Misc. Post

A Load of Bull

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There are facts and there are myths.
There are truths and there are lies.
There are bears and there are bulls.

There are some lies that select members of the financial and real estate industry would love for you to accept as fact. Real estate agents, brokers, lenders, appraisers, contractors, bankers and anyone else who profits from a transaction has a motive to spew lies to the public for their own personal gain. Whether or not they take action to spread those lies is what distinguishes those with ethics from those without.

What’s obvious to fiscally responsible, clear-headed people may not be as apparent to the millions and millions of sheeple who blindly accept the lies told by the National Association of Realtors. The NAR is certainly not the only party with incentives to lie, but they are by far the biggest in number since everyone and their brother seems to have a real estate license these days. I will proceed to pick apart 10 popular RE myths.

Myth # 1 – Real Estate Always Go Up!

While the price of a property may go up over time, its value does not. The price increase correlates with the increase in income and inflation over time. A $85,000 house in 1974 could be worth over $300,000 now, but people also have a higher income than they did 33 years ago. If you take into account maintenance costs and the wear and tear of the property, its value has actually decreased over time because it’s a much older house.

Myth # 2 – What About the Tax Advantage?

You wouldn’t buy an item simply because it’s on sale (well, some people do). Buying a house just for the tax advantage is like buying a Gucci handbag because it’s 30% off. It’s 30% off of what price though? The tax break for the mortgage interest paid is on taxable income. The borrower must have interest expenses greater than the standard tax deduction before he/she can benefit from the tax break. The tax break is nice, but barely offsets the extra costs of homeownership like insurance, maintenance and property taxes.

Myth # 3 – There Isn’t Any More Land

This statement in and of itself is actually true – we’ve explored all corners of the world. However, it’s misleading to use this as an argument to justify home purchases. People live in housing which lies on land. Housing can be a rented apartment, a townhome, a condo, a single family home or a mansion. Just because everyone wants to live in a McMansion doesn’t mean they should or could do that. Last I checked the United States has a lot more land than Hong Kong, Japan or most European cities. No one is going to become homeless due to the lack of land. That’s just absurd.

Myth # 4 – If You Don’t Buy Now, You’ll Be Priced Out Forever!

You have got to be kidding me. Isn’t this what they said during the last bubble, and the bubble before that and the bubble before that bubble? The double-digit growth outside of market fundamentals is simply unsustainable. Just like the previous two US housing bubbles, we’re in for years – not months – of price and volume decline. We’ve already seen volume drop off a cliff and guess what, price is right behind it.

Myth # 5 – You’re Wasting Money When You Rent

It makes sense to buy only when it costs about the same or less than it does to rent a similar place. During the past few years, it costs thousands more per month to “own” than to rent. The money saved from renting is better off invested in a higher yield market. Real estate agents tell you that by renting, you don’t get to build any equity. While that may be true, renters can make a risk-free return on their money with CDs and other savings accounts. Homeowners on the other hand wake up in the middle of the night worrying what the 15% price reduction on their neighbor’s house will do to their so called equity.

Myth # 6 – Real Estate Is a Great Investment

Contrary to popular belief, real estate is a poor investment. Real estate only averages 3%-4% annual return excluding inflation. Factoring in inflation, there’s almost no gain (+0.7% per Shiller study) in home ownership over the long run other than the shelter and warm and fuzzy feelings it provides. Things change when there’s a bubble, but bubbles are by definition unstable. CDs are running at 3.65%, the stock market at 8% over the long haul and 10%+ for slightly riskier index funds. On top of that, cash, stocks and funds are highly liquid. Real estate is the exact opposite – if you can’t find a buyer, you are stuck holding the bag.

Myth # 7 – Everyone Wants To Live In California

Ah yes, the omnipresent sunshine tax of California. Sure the weather is nice, but standard of living is horrendously high. Compared to other states, you don’t get much for your money when it comes to housing. Maybe that’s why our great golden state has experienced a net outflow of people over the recent years. There are more young and middle aged families moving out of California than moving in – citing affordability as the main reason. Besides, if California is so special, then prices should never drop right? It dropped for 7 consecutive years in the early 90s before prices hit bottom.

