Category Archives: Property Rental

Rental Value

How much is a property worth? The ultimate answer is whatever someone is willing and able to pay for it. With the remnants of kool aid intoxication still gripping the market, there is no shortage of people with the willingness to pay any price to own property, but with the constriction of credit, there is certainly less ability to pay for it. This is to be expected in the initial stages of a price decline. People’s memories are of the rally and all the money people made, although we will start to see a reduced willingness to buy as the bear market grinds on.

Once the poison of kool aid has been purged from the collective consciousness of the populace, people will require a new motivation to purchase real estate: it is cheaper than renting. I first wrote about this phenomenon in the post How Inflated are House Prices? I later followed up with a more detailed analysis of the Rent vs. Own decision. Today’s featured property is offered for sale at a price far in excess of its cost of ownership. This property is being offered for sale at $589,000, and it was available for rent in January at $2,300 per month. There is a comparable property currently for rent at $2,500 a few doors away. That puts the value between $368,000 and $400,000 for an owner occupant using a 160 GRM.

31 Potomac Inside

Asking Price: $589,000

Income Requirement: $147,250

Downpayment Needed: $117,800

Monthly Equity Burn: $4,908

Purchase Price: $625,000

Purchase Date: 12/29/2005

Address: 31 Potomac, Irvine, CA 92620

Beds:	3
Baths:	3
Sq. Ft.:	1,300
$/Sq. Ft.:	$453
Lot Size:	1 Sq. Ft.
Property Type:	Single Family Residence
Style:	Dutch Queen Anne, Edwardian
Year Built:	1985
Stories:	2 Levels
View:	Park or Green Belt
Area:	Northwood
County:	Orange
MLS#:	S533522
Source:	SoCalMLS
Status:	Active
On Redfin:	105 days
Unsold in 90+ days

Inside location,Three bedrooms and three baths, with two car garage.
One ved room with bath in main floor. High ceiling, Living room with
fire place. Detacged home in Northwood, close to community pool,spa,
awarding northwood high school.

ved room?

There is a reason for this seller’s reluctance to lower his price: he has a huge downpayment in the property. This was a pure speculative purchase made with much of the owners money. If he could have rented the property for $2,300, he could have covered his payment on the $375,000 mortgage. Now, it is only a matter of how much of his money he is going to lose. If he waits until the property hits bottom, he will lose all of his $250,000 equity investment. As it stands now, if someone is willing to pay his asking price, and if he pays a 6% commission, the total loss will be $71,340.

Why would someone buy this property? The monthly cost of ownership would be about $3,700 per month. The cost of renting a similar property nearby is only $2,500. Also, when you factor in the monthly equity burn of $4,908 due to the declining market, this purchase makes no sense. There is only one compelling reason someone would buy this property: they believe the market is at the bottom and they have fantasies of endless appreciation. Perhaps there is someone out there who is only concerned with “owning” a property to provide for their family, but overpaying for real estate for psychological and emotional reasons is not doing the family any favors.

Someone stands to lose $250,000 on this property. The banks are not lining up to offer 100% financing because they are tired of being the bagholder. If this guy does not lower his price quickly to meet the market, he will be the big loser. If he does lower the price to sell, perhaps he can split the loss with the knife catcher. In whatever form it happens, there is $250,000 that is going to disappear into the ethers. Needless to say, I will not be bidding on this property any time soon.

How tides control the sea, and what becomes of me
How little things can slip out of your hands
How often people change, not to remain the same
Why things don’t always turn out as you plan

These are things that I don’t understand
Yeah, these are things that I don’t understand

I can’t, and I can’t decide
Wrong, oh my wrong from right
Day, oh my day from night
Dark, oh my dark from light
I live, but I love this life

How infinite is space, and who decides your fate
Why everything will dissolve into sand
How to avoid defeat, when truth and fiction meet
Why nothing ever turns out as you plan

These are things that I don’t understand
Yeah, these are things that I don’t understand

I can , and I can’t decide
Wrong, oh my wrong from right
Day, oh my day from night
Or dark, oh my dark from light
I live, but I love this life

Things I don’t Understand — Coldplay

The Place You Rent is For Sale

Life for Rent — Dido

Attention occupant of today’s featured property: it is for sale. From the MLS description, “Driveby Only Please! Do Not Disturb Occupant. No Sign, Tenant not aware Property is For Sale.” Well, they are now. If any of you know this renter, please go tell them what is going on — the power of the internet.

