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Timing the Market, A Banker’s Viewpoint

Credit for this post really goes to 3 Oceans contributor Eric Trailer who sent me this content in a letter this week. My clients got it last week, and the blogoshpere can now benefit. We can assume that Eric has better things to do on Labor Day than blog. I’m guessing something involving his lovely wife and son . . .

To see current market data and price trends over the past year for local communities and confirm or refute Eric’s prognostications on the local market in Palo Alto and the surrounding communities,

CLICK HERE to see real-time market data, courtesy of our friends at Altos Research.

As you have likely been hearing, there continues to be more and more evidence that it will cost prospective home buyers more to purchase a home in select areas of the Bay Area as they allow time to go by.
Why? Let’s look at the basic reasons, then review an example:

1.        The median price across the board in Palo Alto and the surrounding communities has risen since the beginning of the year.

2.        On a national basis, the trough of the market was reached in April.

3.        The conforming loan limit will DECREASE over $100,000 in 2009 to $625,000.

4.        Rates have risen about .5% since the beginning of the year, despite the increase in the conforming loan limit to $729,750

5.        Loan qualifications are becoming more restrictive with each passing week.

6.        More restrictions on loans and a tighter supply of money forces rates to go up

7.        Because loans require more work to process them (requirements today are 4x what they were a year ago), rates will go up.

8.        Inflation is the number one concern of the Fed, and should be the number one concern for all of us.

Let’s say for a moment that you agree that rates are on the rise, but feel as though prices may come down on a $1mm property today; thus, you want to wait. Let’s further assume that you are right and the future price is $950,000, but rates have increased .5% at that future time. Using 20% down, waiting just cost you an ADDITIONAL $117 per month-over $1,400 per year.

But now let’s be more realistic given the appreciation rates of desirable areas of the Bay Area. If rates increase and the $1mm home appreciates to $1,050,000, you are looking at an ADDITIONAL $550 PER MONTH-OVER $6,000 PER YEAR!

What’s the take-away here?   Price matters much less than true cost… My motto has always been that it always pays off to buy sooner than later, provided your holding period is greater than four years. And to prove that I walk the walk, I am happy to share my personal situation written as an article titled, “How to Afford a Home in Palo Alto Without a Trust Fund.”

Kindest regards,

Eric

To call Eric on his walking the walk comment, and get a copy of his article, “How to Afford a Home in Palo Alto Without a Trust Fund.”, click on his pretty picture over there in the contributor column to send him an email.

Tags: 4---mortgage-mania, absolute mortgage bank, mortgage rates, Mortgages, palo alto home prices, Palo alto housing market, palo alto market, palo alto real estate market

A Housing Rebound? - Looking for the bounce

CNN Money is a favorite consumer source for news and sensationalism about issues affecting us financially. A friend uses it as his homepage, and sent me this article on indications that the housing market is pulling out of its downward spiral. Judging by the commentary on the Yahoo news service that picked it up, most people think it is another self-serving article written by real estate agents who want to further dupe consumers into buying homes and further leveraging them selves with unnecessary debt. There, I said it, so you can save your comments.

Here in Sillycon Valley, we are continuing to see variations on the Tale of Two Cities theme, with markets like Palo Alto and Menlo Park holding up strongly (click the links to see current market data), while prices in parts of Sunnyvale and San Jose have fallen off a cliff this year. We won’t mention Sacramento, because it’s not nice to kick ‘em when they’re down.

So, the key leading indicators for monitoring the health of your local housing market are:

1. Is the housing stock shrinking?
2. Are home prices falling at a slower pace?
3. Is it cheaper to rent than own?
4. Are houses becoming more affordable (relative to local incomes)?

Locally, we are still kind of bumping along. The current housing stock in Palo Alto is up slightly, but that isn’t unusually during the late Summer. If the trend continues through Fall, it may signal a trend.

Home prices have been stable here, so that is tough to measure, though the multiple-offer / overbid madness is definitely a rarity these days.

