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Irvine Housing Blog

Irvine Housing Blog

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Owner occupied houses in California are poor financial investments

Posted: 14 Jul 2011 03:30 AM PDT

Owning a house can be deeply emotionally satisfying, but as financial investments, the rewards do not justify the risks.

Irvine Home Address ... 2233 MARTIN #215 Irvine, CA 92612
Resale Home Price ......  $239,900

Hey know,hey now
hey now, hey now
Have you ever seen such a beautiful night?
I could almost kiss the stars, for shining so bright!

Hey now
Hey now
This is what dreams are made of

Hilary Duff -- What Dreams Are Made Of

Since I began writing for the IHB, I have believed part of my task has been to dispel the myths surrounding California real estate. During the real estate bubble people came to believe houses had mystical powers. The kool aid intoxication was very strong because so many people obtained so much free money from incredibly stupid lenders. As the housing bubble continues to deflate, people are finally starting to let go of their most cherished housing myths, but they don't give up easily.

A Home Is a Lousy Investment

Today's young people would be foolish to imitate their parents and view ownership as the cornerstone of personal finance.

By ROBERT BRIDGES -- July 11, 2011

At the risk of heaping more misery on the struggling residential property market, an analysis of home-price and ownership data for the last 30 years in California—the Golden State with notoriously golden property prices—indicates that the average single family house has never been a particularly stellar investment.

In a society increasingly concerned with providing for retirement security and housing affordability, this finding has large implications. It means that we have put excessive emphasis on owner-occupied housing for social objectives, mistakenly relied on homebuilding for economic stimulus, and fostered misconceptions about homeownership and financial independence. We've diverted capital from more productive investments and misallocated scarce public resources.

Yes, that is exactly what we have done. We developed an economy inexorably linked to rising house prices. We encouraged everyone to take on copious amounts of debt to acquire real estate under the false pretense of nearly unlimited free spending money simply for signing some loan documents. This false perception about the true value of real estate caused an enormous price increase which in turn gave a false signal to homebuilders that we needed thousands of McMansions in areas where people had to commute an hour or more to their jobs. The response to the fake demand caused resources to be diverted away from productive uses and into non-productive single-family homes. These wasted resources are gathering dust in empty homes all over California.

Between 1980 and 2010, the value of a median-price, single-family house in California rose by an average of 3.6% per year—to $296,820 from $99,550, according to data from the California Association of Realtors, Freddie Mac and the U.S. Census. Even if that house was sold at the most recent market peak in 2007, the average annual price growth was just 6.61%.

So a dollar used to purchase a median-price, single-family California home in 1980 would have grown to $5.63 in 2007, and to $2.98 in 2010. The same dollar invested in the Dow Jones Industrial Index would have been worth $14.41 in 2007, and $11.49 in 2010.

This example is not fair for a couple of reasons. First, it assumes an all-cash comparison. Leverage on real estate is generally 80%, and during the housing bubble it was 100%. The best leverage in stocks is merely 50%. When prices rise, the leverage makes the returns much larger. Of course, when prices fall, the leverage wipes people out. Also, people generally can't get cash from a stock investment without liquidation. With houses, people were given access to their unrealized gains through cash-out refinancing. Those two advantages made real estate much more attractive when prices were rising and leverage was cheap.

Here's another way of looking at the situation. If a disciplined investor who might have considered purchasing that median-price house in 1980 had opted instead to invest the 20% down payment of $19,910 and the normal homeownership expenses (above the cost of renting) over the years in the Dow Jones Industrial Index, the value of his portfolio in 2010 would have been $1,800,016. The stocks would have been worth more than the house by $1,503,196. If the analysis is based on 2007, the stock portfolio would have been worth $2,186,120, exceeding the house value by $1,625,850.

In light of this lackluster investment performance, and in the aftermath of the recent housing-market collapse, why is there such rapt attention to the revival of the homebuilding industry and residential property markets? The answer is that for policy makers whose survival depends on economic recovery, few activities have such direct, intense and immediate positive economic impact as new home construction.

California's economy is overly dependent upon homebuilding. With 38% unemployment locally, it shouldn't be surprising that the economy is sputtering.

