Noticing more foreclosures of homes in Los Altos. It makes me hesitant to buy now since increased foreclosure activity will depress prices. Comments?

Asked by Cautious Buyer, Los Altos, CA Sun Sep 27, 2009

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16
Optimizedpri…, , Los Altos Hills, CA
Wed Sep 30, 2009
According to many, many articles including detailed analysis of foreclosure trends in California, we are currently seeing the tip of the foreclosure iceberg in high-end areas like Los Altos and Los Altos Hills. The problem lies in what are called "Option ARM" loans. These loans allowed relatively poor people (working professionals) to cram into multimillion dollar homes that were previously reserved for the very rich.

When these loans come due after five years, they don't merely reset to a higher interest rate, they "recast" to a new loan format. Option ARMs were loans that allowed buyers the "option" of paying a normal loan payment, an interest-only payment or a negative amortization payment. Their ability to pay was based on the minimum payment, and with the utter certainty (har har) of a couple's home price going up. People jumped in head first being able to afford ONLY the minimum payment.

When they recast, homeowners are left to get a new loan for their home. Now that there is no expectation of wild returns, banks are forced to only offer "normal" 30-year fixed mortgages to these people--if they are lucky. At minimum these payments are probably twice what the old ones were. These loans were typically given out to people "on the edge" and could barely afford the negative amortization payment.

Again, you have to remember the Bubble days: "cram into as much house as you can so you can maximize your returns!". The more you stretched, it was thought, the more money you would make. So people stretched. Many of those people ended up in Los Altos and Los Altos Hills.

Today Los Altos and Hills both have an enormous "shadow inventory" of people who want to sell but are waiting until the market "recovers" back to the Bubble times.

However deluded they may be, they are often in the position of waiting until hell freezes over to sell their house. This has frozen the market here and made comps very few and far between--so few that you can't trust them as an adequate indicator of the true market.

Foreclosures change all of that. They force the market to get liquid (people or banks must sell immediately), which in turn forces prices to get down to a true market-driven level.

What is that level?

The answer to that can be found in the "price-to-rent ratio" (Google it). In short, a $1 million home should rent for about $5000 per month. It doesn't matter how "nice" or "desirable" or whatever our area is (and our area is all of those things) rent is rent is rent. It reflects what the market will pay to occupy the home.

Right now $5000/month rents you a $2 million or more home in Los Altos if you believe the prices on MLS (which you can't).

So in short, don't buy a house in Los Altos (or anywhere for that matter) unless you could actually make money (or break even) by renting it out. Otherwise you are essentially betting on prices going way UP in the future, which is risky at best.

Also, pay attention to rent prices here too. They have dropped and if unemployment continues and there are more layoffs then rents will be depressed further, which means you need to re-compute for that.

Can you expect appreciation here in the long run?

Demographics and long-term trends are stacked against long-term appreciation. The Baby Boomers are moving away from their big expensive houses next to work (that's us) to smaller homes in the middle of nowhere. Immigration in California is down based on negative sentiment, fewer jobs here and better jobs "there". Many high-paying jobs are leaving California.

All this will have a downward drag on prices here for a long, long time.

In the early 1990s people considered Tokyo, Japan to be a very expensive place that had real estate that would never go down. Japan went through a similar Bubble to the one now deflating in the US. Tokyo prices fell to half of their all time highs and NEVER WENT UP FROM THERE AFTER 15 YEARS AND COUNTING.

This isn't your father's California where prices just keep going through the roof forever. Welcome to Tokyo, folks :-).
4 votes
Optimizedpri…, , Los Altos Hills, CA
Fri Oct 2, 2009
I don't want a long debate here and I always urge people to do their research--ECONOMIC research--and don't just take my word for it. I appreciate getting some level of agreement from a broker for a change. Many are finally starting to talk a little bit of sense.

But it's going to be a long time before they change their spots, and here's an example of that. House brokers still pitch their product like they are working at the Casino and not the Ferrari lot. This attitude will slowly change over the next few years, but until then watch out.