Depending on how you measure it, it’s still cheaper to rent than own, but tell that to my clients who were tossed into the housing market when the rental property was sold and they received a 60 day notice from the new owner.

Houses here are still unaffordable, but take a look at the chart at the bottom of the page and compare San Jose and San Francisco. It may be a good time to get into San Jose, especially if you understand foreclosures and short sales. If not, contact 3Oceans contributor Bart Marchioni, aka Mr. Short Sale.

Remember, real estate is local, and be careful what you read on the internet.

Thanks for reading . . .

Tags: 2008 real estate market, housing market turnaround, mortgage crisis, mortgage mania, Palo alto housing market

Killer Buy vs. Rent Calculator

I long ago put together a buy vs. rent calculator and it served as the basis for my buy vs. rent series.

The New York times has just come out with a pretty good buy vs. rent calculator of their own (might soon disappear behind a paid firewall.)

Its conclusions are basically the same as mine:  Assuming roughly the same rental cost vs. property price ratio as we have here in the Bay Area, you’re better off owning than renting over a 4 year or greater period if property prices appreciate by 5% per year or more.

Tags: Buy vs. rent, Buyer and seller tips, For buyers, Real estate

Bob and Betty Buy a Home (Part 2): We See Some Homes, But Bob and Betty Get Spooked

Let’s continue the saga of Bob and Betty, our hypothetical first-time home buyers who were introduced in the first of a series of articles I’ll be writing.

We met at 9am sharp on Saturday morning at my broker’s office in downtown Palo Alto. Though it’s easier to view homes with clients during open house times, I prefer to do first time tours when nobody else is around.

I had an ambitious tour planned: 12 homes in 4 towns along the 101 corridor. Always exhausting for everybody involved — every time I do this I have more liking for the part of the Redfin business model where clients do this bit themselves! — but nonetheless an important part of the whole process.

While driving, I pointed out important things about the neighborhoods we were in: The typical types of homes, the price ranges, which school district it belonged to, whether it was unincorporated or not, whether it was in a flood zone, where the nearest parks and public services were. I asked them to comment on what they liked and didn’t like in each neighborhood.

At each home we went through the same process, slowly at the first couple of homes, and then more quickly. “What did you like? What did you not like? What did you think of that kitchen? Do you like skylights? Fireplaces?”

By the 5th home I’m usually able to “get it” about what clients are looking for, and with this new knowledge, I crossed out 3 of the remaining 7 homes we had to see.

Suitably tired, we pulled back up to the office around 1pm to review what we had seen, what they had liked, and what they had not liked. I explained the next bit of the process: getting pre-approved. I’m happy to spend a few hours as a sort of “interview” with prospective buying clients, but before I invest too much more, I need them to put some skin in the game too by getting pre-approved. I generally find that if they’re not ready to dig up their financial records and go talk to a mortgage broker, then most likely they’re not ready quite yet to buy a home.

Betty was quite excited about three of the homes we had seen, but it was clear that Bob was losing interest pretty quickly. “Yeah…but nine hundred thousand dollars?” was his most common refrain.

We pressed in on that. Bob had been doing his homework the last week and pulled out all the discouraging figures he had found. Housing starts are down. Interest rates are up. Affordability is down. Condo developments in Las Vegas and Miami are being cancelled. How in the world could prices stay where they are here?

Prices in the Bay Area are indeed a pretty head-scratching discussion topic as they continue to defy gravity, pessimism, and seemingly the laws of economics year after year. I told them bluntly that neither I nor anybody else could guarantee anything about prices here. It is indeed possible that prices could collapse…by 40%…overnight…immediately after they bought a place. Possible? Yes. Probable? No.

I pulled up my secret weapon, Google Earth, on the flat screen wall monitor in the conference room. I zoomed in on the Peninsula and asked two questions: 1) How much land is technically available to build on? 2) How much land is actually available to build on.

The answer to the first question is: tons! From the Bay going west pretty much to Highway 280, nearly every square inch of land is already filled in. From the 280 west to the ocean, there are only a smattering of towns, like Half Moon Bay, Pescadero, and La Honda. The mountains make it difficult to build in that area, but we could certainly fit several hundred thousand more homes there.

