Surreal estate: To buy or not to buy

John Hurwitz, DO, an internist in San Jose, Calif., wants to buy medical offices near the city's O'Connor Hospital. Dr. Hurwitz, a solo physician, says he likely will try to form a partnership with other doctors to purchase offices large enough for his own practice as well as space to lease out to others.

But he has some trepidation about buying new property at a time when there's a lot of talk about a potential real estate bubble, thanks to soaring housing prices. Home prices and sales have hit new highs, with the national median single-family home price reaching $217,900 in July, up 14.6% from a year earlier, according to the National Assn. of Realtors.

But in some markets, $217,900 won't buy you a closet. In Dr. Hurwitz's San Jose, the local Dept. of Housing reports that the city's median single-family home price is $750,000.

The experts are debating whether there indeed is a real-estate bubble, one that will burst like the dot-com stock boom of the late 1990s, sending property values spiraling. Some say the bubble soon will burst. Some say any bubble is confined to certain high-priced locations, such as most anywhere near a coastline. Some say there's no bubble at all.

But while there's no consensus about whether physicians as homeowners should worry about their home values suddenly dropping, there is a consensus that any bubble will not necessarily apply to physicians who are investors in commercial real estate. In many markets, the value of office space is still recovering from its post-Internet boom, post-9/11 doldrums.

And in many markets, the value of medical office space is going up, and is expected to continue to go up, in part because of the expected growing demand for health services from baby boomers.

So what's a physician to do? Nothing rash, at the least.

"Like any investment, you obviously want to buy low and sell high, and people have the mistaken belief that real estate is something that has always grown and will continue to grow. And that is not true. It's like any other investment, it has cycles," says Jason Papier, a principal with PW Johnson Wealth Management in Sunnyvale, Calif.

Inflating the "bubble"

The surge in housing value, combined with a breakneck pace of home sales, has some experts predicting that the market is on a bubble ripe for bursting, with some geographic areas considered more risky than others.

In general, the U.S. coastal areas. including parts of Florida, the Northeast and Southern California, have been seen as the riskiest for price decreases because values have appreciated so much in those areas, and use of such financing plans as interest-only loans, in which buyers put no money down and pay only interest for the first few years of the loan, are more prevalent.

Speculation on whether the market is on the verge of a collapse has run rampant in recent months, with Federal Reserve Chair Alan Greenspan chiming in that there was "froth" and "characteristics of bubbles" in some markets -- shades of his statement before the stock market bubble burst of 2000-01 that the market was seeing "irrational exuberance."

The current cycle has all the ingredients of a boom. It is being fueled by a combination of factors including a rebounding economy, strong consumer confidence, low mortgage rates and new alternative financing mechanisms, says Nicholas Buss, PhD, senior vice president of PNC Real Estate Finance, which is part of a financial services group in Pittsburgh.

But not everyone believes a burst-bubble will materialize. Lawrence Yun, an economist with the National Assn. of Realtors, says the market is not prone to precipitous crashes nationwide. Rather, it may gradually moderate over time.

However, Yun says there have been price drops in local markets, especially those where there have been sharp, prolonged job losses accompanied by an abundance of homes for sale.

But most experts say physicians who own homes in risky markets might be able to shake off any market shift, especially if the properties are their primary residences and are therefore used as long-term investments.

"People need to understand what the landscape is. Obviously, your primary residence is not an investment. Even if it goes up 200%, when you sell it, you have just about the right amount of money to buy the same house across the street," says Russell Lundeberg, chief investment officer of Barrett Capital Management in Richmond, Va.

"If you're not trying to downsize or move to an area with a significantly [different] cost of living, you're not going to be affected by the fluctuations of the value," he adds.

Much of the prognosis depends on the market. Dr. Buss says physicians looking for residential real estate should ask the same types of questions they always have when evaluating a new market, such as whether it is in a good school district.

He says it is not necessarily a bad time to buy a new home as long as proper considerations are made and the home is within the reach of the buyer.

"People who are going to get hurt in this market if it turns -- and it will turn -- are really people who got in it at the end and who leveraged themselves up to get in," he says.

Lundeberg says the market carries risk for people who use their homes "like an ATM," taking out home-equity loans at values that could be subject to shifts.

Also at risk are property speculators. Charles N. Kuhn, president of The O'Dell Group, a Cincinnati-based wealth management firm that caters to physicians, says a small percentage of his clients, hoping to capitalize on soaring appreciation rates, have bought homes as investments rather than residences. He says the practice has gained momentum in part because low interest rates have made borrowing money "cheap."

Some investments in condominiums or other real estate properties are bought and sold for profit so fast that the practice has been nicknamed "flipping." Experts warn that these investments could be especially risky, because they often are made betting solely on the appreciation of the home value.

The flurry of activity in speculative real estate investments might be a sign that the residential market is ready to turn, says Michael Carliner, an economist with the National Assn. of Homebuilders in Washington, D.C. "That's a destabilizing influence," he says.

As interest rates slowly start to rise and talk of a bubble persists, some are beginning to wonder whether it is time to shed investment properties. Papier is among those experts who is advising some clients to reconsider their property holdings.

"To those people, we're saying that now's a good time to cash in on their investment and use their proceeds to invest in other opportunities," he says.

Dr. Buss says investors with real estate holdings should consider how prices have performed versus the market over an extended period, such as 20 years, because the last few years might paint an unrealistic picture.

Commercial properties

How much bearing any decline in residential real estate could have on commercial real estate remains to be seen. They don't necessarily move in sync -- the residential market began heating up as commercial properties started slumping a few years ago. Papier says most commercial properties still have relatively low rents, compared with what was paid for the buildings.

But Dr. Buss says commercial real estate markets in general have some increased activity in recent months. He says the primary driver in such markets is job growth, which has bounced back in the last couple of years.

"It's certainly an improving sector, and the speed at which it's improving is starting to bounce back," he says. "If you're an owner today, you're probably in a good condition."

But medical real estate has been bucking the trend. In most markets, vacancy rates are much lower than they are for other commercial properties. Even if there's a downturn in the economy, that might not change appreciably, experts say. The Medical Group Management Assn. says there was little change in building and occupancy expenses among multispecialty medical practices between 2003 and 2004, the most recent data available.

"The price of renting medical property is still really high," says Papier, saying that limited space near hospitals could be driving the trend. As a result, he has seen some physicians who were previously content to rent space consider purchasing commercial real estate.

That's why Dr. Hurwitz is deciding to dive in. He's looking at space near O'Connor Hospital, which is experiencing a boom in demand because of the recent shutdown of nearby San Jose Medical Center by HCA.

"As long as O'Connor Hospital is here, the real estate will appreciate over time, and the cash flow from the building, from leasing it out, will increase every year," he says.