The Irvine/OC price premium

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Comment on earlier posts in this thread, you don't have to buy where you live, and you don't have to go all the way to Texas for affordable housing. You could get Texas-ish pricing in Lancaster, just north of Los Angeles. But I wouldn't want to live there.





The world is a big place. You can choose to live and work in Irvine, but invest in RE elsewhere.
 
<p>I don't think teacher is too far off, actually. I don't foresee rental rates declining much, if at all, and that supports a price that is not much lower than what you are seeing now (well, maybe another 15-20%). A case in point, if we assume $2600 rent for an 1800sf sfr in Irvine, that would put us at a breakeven of about 3.5 years at a price of $550,000 (20% down, 6.75%, 30-yr, 4% rent inflation). I am assuming max tax deduction rate, but even at a modest deduction rate I calculate a price of $500,000 for this home. Obviously a longer time horizon would raise the purchase price a bit higher. I think these homes are currently going for around $650-700K, so trimming of another 15-20% is a reasonable outlook. We could see more than that ultimately because of consumer psychology and resulting downward pressure, but I think that would be considered a bargain.</p>

<p>When looking at psf prices, this pricing also makes sense relative to historic appreciation rate of the area. Assuming a rate of 7% and psf price of $190 in 2001 that looked to be the norm at the time for an SFR, I also get a price of $550K. I think based on these figures, a psf price in the vicinity of $275 would be considered fair market value for Irvine area.</p>
 
I don't get it - how can you say that someone making 170 thousand can afford an 800,000 home. Even *if* you had 20 percent down the monthly outlay for that would be almost 5000 a month. I guess if you never want to vacation, buy clothes for your kids and eat spam every night then it is probably feasible. And I didn't even add in homeowners and earthquake insurance to the monthly payment.
 
gepetoh,





Whenever you are putting in growth values to make a transaction work, you are overpaying. The breakeven point should not come 3.5 years in the future given a high rate of rent inflation. It should breakeven from day one. Even at a day one rent/ownership breakeven, it still requires 6% house appreciation to reach transaction breakeven due to the real estate commission.





<em>"this pricing also makes sense relative to historic appreciation rate of the area"</em>





Long-term appreciation over the rate of wage inflation is not sustainable. Our historic appreciation rates have happened because interest rates have been declining for 25 years, and DTI ratios have been increasing.
 
<p>IR,</p>

<p>I disagree. In any investment (and maybe it doesn't work this way for RE, but it should), you need to take into account a time horizon. That time horizon must include an expected rate of return. It's the only way you can calculate a proper NPV. Having said that, my calculations do not include any price appreciation of the home, just an expected rental increase rates. That would tend to bring the price down, yes, but it must be considered as the expected g. Breakeven from day one never makes sense in calculating capital expenditure. And from a realistic standpoint of a prospective homeowner, it also doesn't make sense. The fact of the matter is, rent will increase, whereas a 30-yr mortgage will not. So you have to factor that in.</p>

<p>As for the LT appreciation, it is true that those factors have contributed to the historical rate. However, there is also no reason to assume such factors will not occur in the near future, or at least stay stable. It has for the past 30 years, and from a statistical trend standpoint, we must continue to include these factors. We can't selectively exclude them just because we THINK it's not going to happen. And I was actually being conservative, OC's actual appreciation rate is 9.3% over the past 25+ years, but I discounted all of the appreciations from the past 7 years. I think it's a reasonable rate that we have no reason to think would not continue.</p>

<p>I personally think $550K for an 1800sf home is too high. Especially since that is the limit of what I can safely afford, and I feel my income level should yield something closer to 2000-2400sf home. But I do think $450-500K is a reasonable price in Irvine. But that's more a subjective personal comfort level, and does not have much to do with whether that is the fair value or not. I am only interested in what is the best financial decision for me. And based on my personal assumptions of going rates in rent prices and housing prices, I have to make a decision on whether to buy or rent. If renting a comparable home will begin costing more - not at that very moment but as compared to what it is expected to be within my time horizon - then it is time for me to buy the home that I can afford. Of course, if I expect prices to decline below the rent level, then I can take a gamble and wait. I think that may be the case in this environment, which means I may get something at a bargain.</p>
 
gepetoh,





I hear what you are saying. I am just pointing out that if you play games with growth rates to make numbers balance, you are probably overpaying.





