Unfortunately, Part II is more bad news. Rising interest rates are almost certain to cool-off the real estate market frenzy. Some analysts are speculating that Southern California might be particularly affected.
Real estate buyers in California have been some of the most heavily-leveraged borrowers in the U.S. real estate market. Nationwide, mortgage debt has grown faster than home values, significantly reducing home equity. Even worse, in California housing prices have risen tenaciously and home buyers have increased their use of adjustable-rate mortgages to offset the difference.
As interest rates rise, these buyers will be particularly exposed. Any new refinance will incur high fees and a much steeper rate for an already cash-strapped market segment. Additionally, these buyers will lose even more equity in their biggest, perhaps even only, investment. Of course, this might open the market to some other buyers as values readjust.
It does seem housing prices will slow down – some reasonable predictions call for a crash as high as 20 percent. While many have picked California for a bigger crash than the national average, parts of Southern California offer interesting prospects. Los Angeles, for example, has little room left for expansion – as far as the aqueduct is concerned. Coupled with a predicted population explosion over the next decade, land in Los Angeles should still be a great investment in the long term – even if the short term fury cools a bit.
Of course, others are not so pessimistic. For example, David Lereah, NAR's chief economist, said the biggest surprise this year has been the performance of interest rates. "At the end of 2003, most economists expected a gradual rise in mortgage interest rates," he said. "In reality, they declined in the first quarter, shot up during the second quarter and then came back down. The bottom line is mortgage interest rates have been lower than expected, the economy is improving and jobs are being created in an environment of strong housing demand – all favorable factors for record home sales."