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Why Belmont Housing is Hot

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Within my real estate office, I am one of the go to resources for all things Belmont and Redwood Shores with respect to the community. I have had a lot of questions recently concerning some quirky rules for the city of Belmont as it relates to real estate as well as nuances around the school district. Yes, San Mateo County, the “mid-Peninsula” real estate prices continue to increase due to low inventory and strong demand (see previous post https://taosiliconvalley.com/2013/08/26/microeconomics-101-for-real-estate-2/ ). The quaint city of Belmont has always had admirers, but remained a bit under the radar for those who don’t live in San Mateo County. Andecdotally, it seems Belmont has increased in popularity of recent years with nearly every listing generating significant number of offers from home buyers wanting to be part of the community. Why is this dynamic more precipitous than ever? Although this oversimplifies the dynamics….part of the explanation is around the many positive developments of what was already a strong school system. The attractiveness of Belmont includes Water Dog Lake Park, hiking/biking trails, proximity to transportation, and friendly, highly educated people. What ties all of these things together is the award winning Belmont Redwood Shores School District.

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Yes, other nearby cities also have good to very strong public schools. The Belmont Redwood Shores School District has experienced overwhelming community support in the form of passing multiple bond measures and parcel tax measures in the past several years that has allowed Belmont to completely upgrade deferred maintenance, modernize facilities and advance technology investments in the elementary and Ralston Middle schools. Every Belmont elementary school saw major construction projects over the past 2 years that improved the schools significantly and expanded some as well. Within Redwood Shores, Sandpiper is relatively new having been built in the mid 1990’s and Redwood Shores elementary opened in 2010. These schools are nice, clean and (now) modernized. What parent wouldn’t want their kids go to a “newer” schools that rank highly in the state with active parents and a supportive community? It used to be that many of the elementary schools saw strong API scores and would attract homebuyers. Now people hear about the community activism of supporting children’s education above and beyond test scores, and then see the beautiful facilities, before deciding that they will do whatever they can to buy a house/condo in Belmont to be able to send their kids to the schools.

Below summarizes the Belmont Redwood Shores API scores from 2013:

    • Central 935
    • Cipriani 910
    • Fox 915
    • Nesbit 865
    • Redwood Shores 928
    • Sandpiper 938
    • Ralston Middle 907

Belmont and Redwood Shores passed multiple bond and parcel tax measures. Measure U in November 2008 raised $78 million to keep classroom sizes smaller and maintain some enrichment programs, Measures I and N in November 2010 raised $25 million for Ralston and $35 million for the Belmont elementary schools to improve and expand the buildings/facilities. Measure R in November 2013 maintained an expiring $174 parcel tax to support the schools. All of these measures passed with the voters on the 1st try showing a true testament to the community. Passing these measures took time from enormous number of volunteers to drive the campaigns, make phone calls, donate funds, and print marketing materials to educate the people. Then, the people responded overwhelmingly in the polls.

Additionally, there are 3 new City Council members elected/appointed over the past year. Eric Reed, Charles Stone and Cathy Wright all of whom are active in the schools, youth sports and general community happenings prior to them winning a seat on the City Council.

So it’s all positive right? What is the consequence of this popularity?  Simple….a projected continuing growth of school aged children in Belmont and Redwood Shores that will stress school site capacity in upcoming years. There are no easy answers. Many cities/school districts in the Mid-Peninsula face the same challenges. As an example, neighboring San Carlos is seeking new land to build a new school on and evaluating various options to manage growth in their school district.

The mid-Peninsula being midway point between San Francisco and Silicon Valley, nice weather, close to mountains/ocean/bay and really strong schools just offers a balanced lifestyle….and with little raw land to build on, there is just limited supply of new housing units to help absorb this demand. With many changes to the city, and the community support, Belmont may no longer stay sleepy in the shadows of their larger cousins nearby.

