Saturday, January 16, 2010

Almost a Homeowner:

I monitor the Lafayette housing market very closely. A couple of weeks ago a Real Estate Owned(REO) property came on the market that was very intriguing. It was a great lot with an older home on it that was priced at 2001 value. I inspected the structure and determined that I could rehab the house for $70,000 thus making the total cost of the property around $650,000.

I am presently not anxious to own a home in the Bay Area because home values are due to fall another 30% in the high end areas like Lafayette. But this house was pretty special.

On the property's third day on the market I made a low offer that was accepted by the bank. I had a termite inspection and found some wet wood termites. Not a big problem. Dry wood termites are the killer. So far so good.

I received the preliminary title report and decided to perform my due diligence on the "chain of title". I went to the county and found that the bank had botched the foreclosure of the property. There were 2 investors named on the Grant Deed and one of them was not included in the Notice of Default or named in the Foreclosure.

I informed the title company that I needed this included in the title insurance. They mentioned this to the bank and of course the bank backed out of the deal. They are going to start the foreclosure process again and hopefully do it right this time.

The funny thing about this deal is that I mentioned the tarnished "chain of title" to a couple of real estate agents and they said that I shouldn't worry about it. Of course now they admit that I was right. Real estate agents are a little to easy going sometimes.

I would like to express that if you are buying real estate in today's dysfunctional market you must to be very careful:

1) House Value: House prices are still 25% overpriced in Lafayette. If anyone tells you differently they are basing their assessment on emotion and not on the numbers. House prices in Lafayette are on average hovering at 2004 values($440 sq. ft.). Every so often a home comes on the market at a good value. It is normally snapped up immediately. Most of the home inventory in Lafayette is still priced at bubble values. If you buy a house in Lafayette at 2007 prices($545 sq. ft.) you could lose at least 30% of your investment over the next 5 to 7 years depending on the area. Some areas need to trend to under $250 sq. ft. to fall in line with historic value trends. One can argue against this fact but you will be using emotion, nostalgia and hope to defend your convictions. All numbers, trends and economic indicators point in the other direction.

I myself would not consider buying a home priced over 2001 value. In Antioch homes are being sold below 1998 value($110 a sq. ft.). Lafayette was selling at $213 a sq. ft. in 1998. About twice as much as Antioch. Presently the price per square foot difference between Antioch and Lafayette is 4 to 1. This change in buyers attitudes is not the magic of Lafayette but the stubbornness of high end markets to reprice. The same trend happened during the 1990 housing bubble. The same trend has been happening in Japan for the last 20 years.

The price of any home over the long run will trend with household income and rental prices. Antioch is driven more by rental prices. Lafayette is a little more affected by household income. Antioch housing prices are a good value compared to rents in the area. Lafayette homes are a terrible value in relation to household income, rents or any other variable you might care to use to compare.

The last problem with the Lafayette housing market is that there is far to much debt. Also, unfortunately, most of the houses that were bought after 2002 were financed with adjustable rate mortgages that will recast before 2013. A contracting economy, increasing interest rates and exploding "option ARM" loans will have a very negative effect on all high end markets for the next 5 to 7 years.

One could argue that the Antioch real estate market is forming a price bottom. No one can intelligently argue that any high end area of the Bay Area is close to a bottom.

2) Get good advice: Be careful, there are a lot of salespeople that will push you to buy a house. I love the quote by Upton Sinclair: "It is difficult to get a man to understand something when his salary depends upon his not understanding it."

Even neighbors, friends and family can be salespeople. Anyone that presently owns a home has a vested interest in puffing up prices. Most of these people have unrealistic expectations created by the previous 25 years of easy money:

  • The government is the key to solving our economic problems
  • You don't need to save because you can retire with the equity in your home
  • Real estate prices always go up
  • Cash flow is not important when buying a rental property
  • Debt is important to economic prosperity
  • It is not important for our country to save because we will always be able to borrow from foreign nations
  • Buy a home while interest rates are low

The easy money period is officially over. Anyone that does not realize this fact is probably not going to give you the best advice.

3) The Economy: This area was my biggest concern when I made the offer on the house. Our economy is in a deflationary environment. Interest rates are set to increase. Unemployment will be high for an extended period of time. Almost none of the present economic malaise is priced into public opinion.

We have just ended the biggest private sector debt binge any country has ever experienced and now our strategy is to use taxpayer debt to grow the economy. What most people don't understand is that the "private sector" and "the taxpayer" are the same thing. Our citizens are being sold on a policy of borrowing money to pay off their own debt. This machination would be funny except that about a trillion dollars a year is being skimmed off the top by the government. The interest on the trillion dollars a year of graft will be paid by our children to foreign nations.

In 1985 foreign nations owned less than a $1 trillion in US investments. Today, 25 years later, foreign nations own over $15 trillion in US investments. Of course this is not the problem. The problem is the growth trend and our nation's willingness to "give away our country" instead of balancing our budget. If the present trend continues, in the future our largest government expense will be interest payments to foreign nations. Also, we will have a more difficult time paying this debt if a significant amount of our country's productive assets are owned by China, Japan and The Middle East.

Savings and increased productivity are the only ways to increase a nation's standard of living. The debt we are creating will actually reduce our standard of living as our children make onerous interest payments to foreign nations.

I am a little disappointed in not getting the house in Lafayette but there will be many more opportunities in the future as "high end" real estate prices trend downward.

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