2005: Maybe Not Ancient History

Having lived both in the Bay Area during the dot.com explosion and NYC during the MBS explosion, I know a thing or two about financial bubbles. Or at least how they feel in the moment: akin to being at a frat party at 2 am. Everyone is spewing garbage but thinks they are a genius, and the only way to make sense of it all is to drink up or take yourself home.

That’s bubbles.

It is hard to resist the dopamine of collective euphoria. It is only in retrospect in which everyone saw it coming, knew it couldn’t last, etc. We didn’t, for the most part. It is easy to look back with derision about the Dutch and their bout with overpriced tulips, but is that so much different than what happened with Pets.com? Or when folks rushed to own homes in 2005?

Data presented on the major realty sites tends to focus on the gains of the last ten years, more or less. This is handy to their purpose…making a home seem like a great investment, on top of providing other practical and emotional benefits. The last ten years have been great!  However, to fully reap those financial rewards you would have had to buy around 2010, and this was precisely the moment lending was in shambles.

For example, a friend of mine bought a place in San Mateo in late 2010 (3/2, approx. 1300 sq. ft., slightly oversized lot) for a little under 650K. According to Realtor.com it has gone up in value 135% in the last 11 years, and will go up an additional 9% over the next year. She said, at the time, they worried they were overpaying. Despite such potential gains, her non-tech propelled family isn’t going anywhere, short of winning the lottery.

With prices soaring and a constant stream of reasons why prices can’t possibly go down, I start to get nervous. It’s not that I don’t think there is a lot of value in a home in San Mateo. It’s that I can’t shake the feeling there are a lot of outliers in the data which are disguising the facts the overall gains are being distributed in far less democratic manner than they might seem with additional context.

For example, there is an adorable comp on the market in San Mateo which came up pending in the standard two weeks or less (2/2, approx. 1650 sq. ft., oversized lot). The ask price is around 1200 per sq. ft., for a list of 2 million.

Estimates of the property’s value:

Redfin = 2,274,831

Collateral Analytics = 2,445,000

CoreLogic = 2,420,700

Quantarium = 2,328,339

Zillow = 2,305,555

What is of special interesting to me about the comp however is its past sale history.

It sold in the summer of 2005 for 1.4.

It next sold in 2013 for 1.41.

It took eight years to recoup the sticker price, to say nothing of the losses of interest, commission and other ownership obligations. Should the house sell for the low side of the projection, 2.3, it would be easy to tout this as a miraculous achievement. Having bought in 2013 for 1.41 you sell for 2.3. Minus the commission only (4.5%) you are walking with approximately 800K.

Assuming you put the standard 20% down this is 285% return on your money over 8 years. Not bad, on paper, but it goes down significantly when you start stripping out other ownership costs. Then, keep in mind, if you do the math for the guy who bought and held in 2005, had he continued to hold, the return on the property is sliced in half. As it was, he lost a great deal of money. Such are the numbers showing how long it took for a top-notch trophy property located in San Mateo to rebound after the last dip.

I came across another property which tells a story of much greater financial woe and heartache stemming from that period which, for a while, burst with enthusiasm. This one is located in the outskirts of Hayward. Way, way out…I passed a yak.

The house was built in 2003 (4/3, approx. 2700 sq. ft., large lot with Bay view). Its stats are as follow:

Early 2003 – sold for a hair over 800K

Mid 2005 – sold for 1.19

Late summer 2012 – sold for a hair under 700K

Current estimate on Realtor – a hair over 1.4

Realtor points out that the house has appreciated 90% over the last 11 years. However, the bulk of this benefit goes to the most recent buyer. The previous one lost 500K of value between the years of 2005 and 2012. Let’s assume the sale price estimate is correct. If you calculate the return of the asset itself over the span of its first sale and today the overall return looks, to me, a lot more like 75% over the last 18 years. Individual investor results may vary.

How to Lose Money in Real Estate Like a Rock Star – The Hollywood Edition

As a full-time house voyeur, it is important to follow the LA market. This is where celebrity and single family combine in one multi-million dollar frenzy. Nor Cal may have expensive homes, but for the most part they are about as sexy as Mr. Roger’s sweater.

A few celebrities have a reputation for real estate savvy, such as Ellen DeGeneres, Arnold Schwarzenegger, and Jeremy Renner. However, most simply make the news when they buy or sell a home. Recently, a few celebrity sorts had this distinction.

First, in the final blow to the most contentious mega mansion ever conceived by a true Hollywood archvillain, Mohamed Hadid sold his incomplete Bel Air project for 8.5 million. As part of the deal, the structure must be removed, a demo job that won’t come cheap. On the upside, it would be difficult to piss off the neighbors more than the last developer, so you are riding in there as a bit of a white knight. This never hurts when you are dealing with some well-funded, and clearly legally savvy, adjacent owners.