These positive effects are transitory, however, when local economies have insufficient permanent employment to justify a constant level of demand for new housing stock. Existing housing does little to create new employment beyond limited levels of service employment. By contrast, a business investment in the amount of the several hundred thousand dollars represented in the value of a house would likely create many permanent jobs and produce income, profits and competition. As with most things, the benefits of building new homes come with a sobering caveat: What becomes of the work force once the party is over?

This is the question California has been consistently unwilling to face. Houses produce nothing. They are not factories producing widgets saleable to other parts of the world. Houses are pure consumption, and as the Romans showed us, a society based on consumption is ultimately doomed.

Home values may gain value over time, but home equity is locked-in until the house is sold.

It should be, but this author obviously hasn't been reading the IHB. The liberation and spending of home equity is a staple of the California economy.

The profits may then be reinvested or spent, creating significant stimulative effects, but usually this happens when market conditions are strong, exacerbating unsustainable market booms. When troubled assets are dumped, or when defaults occur during weak market conditions, the trough is deepened.

Housing markets may be forever doomed to cyclicality for many reasons, but public policies that stimulate new construction or home purchases by tax and financing subsidies, reduction of qualifying incomes, buyer credits, mortgage backstopping, and preferential zoning and permitting, only intensify these cycles.

These policies are also an admission of California's dependence upon artificial stimulus and Ponzi borrowing.

Efforts to reduce loan balances and to create special rescue programs have reduced the security of loans, challenged the enforceability of contracts, and driven up real borrowing costs.

Actually, no. Loan modifications and other government meddling in the private contracts between lender and borrower should have those impacts, but since the entire mortgage market is government backed, we have not seen these inevitable problems yet. We will. Wait until the conforming limit drops and jumbo financing becomes the only game in town.

Nearly a third of our states do not allow lenders the recourse provisions necessary to go after a borrower's personal assets in case of default on a residential mortgage. The sanctity of mortgage obligations has become the rough moral equivalent of the 55-mile-per-hour speed limit.

There is also a misconception that paying off a home mortgage is a path to financial or retirement security. The reality is that tapping the equity is expensive: Home-equity loans or lines of credit made with low qualifying incomes often command high interest rates and costs. If an emergency occurs—the loss of a job, or a business setback—it's likely that the same conditions creating the problem will lower the value and impede the marketability of the home and curtail the availability of financing for a buyer. Funds set aside for emergencies should always be liquid assets.

In this instance, the professor has drawn a bad conclusion from the need for liquid assets. Yes, people should have liquid assets and reserves for emergencies -- unless they are borrowing with an FHA loan when they will be given a year of squatting -- however, once sufficient reserves are in place, nothing provides peace of mind more than having a house paid in full.

Is it wise for coming generations to continue to view ownership as the cornerstone of personal finance? Young people planning for retirement increasingly face a choice between house payments and contributions to retirement accounts. They simply can't afford both. With the specter of looming cuts in Social Security and other entitlement programs, or even possible systemic insolvency, the challenge for tomorrow's retirees is income self-sufficiency.

It is always unwise to put all your eggs in one basket. During the bubble everyone put as much money as possible toward buying real estate. Think about it, with prices back at 2003 levels, anyone who bought in the last eight years is likely underwater. If that is their cornerstone of personal finance, the foundation is crumbling. They're screwed.

A nation of house buyers becomes captive to the economic cyclicality caused by bursts of construction activity, and it is not lifted or sustained by the limited levels of service employment related to existing housing. By contrast, a nation of business startups and investors supports our capital markets and creates long-term employment, income, exports and the myriad technological advancements desperately needed by an expanding American society.

New home construction and the markets for existing homes should be recognized as activities secondary to, and dependent on, employment. Healthy job markets create healthy property markets, not the reverse.

I have been making the same case for months. The economy will not improve by building more homes. It will take job growth and stimulus from outside of homebuilding and real estate to ignite the real estate market. Homebuilding and real estate sales follow an economic expansion, they do not lead it.

Housing demand driven by job growth creates conditions capable of sustaining a stable level of construction employment, attracting private equity investment, sustaining competitive private debt markets, encouraging capital growth, and ensuring the lowest possible housing prices.

