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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Santa Cruz Rental market in decline?
February 09, 2009
I was having a conversation with a colleague of mine in the office the other day. I was talking about how I feel that the market is still declining, and will decline considerably over the coming year. She asked me if I tell my clients that – and if so, how do I sell any real estate?
Of course I tell my clients that! I feel it would be a breach of my fiduciary responsibility not to tell them that, if I believe it to be true. However, that does not mean that I am telling people not to buy real estate at this time – depending on your situation, it may be a fine time to buy. For example, if you are doing a 1031 tax-deferred exchange, then obviously, this would be a great time to buy some investment property in Santa Cruz.
As another example, I said perhaps you are a renter, and you’ve lost your lease or something, and you’ve got to move. I said that prices have now reached the point where, in some situations, for some people who want to make Santa Cruz home and plan to be here, either as property owners or not, for some years to come, that it may be about the same expense to buy as to rent – or less, depending on where they want to live and what kind of home works for them.
My colleague then said something I had not heard before: “rental prices are dropping in Santa Cruz.” Well, I had heard the first part – that in many parts of the country, rental prices are declining. More specifically, rental prices in San Jose saw 3rd largest drop in the U.S. in the 4th Quarter of 2008. However I had not heard that rental prices were dropping in Santa Cruz – that is something I don’t expect to hear until real estate sales start to turn around.
My colleague figured that the reason rental prices would be dropping in Santa Cruz is that many sellers, rather than selling in a declining market like this one, have opted to just put their houses up for rent rather than try to sell in a market like this, and wait to sell when times are better. Well, I thought, that’s a possibility – I believe there are a lot of would-be home sellers, especially in the mid-county area, who are bursting at the seams to sell their real estate but are putting it until the market exits this cycle.
As it happens, I have a couple of friends who are right now looking for rentals. I met up with them the other night at a birthday get-together, and I asked them: how are you finding the rental market? Now, this is totally anecdotal and not the kind of empirical evidence you’d want in order to prove anything one way or another, but they said: yep, the market is softening.
However, they speculated that the market is soft at the moment because it’s the middle of winter, and this is a time when students are not looking to move into housing, they should have settled in by now.
Curious, I went over to Zilpy.com to see how rental rates are in the 95060 zip code. According to Zilpy, rental rates are pretty flat overall. There does not appear to be any precipitous decline in rental prices. And the Santa Cruz Sentinel wrote an article recently claiming that Santa Cruz County has rising rental prices.
From where I sit, it seems that rental prices in Santa Cruz remain high, and remain steady. We can thank the University of California at Santa Cruz and Cabrillo College for that, to a large degree. There are many other factors as well – many people who would be buying are not, and are continuing to rent, waiting for the market to bottom out. And of course, many people are losing their homes in short sales or foreclosures, and, rather than leave the area, instead decide to stay as renters.
Which brings me back to what I tell my clients – home values are still dropping. Given what it costs to rent a place, and given that rental demand here is likely to remain strong indefinitely, it may make sense for you to buy, even in this market. You’d want to talk to your accountant or financial planner about that, of course. But depending on where you are in your life, it may be this is a fine time to buy.
Posted by SantaCruzBroker at 8:15am
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Craig’s List Rental Scams
January 25, 2009
I love Craig’s List. I love it for many reasons – I won’t count all the ways I love it, suffice it to say that it’s a great public service as well as a prime way to drive traffic to one’s real-estate related web site. 
However, Craig’s List is seen by some predators as a way to defraud, scam, and bamboozle. There’s a rental scam going around on Craig’s List, where someone tries to rent out a house they do not own, one which they saw for sale on Craig’s List. They use the picture from the ad on Craig’s List, and fashion a new, fraudulent ad of their own.
I have a sweet property listed for sale on Monterey Avenue in Soquel, and a couple of people contacted me yesterday about this scam – they had been given the property address by the scammer, and they went and drove by the property, whereupon they saw my “for sale” sign and contacted me, asking if it was for rent or not.