Cost and Return on Investment Estimates for Home Remodeling

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As a real estate professional, I get asked regularly the following question…”what is a rough estimate to upgrade/replace/fix <fill in the blank> in my house?”. I love talking real estate. I am passionate using data and analyzing information to discuss options with people. I enjoy brainstorming home projects with people, and am good at providing insight to my clients on potential ways to modernize, change floor plans, and remodeling options on houses they own or are considering making an offer on.  But, it is incredibly difficult to answer very specific question around cost estimates or ROI, primarily due to a huge range in quality of finishes, labor cost, unexpected costs, differences in people’s houses, individual ability to negotiate, geography, space layout, and myriads of other factors. I thought I would write a bit about this dynamic after I just read an article on Yahoo News on “what is the rough estimate of a Return on Investment of a specific home project”. The reason is all these various articles estimating ROI in the United States is not as relevant in the heart of SF Bay and in particular in mid-Peninsula cities where average condo/house sale prices is almost $800,000 and a small 3bd/2ba starter house that requires work in San Carlos, Burlingame, San Mateo, Foster City, Redwood Shores, Millbrae, Menlo Park, and Belmont surpasses $1+ million.

http://news.yahoo.com/home-remodeling-projects-worth-money-155500763.html

http://money.usnews.com/money/personal-finance/articles/2012/10/25/renovations-that-yield-the-best-return-on-investment?page=2

You can see in the article that states the home improvement projects yield below 100% return on investment (ROI) from a re-sale perspective. In the San Francisco Bay Area where homes are selling from between $600-900 per square feet and demand outstrips supply (see previous post, https://taosiliconvalley.com/2013/08/26/microeconomics-101-for-real-estate-2/)  projects such as a kitchen or bathroom remodel generally will yield well above 100% return on re-sale. I don’t like providing blanket statements like that, because the homeowner can certainly “over improve” a space relative to the neighborhood/house, or design to a very specific taste whereby the ROI may be under 100%. When the $/sq.ft. and the average price of a home is so high, the threat of not seeing a good ROI is significantly mitigated relative to other parts of the US where $/sq. ft is much lower than what we see in Silicon Valley.

I indicate kitchen and bathrooms since those projects require more of an upfront investment to do the project but also since these are key rooms that buyers pay attention to and homeowners have pride over. There are other projects that should easily see an above 100% ROI in our location – new paint (interior/exterior) and flooring readily comes to mind.

In terms of cost estimates, I get asked the most about bathroom and kitchens….surprise, surprise. Let’s start with bathrooms, this has a big range for a complete “gut job” remodel project. For a Master Bathroom (for a smaller “regular bathroom” cost estimates are lower), let’s go with anything from $3000 to $50,000. For $3-5k, you are likely doing most of the work yourself, it’s off the shelf big box store vanity/mirror/lighting with no moving plumbing or electrical around and no special tiling work, and is only a small, basic bathroom. I was recently at a high end bathroom showroom store looking at what I thought was a “higher end” vanity. It was around $6k for a 60″ vanity/countertop. It was beautiful. Then, I looked around the showroom and was a kid in a candy store. Everything was so shiny and awesome. First, that vanity the salesman told me was the “least expensive” in the showroom. They had small 30″ half bath vanities for $10-15k, bathroom faucets for $3k, standalone tub for $2,500, a steam shower set up for $4k. You could easily spend $50,000 (or even much more) for a sweet set-up that you probably see on the old TV show “Cribs”. But more realistically for us regular people, a part of your cost component will be whether you are moving plumbing, do you need to upgrade electrical, new lighting, are you doing custom tile work, type/brand of fixtures, jacuzzi tub or just soaking tub or a tub/shower combination. Clearly, each variation adds $$.

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No question, a kitchen is higher cost and has even higher variability. Just a quick example on simple appliance choices, you can buy a nice refrigerator for $2k, dishwasher for $750, stove/oven for $2k, and range hood for $300. There are more basic and cheaper options available at maybe half that pricing. However, if you wanted to get a “higher end” kitchen appliance set, the starting prices could be as follows…6 burner 36″ Viking/Thermador range for $7k, Chimney hood for $1,500, dishwasher for $2k, wine fridge for $1k, Miele built-in expresso machine for $3,500, and a sub-zero refrigerator for $15k. For just the appliances alone, the cost of a good set can be had for $5k or go up a tier or two and add in a couple other appliances (wine, expresso) and you are now in for $25k. You haven’t started construction yet, picked out cabinets, countertop, lighting fixtures, changed the floor plan, upgraded electrical, or paid for any contractor labor. Thus, when I get pressed on providing a “cost range” for an “average” kitchen remodel that is still not an easy question to answer.