As to this response:

1. California is not Japan, the entire USA of 2008-2022 is Japan of 1992-2006. If you read the details behind our situation (i.e. the state of our financial system, the asset bubble, etc.) you will see many crucial parallels that lead many analysts to conclude that we're in for a very similar ride that Japan had in their real estate crash: zombie banks with little money to lend but propped up by the government to keep them alive enough to not default and spook everyone. Japan responded to their crisis exactly as the US government has, the situation is virtually the same (they once had a very powerful economy too) so many people conclude that we're in for the same exact effect. I would love to hear arguments against this scenario but I haven't heard any. By the way, Japan also had "a tech industry" believe it or not.

2. This notion of "you better buy at the bottom" implies that Bubbles are the norm, and that prices are going to "bounce" off the "bottom" and make speculators rich. It just doesn't work that way. You know how much buying at the "bottom" in Tokyo in 1994 would have made you in 15 years? Virtually nothing.You know how much people you bought at the "bottom" of the .com bubble made off of .com stocks in the last 8 years? On average, zilch. When we "hit" "bottom" we're not going to bounce off again and take off like a rocket. We're just going to hang out there for.... a very, very long time.

In both cases what you hear from brokers is some form of, "I've been following this market for 30 years and I KNOW what is going to happen".

30 years isn't going to help you know ANYTHING. Things have been great in California for the last 30 years. That was then.

Now we have the highest unemployment EVER RECORDED here in Santa Clara county. Financial firms that have been in business for a century are GONE. Our government is running the highest deficits every by a factor of several times. Our country has lost almost half of its asset values leading to the first massive deflationary pressures since the Great Depression .

Do you really think this is a run-of-the-mill "downturn" which we'll just bounce back to business-as-usual from?

Unlike previous economics downturns in the past 50 years our country is faced with severe DEflation. Not INflation, DEflation. Again, please do your research. Look it up.

Meanwhile, the Baby Boomer demographic is a once-in-a-generation phenomenon. A LARGE PERCENTAGE of the population is retiring. This hasn't happened to real estate in California in anybody's lifetime.

Welcome to USA 2.0 folks:

* A home purchase is NOT retirement plan -- it's a lifestyle choice

* A home is NOT "a good investment" -- its a place to live

* Homes do NOT "always go up in the long run"

* Renting is NOT "throwing money away" -- it can be a huge winner in many cases

If you are still thinking about your purchase decision in terms of "how well you will do" then your brain is still in Bubble mode. Stop that.

You buy a house because you want to own a house and not rent one (so you can improve it yourself, not deal with landlords, paint it whatever color you want, etc.). It's a lifestyle choice. It's not an investment. It's not a retirement plan.
3 votes
Optimizedpri…, , Los Altos Hills, CA
Fri Mar 12, 2010
Here's the link that tells the whole story:

http://www.trulia.com/for_sale/Los_Altos,CA/reduceddt;d_sort/

There's an entire page of price reductions in the last 30 days as of today, 3/12/2010.

This aligns perfectly with the macro conditions which continue to be extremely poor for housing. Anybody who thinks that Los Altos will be the one town in the entire country that is somehow not effected by the biggest downturn in our country in two generations... deserves what they get when they end up underwater in 12-24 months...
2 votes
Optimizedpri…, , Los Altos Hills, CA
Wed Oct 14, 2009
Steven,

There are a LOT of sites out there that explain the economics for rent-vs-own. You should take a look at these.

There you will find that the rule of thumb is about $5000 of rent per $million of purchase price. This has its basis in all of the numbers when you add them up and includes the opportunity cost of capital for your down payment and the interest you pay. Just making the house payments is idiotic because you are giving all of your money to the bank in interest. You're much better off putting your money in the bank and GAINING interest (or investing it someplace smart) and paying less rent.

Also, the interest deduction only works if you live in the house. While this might change things for an individual, the overall market "fundamental" is based on the asset's actual working value (demand plus expected appreciation). In other words, the interest deduction doesn't count if you are looking for a market bottom.

Also, not everybody considers owning a universal benefit. A lot of people enjoy the security of having no connection to a house's potential problems such as repairs, taxes, ordinances, and so on. Being tied down to a particular location is also not a benefit.

