San Diego Housing Bubble News and Analysis

Is 20% ROE the right expectation? Personally, I think it seems high. Especially considering most other type of investments are returning much less than that, unless you want to take major risks. if you get 20% ROE from day one, that % can only grow as rent price appreciate.

I think this spreadsheet is designed by house flipper. To make ROE >20%, you can simply choose to use interest only payment. And to make "Cash on Cash" number look good, you will need to put down less down payment.
So it gets you into the optimal case ONLY IF you are holding the property for short-term (and be able to sell it with appreciation) and almost meaningless if you plan to hold it for long-term. Personally, I ignore all the "goals" stated by the spreadsheet, but I do find some of the calculation useful.

By the way, the interest rate is also a little bit higher than the current market price.
Personally, I find temeculaguy's simple formula much easier: if the house price is rent x 100, it is a nobrainer; if it is rent x 125, look really hard; and if it is rent x 150 or above, it is still in its bubble price.

Personally, I find temeculaguy's simple formula much easier: if the house price is rent x 100, it is a nobrainer; if it is rent x 125, look really hard; and if it is rent x 150 or above, it is still in its bubble price.

By this logic, a big 4br house in Mira Mesa that would rent for $2000/month is in its bubble price unless it drops to 250k.

Does not compute.

I am with Dr. Smith on this.

Dr. Smith was my favorite "lost in space" character.

Why can't the MM house go to $250K?

If local incomes were high enough to afford higher monthly payments, the rents would be higher, no?

I think "price anchoring" has affected everyone -- even the bears. Prices in 2005 were nowhere near normal. We need to look at numbers BEFORE the credit bubble (2001 and before) to really understand where prices should be.

Also, "inflation" numbers that focus on costs should not be considered WRT housing appreciation. As costs for other goods go up (especially food, energy, healthcare & other necessities), there is LESS money for housing. All that matters is **income** inflation, and that is not appreciating as fast a cost inflation...that is deflationary for housing.

Going rental rates are more responsive to actual incomes, I think. You can't get an 3/1 ARM with magical pony dust to cover your rent, it must come straight out of your paycheck.

So, someone who could afford a $2,000 rental payment could afford a $250,000 mortgage, assuming it's an old school sane fixed-rate mortgage. The fact that $250K sounds unusually low to you just shows how out of whack prices around here are with peoples' actual ability to pay.

FWIW, in 1996 I remember Rancho Bernardo houses going for $250K-ish. The MM house I'm renting in right now went for well under $200K. And to this day, comparable houses, with larger yards, in my Midwestern hometown go for closer to $100,000.

Yes, I know it's California... but wherever you are, there's only so much juice you can squeeze out of a grape.

Around the bottom of the last cycle, a 3/2 1500 sq-ft house rent for around $1200/month and price were around $160k. That's with ~9% interest rate. You're talking about $1030/month in mortgage with 20% down. If interest rate stay where it is today, a 3/2 1500 sq-ft houst rent for around $1900/month. If price goes to $250k, you're talking about mortgage of $1200/month with 20% down. If mortgage payment stays the same ratio to rent as 1997, price should be around $340k. That 100/125/150 ratio does not take interest rate into consideration.

AN - My experience was similar. We purchased a Clairemont house for 160K in spring 1996. Rent for equivalent properties was 1000-1100 per month. Our mortgage rate was 8.25%.

SFH rents were about mortgage rates + 0 to 1% at the bottom of the last cycle.

P.S. - If rates go back up to the 8% range as I expect, I would expect prices in the same area would drop to somewhere in the 320K range. (I'm assuming real rent growth rates of negative 4 %, i.e. flat rents and 4% inflation).

Let's take a house that rents for 2000/month. I'll use 6.25% 30-year fixed rates. 10% down loans can be obtained from FHA, you'd pay a little extra in closing costs and you'd have to pay 0.5%/year in mortgage insurance, but they do exist. (So I'm told)

It probably does not cash-flow as a rental property above 250k. (I'm too lazy to do the math and I don't have a rental cash flow calculator handy)

At 285k, you can buy it with 10% down and PITI would be equal to rent.

If you view money you pay towards principal as "forced savings", and you include tax benefits, owning starts making sense somewhere in 370-430k range, depending on your tax situation.

If you can afford to put 20% down, mortgage insurance goes away; even assuming 5% forgone interest on your down payment, you can justify buying the house as high as 475k.

geez

You leave the san diego area for a few days and this is what happens...

No, the calculator is not specifically geared towards multi units.

The ROE/ROI value in the calculator should be noted is NOT appreciation. Many people do confuse the two. As for those who think it is too high, consider that ROE is composed of several elements of real estate value - appreciation, cash flow, loan reduction savings, and tax benefits. When all four are working well together, yes, virginia you can get ROE's in the 20% or even higher.