And as anyone can guess, the skill and efficiency and cost of a general contractor and sub-contractor run a wide range range. Often, labor is a big component of the overall budget. Lots of dynamics impact labor cost. Highly experienced and professional full service general contractor with a full team will be more expensive than a one person unlicensed person. Your timeline and how quickly you need it completed will impact cost. Type and complexity of project impacts many decisions. How well do you negotiate? How much risk in the project if something goes wrong? How are you structuring the arrangement with the contractor – fixed cost or cost+ markup. Who is paying for materials. Geographic location. Thus, when a friend from Denver asks about estimating costs vs. a client from Palo Alto, I can safely assume the labor cost for a contractor in Palo Alto will be higher than someone from Denver for the same work.

So a key question to ask yourself in evaluating whether to start a home remodeling job is how important is the “financial ROI” aspect of whatever you do vs. doing a remodel purely because this is the house you will be living in for the next 20 years and you don’t care about the specific style, taste, budget of your remodel and how others will perceive and value your work. That dynamic may help determine and drive what you decide to do, how you design your plans and what finishes/colors you end up choosing.

Again, for those who know me, know that I am not someone who likes to just throw out random numbers and prefer to provide lots of details and assumptions when I do use numbers whether to help provide comparable sales information, to analyze sports statistics or to provide direction on a project. When you do read articles online about home remodeling ROI, keep in mind, the statistics are for national averages/estimates and does not necessarily reflect the SF Bay Area’s valuations. But as always, feel free to contact me if you wanted to brainstorm anything regarding real estate or get my expert opinion about the upcoming March Madness college basketball tournament bracket!

Should I Stay or Should I Go Now?

“Should I stay or should I go now?
If I go there will be trouble
An if I stay it will be double
So come on and let me know”

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Those are lyrics by a classic song by The Clash. Okay, so I admit, I’m stretching a bit trying to be amusing and incorporating those lyrics into a blog post that probably should be more succinctly titled “Should I Sell First, Rent, then Buy?”. Last month, the topic of selling your house first, then renting before trying to buy another house has come up in a conversation I had with a friend and during a recent Coldwell Banker office meeting. Thus, I thought it worthwhile to write a blog on the rationale behind this strategy, the inherent risks and the potential benefits. There are various scenarios on why someone would do this and my perspectives change depending how the reason for doing some and your timelines. The following are two common scenarios.

Scenario 1 – The Empty Nester: couple has owned a larger house for a long time, with adult children

In this situation, my friend has lived in a nice, big house in a nice leafy community for decades and now has grown children, and no longer has a need for a large house with a large yard. He and his wife are contemplating the possibility of “downsizing” their house to a) cash out and take some equity out of real estate while their mid-Peninsula house is at an all-time high, b) move closer and within walking distance of an active downtown area in San Carlos, Burlingame or San Mateo, c) change of scenery of just living somewhere different and d) live in a (smaller) single-story house requiring less cleaning and with a lower maintenance yard.

The conversation revolved around the highly common question of do they sell first then buy or buy 1st then sell; I will tackle this bigger question in a separate blog post. My Peninsula friend then said he’d even consider selling first, then renting a San Francisco apartment for a year or two for fun, before contemplating a purchase. In principle, that sounds like a really cool idea. Long time suburbun couple, cashes out of their house as an empty nester, then rents a hip apartment in the big city SF life for a couple years before deciding where to settle back to. From a financial perspective, let’s look at two rudimentary possible market outcomes:

A) the real estate market remains flat/declines or goes up moderately. In this situation, the strategy above would work out very successfully.

