Real estate experts were largely disappointed with a recent Consumer Reports study on the investment potential of home ownership.

Realty professionals said Yonkers, NY-based Consumers Union's ratings magazine offered some nuggets of useful information for consumers, but the experts more often were critical of Consumer Reports' "Making Your House Pay Off".

The story is available only in the publisher's November issue and to online subscribers.

Generally, based on the premise that the home can be an investment vehicle, Consumer Reports examined the pros and cons of such an investment from the viewpoint of buyers, sellers and home owners. It also examined the investment impact of appraisals, home improvements and so-called "bubble" markets -- markets of high and rising prices that could be prone to price deflation, or sudden popping, much like a bubble with too much air.

"You can't lose betting on the house. That's the mantra prompting millions of Americans to spend whatever it takes to get into their first house, to move up to a better one, to buy a vacation home or rental property, or to pack the home they already own with lavish improvement," the story says in part.

"... But you can lose--and lose big. Many economists and real-estate analysts say that right now bubbles exist in dozens of housing markets across the country, which means if people's incomes can't keep up with the extravagant prices they are being asked to pay, then prices will begin to slacken," according to the Consumer Reports article.

Bursting a bubble theory

Several real estate experts questioned Consumer Reports' bubble market assumptions. They said the highly-esteemed consumer magazine was shortsighted in its use of Wellesley, MA-based Local Market Monitor's price-income ratio as a barometer for overpriced markets. Based on an assumption that a certain income level is necessary to afford homes in a given area, the price-income barometer of value is similar to the price-earnings ratio used by stock analysts to measure a company's financial fitness. The price-earnings ratio is not a fool proof barometer, as analysts on Wall Street are discovering today.

In any event, Consumer Reports used the barometer to find markets most likely to be bubble markets where investments could go bust.

Using the barometer, the story lists three categories of bubble markets, those 15 to 20 percent overpriced; 21 to 30 percent overpriced; and 31 to 48 percent overpriced.

Across all three categories, Consumer Reports lists nearly four dozen markets with popping potential with most of them were in the California-West, New England-Northeast and Florida markets. Denver, New Orleans, Tucson, Des Moines, Minneapolis-St. Paul, Mobile and Chicago among others where also listed as bubble markets.

Experts say based solely on the price-income ratios, any or all of those cities may not be bubble towns.

"Price-income measures tell you little. For example, suppose I tell you that the median home price in an area is $300,000 and the median income in that same area is $70,000. 'Horrors,' some economists argue. 'The median income person can't afford the median home.' This simplistic analysis ignores what portion of current people in a market already own a home and their other assets and buying power," said Eric Tyson, a personal finance advisor from New England, where Consumer Reports says many bubble markets exist.

"If you desire to identify potentially overpriced markets, compare the monthly cost of owning a given home to the monthly cost of renting that same home. After factoring in taxes, if owning costs significantly more than renting, than you've got more potential downside risk," Tyson added.

Investment advice questioned

Richard Calhoun, a real estate broker, investor and statistician from Creekside Realty in San Jose, CA took issue with much of Consumer Report's buying advice.

For homeowners looking to sell their current home and downsize, Consumer Reports says small houses in strong markets won't be a good bargain, but homes further from the city, in less fashionable suburbs or in areas of lower quality school districts could be a better deal.

"This seems to go against the 'location, location, location' rule of real estate. My research indicates that homes appreciate based on the median priced home in any area. This means that the smaller dwelling is exactly the best investment," said Calhoun.

Also, Consumer Reports, pointing to the possibility of a volatile interest rate market, offers conservative, but safe advice to buyers in terms of how much income to devote to home buying. Only 28 to 31 percent of your gross income should be spent on housing, the report says.

"This is the worst advice I have ever heard. Every buyer should look at their own situation. If someone has a stable income (a salary, opposed to commissions) spending every penny on a house is a smart move," says Calhoun who works in Silicon Valley, one of the nation's most expensive housing markets where spending every penny on housing is often more of a necessity rather than an investment strategy.

"Not only does spending more money get a more expensive property that will appreciate more since homes tend to increase by a constant percentage, but more importantly, the more expensive property allows the property to meet the consumer's needs for a longer period. This reduces the number of times the consumer sells and that reduces transactional costs," Calhoun said.

Appraising the magazine report

Finally, from the Consumer Reports-designated bubble market of Mobile, AL, appraiser S. Denise Hall agreed with the much of the magazine's discussion of appraisers who are pressured to certify the buyer's offer as a fair and comparable value -- even when it isn't.

"Automated underwriting has made it even easier for just about anyone to become a mortgage broker, and with the increased competition we've definitely seen an increase in pressure from the banks as well," said Hall.

"I recently lost a major bank client when I refused to 'bump' an appraisal $3,000 so their client wouldn't have to pay private mortgage insurance (PMI). After I explained to the loan officer that the value she was asking for could not be justified and that I had to have support for anything I put my signature to, she simply started begging. We spend a great deal more time simply defending our values to lenders, real estate agents and homeowners." she added.

Not only is it illegal to appraise property at a higher value than it is truly worth, years down the road, when that same property is up for sale, an honest appraisal could kill the deal.

"When I started out in the appraisal business the typical loan-to-value (LTV) ratio was 80 percent, now the typical LTV is somewhere between 90-95 percent. In a resort type area like ours along the Gulf Coast, where property values tend to rise pretty rapidly, people forget that they can fall just as rapidly and have in the past due to steep rises in insurance rates and changes in tax laws involving second homes," Hall said.

Hall indicated the best of Consumer Reports was evident in the study's balanced attention to both the pros and cons of using the home as an investment vehicle. Anyone reading the article should get an equal spin from both sides of the coin.

The article's underlying warning was also on the mark.

Real estate has always been cyclical and will continue to be, but never before have I seen people who are encouraged to use their homes as piggy banks and leverage them to the hilt. What will become of them when the tide turns again, as it surely will, and they finally realize the predicament they have made for themselves?" Hall pondered.

Published: October 18, 2002

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Broderick Perkins parlayed a career in old-school journalism into a contemporary digital news service that really hits home. The award-winning consumer journalist, originally from Wilmington, DE, is founder, publisher and executive editor of the bootstrap DeadlineNews Group, a Silicon Valley-based editorial content and consulting service specializing in residential real estate, consumer news and related editorial consulting services. The DeadlineNews Group includes the website, DeadlineNews.com, offering real estate editorial content and consulting services, and its back shop, the Deadline Newsroom, an open house on news that really hits home. Perkins obtained his formal journalism education from University of Delaware and a journalism boot camp, the Institute of Journalism Education at the University of California-Berkeley. He went on to 20 years of service as a daily newspaper journalist at the Wilmington, DE News Journal and San Jose, CA Mercury News. Perkins covered housing on the San Jose Mercury News reporting team which earned a General News Reporting Pulitzer Prize in 1989 for coverage of the Loma Prieta earthquake. He has also produced real estate, consumer and small business content for the Wall Street Journal, Los Angeles Times, RealtyTimes.com, Nolo.com, Better Homes and Gardens, the National Association of Realtors, Homestore/Move and Intuit/Quicken among more than three dozen publications. In addition to managing the DeadlineNews Group, Perkins most recently served as chief editorial consultant for Nolo's Essential Guide To Buying Your First Home, Nolo, and writes real estate television scripts for RealtyTimes.com.