Myth # 8 – Many Rich Asians Can/Will Buy with Cash in Arcadia

Although Arcadia has a high population of Asians, that doesn’t mean they’re all wealthy. Even if they are, they surely didn’t get wealthy by being dumb. As crazy as this sounds, they know something about money too! Why would they buy when they can rent for much cheaper? Even if they have enough dough to buy in cash, why wouldn’t they just put down enough to get a good interest rate and borrow the balance while investing the difference in a higher yield, low risk market? Just load up Redfin and take a look at the map. There are many, many homes for sale in 91006/91007. Asians are notorious for their bargaining skills and I’d imagine they’ll use those skills when purchasing a home.

Myth # 9 – Rent Will Increase Over Time

Yes, but again, rent is directly correlated to income and demand. Rents can’t skyrocket just because the landlord feels like making an extra buck if there’s no market for it. The renters can only afford to pay so much based on their disposable income. If income in the area does not increase dramatically, rent cannot and will not move much. Moreover, if demand is a reason then it actually builds the case not to buy because if so many people are buying homes, then demand for rentals is small because so many people are home owners.

Myth # 10 – Many People are on the Sidelines Waiting to Buy

With the record high rate of home ownership posted by the Bush administration, it’s clear many people bought during the boom. These people are no longer potential buyers so the buyer pool has shrunk. All the debtors who have or will default are also out of the buyer pool for the next 7 years due to bad credit. There are only so many people left on the sidelines. On top of that, these sideline buyers will have to go through much stricter lending standards since the credit market is much more risk adversed now – as they should be. That means they’ll need to have 20% downpayment, good credit, assets, relatively low DTI ratios and documented income. There aren’t too many people with those qualifications on the sidelines.

I’m not saying never buy a house. There are good reasons to buy a house, but none of the above qualify as a good reason. Instead, they’re all lies told by the industry insiders to boost their earnings.

So…

There are facts and there are myths.
There are bears and there are bulls.
Can you see why they call it bullsh*t?

Property Profiles

Golden McNugget

4 Comments

6709 N Golden West Ave.

2/14/08 Update on listing price reduction

3/25/08 Sold for $970,000 (22% off peak)
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McMansion alert! McMansion alert! McMansion alert!

Here’s another McMansion up for sale. I can’t imagine why anyone would like the look of a house that’s way overbuilt on its lot. The dominating three car garage at the front of the house is so 1980s. According to one of our readers, McMansions are “gaudy” and I agree. The sales history of this property tells yet another story of gambling on a McMansion. Perhaps these folks should have went to the Golden Nugget in Vegas instead of Golden West in Arcadia; they’ll have better odds with their money playing at the tables.

Asking Price $1,225,000 ::: Sq-ft 3477
Purchased Price $1,250,000 ::: Lot Size 6120
Purchased Date 10/13/2006 ::: Beds 5
Days on Redfin 90 ::: Baths 4
$/Sq-ft $352 ::: Year Built 2001
20% Downpayment $245,000 ::: Area Baldwin
Annual Income Required $306,250 ::: Type SFR
Est. Payment* $6,194/month ::: MLS# 12101558

*Estimated monthly payment assume 20% down, 30-yr fixed @ 6.50%

This stretch of Golden West Avenue used to be quiet, but ever since the 99 Ranch Market plaza popped up in the 90s, traffic has increased substantially. This is within walking distance to the aforementioned strip mall in addition to the Pavilions town center next to it. I often see supermarket shopping carts wander down towards the location around this house making the neighborhood look tacky. In addition, it borders the neighboring town of Temple City so it’s not prime Arcadia real estate by any means.

Date Price Appreciation
10/13/2006 $1,250,000 2.2%/yr
09/07/2005 $1,220,000 23.4%/yr
08/31/2004 $985,000 14.9%
10/30/2001 $665,000 311.8%/yr
02/09/2001 $240,000 76.4%/yr
08/29/2000 $186,000 —

As IR would say over at Irvinehousingblog, this is a “rollback” to 2005 prices. From the looks of it, the buyer in 2001 bought the property for $240k, plowed it down, built this monstrosity they call a house and sold it 8 months later for $665k. From there, the bubble takes off and wild speculation begins with transactions in 2004 for $985k to upwards of over a million dollars by bubble-mania-euphoria-year 2005. The current seller bought 15 months ago for $1.25MM on pure speculation, but won’t get burned even if he doesn’t get the asking price. Why? Because it was bought with 100% financing.