One of these people was kind enough to forward the e-mail correspondence she’d had with the scammer. The scammer had provided her with “proof” that he was indeed the lawful owner of the property. Here’s the proof:
and
Those are pretty nifty Photoshop jobs, but they are not anything that would prove ownership of a piece of property. Ownership is is established by the use of deeds in California, not Certificates of Ownership.
Please don’t fall victim to any such scams! The scammer asks the victims to proceed to a Western Union and send in the deposit money, and upon receipt of which he will make arrangements for you to get the keys. Except that since he’s not the real owner, you won’t get any keys, you’ll just end up a lot lighter in the wallet.
Posted by SantaCruzBroker at 9:26am
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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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Introducing Zilpy.com – Rental Info
February 11, 2008
I just heard about a fascinating new web site, called Zilpy.com – it’s like Zillow for rentals. I don’t do rentals, but the rental rates are very important to me, because I need to tell my clients what a property would rent for. That’s the #1 question that needs an answer for an investor, so they can calculate how much the property would be worth to them.
For example, I have a listing at 262 Sunnyhills Drive, in Watsonville. I think it would make a fantastic rental for an investor. After perusing Craigslist.com and the Santa Cruz Sentinel On-Line classifieds (as I talked about in a previous blog entry), I figured it would rent for $1,250 or so per month. Let’s see what Zilpy says:
Zilpy’s Estimate for 262 Sunnyhills Drive in Watsvonville
According to Zilpy, that place could be renting for $1,441 per month – cool. It should be noted that I had to tweak the info that Zilpy had for that property, by adjusting the number of bedrooms, bathrooms, and square footage. Curious, I went on to see what Zilpy figured I could rent another of my listings for, 140 Weeks Drive in Watsonville:
Zilpy’s Estimate for 140 Weeks Drive in Watsonville
Zilp comes in at an even $1,200 a month for that place. That’s pretty suspicious, given that it’s a much nicer property than Sunnyhills – it’s got a 1-car attached garage, an extra bathroom, and about 20% more square footage, but according to Zilpy, it would rent for about 17% less money, even though it’s a superior property.
Given these surprising results, I had to ask myself – where does Zilpy get its data from? I couldn’t actually find out, but here is what their knowledgebase has to say on the subject:
Zilpy employs a comprehensive array of data sources, both online and offline, to gather the most complete rental market activity.
Spare me the details, please! Well, part of the problem may be that Zilpy is apparently using some kind of proximity factor in its algorithm, as well it should – but in the case of Weeks Drive, it comparing it to a couple of rentals in Adult Village, an “adult community” where at least one occupant must be 55 years old to live there, and the other occupant (if any) must be at least 45. That keeps a damper on home values in that area (which is kind of the idea), and it likewise has a depressive effect on rental prices, thus throwing off Zilpy’s estimate for home values.
Jut for grins, I put in another listing I have at 216B Green Meadow Drive, in Watsonville – also a condo. Here is what Zilpy says:
Zilpy Estimate for 216B Green Meadow Drive in Watsonville
According to Zilpy, this unit (a three bedroom, 1.5 bathroom, 1 car attached garage) ought to be bringing in $1,737 per month.
As an investor, I’d take those numbers and do some back-of-the-envelope calculations. First thing I would do is take the HOA fee right off the rental amount. That’d help me with an apples-to-apples comparison. Here’s how it breaks down:
The bit of data I’m after here is in the last column, the GRM, or Gross Rent Multiplier. This is the number of years it would take to pay off the mortgage, assuming 0% interest, if the property were rented 100% of the time. At 16.11 years, 216B Green Meadow Drive takes the prize. Of course, the data is flawed – 140 Weeks Drive would rent for more than 262 Sunnyhills, etc.
Even though it is flawed, Zilpy.com is an interesting web site, and if you are considering doing some real estate investing, I encourage you to take it for a spin.
Posted by SantaCruzBroker at 12:44am
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