Jul302013
Inland Empire housing markets are still extremely undervalued
Many housing sub-markets in Coastal California have already reflated to affordability limits, and many are surpassing peak bubble prices. The beaten down housing markets of the Inland Empire (Riverside and San Bernardino Counties) have bounced significantly off the bottom, but they are still extremely undervalued by historic norms between rent and cost of ownership. The rising prices are turning off private-equity funds, but mom and pop investors can still find plenty of good deals with upside potential.
Riverside County
Riverside County, California, is directly east of Orange County. It’s population exploded over the last 40 years as Los Angeles and Orange Counties were built out and house prices were pushed up by high wage earners to levels many could not afford. Riverside County offered the chance for a large house at a low price — and a hellish commute. Despite the traffic on the roads connecting Riverside County to LA and OC, housing development continued unabated right up through the collapse of the housing bubble.
Riverside County houses typically trade at a discount to rental parity. In fact, the nearly 25% discount puts Riverside County properties near payment parity, the price point where PITI equals rent. Owners in Riverside County benefit fully from tax savings and amortization whereas OC buyers need this to offset their higher house payments.
Note the orange line below. This represents the fundamental value of Riverside County homes relative to rent. Notice in particularly the period from 1993 to 1999 when house prices hovered near this line. That is the resting point where a normal market would find equilibrium. As you can plainly see, house prices bubbled enormously, then crashed below fundamental value, and even with the big rise off the bottom, the market is still significantly undervalued.
The charts below show the yearly percentage change in resale and rental prices. A few things jump out. First, the housing bubble with its 35% Y-o-Y appreciation was obviously a cause for alarm — for anyone who understood value. The current rate of appreciation is equally alarming, but since the market is so drastically undervalued, this rapid increase may cool off without leading inevitably to a price crash.
The second thing that catches your eye is the dramatic spike in rents in 2007 and 2008. This certainly isn’t due to any improving fundamental. House prices were crashing, and the economy was imploding along with it. The huge increase in rents was caused by foreclosed owners becoming renters and bidding up the available rental stock. The conversion from owner-occupied status to rental units did not keep up with the new demand. However, once investors started buying up these properties and converting them to rentals, rents declined for a while, and only recently have they begun growing again, albeit at a tepid pace.
The charts below show the relationship between house price and rental parity. Again, you can see the stable period from 1993 and 1999 that serves as a basis for establishing value. This market went from nearly 30% under rental parity to an astonishing 100% above rental parity during the housing bubble. What’s equally astonishing is the depth of the crash. House prices bottomed out more than 50% below rental parity. No wonder investors were flocking to this market.
The OCHN rating system was lukewarm on this market for much of the 1990s. The market was stable, but never really undervalued. The housing bubble dropped the rating to its lowest possible reading for several years, and the crash raised it to the highest possible rating for the last several years. This market is still a very good value.
The final two charts show exactly why investors are focusing on this market. During the 1990s, cap rates exceeded mortgage interest rates making most of Riverside County cashflow positive. The bubbles both caused cap rates to plummet.
The bottom chart shows the conditions facing financed investors. Cash-on-cash returns peaked at nearly 25%. The recent price increases have dropped these returns to 15%, but that’s still very good by historic measures. Unlike OC, properties in Riverside County are still cashflow positive.
San Bernardino County
San Bernardino County, California, is due east of Los Angeles County and north of Riverside County. It shares much the same settlement history as Riverside County, and the two are often referred to as a single unit, the Inland Empire.
San Bernardino County shows the same pattern of valuation and trends as Riverside County, but San Bernardino is even more undervalued.
San Bernardino County has not recovered as quickly as Riverside County. I expect to see more investor activity there as the large funds leave Riverside County looking for better cap rates.
San Bernardino County did not get quite as overvalued as Riverside County, but its crash was even deeper. At the bottom it was a jaw-dropping 60% below rental parity.
The attractiveness of San Bernardino County to investors is clear. Cap rates are higher, and therefore, so are financed returns.