It reminds me of the dilemma of "getting a fill" when you are trading. When you put a bid into the market, you are always hoping the market will come down to your bid price and fill your order. If the market does not drop enough, you don't get filled. If you bid too much, the market drops well below your entry point, and you are underwater on the position. IMO, this is what we are really discussing here.





If you are worried the market will not drop enough for you to buy the house you want at the price you are willing to pay, then you risk not getting a house. The natural reaction to this dilemma is to raise your bid. You can construct financial models to justify any purchase simply by putting in growth rates for rent or appreciation or whatever. It is all a mental exercise to cover for the emotional worry that you might not get filled at the price you want. This nervous reaction to a declining market will be responsible for people overpaying all the way down during the decline.





That being said, you may very well be right, and the market may not correct as much as I believe. If market conditions change, I will certainly reevaluate my beliefs on the market bottom. I don't want to miss my opportunity to own a house because I held out for a price level that never came either, but I also don't want to justify an emotional decision with smoke and mirrors.
 
<p>IR,</p>

<p>I agree, if these assumptions are made arbitrarily in order to satisfy one's needs, then one can make undue mistake in their calculations. My numbers are based on historical data however, which from a technical standpoint is the only thing you can base on and stay objective. So you put in numbers based on historical data (4% annual appreciation for rent is a historically reasonable rate), and come up with a number that would be an expected figure. The difference is Required Rate of Return vs. Expected Rate of Return. What I might require can be different than what I would expect in the current - or in my case, historic - market. And without making any assumptions on what the market would do in the future, historic data are the best estimate, especially for long-term forecast. </p>

<p>I think we agree on that arbitrary assumptions involve unsystematic risk, that we want to eliminate as much as possible. By using historic data, only systematic risk remains, and that's what I tried to base my numbers on.</p>
 
<p>To get a little context of the history of affordability, you can look at the National Association of Homebuilders Housing Opportunity Index. </p>

<p>



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http://www.nahb.org/page.aspx/category/sectionID=135















</p>

<p>For the data addicts on the board, it has quite a bit of info on various metro areas. Unfortunately, the series for Orange County only goes back to 2005 (for other areas, there is also data missing for late 2002 and early 2003).</p>

<p>If you look at Los Angeles as a similar example, in the late 1990s, affordabiliy ranged between about 40% and 50% of homes that a median-earning family could afford with a 30-year loan and 10% down. In 2002, the median LA County house cost $240k, exactly 33.3% more than the US average. There was a similar "premium" for living in LA from the mid 1990s to 2003. </p>

<p>By June of 2007, LA's median house was $530k, 121% more than the US average. The median income could afford only about 3% of the homes being sold in LA County. </p>

<p>Thus, you can see how much the premium for living in LA has changed in 5 years. Has LA become a much better place to live in that time? Has the rest of the US gotten much worse? I don't think so. </p>

<p>This situation happened before, in the last Southern CA price runup. LA home prices were 80% above the US median in 1991. Four years later, they had dropped to 38% above the national average. </p>

<p>Here is the NAHB's explanation of how the index is compiled:</p>

<p>"The Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income based on standard mortgage underwriting criteria. Therefore, there are really two major components -- income and housing cost.</p>

<p>For income, NAHB uses the annual median family income estimates for metropolitan areas published by the Department of Housing and Urban Development. NAHB assumes that a family can afford to spend 28 percent of its gross income on housing; this is a conventional assumption in the lending industry. That share of median income is then divided by twelve to arrive at a monthly figure.</p>

<p>On the cost side, NAHB receives every month a CD of sales transaction records from First American Real Estate Solutions (formerly, TRW). The data include information on state, county, date of sale, and sales price of homes sold. The monthly principal and interest that an owner would pay is based on the assumption of a 30 year fixed rate mortgage, with a loan for 90 percent of the sales price (i.e., 10 percent downpayment). The interest rate is a weighted average of fixed and adjustable rates during that quarter, as reported by the Federal Housing Finance Board. In addition to principal and interest, cost also includes estimated property taxes and property insurance for that home. This is based on metropolitan estimates of tax and insurance rates from the 2000 Decennial Census, as estimated by NAHB from the Census Bureau's Public Use Microdata Sample (PUMS). Mortgage insurance is not currently a component of the HOI." from <a href="http://www.nahb.org/generic.aspx?sectionID=135&genericContentID=533">http://www.nahb.org/generic.aspx?sectionID=135&genericContentID=533</a></p>

