Monthly Archives: October 2009

IHB News 10-31-2009

Happy Halloween from the IHB.

12 Stonewood Irvine, CA 92604 kitchen

Irvine Home Address … 12 Stonewood Irvine, CA 92604
Resale Home Price …… $525,000

{book1}

It’s so dreamy, oh fantasy free me
So you can’t see me, no not at all
In another dimension, with voyeuristic intention
Well-secluded, I see all
With a bit of a mind flip
You’re there in the time slip
And nothing can ever be the same
You’re spaced out on sensation, like you’re under sedation
Let’s do the Time Warp again!

The Time WarpRocky Horror Picture Show

For those of you looking for something interesting to do for Halloween, I suggest you attend the Rocky Horror Picture Show. There is a midnight showing on Halloween.

I went to see this movie in the mid 1980s. I remember taking a bag of supplies including newspapers, squirt guns, toasted bread, really unusual items that would be needed at different times during the show. It was true audience participation, and you don’t see that often anymore, particularly at the movies.

People who have seen the movie dozens or hundreds of times shout questions that are answered — out of context — by the character on the screen. Some of the comedic quips are really funny.

It is one of those experiences you do once (maybe twice) because it is fun and unique, but the movie is really bad, and depending on the theater where you see it, you may get wet, peppered with ice and toast, and be overwhelmed by the mob. Some theaters really make it a loosely controlled scrum. It reminds me of the OC Mud Run. I would have hated to have cleaned up the mess in the theater where I watched this movie….

Yes, that is Susan Sarandon, and no, that is neither Freddie Mercury nor Bill Gates.

IHB News

Block Party 11-9-2009

I added functionality to the calculator. I added a section for loan qualification based on current market DTIs. If some lender would post or email me an more accurate and current standards are, I can update the calculator. I have also added a new spreadsheet below the original calculator that calculates the Time To Payoff.

The IHB did a report on a property in Redlands. IHB Fundamental Value Report Redlands Property.pdf Whenever we do these reports locally, properties almost always are selling for more than the IHB Fundamental Value. This property in Redlands is typical of what you find in Riverside County: poperties trading for 30% less than they should be — or to be more accurate, they are trading at their bottoming price even at natural interest rates. In markets like Las Vegas and Riverside County, prices have overshot fundamentals. The ruinous supply will take its toll in these markets, but with affordability being so good, people will step up to buy these properties.

Housing Bubble News

Government Price Supports Create Mini-Bubble

Monthly ReviewDean Baker‎Oct 29, 2009‎

If there are no changes in behavior among these actors now, when the wreckage of the housing bubble is everywhere, then it is a safe bet that the market is

Democrats and Republicans Agree To Keep Juicing The Housing Market

The Business Insider‎Oct 29, 2009‎

Nevada has been hard-hit by the bursting of the housing bubble. The chamber’s top Republican, Senator Mitch mcconnell, also said most senators support the

Admin. backs housing tax credit

msnbc.comMark Murray‎Oct 29, 2009‎

It creates another housing bubble by providing a crutch to the market, which in turn again over-inflates the values of houses, which will lead to another

US home prices appear to have bottomed out

Los Angeles TimesAlejandro Lazo‎Oct 27, 2009‎

Christopher Thornberg, a Los Angeles economist who was an early predictor of the housing bubble, disagreed. “I can’t emphasize enough how this rally in the

Housing Prices Are Rebounding Seeking Alpha (blog)

Did Anyone Hear About the Housing Bubble and the Economic Collapse?

TPMCafé (blog)Dean Baker‎Oct 28, 2009‎

Alan Greenspan would have insisted that the housing market is just fine and that there is no risk of a nationwide fall in house prices.

The Amnesia in Financial Markets

ForbesBernard Condon‎3 hours ago‎

The last time the monetary spigot was wide open it led to a credit bubble, a stock bubble, a private equity bubble and a housing bubble–and we all know how

Experts say economy crushing Las Vegas real estate market

Las Vegas SunBrian Wargo‎9 hours ago‎

People were overleveraged and thought the bubble would never burst, and now they must get used to what the term “normal” means, he said.

Uncertain Commercial Lending Losses Could Make 2010 a Scary Year for Wells

American Banking News‎4 hours ago‎

into the teeth of down cycle in commercial real estate — where the bulk of bubble-era loans are due to be repaid or refinanced between 2010 and 2012.

12 Stonewood Irvine, CA 92604 kitchen

Irvine Home Address … 12 Stonewood Irvine, CA 92604

Resale Home Price … $525,000

Income Requirement ……. $97,731
Downpayment Needed … $105,000

Home Purchase Price … $634,000
Home Purchase Date …. 3/15/2006

Net Gain (Loss) ………. $(140,500)
Percent Change ………. -17.2%
Annual Appreciation … -4.6%

Monthly Mortgage Payment … $2,280
Monthly Cash Outlays ………… $2,990
Monthly Cost of Ownership … $2,250

Redfin Property Details for 12 Stonewood Irvine, CA 92604

Beds 3
Baths 2 full 1 part baths
Size 1,681 sq ft
($312 / sq ft)
Lot Size 2,459 sq ft
Year Built 1978
Days on Market 87
Listing Updated 9/28/2009
MLS Number P697141
Property Type Condominium, Residential
Community Woodbridge
Tract Othr

According to the listing agent, this listing may be a pre-foreclosure or short sale.

Woodbridge is a very desirable area in Orange County. This house has a great floorplan, high ceilings, lots of light coming through. Kitchen has granite tile countertop. Spacious master. Enjoy all the amenities that the Lake has to offer: pool, spa, tennis and sports court, club house and the the beautiful Lake.

and the the beautiful Lake. Is the listing agent stuttering?

This property was purchased at the peak for $634,000. The owner used a $475,500 first mortgage, a $158,500 second mortgage, and a $0 dowmpayment. On 2/13/2007, she refinanced with a $636,500 Option ARM with a 1.87% teaser rate, so she did manage to extract $2,500 plus reduce her payment to where she was saving hundreds over renting with the minimum loan payment.

Now that owners like this one are faced with the prospect of actually having to pay back the large sums they borrowed, they are walking away.

