Doug Fabian, editor, Successful Investing; and Josh Lewis, first vice president, Stearns Lending

As published in Scotsman Guide's Residential Edition, July 2005.

In the past five years, we have witnessed an explosion in California real estate. Housing values have jumped an average of 22 percent each year. Since 1999, the median price for a California home has soared from $200,000 to a record of $509,230 in April 2005, with trends showing robust housing sales and values continuing to climb.

In an up-cycle such as this, indi- viduals — especially speculative homebuyers — must understand that market psychology lags behind reality. Fear-based decisions are pumping new life into a market that has topped out in terms of real demand and affordability. It is time to consider the real demand for California real estate and what could cause prices to fall when investors are forced to sell.

Affordability status threatens demand
A housing euphoria has set in for the past 18 months. It has driven speculators to throw caution to the wind as they rush to get into the market at all costs.

Aggressive financing programs and relaxed lending guidelines have significantly lowered the barriers to entering the game. People without a significant equity stake, down payment or income to support the traditional debt-to-income ratio of roughly 1-to-3 are entering the real-estate market in droves. Buyers now can leverage real estate with zero down, no income verification and debt-to-income ratios that exceed 50 percent of their gross income. Rising interest rates and tighter credit standards could turn the inevitable housing correction into a glut of foreclosures, which would hasten a rapid fall in prices.

It also is essential to recognize that affordability also could drive a fall in California real-estate values. Even with record-low interest rates, the average monthly housing payment hit an all-time high. The only time housing payments ever approached this level, in terms of dollars adjusted for inflation, was in 1982. Then, the prime rate was as high as 17 percent, compared to today’s 6 percent. The booming real-estate market of the late 1970s and early ’80s was flattened. Today, any upward move in interest rates will further decrease the record-low affordability and limit the demand of potential homebuyers.

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