Today is a great case study in what a property is really worth. We have both an asking price and a statement of what the unit currently rents for. That should eliminate most of the conjecture concerning rent. I am going to show the calculations for cost of ownership and calculate the breakeven amount for an owner occupant.

437 Deerfield Kitchen

Asking Price: $515,000

Income Requirement: $128,750

Downpayment Needed: $103,000

Monthly Equity Burn: $4,291

Purchase Price: $495,000

Purchase Date: 4/16/2004

Address: 437 Deerfield #130, Irvine, CA 92606

Beds:	3
Baths:	3
Sq. Ft.:	1,367
$/Sq. Ft.:	$377
Lot Size:	–
Property Type:	Condominium
Style:	Cape Cod
Year Built:	1985
Stories:	2 Levels
Area:	Walnut
County:	Orange
MLS#:	U8002422
Source:	SoCalMLS
Status:	Active
On Redfin:	5 days

Driveby Only Please! Do Not Disturb Occupant. No Sign, Tenant not aware
Property is For Sale. Sale Subject to existing Lease $2,150./Month
(Expires Nov. 2008). Ideal End Unit Location with Direct Garage Access
(1 Car) plus 1 space across driveway. Charming Windwood Townhome. 2
Story, 2 Master Suites, Remodeled Tiled 2 Baths and 1/2 Guest
downstairs with 3rd bedroom Den/Office down. Inside laundry. Open
Kitchen, Eat at Bar and large Diningroom. Vaulted Ceilings, Slate
Fireplace with slider opens to large L-shaped Patio. Lovely
neighborhood with parks, Trails, Tennis&Sports Courts, Community
Pool/SPA. Walking distance to shopping center, bus station, school and
easy access to freeways. Washer, dryer and refrigeratior included. Call
Audrey with Questions 714-612-9557. Interior Inspection ONLY with
Accepted/Qualified Offer.

refrigeratior?

For those of you who read from out-of-state, you can see that a crappy 3/2 in Irvine still rents for more than $2,000. This property is borderline on whether or not an owner-occupant would want to live here long term.

The following are calculations for the cost of ownership. If you want a refresher course on these costs, see the post Rent Versus Own:

$ 359,590	Purchase Price

$ 71,918	Downpayment @20%
$ 287,672	Mortgage @ 80%

$1,818.28	Mortgage Payment @ 6.5%
$ 299.66	Property Taxes @ 1%
$ 74.91	Homeowners Insurance @ 0.25%
$ 74.91	Special Taxes and Levies @ 0.25%
$ 176.00	Homeowners Associate Dues or Fees @ $176
$ 149.83	Maintenance and Replacement Reserves @0.5%
$2,593.60	Monthly Cash Cost

$1,558.22	Interest on First Payment
$ (408.28)	Tax Savings @ 25% of mortgage interest and property taxes
$ (260.06)	Equity hidden in payment
$ 224.74	Lost Downpayment Income @ 5% of Downpayment
$ 2,150	Total Cost of Ownership

As you can see from the calculation above, this property is only worth $359,590 to an owner-occupant to break even on the cost of ownership. I included for reference the cost of private mortgage insurance (PMI) if you put less than 20% down. Of course, this would reduce the breakeven price even further.

$ 325,440	Purchase Price

$ 9,763	Downpayment @3%
$ 315,677	Mortgage @ 97%

$1,995.30	Mortgage Payment @ 6.5%
$ 271.20	Property Taxes @ 1%
$ 67.80	Homeowners Insurance @ 0.25%
$ 67.80	Special Taxes and Levies @ 0.25%
$ 135.60	Private Mortgage Insurance @ 0.5%
$ 176.00	Homeowners Associate Dues or Fees @ $176
$ 135.60	Maintenance and Replacement Reserves @0.5%
$2,849.30	Monthly Cash Cost

$1,709.92	Interest on First Payment
$ (444.43)	Tax Savings @ 25% of mortgage interest and property taxes
$ (285.38)	Equity hidden in payment
$ 30.51	Lost Downpayment Income @ 5% of Downpayment
$ 2,150	Total Cost of Ownership

People using FHA financing to put only 3% down have a higher cost of capital, and they have to pay PMI, so their breakeven is lower than someone putting 20% down.