Ownership Cost: Taxes and Opportunity Costs

Taxes and opportunity costs impact the financial life of owners in ways that have nothing to do with the property. Today we will examine these two features more carefully.

5 WILDBROOK Irvine, CA 92614 kitchen

Irvine Home Address … 5 WILDBROOK Irvine, CA 92614
Resale Home Price …… $495,000

{book1}

My strength slips away
Soon I must fall
Victim of fortune
My sources grow small
Life slips away
As demons come forth
Death takes my hand
And captures my soul

Black Magic — Slayer

Today is part 5 finishing the series on Ownership Cost:

Ownership Cost: Income, Payments and House Prices

Ownership Cost: Interest Rates and Downpayment Requirements

Ownership Cost: Property Taxes and Mello Roos

Ownership Cost: Homeowners Associations

Ownership Cost: Taxes and Opportunity Costs

Four Major Variables that Determine Market Price

Over the last four days we looked at the four main variables that determine home price:

  1. borrower income,
  2. allowable debt-to-income ratios,
  3. interest rates, and
  4. downpayment requirements.

Today we are looking at tax implications and opportunity costs because these number will give you a more accurate measure of the impact home ownership will have on the owner’s financial life.

Taxes

Owning real estate has two significant tax benefits: (1) favorable capital gains tax exemptions and (2) income tax benefit through the home mortgage interest deduction (HMID). Be forewarned that this is not an exhaustive treatise on every permutation in the tax code. I am going to look at the general case the most people will find themselves in.

Capital Gains Taxes

If you own a home more than two years, you can ignore the gains on the first $250,000 or $500,000 if your married. If you don’t make more than $250,000 or $500,000 on the sale — which most people don’t — then you don’t pay any capital gains taxes. It is a tremendous tax advantage that favors capital gains and appreciation.

The reason we have a large deduction or excluded amount is because years ago when there was no exclusion, long-term homeowners would be punished with capital gains taxes when they sold a principal residence when most of that gain was due to inflation. Without a method of adjusting the purchase price basis for inflation (like using the CPI), owners are being taxed on the profits created by inflation. They are getting less than their money back when you consider money’s purchasing power.

Personally, I think it would be a good idea to link the property basis to inflation. An exclusion can be created by linking the basis for the capital gains to the Consumer Price Index, and the tax can be levied on any overage. For instance. If someone purchased a home for $100,000 when the CPI was at 100, then later the property was sold for $300,000 when the CPI was at 200, the tax would be levied on only half the profit:

Adjusted Basis = Original Price times new CPI divided by old CPI
Adjusted Basis = $100,000 * 200 / 100 = $200,000.

$300,000 Resale Price
$200,000 Adjusted Basis
$100,000 Profit subject to Capital gains tax.

This gets around the issue of inflation taxing while taxing irrational exuberance. It will never happen.

The big tax break for capital gains is what makes life as a mid-term flipper possible. There were many people during the bubble who bought with intention of flipping in two years when their gains would not be taxed. Of course, this tax strategy took second place to the pandemonium of the crazy market rally.

Favorable capital gains tax treatment is really a tax-free retirement savings account Uncle Sam worked into the system to benefit homeowners. If you own a property long enough to have capital gains, and the sale of that home represents a significant portion of family savings (which is usually does), the capital gains tax benefit can have significant financial impact on your financial life in retirement.

Income Taxes and the Home Mortgage Interest Deduction

The tax code allows wage earners the ability to give up the Standard Deduction and write off Home Mortgage Interest against their income on Schedule A. If the taxpayer is already itemizing deductions for expenses not related to home mortgage interest, then the taxpayer recieves the full benefit of this deduction.

The deduction is simple. Lenders issue a form 1098 telling a borrower how much interest they paid during the year, and this is put in the tax forms as a deductible interest expense. It does phase out for loans over $1,000,000, and there are exclusions from the deduction, but for most borrowers this is a significant benefit of ownership.

The root of this very popular deduction comes from the need to give owner-occupants the same tax advantages landlords have. Why should landlords get to deduct interest expense and owner-occupants can’t? Whether or not this is justification for the deduction, I don’t know. I do know that it will not be going away any time soon.

Calculating the true tax benefit of owning versus renting

The income tax benefit is calculated in the IHB Fundamental Value Report based on a simple estimation that most buyers will be getting a tax benefit at about 10% lower than their highest marginal tax rate. We base our estimate on two factors: (1) not all of the interest deduction would have been taxed at the highest marginal rate and (2) the loss of the Standard Deduction reduces the value of the home mortgage interest deduction. Anecdotally, when people expert in tax matters have run scenarios with tax software, the 10% reduction in effective tax savings has proven a useful estimate.

Let’s look in more detail as to why this effect happens. Assume a borrower has $50,000 in mortgage interest during a tax year, and this borrower makes about $150,000. For this borrower, the portion over $137,050 is taxed at 28%, and the amount between $67,900 and $137,050 is taxed at 25%, the gross tax savings would be about $12,888 for an effective marginal tax rate of 25.5%. This is the impact of crossing marginal tax rate lines.

Also, to be more accurate, we must subtract the negative impact of giving up the Standard Deduction of $11,400 for a family. If borrowers have $50,000 in deductible interest, but they have to give up $11,400 in tax benefit to get it, the net tax write off is $38,600. Crunching the numbers shows the tax savings is $10,038 instead of the $12,888 people thought they are getting. This reduction in tax benefit due to giving up the Standard Deduction.

When you combine these two effects, a good guide is to take 10% off the borrower’s highest marginal tax rate.

Opportunity Cost

When a buyer puts money into real estate and takes ownership, it changes their financial life. Money for a downpayment had to come out of some other asset even if this is only a savings account or CDs. The place where the money used to be parked either paid interest or provided some return. The interest, dividends or positive change in value of the competing asset is an opportunity cost the buyer must consider.

For instance, a buyer could choose to rent and park their money in a 2-year CD and earn about 2.25%. When someone goes to buy a house, they will take money out of CDs and put it into real estate where it earns nothing — unless prices appreciate. However, when considering the purchase from a cashflow basis, owning the asset can provide a cash return if your cost ownership is less than the cost of renting the same unit. This return is independent of appreciation and provides the only reasonable financial reason to own when prices are flat or declining.

