Thursday, November 5, 2009

Good Deals

Mike in LBC writes:

El Bee,

Is there anywhere on this blog site, where you throw out a couple steps to follow, for noob real estate dummies like me, to see if a property is a good deal? What steps do you take, when you want to see if a property is a good deal?

And this is just a suggestion, but I would really like to see you find a property that you think IS a good deal, and maybe tell us why, and how to find them.

My permabear permafrost has thawed considerably this year, and I'm not afraid to tell my readers when I think something is approaching a decent buy. The reason I don't feature more "good deals" on this blog is because, frankly, the few that exist don't last long on the market. And for good reason. In fact, sometimes I'll have a finished post in the can only to discover the property sold before I could publish it.

And with all of the government intervention (whatever you think about all the taxpayer cash being dropped from B-2 bombers, you have to admit it seems to be working as far as spreading the pain gradually instead of the precipitous equity-destroying tailspin we saw in 2007-2008) it's even more difficult to determine what the "real" value of a property is.

I think everybody's biggest fear is that they will put all their hard-earned money into purchasing a house, only to watch the value plummet immediately.

But why is being a little bit underwater such a big deal? Sure, nobody likes to think they paid too much for anything (just listen to people brag about the "deals" they get on car purchases and how they "raked that salesman over the coals"--you don't often hear about the people that got home only to realize they got cornholed on the "clear coat protection"), but assuming you bought a house you love (or at least see yourself in for a decade) who really cares about timing the bottom perfectly?

The real question is: If you buy today will you be more than "a little bit" in the red a few years down the road?

I can't tell the future. Anybody who claims they can is certifiably full of it.

But what I can tell you is if the Superbears are waiting for $99 per square foot in coastal Long Beach, you'll be grousing about "unsustainable" home prices until you're living in a home staffed with nurses. I don't want people to hang their hat on a "tsunami" of REO properties flooding the market and crushing prices. I just don't see that happening anymore. What incentive does the government have to force banks to release their inventory?

I also don't want buyers to pin their hopes to rising interest rates bringing values down. First, we don't know for sure that that will happen. The conventional wisdom is that higher rates equal lower values because people can't finance as much, but what if as rates rise more people jump in before rates get out of control, thus raising home prices? Then what? Second, do you really think the goverment is going to let that happen?

Look, I'm still pretty bearish, but I have to say the incessant doom and gloom is getting old (if the Mad Max theorists are correct, our currency will collapse and blogs like this will be pointless. All property without tall gates will become worthless and we'll be scrounging for water and ammo and won't give a crusty crap about granite countertops). Because although some delusional sellers set "Wishing Prices" I think some permabears are holding out for unrealistic prices. Just like those idiot sellers are never going to get $900,000 for that 1 bed/1 bath with ocean views, you're not going to get it for $90,000.

Housing in Southern California is expensive. It always will be. The maintenance alone will ensure that. It's a luxury item, a consumable. And just like there is a reason BMWs cost more than Scions, if you want to own a nice home you're going to pay for it. So please don't let the perfect (price) be the enemy of the good.

If you have to buy and the numbers are "close enough," then buy. Do it. But understand it comes at the cost of being a bit underwater for the next few years--maybe five or more if things really hit the skids. If not getting a "great deal" doesn't bother you (and judging by the sales activity of late, it doesn't seem to be troubling too many) then go for it.

BUT, also don't get in way over your head if the fundamentals aren't right. Sometimes "expensive" things are completely worth it (a Shelby Cobra Mustang costs about twice what a stock GT does, but I'll gladly pay the premium to hear that supercharger whine every day). I realize that people, after being priced out during the last eight years or so, are champing at the bit to buy and "get it over with," but just understand that we're not at a true bottom in coastal Southern California. Prices are still way out of line with incomes.

My guess is that we're in a dead cat bounce right now fueled by government spending and attempts to kick the can down the road (Hell, Fannie Mae today just approved a plan to avoid realizing losses on their disastrous portfolio by allowing deadbeat homeowners to rent their house from FNM at no more than 31% of gross income. Hey shitbrick, don't you think implementing that rule on the mortgages you insure would have avoided this clusterfuck in the first place? Anyhow, there's a bunch of homes that should be REO inventory that won't see the light of day for at least another 12 months. Kick the can, kick the can). But after this temporary re-inflation, we'll continue our gradual decline and scrape along the bottom for a few years. In other words, the idea that we're going to have another monstrous housing bubble and you'll "miss your opportunity" if you don't buy now is a total crock.

I simply don't see dangerously loose lending practices or massive statewide wage increases on the horizon to support increasing prices (but I do see significantly rising taxes, which will put a dent in housing budgets. How did you think we were going to pay for the California budget deficits, housing tax credits, and financial bailouts?).

To answer your core question, Mike, here is how I determine whether a primary residence is a good deal:

1) It's as nice or nicer than your rental, and the cost is roughly the same (if your monthly PITI is less than your rental rate, that is a SMOKING deal). If you get in trouble and have to move, and renting it out will cover your monthly payment, you got a good deal.
2) You're proud to show it off, yet the purchase price is only 3.5 times your annual income (4x income, although riskier, seems to be what most Californians are comfortable with, but we're talking about what makes a "good deal")
3) You are spending no more than 31% - 33% of your gross monthly income on housing--including principal, interest, HOA, taxes and maintenance (that's not my number--that's the "safe" number determined by mortgage lenders before they took crazy pills. For fuck's sake, EVEN FANNIE MAE IS NOW ADMITTING THAT 31% IS THE MAXIMUM AMOUNT THAT PEOPLE CAN PAY FOR HOUSING AND REASONABLY EXPECT TO MAKE THE PAYMENTS!).
4) You can afford it without stretching too far, while simultaneously being able to afford to live a good life.
5) You're buying it to live in and not as an "investment." If it's an investment, it will never seem like a good deal because the constant flow of money you'll be putting into maintenance and taxes will be little red daggers on an Excel sheet and not the trade off for homeowner pride. If it's a home, that stuff won't matter.