San Bernardino County properties are not as desirable, and many of the markets have difficulty keeping renters in place. The returns are enticing, but the management headaches are greater.
Rising interest rates won’t hurt these markets
Because most of the readers of this blog live in Coastal California, it’s easy for us to have a skewed impression of the broader housing market. Many housing analysts have been claiming rising interest rates won’t impact the housing market. It will impact OC, but it won’t impact the Inland Empire. As I reported last week, Coastal California housing markets will hit affordability ceiling first. Rates would have to rise quite a bit to hurt the Inland Empire.
Today’s featured property is a short sale in Aliso Viejo. The owner bought in 2003, and managed to extract about $200,000 in refinances and HELOC money before prices went south. He’s struggle to pay the mortgage, and he just got a loan modification. I wouldn’t be surprised to see this one taken off the market. If prices keep rising, by next year, he can get out without losing any money. Of course, if prices don’t keep going up, he is stuck in a house he can’t afford hoping that something will work out.
Perhaps he shouldn’t have extracted that $200,000. His life would be easier today if he hadn’t.
[raw_html_snippet id=”newsletter”]
[idx-listing mlsnumber=”OC13145411″ showpricehistory=”true”]
17 CUERVO Dr Aliso Viejo, CA 92656
$490,000 …….. Asking Price
$387,000 ………. Purchase Price
5/6/2003 ………. Purchase Date
$103,000 ………. Gross Gain (Loss)
($39,200) ………… Commissions and Costs at 8%
============================================
$63,800 ………. Net Gain (Loss)
============================================
26.6% ………. Gross Percent Change
16.5% ………. Net Percent Change
2.3% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$490,000 …….. Asking Price
$17,150 ………… 3.5% Down FHA Financing
4.38% …………. Mortgage Interest Rate
30 ……………… Number of Years
$472,850 …….. Mortgage
$146,244 ………. Income Requirement
$2,362 ………… Monthly Mortgage Payment
$425 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$102 ………… Homeowners Insurance at 0.25%
$532 ………… Private Mortgage Insurance
$357 ………… Homeowners Association Fees
============================================
$3,778 ………. Monthly Cash Outlays
($656) ………. Tax Savings
($636) ………. Principal Amortization
$27 ………….. Opportunity Cost of Down Payment
$81 ………….. Maintenance and Replacement Reserves
============================================
$2,594 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$6,400 ………… Furnishing and Move-In Costs at 1% + $1,500
$6,400 ………… Closing Costs at 1% + $1,500
$4,729 ………… Interest Points at 1%
$17,150 ………… Down Payment
============================================
$34,679 ………. Total Cash Costs
$39,700 ………. Emergency Cash Reserves
============================================
$74,379 ………. Total Savings Needed
[raw_html_snippet id=”property”]
This is a flawed analysis that assumes housing markets will rerun historic patterns. Not true. The world has changed.
In today’s economy, only those with an education from a decent or better college in the right major will prosper. The rest of the population is in trouble. In general, the demographic of the population in trouble usually rents in the coastal region, or rents/owns in the inland empire. Hedgies and IMs recognize this, and stopped buying inland empire, even though the author of this article thinks all will return to historic patterns. Wrong.
Secondly, the “correctly educated” demographic is doing better than ever. This is why the coastal region has caught a bid, and will continue to do so. You should focus on investing where income growth exists, and that is in the coastal region. There is little income growth in the inland empire. Fundamentals matter.
It is possible money printing will push inland prices up some, but the fundamentals are not there. The coastal region has both money printing and fundamentals pushing prices.
Dude, all talk about ”fundamentals pushing prices” is nothing more than hot-air until the QE ‘punchbowl’ is taken away.
Next!
true story. but will they take the punchbowl away?
If they don’t then I need to go into metals or commodities because it will be the Wiemar Republic.
It all depends on how to view the opps in the inland empire. The coastal always attract crowds, but the density and traffic are bad. It will push people out of the core. As long as the Southern California economic is still growing, it will need more houses. It is just the price will not appreciate that fast.
