Should real estate make you nervous?

In the late 1990s, on an almost weekly basis, I warned listeners of my radio show against buying technology stocks. In fact, in our financial planning practice, we never bought Internet, dot-com or telecom stocks for our clients. Although we took a lot of flack in 1998 and 1999 for this stand — some clients complained that their portfolios were up only 40 percent while “everyone else,” they claimed, was up 400 percent — we were proven right when the dot-com bubble burst in the early 2000s. Today, I’m issuing similar warnings regarding real estate investing, as new data indicate that something is amiss in the residential real estate market.

Although we’re not expecting an outright collapse in prices like we did in tech stocks, it is foolish to expect real estate prices will continue to perform in the next five years as they did in the past five years, and the current decline in many markets is likely to continue.

Any of the following cause real estate prices to decline:

— An increase in interest rates

— An increase in the number of buyers who finance most or all of their purchase

— An increase in the use of adjustable rate, interest-only or negative amortization loans

— An increase in unemployment

— An increase in housing inventory

— An increase in inflation and property taxes

— An increase in the stock market

To further boost the size of the mortgage, unprecedented numbers of homebuyers are turning to loan products that feature lower interest rates than the 30-year fixed. They are turning to ARMs, IOs and Negative Amortization loans. In fact, in 2005, 30 percent of all mortgage loans were of this variety, according to the Mortgage Bankers Association. Although these products make initial monthly payments more affordable, there’s a catch: At some point in the not-too-distant future, the monthly payment skyrockets, even if the interest rates in the economy don’t rise! Indeed, with some of these loan programs, hapless homeowners will find themselves with monthly payments that more than double.

Many homeowners will be selling their houses as they discover they can’t afford them any longer. The more homes on the market, the more that sellers must compete for buyers, and that means a flattening or even a decrease in prices. Currently housing inventory is the largest it has been in several years.

An increase in inflation is also problematic. Many homes in America are heated by oil, and oil prices have skyrocketed thanks to Katrina and the war.

I don’t expect a collapse in prices like we saw in tech stocks. That means you’ll be fine, provided you aren’t expecting quick profits, and provided you own your home for lifestyle reasons and not speculative ones. However, if you bought real estate because you expected the price to double in a year or two, you’re likely to be disappointed. Or worse.

Financial Adviser Ric Edelman can be reached at [email protected].