Unreal Estate

By Daniel Kadlec

When the stock market was flying six year ago, some folks looked at their soaring portfolios and concluded they had enough money to retire--only to have to burrow back into work after the Internet bubble popped. Now another set of aspiring retirees, this one reveling in inflated home values, may be in for a similar rude awakening.

Houses are not tech stocks. If your property doubled in value over the past 10 years, you can be reasonably sure that it will hang on to some, if not much, of the gain. But counting on further rapid appreciation is foolish. The average home price declined in a fourth of U.S. cities in the second quarter of this year, the most recent period for which data are available. Overall, home values still rose, but the rate of growth registered its largest falloff on record.

Softening home prices pose a bundle of problems. Not least is that millions of people borrowed heavily against their homes as values rose in recent years. Many figured that prices would keep shooting higher and allow them to preserve their home-equity cushion even as they took funds out. That game appears to be over. Tapping deeper into your home equity now could leave you short of your goals if your plan is to sell, buy smaller and live off the difference. Meanwhile, downsizing in a weakening market could take many months and net less than you might imagine.

Further borrowing poses another threat: you could be saddled with high mortgage payments just as your income drops. Indeed, folks now approaching retirement are expected to be more burdened by mortgage debt after leaving work than any previous generation, a 2005 Harvard study found.

Another popular alternative for retirees counting heavily on their homes for income is the reverse mortgage, an annuity you receive after signing the house over to a financial institution. This approach to cashing in on your house makes sense as a last resort. The good part is that the bank can't force you out even after paying the full purchase price. But the not-so-good part is that you could lose control of what may be your largest asset, including the ability to pass it on to your children. For all those reasons, "we don't consider the house an income source in our calculations," says Sophie Beckmann, a financial planner at A.G. Edwards.

Still, folks bent on retiring will find it difficult to resist thinking of a greatly appreciated home as the final piece of their call-it-quits puzzle. If you're of that mind, at least learn from the tech bubble. Would-be retirees who got bruised most back then were the ones who watched their technology stocks soar beyond expectations, enabling them to hit their savings goals ahead of schedule and quit work--but who failed to diversify and got stung when those stocks later plunged.

If real estate is what got you where you are today, hold on to your residence if you can but consider shedding any real estate investment trusts, spec homes, mortgaged rental properties and maybe even the beach house. "A lot of people look at a pie chart of their assets and find that real estate is a very large wedge," says Skip Massengill, managing director of Commerce Capital Markets, a financial planner. "Yet they may not have any idea what could happen if a bunch of properties come on the market." Hint: prices typically fall.

The softening real estate market poses yet another problem for retirees, who, with some luck and good health, might live to 95 or 100. With so many years left, they need assets that generate growth and can outpace inflation. Historically, real estate (entering a funk) and stocks (still trying to recover from the bust) have been the answer. They will be again one day. But the longer it takes for them to recover, the more you need in your nest egg before pushing the retirement button.