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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Is 2009 The Year to Buy Santa Cruz Real Estate?
January 17, 2009
This is a question that I get asked, and find myself asking, quite a bit these past couple of weeks. I am working with a number of buyers who are skittish and waiting for prices to hit just the right point. After all, what’s the sense in buying a depreciating asset? Who wants to buy something that they know is going to lose them money – maybe a lot of money – within a few months after buying it?
One of my clients sent me a link to a great web site – Housing Crash Continues, Bubble Pops. It lists 14 great reasons why this is a terrible time to buy real estate. It’s pretty strong stuff, with lots of inflammatory statements like, “Realtors just lie outright about…”. Well, I always say, never attribute to malice what can be explained by stupidity. I don’t think that Realtors are habitual liars, but it’s true that many of us are not as perhaps informed as we might be.
I won’t address all 14 points that the The Housing Crash guy brings up, but I would like to make a few comments. The Housing Crash guy says:
A landlords’ rule of thumb is that a house price should be a maximum of 15 times the annual rent for that place, yet in coastal areas, houses are still selling for 30 times annual rent
I think he’s got a good point there – which goes to underscore my belief that prices in Watsonville are actually very reasonable at the moment. Looking at Craig’s List rentals for Watsonville, I see you can rent a 3-bedroom condo in Apple HIll for $1,875 a month. Those condos are now selling for around $190,000. So at $1,875 a month, that’s $22,500 a year, or $337,500 over 15 years. Hmm…so does that mean according to the Crash Guy, we should all be moving to Watsonville?
Put another way, how much does it cost to own that same condo which rents for $1,875 a month? Let’s say you put down the minimum 3.5% as required for an FHA loan, and that you are paying 5.75% interest per month, which includes the allowance for the FHA insurance. You’d need a down payment, then, of just $6,650, and you’d have a loan of $183,350. Your fully-ammortized 30-year loan payment would be about $1,070 per month. Then you’d have property tax of about $175/month, and then of course your HOA fee for that unit of about $290/month. That comes to $1,535 per month. Hmm. It costs less to buy in Watsonville than to rent.
I know, I know – you don’t want to live in Watsonville. You’d rather pay a premium and live near the beach, or closer to your job in Silicon Valley, or closer to your friends who all live near downtown, or maybe you don’t want to live in Watsonville because you’re spooked by los pandilleros, or you want your kids in a better-performing school district. Whatever your reason, I can accept that you might be interested in buying somewhere other than Watsonville (even though I think real estate there is a an exceptionally good value at the moment).
We all know that prices in Santa Cruz are a lot higher than in Watsonville, but let’s see some examples. Let’s start by looking at Craig’s List rentals in Santa Cruz. Wow, they’re a lot higher than in Watsonville! Thank Goodness for UC Santa Cruz, drivin’ that rental market right through the roof, eh landlords? Looking over the ads on Craig’s List, it’s safe to say that a 3 bedroom, 2 bathroom house would rent for about $2,400 a month in Santa Cruz, assuming it was in a not-so-great location. That’s a pretty conservative assessment, having looked at what’s available.
At $2,400 a month, that’s $28,800 a year – times 15, that’s $432,000, which is the maximum that The Crash Guy says you should pay for a house if it rents for $2,400 a month. Are there any 3/2 houses in Santa Cruz for $432,000? No, of course not! Don’t be silly. But there are presently six 3-bedroom, 2-bathroom houses in the city of Santa Cruz under $500,000.
Does that mean that housing prices are still too high in Santa Cruz? According to the Crash Guy – yes. According to me – yes. I do think that prices in Santa Cruz (and Capitola, and Soquel, and Aptos, etc.) are higher than they will be towards the end of the year. Does that mean you shouldn’t buy a house in Santa Cruz in 2009?
Good question. Let’s look at the payment for a $500,000 house – but let’s assume you’re putting down a reasonable 10% instead of the FHA minimum of 3.5% – so you’d have a $450,000 loan, again at about 5.75% because with only 10% down, you’d still need to pay mortgage insurance. A 30 year fixed loan at 5.75% would run you $2,626 a month – plus $458/month in property tax, plus about $75/month for insurance, leaving you with a monthly payment of about $3,159.
However, you mustn’t forget about your mortgage interest tax deduction – of that $2,626 per month, about $2,100 is interest (gulp) – plus the $458 in property tax (which is also deductible), means you have a monthly tax deduction of $2,558. Let’s say you’re in a tax bracket of 25%, and you can figure you’d save about $640/month in federal and state taxes, bringing your effective monthly after-tax payment to about $2,519 per month, or just about $120 more than renting.
Is $120/month too high a price to pay for the benefits of ownership vs. renting? You tell me.
Here’s what I will tell you: it seems clear to me that there are many properties in Santa Cruz county which now make economic sense to buy, and that number is increasing, and will continue to increase throughout the year. There is no shortage of blogs to read (try here, and here, for example) suggesting prices will continue dropping beyond 2009. I admit – quite possibly, this is true.
