Protecting yourself from a housing slump

Room to rise
In the short term, BusinessWeek's Luxury Housing Affordability Index shows cause for concern about prices, especially in hot coastal markets. The index tracks whether upper-bracket houses are affordable to people with upper-bracket incomes, analogous to the National Association of Realtors' index for median-priced houses. Among major metro areas, the index shows, high-end housing is the least affordable in Los Angeles, followed by San Diego. In contrast, up-market properties consume a smaller share of income in Atlanta and Detroit.

The recent sharp boom in prices has caused many people to forget that in normal times, housing is a slow-growth investment. From March, 1975, through the end of 1999, OFHEO's single-family house price index rose 268 percent — just a shadow of the 1,663 percent increase in the Standard & Poor's 500-stock index. In the short time since then, the house price index has jumped 47 percent, even as the S&P fell 24 percent. That suggests people who once speculated on stocks have turned to real estate.

Sure, there are plenty of cities where prices are reasonable and could continue to climb. David Lereah, chief economist of the National Association of Realtors, recently finished a book, due out in February, called Are You Missing the Real Estate Boom? He predicts that strong growth will boost incomes, mortgage rates will stay reasonable, immigration will feed housing demand, zoning laws will restrict construction, and demand for housing from baby boomers and their children, the echo generation, will remain strong. Says Lereah: "I foresee a healthy expansion."

Still, a lot of homeowners and potential buyers in super-hot markets worry that 2005 could be the year that the housing bubble finally pops. The best insurance against that is old-fashioned financial conservatism. If you keep your leverage modest and prepare yourself to sit tight, even a steep drop in prices should be manageable.

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