Owner-occupied homes will always be the basis for healthy and stable neighborhoods. But coming generations need to realize that while houses are possessions and part of a good life, they are not always good investments on the road to financial independence.

Mr. Bridges is professor of clinical finance and business economics at the University of Southern California's Marshall School of Business.

I have my doubts Californians will ever give up their dreams about real estate riches. The lure of free money is too strong. Who wouldn't want to quit their job and just own a nice house that provides all their needs? It beats working for a living.

Happiness through regular cash infusions

It may take a decade or more, but the lifestyle choice to borrow and spend home equity must come to an end. The housing ATM has been turned off for almost six years now, but the memory of that life remains sitting dormant waiting for another housing bubble to germinate and take root.

  • The owner of todays featured property paid $258,000 on 10/17/2002, which makes this a 2002 rollback. We now stand at nine years of zero appreciation. She used a $232,200 first mortgage and a $25,800 down payment.
  • On 5/27/2004 she refinanced with a $238,000 first mortgage.
  • On 1/6/2005 she refinanced with a $276,000 first mortgage.
  • On 2/7/2006 she refinanced with a $296,000 Option ARM with a 1.25% teaser rate and obtained a $40,000 HELOC.
  • Total mortgage debt is $336,000.
  • Total mortgage equity withdrawal is a paltry $103,800, a lightweight by Irvine standards.

This form of HELOC abuse is characteristic of someone who irresponsibly ran up credit card bills each year living beyond her means then went to the housing ATM to pay it off. The yearly refinances reflect a serious degree of HELOC addiction.

This property is available for sale via the MLS.
Please contact Shevy Akason, #01836707 

Irvine House Address ...  2233 MARTIN #215 Irvine, CA 92612
Resale House Price ......  $239,900

Beds:  1
Baths:  1
Sq. Ft.:  934
Property Type: Residential, Condominium
Style: One Level, High or Mid-Rise Condo
View: City
Year Built:  1991
Community:  Airport Area
County:  Orange
MLS#:  P773847
Source:  SoCalMLS
Status:  Active
THE METROPOLITAN IS THE PIONEER OF EXECUTIVE LUXURY CONDOS IN IRVINE. GREAT Location! Min. to Fwys, OC Airport, Shopping and Beaches! Marble Tile Floors in Kitchen, Entry Way and Bathroom. Off-White Textured Carpet, White Moldings & Doors all Neutral Colors. 
Proprietary IHB commentary and analysis 

The Metropolitan was the bleeding edge of luxury condos in Irvine. Just like the condos built during the bubble, they were the wrong product built in the wrong place at the wrong time.

Resale Home Price ......  $239,900
House Purchase Price … $258,000
House Purchase Date .... 10/17/2002

Net Gain (Loss) .......... ($32,494)
Percent Change .......... -12.6%
Annual Appreciation … -0.8%

Cost of Home Ownership
$239,900 .......... Asking Price
$8,396 .......... 3.5% Down FHA Financing
4.59% ............... Mortgage Interest Rate
$231,504 .......... 30-Year Mortgage
$50,803 .......... Income Requirement 

$1,185 .......... Monthly Mortgage Payment 
$208 .......... Property Tax (@1.04%)
$0 .......... Special Taxes and Levies (Mello Roos)
$50 .......... Homeowners Insurance (@ 0.25%)
$266 .......... Private Mortgage Insurance
$392 .......... Homeowners Association Fees
$2,102 .......... Monthly Cash Outlays

-$109 .......... Tax Savings (% of Interest and Property Tax)
-$300 .......... Equity Hidden in Payment (Amortization)
$14 .......... Lost Income to Down Payment (net of taxes)
$50 .......... Maintenance and Replacement Reserves
$1,757 .......... Monthly Cost of Ownership 

Cash Acquisition Demands
$2,399 .......... Furnishing and Move In @1%
$2,399 .......... Closing Costs @1%
$2,315 ............ Interest Points @1% of Loan
$8,396 .......... Down Payment
$15,510 .......... Total Cash Costs
$26,900 ............ Emergency Cash Reserves
$42,410 .......... Total Savings Needed

BTW, the appreciation outlook for housing is not good:

20% Drop in Housing to Cause Recession in 2012, Says Gary Shilling

real estate home sales


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