Loan 1: $1,000,000
Loan 2: $250,000
Downpayment: $0

With zero downpayment, the flipper walks away with nothing but a dinged credit score. In this case, the 2nd mortgage lender will lose $25k if they get their asking price. It’s not pretty either way, but the lenders were stupid to do 100% financing and this should teach them not to do that again.

This property has been on the market for 3 months and it’s likely it will remain unsold without a significant price reduction. If I were to spend around $1.2MM, there are much better choices in more desirable parts of Arcadia such as this in Peacock Village, this and this up in the Highlands.

Analysis

Market Fundamentals

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A financial bubble can be defined as the inflated, over-valued state of a market by unsustainable means. It is important to distinguish between what an asset is worth compared to its fundamental value.

A house is worth what a buyer is willing to pay for it. During the past few years, a typical single family home in Arcadia could be worth $1MM because people were willing to pay that dollar amount. On the other hand, its value is determined by its intrinsic offering – whether that is the shelter it provides or the cash flow it can generate. When I say “market fundamentals,” I am referring to the factors that contribute to its value, not worth.

It is important to define and understand market fundamentals because it helps illustrate the state of the market and how far away are we from the stable, historical trend. In this post we will take a deeper look at three big factors that are tied to proven fundamental values:

  • Comparable Rents

  • Income

  • Supply & Demand

Comparable Rents

Comparable rents are directly related to market fundamentals because it gives a baseline measurement of the value and worth of a property. Whether you rent or own your house, you have a place to live – that is its worth. Its value comes from how the rent and home prices are tied. If you are an investor, you have to rent it for more than it costs you to own it on a month to month basis.

After all, it makes no financial sense to purchase a home when you can rent it for a fraction of the cost, giving the renter a chance to invest the extra money in another financial market at a higher yield. Then again, most people buy property based on emotional, not financial justification. Contrary to popular belief stemming from the lies of the National Association of Realtors, real estate is generally a poor investment in terms of rate of return. We will have to discuss this another time.

Income

Incomes are directly tied to rents. That’s a fact. Why? Because most people pay rent with their salary/wages. Last I checked, there aren’t too many folks born with a golden spoon and just live life off daddy’s payroll. On top of that, have you ever heard of anyone applying for a $500,000 loan at the bank to pay rent? No. Rents are paid with after-tax, net, disposable income.

In my opinion, this is the single most important factor in market fundamentals. It’s at the very core of how much house one can afford to rent or buy. Interest rates are also important, but are secondary players since you don’t need a loan to rent a place.

Supply & Demand

As home prices go up and people realize that it’s cheaper to rent than to buy, the pool of buyers dwindle and supply of homes move up. When home prices drop back in line with the rental rates of comparable properties, the scale shifts and an increase in buyers join the market to absorb the supply of homes for sale. It’s basic supply and demand.

We can analyze it until we all turn blue in the face, but it all boils down to where to put the money. Spend it on an depreciating asset and strap yourself to the house because you can’t afford to do anything else? Or rent a comparable place for much less, invest the difference and add to the future-home-down-payment piggy bank? I think you know where I stand.

Arcadia home prices are falling and will continue to drop until it reaches its market fundamental value. This will take years.

Property Profiles

$900,000 Dirt

8 Comments

300 E. Camino Real Ave.

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Directly from Redfin: “NOT A CORNER LOT. LOT SIZE 16082 SQ. FT. (86X187). THE HOUSE WAS DAMAGED BY A FIRE. ORIGINAL LOT SIZE WAS 91X187. THE OWNER WILL GRANT 5 FEET TO THE NEIGHBOR ON THE EAST IN AN EASEMENT OR A LOT ADJUSTMENT. PROPERTY SOLD FOR LAND VALUE ONLY. NO WARRANTY, IMPLIED OR EXPRESSED. NO TERMITE ON BOTH THE HOUSE AND THE GARAGE. PLEASE DO NOT ENTER THE HOUSE OR THE GARAGE.”