For that matter, if you remove "this will make you rich in the long run" from people's reason to buy a house in California (and only a crazy person wouldn't these days) then I suspect that the number of people truly interested in taking the plunge into real estate ownership would drop dramatically. Renting is soooo much easier all things considered.

Meanwhile, by the way, rents are plummeting in Los Altos and Hills as near as I can tell... This is very BAD if you are an owner and GOOD if you are a renter...
1 vote
Steven, Home Buyer, San Jose, CA
Tue Oct 13, 2009
I agree that houses are overpriced in Los Altos, but it's not quite as bad as the previous posters suggested according to my numbers. Let's use Tony's example. Assuming his $3K rental is $1.2 million, then the mortgage payment on a $960K jumbo loan with 20% down at 6% (pretty reasonable if you pay a point or two) is $5756 per month. Add in tax of $1250 per month and subtract mortgage interest deduction of $1920 (assuming 40% marginal state and federal tax rate) and no property tax deduction due to AMT, I get a total payment of $5086 (5756+1250-1920). But $956 of that payment is principle, so, in reality, I'm losing $4130 to own, vs. $3K to rent. So the own premium is about $1K. So, yes, houses are overprice relative to rent, but it's not anywhere near 2X difference. So, I estimate Los Altos prices need to come down about 20% to be even with renting. However, I'm not sure prices will ever been "even" with renting - owning provides other tangible benefits over renting, so that has to be factored into the cost comparison as well because obviously, we're not comparing apples to apples when comparing owning vs renting. For the same cost, most people would choose to own.
1 vote
Optimizedpri…, , Los Altos Hills, CA
Mon Oct 12, 2009
As a follow-up here, check out Tony's retirement plan based on RENTING for the next 30 years:

Buy Scenario:

1. Put 300k down.
2. Pay $6k/month in payments
3. Pay $1k/month in property taxes
4. Pay $500/month in upkeep
5. Pray there is not a downturn in your area, an earthquake, that you don't need to relocate, etc.

Rent Scenario:

1. Pay $3k/month in rent
2. Save $4500/month @4% interest
3. Pray there IS a downturn in your area (cheaper rent), your fine if you want to move, etc.

Retirement plan results, BUY: You own a house worth about $1.3m*

Retirement plan results, RENT: You have $3.1 MILLION in CASH*

Still think renting is "throwing money away"?


* All not adjusting for inflation, but there are many investments that can hedge inflation besides real estate and have much higher more consistent gains. Inflation raises interest rates and high interest rates slaughter the housing market. If you expect inflation, housing the LAST place you should put your money.
1 vote
Tony, Home Buyer, Los Altos, CA
Mon Oct 5, 2009
I had seriously looked into buying a home in Los Altos for a while, but finally I came to a conclusion that it just isn't a time to buy a home in Los Altos right now; I'd rather wait another year or two, maybe even longer if I have to. Home prices in Los Altos, although dropping, yet at slower rate that other depressed places, are still way too high. I decided to rent and moved out of my condo because renting is much much cheaper using price-to-rent ratio for the purpose of comparison.

This month, I am recently renting 3 bedrooms, 2 full baths house with 1900 sq ft of living area (1 living room, 1 family room and a kitchen) and a little more than 10,000 sq ft lot (a nice front and a back yard), and 2-car garage for $3,015 per month.

For this similar house in Los Altos, now it would cost at least 1.2 million to 1.3 million dollars (estimated by Trulia and Zillow). If one were to purchase this similar house, his/her monthly mortgage would be about $6000/month, plus property tax and insurance fee(s), not to mention routine maintainance fees. As you see, this is just a simple calculation to illustrate that renting is an obviously better option than buying a home in Los Altos at this time, even after you subtract mortgage interest and property tax deductible.

Why homeowners rent their houses for cheaper monthly rent than before? They all believe that they cut some lost in the next couple of years, then the market will bounce back. Who knows what will happen in the future? But based on all the available information and news now, housing market doesn't seem to bounce back any time soon. They are lucky if the prices will just stay flat! In the mean time, just take advantage of the cheaper rent!
1 vote
Bay_area_ll, Home Buyer, Oakland, CA
Tue Oct 30, 2012
I dont think you're going to see much impact from Option Arms in Los Altos.
0 votes
Bryan Robert…, Agent, Los Altos, CA
Thu Dec 16, 2010
We're now at the end of 2010 and the market has increased this year. You're welcome to stop by my blog to read the market reports for recent months to get the details, however, the market in Los Altos has increased.

