Jul292015

Investing in San Bernardino: opportunity or disaster?

Properties in distressed communities surrounded by strong demand for real estate often provide opportunities for investors betting on an economic recovery.

Distressed property investing is both a science and an art. Finding a distressed property market is not difficult, and anyone who understands business math enough to compute a rate of return can measure which markets are a good deal in today’s dollars — the science.foreclosure debris

The art of distressed property investing is recognizing which of these markets the conditions are temporary and in which markets the distress is a long-term problem. I am bullish on Las Vegas because I believed the local economy would recover there because the distress was temporary.

There are many distressed property markets where I am not bullish. Detroit, Michigan, may never recover. They may end up bulldozing a significant portion of their empty housing stock. Here in California, I wouldn’t touch Bakersfield, Fresno, or Santa Maria. They are too far from major population centers to see spill-over economic growth, they are seeing varying degrees of demographic shifts and out-migration, the school systems are awful, and their local economies are not very diverse.

The fringe markets within 90 miles of major population centers will recover eventually, but the timing of this recovery is difficult to evaluate.  As a general rule, the recovery starts at the coast and moves inland. The coastal counties have recovered, and west Riverside County is showing strength, so eastern Riverside County and San Bernardino County are next in line — assuming deep structural problems don’t keep these areas down.

San Bernardino: Broken City

San Bernardino, once a sturdy, middle class “All-America City,” is now bankrupt, the poorest city of its size in California, and a symbol of the nation’s worst urban woes.

By Joe Mozingo, June 14, 2015housing_bubble_survivor

With a rake and a mask, the motel manager steps carefully into Room 107.

This afternoon, Sam Maharaj will evict a couple and their 4-month-old baby for not paying their bill. The mother sits on the side of the bed, still twitching from slamming methamphetamine the night before.

Maharaj sinks the rake’s tines into an ankle-deep thicket of dirty diapers, hypodermic needles, crusted food, hot sauce packets, broken Tupperware and cockroaches, living and dead. A South African immigrant of Indian descent, he never expected that his piece of America would look like this. …

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What do you make of the circumstances depicted above? On one hand, we have a woman struggling to raise a child under difficult conditions. On the other hand, the squalor is caused by the woman herself, not by circumstances beyond her control.

Perhaps that baby in this photo will grow strong and healthy in a loving environment, but based on the photo, this baby’s has some challenges ahead.House_Crash

Over the last three decades, the economy imploded. The rail shops and the nearby steel plant closed. So did Norton Air Force Base, costing the city 12,500 jobs. Downtown businesses vacated. Law offices decamped to Riverside when the federal bankruptcy and state appellate courts moved.

But there are still middle-class neighborhoods and amenities: a symphony, a country club, the Starbucks and El Torito along Hospitality Lane. …

Based on the disappearance of these basic industries, one may conclude the city is dead, but the proximity to the sprawl from LA makes it likely that some other industries will move in to replace those that leave.

On my recent vacation to Wisconsin, I drove through a few towns on the Wisconsin River devastated by the loss of paper mills. These towns are not proximate to any major population centers, and the economies there will not recover in the next two or three decades. San Bernardino is fundamentally different.devastated_market

On the city’s northwest edge, Morris drives past the latest developments of large Spanish-style homes on curving, smooth-black streets with banners reading “New Frontier” and “The Colony.” It’s suburbia at a fraction of what it would cost closer to Los Angeles.

Median income in this area is above $65,000, nearly five times what it is in the bleaker parts of town. Stay very close to home and you might imagine you’re in Irvine or Santa Clarita.

To confuse San Bernardino with Irvine would take some serious imagination.

Yet even this relative upper crust lives with the problems of a city gone broke: subpar schools and potholed streets just outside their immediate neighborhoods; high crime, slow police and fire response times; and trash and tumbleweeds that pile up against rusty chain-link fences. …

Taxpayer_dilutionThese problems result from the economic decline from the housing bust and the loss of other major employers. When the economy improves (assuming it does), people will move back in, money will flow to the coffers of local government, and many of these problems will disappear.

When the recession hit, San Bernardino’s foreclosure rate was 3.5 times the national average. It was inevitable: Only 46% of San Bernardino’s working-age residents have jobs — the lowest figure in the state for cities anywhere near its size. And so the statistical landslide built momentum as property and sales taxes fell by more than a third in recent years.

As the economy unspooled, the police and fire unions kept shoveling money into council members’ campaigns. In 2008, over Morris’ objections, the council gave them a generous gift. Employees of the Police and Fire Departments could retire at 50 years old and their pensions would give them 3% of their final pay for every year they had worked.

A fire battalion chief making $148,000, could retire at that age and collect $133,000 a year for life — with increases for cost of living.

By 2012 the city was spending 72% of its general fund on the Police and Fire Departments, mostly on salaries and pensions — compared to Los Angeles, which spends 59% of its general fund on those services. More than half the sworn fire personnel earn more than $150,000 a year according to city records.

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Unlike the explosive push driving people from hollowed-out Rust Belt cities, San Bernardino’s economic implosion is sucking people in: immigrants, parolees, Los Angeles gang members and those like the Lopezes, who can’t afford to live anywhere else in California. …

As I noted in yesterday’s post Why are condo prices so volatile?, undesirable communities, neighborhoods, or housing types only gain buying interest when better alternatives are not available. As prices rise everywhere else, San Bernardino becomes the affordable alternative, so buyers become more active there, and house prices rebound.

It takes the contributions of generations for a city to succeed, Morris says. “I think to be rooted is one of the most important and least recognized needs of our human soul.”

“We leave a Detroit. We leave a Stockton. We leave a San Bernardino. That’s a great sadness to me,” Morris says.

The cities in the greater LA metropolitan area will always have opportunity for redemption. These cities are too close to too much money to remain down for too long. With high demand all around and a lack of supply, real estate in these markets will recover, but in the undesirable areas, the prices will always be volatile. This provides opportunities for cashflow investors to pick up good properties during the down times. San Bernardino is still a good investment today.

OCHN_San_Bernardino_Housing_Market_Report_2015-6

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