Los Angeles Real Estate: Prudent Investment or Insanity?

Self | 11/18/2003 | David H Dennis

[daviddennis]

My landlord is selling the house I'm presently renting, and so I have been thinking it's about time I actually look into buying a house.

I talked to a lender, and they are willing to loan me about $500k with nothing down, which is good because I don't have savings other than $10k or so to deal with closing costs.

I was very surprised at the terms: Interest only at 5.65% for two years for 80% of the balance, with the other 20% at 9.9% for 15 years with a 30 year amortization. Since I'm used to the idea of the 30 year mortgage, this looks like fiscal insanity, since I'm not paying off anything, and in two years I have to go through the whole horrid financing mess again.

The upshot is that, even with these generous payment schedules, I would have to pay $3,314 a month for a $500,000 house, which - if you didn't know - is pretty much low-end, bottom of the barrell housing if you want to live in a pleasant area of LA. (This amount includes first mortgage, second mortgage, taxes and insurance).

Now, I would get about a $800 a month tax deduction, and if I got a house with a guest unit I could lease it for $750-1,300 a month depending on how nice it is.

If home prices continue to go up as they have, this is a very smart thing to do. The tax deduction plus the rental income would wind up getting me about half the money I needed. The other half would be a few hundred dollars more than I pay in rent now.

If interest rates increase substantially during the two years I'd own the loan, and my income did not increase, I could be in big trouble because I wouldn't be able to refinance and still keep my payment down to a reasonable level. I would then have to sell the house into what I'm sure would be a declining market.

If home prices go down, this is a very stupid move indeed since I would be gaining hardly any equity. I was thinking of paying the 30 year second mortgage over 15 years, which would only be about $200 a month more. Then I'd have SOME equity, but still, the whole deal seems amazingly risky from the bank's point of view.

I want to buy in a unique area of the city, such as Topanga Canyon, where unusual conditions make the area very desirable. Although this is very expensive, in my view it does shield me somewhat from real estate declines because my house would be something unique that would still be valued by the market. As I told the loan broker, people like me who want hillside homes with views are maybe 1% of the market, chasing .1% of the homes.

If Los Angeles is indeed fated to increase in population, and if the population continues to be fairly wealthy and home-hungry, then this seems like the right thing to do despite the huge debt burden. But if the population winds up being people with no money, I could still see things go sour if the economy went bad, or more people with no money flooded in.

I would appreciate any thoughts. Feel free to ping any other knowledgable people.

[daviddennis]

Your thoughts?

D

[Poohbah]

Do you absolutely need to live and die in L.A.? If you can find gainful employment in your area of expertise with reasonable advancement prospects elsewhere, I would seriously (and seriesly :o) consider moving almost anywhere else.

[buffyt]

Can you stand to live farther out say Claremont? or Victorville? Housing is MUCH CHEAPER out there. And there are lots of areas that are springing up that are brand new affordable homes. Victorville is unbelievably cheap, much cheaper than the town I live in in Lake Jackson Texas. Nice growing town, but pretty dry and sandy. We lived in San Marino 1988-1990 and our house was $10K a month. It was worth $975K then - it is worth $1950K now. Unreal. I know a gal who bought a house in San Marino for $200 and it was worth $800K about ten years later.

[MineralMan]

Personally, I recommend against this course. If you buy in the mid to upper end of the normal market, you're cruising for a possible bruising.

Far better to purchase a dingbat at the lower end of the market, but in a decent area. Put some sweat equity in the place then sell it in a year or two, before that interest-only loan comes due. Buy up, but still not in the range you really want. Again, buy something that needs some work and turn it around, too.

The idea is to build value as equity, increase your available funds for down payment money, then move into the house you want without having that interest-only balloon floating over your head.

Just one homeowner's opinion.

[buffyt]

We were in Claremont for a temp. relocation and didn't sell our home here, so we got an apartment out there. Still in LA county. Our rent for a very nice apartment was $1000. Our daughter's rend in Austin Texas was $2000 a month. Her rent this year for a VERY OLD small duplex is $583 a month times three renters. The landlord makes $3600 a month off a really old house. I guess in a college town they can charge whatever they wish, I heard that houses sell for a huge amount there too. There are areas in Houston where homes go for many many millions. There is a home in Dallas for sale for $12,500,000 right now.

[Cicero]

It's a risky time to get a variable rate mortgage. Rates will probably stay low well into 2004, but sooner or later they will start rising again, either because the economy improves, or more ominously because the dollar keeps weakening, foreign banks become less willing to hold our debt, and the Fed has to raise rates even though it will damage our domestic economy.

The other issue is whether we are toward the end of a housing bubble and values may start to decline or even drop significantly. Nobody can predict this for sure. Even if there's a bubble, who knows when it will pop?

But I would avoid any kind of variable rate mortgage without a definite cap on it if at all possible. We may be seeing rising inflation and rates down the line.

The rest is really up to you.

[Amerigomag]

Dear Dave. Hard to help because LA is a big place. Is the property near Compton or the Simi Valley? Is it located in an enclave or within three miles of a Mexican barrio?