For the San Diego/Mira Mesa area, the calculator is correct - you still have a ways to go before you are able to purchase a property, and have it cash flow as a rental. Certainly you can play with the factors and try to make it cash flow based on interest only or decreasing expenses, but you should do this based on knowing what you're doing and as a way to compare other properties which don't have those problems or non-issues. If you are serious about using the calculator to analyze the property, you should try to account for as many expenses as possible and try to also be realistic as to how you can change certain factors to make the property work. For example, you can be stupid and try to put in a 10% appreciation rate, which makes everything look supergoody. However, we all know the consequences of making such an absurd assumption.

As for me being a flipper, I have only flipped one property. My sister-in-law rented out her house in a very far off location, and the tenants trashed it. She wanted to basically jingle mail the property. I gave her an alternative, put in $20k to fix up the property and got it sold and made $20k in profits. I anticipate that is the only time I will ever flip a property.

Still, understand that the purpose of the calculator is not to flip (there are better calculators around for that) or to tell you the obvious - that it's not going to cash flow in San Diego. The purpose of the calculator is to analyze and compare SEVERAL properties, each with its own ROE calculation, across the country. By using the ROE, you can decide which is a better buy - an SFR in Mira Mesa for $400k, or (in my case) a 4 unit property in Alabama for $115k. I put in there my criteria for choosing properties, but you should consider that for all the properties that meet my criteria, I have to choose which one. So depending on my wishes, I can choose a property with a low ROE or a high ROE, but my minimum is 20%. For more desirable areas and high vacancies, I will compromise with a low ROE (especially if the economy there is taking off). However, for lousy areas, I will require a higher ROE in order to offset the risk.

surveyor,

I think your assumptions are excellent. The entire foreclosure "crisis" could have been completely avoided if buyers used conservative guidelines when making a purchase.

We should not assume the mortgage deduction will always be there, especially on investment properties. Same with Prop 13 protection. We have record levels of debt at all levels, and that includes the state and federal governments. They will need to increase revenues, and these protections would be the first things under consideration, if I were a politician.

Inflation was a given when we had the Baby Boomers pushing up prices for things over many decades. The buying power of the Boomers (with good incomes, more stable jobs, better healthcare & pension plans, etc.) is being replaced by the lower incomes of immigrants from poor countries. We also have lower wages & benefits for Americans due to globalization. It is no longer a given that housing prices will rise in perpetuity. We may well see declines for many years, perhaps decades.

Rents do not always go up, and rent increases should not be factored into the equation, IMO. As an investor, I'm looking at what the numbers tell me **right now** and try to consider what obstacles might lie ahead (higher vacancies, recessions, neighborhood deterioration, problem tenants, etc.). If things get better, lovely, but I would never presume they will do so, especially now.

thanks CA.

I've made enough mistakes in real estate that I really advise not "cooking" the numbers. Those guidelines I put in the calculator are really for your protection. If the property doesn't even meet those rules, then you really have to ask if the property is a good buy, even if it's dropped 30% to 40% (and it also shows you how out of whack our fundamentals are). I admit that a property fitting those rules is a very good property, but do you really want to go against the rules and get a less than terrific property?

Now I'm not saying you shouldn't buy the property. Will the Mira Mesa market bottom out and start shooting up more than the 4%/yr. appreciation I've assumed today? It's certainly possible, but it's still a big risk.

Anyways, I put up the rules because certain people always asked what criteria I looked at in order to choose properties. The rules are a beginning, not an end. The ROE calculator incorporates many principles that are basic for real estate investing, but it is not a substitute for your research.

Still, if anyone does not know how the ROE works, a lot more research needs to be done.

Correct me if I'm wrong, but it seems like this calculation is geared more for investment property than primary resident. Using this spreadsheet and estimated # from 1997 for 3/2 1500 sq-ft SFR in MM, ROE was about 14%. Is it possible that some area will never get 20% ROE?

surveyor,

Thanks for the response.

Let's say you have $300k to invest in real estate.
When the market reaches the bottom, which is a better option:

1. Buy a number of SFHs.
2. Buy multi-unit properties (i.e. 4-plexes).

It seems like the multi-unit properties generate better cash flow. But what about appreciation ? Do SFHs appreciate better than 4-plexes ?

It seems like the multi-unit properties generate better cash flow. But what about appreciation ? Do SFHs appreciate better than 4-plexes ?

I would go for something that cash flows better now, then depend on appreciation that may or may not happen. Each extra dollar you can use to pay down a mortgage is earning 6%-7% a year on less interest.

While I think this rent v. own calculator exercise is a useful one for cross-comparison of potential investment properties, it misses the obvious point of potential residential properties.

A long-held investment property in California, be it SFR or multi-unit, is blessed with low property taxes thanks to Prop. 13. This is but one factor helping to moderate rents when compared to expected PITI in a purchase scenario.