Asking Price $899,900 ::: Sq-ft 1264
Purchased Price $180,000 ::: Lot Size 16,082 sq-ft
Purchased Date 02/02/2000 ::: Beds 3
Days on Redfin 26 ::: Baths 1
$/Sq-ft $712 ::: Year Built 1918
20% Downpayment $179,980 ::: Area Santa Anita
Annual Income Required $224,975 ::: Type SFR
Est. Payment* $4550/month ::: MLS# A08000266

*Estimated monthly payment assumes 20% down, 30yr fixed @ 6.50%

Why do so many realtards insist on writing their entire description in ALL CAPS? It’s very difficult to read and I feel like they’re screaming at me. What do they mean “OWNER WILL GRANT 5 FEET TO THE NEIGHBOR?” Five feet from where? Five feet along the entire east side of the house? Why would I want to do that? And who cares that there’s “NO TERMITE ON BOTH THE HOUSE AND THE GARAGE” because it’s a BBQ’d house anyways.

Since the house has fire damage and they’re selling it for land value only, they’re asking $899,900 for dirt. It’s for 16,082 sqft of dirt, but all you get is dirt. Actually no, you get dirt plus a burnt down house that you’ll have to pay to bulldoze before you can get a city permit to rebuild on the lot. Would you pay $899,900 for dirt when you can get a 2000 sqft house behind the lovely arboretum?

Don’t give me that bull about building PUDs or condos on that big 16,082 sqft lot to sell for a profit. Even if the property is zoned for that kind of development, the RE market is too dead to turn any kind of profit for the next several years. This looks like yet another case of complete separation between the asking price and market conditions. I don’t see a transaction at this price. How much would you pay for this property?

Analysis

A Serious Affordability Issue

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The Fed’s brilliant stimulus plans includes raising the conforming loan amount from $417k to upwards of over $700k depending on the area. Great, so the government’s idea to solve this massive credit crisis for its nation of debtors is to further encourage consumer spending and debt! The American people are swimming in debt and they certainly don’t need more of it. There is an affordability issue here and someone needs to tell the folks in Washington D.C. that we need LOWER housing prices, not higher ones.

According to HousingTracker.net, the folks in Los Angeles County spent 30% of their income on their mortgage payment in 1997 and that number grew to a whopping 63% by 2007! Most financial advisors don’t recommend spending more than 35% of one’s income on housing (buy or rent).

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To be conservative, one should buy a house priced at no more than 3 to 4 times their annual income. Ratios from 2.5X to 4X income is considered affordable, 4X to 5X income presents an affordability problem, 5X to 6X income is very unaffordable and 7X+ is financial ruin. Over the past few years, this ratio has been on the rise at an unsustainable rate from 4.4 all the way up to over 10!

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The data for Arcadia is not much different than that for all of LA county. Actually, it’s worse because the price-to-income ratio for Arcadia starts at 5.1 in 1999 and increases to over 11 by 2007. Can you imagine buying a house that costs over 11 times your annual income? Anyone who says prices are not going to come down and that the market is going to “rebound” anytime soon is a liar. Without a substantial increase in income, home prices are destined to decline back to sustainable values.

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It seems that there’s a lot data out there for LA County, but not much specifically on Arcadia. In the coming months, I plan to do more in-depth analyses on fundamental values, affordability and other measures of the market so if anyone has Arcadia specific data on median home prices and incomes for the past 10-20 years, I would appreciate it if you shared that with me.

So with that in mind, where do you think we are now? Denial, Fear, Depression, Panic, Capitulation or Desperation?

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Submit your vote for the poll on the right sidebar.

Property Profiles

Live Flipper

10420 E. Live Oak Ave.

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This speculator-investor didn’t get the memo so I better spell it out for him again – the US housing market is dead. These people are either really greedy or really stupid. I can’t figure out which it is, but it’s probably a bit of both. This is a classic flip and my guess is this person watched too many HGTV shows like Flip-That-House and Property Ladder.