If Coastal California real estate is such a great investment, why aren’t the private equity funds buying houses here? The guys who manage billions of dollars can’t all be wrong.
I would rather be parking my money where the cashflow is good and the potential for rebound appreciation is present. Neither is true in Coastal California.
Boy am I glad only the smart educated people are gonna make it.
There are plenty of people without your vaunted degrees that make a hell of a lot of money.There are people with degrees are so far in debt it’s not funny. You assume having a degree somehow makes you immune to debt or stupidity in general
“Riverside County houses typically trade at a discount to rental parity. In fact, the nearly 25% discount puts Riverside County properties near payment parity, the price point where PITI equals rent. Owners in Riverside County benefit fully from tax savings and amortization whereas OC buyers need this to offset their higher house payments.”
I guess that is the distance and gas costs factor in. If you live in the IE your gas costs and miles on your cars requires a lower house payment to make it feasible.
Yup, I think Mike is right…the problem with Riverside/San Bernardino has always been an employment mismatch…the housing is there, but the jobs aren’t – at least not the skilled white collar jobs. That’s why people that live there have horrible commutes.
I know this is not the norm, but my friend’s law office is in Riverside and he lives in Coto, so he commutes to and from Riverside almost every day.
The way development plays out is that houses always pioneer a new area. After enough houses are built, small office, retail, and other commercial uses move out there too. Commercial properties are subject to the same pricing pressures as residential. It doesn’t make sense for a businessman, particularly a manufacturer, to pay the high rents or high prices for space in Coastal California when there is an eager workforce and cheap office space in the hinterlands. Within 20 years, many new businesses will relocate out to the Inland Empire, and the commutes will be much shorter. The first wave of this can be seen in the new office complexes in Corona. This trend will continue until Corona becomes more expensive, and then they will start building more office space in Moreno Valley. It’s just a matter of time.
Does agriculture count as an employer? My grandfather worked the orange groves in Riverside, but only commuted from Casa Blanca. Citrus was big business in the IE in those days.
No.
I don’t know how accurate is this index. It was created by Ed Butowski to capture inflation data. It based on the cost of real items households use and purchase. This data is for the Los Angeles Area CPI.
2011: 12.3%
2012: 13.2%
The Chapwood Index
Now, this company is trying to sell financial services. However, I wonder why S&P, Moody’s, or some other company have put together their own CPI index independent of the US’s calculations.
If wages not increasing the cost of living is increase this has to lead to even more defaults in the future. If fact, DTI probably needs to be revised to lower percentages.
More inflation signs and lack of employment
Copper theft ‘like an epidemic’ sweeping US
Copper is such a hot commodity that thieves are going after the metal anywhere they can find it: an electrical power station in Wichita, Kan., or half a dozen middle-class homes in Morris Township, N.J. Even on a Utah highway construction site, crooks managed to abscond with six miles of copper wire.
Those are just a handful of recent targets across the U.S. in the $1 billion business of copper theft.
“There’s no question the theft has gotten much, much worse,” said Mike Adelizzi, president of the American Supply Association , a nonprofit group representing distributors and suppliers in the plumbing, heating, cooling and industrial pipe industries.
“There was a perception that copper theft slowed down after the recession, and the rise in commodity prices seemed to ease off,” he said. “But that’s not the case. The theft has only been growing.”
Stolen copper is valuable as scrap because the metal is used for so many items-from fiber optics to plumbing to anything electrical-and the profits are tempting.
“Copper prices have leveled since the recession, but they’re still high enough to have people steal it,” said Michael Gurka, managing director of Spectrum Asset Management, a Chicago investment firm.
“It’s also a very tangible asset and hard to trace, and reselling it can bring in lots of money,” he added.
Ten years ago, copper futures traded at 80 cents a pound on the Chicago Mercantile Exchange. By 2006, they were at $4 a pound. They are now trading at about $3 a pound , lower than seven years ago but still 375 percent higher than 2003.
