Real estate: When booms go bust...

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Real estate: When booms go bust...Home prices can and do go down. Here's what declines have looked like in the past.

Across America, real-estate prices continue to confound the skeptics. Many Americans have come to think of their homes as rock-solid investments with little downside.
And why not: For the past 40 years, national home prices have surpassed inflation by a percentage point or two on average and there has never been a national real-estate bust.
But are people ignoring the risks?
"I think Americans are not well aware that many markets are risky," says Ingo Winzer, president of Local Market Monitor, which sells real-estate market analysis to corporate and consumer clients.
Those investors should realize that price reversals do happen, even if only locally rather than nation-wide. A look at the not so distant past reveals numerous examples of cities that went through housing busts -- followed by years of falling prices. Some have never fully recovered.
Once hot, then not
Take Los Angeles, where real estate has been turbocharged for nearly 10 years. But the early 1990s were a different story; the average house price in L.A. dropped from $222,200 in 1990 to $176,300 in 1996, a loss of 20.7 percent.
Furthermore, those are nominal prices, not real values. To calculate the loss more realistically you would have to figure in the cost of inflation: $222,200 in 1990 would have been worth $266,700 in 1996 dollars, which means the actual loss for homeowners buying in 1990 and selling in 1996 was closer to 34 percent.
Not exactly the Nasdaq meltdown for investors, but getting closer.
But that's L.A., where the aerospace- and film and television production-based economy can be a bit volatile. What about cities in more traditional areas? How did things play out in Peoria, Ill. for instance?
Not well, not in the early 1980s at least. Peoria experienced real-estate price drops amounting to more than 15 percent tied, in part, to strikes and lay-offs at Caterpillar, the city's biggest employer. In 1981, the average home there sold for $60,800. By 1985, that had dipped to $51,400.
"Oil patch" cities, suffered even sharper declines. In Oklahoma City prices plummeted 26 percent from 1983 to 1988. It took 15 years for prices there to return to nominal 1983 levels.
Houston home prices fell 22 percent from $111,000 to $86,800, and also took 15 years to rebound.
Counting inflation, the average Houston home, which cost just $159,700 in 2004, is actually worth less now than it was 22 years ago. When, adjusted for inflation, a home cost about $219,000 in 1983. In Oklahoma City, the inflation-adjusted price in 1983 was $196,600. Today, it's just $135,100.
The boom will end, but when?
History seems to dictate that the current price boom is at risk.
One factor is that real-estate investing has spiked, pressuring prices upward.
In Phoenix, according to Bill Jilbert, president and COO of the Coldwell Banker brokerage there, investors from Nevada and California have invaded the Arizona market, and "affordable housing has been pushed to extremes." That story is echoed in many local markets.
Low interest rates have also kept real estate bubbling. Cheap mortgages enable entry level buyers to get into the market and wealthier ones to afford more expensive houses.
That means higher demand and higher prices at all market levels.
Winzer says that low rates "have extended the cycle."
Winzer assesses local market risk by taking into account economic and population growth, construction costs, vacancy rates, and, especially, income.
He also considers such factors as density and access to open land. Prices in densely settled New York have always been higher than those of cities with lots of space for new housing.
Winzer considers real estate "very risky right now." And because the price run up has been so high he expects the adjustment period – where home prices stagnate as income catches up -- to take a very long time. Before they purchase a home, buyers better figure on scenario of many years of little or slow home-price appreciation. Counting on home price increases could be a big mistake.
The boom has already gone on longer than Winzer thought it would. "Bubbles do tend to last longer than most people expect," he says, "and end quicker."