However…it ain’t gonna happen! Most of that land is owned and/or protected by Federal, State, County, or City governments, private trusts, conservatorships, parks, and so forth, and not much building is going on.

If you can’t go West, then you have to use the Manhattan strategy: go up. Again, that ain’t gonna happen. San Francisco and San Jose have modest but growing skylines of high-rise buildings, but in between it’s rare to find any structure taller than 8 or 10 stories, and for the most part it’s only up to 3 stories tall. Those zoning restrictions aren’t going to be changing any time soon.

Essentially, 50% of the classic economic supply/demand equation is pretty much fixed, so the real question is what will happen with demand?

Again, at least for the short and medium term, the answer to that is pretty clear: demand is, and will likely remain, robust. Google and other local tech companies are doing well. Venture capitalists are pulling out their wallets again. Start-up nirvana 2.0 is here. Immigrants from across the country, and indeed the whole world, continue to move here.

So, could prices fall by 40% overnight?  Absolutely! But in the only scenario I can come up with in which that happens — a scenario which involves an earthquake, a terrorist attack, and bankruptcies of the top 5 tech employers in the area…all within 3 months of eachother — falling equity may not even make the top 10 list of concerns for many people.

We parted company, and they promised to get back to me within a few days about whether they were ready to proceed. I had my doubts, mostly about Bob.

Sure enough, a few days later I got a phone call from him. “We’ve decided to wait it out,” he said. “We’re just a bit nervous about these prices, and we’re not in a big hurry to buy.”

We agreed to keep in touch every few weeks and see how things developed.
Welcome to real estate in the Bay Area.  Prices are high, and you need a certain amount of faith and intestinal fortitude to dive in for the first time.

Tags: Buy vs. rent, Buyer and seller tips, Choosing an agent, For buyers, Google Earth, Home buying, Previewing homes, Real estate, Redfin

Bob and Betty Buy a Home (Part 1): We Meet, Discuss Their Needs, and Crunch some Numbers

Let me introduce you to the two newest stars of this blog: Bob and Betty, a fictional family, sort of a composite blend of numerous past clients. In this x-part series, where “x” is currently an unknown number, I’ll walk you through how we got them into a home, despite the heroic efforts of a cantankerous market, an incompetent mortgage broker (soon fired), and a sleazy Realtor or two to thwart our plans. Enjoy the ride…

————

I first met Bob and Betty about a year ago at a social event hosted by mutual friends. They had moved up to the Bay Area from Los Angeles two years previously after finishing their graduate studies at UCLA — Betty an MBA, and Bob a PhD in bio-something-or-other.

We got talking about the real estate market — a common topic these days — and their sticker shock, only now wearing off, about Bay Area real estate prices. LA prices aren’t exactly cheap either, but the Bay Area certainly has it beat. Bob and Betty were doing what most young recently arrived Bay Area transplants do: renting. Though in no particular hurry to own their own place, they had begun to think about it, but were, quite naturally, concerned about what might happen to home prices. Their angst wasn’t helped much by a constant barrage of doom-and-gloom articles in the media.

We traded emails and spreadsheets a few times, then met for coffee a few weeks later. Since they were both interested in the numbers, I walked them through my “buy vs. rent” analysis, which basically shows that in the short run, it’s definitely cheaper to rent than to buy, but in the long run, with even modest growth assumptions, it’s definitely better to buy than to rent. They appreciated the analysis, but were still skeptical.

Fair enough. The primary motivator for buying a personal residence is usually emotional — stability, putting down roots, raising a family — and the analysis at which I excel (pun intended) is usually just the icing on the cake once they’ve made the emotional commitment to home ownership.

We spent some time talking about what their ideal home might be. They love entertaining, and Bob loves cooking, so a nicely done-up kitchen opening up to an entertaining area would be ideal. Not being much in the handyman department, they prefer a home that’s move-in ready, not a fixer. Bob works in South San Francisco for a biotech company, and Betty in Sunnyvale for a tech startup, so anywhere in between the two — preferably along the 101 corridor — would work. Three bedrooms or more, 1.5 baths or more, roughly 1600 square feet. Betty is somewhat noise sensitive, so too near the highway, a busy road, or the train might not be good. They don’t have kids, and probably won’t for a few years, so being in a good school district isn’t that important.