But really, #1 is the most reliable. And that's because rents are tied DIRECTLY to income. Since there is no way to finance your rent, your monthly payment comes only out of the money you take home each month. Simple, right?

I don't know if I answered your question, but those are my coffee-addled thoughts.


  1. 3) You are spending no more than 31% - 33% of your gross monthly income on housing

    And realistically, that should include taxes and maintenance.

    And...if you are really spending 33% of your gross, that is probably 50% of your take-home pay. That means you are not taking any vacations farther than your backyard, or maybe a state campground if gas is cheap. And you are going to be hard pressed to save much for retirement or kid's college.

    So...20-25% is a "safe" percentage of gross income.

    But you can do 33% (or 43%!) since real estate prices always go up in California, and you will be able to fund the kid's college, and your retirement, using HELOCs


  2. Freedom,

    I hear you about 31% - 33%. For a "good" deal, that's probably still too much income toward housing.

    I'm just trying to realistic, you know? Me personally, when I get hitched I want to be able to afford a fairly nice house on just one income. That's "safe" to me. But I'm also competing against reckless people who don't plan further than the end of their nose. In other words, I could wait my whole life for prices to come down to that kind of affordability.

    The funniest thing to me is people got accustomed to $400,000 condos, when just eight years ago most of those places were like $250,000. We didn't have massive foreclosures in 2001, so that must have been affordable, right?

    But wages haven't gone up that much since the early 00s, so how is $375,000, $350,000 or even $325,000 suddenly "affordable"?

    Common sense tells me prices need to come down to those levels. But, as you and I have seen, conventional wisdom as of late seems to have gone the way of the Dodo.

  3. Good points, all. Your number one rule is a good one, to which I would only add: Your cost of ownership is roughly the same as your rental AND you have been able to put away a sizable downpayment with a few months worth of "reserves" while paying for said rental and maintaining your desired lifestyle. The ability to save while meeting monthly debt obligations is the only true way to measure what's affordable to an individual--and probably why so many low down-payment buyers find themselves house poor in the long run.

  4. Great post el bee! Agree wholeheartedly with all the above. As bad as renting is, friends and relatives who bought at the peak and are now way underwater are hating life much, much more. At least I get to put money away every month and know I can always bail to something cheaper in a month if things go sour.

  5. "I realize that people, after being priced out during the last eight years or so, are champing at the bit to buy..."

    El Bee don't bite my head off but I think it's "chomping" at the bit not "champing". Other than that typo / thinko I agree with what you said.

  6. Great post el bee. You keep on asking the same question I do which is hot the f did prices go from 200's to 400's, and people'e incomes aren't in line. At the same time, govt. is doing everything they can to keep property values inflated. It is as if the people on east coast don't appreciate what was inflated out here, and do all this stuff. I am still dissapointed b/c I can't meet all my obligations ie. saving for retirement, and stuff, and buy a house at half million dollars....

  7. A good and balanced post el bee and one with which I can find no quarrel. One point you allude to is that as rents come down (reflecting the lower income reality), surely housing prices do as well. This might take some time but I believe that the two are intrinsically tied, with rent usually leading the way...


  8. The actual idiom is "CHAMPING at the bit." Although "chomping" is commonly used and therefore also accepted as correct. But I appreciate you keeping me on my toes.

  9. Yikesboy,

    Good point. And with Fannie Mae entering the rental market, you better believe they'll undercut nearby landlords to keep people from moonwalking.

    More downward pressure on rents = less of a reason to overpay for a property = property values continuing to decline.

  10. THANKS El Bee!!!!!!!!!!!!!!!!!!!!!

    That helps a TON!

    See, I'm a total noob to RE. I'm no dummy, but sometimes when you are a noob with something, you can make a lot of dumb mistakes, or miss some pretty obvious things.

    I trust your judgment immensly in this area, so I just wanted the basis of a formula, for which I might use, if and when I make a move.

    I see you use the Redfin site a lot, versus, so I plan to familiarize myself with that one.

    I don't know how you get the comparables, nor how you get the price per square feet chart. That'd be the only other thing I'd ask about.

    I'm guessing I could probably find that stuff on the redfin site...

    I know you are a busy man, but any thoughts on my dream property, at 125 E Harmon in Vegas??

    I contacted the realtor, but he said something about it being impossible to get a loan on a condo/hotel. I've got to contact my lender, to see about that.

    Other than that, it seems to me that the most room for growth, after purchasing, would be in Vegas.

    Unless that city somehow implodes, I think a lot of the real estate out there is going to skyrocket, at some point in the future.

    Any thoughts?

    thanks again, and have a blessed day!

  11. Hey El Bee- I vote for this property as being a future feature of Long Beach greedtard hall of fame:

  12. Great post and comments.
    El Bee, you mention one critical point in your comments here. That is buying the house based on one income. So many people have fallen into the two income trap in SoCal. I understand that a couple anxious to buy will do just about anything to get into a home, but considering both incomes in the calculations is very risky (IMO) and depending on how far stretched, pretty much locks the couple in. they BOTH have to keep working to afford their lifestyle. Life's inevitable bumps can quickly turn this situation into a financial nightmare....job loss, illness, pregnancy etc.
    Of course, this is just a general statement and each case is different, but I know way too many people who are suffereing now because they assumed that these two incomes would ALWAYS be there (and growing).
    Sorry for the rambling, all. Not enough coffee yet.