Calculating Opportunity Cost

Projecting future costs is more an art than a science. Trying to estimate the opportunity costs of an average investor over the life of a 30-year mortgage is a guess at best. However, since this opportunity cost is real, there are useful theoretical models for providing an estimate to use in decision making.

Interest rates on savings are tethered to mortgage interest rates as all debt and deposit instruments are tied together in the web of risk and return in the debt market. The loosely correlated relationship between mortgage debt and reliable savings returns like medium-term Certificates of Deposit is the basis for estimating opportunity cost.

When mortgage interest rates are very high, the demand for money is high, and lenders will be paying high CD rates to try to supply the demand for money through loans. The inverse is also true. When lenders do not need money to loan, interest rates fall, and lenders do not need to pay borrowers much for money. Plus, in a deflationary environment the lender has no reliable customers to loan the money to anyway.

This direct relationship between mortgage interest rates and CD rates — irrespective of how loosely correlated they may be — is the basis of my calculation. I make the following assumptions:

  • CD Rates will never fall below 1%.
  • As mortgage rates go up, CD rates will go up 66% as fast.

When I put in different test numbers, the stretching spreads this formula creates does re-create the same phenomenon that happens in the real world when inflation expectation is added into the market’s thinking.

We have the ability to override our default settings and put in whatever inputs you believe most accurately reflects your financial situation in our reports.

5 WILDBROOK Irvine, CA 92614 kitchen

Irvine Home Address … 5 WILDBROOK Irvine, CA 92614

Resale Home Price … $495,000

Income Requirement ……. $92,146
Downpayment Needed … $99,000

Home Purchase Price … $555,500
Home Purchase Date …. 12/9/2004

Net Gain (Loss) ………. $(90,200)
Percent Change ………. -10.9%
Annual Appreciation … -2.3%

Monthly Mortgage Payment … $2,150
Monthly Cash Outlays ………… $2,820
Monthly Cost of Ownership … $2,130

Redfin Property Details for 5 WILDBROOK Irvine, CA 92614

Beds 3
Baths 2 baths
Size 1,816 sq ft
($273 / sq ft)
Lot Size n/a
Year Built 1980
Days on Market 84
Listing Updated 10/11/2009
MLS Number S584100
Property Type Condominium, Residential
Community Woodbridge
Tract We

According to the listing agent, this listing may be a pre-foreclosure or short sale.

Spacious single level home with formal dining and living room. Open kitchen with a large breakfast nook. Great private yard. Two car garage with indoor laundry. Located in the heart of Irvine in the woodlbridge village that offers, two lakes, pools, and tennis courts.

This short sale was purchased on 12/9/2004 for $555,500. The speculator used a $400,000 first mortgage, a $125,000 second mortgage, and a $30,500 downpayment. On 12/30/2005 he opened a HELOC for $208,000. Total property debt is $608,000. Total mortgage equity withdrawal is $$83,000 including his downpayment.

I don’t know what hoops people are being asked to jump through to get loan modifications, but this owner has dutifully stopped making payments and listed the property for sale.

Foreclosure Record
Recording Date: 07/15/2009
Document Type: Notice of Default
Document #: 2009000378012

Irvine Housing Blog No Kool Aid

I hope you have enjoyed the week of analysis posts here at the IHB. I may not be so ambitious next week. I over did it.

Thank you for reading the Irvine Housing Blog: astutely observing
the Irvine home market and combating California Kool-Aid since
September 2006.

Have a great weekend,

Irvine Renter

😉

Ownership Cost: Homeowners Associations

I asked our resident HOA expert to write a few words about HOA issues for today’s post. The author has served on the board of his large HOA for 16 years,
worked for one of the largest HOA management companies, and was also on
the Fountain Valley City Council for six years. Lately he’s been
working to expose the scandal behind the sale of the Orange County
Fairgrounds with this link.
He’ll be responding to comments.

360 East YALE Loop 15 Irvine, CA 92614 kitchen

Irvine Home Address … 360 East YALE Loop 15 Irvine, CA 92614
Resale Home Price …… $608,000
{book2}

Do you remember the good old days before the ghost town?
We danced and sang as the music played in any boomtown
This town (town) is coming like a ghost town

Why must the youth fight against themselves?
Government leaving the youth on the shelf
This place (town) is coming like a ghost town
No job to be found in this country
Can’t go on no more
The people getting angry

Ghost Town — The Specials

High HOA fees can make a ghost town out of a good neighborhood. This cost is unique among our cost estimates because there is a high degree of uncertainty about the future of HOA fees — and worse yet, the possibility of assessments — that are not in a point-in-time analysis like the IHB Property Valuation Report.

Today is part 4 in the ongoing series on Ownership Cost:

Ownership Cost: Income, Payments and House Prices

Ownership Cost: Interest Rates and Downpayment Requirements

Ownership Cost: Property Taxes and Mello Roos

Ownership Cost: Homeowners Associations

Ownership Cost: Taxes and Opportunity Costs

Four Major Variables that Determine Market Price

Over the last three days we looked at the four main variables that determine home price:

  1. borrower income,
  2. allowable debt-to-income ratios,
  3. interest rates, and
  4. downpayment requirements.

Today we are looking at homeowners associations because this expense (1) reduces your payment to the lender, (2) reduces the
amount you can borrow and bid, and thereby (3) reduces the value of real
estate. People can persuasively argue that HOAs add more value than they cost, and I believe this is true, but that value is reflected in market comps. When you examine the details of cashflow, HOAs are a cost, nothing more.

The following is the words of our guest author OC Progressive.

Avoiding the toxic condo association

As the housing crisis continues, some condo associations can
be dominos lined up to fall.

This is not to say that you should avoid any
property with
a Homeowners Association, and in large swathes of Orange County,
it’s very hard to have a property that doesn’t have an HOA. As a best
example, let’s
look at my large scale HOA in Fountain Valley. This is a master
recreation association which
maintains 20 acres of parks, three pools, and some buildings in a forty
year
old neighborhood with 1,048 homes. The association runs a swim team,
picnics,
kids’ events at holidays, and doesn’t get involved in telling people
what color
to paint their homes. The city maintains the streets, street
lighting, sweeps the streets, writes parking tickets, and has code
enforcement officers to keep properties maintained.

