Caveat Emptor for Watsonville Investors
May 24, 2009
I’ve got some clients, and they’ve got some money to invest in Real Estate. They are not looking to speculate on real estate – that’s how so many people ended up getting foreclosed on in Watsonville, and in California, and in many other places throughout our glorious but fading homeland. Rather than simply speculate, my clients want to make smart, long-term investments.
A Speculator is someone who is placing a bet – they put some money down, and their bet is that the value of whatever they buy will go up. They may have reasons to speculate that the price will rise, but it’s more of an anticipation, an educated guess. This is what so many people did wrong – they bought real estate they could not afford to hold on to, speculating that it would always be worth more than they paid for it, so they could get out, easy, and make a handsome profit for their trouble.
These clients of mine are probably not what you would call professional real estate investors – but they want to buy real estate as if they were – and after they do buy a few properties, and if they keep with it, hey, before you know it – they will be professional investors, after all, every professional has to start somewhere.
One of the primary things an investor wants is a good “cash on cash” return on investment . That is, they want to put up some cash, and have that cash investment return them money, put money back in their pocket, each and every year. So let’s say you put $100,000 down into a property, and you want to get a 10% return on your investment – that means, that after all expenses and costs, you get back $10,000 pear year on your $100,000 invested.
And that is where a lot of investors go astray, I think. They don’t have realistic numbers as to the income the property will generate and the costs that owning, financing, maintaining, and renting the property will incur. As it happens, my clients went on to my web site and found my handy Excel spreadsheet for income property analysis. It’s a really great tool (to be used for estimating purposes only, of course! Contact your legal, tax, and accounting professionals before making any investment decision!) to help you figure out what kind of a return you can expect on any given property.
There are some key numbers you need to know. The first, is the interest rate on the loan you will be getting. This is tricky – many times, your loan broker will quote you a figure, and then your actual interest rate turns out to be 1/4 or 1/2 or even a full percent higher than that. Make sure you ask for your Good Faith Estimate from the lender so you will know what your actual interest rate is going to be, and if you have to pay any points to get it.
You will also find out how much of a down payment is required. At first, my clients were figuring they’d only need 20% down for a non-owner-occupied real estate loan. Their lender informed them, when asking about their actual rate, it would be 25% down.
Another key bit of information you’ll need to know is, how much can you actually rent the property out for? The rental market in Watsonville has been extremely tight of late, and rental prices have been very high – or have they? I had recommended my clients look on Craigslist and also on Zilpy.com to see what the rental prices were looking like. The problem with that, though, is that these are asking prices for rent. It does not mean that they are the actual prices people are paying.
When you’re an investor, every month a unit sits vacant kills you. If you are asking too much for rent, you are not going to attract the kind of quality tenants you are looking for. You need to price the unit well for quick rental to attract quality, long-term tenants.
I talked to a property manager down in Watsonville about the rental situation. She said that the rental market had softened considerably, especially since the Housing Authority of Santa Cruz County had put a freeze on new housing vouchers. Ouch. According to the lady I spoke with, actual rents in Watsonville are now down about 20-25% from a year ago. D’oh.
What this means for my clients is that the amount of money they can afford to pay for a property, given their higher interest rate and lower rental rates means that they can offer less for a property than they had first thought – in order to make that 10% (or near 10%, anyway) cash-on-cash return on their investment. And there’s another important factor to consider for you number crunchers out there – closing costs and fix-up costs. It could be you need 25% down for your loan, and then another $10K for closing costs and another $15K on top of that to rehab the property so that its condition will make it desirable to rent quickly and for the highest rent possible. The $100K you thought you were investing could easily look like $125K before the first tenant moves in, and if you want to get 10% back, you’ll need to see $12,500 per year free-and-clear.