B) the local real estate prices continue rising 10-20% per annum. In this situation, being out of Bay Area real estate would come at a negative financial impact. I use the term rudimentary in above paragraph, as you can include dozens of other variables to really determine “financial impact”. For instance, it would be theoretically possible if one freed up capital in selling off a real estate asset and then reinvested that capital in a different investment opportunity that ended up yielding a higher return than if that person remained in real estate; and if you were to include that possibility, you’d need to incorporate “beta” and inherent riskiness between asset classes into that analysis as well. But let’s simplify thing in this following sample calculation. Let’s say your current (larger) house can sell at $1.8 million in Spring 2014 and the target would be to purchase a smaller 3 bedroom, 2 bath house in San Mateo for $1.2 million which would allow you to cash out almost $600k in equity (not factoring in cost of sale, taxes, etc.). What if you sold your current house for $1.8 million, then rented a super-hip SF apartment for 2 years and then started looking to relocated back to mid-Peninsula again in year 2016. And in this situation, the Bay Area real estate market continued going up 15% per year for these two years. That $1.2 million house in 2014 would be priced at $1.587 million yielding net cash of $213k (from the $1.8 million) as the 3 bedroom house would have gone up by $387k. Additionally, there is the cost of the hip apartment rental in SF which will probably be between $4000-6000 per month for a nicer unit in a hip neighborhood which wouldn’t go towards any mortgage principal at all. Now, we aren’t factoring in impact to tax writeoffs, income earned from reinvestment of the freed up capital and other items, but this simple example seeks to illustrate a financial risk in being out of Bay Area real estate market…..in a potentially rising real estate market.

No one knows what any market will do in the short term whether that is stock market, real estate market, currency market, commodities market, etc., but would you be prepared to “gamble” on being out of Bay Area real estate if you ultimately know you wish to own real estate in the long term as both a financial and lifestyle investment?

Scenario 2 – Young Family: seeks to move into bigger house and are not able to buy 1st then sell, so they wish to sell 1st, do short term rental while looking to purchase larger home.

Why would they want/need to do that? They may not have the requisite down payment unless they sold current house, or can qualify for a new mortgage while owning their existing house/mortgage. They may be able to take advantage of having a larger down payment after selling their current house, and be ready to buy and move into a new house, and not have to put in a contingency to sell their current house as part of their offer. There would be more flexibility to put in an aggressive offer with “cleaner” deal terms with this strategy. And certainly, as (B) above references and with any path, there will be potential risks too. There is no right or wrong way to proceed per se.

There will be implications no matter how this situation is handled. Having the money in the bank and ready to make offers with large down payments and without the complications of selling another house would generally improve the probability of winning in a multiple offer situation. But I wanted to just delineate between scenario 1 where my friend would be looking to temporarily cash out of the real estate market for a period of time just to “have some fun” living in the city for a couple years. He and his wife would be gambling in a situation where he has other options should he wish to pursue them. I would advise them to make sure to evaluate all his various options and just to make sure he knows what the various outcomes could be. Versus scenario 2 for the move-up buyer which is a very different situation with different expected timelines; in this scenario, there is risk, but based on timeline and the high competitive Bay Area market, these buyers have more limited options, but the timeline also is presumably shorter too. Thus, there are ways to try to mitigate some of the risks. But more importantly, there is potential upside in going down this path in terms of trying to buy the larger house.

There is generally a major dilemma with many of my friends and clients who are seeking to buy larger houses from their current place. Do you a) sell 1st then buy, b) buy 1st then sell, c) make contingency offers? Very challenging situation in the hot Bay Area market where many/most properties have multiple offers and some have an incredible number of offers. I will do a future post analyzing the options on this. No easy answers no matter how you disect it.

An Example of a Real Estate Investment that Just Didn’t Make Sense

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Last night a good out of area friend called me at home (yes, phone on a landline…not email, text, Facetime, IM, Facebook or any other numerous ways to communicate) to get my advice on a possible rental house that just came on the market. My friend has some capital that he wants to redeploy to real estate rather than leaving it in the stock market. He forwarded an email from a real estate agent on the opportunity. After doing my back-of-the-envelope calculations, and speaking with my friend in more detail, I quickly concluded that I didn’t think it was a “good” investment for him, and that I didn’t think key points with the original investment thesis applied to my friend. Although the agent wasn’t wrong in his statements per se, it didn’t apply to my friend’s investment profile and situation. The recommendations applied more for an owner occupied buyer rather than a financial investor and could have caused headaches for him at an unattractive financial return.

Below is an edited version of the email and I will attempt to address some of the sections that I reference with names, city and some other details altered to protect confidentiality.

