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.

[BunnySlippers]

Los Angeles Real Estate: Prudent Investment or Insanity?

I have heard this question over and over and over for decades. Let history be your guide. There is no reason for So Cal real estate to decline.

[larryjohnson]

prop 13. You pay 5k per year in prop tax.

[doug from upland]

I've been a broker for 26 years and taught RE Law, Practice, Finance, and Economics at the college level for 10 years. This market still perplexes me. People are paying insane prices, but then someone pays an even more insane price. I thought it would have leveled off by now and expected a price correction.

Among the things driving the market are, of course, supply and demand. We have huge numbers of illegal aliens in this state. They are buying the lower end and pushing up the prices, thus the prices are pushed up as people move up.

Part of what you will have to guess is the position of interest rates. Prices will stay firm as long as people can afford mortgages. It appears that people don't care what they pay, as long as they can afford the 30-year mortgage. At 9%, payments would be considerably higher, and people simply would not qualify as they do now. Prices would come down. It interest rates hit 9%, our entire economy will have tremendous problems. So, I think that Greenspan and his cronies will do everything possible to keep them down.

Keep in the back of your mind the thought that L.A. is a Second Tier City. That means that, according to the ISO, which does insurance ratings, L.A. is ten times more likely to be hit by a terrorist event than a suburb. It joins Philadelphia, Seattle, Houston, and Boston. Tier One cities are D.C. New York, Chicago, and San Francisco. They are one hundred times more likely to suffer a terrorist attack.

L.A. has been steadily become a cesspool of the poorest and most dependent. It is a cesspool of crime. It is becoming a third world cesspool. Besides deciding if you can afford it, you have to decide if you want to live in and and raise your kids in that city.

As to moving further out, the freeways will be getting slower every year. Five million illegals are not going back home any time soon. You will get value if you fo further out, but the cost of the commute in terms of money as well as your sanity will take a toll.

[DumpsterDiver]

I'm a CPA & a Broker

A mortgage broker?

[gubamyster]

Sorry, a CPA & Real Estate Broker - both licensed in California.

[daviddennis]

To answer some of the questions:

• Woodland Hills is in the west side of the San Fernando Valley, near Thousand Oaks. Topanga Canyon is south of Woodland Hills, between Malibu and Pacific Palisades.

• Topanga Canyon is a hilly area known for the beauty of the scenery and the uniqueness of the homes and people. It's an area filled with 60s dropouts. It has a very warm, hospitable appealing character. When I had a flat tire on the main drag, people stopped and helped me out. The views from most Topanga homes, even entry level ones, are stunning.

• Woodland Hills is an "edge city" with a huge and thriving businesses district called Warner Center. South of Ventura Blvd, there is a very nice hilly area that has many similarities to Topanga Canyon. It is there that I'm looking.

• The areas I'm considering investing in have virtually no recent immigrants. In Woodland Hills, two bedroom apartments rent for $1,500 a month and up. In Topanga Canyon, there are no apartments. Guest houses rent for over $900 a month.

• In both places, entry level houses are $399k+, even on busy streets. So I am looking at the cheapest houses in the market.

• I make decent money in LA. I have excellent work skills but horrible networking and self-marketing skills. To establish myself elsewhere would be horribly difficult. So I'm inclined to say that I pretty much have to stay here.

• By the same token, I work in Woodland Hills. Moving far from Woodland Hills would mean I would have a torturous commute. I've tried that and it's not for me :-(.

• I could move to a cheaper part of town. I would prefer not to, but I could. My intuitive sense is that if I went to an area like Canoga Park, the risk of reduction in home values would be significantly higher. Even Canoga Park, dismal as it is, has an average home price over $350k. My feeling is that I'd rather pay $450k for a home in an area I know will stay nice.

Many thanks for your thoughts so far; keep 'em coming!

D

[chilepepper]

Real estate is a tricky game. I bought a house in Massachusetts straight out of college and it was a terrible investment. with great effort i was able to break even...

My take on real estate in general is to pay attention to the baby boom: the wave of WWII & later babies is what defines all economic movement in the US, and to a lesser degree the rest of the world.

These folks are starting to reach retirement age, and MOST of them have already bought a house -- they will probably only be interested in selling the one they have for a smaller one, and this process can only accellerate.

At some point, they (us -- *ME*) will all be gone so what happens to these houses they bought? who will buy them?

This isn't to say that there aren't good deals to be had, but i personally would never buy anything unless i could pay for it in cash -- cars, houses, etc included. the only benefit of paying interest for anything is in lowering taxes, and i find that a suckers bet if there ever was one...

to me, perfection is to live with ZERO debt... i ain't saying its easy...

[DumpsterDiver]

Forgive my ignorance, gub, but what is the difference between a real estate broker and a realtor?

I can't believe I have to ask an elementary question such as this. :)

[ReagansShinyHair]

http://moneycentral.msn.com/content/Banking/Homebuyingguide/P37627.asp

See the above article about homebuying.

A quote from it:
"After dropping more than 20% in the 1990s, Los Angeles home prices took almost 10 years to regain their peak, says real estate expert John Karevoll, an analyst with DataQuick Information Systems. Anyone who lived here during that time knows people who were “upside down” -- owing a bigger mortgage than the home could be sold for. Thousands of people simply walked away from houses they couldn’t sell, trashing their credit ratings in the process."