Hadid has thus demonstrated how to take a piece of perfectly good land, invest years of your life and millions of dollars into its development, and walk away in bankruptcy. This is how the pros lose big. It also is a reminder of one of the key differences between spending 45 million on a trophy house and a Picasso. When the government decides to start breathing down your neck, you can’t just roll the thing up and take it to a safe deposit box in Switzerland.

When amateurs lose money on real estate it usually isn’t that extreme. But celebrities losing money on the resale of their house is surprisingly common. This week we examine the case of Motley Crüe drummer, Tommy Lee.

The property in question was purchased by the performer for 5.85 in 2007, per an article compiled by Realtor.com. It looks exactly like the kind of home you should own if you are a rock star. There is a pool taking up most of the yard, a movie theater with concession stand, retractable roof, and tricked out recording studio. Its style is bold and elaborate, and one would expect, customized a great deal by Tommy Lee.

https://www.redfin.com/CA/Calabasas/24359-La-Masina-Ct-91302/home/3511704

Unfortunately, in doing so he broke many a cardinal rule in real estate. For one, he now has the most expensive house on a block of similar houses. The house is a unicorn amongst a stable of dull, identical ponies. It is twice as large and exponentially fancier.

Further, there is too much style. It is a tall ask for a buyer to absorb it whole. However, renovating almost 10K sq ft is not for the faint at heart.

Additionally, let’s consider the main buyers of houses of houses located in the Westridge development in Calabasas. Google map reveals it to be exactly the kind of place family buyers flock to live, and rock stars fear to tread. Tommy Lee, while clearly building a home he could enjoy to the fullest, was also actively constructing a toddler deathtrap destined to drive away buyers in droves.

And finally, in what I can only assume was the coup de gras to the whole “Build-Your-Dream-Home-And-Hold-Forever” strategy, Tommy Lee fell in love. While the house in question has been on and off the market since 2016, this month he went ahead and closed on a new one in Brentwood for 4.15. One can only imagine the new Mrs. appreciates a fresh start in a new space two years on from the wedding.

As for the fate of the one on the market?

Yikes.

This could take a while without a major price cut or change in marketing strategy. Buyers for such a product are few and far between. On the upside, Tommy Lee doesn’t seem to be suffering all that much financially over the matter. Blowing a few million on a sick pad an walking away at a loss without missing a beat? Nothing more rock star than that...

Tale of Two Bungalows

On the east side of the block of South B between 9^th and 10^th there sit a row of same plan duplexes, each consisting of two 2/1 of approximately 1K sq ft per unit, arranged on long, thin lots around 7500 sq ft. This weekend I went along with my friend Sam to inspect two properties with nearly identical layouts which she was considering for rent. What we discovered were such stellar examples of the Dr. Jekyll and Mr. Hyde of landlords the whole episode felt like a parody.

Both landlords have properties purchased long ago. Both landlords have properties which have been sitting empty for many months due to the slower rental market post-Covid. Both landlords had units with similar layouts on the same block. Here the similarities end.

At the first unit we were met by a sweet little old lady who had been chatting amenably with the tenant in the back unit. The unit she was showing was freshly painted, inside and out. The carpets were clean and recently vacuumed. The bathroom and kitchen were updated. There was an adorable back patio with the perfect orange tree (you have to pay extra for that). She explained how, in order to make the place more appealing, they had moved a few fences to enlarge the space. They had owned it for 40 years, she said, and you can tell she felt real affection towards the property.

The front yard, she explained, was in the process of being redesigned. She had tried for years to maintain a nice lawn, but she was ceding the war to the neighbor’s gophers. She would not, she insisted, make it plain stone. Her aesthetic ambitions were higher minded than a cheap stunt like that.

Finally, in a gesture which made me want to sell my house and move in myself, she apologized for the state of the windows, which did not appear dirty to me. Whoever moved in, the landlord promised, could set up a cleaning to suit their schedule. She would pick up the tab. For all this, she was asking $3150 a month.

Our next appointment was a few units south. The expectation was that this place would be cheaper, for a reason. It was purchased in 2000 by another landlord who has rented to friends for years. I understand that getting lower rent often requires compromise, but this guy, who I’ll call Bill, is beyond, in my opinion. Codes are broken. Service providers are sketchy. Fix times are extended. I mean, the man didn’t even pave their driveway after cars kept getting stuck in the mud. He bought a dump truck of gravel, which they had to spread out themselves. In San Mateo! Solidly into the 21^st century!