I saw a 2-bedroom/1-bath 900 square feet house today listed at just under $600k. One of the lowest priced SFR for sale in (above average neighborhood). As we discussed, the other (really desireable and one of the best neighborhoods in the area) neighborhood you are contemplating, I believe to be at the peak of the market, too expensive, and with little upside. There is much potential for appreciation with this bungalow and this particular area. The cap rate won’t be that great on it. The play here is that if you add square footage to this property and double the size, this could become a $1 million dollar house. The condition is good overall and livable. It would be perfect for a small family to live in and then down the road add an one or two bedrooms and another bathroom or two. The street location is good with many over Million-dollar houses. If you added an extra couple bedrooms and a bath approximately doubling square footage, it would sell for $900k. Do note that many builders can build for around $125 a sq. ft.

First, let me emphasize there are NO right or wrong answers. Second, although I know a bit about the area where my friend lives, I am not an expert, as I do not live there or buy/sell houses there. With that being said, the points I make below still apply to my friend’s situation as my statements are not geographic specific.

So where do I begin?

1) The opinion of whether the market and the specific “best neighborhood” is at the peak or not is irrelevant when comparing cities in the same vicinity. If one attractive city is near the peak, then the city next to it which is also a good city also would be at the peak or vice versa. The overall market of those cities will be highly correlated at close to 1.0. It wouldn’t affect which city to buy in if they are fairly similar and right next to one another. One city won’t go up while the other city goes down. For example, in SF Bay Area, if Palo Alto represents a highly desirable city, its values will still be highly correlated with neighboring Menlo Park, or even San Carlos.

2) This is actually 1a. Regardless of one’s viewpoint of near term market appreciation potential, what the agent didn’t factor in at all is that my friend is looking at this investment as a LONG TERM (20+ years) rental hold set up through retirement. The asset will appreciate over the course of 20 years. Then the questions become, is one city going to appreciate faster than the other in terms of valuation, rents or other financial factors. The agent’s statement that pricing is at its peak implies his assessment of near term pricing – not long term.

3) The cap rate won’t be that great. That’s an understatement. I did a quick calculation on this and I estimate the cap rate on this deal “as is” to be between 0.5-1.5%. That is horrible for a “cash flow” oriented investor. I won’t go into details on cap rate as there are many, many factors that go into it. Cap rate generally is inversely correlated with attractiveness of the neighborhood/house/street/etc. As an example, Palo Alto will have one of the lowest cap rates around compared that to a house in city with many foreclosures like Stockton or Tracy which will have a high cap rate (8-12%+). A cap rate of ~3% is considered low but typical for a house in a super strong, high demand city with strong school system, etc. that is renovated and in move-in condition. Pitching a 1% cap rate deal on a 2 bedroom less than 1000 sq. ft. bungalow?

4) Doubling square footage and altering it from a 2/1 to a 4/2.5 would increase price from $600k to $1 million. That statement in itself doesn’t lend credence. How much will it cost to double the sq. ft.? Is that even possible on the lot? The $/sq. ft. actually decreases in that statement so why does that support this as a good investment? There isn’t enough data/calculations/analysis to provide support on an investment thesis with that generic statement alone.

5) Builders can build for around $125 per sq. ft. That is a totally misleading statement. My friend has a full-time corporate job. He is NOT a builder, doesn’t have builder pricing for materials and labor. And the data being reference is for big builders, likely not even realistic for a general contractor. A random consumer can’t come close to adding sq. ft. to a house by hiring a General Contractor, Architect, etc. and doing the work for that dollar range. The number cited could have gotten my friend into trouble had he relied on the number for his analysis.

6) And finally, notwithstanding statement 5 above, my friend wouldn’t want to do a MAJOR construction project. The house he recently sold was an awesome house in an awesome city in which he received multiple offers and did well on the house in terms of price. Although the house was in solid condition, he could have done a few small projects like updating the bathrooms, refinishing the hardwood floors, or even done some work to the kitchen. Any updating effort prior to listing the house would no doubt yielded a positive Return on Investment. But he is a busy corporate executive with no interest in a house project. Would he really consider going through and doing a tear down major construction project that is really only (possible) play on what the agent is pitching. And even if they were prepared to do that, I’m not even sure there is enough profit margin to go through that major effort, financial investment and higher risk to even consider it.

