Let's talk about the boom towns in the residential real estate market and figure out what markets will stay strong. The Federal Deposit Insurance Corp. announced that they have identified 55 boom metro markets at the end of 2004 - 21 of which are in our Golden State. A real estate boom market has been defined by the FDIC as an area where real price-growth increases amount to at least 30 percent over three years. 2004 saw 55 boom markets - up from 32 a year earlier. Those areas are concentrated in California (21), the Northeast (18) and Florida (11).

Home-growth prices (appreciation minus inflation) have risen to their highest levels since the FDIC began collecting data in 1977...but few are speculating that this bubble is going to burst. According to the FDIC studies, only 17 percent of all housing booms end in busts. A bust is defined as a drop of 15 percent over five years. Data indicates that busts are preceded by a significant stress in local economies, such as loss of jobs, because the new president is from another part of the country, and shifting development from that area. Disasters such as earthquakes, fires, floods and riots can also contribute to a bust. 

"Fixed mortgage interest rates have fallen compared with a year ago, and remain below 6 percent," said Jim Hamilton, president of the California Association of Realtors. "This continues to propel both sales and the median price of a home as consumers gauge current market conditions against future interest rate increases."

According to the Federal Housing Finance Board, the average effective mortgage interest rate for existing homes was 5.83 percent during the second quarter of 2005, up from 5.77 percent in the first quarter; the rate was 5.73 percent in the second quarter of 2004. This is a weighted average interest rate between fixed and adjustable loans, including the cost of points, and represents the bottom-line mortgage cost.

"I don't see anything likely to cause any radical changes in the market," said Michael Carney, finance and real estate professor at Cal Poly Pomona. "If people start getting panicky about the bubble business, that can have a psychological effect on the market, but that's not happening."

Nationally, approximately 60% of homeowners expect the value of their homes to increase by at least 5% annually during the next several years, according to an online survey of 1,001 American consumers calculated by RBC Capital Markets. The study revealed that  24% anticipated annualized gains of 10 percent or more over the next few years. A minimal 3% of respondents said they expect their home values to decline over the next few years.

10% of the respondents said rising home values have affected their spending habits. And over half of those surveyed disagreed with the notion that real estate gains impacted their spending even though 51 percent either sold their home or borrowed against their home equity in some fashion. Ironically, those that disagreed most with the idea that real estate gains had impacted their spending were those in higher income brackets (defined as those making over $100,000) and those that had already experienced the biggest real estate gains, RBC reported.

There are several aspects of the housing boom that makes analysts nervous. One
factor is the rise in interest-only mortgages. This popular option - which accounted for 61% of homes loans in 2004, allows buyers who would not qualify for 30-year fixed mortgages to get approved for low fixed rates for three or five years. These later convert to loans with sharply higher payments, which may force some owners to sell their homes, possibly flooding the market.

David Soleymani, managing director of First Capital Mortgage is already observing. He has borrowers that are 3 years into an interest-only 5-year fixed loan at 4.25% are switching to mortgages that are fixed at 5.87% for 10 years. Essentially, they've traded a $3,400 monthly payment for one that's guaranteed at $4,700 for 10 years.

"They're paying a huge premium, but they're getting 10 years' protection instead of the two they had left," Soleymani declared. "They can now ride out a whole interest-rate and housing cycle without worrying about an increase in their payments."

Economists state that if long-term mortgage rates rise no more than 2 percentage points, there should be a big drop in the real estate market. But, the Fed is aware of the fact that if there is a radical rise, it may result in an increase in foreclosures and a reverse in housing activity.

"Not only are most people expecting big real estate gains to continue, the vast majority of people don't believe these gains have impacted their spending. These opinions run contrary to most data in the marketplace regarding the real estate wealth effect," said Scot Ciccarelli, managing director of equity research for RBC Capital Markets. "In our minds, the question is whether people have spent more freely than they otherwise would have because of their real estate gains and don't even recognize it. If that's the case, a simple slowing of real estate gains, not just a fall in housing prices, could have a significant adverse impact on spending patterns."

About 60 percent said rising gas and energy prices were already causing them to cut back on their spending. And, by a 2-to-1 ratio, people are more positive about their personal financial situation than they are on the broader economy. On average, just under 40% of respondents were optimistic about their personal financial situation and just over 30% were concerned or pessimistic, the survey found. 20% were optimistic about the broader economy while just over 50% were concerned about the economy.

Los Angeles can be feel comforted by the third quarter housing and economic forecast released by the University of California, Los Angeles.

"The slowdown is now considered to be more gradual than predicted in June as the projected reduction in housing construction is still in the future," according to an announcement from forcast spokesperson ,Michael Bazdarich. "In California, there are hopes for a 'soft landing' as the economy weakens over the next two years. The Los Angeles forecast mirrors that of California, as a number or risk factors including payroll employment and residential real estate pose a threat to the moderate growth currently being experienced."

The forcast calls for a slowdown in the U.S. economy through 2006, with declines in housing construction on the horizon.

UCLA Anderson senior economist Ryan Ratcliff states, "Any trouble in real estate markets is more than six months out, so our forecast is for a slowdown in housing in early 2006, leading to a broader economic slowdown in 2006-2007. At this time, there is not enough evidence from our leading indicators to suggest that this slowdown will become a full-blown recession."