Properties don’t turn over very quickly here, but we’re
still seeing the results of the borrowing binge. Our assessments over 90 days
past due have tripled in the last year, and the money we will write off as
uncollectible could be in the $10,000 range next year, versus less than $1,000
last year. It doesn’t make the directors happy, but our budget is over $750,000
a year, our capital reserves are fully funded at close to $500,000 and we have
operating funds in the bank of over 100,000.

So a ten-fold increase in uncollectible assessments is a
blip on our balance sheet. A couple more years like this and we might have to
raise assessments another dollar or two a quarter.

Los Condos Diablo

Let’s take the reverse of this scenario, with a condo
association somewhere in South
County we’ll call Los Condos
Diablo. It’s a 200 unit association where everything is a common asset – not just
the land, but the sidewalks, streets, street lights, the roofs and walls of
every building, the trash enclosures, stairways, patios and decks.

Builders threw the place up quickly and there have been
serious ongoing maintenance problems which have been handled with band-aid type
repairs. The board of directors has been very reluctant to raise assessments,
so the reserves are funded at around 20% . Emergency safety repairs, collapsing
stairways, remediating mold problems from roof leaks, and other expensive problems
keep preventing them from catching up on maintenance. Exterior second story
decks that should have had a new surface coating, new paint and gutters now needs to
be torn down and completely rebuilt.

So instead of being like my HOA, where we are current on all
of our maintenance and have $600 in the bank for each homeowner, Los Condos Diablo
has net deferred maintenance liabilities of $5,000 a unit, and is struggling to
pay their bills every month. Because so many structural elements have been
compromised, to bring this set of buildings to good condition would take over a
million in reconstruction, money they don’t have and can’t save or borrow.

And here’s the kicker for that condo association. They were
upside down on their maintenance before people started defaulting on their
loans, and people are defaulting like crazy. These were entry level condos, and
when prices started rising, lots of folks cashed out and moved up. Over half
the units turned over close to the peak, and probably two thirds of them are
underwater.

When someone loses a job or just gives up, they stop paying
their HOA fees. The HOA starts adding penalties, filing liens, sending notices,
and running up legal costs. Ultimately, some day, the bank forecloses and the
property changes hands. At that point all of the past due assessments get
written off. The bank is only responsible for paying from the date they assume title. Worst of
all, a management firm or collection firm might now be owed late fees and legal
fees that were assessed.

With assessments of $250 per month past due for 18 months, plus another $500 in fees the
condo association is out $5,000 that they need to collect somehow from the rest
of the owners. If ten percent of the 200 units go belly up, the remaining 180
owners each now has another $555.00 apiece in debt that they share with the
remaining owners.

Now let’s add another kicker. The Directors of the Condo
Association, volunteers who have stepped up out of civic duty, see all of this
coming and can see it getting worse and worse. Their neighbors rise up in anger
when they try to raise assessments, cursing and threatening recall. Instead of continuing to take abuse from their
neighbors, they resign or sell out and move on, leaving the community without a
board of directors. The management company tries to hold a new election, and
nobody volunteers. They send a letter to all the owners, resigning their
contract.

So the State Department of Real Estate ….. Oh wait, there
isn’t any agency with responsibility to pick up the slack for a failed condo
association. What happens next is anybody’s guess, but it will most likely
involve lawyers and the Superior Court, adding another layer of debt to each
owner.

So if you think you’re getting a bargain in a low-end bank
owned condo, you might in fact also be buying a big liability that you will
have to pay for somewhere down the line.

Never, ever make an offer on a condo without getting a copy
of the last year’s budget, and seeing the state mandated disclosure from the
reserve study.
If you can’t get it, walk away. WALK AWAY, and if an agent tells
you it’s not important, he’s either a fool or a scoundrel.

Reserve Studies

A reserve study is a document that is updated every year as
required by state law. It’s fairly complex, yet also pretty simple.

We know
that woodwork on buildings needs to be painted every four years and stucco
every eight years. We know the pool needs re-plastering every twelve years. We
know that the life on the flat roof is around fifteen years, and that the
playground equipment should be replaced after every fifteen years. So an
analyst assigns a cost and a life to each major component of an association.
Then they figure out how much the association should be saving for each
component, and plug it all into a big spreadsheet. That shows how much should
be available every year for major maintenance and replacement items, and how
much the association should be setting aside so that money is available. The
idea is that the level of assessments remains very stable as long as the
association doesn’t have to pay for several major components all at once from their
monthly assessments.

There’s a big catch. The state requires that you do a study,
disclose the results, and have a plan if there’s a deficiency, but the
association doesn’t actually have to appropriate the money
, and most fall
short.

So a smart buyer has to look at the summary of the reserve
study has to be mailed with the budget, and the calculation that is required by
state law.

Here’s what it looks like for a fully-funded reserve from my
own association.

Based on the method of calculation in paragraph (4) of subdivision (b) of Section 1365.2.5,
the estimated amount required in the
reserve fund at the end of the current year is 452,933
based in whole or in
part on the last reserve study or update prepared by Advance Reserve Solutions,
Inc. as of January 1,2008. The projected
reserve fund cash balance at the end of the current fiscal year is $433,225
,
resulting in reserves being 96% funded at this date, The current deficiency in
the reserve fund represents $18.81 per ownership unit.

This is a source of pride. For every one of the 1048 units, there is $413.38
in funds dedicated to replace everything. That money is set aside in separate
accounts that can’t be used for operating expenses, and there’s an annual
contribution to maintain the counts at close to the ideal level.

Let’s say you have another association, where the
association hasn’t funded their reserves. That line might show reserves funded
at 50% and a deficiency in the reserve fund of $1153.41 per unit. Is that bad?
Not necessarily. But you better budget for your HOA assessments to increase by
20% per year, which is the maximum allowed by state law without a vote of the
members.

Although it’s improbable, even an association with reserves
funded at 10% might be financially solid if they have just completed re-roofing
every building and replacing every piece of deteriorating wood work.

Where does the red flag go up, where you should just steer
clear of a condo?