Thus, the one statement that may be accurate is the sentence on being “…perfect for a small family to live in and the down the road add on….”. That is probably the target buyer on this house, not for a small financial investor that just want to re-allocate some money to a property that is in good condition in a good neighborhood that will generate solid cash flow and not cause a lot of headaches. The opportunity just doesn’t make sense from a financial return perspective or a good fit in terms of my this particular investor’s time horizon and investment profile.

Mortgage rates have risen since its all-time low….should this impact your timing to buy?

Source: Image taken from http://www.forbes.com 7/15/2013.

Lots of news around mortgage rates in last few years, and particularly in 2013. According to Freddie Mac, the 30 year fixed, conforming mortgage rate hit a low of 3.31% on November 21, 2012. When I started writing this blog entry on September 19, 2013, the average 30 year fixed, conforming mortgage rate hovered around 4.5% – an approximate 119 basis point (“bp”) uptick; since then, as of November 7, the average went back down to 4.16%, 88 bp higher than the 2012 low. Nearly 1% increase seems like a big jump, as this has been a greater increase that what consumers have been used to. I regularly get questions around what this interest rate movement means for owner-occupied buyers and investors alike. Then, the second order question is how this will affect real estate valuation in the near and long term.

First, a straightforward mathematical calculation: possessing a higher interest rate on the same loan amount yields higher monthly payment. For example, on a 30 year fixed loan at last year’s historical low of 3.31%, a $700k loan amount would result in monthly mortgage payment of $3,069.51. At 4.16%, the same loan would have a monthly payment of $3,406.80 aggregating to a $4,047.06 in annual higher payment. With that being said, some percentage of this payment amount is towards interest which would usually be tax deductible for owner occupied residences so the net difference isn’t quite as large as stated above. A few hundred per month is higher payment may affect someone’s ability to carry that size mortgage, but it’s certainly a factor that need to be financially calculated and assessed against the person’s overall financial picture.

Let’s first discuss impact on mortgage rates for investment properties. Rates don’t affect cap rate (I will do a separate post on “cap rates” in the future) assumptions which investors use to help value real estate investment assets. However, it does impact net cash flow and cash-on-cash returns. Currently, investment properties face high demand from well capitalized individuals and professional investment groups. Good asset in appealing areas often produce multiple offers. This includes the 5+ unit commercial apartment building segment too. The primary drivers include i) SF Bay Area population with strong cash positions in a rapidly rising techonology stock market seeking diversified asset classes by which to invest, ii) major influx of international buyers who wish to buy and hold in Tier 1 geographies such as SF Bay, and iii) historical low interest rates to lock in for stronger cash-on-cash returns. With respect to the interest rates, this certainly is driving some of the demand as investors are looking to lock in the low interest rates for better returns.

In terms of a common question I get from buyers who wish to purchase their first home. Above and beyond the question on whether they believe the real estate values will continue increasing or if they believe prices can’t go any higher, buyers are making decisions on the following dynamic:

  1. Should I try to buy ASAP before interest rate rises higher?
    1. Or if interest rate rise higher, will that lower property values and render the higher rate better or worse than current conditions?
  2. Should I wait a bit to see if interest rates go back down? Similar dilemma dictates that I am more reluctant to buy now because my buying power is now lower and can afford a lower purchase price because of the higher interest rate.
  3. Or the 2nd order of thought from #1 above is that I believe interest rates will rise, and because of higher interest rates, I believe property values will be negatively affected. Because I have a bigger down payment to purchase a house, I would be relatively advantaged relative to other buyers who must finance a higher loan amount at the same purchase price. Thus, I may prefer to wait.

These are no easy questions and no clear answers. One dynamic that I may alert you to is the following chart compiled by Freddie Mac on the 30 year conforming fixed average interest rate since 1990 when the average rate hovered over 10%. I still recall thinking to myself when rates went below 5%, how low it was and whether it was sustainable by the Feds, but then it crepts to the low 3% last year. While it is over 4% right now, this still represents a very low rate historically.

Who knows what interest rates will do in the near future and how that will impact real estate valuations? Potential owner occupied buyers and sellers need to consider your life and financial situation. How important is home ownership to you in terms of lifestyle? How sensitive is your financial status to changes in rates and affect your ability to buy? This may affect timing and motivation. Either way, talking directly with a couple mortgage lenders is adviseable to get a sense on your situation and help determine what you can qualify for.