The above analysis is exactly what I will look at when I consider buying a home. As you can see, prices are still too high for me. This property has to fall 30% from its 2004 purchase price before I would show any interest in it at all (not that I want to live in today’s property.) This owner used 100% financing, so she has been running a negative cashflow on this property for 4 years now. I doubt she cares what it sells for because even at her fantasy asking price of $515,000, she will still not get enough out of the property to pay off the loans. Some knife catcher may pay between $450,000 and $475,000 today because they will not do the analysis above, or they will not do it properly. I am constantly amazed at the level of ignorance among buyers. In the past, you could buy at almost any price, and the market would always bail you out. Unfortunately, sometimes prices do not come back for a very long time. The Great Housing Bubble is one of those times.

I haven’t really ever found a place that I call home
I never stick around quite long enough to make it
I apologize that once again I’m not in love
But it’s not as if I mind
that your heart ain’t exactly breaking

It’s just a thought, only a thought

But if my life is for rent and I don’t lean to buy
Well I deserve nothing more than I get
Cos nothing I have is truly mine

I’ve always thought
that I would love to live by the sea
To travel the world alone
and live my life more simply
I have no idea what’s happened to that dream
Cos there’s really nothing left here to stop me

It’s just a thought, only a thought

But if my life is for rent and I don’t learn to buy
Well I deserve nothing more than I get
Cos nothing I have is truly mine

While my heart is a shield and I won’t let it down
While I am so afraid to fail so I won’t even try
Well how can I say I’m alive

If my life is for rent…

Life for Rent — Dido

Floplords

During the Great Housing Bubble, many speculators tried to make money through trading houses. The vast majority of these traders were not professionals but amateurs who thought they could be professionals. Most amateurs ended up losing money because they did not understand what it takes to be successful in a speculative market. The first and most obvious difference in the investment strategy between professional traders and the amateurs in the general public is their holding time. Traders buy with intention to sell for a profit at a later date. Traders know why they are entering a trade, and they have a well thought out plan for their exit. The general public adopts a “buy and hold” mentality where assets are accumulated with a supposed eye to the long term. Everyone wants to be the next Warren Buffet. In reality this buy-and-hold strategy is often a “buy and hope” strategy — a greed-induced, emotional purchase without proper analysis or any exit strategy. Since they have no exit strategy, and since they are ruled by their emotions, they will end up selling only when the pain of loss compels them. In short, it is an investment method guaranteed to be a disaster.

There is plenty of evidence houses were used as a speculative commodity during the Great Housing Bubble. Since the cost of ownership greatly exceeded the cashflow from the property if used as a rental, the property was not purchased for positive cashflow, and by definition, it was a speculative purchase. Confirming evidence for speculative activity comes from the unusual and significant increase in vacant houses in the residential real estate market.

National Homeowner Vacancy Rate, 1986-2007

If markets had not been gripped by speculative fervor, vacancy rates would not have risen so far above historic norms. If houses had been purchased for investment purposes to make money from rental income, the houses would have been occupied after purchase and vacancy rates would not have gone up. A rise in vacancy rates would have resulted in downward pressure on rents, and the investment opportunity – if it had existed initially (which it did not) – would have disappeared with the declining rent. There is only one reasonable explanation for increasing house prices and increasing rents during a period when house vacancy rates increased 64%: people were purchasing houses for speculative gains and leaving them unoccupied while the owners waited for prices to rise.

When house prices stopped their dizzying ascent, many speculators found themselves with large monthly debt service costs and no income to offset expenses. Many chose to quit paying their mortgage obligations and allowed the property to be auctioned at foreclosure. Many chose to rent the properties to reduce their monthly cashflow drain, and they became accidental landlords. In the vernacular of the time, they became floplords – flippers turned landlords.

Becoming a floplord was fraught with problems. First, they were not covering their monthly expenses, so the losses on the ”investment” continued to mount. This was a convenient form of denial for losing speculators because they believed they were buying themselves time until prices rose again allowing them to sell later either at breakeven or for a profit. Since they bought in a speculative mania, prices were not going to recover quickly and the denial soon evolved into fear, anger and finally acceptance of their fate.

Another problem floplords faced was their own inexperience at managing rental properties. Most had never owned or managed a rental property, and none of them purchased the property with this contingency in mind. They often found poor tenants who did not reliably pay the rent or properly care for the property. This created even more financial distress and greater loss of property value as the property deteriorate through misuse.