We talked about their budget, and ran some quick numbers. It seemed that a $950,000 home would be well within their reach.

We made arrangements to meet again the next weekend, when I would show them a half-dozen or so homes that might work, and start to get them acquainted with the neighborhoods.

An excellent first meeting, I thought, though I sensed a certain amount of hesitation in them. I made a note to explore that hesitation further the next time we met.

Tags: Buy vs. rent, Home buying, Real estate

Buy vs. rent — #3 — the long term

In my previous post on this topic, we confirmed people’s intuition that in the Bay Area, it’s usually quite a bit cheaper in the short run to rent than to buy — even with aggressive financing options such as interest-only loans. So why would any sane person actually buy a property here?

Turns out it’s the financial benefit, and not insanity, that drives people to buy, bubblistas’ theories to the contrary notwithstanding. Continuing with our saga about our Mountain View home with a rental value of $2400 per month and a purchase tag of $825,000, let’s continue running the numbers, this time over a five-year period instead of just a month. If you were to buy the home today, you’d be out your 10% down payment of $82,500. During your first year of owning the home, you’d be out another $55,000 in combined mortgage, tax, maintenance, and insurance payments — that’s after deducting your substantial tax savings. Your first year’s rent, however, would be only $28,00. Ding ding. Round 1 to the renters.

Let’s assume that rents are increasing by 5% per year. (Again, purists may object that that hasn’t been the case over the last half decade. True point…but go further back in time to the late 90’s dot.com era when rents were increasing literally around 15% to 20% per year. Over the long term, 5% is probably a reasonable approximation.) In year 2, you’d pay $30,240 in rent but be out over $50,000 if you owned the property. Ding ding. Round 2 to the renters.

It’s looking like a one-sided contest so far, but let’s wait till the end of year 5 where you’ll see the the owners, pride intact, perform a solid KO over the renters. By the end of year 5, you’d have spent a total of $159,00 to rent the property. Your total ownership expenses, after considering your tax benefits, would be nearly $343,000. Let’s say you sell at the end of year 5. Further, let’s assume properties have been appreciating by 5% per year during that time, and that your selling costs are 6% for realtor fees and 1% for miscellaneous other fees. Keeping in mind Uncle Sam’s generous $250,000 capital gains tax exemption ($500,000 for married couples), you would end up pocketing $286,000, meaning that over your five year ownership period you’d have spent $56,000 out of pocket instead of $159,000 if you’d rented. (If you’re a hard-core numbers type and want to see the math behind these numbers, let me know.) Let’s update our graph:

“But…but…but” sputter the renters, reeling from their blow, “that’s not fair! Owners may end up paying less in the long run, but surely it’s got to count for something that in every single year we renters paid less? Isn’t there something about the time value of money?”

Fair point.

To account for the fact that a dollar spent today is more painful than a dollar spent tomorrow, we use a neat Finance 101 trick called “Net Present Value” (NPV) which enables you to compare two completely different sets of expenses — like five years of ~$30K per year in rent vs. five years of ~$50K per year in ownership expenses followed by a windfall of nearly $300K.

The NPV, as it turns out, evens the players up a bit…but the owners still win, hands down, by about $50,000 in NPV. (Again, for folks interested in the numbers, I used a discount rate of 5.8%, which again I’m happy to explain to anybody who asks.)

Rounds 1 through 5 go to the renters…but the final KO, and a solid one at that, goes to the owners.

Tags: Buy vs. rent, For buyers, Real estate, Real estate data

Buy vs. rent — #2 — the short term

Tags: Buy vs. rent, For buyers, Mountain View, Real estate, Real estate data

Buy vs. rent — #1 — the big picture

Tags: Buy vs. rent, For buyers, Real estate

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