According to the latest statistics from the National Insurance Crime Bureau , which tracks incidents of metal theft, 25,083 claims were filed from 2009 to 2012, compared with 13,861 from 2006 to 2008. Nearly 96 percent of the claims in the more recent period were for copper theft.
The five leading states for the thefts are Ohio, Texas, Georgia, California and Illinois, the NICB said.
The problem has been left largely to local law enforcement agencies, though the FBI has stepped in and arrested dozens of people over the last five years .
On its website, the FBI says copper theft is “threatening U.S. critical infrastructure by targeting electrical substations, cellular towers, telephone land lines, railroads, water wells, construction sites, and vacant homes for lucrative profits.”
Funny you mention that. Copper thieves ripped out everything they could from one of my company’s pumping station. They did it twice in one month. Shut down the station that includes a very high producing well. This translates to us having to buy water instead of pumping which makes customers pay more for their water.
They are very sophisticated. They opened up the panel boards, the casing in the booster pump, casing in the well pump, and the trenches that run along the stations. They are also very strong. Those copper cables are very heavy.
The housing contributed nothing to the home ownership rate
The U.S. homeownership rate, which soared to a record high 69 percent in 2004, is back where it was two decades ago, before the housing bubble inflated, busted and ripped more than 7 million Americans from their homes.
With ownership at 65 percent and home values rising, housing industry and consumer groups are pressing lawmakers to make the American Dream more inclusive by ensuring new mortgage standards designed to prevent another crash are flexible enough that more families can benefit from the recovery. Regulators are close to proposing a softened version of a rule requiring banks to keep a stake in risky mortgages they securitize, according to five people familiar with the discussions.
Lawmakers currently shaping housing finance are seeking to reduce the government’s role in keeping rates affordable for riskier borrowers while ensuring homeownership is within reach of minorities and first-time buyers who could be needed to sustain the housing recovery as borrowing costs rise from record lows. Who will be able to buy property depends on the balance they reach, according to Anthony Sanders, a professor of real estate finance at George Mason University in Fairfax Virginia.
“Low down-payment loans coupled with exotic adjustable rate mortgages helped fuel a massive housing bubble, which ultimately burst and took down the financial sector,” said Sanders, who was the former head of mortgage-bond research at Deutsche Bank AG. “So the question now is do we want to do this again?”
I really didn’t believe a City was crazy enough to try it. Oh, El Monte my hometown.
A City Invokes Seizure Laws to Save Homes
The power of eminent domain has traditionally worked against homeowners, who can be forced to sell their property to make way for a new highway or shopping mall. But now the working-class city of Richmond, Calif., hopes to use the same legal tool to help people stay right where they are.
Scarcely touched by the nation’s housing recovery and tired of waiting for federal help, Richmond is about to become the first city in the nation to try eminent domain as a way to stop foreclosures.
The results will be closely watched by both Wall Street banks, which have vigorously opposed the use of eminent domain to buy mortgages and reduce homeowner debt, and a host of cities across the country that are considering emulating Richmond.
The banks have warned that such a move will bring down a hail of lawsuits and all but halt mortgage lending in any city with the temerity to try it.
But local officials, frustrated at the lack of large-scale relief from the Obama administration, relatively free of the influence that Wall Street wields in Washington, and faced with fraying neighborhoods and a depleted middle class, are beginning to shrug off those threats.
“We’re not willing to back down on this,” said Gayle McLaughlin, the former schoolteacher who is serving her second term as Richmond’s mayor. “They can put forward as much pressure as they would like but I’m very committed to this program and I’m very committed to the well-being of our neighborhoods.”
Despite rising home prices in many parts of the country, including California, roughly half of all homeowners with mortgages in Richmond are underwater, meaning they owe more — in some cases three or four times as much more — than their home is currently worth. On Monday, the city sent a round of letters to the owners and servicers of the loans, offering to buy 626 underwater loans. In some cases, the homeowner is already behind on the payments. Others are considered to be at risk of default, mainly because home values have fallen so much that the homeowner has little incentive to keep paying.