My parents' very-nice-area-of-SoCal house went from $450,000 to below $300,000 around 1990-91. Now, of course, it's up around $650,000. Still, I know several neighbors who bought for $500,000 in the neighborhood and then had to sell for $350,000 due to relocation for job purposes, etc. If you have a good chance of sticking it out in the house for 10 years, then you probably will not lose money. If there is a good chance you will sell soon, you could lose a lot if prices do go down. If you "let history be your guide", you will be cautious and buy because that is where you would love to live, not because you think it's a "sure thing".

[Uncle Hal]

A couple of things. My mother in law bought a cottage (maybe 1000SF) in West LA in the mid 30's for $3,000. Her heirs sold it for $650,000. in 90 (it was zoned for 4 units). I bought a 1500SF house in Mar Vista in 63 for $30,000 and sold it in 79 for $200,000 (divorce). In 1980 I bought a condo in the Marina for $133,000 and sold it in 95 for $235,000. That same condo I am told would be worth $400,000 today. I have since moved out of LA but miss it when I go back. If history is any guide you cannot lose.

[wtc911]

You are not ready to buy this house or a similarly priced house, especially with the conditions you sketched out.

We own a number of properties and use the interest only loan option on investments only, and, only if the rent roll covers at least 150% of the payment. If you cannot significantly pay down the principal on that loan then you will end up paying interest on the same money twice.

As for your expected $800/mo. deduction you should understand that you still have to pay the same amount monthly and only realize the benefit of that deduction in the following year at tax time. You should also understand that an $800 deduction will not translate to $800 savings. Other factors, such as your bracket of taxation come into play.

If you are counting on a tenant to meet your payment expect to dig into your own pocket for every month that you do not have one. This will happen more often than you think unless you find the magic tenant and sign a long term lease.

With a tenant you insurance costs will go up as will your maintenance costs.

What will your PMI costs be?

How secure is your employment? Where are you in your career earning power wise?

I am a firm believer as RE as an avenue to wealth which is an avenue to freedom and I applaud your thinking...I just don't think you're really ready to pull the trigger...what kind of condo will $350k buy in SM? maybe there's a place to start.

[calljack]

I work in Woodland Hills and live in Canoga Park. Been here over 25 years. You have mail.

[gubamyster]

Forgive my ignorance, gub, but what is the difference between a real estate broker and a realtor?

No apology necessary. Those terms are usually confused & used loosely. The term "Realtor" means you belong to the National Association of Realtors.

The real distinction is between broker & agent. An agent must work for a broker who reviews & signs off on the agent's paperwork. The broker gets the full commission & then splits it with the agent. So if you are an agent you must split your commission with your broker. However, if you are a broker, & complete the deal yourself, then you get the full commission. A broker can own their own company & complete sales/purchases on their own.

[Husker8877]

Have you ever owned a home before? Have you ever survived a Residential RE crash like in 1990-1996 California?

What lender in their right mind will lend you 100% on terms you quote?

First rule: NEVER EVER trust a mortgage broker!!! They pack more waffle-ability into their so-called "commitments" than Clark and Kerry combined.

Second Rule: If you are buying a home with no cash down, you are not buying a home, you are buying trouble at the very first hiccup in RE market. Mortgage brokers care only about whether or not they can ram a large loan down some naive lender's throat--not whether or not you can survive a touhh market or even 2-3 months income loss.

I'm a banker. I am not a residential mortgage lender, but I am well-versed in the many ways they can cause you terrible grief. Most of my clients (generally very sophisticated, experienced property owners) have at least one horror story to relate regarding mortgage lender scum (not ALL are scum, but so many are--the used-car salesman of 1995 is usually now the top-producing mortgage lender in most offices. Fresh meat, you know...)

Just BEWARE!

[Oldeconomybuyer]

I agree with the points in #15.

As someone old enough to remember 12% mortgage rates, the impact of interest rates on RE value is significant.

[ibbryn]

bumping so I can check in on daviddennis later

[gubamyster]

As for your expected $800/mo. deduction you should understand that you still have to pay the same amount monthly and only realize the benefit of that deduction in the following year at tax time.

This is not exactly correct. You can immediately go to your payroll department and change your W-4 withholdings and receive changes to your current payroll withholdings. Depending upon your company, this would become effective within a couple of payroll cycles. You would have less taxes taken out & thus be able put that towards your mortgage. With the deductions, you would owe less taxes next filing date. I assume your tax advisor would have calculated out the $800 amount you are quoting based on last year's income & this years projected earnings, as well as the deductions you will receive for the home ownership.

[DumpsterDiver]

Thanks. Would I be correct in assuming that realtors and selling agents are doing the same job, just with different job titles? Or are there separate licenses for each, with one having more training than the other?

[Grim]

Woodland Hills is a better area of Los Angeles so you're ok there in terms of re-sale value. Remember, you generally want the least expensive house in the best area and not the other way around.

Pay for a professional appraisal to establish actual realistic value. If and when you make an offer be sure to make the sale "contingent" on a professional inspection.

If everything works out and you buy the home, you should be able, after one year of "seasoning" your mortages, to refinance the entire debt to something better than you're presently being offered. In fact, you might want to shop around for a better mortgage arrangement than the one you described.

Real estate values in California are bound to continue upward as there is a severe housing shortage.