Here's a good rule of thumb. Land prices will continue to rise in California until the population is controlled (immigration control) or the liberals legislate redisritibution of land wealth ( rent control, low rent housing, etc.).

The questions you really need to ask yourself involve quality of life. The rest is just money.

[Oldeconomybuyer]

I sold a home in Northern California in 1999 that I thought was at its peak. Since then, it' gone up in value an average of over 25% per year.

That said, there are two basic schools of thought, a) there surely will be a housing correction in LA at some point, and b) home prices in LA are following the law of Supply and Demand.

It goes against my basic instincts, but I subscribe to the latter. I simply believe that as long as the LA area is attractive to both domestic and foreign buyers, home prices will remain at least stable if not robust. Barring a catastrophe, buying a home in LA is a safe bet.

[snopercod]

The three rules for investing in real estate:

1. Location
2. Location
3. Location

[gubamyster]

Real estate in CA is a great investment, even in this market. If you can get in, over the long-term, you can't hardly go wrong. However, you should be represented by a Broker or agent, even if you are buying the house you are renting. You need to have somebody representing your interests, and the seller will pay the commissions.

It sounds like you are also working the tax savings angle, but if you need any specifics, I'm a CPA & a Broker, so maybe I can help.

[So Cal Rocket]

Don't forget that as a homeowner, if the water-heater blows, or the furnace stops working, or the carpet needs replacing, you can't ask the landlord to fix it...

So, make sure you include in your calculations the additional costs of home maintenance.

[ClintonBeGone]

If interest rates increase substantially during the two years I'd own the loan, and my income did not increase, I could be in big trouble because I wouldn't be able to refinance and still keep my payment down to a reasonable level. I would then have to sell the house into what I'm sure would be a declining market.

It's likely a good investment. What I fear is the 2 year arm (adjustable rate mortgage). A lot of lenders will give you a 2 year arm with a 3 or 5 year prepayment penalty. The prepayment penalty is sometimes 1% of the balance, or worse, 6 months worth of interest, which in your case could be like $18,000!. I'm going to freepmail you the contact information for a friend of mine who would be happy to help you get a decent fixed rate loan. It will still be 100% financing and take the form of 2 loans (80/20%) but both will be fixed. Also, what you when you finally buy, make sure you write the purchase agreement to cover your costs AND prepays (taxes and insurance). For example, house costs $500,000. Write the offer for $510,000, with the seller paying $10,000 in closing costs and prepays. Good luck David!

[buffyt]

West Covina, Chino, La Habra, Whittier, Victoria, San Bernardino, Rowland Heights, Pico Rivera, Santa Fe Springs, La Mirada, Hacienda Heights, Baldwin Park, La Puente, Montebello, Downy, Upland, Covina, Rialto, Fontana, Alta Loma, Diamond Bar, Grand Terrace, El Monte, San Dimas....
all have comparatively affordable home prices. I was very impressed with the beautiful new homes being built in Victorville. Less than $100 a sq. ft. I don't know if that is too much of a drive for you. I have LA real estate ads here in hand. Homes for sale booklets I picked up last time I was in LA.

[CatoRenasci]

Don't neglect the effect of low interest rates on the equation. What's worth more today at very low rates would be worth substantially less at 10% interest rates, let alone the 18% we saw in the Carter era. Do the math. Also consider the general availability of money to borrow. Lenders won't lend if their rates of return (interest is the cost of money plus the risk factor) don't work out.

My view is that LA is a bubble waiting to happen. Of course, I live in a similar East Coast bubble.

[speedy]

Assuming you don't get caught up in short term problems with your mortgage, the value of housing in any desirable part of LA is going to keep going up in the long run. While there are always the short-term (3-5 years) corrections, the value of housing in LA has done nothing but go up for at least the last 60 years. Cities like LA and NY will always have apocalyptic critics who see them on the verge of ruin, and yet property values just rise and rise and rise. There will always be an adequate supply of rich, flakey people who want to live in Topanga and to whom money means nothing. Again, assuming you can handle a variable rate mortgage, you can't go wrong. As a former Claremont resident (and still nostalgic about it) it is true as another poster said that you get more house for your money there and it is indeed a wonderful area. But I loved those hikes through Topanga!!

[alisasny]

Is he investing at this time or needs a home and is sick of sinking his money into rent with no returns?

Frankly he needs a place to live and with no money down his quoted rates sound reasonable.

[Orangedog]

The CA real estate market kinda reminds me of when stock in Yahoo was ~$250/share. It will probably go down faster than it went up.

[cmsgop]

Forget LA, Check out Orange County. In Irvine you can get a nice selection for $500k. One more thing, it's a very safe bet that you will make money in a few years.

[CatoRenasci]

I have lived in LA, and I think the only places I could consider are Brentwood, Bel Air, Westwood, Hombly Hills, San Marino and parts of Pasedena or the Hollywood Hills. Marina del Ray or the beaches if I were younger and single. Maybe Topanga Canyon or parts of Santa Monica. Out East, the smog is too bad, and the driving distances just too great.