Many cities, particularly those where minority residents were steered into predatory loans, face a situation similar to that in Richmond, which is largely black and Hispanic. About two dozen other local and state governments, including Newark, Seattle and a handful of cities in California, are looking at the eminent domain strategy, according to a count by Robert Hockett, a Cornell University law professor and one of the plan’s chief proponents. Irvington, N.J., passed a resolution supporting its use in July. North Las Vegas will consider an eminent domain proposal in August, and El Monte, Calif., is poised to act after hearing out the opposition this week.
While I agree that Riverside and San Bernardino counties still have good cashflow potential, I think the amount of undervaluation is overstated by this analysis. While OC is faily homogenous in it’s housing stock, the IE counties stretch from the border of north Orange County all the way to the Nevada stateline. There is a ton of cheap housing stock in the desert cities that isn’t necessarily what people think of when they think of investing in these two counties. The heavily populated areas near OC should probably be segregated from the desert portions of the IE to get a more accurate picture of how prices compare.
I have all that detail. There is a big variety in Inland Empire housing markets just as there is huge variety in OC markets. There are even communities out there that sell at a premium to rental parity.
The cheap communities are also generally small communities, so they don’t bring down the median as much as you might think.
Let’s go Morongo Basin! I have a couple of acres out there. Maybe my grand kids will see development.
A Family Spent $100,000 on Beanie Babies to Put Their Kids Through College
In 1993, the world went crazy for Beanie Babies, small, plush animals by toy company Ty.
Heralded as valuable collectibles, people would rush out to buy the $5.95 toys for their children or themselves, eagerly waiting for them to appreciate in value.
But then the Beanie Baby bubble burst.
As far as bubbles go, it wasn’t bad — at worst, most collectors were stuck with a few worthless stuffed animals they’d overpaid for.
But one family found themselves sunk by the toys.
The Robinsons of Los Angeles currently have tens of thousands of Beanie Babies, all stacked neatly away and labeled in boxes. The family estimates they spent roughly $100,000 on the collection, thinking it would eventually appreciate in value and pay for their kids to attend college.
But the spending was only the tip of the iceberg. For a time, the family let the dolls rule their lives, hopping from one “Beanie joint” to another, trying to sidestep the “one-per-family rule” by recruiting neighbors to make purchases for them and going to extreme lengths to catalogue and preserve their Beanie Baby hoard.
“This is like admitting to a drug addiction,” Chris Sr. now says of the Beanie Babies. He knew the schedules of when new toys were being released, and had an inside source about how much they would be worth.
Eventually, Chris Senior thought that selling the stuffed toys would help pay for his children to go to college. “That was the plan. It never happened because we never sold them, we just bought them,” Lesleigh says. “We missed that boat.”
The family still has between 15,000 and 20,000 beanie babies. But they admit despite how dire the circumstances are now, the beanie babies could come around again.
I think as mortgage rates continue to rise in the coming years, the home price-to-income ratio will be a much better factor to determine value.
Read the story below and you’ll realize just how deeply dependent the OC is to cheap money, mortgage tax deduction and GSE’s/FHA.
===========================================
Forbes.com
4/16/2013 @ 8:22PM
Zillow has noticed a trend that could become problematic for both the U.S. housing market and policymakers in coming months.
By looking at two metrics — an affordability index and a price-to-income ratio — Zillow researchers have determined that low mortgage rates that make homes appear incredibly affordable are overshadowing a bigger overall trend in which the overall prices of homes are actually significantly more expensive than historic norms relative to annual incomes.