Year Average
1990 10.13%
1991 9.25%
1992 8.39%
1993 7.31%
1994 8.34%
1995 7.93%
1996 7.81%
1997 7.60%
1998 6.94%
1999 7.44%
2000 8.05%
2001 6.97%
2002 6.54%
2003 5.83%
2004 5.84%
2005 5.87%
2006 6.41%
2007 6.34%
2008 6.03%
2009 5.04%
2010 4.69%
2011 4.45%
2012 3.66%

Are Skills Used in Playing Texas Hold ‘Em Similar to Real Estate Investing?

pokerrealestateimageBack in the early 1990’s a friend who lives in Southern California who I will call “LT” started working as a real estate agent. He worked hard, he hustled, he schmoozed and he sold. LT is a total people person. I knew he would do well. The story could end with me saying that LT is now a top producing agent and that hard work pays off. But not only is he a really good agent, but he became an astute real estate investor and a successful part-time poker player. How did he leverage his realtor experience into investments and poker playing. Are there commonalities between playing Texas Hold ‘Em and investing in real estate?

A few years into LT’s real estate sales career, he started investing his savings and buying rental properties for himself. And he kept buying, and buying. He did this for nearly a decade owning anywhere between 5-10 properties at a time. He bought where he thought were opportunities for upside appreciation potential and/or would generate a good future rental cash flow – probably more based on appreciation potential. LT was bullish on the local S. California real estate market and like everyone in the US had access to easy and low interest rate mortgage financing during the mortgage boom of late 1990’s to early 2000’s.

During that time, many high income earners who were in successful corporate careers were super busy and didn’t buy investment real estate even though they were tempted to – particularly as prices increased. But they were very conservative in “diversifying their portfolios” (given many owned their own homes) and also did not want the extra responsibility of being a landlord. In the mid-2000s, LT sensed the market was softening, and over a few year stretch LT sold most of his real estate investment portfolio. He timed the market on both the buying and selling side nearly perfectly. A couple friends commented that LT had a lot of luck on his side. Although I certainly believe there was a bit of luck, but I believe more that LT possesses some attributes that led him to become successful in his investment decisions and timing.

Here is my opinion on LT’s real estate endeavors:

  • LT was active in the market, knew the neighborhoods and was an expert in his field of real estate so he had high confidence in his opinions on the local real estate market.
  • LT was able to take on some more risk than others given his personal situation
  • LT had relationships within the industry and was aggressively seeking opportunities
  • LT uses gut instinct, and trusts it enough to put his money where his mouth is

Many of us would be building large spreadsheets and running sensitivity analysis and other forecasting tools. I certainly recommend this as a core activity as a potential investor and I always do this exercise even when I know right away if is a good deal. You want to know your cash-on-cash returns, cap rate, IRR, effective gross income, GRM, and other metrics. I’m sure LT made some of these calculations. But what often happens is “analysis paralysis”. The future is uncertain, you may be bullish on an investment opportunity, but there are always 2 or 3 things that can go wrong. This is when many if not most people are reluctant to act or don’t have the gumption to just make the leap.

  • Did LT have skill in timing the market perfectly? Yes!
  • Did LT see a bit of luck in just how well he timed it? Sure!
  • But what did LT have that most others didn’t have? He had courage and conviction.

I have such high respect for LT, and he remains a very good friend of mine. Sure his timing was remarkable, but I give him 100% credit for how things worked out for him in real estate. The fact of the matter is that he put money behind his belief that real estate would be a good investment during those years and it paid off for him. He is still doing real estate sales, but he also spending part of his time as a semi-professional poker player enjoying the fruits of his earlier labor.

I believe investing of any sort (stock, company, real estate, currency, start-ups, etc.) has many similarities to playing poker. In poker, you must be able to i) calculate probabilities under uncertain scenarios, ii) have a read of the situation of what others are doing, iii) evaluate each hand against your current chip count to figure out betting strategy, iv) determine pot odds and make decision around the risk-reward proposition, v) have courage to go with your read and calculations, and vi) possess just a bit of luck. You want to minimize the luck factor as much as you can to maximize your pot odds. Back in my day of playing home games with friends, I was a strong poker player. LT is one of the few poker players amongst my friends who I would hesitate in playing seriously against. But when we do, and he occasionally beats me….of course I tell LT that he just got lucky!

