Our open thread this weekend contains a brief analysis of the Riverside County housing market. All of Southern California’s real estate markets are interconnected by commuters. What happens over the hill impacts pricing here in Irvine.
Here is a great article from the LA Times: HUD’s Dollar Homes falls short of mission.
I would like to share with you some interesting blog posts I read this week at The Housing Chronicles Blog,
And related to today’s topic:
They say an end can be a start
Feels like I’ve been buried yet I’m still alive
It’s like a bad day that never ends
I feel the chaos around me
A thing I don’t try to deny
I’d better learn to accept that
There are things in my life that I can’t control
If I Ever Feel Better — Phoenix
Will prices ever stop falling in Riverside County? Will their real estate market in the Inland Empire rise like a Phoenix from the ashes? Prices will not rise any time soon, but there will be an increased activity among cashflow investors absorbing the inventory of foreclosures. Eventually, all of the houses from the bubble will be recycled, and the new homeowners will not have near as much debt as the previous ones. The economy will recover, and life will go on.
Riverside County and parts of San Bernardino County are collectively known as the Inland Empire. It is a mess. Unemployment is high, house prices are already down 50%, and they are still falling. Prices will continue to fall until real estate savvy cashflow investors loaded with cash enter the market and begin absorbing the inventory. Call it opportunistic, vulture investing, value buying, or whatever term you think appropriate, but the people who invest in this manner are the ones who will create the bottom with their buying activity.
In every disaster there is opportunity. Uncertainty in any market negatively impacts pricing; however, there is a price point where investors believe they are being properly compensated for the risks they are taking on. Even now, there are properties in Riverside County that warrant serious consideration from cashflow investors.
Think about it, let’s say you find a property where the cashflow value with a 10% return is $180,000. However, you are worried that you will have difficulty finding tenants for the next two or three years. How much income might you lose? $10,000? $20,000? Discount the property to account for the difference. There is generally a price point where an investment makes sense.
Cashflow investing is a process of determining value, evaluating risks and discounting as appropriate. Whoever has the most aggressive set of assumptions will acquire a property in the open market. Those who are too aggressive will lose money, and those who are too conservative will never transact. That is how markets work.
The Inland Empire
I want to thank Boyd Martin of Market Profiles for providing the information presented today. He provides an analysis of New Home prices in various sub-markets across California. Like many in my industry, I receive his quarterly updates. I called him on Thursday to obtain his permission to reproduce his study from the 4th quarter of 2008 for the Inland Empire.
I mentioned a couple of weeks ago the BIA website NewHomesMatch.com. They have every floorplan of every new home in Southern California in their database. It is a really cool service.
All of the data presented today is accurate for new homes. These prices are not reflective of resale home prices. New home prices are a much better indicator of market strength and direction. The active builders do not live in denial because they must sell their inventory to stay alive. If that means prices must be lowered, then they will lower prices. At whatever price levels new home bottom, resale homes will bottom out even lower usually 2 or 3 years later because the less expensive new homes puts tremendous pressure on resale prices. This deep recession may put our resale market bottom back from 2011 to 2012 or 2013.
The Inland Empire’s Local Markets
Above is the grahpic from his update. I have used his graphic to provide a general overview of the Inland Empire markets:
As you might expect, the sub-markets in the Inland Empire can be broadly grouped by their proximity to Orange and LA Counties. The growth in these markets began as a “cost push” of housing as people sought less expensive homes. This still goes on today.
The first of these sub-markets is the eastern edge of Orange County and Corona. The next level is the Riverside and Lake Elsinore Markets. Further inland you arrive at Moreno Valley, Perris, and Murrieta. The extreme fringe of this market is Banning, Beaumont, San Jacinto and Hemet.
The further out on the fringe you go, the less expensive pricing becomes, and the more risk you take on as an investor. As prices crash, people migrate to the west. This leaves the eastern fringe markets with excess supply and problems with vacancy. Properties on the eastern fringe require major price reductions to compensate for the risks of vacancy and declining incomes. These are also more difficult to manage. Since the extreme eastern markets are also the markets that saw the most construction during the bubble, there is a huge turnover of homes due to foreclosures. However, this is also an opportunity; this is where you can pick up a house that is less than 5 years old for prices well under construction costs. In short, they almost are giving them away.