As a rule of thumb, less is more, but bigger is better. The
fewer parts of the individual units that are maintained by the association, the
less likely you are to face significant issues from underfunded reserves and
deferred maintenance. And also, the larger the association, the more likely you
are to have professional management, and the more units you have to divide
fixed annual costs like the corporation filing fees, d&o insurance policy,
cost of the reserve study, et cetera.

Before you start looking, find a real estate agent to represent you who
understands what you’re talking about, and knows that you’re going to need a
copy of the last budget before you make an offer. Just as there are HOA’s where
you’re actually getting a valuable share in cash assets as part of your
purchase, there are professionals out there who will help you gather the
information you need to make a good decision.

Then use some common sense and use your eyes.

Look at the numbers in the budget and the reserve study. How long would it take the association to
catch up on under-funded reserves? How
much is the deficit in relation to the value of the unit and the current
monthly payment? Underfunded reserves are frequently associated with
dysfunctional condo politics, deferred maintenance and serious rates of
delinquencies. Politics? Yes, some associations have repeated recall elections,
with warring factions wasting money on attorneys while their finances fail, or
they have idiots elected to their boards who are more interested in the
neighbor’s dogs than preserving and protecting assets.

So if the numbers don’t look good, they may in fact be far, far worse.

Also, look for signs of deferred maintenance – rust on
wrought iron fences, peeling paint and dry rot, missing roof tiles, cracks in
asphalt are the most obvious, but with a sharp eye you can look at the edges where
the decks meet stucco, where the eaves meet the roof and see if these most
vulnerable areas look as if they’re tightly sealed and well-maintained.

Whatever you do, steer clear of Los Condos Diablos, the nightmare association
where everything is going wrong. At its worst, it’s broke, internally at war,
and unable to find a way out of the hole that its owners have been excavating
for years. Every dollar you put into a part of a failing condo association is at
risk.

[end of quote]

HOA Analysis Service

The author of today’s post has been in contact with me via email for quite some time. He is contemplating offering HOA analysis as a service, and I told him it is a great idea. IMO, getting an HOA analysis is just as important as getting a home inspection.

Both HOA analysis and home inspection are insurance against unknown expenses you may face in the future if you acquire property. A cracked foundation can cost you tens of thousands of dollars — an underfunded HOA can cost you even more. Both are equally important.

Unfortunately, to my knowledge, nobody is providing HOA analysis as a service. The documents are hard to get (HOAs are not keen to display their dirty laundry), and the initial review is time consuming, but such a service would cost no more than a home inspection, and perhaps even less.

In a post-Great Housing Bubble era, we will see a financial wasteland on HOA balance sheets. Many have always been underfunded, but even strong HOAs will suffer when the payments stop coming. Most readers of the Irvine Housing Blog will buy in a community with an HOA. Without this service, it will be a crapshoot whether or not you find a stable and well-funded HOA.

If any readers care to comment on whether or not you consider this service to be valuable, perhaps we can convince the author to offer this service to everyone. I think it would be great.

{book2}

360 East YALE Loop 15 Irvine, CA 92614 kitchen

Irvine Home Address … 360 East YALE Loop 15 Irvine, CA 92614

Resale Home Price … $608,000

Income Requirement ……. $113,182
Downpayment Needed … $121,600

Home Purchase Price … $526,500
Home Purchase Date …. 6/24/2009

Net Gain (Loss) ………. $45,020
Percent Change ………. 15.5%
Annual Appreciation … 15.5%

Monthly Mortgage Payment … $2,641
Monthly Cash Outlays ………… $3,450
Monthly Cost of Ownership … $2,600

Redfin Property Details for 360 East YALE Loop 15 Irvine, CA 92614

Beds 3
Baths 1 full 2 part baths
Size 2,187 sq ft
($278 / sq ft)
Lot Size n/a
Year Built 1986
Days on Market 4
Listing Updated 10/20/2009
MLS Number S593399
Property Type Condominium, Residential
Community Woodbridge
Tract Ge

According to the listing agent, this listing is a bank owned (foreclosed) property.

Two story end unit with 3 bedrooms and 2.5 baths. Large Living Room with vaulted ceilings and fireplace. Formal Dining Room and breakfast nook plus Family Room with another fireplace! Master suite has separate tub and shower. Upstairs laundry. Mirrored wardrobe doors in all bedrooms. Large sideyard with lots of hardscape and a fireplace.

This property was a peak purchase with an Option ARM. The owners held out a bit longer than most because they had some of their own money in the deal.

The property was purchased on 10/18/2006 for $710,000. The owners used a $568,000 Option ARM with a 1% teaser rate, a $71,000 second mortgage, and a $71,000 downpayment. The gave up in late 2008…

Foreclosure Record
Recording Date: 05/28/2009
Document Type: Notice of Sale (aka Notice of Trustee’s Sale)
Document #: 2009000272123

Foreclosure Record
Recording Date: 02/26/2009
Document Type: Notice of Default
Document #: 2009000091143

The auction price is 26% below the original purchase price. The lender is trying to recoup a bit more with this asking price. Given the state of our market, they will probably get it.

Ownership Cost: Property Taxes and Mello Roos

We continue our focus on Woodbridge HELOC abusers and Ownership Cost with a discussion on property taxes and Mello Roos.

13 LONGSHORE 79 Irvine, CA 92614 kitchen

Irvine Home Address … 13 LONGSHORE 79 Irvine, CA 92614
Resale Home Price …… $560,000

{book1}

Raven hair and ruby lips
sparks fly from her finger tips
Echoed voices in the night
she’s a restless spirit on an endless flight
wooo hooo witchy woman, see how
high she flies
woo hoo witchy woman she got
the moon in her eye
She held me spellbound in the night
dancing shadows and firelight
crazy laughter in another
room and she drove herself to madness
with a silver spoon

Witchy Woman — The Eagles

Today is part 3 in the ongoing series on Ownership Cost:

Ownership Cost: Income, Payments and House Prices

Ownership Cost: Interest Rates and Downpayment Requirements

Ownership Cost: Property Taxes and Mello Roos

Ownership Cost: Homeowners Associations

Ownership Cost: Taxes and Opportunity Costs

Four Major Variables that Determine Market Price

Over the last two days we looked at the four main variables that determine home price:

  1. borrower income,witch pumpkins
  2. allowable debt-to-income ratios,
  3. interest rates, and
  4. downpayment requirements.