The problems of renting were not confined to the floplords. Sometimes the renters were the ones who suffered. Many floplords collected large security deposits and monthly rent checks from tenants and failed to pay their mortgage obligations. This situation is called “rent skimming,” and it is illegal in most jurisdictions, but this crime is seldom prosecuted. Most of the time, the first indication a renter had that their rent was being skimmed was finding a foreclosure notice on their front door. By the time of notification, several months of rental payments were gone and the renters were evicted soon after the foreclosure. Renters seldom recovered their security deposits.

Valuations in Northwood for homes 2,000+ SF are still bubbly. Recently we featured a floplord looking to cover about 2/3 of his ownership cost (or ask 50% more than the property is worth depending on your point of view.) Today’s post features another floplord in the neighborhood with Secret Gold. The property is going to be a big loser for the owner, and since you can rent an identical property for $3,900, it doesn’t make much sense to spend around $5,500 a month to buy it, unless of course, you like the $7,400 a month equity burn on top of your oversized payment.

$3900 / 4br – Gorgeous home in Northwood

Asking Price: $888,000

Income Requirement: $222,000

Downpayment Needed: $177,600

Monthly Equity Burn: $7,400

Purchase Price: $1,080,000

Purchase Date: 5/15/2006

Address: 38 Secret Garden, Irvine, CA 92620

Beds:	4
Baths:	3
Sq. Ft.:	2,315
$/Sq. Ft.:	$384
Lot Size:	–
Type:	Single Family Residence
Style:	Contemporary
Year Built:	2005
Stories:	Two Levels
Area:	Northwood
County:	Orange
MLS#:	P601385
Status:	Backup Offers Accepted
On Redfin:	165 days
Unsold in 90+ days

WOW!! Take a look at this Beautiful home in Desirable gated commmunity of Northwood II. OUTSTANDING SCHOOLS, PARKS, POOL AND CLUB HOUSE. ! Beautiful quality upgrades. Gorgeous gourment kitchen with cherry cabinerty, stainless appliances includes, wine refrigerator. Island breakfast bar, beautiful granite counters. Prestine wood floors, upgraded carpet, window coverings. French doors lead to relaxing patio with soothing waterfall. Short distance to shopping, library and the NEW GREAT PARK IN PROGRESS. Move-in condition. Low homeowner association fee.

WOW!! This realtor can’t spell commmunity, gourment, cabinerty, or Prestine. I am not a stickler about spelling, and in fact, I am not a great speller, but when the computer puts a big red line underneath it, I have to go out of my way to ignore it. Please, someone at the MLS needs to get spell check software.

What does the Great Park have to do with anything?

Interesting that $120 a month for an HOA fee is considered low.

This property was purchased at the peak, and now if they get their asking price, the sellers stand to lose $245,280 after a 6% commission. This is their best-case scenario. If they become a floplord and hold the property all the way to the bottom, they will lose close to $500,000. Of course, they could always hold it until prices come back… in 2030.

Let your arms enfold us

Through the dark of night

Will your angels hold us

Till we see the light

Hush, lay down your troubled mind

The day has vanished and left us behind

And the wind, whispering soft lullabies

Will soothe, so close your weary eyes

Let your arms enfold us

Through the dark of night

Will your angels hold us

Till we see the light

Sleep, angels will watch over you

And soon beautiful dreams will come true

Can you feel spirits embracing your soul

So dream while secrets of darkness unfold

Secret Garden — Prayer

Rent

You dress me up, I’m your puppet

You buy me things, I love it

You bring me food, I need it

You give me love, I feed it

And look at the two of us in sympathy

With everything we see

I never want anything, it’s easy

You buy whatever I need

But look at my hopes, look at my dreams

The currency we’ve spent

I love you, you pay my rent

I love you, you pay my rent

Rent — Pet Shop Boys

Why rent when you can own for twice the cost?

That is the question today’s seller needs to answer. Today’s featured property is being offered at $1,120,000. If you divide by 160, you arrive at the monthly cost of ownership of $7,000 a month. There is a house in the same neighborhood that is a very similar comparable for rent at $4,500 a month — which I suspect is negotiable. So why would I spend $2,500 a month extra for today’s featured property? I can’t think of a good reason, but then again, I could not understand why people were willing to pay a 100% premium for ownership during the bubble either.