However, I would argue that if you want to live in Santa Cruz, and you have the option of either renting or buying, that for many people, the numbers will soon pencil out to where buying may, in fact, be the right choice for you in 2009. There. I’ve said it. But I won’t be offended if you want to take that with some salt on the side.
Posted by SantaCruzBroker at 11:47am
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Santa Cruz Real Estate in 2009
January 02, 2009
Happy New Year! I hope everyone had a safe and sane New Year’s Eve, and I hope that as I type this on January 2nd, most of you are taking the day off to spend on vacation, or with friends and family. We’ll all get back to the grindstone soon enough, but I think that after all the chaos and tumult of 2008, everyone deserves a four-day weekend to start off the new year.
Can you feel it? I’m feelin’ it. I am, of course, referring to the angst surrounding the real estate market. There are a lot of people out there who would like to buy a home in Santa Cruz in 2009. There’s also a lot of people who would like to sell a home in Santa Cruz this year, too, but feel they cannot or should not because they now owe more than their homes are worth.
Thanks to the likes of Google, many of you can easily find the predictions for the 2009 real estate market. I’ll give you a summary of what they’re saying: prices are expected to continue dropping through much of 2009 (probably all of it, if you ask me) but not by much. Interest rates should remain low at least for the first half of the year. We may start to see a rebound in prices in 2010, but it will be moderate.
The much-loved California Association of Realtors has put out a report titled State of the California Housing Market 2008-2009. Unfortunately, they want you to pay $29.95 to download the PDF, but the press release for the report’s availability does give some juicy nuggets:
- Approximately 1 in 5 home sales is due to foreclosure, short sale, or default
- Home sales will increase 12.5% in 2009 compared to 2008
- California Median Home Price to decline by 6% in 2009 to $358,000
From where I’m sitting, 2009 is looking like it is going to be the year to buy a house in Santa Cruz. I have been telling people all throughout 2008 that it’s OK to buy a house in 2008, but if you can wait, 2009 will be better. The question then arises – is it good to buy in January 2009, or would it be better to wait until, say, December?
Given that home prices are likely to keep dropping throughout the year, in many cases it will make sense to wait as long as you can before you buy a house. However, one thing that’s known for sure is that right now, interest rates are very low, and you might want to buy now to lock in a really low interest rate.
One thing that we don’t know right now is what effect the recession will have on the job market locally. Rising unemployment will add fuel to the foreclosure fire, and that will certainly increase downward pressure on prices. If the job market gets really bad and stays bad, prices could decrease by a lot more than the 6% the California Association of Realtors predicts.
Even if the recession is longer and more protracted that most fear, I still feel you’ll probably do OK buying property in Santa Cruz in 2009 – provided you are making a long-term investment.
Posted by Administrator at 6:00am
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Interest Rates Plunge for Homes in Santa Cruz
September 08, 2008
In case you haven’t heard, over the weekend the free-marketeers over at the Treasury Department have taken over Fannie Mae and Freddie Mac. I’m all for it, of course. The hypocrisy kind of makes me sick – they’re all for government intervention to help out the banks and whatnot, but when it comes to helping out the middle and lower classes with, I don’t know, a tax cut or a single-payer health care system – forget it.
But I digress – I’m totally for the bailout. We just can’t afford a collapse of the whole mortgage lending system. That would just be catastrophic, and would end up hurting many more people than simple inaction and the possible collapse of Fannie and Freddie.
The good news out there for you, Mr. Middle Class Home Buyer, is that interest rates have plunged. Apparently, a confirming 30 year fixed loan is down to about 5.75%. That’s pretty good. Rates had been about 6.5% on Friday, so this is a huge drop.
Now, for those of you who are using FHA Financing (typically first-time and low-income buyers) – you’re out of luck. It seems that FHA rates will remain about 6.5% for the time being.
Of course, as you can imagine, an event of this magnitude is likely to cause quite a bit of perturbation. Rates could be this low only for a short time – they could go right up again before we know it. Or, of course, they could drop even further. Who knows?
Interest rates vary all the time, and they vary from borrower to borrower and lender to lender. But let’s assume that on Friday, your rate would have been 6.5%, and today, it’s 6% – in other words, a 1/2% drop. Let’s also assume you’re buying a median house in Santa Cruz, and you’re putting down, say, 15%. The median price these days is around $610,000 – so your loan would be $518,500 (yes, I’m assuming you have $91,500 handy for a down payment!).
At 6.5%, your principal and interest payment, for a 30 year fixed loan, would be $3,277.27.
At 6%, your principal and interest payment for a 30 year fixed loan, would be $3,108.66. That’s a difference of $168.61 a month.
Hey, calm down! Don’t get so excited! It may not seem like much – but it is a bit more than a 5% savings in monthly payments. Until you figure in tax and insurance, of course. Your tax would stay the same – about $559 per month, and insurance would be, oh, $75 a month. So your true payment with a 6.5% rate would be around $3,911.27 a month, which puts your actual savings of $168.61 at somewhere around 4.3% per month.
Still, $168.61 ought to pay for at least a few refills of the ol’ Prius, eh?
Posted by SantaCruzBroker at 2:54pm
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