While we are on the subject, let me ask this: why are rental prices in Watsonville down 20-25% from a year ago? I don’t know for sure, but here’s what I think: it used to be there were a lot more owner-occupants in Watsonville than there are today. A year ago, there were less rental units available. All the people getting kicked out of their houses by foreclosure were competing for the scarce rental stock. Now, a lot of those formerly owner-occupied houses have turned into rental houses, thereby increasing supply. At the same time, not as many people are getting foreclosed on at the moment because of the various foreclosure moratoria which have been in place. And, of course, the unemployment rate in Watsonville is reported to be at 25% – that’s huge, and I think it means a lot of people are going to be sharing housing, families living with families, rather than each family having their own individual place as I’m sure they’d prefer in many cases but owing to the weak economy cannot afford to do so at the moment.
And, one other thing: what do you think these lower rental rates are going to do to home values? Will they have no effect? Bah, humbug. I dare say they will continue to drag down property values in Watsonville, and that we have not yet hit bottom. A lot of the buyers in Watsonville today are investors – and a real investor will only be able to pay so much for a property to get the return they need to justify the considerable risk. Also, as rental rates decrease, it blunts the incentive to for someone to buy – as the chasm between monthly rent and a full PITI payment widens, more fence-sitters are likely to stay there on that fence, and continue to wait out the market.
To all ye would-be investors, in Watsonville and everywhere else in our Golden State, I say: rock on, but play it safe, and always use your green eyeshades when analyzing any real estate investment. I’d hate to see you end up like thousands of well-intentioned but mis-guided “investors” before, with your investment dollars flushed down the drain and a bitter taste in your mouth.
Posted by SantaCruzBroker at 1:00pm
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Billions, Trillions and a House in Santa Cruz
September 30, 2008
These sure are interesting times. Washington Mutual (my bank) – gone. Wachovia (which just bought up World Savings a while go) is now part of Citibank. The much-touted $700 billion bailout plan gets shot down in the house of representatives, and Wall Street falls 777 points to erase $1.2 trillion dollars in market value. Glad I sold all my stocks 2-3 weeks ago.
I know, I’m part of the problem. I should have just sat there and watched as my hard-earned dollars evaporated, sucked it up, been a man, and lost all that cash, the price to pay for participating in our capitalist system.
Except that I, like many of you, can’t help but feel that the system is, perhaps, a bit rigged in favor of the big guys. Like Washington Mutual, for example – my understanding is, the Feds took it over, wiped out the shares of everyone who owned it, and sold it to JP Morgan Chase for a couple of billion dollars. And the WAMU shareholders got nothing.
So what does all this have to do with Santa Cruz Real Estate? Pffft. Wish I could tell you. One thing that’s very interesting to me is this claim that the credit markets are “frozen” and that’s why we need this $700 billion bailout. From where I sit, the credit markets do not appear frozen. At worst, they appear congealed.
I’ve actually been selling a lot of real estate this year, and almost everyone who is buying is getting a loan. It is true that in order to get a loan these days, you must meet a much stricter standard. Last I checked, though – that’s a good thing. Easy credit, liar loans, all that – isn’t that how we got in this mess to begin with?
So let me assure you – if you want to buy a house in Santa Cruz, and you have decent credit (at least a 580 FICO Score to qualify for an FHA loan, I believe) and you have the debt-to-income ratios required by the guidelines. But if you have that, a pulse, and a paltry 3.5% down payment – you’re in.
Let’s say you want to buy a starter house or condo for $500,000. Mind you, the median price these days in the county is $585,000 (as of August), so it’s getting to the point where you can actually buy a habitable structure in a somewhat central location for that kind of bread. You’re looking at a down payment of $17,500. That would leave you with a whopping loan of $482,500 and payments (all-in, including principal, interest, property tax, and insurance) of about $3,500 a month (roughly, approximately – and that’s before your considerable mortgage interest tax deduction).
What’s that, you say? $3,500 is a lot to pay every month? Yeah, it is. So perhaps you would want to – gasp – have a bigger down payment, like 10 or 20%. Or buy a smaller house, or live somewhere less central. Or, wait another six months or a year before buying. Because prices are going down further. Except in Watsonville and north Monterey county, I think they can’t possibly go down much further there.
