that risk scores increased by 14.3 percent nationally during the October-to-April period compared with the previous six months. When there’s more inherent danger in a particular market, lenders pay much more attention to “collateral risk,” or the chance of a decline in a given property’s value.

While it can be argued that Florida home loan scrutiny hasn’t been all that intense in an era of double-digit home-price growth, and it’s incredibly difficult to predict housing market turns, the red flags are still being waved.

For instance, it’s no secret that there are plenty of unsold condos in South Florida, and that market (among others) has been driven by speculators from all over the world. The following were the largest percentage increases from November 2005 through April this year in metropolitan areas that Ela identifies as risky:

• Miami/Miami Beach, up 77 percent.
• Hawaii, 52 percent.
• New Hampshire, 42 percent.
• Bellingham, Washington, 33 percent.
• Kennewick-Richland-Pasco, Washington, 28 percent.
• West Palm Beach/Boca Raton, Florida, 26 percent.
• Riverside-San Bernardino, California, 22 percent.
• Rochester, New York, 22 percent.
• Camden, New Jersey, 11 percent.

Several regional markets, including Southern California, Florida and Nevada are seeing a cooling trend, but much of this real estate cooldown is due to the fact that the cycle is nearing an end and not because of a steep rise in interest rates — in essence, it’s a breather.

No market picture is complete without a detailed evaluation of all forms of risk, including exposure to the perils of the Florida home mortgage loan market. How much risk are you willing to take? If you are financing with adjustable-rate loans, how much of an increase in monthly payments can you afford if interest rates rise? If the property you’re investing in suddenly loses principal, would that be a problem?

This is a pointed dilemma if you’re investing with interest-only Florida mortgages that adjust to short-term rates. Say you had an “option” adjustable-rate loan and the rate went from 5 percent to 6.5 percent. Your monthly payment would rise 123 percent. Could you handle it?

“As Americans struggle to become homeowners the use of interest-only and optional payment mortgages continues to increase,” said a study by the Consumer Federation of America last month.

There may be rough times ahead in some of the hottest housing areas. Check all your gauges and you might see risk rise and fall rapidly… or you might find that all this Florida housing bubble talk is just a lot of hot air.