East OC and Corona
As you can see from the graphic, new home prices in Corona declined in price about 10% last year. They are also still building a lot of McMansions (3,409 average square footage). What do you think this does to pricing in Orange County? Some people are going to go to Corona and buy a new McMansion for $150/SF, particularly when the Irvine Company still wants to get $385/SF. (Here is one for $109/SF) There is no way OC pricing holds up when new homes are available that close for that much less. Yes, I know, none of us want to go live there, but we are the Irvine Housing Blog; we do not represent a typical market cross section. Many people will go over the hill to buy these houses. Prices there have probably not bottomed, particularly for new homes, but their market is closer to the bottom than to the top.
Riverside and Lake Elsinore
This next market segment could probably be separated into two different markets as Riverside and Lake Elsinore have very different market dynamics. Riverside has more of an economic base than Lake Elsinore does because it is a more established community. Lake Elsinore more than doubled in size during the bubble whereas Riverside saw a much smaller percentage increase in its population. That being said, I lump these together because they both represent an additional 20-30 minute drive from the OC and LA markets.
As you can see, the pricing in Lake Elsinore is getting hammered. If you really want to see carnage/opportunity, take a look at nearby Wildomar. How does $31/SF for a 2006 home grab you? (Most are near $70/SF) There isn’t a pooper-scooper big enough for some of these markets. The general pattern to look for in Riverside county is to find concentrations of houses built during the bubble, and you will find entire neighborhoods of REOs and very low prices.
I consider these markets some of the better cashflow investment opportunities. Even though the current inventory is high, it will be easier to attract and keep renters here because you have two other markets even farther to the east you can attract renters away from. These markets will be less damaged by the westward migration than will the extreme fringe markets.
Moreno Valley, Perris and Murrieta
The third level inland is a high-risk market. There is little economic activity out there because it is dependent upon real estate. Market conditions will get worse here, and coditions will stay bad for quite some time. There are cheap houses here too. This one is $45/SF. However, based on current pricing across the area, this is the market slice I find least attractive. IMO, prices not low enough to compensate investors for the risk. I foresee continued downward pressure on prices across this entire market swath.
You can already see the brutal beating the Moreno Valley market is getting. Prices are down 20% YOY there.
Banning, Beaumont, Hemet and San Jacinto
This last market is utter chaos. When Jim Cramer talked about “plowing under the Inland Empire,” this is the area he was talking about. The sleepy little communities in this area exploded with housing developments from 2003-2006. Everything out there is new. Now, with the collapsing prices to the west, everyone is abandoning their homes and moving closer to work and cutting their housing costs in half. This area is a disaster zone. It will be the last to recover. However, for those with a long-term market view and a lot of nerve, this is where the home-runs will be hit. There will likely be many properties less than 5 years old transacting near $40/SF. Here is one at $42/SF. At those prices, you could almost let it sit empty for three years and just factor in the vacancy loss to your calculations (maybe not that long, but you get my point). There is a price point where these properties become attractive. Anyone thinking about investing out there needs to be fully aware of the risk. There is a reason the prices are so low.
Notice that in none of this discussion did I mention appreciation. These properties are cashflow investments; appreciation is not a consideration. Sure, if California blows up another massive housing bubble some of these properties may provide a convenient exit point by offloading it to some fool caught up in a financial mania. But realistically, prices are not going up in Riverside County for a very long time. If you want to buy an “investment” property in these markets because you think pricing is going to recover soon, you are a fool.
Bull or Bear?
For those of you that want the IHB to remain permanently bearish, I am sorry, but I am not a permabear. I am still very bearish on Irvine and most of Orange County. I am still somewhat bearish on pricing in the Inland Empire, but price levels in many areas do cashflow. This is a fact. There are risks in this market: (1) prices might drop further, (2) rents may decline, (3) jobs might disappear, and (4) incomes may go down. But an objective analysis of many properties in Riverside County shows that buying them and renting them out currently provides returns superior to other investment classes. It is what it is.
Does reporting this fact make me bullish? No, it makes me a reporter of market conditions. Only an investor who weighs the risks and rewards and has an accurate idea of what they want can determine whether they are bearish or bullish on any given asset class. Some people will look at these properties and conclude prices must drop further; others may not. No investment is without risk–a fact that escaped everyone who was speculating on the sure thing during the bubble.