Asking Price $899,000 ::: Sq-ft 1746
Purchased Price $610,000 ::: Lot Size 10,530 sq-ft
Purchased Date 08/09/2007 ::: Beds 3
Days on Redfin 10 ::: Baths 3
$/Sq-ft $515 ::: Year Built 1940
20% Downpayment $179,800 ::: Area Live Oak
Annual Income Required $224,750 ::: Type SFR
Est. Payment* $4545/month ::: MLS# 22104087

*Estimated monthly payment assumes 20% down, 30yr fixed @ 6.50%

This flipper bought the property just 5 months ago in August of 2007 for $610k. At that point, the market was already showing signs of serious issues and softening, yet this flipper was so inundated with greed that they proceeded with the flip anyways. From the looks of it, they updated the kitchen, bathroom and flooring. For a mere $899,00 they threw in some shutters as a bonus. If you made $250,000 annual income, would this be the kind of house you would want to live in?

While both the house and the lot is of good size, it’s located at the very south part of Arcadia near Temple City and El Monte. A house in that neighborhood doesn’t warrant the $899k asking price. In addition, they got lazy during the renovations because they didn’t even bother to get a permit for the bathroom addition. That makes me wonder what other corners they cut during construction.

Let’s take a look at their numbers.

Purchase Price: $610,000
Downpayment: $209,600
1st Mortgage: $400,400

Assumptions…
Monthly Payment w/30yr-fixed @5.5%: $2,273/month
Cost of Renovations: $50,000

I’m surprised to see this flipper put as much downpayment as he did when he could have probably gotten away with just 5%-10% down. Regardless, if he gets his asking price of $899,000 and taking into account the above assumptions, he stands to make $227,635 before paying capital gains tax. That’s equivalent to mind-boggling $45,527/month!

In this credit-crunched market, there are no more liar loans or 0% down. Assuming there’s a lender willing to do just 10% down, that would leave a mortgage of $809,100. With no more secondary mortgage market, that’s a jumbo loan at say 6.5% for someone with a great FICO score. That’s a monthly payment of $5,114 excluding insurance, taxes and maintenance.

How buyers out there have a 700+ FICO score, $90k cash for downpayment, documented income and can afford a $5,000 monthly mortgage payment? And how many buyers that qualify would want to buy this house? Not many, if any.

News

Weekly News Recap 1/24/08

Every Friday I will provide a short list of news headlines that reflect the current state of our housing market; either locally, statewide or nationally. If you feel that I’m missing one, please leave a comment linking to the article.

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1/17/08 – Median house price tumbles 15% in California

In addition to tumbling home prices, the article also reports that sales volume have “plummeted 41.4 percent… compared to December 2006.”

1/21/08 – A Recession, If It Comes, Could Be Worse Than Those of Recent Past <Wall Street Journal>

Talks of recession will only increase as the market attempts to correct itself. It was only the last two weeks that major media has latched onto this eye-catching headline. Those in the blogosphere already saw this coming since mid-2007 and maybe even earlier.

Housing is in the midst of its worst downturn since at least the 1970s.

1/22/08 – Panic! Fed cuts rates 75 basis points

In a very sudden move between Federal Reserve meetings, the overnight rate was cut down to 3.5%. Terms such as “market meltdown”, “recession” and “panic” are used liberally.

It was the largest cut in the federal funds rate since 1982…

1/23/08 – Prices Expected to Free Fall in 2008 and through 2009

Merrill Lynch has been very critical of the market and for good reason. There needs to be a price correction before the market can pickup again. All the while, the National Association of Realtors (NAR) is quoted saying,

Merrill Lynch’s figures are way too pessimistic… There is so much variation in local housing markets, and we see stable price conditions for 2008.

And the most significant news of the week?
1/24/08 – Congressional leaders reach tentative deal on economic stimulus package

The good news? 95% of tax payers will receive a refund check this year.
The bad news? They want to raise the conforming loan amount so people are encouraged to take on more debt!

Frank said Fannie and Freddie would be able to buy mortgages worth up to 125 pct of the median value of a home in any given region, up to a new limit of 730,000 usd. The current limit on so-called conforming loans is 417,000 usd.

Tracking the Arcadia and San Gabriel Valley Housing Market