Oct282013

Ten most undervalued and five most overvalued OC housing markets

I recently reported the housing bubble fully is reflated in Irvine, California, and the OC housing market ricochets off affordability ceiling. Since the OC market is now priced very near its historical relationship between the cost of ownership and the cost of rent, I want to take a more detailed look at what’s happening across the county and find those markets where deals still abound and those markets where none are found.

With the dramatic increase in price and rising interest rates, affordability is declining rapidly. As a consequence, the OC housing market, which started the year rated a 10, is now dropping down to a 7. While this is still a good rating by historic standards, it’s not the buy signal it once was.

Taken in historical context, the housing bubble, and the overshoot of values to the downside are apparent. The last time the market stabilized at near rental parity, it clung to that level for nearly a decade. With the housing market’s extreme sensitivity to mortgage interest rates, and with toxic loan products banned by the new residential mortgage rules, prices shouldn’t easily detach from this equilibrium value and inflate another bubble. With our restricted inventory and high percentage of cash buyers, we may still see a mini-bubble inflate over the next few years.

Resale prices have been going straight up, and the pace of the increases is remarkable. The rally has been cooling in recent months, but we’ve seen no pullback in prices so far, and with interest rates dropping down near 4% again, buyer interest should remain strong over the fall and winter. In fact, I believe this fall and winter represent a great opportunity for those who don’t want to compete against the crazies who will come out again in the spring.

What’s concerning many market watchers is the rapidity of the increase. The only two times in the last 25 years that house prices rose faster than wages, they crashed hard afterward. If the current rally flattens down to a normal rate of appreciation paralleling rent and wage growth, we may avert another crash, but given our history of price volatility, we may see another mini-bubble as buyers get carried away prior to interest rates rising and taking away the punch bowl.

Rents have been rising slowly but steadily. The influx of new apartments should keep price raises in check for several years, but an improving economy should also keep rents going up.

Rents are in their stable long-term range.

What jumps out about the graph of the cost of ownership and rents is the dramatic increase in ownership costs. It’s gone up even steeper than house prices because interest rates have also been rising.

In the past, such steep rises in cost of ownership was offset by toxic mortgage products that allowed fools to make the same payment yet finance prodigious mortgage balances. The recent near-vertical increase in the cost of ownership was entirely absorbed by new buyers. This is largely what’s caused the lack of enthusiasm from buyers lately.

The cashflow investment opportunity in OC has never been very good. Our brief window of opportunity to pick up cashflow-positive properties in OC has closed.

The market overall is still not overvalued by historic norms. We’ve erased the undervalued condition, and the market is now valued right where it typically finds an equilibrium.

The OCHN rating system rates markets between 4 and 6 most of the time. It’s rare that market conditions strongly favor buyers and earn readings of 7, 8, 9 or 10. Although the market is not as good as it was, put in perspective, it’s still pretty good.

The reflation of the housing bubble has not been even and uniform. Over time, I believe these markets will resume their relative valuations compared to each other and to their own historic norms. Since all these markets are adjacent, there is significant substitution effect between them. When one becomes overvalued, it turns off buyers who look for bargains elsewhere. It is my opinion that the list of undervalued markets below will see above average appreciation over the next three years while all markets equalize.

There isn’t much commonality in the markets above. We have premium markets like Coto de Caza and Yorba Linda as well as discount markets like Anaheim or Santa Ana. There is no particular reason these markets should remain undervalued.

Unlike the undervalued markets, the overvalued markets do appear to have a common bond — they are mostly beach communities. Some will argue beach communities are always inflated, so this is to be expected. That is an erroneous way to look at this data. Each of the beach communities carries a significant historic premium, that much is true. However, they are inflated even by that standard. No matter how you look at these communities, prices have simply gone up too high too fast. A correction is in order.

Over the last 25 years, the disparity of income and wealth has favored the top 1% above all others. Perhaps the reason these beach communities have a larger degree of relative inflation than they did 20 years ago is due to the concentration of wealth among these individuals. If you believe that to be the case, then today’s prices are reasonable. Of course, if you plan to invest in these properties based on that continuing, you better hope we don’t see populist changes in attitudes and tax laws that could reverse this trend.

This fall and winter is a good time to house shop

There is never a perfect time to buy. It would have been great to have purchased in the fall of 2011 when inventory was abundant, interest rates were low, and prices were much lower. Of course, the only people who bought then were the brave souls who purchased while prices were still falling. With prices up and interest rates up, the deals are not as compelling today, but inventory is still on the rise, and interest rates are coming down again after the fed fake on taper was announced. Anecdotally, I’m told buyer activity is still low, so competition for properties is low right now. The cloud inventory probably won’t be coming down in price any time soon, so waiting isn’t likely to get a better deal unless policies change at the banks. If you’re thinking about buying, I would encourage you to look now rather than wait for spring when interest rates might be higher and competing buyers will be active.

Fixer Opportunity

Today’s featured property is trashed, and it’s unlikely any bank would finance it. However, with the abundance of cash buyers, someone with vision could buy this place and create significant value. The Coto de Caza community is still undervalued, and between the value add of improving this property and the likely appreciation from getting it below historic value, this property could be a real winner.

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[idx-listing mlsnumber=”OC13217870″ showpricehistory=”true”]

31862 VIA PATO Coto de Caza, CA 92679

$477,750 …….. Asking Price
$911,352 ………. Purchase Price
10/11/2012 ………. Purchase Date

($433,602) ………. Gross Gain (Loss)
($38,220) ………… Commissions and Costs at 8%
============================================
($471,822) ………. Net Gain (Loss)
============================================
-47.6% ………. Gross Percent Change
-51.8% ………. Net Percent Change
-58.2% ………… Annual Appreciation

Cost of Home Ownership
——————————————————————————
$477,750 …….. Asking Price
$16,721 ………… 3.5% Down FHA Financing
4.24% …………. Mortgage Interest Rate
30 ……………… Number of Years
$461,029 …….. Mortgage
$131,440 ………. Income Requirement

$2,265 ………… Monthly Mortgage Payment
$414 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$100 ………… Homeowners Insurance at 0.25%
$519 ………… Private Mortgage Insurance
$98 ………… Homeowners Association Fees
============================================
$3,396 ………. Monthly Cash Outlays

($565) ………. Tax Savings
($636) ………. Principal Amortization
$25 ………….. Opportunity Cost of Down Payment
$80 ………….. Maintenance and Replacement Reserves
============================================
$2,299 ………. Monthly Cost of Ownership

Cash Acquisition Demands
——————————————————————————
$6,278 ………… Furnishing and Move-In Costs at 1% + $1,500
$6,278 ………… Closing Costs at 1% + $1,500
$4,610 ………… Interest Points at 1%
$16,721 ………… Down Payment
============================================
$33,887 ………. Total Cash Costs
$35,200 ………. Emergency Cash Reserves
============================================
$69,087 ………. Total Savings Needed
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