(FORTUNE Magazine) – In early 1999, David Barnes, an executive who manages wind farms for investment bank Babcock & Brown, bought a modest stucco ranch in a bedroom community near San Diego for $350,000. He wanted it for the usual reasons: as a place to raise a family, store the RV, and park his golf clubs. Since then the real estate frenzy has pushed the value of that ho-hum house to $1.1 million, handing Barnes an unexpected, maybe once-in-a-lifetime paper windfall, the kind of money it would take him decades to save on his salary. Barnes--like millions of Americans in the same position--can lock in the gain only if he sells. Under normal circumstances he wouldn't dream of changing cities to cash in on his home. But these times are so extraordinary that he's decided to do just that: grab the money and move to Dallas, a far cheaper city. "The runup is so big that I've decided to seize a rare opportunity," he says. "I'm afraid the bubble will burst, so we'd lose a lot of our gain if we wait."

At 44, Barnes is taking this radical step because pocketing the extra money now will virtually clinch his cherished goal of retiring in ten years or so. As a member of the new economy's flexible workforce, Barnes will take his job with him: He spends most of his time on the road, supervising maintenance for wind farms coast to coast. Moving to Dallas will bring Barnes closer to his daughter's home. "But my main motivation," he says, "is the money." Assuming he sells the house for $1.1 million and pays off the $280,000 left on his mortgage, he'll clear more than $700,000 after taxes and closing costs. He'll also get a major housing upgrade. For just $470,000, he's buying a 5,000-square-foot brick-and-stone manse on 1.5 acres planted with magnolias and pines. Essentially, Barnes is doing housing arbitrage: shifting money from a highly risky market to a reasonably cheap and stable one.

From San Francisco to Miami, Seattle to Boston, America's homeowners are asking the same crucial question: How do I protect the huge gains in my house? If you're part of the multitude who haven't saved nearly enough for their golden years, your house could prove your salvation. The boom has probably transformed your home into your largest source of wealth. And if you reside in a traditionally volatile coastal market, that wealth is now sitting in a high-risk investment. Homeowners are rightly worried that prices could soon slide from today's incredible heights. Locking in the gains now, as David Barnes did, could mean a far more comfortable retirement.

Selling isn't right for everyone. If you're a decade or more from retirement and tied to your job in Scarsdale or Palo Alto, for example, and you plan to live in your house a long time, Barnes's strategy doesn't make sense for you. But don't despair: While you'll probably suffer through a rocky market, prices will eventually resume their upward trend, as they always have. Over ten or 15 years, your house should hand you a return that's a bit better than inflation. Just don't expect the kind of bonanza we've seen in the past decade.

If you have some flexibility, though, think seriously about taking a profit and moving to a cheaper area. Sure, uprooting the family is painful, and you'll miss your tennis buddies and the local doctor. But this market is so crazy, the money so huge, that the outsized gains could easily tip the scales in favor of a sale. And if you're nearing retirement and plan to sell eventually anyway, it's practically a no-brainer. Say you plan to keep working for another two to seven years and then move to a less expensive place such as Texas or North Carolina. Sell now, bank the money, and rent for a few years before you move to your new city.

That's right: Rent. While home prices are dangerously high in hot markets, rents are generally a screaming bargain. The disconnect between prices and rents carries two strong messages, especially for folks planning to retire in a few years. First, prices can't keep soaring while rents stay flat. The rent--what you'd pay to live in the house--is the fundamental factor driving its value, just as earnings growth guides stock prices. Booming prices and depressed rents are an unstable, unsustainable combination, a flashing red alert that we're in a bubble. Second, you can grab a peak or near-peak price on your house, then rent a similar one for as little as half the cost of owning it (even after factoring in the tax benefits of ownership).

Why are rents keeping cool while prices keep getting hotter? Because a large swath of today's buyers aren't purchasing homes to live in. The U.S. is creating 1.2 million new households a year, yet we're building about two million homes and condos. So 800,000 units are serving not as primary residences but as investments or as second and third homes. These houses and condos often go back on the market as rentals, since owners need the income to cover the mortgage payments and taxes. The glut is keeping rents down.

In most big coastal cities, it now costs 40% to 70% as much to rent as to own. Home prices in those places have either doubled or almost doubled since 2000. But in most of them, rents have barely budged. In San Francisco, for example, rent on the median-priced house runs $1,532 a month, according to Torto Wheaton Research, a unit of real estate brokerage firm CB Richard Ellis. Carrying the same house costs the owner $3,424 a month.

Of course, if you wait, you could end up getting even more for your house. But you're taking a risk. The higher prices go, the bigger the eventual correction. In some markets, prices could fall sharply. "There's a danger of a decline in New York, San Francisco, and Boston because you have a combination of astronomical prices and no job growth," says Ingo Winzer, who runs The Local Market Monitor, a newsletter that analyzes housing prices across the country. In markets where job growth is stronger, notably Phoenix, Los Angeles, and San Diego, prices are more likely to go sideways for a long time. You could get stuck for years with a zero return on the money locked in your house. But if you sell and put the money in bonds and dividend-paying stocks, you should reap a relatively safe return of 5% or so that will keep your retirement account growing.

To make matters worse, it could take you a lot longer to sell your house three years from now than it would today. When thriving markets go soft, offers dry up, and the few buyers lob in low-ball bids. It might take you a year to get your asking price--which could be well below what your house would sell for now. If you've managed to buy your retirement home, you'll take a bath paying the interest and taxes on the unsold house. If you need the money from the old house to buy the new one, you could sacrifice a year of relaxation in a spot you cherish for the stress of struggling to escape at a decent price.

