By Mike Heayn

The quick and dirty answer is no. Real estate does not crash like the stock or bond market. However, the real estate market can and does correct itself. The one thing to keep in mind about real estate values is that price is relative to the rest of the economy. It is highly unlikely that a $750,000 house will ever be valued at $7,500 unless everything else is similarly devalued. This means if your 4,000 square foot house dropped to a value of $7,500, from $750,000, than the value of your $40,000 Hummer would drop to $400 or less.

Real estate has not historically crashed on a national level. Instead, real estate values adjust or correct locally. This means that, hypothetically, values could drop in Los Angeles, but stay the same in Dallas. Several reasons for value corrections exist. A real estate market could be affected by a natural disaster such as an earthquake, hurricane or tornado. Another possible factor is changing demand based on external market forces. For example, a large corporation, which employees several thousand people could move to a different city or country, thus removing thousands of people from the market. When values do correct themselves, money that once went toward property improvement and new construction begins to flow to other areas such as the stock or bond market.

Just because real estate does not crash on a national level, it does not mean that national factors do not affect the local real estate markets. National news media, political events such as elections, and “consumer confidence” all play a part in driving the local real estate market. Given the variety of forces at play in the market, it is impossible to say for certain what effect an event will have on the market. Values can adjust 30 percent, 40 percent, possibly even 50 percent in an area, but the area would need to be severely over-valued for this to take place. Other events such as interest rates do affect real estate due to their affect on purchasing power available in the market. However, a panic will usually cause a correction in values much faster than any type of interest rate increase or decrease.

California experienced a large exodus of people in the early 1990’s. After the 1994 Northridge earthquake, 100,000 people were leaving California a month. Today, there are close to 100,000 returning to California a month, helping to fuel the strong real estate market of the past few years.

Buying real estate, even in a down market, is not necessarily a bad idea. If you are buying a house it provides shelter which is a basic necessity, regardless of the value. In addition, if purchasing your own residence, you get the tax benefit of writing off the annual loan interest. For homeowners planning on raising a family in their newly purchased house, they will be holding their asset much longer and will probably not notice any short-term decreases in value.

However, the dream of homeownership can be destroyed by brokers who try to place unknowledgeable buyers into exotic loans such as negative amortization loans. These loans are sold as low payment loans, but after a fixed period they adjust by as much as 100 percent of the initial payment. For example, if you had a $500,000 loan with a 3-percent introductory rate for the first year, your payments would be $2,108.02. But, after the first year, if your payment consisted of a 3.5 percent margin tied to an index that was at 5 percent, the fully indexed rate would be 8.5 percent, making your payment jump to $3,757.50 — a whopping $1,649.48 increase. That can be a payment shock many people are not prepared for and some cannot afford to pay. Do not be misled by exotic loan products that promise the world, many times you are just delaying the inevitable high payment. Eventually, loans do have to be paid down.

The national real estate market will not crash. Locally, real estate markets will notice corrections, some of which will cause a decrease in values. One thing remains, real estate is and will always be a tangible asset, which provides shelter and tax benefits.

(Mike Heayn is a Washington Mutual multi-family loan consultant. He can be reached at (310) 428-1342 or michael.heayn@wamu.net. Visit his web site at www.re101.net.)