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.

[wtc911]

As a self-employed I didn't think of that angle. I still think, based on what info DD provided, that his intention is admirable but ill-advised. I would give the same answer to any of my own kids, given the same circumstances.

[gubamyster]

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?

Realtors just means you belong to the NAR. Agents & brokers can represent either (and sometimes both) the seller and the buyer. No separate license is necessary. However, there are differences between a broker license and an agent license.

[stumpy]

In the north end of L.A. County (near the community of Gorman) there is a 3500+ square foot house on 10 acres of land in an area of big trees that touches up against Angeles National Forest land. It was on the market for 425k. Located 15 minutes from I-5, and about 45 minutes from magic mountain theme park. Lots more house for the money.

[DumpsterDiver]

OK, now I get the distinction. Thanks for taking the time to answer.

[stumpy]

When you buy, have the seller provide a "home protection policy", and then renew it when it comes due.

[sergeantdave]

You're buying at the top of the California housing bubble. You could be stuck with a whopper mortgage payment and a declining home value. Ouch!

Then again, some lefty California judge could declare that all private property belongs to the state and you'll get to live there rent free, ala North Korea, with all the tree bark you can eat.

[Willie Green]

Move to another state.
ANY other state.
California is a trendsetter, and it'll be the first to collapse to Third World parity.
Try Tennessee. Cost of living remains relatively reasonable.
And the TVA gives reasonable assurance that you'll still have access to fresh water and electricity, something that can't be said for California.

[L,TOWM]

Similar position bump.

[gubamyster]

As a self-employed I didn't think of that angle.

Even as self-employed, you could reduce the quarterly estimates you currently would be making, realizing an immediate tax savings.

[taxcontrol]

Get educated

www.richdad.com
Read the first 4 books - then decide.

[Maximum Leader]

I agree, I think Southern California is in the middle of a real estate bubble. I suppose if a buyer can get a 30 year fixed that they can afford, it will all turn out OK in the long-term (but in this economy, who has that kind of job security?).

Last March, the actor James Woods (who's brilliant) was telling Jay Leno that he sold his house and was renting (IIRC he told Jay he was living in a hotel). He thought the LA real estate market was crazy and was waiting for the market to drop to a more sane level before he bought again.

That would be my gut reaction. If my company moved me out to LA, I'd just rent.

[A CA Guy]

There is the school of thought in California that there isn't construction underway anywhere, so values are up because of there being no availability of product.

Then there is the school of other-thought that interest rates have been kept artificially low, so though sales prices have risen, it is still cheaper than paying a 9% rate.

I am getting some additional education right now in the real estate field. I am having a series of instructors; some of which are in the appraisal field. The one tonight and my last one are highly placed within Washington Mutual.
Their thoughts were that even they can't tell you which direction RE is going for sure, but certain indicators suggest we are about to enter a cycle where prices will go down.

Everything is cyclical and for every rise of percentage points for a loan will result in lower real estate prices.

I was told you could expect perhaps 10% off the current price for EVERY 1% increase in the loan rates.

The sign that we are in the last cycle of rising prices concerns the condos. They are the last to see values rise and the first to see them drop. Well, the condos got their bump and you should look for a drop in their prices first a time before it will hit residential homes.

9% loan? I know jumbos are a bit more expensive, but I thought most residential loans were at most maybe 6.25%.
I haven't been following this, but you seem to be getting a very high rate. Maybe that is because of the nothing down. You get in for free if you pay nearly an additional 50% in loan rates. Not a deal as far as I am concerned.

Good luck, if you can make your fist home a $500,000 one you are a good money earner, though I don't understand how you have almost NO SAVINGS! That is a paradox for me.

[sangoo]

When interest rates rise you will see a decline in property values, no question about it. That doesn't mean that in the long run values won't increase, but to think they continually go up is nonsense. I remember one of my appraisers telling me in 1988 that we, in California, were immune to value declines due to this, that and who knows what else. Right.

[A CA Guy]

You mean get F'd, he's a known fraud. For heaven's sake, the author has said that Rich Dad NEVER EXISTED. This is a fabrication and this pyramid scheme guy makes a living duping people into seminars at $3000 a pop.

Does he boast of all his bankruptcy's in those seminars? NO!

Avoid Robert T. Kiyosaki’s book Rich Dad, Poor Dad and others like the plague.

http://www.johntreed.com/Kiyosaki.html

[Carry_Okie]

I agree with you about the desirability of Topanga and its propensity to appreciate. From your emotional statements, it sounds to me like you are committed to living there. Were I you in that case, I would save my money, bide my time, befriend a banker or realtor maintain a set-up for the financing and look for a repo.

Make sure your prospective neighbors are OK with brush clearing and such or you could be buying a death trap. I would be doing the homework on learning how to care for that kind of land properly, NOW. You might want to consult with the local Resource Conservation District, Fire Marshall, and/or a well-regarded arborist for a cheap education.

I hope you know where I stand on landscaping: if you are going to introduce a non-native plant, please be responsible and make sure it can't get out of control, even if you leave.

If you are buying a fixer, how skilled are you? Else will you be able to afford a $25,000 upgrade while making those payments? Otherwise, a $500,000 place sounds like its over your head, especially with a balloon payment in a time of higher interest rates. I'd get a combination of a conforming first and an equity line of credit. It's a lot of flexibility for the future. Pay down the equity line and save it for a rainy day.

[steveo]

self bump

[patton]

Look, I own a .5 mil home (actually, a little more) - but I

own it in a high-growth area.

Bottom line - get out of LA.

[Pagey]

BUMP for later

[skraeling]

Far better to purchase a dingbat at the lower end of the market, but in a decent area.

Agreed. Buy the weakest house in the best neighborhood you can afford, and let the rest of the properties pull yours upward as you spruce it up.

[Queen Jadis]

BUMP