Asking Price: $1,120,000

Income Requirement: $280,000

Downpayment Needed: $224,000

Monthly Equity Burn: $9,333

Purchase Price: $451,000

Purchase Date: 1/15/1999

Address: 18 Arizona, Irvine, CA 92606

Beds:	5
Baths:	3
Sq. Ft.:	3,337
$/Sq. Ft.:	$336
Lot Size:	6,700 Sq. Ft.
Type:	Single Family Residence
Style:	Other
Year Built:	1999
Stories:	Two Levels
Area:	Walnut
County:	Orange
MLS#:	S518715
Status:	Active
On Redfin:	36 days

This Great Home Located in Prestigious Gated Harvard Square Is The End Unit and Has a Great Lot Size. Spacious Living W/ 5 Beds Plus Open Bonus Room and 3 Full Baths w/ New Travertine Floors. Main Floor Bedroom and Full Bathroom. Large Family Room and Breakfast Nook, Light and Bright. Open Kitchen w/ Granite Countertop/Backsplash, Oversize Pantry. Hardwood & New Polished Travertine Floors Thru Downstairs. Designer New Paint and New Berber Carpet. New Baseboard Thru the House. Jacuzzi-Like Bathtub in Master Room. Large Size Backyard w/ Covered Patio, Fruit Trees, Vegetables and Stone Water Falls. 3 1/2 Acre Community Park In The Center of The Community w/ Pool, Children’s Play Area & Much More. Enjoy This Community’s Amenities.

Why Is This Written In Title Case?

Here is a seller betting on the high-end-is-immune theory. As I look at listings around town, I am noticing a great deal of this. The people who own the largest homes in the neighborhood are clinging to their $1,000,000+ asking prices while properties all around them are dropping like bombs. Good luck with that asking price.

Our comparable rental is 10 Indiana:

$4500 / 6br – 6 bedroom Home with Incredible Pool

If we assume the above comparable is market rent, then the featured property is worth $720,000. Given that they paid $451,000 back in 1999, $720,000 seems about right.

$1,120,000 well, if you have enough kool aid…

Old Spice

Take or leave it or just don’t even bother.

Caught in a craze it’s just a phase

or will this be around forever.

Don’t you know it’s going too fast

Racing so hard you know it won’t last.

Don’t you know what can’t you see,

Slow it sown, read the sign so you know just where you’re going.

Stop right now, thank you very much,

Stop — Spice Girls

Another song about the housing bubble… or is it romance… or was there a difference? Everyone got crazy about real estate thinking the rally would last forever. Prices were going up so fast people ignored the signs, and now the music has stopped. Do you have a chair?

Finding comparable properties for sale and for rent provides a good way to check neighborhood fundamental values. Today, I am featuring a for sale property a few doors down from a rental of similar size and configuration.

Asking Price: $735,000

Income Requirement: $183,750

Downpayment Needed: $147,000

Monthly Equity Burn: $6,125

Purchase Price: $177,500

Purchase Date: 7/22/1986

Address: 15 Spicewood Way, Irvine, CA 92612

Beds:	3
Baths:	3
Sq. Ft.:	2,369
$/Sq. Ft.:	$310
Lot Size:	3,040 Sq. Ft.
Type:	Single Family Residence
Style:	Other
Year Built:	1968
Stories:	Two Levels
View(s):	Park or Green Belt
Area:	University Park
County:	Orange
MLS#:	S519808
Status:	Active
On Redfin:	19 days

Spacious Julliard Model. Wow!3 Bedrooms each with its own bathroom. One bedroom and bathroom downstairs. This home boasts a sunroom, cozy fireplace, catherdral ceilings, skylight and track lights in Living Room. 2 Large private enclosed patios to entertain your guests. Newer windows in all the rooms. Recessed lighting in Kitchen. Cook to your hearts delight on the 5 plate range. Tile entry way and formal dining room. One wall fully mirrored. Near acclaimed schools, shopping, University and excellent community amenities. Very QUIET! NO MELLO ROOS! LOW TAX RATE! This home is built for entaining. A Must see! Bonus Room was converted to master bedroom

How many people would remember a model design from 1968?

entaining? catherdral?

No pictures of the kitchen, so I am suspect of its quality.

So how much would a property like this rent for? Try $2,500.

$2500 / 3br – PRESIDENT’S WEEKEND SPECIAL- BEST VALUE IN IRVINE!

IMO, this rental is a very good deal. It is just over $1 / SF per month. If this is a valid market rent, then how much is the featured listing really worth?

$2,500 * 160 = $400,000. Hmmm…

Should I pay $735,000, or should I wait for the price to drop to $400,000? That is a tough one. I think I will wait…

Irvine Housing Blog

Established September 2006