Today we are looking at some of the minor cost inputs that work by influencing the four major ones; property taxes and Mello Roos taxes.

When you qualify for a loan, the difference between what your income can support and the payment you can make to the lender is a number of related expenses that only homeowners must pay; property taxes, special assessments and Mello Roos, insurance and homeowners associations. These expenses (1) reduce your payment to the lender, (2) reduce the amount you can borrow and bid, and thereby (3) reduce the value of real estate. Over the rest of this week, we will look at these costs of ownership.

Property Taxes

Property taxes have long been a source of local government tax revenues. Real property cannot be moved out of a government’s jurisdiction, and values can be estimated by an appraisal, so it is a convenient item to tax. In most states, local governments add up the cost of running the government and divide by the total property value in the jurisdiction to establish a millage tax rate.

California is forced to do things differently by Proposition 13 which effectively limits the appraised value and total tax revenue from real property. Local governments are forced to find revenue from other sources.

Proposition 13 limits the tax rate to 1% of purchase price with a small inflation multiplier allowing yearly increases. In California, the first half of regular secured property tax bills are due November 1st, and delinquent after December 10th; the second half are due February 1st, and delinquent after April 10th each year. If the delinquent date falls on a Saturday, Sunday, or government holiday, then the due date is the following business day.

Often the lender will compel the borrower to include extra money in the monthly payment to cover property taxes, homeowners insurance, and private mortgage insurance, and these bills will be paid by the lender when they come due. If these payments are not escrowed by the lender, then the borrower will need to make these payments. We have had some contentious discussions about impound accounts, and I remain a fan of them. The tiny amount of extra interest you may make saving in your own account is not worth the hassle.

Due to Proposition 13, the property tax bill is very easy to calculate; take one percent of the purchase price. Divide it by twelve to get the monthly cost. We do this in IHB Property Valuation Reports.

Automatic re-assessment for cash-out refinancing

An idea emerged from the aftermath of the housing bubble; limit HELOC abuse by making cash-out refinancing in excess of the original purchase price an event that triggers property tax re-assessment. The effect is to drive up the cost of borrower money and discourage the behavior. It would probably be very effective.

The lenders would cry foul, and in particular there may need to be an exception for reverse mortgages to accommodate seniors (I think reverse mortgages are a bad idea, but forcing retired people to leave their homes is probably worse). Despite the resistance, the legislation if passed would curtail HELOC abuse, but in an economy dependant upon Ponzi Scheme financing, such legislation is unlikely; although, if the budget shortfall gets bad enough, everything will be on the table.

Mello Roos Taxes

In our reports, we classify these as other taxes and assessments because Mello Roos fees are paid through your tax bill. To understand how this became a tax you pay, a brief overview of the Community Facilities District Act is in order (What is Mello Roos?.pdf). From Wikipedia:

A Mello-Roos District is an area where a special property tax on real estate, in addition to the normal property tax, is imposed on those real property owners within a Community Facilities District. These districts seek public financing through the sale of bonds for the purpose of financing public improvements and services.
These services may include streets, water, sewage and drainage,
electricity, infrastructure, schools, parks and police protection to
newly developing areas. The tax paid is used to make the payments of
principal and interest on the bonds.

Mello-Roos is deductible in some cases but not in others.

That is the textbook version, now I will give you mine. Imagine you are a real estate developer, and you have a parcel of land that would be worth $10,000,000 if it had infrastructure installed; unfortunately, you do not have the money to install this infrastructure and wait for the investment to come back to you in land or home sales.

What if you could take out a 30-year mortgage on your infrastructure improvements and borrow the money? Now you can finance the deal and develop the land, but there is still a problem. How do you get the homeowner to pay off the infrastructure mortgage after they buy the house?

The solution elected officials came up with was to create a special tax district so the repayment of the bonds to fund the infrastructure is bumped up the payment priority list. In short, you can’t avoid paying Mello Roos, or the tax man will be after you, and he has the power of foreclosure, though it is seldom used.

For those of you that are homeowners, the next time you write that check for Mello Roos, realize that you are paying down the loan for the infrastructure around you. You didn’t think the developer absorbed those costs, did you? That would cut into profits.

Realistically, Community Facilities Districts do encourage private development by making marginal projects feasible. It keeps development in the hands of private individuals rather than municipalities developing their own roads, streets and utility systems. To the degree you believe these results are desirable, you should support Mello Roos.

Without the ability to develop marginal projects, supply is always lagging behind. The Community Facilities District Act does encourage development to lead into growing markets and blunt the impact of supply shortages. Despite the additional supply this law puts on the market, it has failed to prevent housing bubbles.

Determining Mello Roos

Property taxes and Mello Roos fees are deducted from a borrower’s available income to service cashflow, and thereby it reduces the amount they can finance. In essence, there is already a 30-year mortgage on the property you must pay off — your portion of the Mello Roos — so the purchaser money mortgage must be paid with left-over funds.

Builders and developers both know the impact of Mello Roos, so builders will pay less for lots with high Mello Roos fees because they know they will have to discount the purchase price of the final product in order to qualify any buyers. Developers want the Mello Roos fees to be as high as possible because the higher the fees, the greater the bond revenue developers receive. Builders want the Mello Roos to be as low as possible to give them competitive advantage. The resulting compromise usually puts Mello Roos at between 0.5% and 0.8% of total value.

The good news with Mello Roos is that the fees are fixed. As house prices go up, the Mello Roos fees become less burdensome to later buyers. If the Mello Roos are set at 0.8% of an initial $200,000 sales price, the same figure represents only 0.4% of a $400,000 resale price. Of course, the reverse is also true.

When the Irvine Company first opened Woodbury and Portola Springs, they were priced to the peak and they had maximum Mello Roos. Now that houses are selling for lower price points, the Mello Roos start to become onerous. If the original sale price of a condo was $400,000, and the Mello Roos were 0.8% of value, if the condo resells for $200,000, the Mello Roos now represent 1.6% of the purchase price. That is a stiff property tax bill by California standards.

Does anyone know if the Irvine Company has bought down the bonds on Woodbury or Portola Springs, or are new buyers going to get a huge Mello Roos tax bill and an unsettling surprise?