The affordability index measures the percentage of a homeowner’s monthly income devoted to housing (mortgage) payments. In the pre-bubble period from 1985 through 1999, homeowners spent 19.9 percent of their monthly income on mortgage payments. But because of historically low interest rates currently in the 3 to 4 percent range, at the end of Q4 2012, homeowners were spending only 12.6 percent of their monthly incomes on housing payments — or roughly 37 percent below historic norms. Low interest rates have translated into more purchasing power for homeowners, as the cost to finance homes has gone down. (In OC we are spending much higher percentage of our income to service mortgage payments)
The price-to-income ratio looks at the total cost/price of a home relative to median annual incomes. Historically, the typical, median home in the U.S. cost 2.6 times as much as the median annual income (so if the median income in an area was $100,000, the median price of a home would typically be about $260,000: $100,000 * 2.6). (Once again, we are spending in OC a much higher multiple than the national average)
While historically low mortgage rates are translating into big savings for homeowners, those same low monthly payments are masking a troubling trend. While home values have been on the rise for the past year — in some areas appreciating by 15 percent or more annually — median wages haven’t kept pace. As a result, home price-to-income ratios in many areas are climbing.
Because wage appreciation has failed to keep pace with home value appreciation, once rates rise and the illusion of affordability driven by smaller monthly payments disappears, the market will be left with homes that could potentially be too expensive to afford on the typical median wage.
“The days of historically high levels of housing affordability are numbered,” said Zillow Chief Economist Stan Humphries. “Current affordability is almost entirely dependent on low interest rates, and there’s no doubt that rates will begin to rise in the next few years. This will have an undeniable effect on demand for housing, as home buyers will have to spend more of their incomes to buy a home. Home values will have to either remain stagnant while incomes catch up or, quite possibly, home values will have to fall in some markets. This will especially be the case in some markets that have seen strong home value appreciation.”
Homeowners in 24 of the 30 largest metros covered by Zillow were paying more for homes in the fourth quarter of 2012 relative to their region’s median income than they were from 1985 through 1999. Metros with the largest difference between their pre-bubble and fourth quarter 2012 price-to-income ratios included San Jose (52.1 percent more), Los Angeles (48.8 percent more), Portland, OR, (45.4 percent more), San Diego (44.6 percent more) and Denver (40.8 percent more).
Of the 30 largest metros covered by Zillow, only Cincinnati (3.1 percent less), Chicago (3.9 percent less), Cleveland (6.7 percent less), Atlanta (13.9 percent less), Las Vegas (14.6 percent less) and Detroit (25.5 percent less) posted price-to-income ratios in the fourth quarter of 2012 that were less than historic norms.
http://www.forbes.com/sites/zillow/2013/04/16/high-home-price-to-income-ratios-hiding-behind-low-mortgage-rates/
I live in the IE – Eastvale currently. It’s exploding in price gains, aided by an unbelievable drop in inventory. There are still a large portion of cash offers, even for the “flipped” homes and then they are put up for rent. Most of the cash offers are foreign investors, primarily Asian. I’ve heard Eastvale referred to as “East Irvine” – lots of high end European cars in the driveways.
Lots and lots of rentals in Eastvale, Corona near the 91, and Chino/Chino Hills. I believe anything in “west” Inland Empire with reasonable commutes will continue to have demand, but I think the days of 500k Moreno Valley or Lake Elsinore track homes will not come back.
We distinctly remember this unpleasant feeling of uncertainty that turned into this dire feeling of hopelessness as the market turned and we could not sell our house. We decided to throw in the towel and pray for that soft landing everyone was talking about.
It was a full on BUST and our worse nightmare.
It seems like one day we woke up and like magic we were sitting pretty again, to our amazement homes prices in Irvine are reflated. So, what the hell now we can sell and retire so we listed the house. Plenty of traffic 45 days ago and we received offers over asking. The first deal fell through, no problem our Realtor made a few calls and we had another deal in the works within days. That fell through ten days ago and traffic since has been minimal in comparison so we reduced and have another deal in the works.
We are starting to get those same unpleasant feelings we did back in 2008 and know from 45 years owning homes that housing prices goes up and they go down, always have always will.
It’s always different and it’s always a timing play.
[…] ———— (interactive chart) Just In: Latest Monthly Home Values – Zillow Real Estate Market Reports ———— Inland Empire housing markets are still extremely undervalued – OC Housing News […]