Table of Contents Late Fall 2007  •  Volume 3, Number 2

Building Financial Independence on a Bubble?

By Frank D. Prestia

The world of real estate transactions generally involves two parties who ultimately want the same thing: a transaction. Despite their diverging interests, disputes over price and terms, irreconcilable personalities, and attention to immaterial details, an attorney needs to have some real world understanding of people and interpersonal skills to reach mutual acceptance on a contract, keep these parties together and close the transaction. In short, you can provide all the legal advice in the world, but when that newlywed couple or the family of four finally find the home they want or the seller who recently lost his/her job needs to sell, it is important to provide that advisement in light of your client’s ultimate goal.

It is also important for an attorney to have some familiarity with the real estate market and the different cast of characters that are involved. In the same way, you can know all about the law, but when you go to court to litigate, you need to know the laws and case law, information about the jurors, how to “work” the courtroom, the Judge and the Judge’s staff, etc.

Real Estate Bubble?
Is there a bubble? Is there a correction? Around the country many housing markets are down. In my opinion, however, in certain markets (e.g. my area of Western Washington State) housing prices have increased and been sustained by a variety of factors, the greatest being a small class of highly paid executives and transplants from other states. Even in those areas with sustained prices, the average salaries have not, do not, and will not keep up with increases in housing prices. As the rest of the economy slows it will at some point affect the local housing market.

Potential problems are compounded with the recent housing boom. Akin to the tech stock boom of the late 1990’s, market exuberance pretty much made picking stocks based upon careful research and analysis seem silly and many people became stock traders and/or day traders. Furthermore, the over exuberance of the public further escalated the gravity of the situation. Unfortunately, many people learned this lesson the hard way when the tech bubble burst.

Why Does This Happen?
Every time there is an opportunity to make money in a particular industry, there is a vast influx of people to that industry. Unfortunately, some of these individuals have no expertise, no long term dedication and commitment and unfortunately no long term accountability.

Statistically, there has been a tremendous increase in the amount of licensed real estate agents in Washington, where a person without a high school diploma need only attend 60 hours of classes and pass the real estate exam to become a licensed agent. Unlike the process and work involved in becoming an attorney, a person can typically become a real estate agent in a few weeks and regardless of how good of an agent that person is, experience is important. What sometimes happens is people hire these agents because they are family members or friends and rely on them for advice on significant transactions, which is similar to getting stock tips from your newly licensed friend/family member in the late 1990s.

The internet, online real estate courses and online real estate listings have made it easier for individuals to enter the real estate market. This is similar to someone buying pleading forms or a last will and testament on line: these forms only “scratch” the surface of the process. Simply finding a home you desire is only the first step and unfortunately many people buy a home without understanding the financial risks, costs of ownership and maintenance, and ultimately may be “upside-down” (mortgage and costs of closing are higher than profit) once the market corrects itself. Some people will even go so far as to get a real estate license to save on commission which is reminiscent of people trading stocks directly and without a broker in the late 1990s. They saved on commissions too and sure many made money, but how many were able to keep it?

Unfortunately, many people have used their home’s appreciation and belief of continued appreciation to continually finance debt for vacations, investments, luxury items and so on. Well, as the market “corrects” itself, many of these same people will be unable to sell their homes with any equity, with some even having to pay off debts at closing.

In fact, many of the challenges being faced by the sub-prime mortgage and lending institutions are directly related to the overvaluation of real estate by borrowers. Specifically, if Lender lends home Buyer money to purchase a property valued at $1000,000.00 even though Buyer may have questionable financials but based on Lender’s belief that property values will keep rising which protects Lender’s loan by having more equity, then if values diminish by 5%, then that same property is now valued at $950,000.00 so the Lender’s concerns regarding Buyer’s financials and potential “time on the market” if Lender needs to sell home are compounded.

Should People Still Invest In Real Estate?
It this writer’s opinion (which is admittedly a bias one since I believe in my professional services) there are definitely sound investments in real estate, as there were during the stock boom of the 1990s. Also, so long as a region’s residents cannot afford the average home, there will be a need for commercial and investment rental units: apartment buildings and storage/warehouse units. Along the same lines, businesses will be unable to purchase space and will have to rent office, retail and industrial space.

However, after reaching record prices for office buildings, apartments and hotels earlier this year, commercial real estate prices are expected to decrease by up to 15% in certain markets in the next 12 to 18 months. The area potentially hit hardest will be office buildings, which I think is partially attributed to new technologies which make it easier for small professional offices (like a solo law practice) to work from home. Recently, Bloomberg Office Property Index fell 2.9 percent, led by SL Green Realty Corp., Manhattan's largest office landlord. Shares of the countries largest commercial broker, CB Richard Ellis Group Inc. dropped 9.3%. As always, potential opportunities will be available to the knowledgeable investor.

Ultimately, the world of real estate transactions is a fascinating field with plenty of complex issues and an interesting cast of characters. Fortunately, from the real estate agents, to the lenders, to the inspectors and appraisers, to even the attorneys and parties themselves, everyone wants a smooth transaction and to “Close.”

Frank D. Prestia is the co-founder and designated broker of Prestia Group, a real estate brokerage. He can be reached at 206-624-9366 or or you can visit his web site at www.prestiagroup.com.

Copyright 2007

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