Let’s say, though, that you have $20K for a down payment, and you’re fine with a $3,500 monthly payment. You might be wondering about your closing costs – those can be considerable, especially if you are in fact going with FHA financing.
No worries, mate! Put a shrimp on the barbie and let the seller pay your closing costs. Most sellers, if you write them a high-enough offer, will be happy to pay your closing costs. Even in a short sale, and especially if you’re buying a bank-owned REO property. You might even be able to lower your rate by paying a point or two, which is not a bad idea if you’re planning to stay in the home longer than 3-4 years.
It hardly needs to be said, of course – but if you’re planning to buy a house, you’d better plan on being there at least 3-4 years. At least. Real estate is a long-term investment. Not like that crazy silly stock market. 
Posted by SantaCruzBroker at 8:29am
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Pre-Qualification, Pre-Approval – what’s the difference?
April 19, 2008
To be, or not to be, that’s is the question. To pre-qualify, or get pre-approved, what’s the difference? There’s a big difference, and if you are looking to scoop up some real estate in today’s rocky credit market, it’s important to know the two apart.
This is something I hear all the time: “Getting a loan won’t be a problem for me.” Or, how about, “I have a friend who is a mortgage broker, and he says based on my income and credit score, it will be easy to get a loan.” Talk about famous last words before your financing never materializes!
So here’s the the skinny. Pre-Qualification is basically what happens when your buddy the mortgage broker asks you how much money you make, and how much your expenses are, maybe he runs a credit report,and then issues you a spiffy letter saying “Based on So-and-So’s income, credit score, and blah blah, I have pre-qualified So-and-So for a purchase price not to exceed $XXX,XXX.”
Granted, this is better than a poke in the eye with a sharp stick. When you are going out to buy some real estate, leave the sharp stick at home and if you don’t have anything else, bring your pre-qualification letter with you. OK, not really, you can leave that behind when you’re actually out looking at properties, but you’ll want to have it handy for when you want to write up an offer.
Here’s where it gets a little rough: sometimes, even though a mortgage broker will pre-qualify you, he will write on the letter, “So-and-so is pre-approved to buy…” when in fact, they are not pre-approved to buy anything. So what’s the difference?
You’ll know the difference when you actually go to get pre-approved. Here’s how to tell if you are pre-approved:
1) It took at least several days of work to get pre-approved
2) Your mortgage broker kept asking you for lots and lots of documentation
3) You have an actual loan number from an actual lender (e.g. Wells Fargo, Chase, Washington Mutual).
The difference for pre-approval is that the lender, not the mortgage broker, has actually approved you for the purchase of a house. You have supplied the requisite documentation (and there’s a lot of it, usually) and you have passed through the lender’s underwriting process. At this point, the only missing part of the equation is the collateral – that is, the property you are going to buy. The lender needs to appraise it and make sure it meets the other guidelines for the loan.
Even if you think that you won’t have any trouble getting a loan, even if you have all the assurances in the world from your friends in the mortgage business – get pre-approved by a lender, not a mortgage broker very early in the home-buying process. This will likely save you much wailing and gnashing of teeth down the road.
Another benefit of pre-approval is that you will know what actual loan you will be getting. You’ll know the interest rate (although it may fluctuate), any points, any special features of your loan, etc. You will also at this point should be able to get from the mortgage broker a good faith estimate of closing costs, so you will know how much actual cash you will need to close the loan – and loans don’t come cheap! Of course, you may be able to get the seller to pay for your closing costs – in a market like this, it isn’t too tough.
If you are thinking of buying a house in the next several months, do yourself a favor: get pre-approved, now. The process may take longer than you think, and it will be very beneficial to know what your actual payments and closing costs will be long before you actually incur them.
Posted by SantaCruzBroker at 7:55am
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