Anyhow, I was prepared for this unit to be down market from the one we had come from. Bill did not disappoint. As an indifferent young man (not Bill) opened the place for us to look around, I was instantly transported to the most beat up rural properties I have had the opportunity to inspect in person. The condition was deplorable.

The floors wood floors were scuffed. A tile was missing off the tub, which reminded me of what you might find in a cut rate hostel. Dark scum was apparent on the tile floors. The kitchen appeared to be original, and none of the cupboards closed all the way. The backyard was a tangle of weeds, and contained a rusted old shed, a barbeque covered in spiderwebs, and a large, broken screen. All this was going for $2700 and one month free with a year lease.

In the end, it is unlikely Sam will take either. Her timeline for moving out of her current place is flexible, as is the part of the Bay where she settles. A friend gave her the number of a property manager in SF, and insisted they were offering better deals than in San Mateo. For once, it is renters who have options, and they plan to exercise them.

 

*Please note, despite the ridiculous discrepancy in condition Redfin predicts their sale price to be within 1.5% of each other. Such is the power of stale data…

Feeling Bearish in a Bull Market

Perhaps the most famous naysayer to the notion a home is an investment is Robert Kiyoskaki. Per his seminal book, Rich Dad/Poor Dad, the conventional wisdom is bunk. Committing to 30 years of mortgage payments represents a liability, not an asset. Even when owned free and clear there are associated expenses, such as tax, insurance and maintenance. Sure, you can sell, but then where would you live?

Conversely, Kiyoskaki considers an investment a passive stream of income that is profitable today, not, potentially, at some nebulous point in the future. My boss in NYC had this discipline back in 2006 when the name of the game was pay now for income streams that will “inevitably” come to fruition as rents rise every single year forever. If he couldn’t get a little bit of upside from day one, he didn’t buy. Please refer to the new book Saving Stuyvesant Town: How One Community Defeated the Worst Real Estate Deal in History for an example of how you can make a few billion disappear in less than a decade by betting on future cash flows that never materialize.

While it may be a personally satisfying to watch your predicted value rise on the realty websites, you can’t eat equity. Having Zillow tell you your house is worth a million dollars more than what you purchased it for ain’t bad. However, it is a far cry from having a million dollars in the bank.

Americans loves to own their own homes. It’s our thing – an essential part of living the dream, we are told. According to Princeton University’s The Eviction Lab 45.67% of Californian’s rent. San Mateo County is a hair more, at 46.72%. Comparatively, an article published this week by Isacc Würmann on housing activism in Europe estimates population of renters in Berlin is 85%.

But does it actually make financial sense, based on the numbers, to own a home in the Bay Area?

For people who have only followed the Bay Area housing market it might be hard to believe that people in other parts of the country buy a home to save money on rent. If you are able to come up with the down payment in the rural Illinois town where I hold property, your monthly payment with mortgage and insurance on a 70K house is about $400. Rent on the equivalent home would be at least $900.

This could not be further from what is happening right now in the single family market in the Bay. Consider a comp which closed earlier this month. It was a cheerful little house on a quiet block in Shoreview (2/1, 820 sf ft house, 5250 sq ft lot). It closed at 1.14, for an estimated monthly payment of $7665 with a conventional mortgage. This is more than twice the estimated high rent of 3800 (Redfin).

How is this justified? Asset appreciation, they say.

On a base level, this is true. My favorite Illinois rental is predicted to have risen less than 7K since 2016, and this doesn’t take into account the 7K we put into it at purchase. However, it brings in a positive cash every month like clockwork.

Compared this to a home sold in San Mateo in 2016 which is said to have appreciated 533K in the same amount of time, or 38%. Yet one should take out the approximately 125K in interest paid in the first 5 years of the loan. Now, from the 408K remaining you can back out the commission at 4.5% of the sale price and you are down to a profit of approximately 319K, or 22% over 5 years. This also assumes no other capital expenses in that period (HA!).

Additionally, unless you sell, it is hard to call it an asset when the expected fixed monthly payment is over 7K a month and the expected rent per month during the equivalent period was around 5K. If you aren’t living there, you are losing actual money day in and day out for the benefit of counting on the future benefit of undeterminable gain. If you are living there, you still ought to back out the 2K a month for the 60 months you have been paying more to own than rent from the profits. Down to a profit of 199K, your return at sale would be predicted at closer to 13.7% over 5 years. The situation does not improve if you are subject to capital gains.*

If the psychic value of being a homeowner outweighs the math, go forth and own my friend. Ditto that if you have piles of cash or an overwhelming fear of inflation. Otherwise, Kiyoskaki’s point on the heavy liability of homeownership is worth considering in the heat of the current bidding environment.