13 LONGSHORE 79 Irvine, CA 92614 kitchen

Irvine Home Address … 13 LONGSHORE 79 Irvine, CA 92614

Resale Home Price … $560,000

Income Requirement ……. $104,246
Downpayment Needed … $112,000

Home Purchase Price … $585,000
Home Purchase Date …. 11/21/2003

Net Gain (Loss) ………. $(58,600)
Percent Change ………. -4.3%
Annual Appreciation … -0.7%

Monthly Mortgage Payment … $2,432
Monthly Cash Outlays ………… $3,180
Monthly Cost of Ownership … $2,390

Redfin Property Details for 13 LONGSHORE 79 Irvine, CA 92614

Beds 2

Baths 2 baths
Size 1,930 sq ft
($290 / sq ft)
Lot Size n/a
Year Built 1983
Days on Market 61
Listing Updated 10/21/2009
MLS Number S586981
Property Type Condominium, Residential
Community Woodbridge
Tract L

According to the listing agent, this listing may be a pre-foreclosure or short sale.

Back on the market!!! Unique luxury townhome located in the ‘South Lake’ area of Woodbridge. Tri-level floor plan featruring 2 bedrooms + FULL DEN located on the water with amazing views! Upgraded kitchen with granite counters, stainless steel appliances, remodeled bathrooms featuring travertine & slate. Huge master suite with large retreat, walk-in closet, finished attic. Inside laundry room on 3rd floor!

featruring?

Today’s featured property was a classic housing bubble workhorse — the owner worked this place for every penny of appreciation available.

  • The property was purchased on 11/21/2003 for $585,000. The owner used a $400,000 first mortgage, a $126,500 second mortgage, and a $58,500 downpayment.
  • On 2/18/2005 the owner refinanced the first mortgage for $525,000.
  • On 7/13/2005 he refinanced for $605,500.
  • On 4/19/2006 he refinanced for $720,000.
  • On 7/2/2009 he stopped paying his mortgage.
  • Total property debt is $720,000.
  • Total mortgage equity withdrawal is $193,500.

Foreclosure Record
Recording Date: 07/02/2009
Document Type: Notice of Default
Document #: 2009000349556

Ownership Cost: Interest Rates and Downpayment Requirements

Federal Reserve interest rate support is a major reason not to buy a home. When these supports are removed and interest rates rise to market levels, loans will get smaller and prices will go lower — when the shadow inventory finally arrives.

4 EARLYMORN Irvine, CA 92614 kitchen

Irvine Home Address … 4 EARLYMORN Irvine, CA 92614
Resale Home Price …… $1,150,000
{book1}

Darkness falls across the land
The midnight hour is close at hand
Creatures crawl in search of blood
To terrorize y’alls neighborhood

I’m gonna thrill ya tonight, ooh baby
I’m gonna thrill ya tonight, oh darlin’
Thriller night, baby, ooh!

The foulest stench is in the air
The funk of forty thousand years
And grizzly ghouls from every tomb
Are closing in to seal your doom

And though you fight to stay alive
Your body starts to shiver
For no mere mortal can resist
The evil of the thriller

Thriller — Michael Jackson

The foul stench in the air is the fetid paper on the books of the Federal Reserve.

Today is part 2 in the ongoing series on Ownership Cost:

Ownership Cost: Income, Payments and House Prices

Ownership Cost: Interest Rates and Downpayment Requirements

Ownership Cost: Property Taxes and Mello Roos

Ownership Cost: Taxes and Opportunity Costs

Ownership Cost: Homeowners Associations

Four Major Variables that Determine Market Price

Yesterday, we discussed the four variables that determine the purchase price of a property:

  1. borrower income,
  2. allowable debt-to-income ratios,
  3. interest rates, and
  4. downpayment requirements.

Today we are looking at interest rates and downpayment requirements.

Interest Rates

Interest rates go up, and interest rates go down. Interest rates are
the yield on debt instruments. If investors lose their appetite for
mortgage debt, prices of mortgage-backed securities goes down, payment
yields go up, and mortgage interest rates go up with them. This concept
is important to understand because right now, the Federal Reserve is the only buyer of agency paper at price levels yielding 5%.

Private investors are demanding higher returns due to the obvious
risk of loss in a declining market. The Federal Reserve feels it needs
to step in to stabilize crashing markets by preventing an
over-correction in risk premiums to make the free-fall worse. In
crashing markets, 8% mortgage interest rates probably do not warrant
the risk of default loss.

The FED will retain this defensive market safety net until risk
premiums and market mortgage interest rates get close enough to their
support price that they can begin to unwind the program. It isn’t
likely that private investors will return to buy mortgage debt at 5%
yields any time soon, so the FED will have to be cautious in how it
unwinds its supports.

This government intervention underscores the difficulty of
forecasting interest rates and how fluctuations will impact the housing
market. Think back to early 2008 when there when people still denied
the housing bubble. Nobody imagined the Federal Government would assume
ownership of the GSEs (at the time they were private companies), and
that the Federal Reserve would be buying GSE paper at over-market
prices. These unprecedented events would suggest a market cataclysm —
the fodder of conspiracy theory nutters. Yet, here we are.

Interest Rates have a major impact on how much someone can borrow.

The big fear rational people have is that mortgage interest
rates will rise back to historic norms of 8% or go even higher. If this happens, the
housing market can easily drop another 30%. This may be the fate of
Irvine. As I look around at other nearby markets, they have already
fallen to the point where nice properties that would be above rental
parity here are trading for cashflow investor levels. A 30% drop in
affordability in beaten down markets will not necessarily push prices
lower because they have already overshot fundamentals. Irvine is not
trading below rental parity or below historic norms; it has a long way
to fall.

The chart above illustrates an important financing point and a legitimate reason not to buy a house.

it will be interesting to track the future and see where mortgage interest rates peak during the next cycle. If we really do get a 2011 Inflation Spike, it will be much higher than 8%. It is realistic to believe mortgage interest rates will hit 7.5% at the peak of the next cycle in 2013. Are they staying at 5% forever?

The table shows how rising interest rates will effect median price in Irvine at rental parity. What happens if mortgage interest rates are allowed to find a natural market? How do we know where the natural market is?

