.bodytext {float: left; } .floatimg-left-hort { float:left; margin-top:10px; margin-right: 10px; width:300px; clear:left;} .floatimg-left-caption-hort { float:left; margin-bottom:10px; width:300px; margin-right:10px; clear:left;} .floatimg-left-vert { float:left; margin-top:10px; margin-right:15px; width:200px;} .floatimg-left-caption-vert { float:left; margin-right:10px; margin-bottom:10px; font-size: 10px; width:200px;} .floatimg-right-hort { float:right; margin-top:10px; margin-left:10px; margin-bottom:10px; width: 300px;} .floatimg-right-caption-hort { float:left; margin-right:10px; margin-bottom:10px; width: 300px; font-size: 10px; } .floatimg-right-vert { float:right; margin-top:10px; margin-left:10px; margin-bottom:10px; width: 200px;} .floatimg-right-caption-vert { float:left; margin-right:10px; margin-bottom:10px; width: 200px; font-size: 10px; } .floatimgright-sidebar { float:right; margin-top:10px; margin-left:10px; margin-bottom:10px; width: 200px; border-top-style: double; border-top-color: black; border-bottom-style: double; border-bottom-color: black;} .floatimgright-sidebar p { line-height: 115%; text-indent: 10px; } .floatimgright-sidebar h4 { font-variant:small-caps; } .pullquote { float:right; margin-top:10px; margin-left:10px; margin-bottom:10px; width: 150px; background: url(http://www.dmbusinessdaily.com/DAILY/editorial/extras/closequote.gif) no-repeat bottom right !important ; line-height: 150%; font-size: 125%; border-top: 1px solid; border-bottom: 1px solid;} .floatvidleft { float:left; margin-bottom:10px; width:325px; margin-right:10px; clear:left;} .floatvidright { float:right; margin-bottom:10px; width:325px; margin-right:10px; clear:left;} We are all familiar with the problems in the capital markets as they relate to subprime lending. We might be asking ourselves how this affects the capital markets for investment purposes.

What is happening in the housing market happens in many industries. The housing market was very strong over the past five to seven years and even beyond. When the stock market was hitting the skids in early 2000, people began putting their investment dollars into real estate. Even those who just owned a home did well with their real estate holdings.

In many cases it created a lifestyle that many could not have sustained had it not been for increasing real estate values. Many apartment renters jumped into the game of owning real estate because of lending practices. Developers got greedy, home builders got greedy, and so did real estate investors.

What has ensued is an overproduction of product because things were going so well. As of July 31, 2007, Des Moines had a 10-month inventory of new homes on the market, based on statistics from the Multiple Listing Service for this market. This market will have to go through a down cycle in order to absorb this inventory. This overproduction of houses will work itself out in time. Again, this is no different from many other industries that overproduce when their products are selling briskly.

Buying real estate using mortgage loans is like buying equities on margin. As long as the values of those equities continue to increase, you will make money and dramatically increase your returns compared with paying cash for that investment. If the value of that stock decreases, you will lose the money invested at a precipitous rate and could potentially owe additional money depending on how hard the fall.

The real estate market is no different. If you purchased real estate with no money down or have a high loan-to-value ratio, and then the value of the property goes down and on top of that you have short-term financing, chances are you are going to be squeezed out of your real estate. In many cases recently, loan-to-value ratios were above 100 percent; in other words, the borrower owed more for the property than its value.

The stock market crash of 2000 is a good parallel to the current real estate market; as former Federal Reserve Chairman Alan Greenspan once said, “too much irrational exuberance.” But remember, though the technology stocks were hit hard, the rest of the market took a downturn that was not nearly as severe. After the crash, the stock market has recovered slowly but quite nicely. This will also happen in real estate; some sectors hardly will be affected by the downturn while others are hit hard. Over time the real estate market will improve. It will come back slowly, just like the equity markets.

Back to the question of how this affects the capital markets for investment purposes. Capital is in constant flux; the dollar changes in value on a daily basis. Real estate is an illiquid investment, so when a segment of the real estate market suffers, the capital markets tend to panic and look at real estate overall as a risky investment.

Lending institutions have been falling all over one another to lend money. This aggressive nature will change. When it comes to borrowing money to purchase real estate, lenders are going to stiffen their underwriting criteria. There will be more scrutiny of appraisals, lower loan-to-value ratios will be required, shorter amortization periods will be offered, loans will come due sooner and fees will increase to pay for additional underwriting.

The end result will be that investment returns will have to increase to absorb some of these increased costs of borrowing money. In other words, a saner marketplace for real estate.

Rick Krause is an income property specialist with West Des Moines-based Iowa Realty Commercial.