<p> </p>

<p> </p>

<p> </p>
 
<p>IR,</p>

<p>The best advice I can give you (because I like you for who you are) is to start identify the home that you like at minimum 50% DTI. Prices have dropped enough, and may drop a little more; at least, you have little competition now, which increase your chance of getting what you really like.</p>
 
<p>gepetoh,</p>

<p>If you look at my other post on Irvine census of 2000 family income and home prices, you'll see that not too long ago the median price of a house was in the upper $300K. Residents then could rationally budget mortgage costs as a reasonable percentage of their take-home pay. Now, new buyers cannot given that incomes have only risen modestly since 2000. They must either sacrifice tremendously in other areas, which would only hurt local businesses as they would have reduced discretionary income or hope for a bailout from the government, which is unlikely. As for rents, if the market craters like I and others expect a ton of housing will come on the market that will force current landlords to lower rents. Why rent a 1200 sqft apartment when for the same amount you can get a 2000 sqft house?</p>
 
<p>IR,</p>

<p>I bought my first home with 60%DTI and did just fine as far as cash flow (I had median income). If I kept this home, and assuming my income is still median, my DTI would be something like <10%. I guess I am saying you have to start somewhere to get somewhere. </p>
 
<p>Everybody's a genius in a bull market.</p>

<p>Nothing against NIR, but such a DTI would require that you not save for retirement or have an emergency fund, and basically live for your house. And you better not become ill, unemployed, or suffer any of the vagaries of life. I think I'd rather play craps. It's more fun and the wait staff brings you free drinks.</p>
 
Does anyone think the plethora of people enduring 50% DTI's will not default in huge numbers once they go underwater?





I would pay on a 28% DTI forever because it isn't any more expensive than rent. I would walk from a 50% DTI in a nanosecond once I went underwater...





Plus, at this stage in my career, I don't anticipate to many more 100% raises to lower my DTI.
 
<p>IR,</p>

<p>I don't agree wih you here.</p>

<p>Foreclosure (or equivalent) makes you a social pariah for a very long time.</p>

<p>You would be hard-pressed to obtain jobs, apartments, insurance, etc.</p>

<p>If you were lucky enough to obtain these items, you would face extremely onerous terms on them.</p>

<p>In addition to being immoral, it would cost you greatly.</p>

<p> </p>
 
<p>A former mortgage broker talking about morality.....that's a good one.</p>

<p>It would be a business decision if IR walked away, nothing more. </p>
 
<p>garfangle,</p>

<p>That is a good point, and I agree there is a disconnect between the median income & median prices. So it begs to reason, then, why would a rent-to-mortgage balance not equate to income-to-mortgage balance? I think this answer lies somewhere in income-to-housing cost ratio, which looks to have crept up in the recent years. Case in point, a family with the median income of $83K would likely prefer at least a 3/2 townhome, which in Irvine would run you around $2400. This price point would mean the house should cost $465K. However, this rent rate would be over-extending for this family, since it would be around 35% of their gross income. </p>

<p>First of all, these homes are not on the market for $465K, more like $600K, which indicates they are overpriced from that standpoint. Second, the rent level for these "median" level homes should be around $2000, which indicates that rent may be overpriced, and that even the current rent-equivalent $465K is overpriced. So perhaps there is room for the rent to come down in Irvine. My assumption was that rent would increase at the present rate, which is a reasonable, objective assumption. This may indeed not be the case, and rent stay flat for the next several years. In that case, the downward pressure in housing prices would be greater.</p>
 
Janet,





There was another thread where we had a discussion on the pain of walking away. Personally, I wouldn't put myself into a 50% DTI under any circumstances, so the point is mute in my case, but for others, it may not be so clear.





One of the social changes that will also come out of the deflating housing bubble is going to be a special circumstance known as a "bubble bankruptcy" or perhaps a "real estate bankruptcy." We already have a special class of bankruptcies for medical issues because our healthcare system is so messed up. People with medical bankruptcies are common, and there is a sense it was due to circumstances beyond their control. The same will be true of bubble bankruptcies.





As for the morality of bankruptcy, that is another subject. Were people driven to bankruptcies by medical bills behaving immorally? I suppose one could argue they should have had better insurance, but 20% of a cancer treatment will still drive most people into bankruptcy. Whatever we might think of the morality of bankruptcy, there is going to be a lot of them as this bubble deflates, and it will make more sense for these people to do so than to try to pay off a massive debt for something they no longer own.
 
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