Real Estate Is Hot ... Don't Get Burned: How CPAs Can Help Clients Survive a Tough Market
If the 1990s were noted for irrational exuberance in the stock market, certainly the early 2000s will be remembered for hysteria in real estate. How hot is it? Sales of existing homes in the western United States rose 5.1% to a record-breaking annual rate of 1.66 million units changing hands in January 2003--3.1% stronger than January 2002--according to the National Association of Realtors (NAR). With it went the median existing-home price, which soared to $219,600--an amazing 10.4% spike from the same month a year earlier. In the Northeast the median existing home price was $175,000, up 14.9% from a year ago. With the stock market still in the doldrums, it's no wonder people are considering home buying a better bet. But is it? Whether the exuberance in today's residential real estate market is rational or not, only time will tell. In the meantime, how should CPA/financial planners advise their clients in this volatile climate? Should clients buy houses and "flip" them like so many poker chips? Can houses be expected to yield returns like other investments? This article answers those questions and highlights some of the areas where CPAs can guide home buyers and sellers to a smooth transaction. RECORD LOW INTEREST RATES A home is a place to live, not an investment. Randi Grant, CPA/PFS, CFP, a partner with Berkowitz Dick Pollack & Brant in Miami, says, "Never look at your home as an investment or source of future income--only as a roof over your head." People can gain a false security watching their home values increase, reasons Grant, but they may have to use all of that gain to find comparable living space later. With today's low interest rates, many current homeowners can't resist tapping into the equity they've built up in their homes to make improvements or fund other purchases. If clients want to realize the financial gains their homes represent--without moving--and take advantage of the historically low interest rates, Angelo Ciullo, CPA, a partner with Trien Rosenberg Rosenberg Weinberg Ciullo & Fazzari LLP in Morristown, New Jersey, and New York City, recommends refinancing. "Homeowners should lock in the lowest rates in 40 years," says Ciullo. "Generally, we CPAs don't like debt," notes Bob Doyle, CPA/PFS, a partner in Spoor, Doyle & Associates in St. Petersburg, Florida. "Now that tax and interest rates are so low and itemized deductions are limited, the tax benefits of debt are not as attractive as they used to be." Despite the absence of these benefits, Doyle is having a hard time telling his clients not to borrow for 30 years at 5%. "Even though the client pays much more interest on a 30-year vs. a 15-year loan, with rates as low as we've seen in a generation, I feel compelled to support my client's borrowing plans." However, there has been less argument for recommending adjustable rate mortgages (ARMs) in this market. Ciullo says the interest rate on an ARM is fixed for a short period, say three to five years. After that, the rate floats based on an established index, such as the one-year Treasury bill rate. "Mortgage bankers love ARMs," says Ciullo. "But adjustable rate loans are wise only in the short term," he says, since rates could start heading up. That possibility puts the borrower "constantly at risk" unless he or she refinances, with all the associated costs of doing so. Ciullo's bottom-line advice: An ARM is not a good choice unless you know you will occupy the home only for a short time. Doyle agrees: "I don't think there's a lot more downside potential left in rates. The trend seems to be more toward the upside. So why use an ARM if you're going to be in the home for a long period of time?" Eventually, homeowners who don't pay off the debt quickly or sell their houses have to refinance to a fixed-rate loan--usually after rates have started to climb. At that point, what had seemed like a cheap, quick and cheerful way to grab low interest rates may come back to bite them. …