That's a sacrifice that Bob Wood, a 62-year-old health-care consultant, didn't want to make. In the past year he and his wife, Sue, a facilities manager, have sold both of their houses: their main residence in Walnut Creek, Calif., a tony community east of Oakland, and a vacation home in Lake Tahoe. "We just had too much of our portfolio in real estate," says Wood. "We planned to sell in a few years anyway, so we wanted to avoid the risk that the market goes awry." The Woods pocketed a total of $1.4 million after paying off a $200,000 mortgage. On the Walnut Creek house they benefited from a fabulous tax break for people selling a primary residence: The first $500,000 of the gain (for singles, it's $250,000) is exempt from federal and state income tax.

Now the Woods are renting a $700,000 home in Walnut Creek, just a mile from their old house, for $2,000 a month. "It's a total bargain," says Bob. "The rent doesn't come close to covering the costs of owning a house that expensive." Meanwhile the Woods are building their dream retirement home in a country-club community in Meadow Vista, between Sacramento and Lake Tahoe. For a total cost of $1.1 million, they're getting a house that's 3,700 square feet, twice as big as the one in Walnut Creek.

But isn't it risky to be putting money back into California real estate? "Houses in Meadow Vista aren't nearly as pricey as the ones in Walnut Creek, so there's less chance of a fall," says Wood. He and his wife also plan to live there for many years to come, so they can ride out a tough market. In effect, the Woods are rebalancing their portfolio to hold less in real estate and more in cash. If they take out no loan on the new house, their cash tied up in property will drop from $1.6 million--the $1.4 million from the sales plus $200,000 they paid for the lot in Meadow Vista--to $1.1 million. The extra $500,000 goes into savings.

From a purely financial standpoint, the smartest play is to buy in a retirement market where prices haven't risen much or have just started to jump. The roster of such enclaves is studded with attractive names, among them Asheville, N.C.; Austin; Charleston, S.C.; Pensacola, Fla.; Salt Lake City; and Santa Fe. In Asheville, retirees can buy a four-bedroom house on three acres with gorgeous views of the Blue Ridge Mountains for $400,000, less than half of what a tiny ranch goes for in Walnut Creek. But what if your heart's set on an expensive locale? At least buy something cheaper than the house you just sold--a condo or townhouse in one of the thousands of adult communities sprouting in the Sun Belt, for example--so that you take a chunk of your gain off the table.

No matter where you buy a retirement home, don't be so frantic to act right this minute that you neglect to research things like the quality of the local hospitals and the rate of increase in property taxes. "Before buying, you should take vacations in the community, read the local papers, learn about the good and bad areas," says Terry Gustafson, a financial planner in Carlsbad, Calif. "The biggest mistake is buying in a place that you learn too late isn't where you want to retire." If you rush into the wrong community, the cost of relocating twice--everything from commissions to moving expenses--will eat up a big part of your original gain.

Instead, follow the example of K.C. Hutter and her husband, Jerry, a CPA, both in their early 60s. They spent two years visiting towns near the water up and down the West Coast before settling on Port Townsend, Wash., a hamlet of 8,000 set like a jewel on the Olympic Peninsula. They learned it was a mecca for boaters--Jerry is an amateur boat builder--and found that property taxes were relatively low and real estate prices had not yet zoomed. The payoff: a manor house they adore on five acres for a bargain price of just $649,000, half what they got for their home in San Diego.

Assuming you've taken such precautions, it can be wise to buy a retirement home now even if you won't move there for a few years. The reason: You can still grab a 30-year fixed mortgage while rates are extremely low. Just make sure you're buying into a market where it will be easy to rent out your retirement home for a few years until you're ready to move into it. Otherwise your carrying costs will eat up part of the gain on the house you sold. That's another reason to favor markets where prices haven't seen big spikes. In places like Dallas, Asheville, and Santa Fe, investors haven't been nearly as active as in Miami or Las Vegas. Those quiet markets don't suffer from a glut of high-end rental housing.

If you're in your 30s or 40s but can't leave your home city, you may be tempted to try to time the market by selling your house now, renting for a few years, then buying back in. Don't. You're likely to hand back too much money in transaction costs. In Manhattan, for example, selling a condo in the $1.0 million to $1.3 million range (around the average for a two-bedroom) costs about $90,000 in taxes and fees, including a 1.83% state and city transfer tax, plus a 5% to 6% commission. And that's assuming the gain is $500,000 or less for a couple and hence free of capital gains tax. Buying back the same condo costs about $40,000, including a 1% state "mansion tax," a mortgage tax, and title insurance. If your original gain was $500,000, you're giving back $130,000, or more than 25% of it, in transaction costs. Unless prices collapse and you buy back at an absolute song, you're better off staying put.

The best move for those tethered to a hot market may be downsizing. You'll still own high-risk real estate, but you'll act on one of the basic strategies of financial planning: Rebalance your portfolio to avoid concentrating too much of your wealth in one place. Tim McIntosh, a financial planner in St. Petersburg, just sold a stately old home for twice what he paid for it in 1999, then bought a far less expensive townhouse. The trade enabled McIntosh to add several hundred thousand dollars to his retirement fund. "This market reminds me of tech stocks in 1999," he says.

Think hard about that comparison to the tech bubble. When investors start running things in the housing market, you know it's time to bail.

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