I did a market band analysis of homes priced in the $2-3 million range in Los Altos as many pessimists foretold further drops in that market segment. I'm happy to report that this year that segment has stabilized and is beginning to move up.

Short sales, default notices, and foreclosures are not major factors in Los Altos or Los Altos Hills. Both markets have had a handful of all those things and the homes generally sell on the open market for about the same price as a normal house. There are a few notable exceptions and the homes that didn't sell or sold at low prices had issues with location, condition, design, size or style.

Inventory levels are very low and buyer demand has been high going into the end of the year. You're welcome to watch the market going into 2011 but I think you'll find that most homes will do what they did this year, sell fast and at or above listing price.
0 votes
Bay_area_ll, Home Buyer, Oakland, CA
Mon Nov 1, 2010
so have prices dropped yet?
0 votes
Holder Real…, Agent, Menlo Park, CA
Tue Apr 13, 2010
Hi there.

From where I stand, Los altos and Los Altos Hills were the most inflated of the mid-peninsula, luxury markets. They have also had their values drop sooner, quicker, and more than other high end markets locally.

It seems activity for the market below $1.5 mil has picked up, with multiple offers coming back into the mix. even some homes in the low $2 mils are selling, but the market above that is pretty stagnant no matter where you look.

A large proportion of buyers of previously had the cash to make the purchases either lost it or are holding onto what they have. Those who could finance the home no longer can due to higher down payment requirements and a much higher spread between conforming loan interest rates and jumbos.

So the buyer pool has shrunk considerably (for $1.5+ mil homes) and the economy is flat...your guess about the future is as good as mine, but it seems some of your fellow buyers are waiting on the sidelines.
Web Reference:  http://www.atlistings.com
0 votes
Gilbert Rich…, , Santa Clara County, CA
Sat Feb 27, 2010
Los Altos has been somewhat stabilizing, from what I have seen. I am doing a loan there right now and the values have bounced back in the last 60 days.
0 votes
Bay_area_ll, Home Buyer, Oakland, CA
Sat Feb 27, 2010
If you are that concerned about price dropping then you should probably not be buying in Los Altos.

Obviously good to buy at a lower price but for a purchase in Los Altos you should be thinking more long term.
0 votes
Tony, Home Buyer, Los Altos, CA
Wed Oct 14, 2009
Steven,

You've provided a great analysis thus far. However, you didn't calculate other necessary expenses such as property insurance (fire, flood, earth quake), fees for the gardener to cut the grass and trim the branches once every two weeks ($200-$250/month?), expenses for potential property damages (?). I don't really know how much would those be?

Would you please factor these in and see what the results would be? Thanks.
0 votes
Ashok, Home Buyer, Los Altos, CA
Tue Oct 13, 2009
Here's another article on Option ARM recasting in the bay area. Pretty Scary!


http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2009/09/20/…
0 votes
Norman Aless…, Agent, San Jose, CA
Wed Sep 30, 2009
Hi Cautious Buyer,
I completely agree with optimizedpri up to a point, and that point is Cal recovering. I agree we won't see prices like we did and that there will continue to be more forclosed homes, but Cal is NOT Japan and as the tech Industry begins to recover the market should stablize, but not for awhile. If you are Not a risk taker I suggest you wait, you will not buy at the bottom but you will feel more secure when you do purchase. I would follow the market and the home prices as well as interest rates. Remember no one knows when the bottom of the high end market will be, but you CAN make a great purchase with a little patience and some research.
P.S. most investors who make a good living at it, buy when everyone else is predicting "doom and gloom".
As in any Market it is never as bad as people say, and on the other side it is never as good as they say either.
Buy when you are ready and you have done your home work.
Regards,
Allyson
408-705-6578
allyson@homesbyallyson.com
DRE# 01397256
0 votes
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