As a result, for any given neighborhood, you can almost always find a comparable property that is cheaper to rent than to own de novo.

This is most emphatically NOT the case in much of the country. In fact, in many areas, you pay a PREMIUM to rent. Your mortgage payment would probably be lower. Why? Don't ask me, just accept that that is the case.

We just moved out of a very nice SFR in Marin County for which we paid 3100/month. It was listed for sale, staged, sold, and closed within 3 WEEKS for $1M even. (Listed at $1.029M). I can assure you that if you were to wait for 100X monthly rent pricing here in Southern Marin you would go to your grave without a purchase. That is too long for many. At some point in the real estate cycle, the multiplier will bottom, but it may not coincide with the bottom in the real estate market.

What's the right multiplier? Who knows? I contend that where price appreciation historically is expected, the rent multiplier will be higher than in areas where price appreciation is spottier. Where prices are in decline, (see Detroit and its suburbs), that rent multiplier will be really low. Does that mean that Detroit real estate is a good buy now? It depends on more than a simple equation.
How do you account for expected depreciation? How low can real estate go? Obviously, it can go to near zero. In many neighborhoods of Detroit and Cleveland, you can find SFR houses for 10-20-30K easily. Easily. Pop a section 8 family in there at $800/month and it will cash flow NO PROBLEM. Is it a good buy? A rent multiplier will NOT yield that answer.

Your mileage may vary.

BTW, I think our former house was overpriced. But at 900K, we might have purchased. That would have been nearly 300X monthly rent, and it would have been a GOOD deal. You have to live somewhere my dad always said.

Whenever the RE cycle bottoms, you will usually see PITI payments are lower than rents.

Why? Because the barrier to ownership used to be a good down payment and good credit with high qualifying standards. Once you got that DP, you could usually do better than renting, especially with the mortgage deduction.

As credit tightens, I believe we will see this again -- even in the better areas, with a few exceptions.

gn:

There are several advantages to mult-units. One is vacancy - if a tenant leaves your SFR, you are 100% vacated, vs. one tenant departure in a 4 unit is 25%. It helps your cash flow. Also, 4 units is still considered residential so it is fairly easy to purchase. There are other advantages to SFR's too, but my preference is multi-units.

It really depends on your disposition though and patience. Multi-units are for serious real estate investors and have more frustrations. They are more time intensive, so being a part time property manager may not appeal to most people. If that is the case, avoid multi-units, try SFR's and see if it's to your liking. That to me is a more serious question to answer as opposed to whether or not multis trump SFRs as a better investment (in which case, they do, if for no other reasons economies of scale).

As for appreciation, the multi-units have been appreciating like their SFR counterparts. However, there is not the same pricing pressure on multis because they have not been as subject to the funny loans and overreaching that has permeated the regular housing market. Or at least it hasn't reached the multis yet as far as I know. Still, you can count on multis appreciating in certain ways similar to SFR's, with a bit of stickiness in prices. I can see SFR prices going lower right now because of the foreclosures. Unfortunately, I don't see multis going through that process for at least awhile (if at all) and you may get tired of waiting for multis to pencil out in San DIego (which also may never happen).

It is because of these possibilities that I have essentially given up on buying investment properties in San Diego (and California).

If there is a segment of multi-units to watch, it is the medium sized multi-units, from 5 units to less than 100 units. The commercial loan market has been absolutely terrible for loan applicants (something I can personally attest to) and it has been extremely difficult getting funding. The sellers or owners of these medium sized multi-units can be under a lot of pressure and I am seeing a lot of deals in those areas. Still, the problem is the difficulty in obtaining these commercial loans. They are not federally backed for the most part so they are extremely picky on who gets these loans and even if you find a good deal, you may not be able to find funding for it anyways. Catch-22.

Anyways, other comments:

1. This ROE calculator is NOT a rent-vs.-owning calculator. It is strictly for real estate investing purposes. The calculations for rent-vs.-owning are different.

2. Regarding estimating appreciation, in general you should use a 4% rate for appreciation for all properties. However, there is a catch because, like others mentioned, there are locations in the U.S. that do not appreciate at the same rates as others. There is also for those who are really savvy within the real estate markets they know, they can time the market and know what kind of appreciation to expect at certain points of the market. Somebody mentioned Detroit. For those in the know, Detroit (and that whole rustbelt area), you cannot expect to make money on appreciation. In fact, the prices there tend to DEPRECIATE (the rustbelt area is known to real estate investors as a "cash flow" market, cash flowing being the primary way to make money in that area). So if you are comparing a property in the rustbelt area vs. San Diego, you have to put in a 0% or -4% appreciation rate vs. San Diego's 4% appreciation rate. From that you can take a look at how the ROE between the properties shake out and see which one is better.

3. Yes, the calculator is geared more towards investment properties.

Honestly there are so many variables you can play with in the ROE calculator. Unless you really know what you are doing, keep it simple.