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Can these high rates of appreciation in second home markets really continue? Many experts believe, *Yes!*, it can sustain for a long run (not months, but years). The fundamentals of rapid appreciation equate to supply growing slower than demand. Supply in areas such as South Florida have been rapid (78,000 new or planned condo units entering the Broward/Dade county market by 2007), but material shortages and hurricanes have slowed the ramp-up and created a large amount of pent up demand chasing reduced supply. Also, the foreign buyer demand in the Miami area is extremely high, this means these buyers are using currency that is 20-30% strong than last year. A 30% rise in property values is easily absorbed in this environment.)

In areas such as Arizona and Las Vegas, water concerns and lack of infrastructure and skilled laborers have slowed the rapid pace, but the grow rate is still staggering. Other scenic second home destinations, like the mountain states, Pacific Northwest and Florida Keys have environmental hurdles which raise the barriers to entry for developers and restrict supply. A restricted supply in the face of demographically empowered demand is always a formula for rapid price appreciation (CA in 1970*s).

What goes up must come down? Yes. But a 20% per annuim rise for 5 years, followed by 5 years of stagnation or a 10% loss, is still 5%+ annual growth rate (worse case). If leveraged at 90%, the return on initial investment is still 44% per year. The hard part is making sure the best years are in the beginning* even hard is selling at a peak.

How Important Are Interest Rates, Loan Program Flexibility and Affordability?

Interest rates (the cost of money) has been a driving force in the rate of appreciation and the lure of real estate as an investment. Low rates make marginal real estate deals look attractive. Low rates help marginal home buyers buy larger homes or enter the market, increasing demand. There is a direct correlation between the cost of money and the value of highly leverage real estate. Many second homes are being purchased with cheap and easy money from lenders. But many cottages are being purchased with windfalls from inheritance in our history's largest generational wealth transfer, and I believe this will reduce the effect of higher rates on the second and retirement home markets. Another key factor is the lack of leverage in the second home/cottage market. Data proves Loan to value ratios are much lower than the highly leveraged primary home market.

But there is no reliable data to help us know if refinancing and leveraged primary homes are allowing for these under-leverage second home purchases. I suspect if given the choice, many cottage owners, if forced to choose, would keep the cottage and give the bank the city dwelling. Home is where the heart is, not the largest mortgage payment.

I am much more concerned about the first home and the *move-up* buyer's distaste for higher payments caused by higher interest rates. The traditional real estate market will feel a greater effect if there is a sharp spike in the cost of funds. If rates rise moderately, and incomes increase in proportion, there is a good case to be made that prices may narrowly be affected. But if income stagnate, and rates/inflation rise rapidly, the second home market will continue, while the primary housing market will stumble. So the case for risk has shifted, traditionally lenders considered cottage loans more risky. I argue, they are inherently less risky and growing more secure with every fed move.

Immigration policy and the dollar's real value may turn out to be more important to general home values than interest rates. If foreign investors feel at home again in America, they will likely take up more permanent residence here in larger numbers. If the dollar continues to devalue, our real estate is a bargain that cannot be passed up by the world's boomers.

Loan flexibility/availability may also be a damper on real estate values, as the age of derivative finance comes to light in institutions like FNMA, FHLMC, GNMA and large mortgage banks; we will see less aggressive lending in many markets (especially first time home buying). Since the second home is where the homeowners *heart is*, I believe the risk of default may shift to be greater in primary homes vs second residences, especially if the borrower is nearing retirement. Risk aversion will be a primary trend in the next few years among lenders, but without making loans, bankers do not get bonuses. So more liquidity will be directed at the second home market. Even as rates generally trend up, second home buyers will find more opportunities to lever vacation property with higher LTV's and lower rates and fees.

Data proves, second home loan terms in the last 3 years have become dramatically more accepting of these purchases, as down payment requirements have fallen from 20%+ to as low as 5% and new products have already been offered to this affluent market.