 

 

*Yes, there may be SALT tax benefits to consider, but they have been capped now. Also not included in this model is the impact of closing costs, such as staging, as well as the unexpected costs of ownership which tend to crop up all too regularly, such as appliance replacement, mold mitigation, window replacement, yard maintenance...

 

Why Pay Over Market

If you fall in love with a house and can afford it, go ahead and pay more. If you have a strict timeline in a constrained market, go ahead and pay more. Money talks, as they say, and this is of course the number one way for the consumer to make themselves heard. When there is only one and you want it, strike.

However, are overbids always the result of irrational exuberance?

Back in 2017, as I went over the numbers in the Highlands, one data point stood out. It wasn’t the biggest overbid: 15% over ask versus a high of 34%. What got me was the price per. The low comp was $607 a sq ft, which correspond to the fact it was a very large (3790 sf) and stylistically…unique. The second highest comp was $1282 a sq ft, due to, I expect, the flat, nearly 10K sf ft lot accompanied by an almost vintage Eichler, always a selling point to the architectural purist out there. Finally, my outlier, which clocked in at $1515 per. WTF??? Why would anyone do that?

Back then, I raised an eyebrow, but let it go. People do all kinds of odd things in this world. Tacking on 18% more per than the other highest bidder isn’t that out there, especially when the total purchase price was within 1.3%.

Revisiting the data set, I went back to that question of why. Why did someone pay so much a square foot back then? How is it working out for them today?

First stop was the realty websites, followed by Google Maps. Results? The visual reveals a new building being framed.

We are dealing with a teardown situation. There are two typical cases of a total redo. There is the discerning homeowner who wants to create a dream home from ground up and has the patience, vision and means to do so. Then, there is the speculator, or flipper, in HGTV speak. The investor pays $1515 per for $1140 and has a basis of 1.727. The you rebuild at the non-retail price of, say, $300 per for 2300 and now your basis goes up to 2.417 – enough to maybe get you a visa thrown into the investment mix.

Assuming someone is willing to buy it for today’s average sale price in the Highlands ($1500 per says Redfin), you sell at 3.45. Subtract a discount commission, you are taking in over 875K. Given the timeline under consideration, that isn’t terrible, but nothing which couldn’t have been accomplished with some clever Bitcoin trades and a hell of a lot less headache. Another problem with the notion it was purchased to flip is that it still hasn’t come back on the market. Contractors who know what they are doing can bang out a mini mansion in 18 months flat. It should have hit the market by spring of 2021 if the plan was to sell.

My fallback assumption was that someone built themselves a luxe dream home, money be damned. My guess then, was the place would be, upon inspection, gorgeous, no expenses spared…because if you have the money and want it enough, why not. Knowing the photos available lag real life by many moons, I went to investigate.

Final answer?

Both of those scenarios were incorrect.

From what I can tell, they paid extra because they wanted THAT lot. If there is a big lot you really want which has a small house on it, you are in luck. Most folks will be paying simply for the house, maybe a little extra. Therefore, going a hard on the price per wins you the hand. I mean, the house…

Why did this lot get this financially well-endowed individual all geared up to break out the Benjamins (and then some)?

1)      Oversized (8640), which allows a higher sq ft rebuild

2)      Quiet block off a cul-de-sac

3)      Good school to attract long term family renters

4)      Corner Lot

Wait a minute! Corner lot? Since when was that a plus? Doesn’t it limit the backyard due to having two setbacks from the sidewalk as opposed to one?

Sure. But that only matters if you aim is maximizing the size of your bucolic oasis. Not everyone thinks that way. For example, if your goal is a low maintenance revenue flow, you are throwing some pavers in the yard and calling it a day.

Beyond that, the corner offers a special benefit for anyone seeking to turn a single residential house into a rental which operates more like a duplex. Because the house has two sides facing a street one may design it so there are two separate driveways, one on each. The tenants benefit from a sense of privacy, as well as twice as much off-street parking.

That is the new setup of my comp. After untold amounts of money on construction, it is a very plain looking building, with a utilitarian, rock strewn yard. There are two entrances and two driveways, one on each side. Both of the off-street parking spots were occupied by sensible family cars.

Under the assumption the owners of this place are now collecting not one but two revenue streams, both which should be superior given the particular configuration of the lot in question, why wouldn’t you pay a little more to ensure yours is the winning bid? As a percentage of the total project, the 229K overbid represents perhaps 10% of the total project cost (HA!). However, if you are now renting a 3/2 (Realtor’s estimate $4600 a month for a house in that area) as well as a one bedroom ($2185 average in San Mateo per Zumper) your monthly revenue has been kicked up almost 50%. In the long run, that makes sense to me.