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19 July 2007

Florida and California top US investment risk list

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by Brian Turner

Florida and California top US investment risk list

Property in Florida tops a list of investment risk areas, with areas of California close after, in a study conducted on the US real estate market published by Forbes.

Miami and Orlando are two cities in Florida that topped the risk list, with Californian cities Sacramento, San Francisco, and San Diego, taking 3rd, 4th, and 5th place respectively.

Other cities in the top 10 for high risk included Kansas City, Phoenix, Cincinnati, Chicago, and Denver.

The list was compiled by assessing various factors, including a high share of adjustable-rate mortgages, high loan-to-value, high vacancy rates and slumping prices. The cities that scored highest on these were judged to be most at risk from future shocks, such as rising interest rates.

The number of adjustable-rate mortgages (ARM) – similar to UK discounted fixed rate mortgages – leaves borrowers on reduced rates, which increases the potential for serious repayment problems as interest rates rise. Which is exactly what has already been happening in the US, with further rises being predicted.

The risk factor really kicks in when a high percent of mortgages in an area are ARM’s.

San Francisco, San Diego and Los Angeles all have the highest percentage of these, and additionally these cities have very high price-to-earnings ratio, which make them relatively unaffordable for most residents – leaving the markets potentially overvalued and vulnerable to correction.

Additional risk factors include cities with a high proportion of mortgages with loan-to-value ratios in excess of 90%. Loan-to-value (LTV) measures the size of the mortgage to a home’s overall value. In a standard home buy, the down payment is 10% of the overall value, meaning the LTV is 90%.

Homes where the LTV is above 90% means home owners have little equity, and are more likely to default on a mortgage.

If the market becomes difficulty, owners walking away from high LTV mortgages can depress prices and markets further, which is exactly what is happening in the US subprime mortgage market at present.

Additional risks included vacancy rates, which suggest over-supply. Although local economic conditions can mitigate these, Orlando specifically stood out as having a vacancy rate of over 5%, which means buy to let markets are already under pressure.

Overall, the Forbes report highlights the economic pressures and factors underlying the US property market, and UK investors are advised to be keenly aware of these when making a purchasing decision.

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