Currently, prices yielding 5% do not catch the long tail of market demand. The Federal Reserve is buying 100% of the agency paper. If prices were at market clearing prices, the Federal Reserve would be buying 0% of the agency paper market. The long tail of demand may be very near the natural market clearing price, or it may be very far away.

I am inclined to believe it at least as far away as the 6.76% peak of the last cycle in July of 2006. At the peak of that cycle, financial markets were delusional about mortgage risk at the peak of the housing bubble. Risk premiums are certain to be higher now.

If interest rates merely reach the previous peak, it removes 15.1% of the borrowing price support. If interest rates move back to their 37-year mean of 8%, 26.8% of the borrowing price support is removed from the market.

Do you realize that prior to 2002, mortgage interest rates had only been under 7% one time in the previous thirty years? It hit 6.9% in 1998. During our last interest rate cycle during the wild credit expansion of The Great Housing Bubble, the peak did not reach the previous 30-year low.

Mortgage Interest Rates, 1972-2006

I think it is very reasonable to assume mortgage interest rates will move higher, perhaps much higher.

Are you comfortable buying with that much of the price support is air from the Federal Reserve?

Downpayment Requirements

Downpayment requirements have traditionally been very high. During the 1920s, interest-only loans with 50% downpayments were the norm. Very few people owned their houses. By the 1950s, conventionally amortized loans with a 30-year term and 20% downpayments became the norm, and house prices rose significantly from the bottom of the Great Depression to the 1950s due to the increased use of leverage in real estate.

That is the end of the road for financial innovation. All attempts to tinker with the stability of conventional financing have failed because they are all Ponzi Schemes. People must have a reasonable expectation of paying off a loan in their lifetime. Multi-generational debt is frowned upon here in the United States, so any term beyond 30 years really doesn’t make sense. If you feel like you will never pay it off, you will not try, and you fall into Ponzi thinking and borrow in terms of maximum debt service. It is crazy.

By 2005, Option ARMs and 100% financing left us with 0% downpayments as the cycle reaches its ultimate limitation — they are giving it away. Not surprisingly, prices skyrocketed; unfortunately, the terms of the Option ARM were not stable and the Ponzi Scheme blew up. We are back to the 1950s in the world of mortgage finance — that is a good thing.

The 30-year fixed-rate fully-amortizing loan is the only stable loan product, and a significant downpayment is required to keep down speculation. As downpayments get smaller, the incentives to speculate with lender money get larger. With no-money-down the incentive to speculate hits infinity. One-hundred percent financing with no qualification is a free-for-all no-limit housing market casino.

Savers gain advantage bidding on real estate.Biggest Saver

My calculations of value in the table at the top of the post assumes the downpayment added to the loan to obtain value is 20%. Irvine buyers are unique in that they put in very large downpayments. Most buyers don’t have 20% down. Most buyers don’t have the current FHA standard 3.5% down either, or we wouldn’t have tried 0% down to begin with.

When it is an FHA buyer — which 21.5% of buyers are again — they generally only put the minimum 3.5% down. The loan plus the downpayment is about 16.5% lower for an FHA buyer than it is for a conventional borrower putting 20% down, assuming both are qualified using the same income and same DTI.

In the real world, the conventional borrower is also utilizing a higher DTI ratio. Instead of being limited to the FHA 31% front end DTI, conventional borrowers are often allowed to go into dangerous waters with 32% to 38% DTI levels. This additional money put toward debt service makes for larger loans.

The borrower with enough cash to put 20% down has a significant bidding advantage over the FHA buyer. The lower downpayment amount and the smaller loan balance make FHA less desirable than conventional financing for borrowers looking to bid up prices. FHA financing can be looked at as training wheels for mortgage borrowers.

After some period of time in a normally appreciating market (if there is such a thing), the combination of loan amortization and home price appreciation results in home equity exceeding 20% of the resale value of the property. When there is enough home equity that a more expensive house than your own house could be purchased with 20% down using your equity as the downpayment, you cross a threshold; you have access to the higher DTIs, and you can borrow more money to take the next step up the property ladder — if you are willing to give up some disposable income to have the house.

In the end, it is not the highly leveraged that gain the upper hand in real estate, it is the savers. The real estate market will always boil down to loan plus downpayment. The more money you have saved, the greater your downpayment and the more you can bid to compete with others at your income level. The saver always comes out ahead.

4 EARLYMORN Irvine, CA 92614 kitchen

Irvine Home Address … 4 EARLYMORN Irvine, CA 92614

Resale Home Price … $1,150,000 WTF

Income Requirement ……. $214,077
Downpayment Needed … $230,000

Home Purchase Price … $900,000
Home Purchase Date …. 9/8/2008

Net Gain (Loss) ………. $181,000
Percent Change ………. 27.8%
Annual Appreciation … 13.0%

Monthly Mortgage Payment … $4,995
Monthly Cash Outlays ………… $6,430
Monthly Cost of Ownership … $4,820

Redfin Property Details for 4 EARLYMORN Irvine, CA 92614

Beds 4
Baths 2 full 1 part baths
Size 3,068 sq ft
($375 / sq ft)
Lot Size 6,270 sq ft
Year Built 1980
Days on Market 4
Listing Updated 10/22/2009
MLS Number S593193
Property Type Single Family, Residential
Community Woodbridge
Tract Ld

WOW! If you want Woodbridge, you have to see this home! Right across the street from Meadowpark Elementary, gorgeously upgraded and with an unusually large lot; it really doesn’t get any better than this! With 4 bedrooms, 2.75 bathrooms and a huge bonus room across the top of the 3 car garage, this floor plan is family friendly. The entire downstairs has been remodelled with new front door, gorgeous cherry wood built-ins in living room/dining room, all new kitchen with everything-granite counters, added built-ins in the kitchen nook and all new top-of-the-line stainless steel appliances. All new windows & doors throughout, updated paint colors, this home is move in ready! Add your own private spa in your huge back yard & this one is an all around, hard to beat Woodbridge FIND!!! Serious EQUITY seller has priced this home right at the last sale of a comparable home so don’t procrastinate because this one will go!

Serious equity seller? You mean a delusional flipper who only believes he has equity. Based on when he bought, he would be lucky to get out at breakeven. You never know with today’s market though.