Microeconomics 101 for Real Estate

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Basic Concept of Supply and Demand:

One of the most useful classes I took in college and graduate schools was Microeconomics. I love economics theory – so elegant. Economics make sense to me.  At the core of market pricing, there is a concept called supply and demand. How much supply is there in the market place plotted on a graph against price on Y-axis and quantity on the X-axis? How much demand is there in the market place plotted against the same graph? In this theoretical exercise, the Supply curve and the Demand curve intersect and meet within the graph that determines the theoretical price. Simplistically, the following theoretical conclusions can be made:

a)    Supply goes up (Demand remains the same), pricing decreases

b)   Supply goes down (Demand remains the same), pricing increases

c)    Demand rises (Supply remains the same), pricing increases

d)   Demand goes down (Supply remains the same), pricing decreases

TrimTabs Investment Research:

Many years ago, I came across a very interesting investment research and data firm called TrimTabs Investment Research that also runs an ETF and formerly a hedge fund. They have been in existence for over 20 years. Most consumers have never heard of them, yet the largest hedge funds in the world pay 5 to 6 figures annual subscription fee to get access to their specialized research and data which they use to help with their investment strategies. Additionally, several years ago, Goldman Sachs even bought a minority stake in them. The TrimTabs premise is that the stock price movement is as much a function of the supply of float in the market combined with the demand side indicators such as money flows of mutual funds, ETFs and hedge funds, than any other more traditional stock valuation methodologies. Through their proprietary data collection and measurement tools of both the supply side and demand side indicators they conduct data analysis and then put forth bearish or bullish calls for the US market, sectors, and international markets.  See http://trimtabs.com/global/liquiditytheory.htm for more information. Certainly, this isn’t foolproof all the time, but this theory makes sense to me and I certainly believe supply and demand factors contribute to stock market movements.

Real Estate Supply and Demand in the Bay Area:

It appears that the Bay Area (and other key markets around the US) is being impacted by the ‘imbalance’ of supply and demand contributing to the phenomenon of a rapidly appreciating real estate market. Providing some feedback at a rudimentary level:

Demand:

In the mid-Peninsula, in cities which include San Carlos, Belmont, Burlingame, San Mateo, Redwood City, Millbrae, Foster City, Redwood Shores and Menlo Park, you will read about the strength of the economy and how much wealth there is to purchase property and thus driving up price. All of those aspects are directionally true. After a few years of slow demand where people were not feeling as confident about the economy, their job situation, their stock option value, or trend of real estate prices, the last couple years it seems people are feeling good about many of those items. The stock prices have risen precipitously such that there is higher value in stock portfolios or in employee stock option grants. High technology is doing well and lots of start ups abound and growing. Formerly underwater houses have recovered such that equity available for down payments on new houses. But also, as prices have really increased in the past two years, there is now a fear for new homebuyers, investors or move-up buyers that if they don’t lock in and purchase a new house now, that in another year or two, prices will continue to appreciate thus either pricing them out of the market or having to purchase a less desirable property in the near future. Demand appears good.

Supply:

A major driver that seems to be impacting the degree in ramp up of prices is the lower supply of property available in the market. So good demand + lower supply = higher increases in price.  In San Mateo county and Santa Clara county, the heart of Silicon Valley, there is very little land to build new houses/condos. Land is extremely expensive which includes land that currently has an old house on it (“tear down”). New construction appears to be increasing in select pockets, but again, there is limited supply of available land. However, for several years, new construction virtually stopped so there was no new pipeline of new properties in up until recently.

Additionally, supply of homes relies of existing owners selling their current house. Certainly, there are sellers, but it’s clear that buyers outnumber sellers. I have my hypothesis on why sellers have been more hesitant to sell, but I’ll save that for another post.

Open Questions:

In the meantime, what does this mean for current buyers looking to participate in the real estate market? What is your prediction on future demand for property? When do you think the supply side issues will loosen? And how might the recent uptick in interest rates affect supply and demand?

It is a hot real estate market, is this a good time to invest in a rental property?

Because of my financial expertise and analytical bent combined with people’s wide ranging interest in real estate, I am regularly asked if it is a good time to buy Silicon Valley houses as an investment. There are just so many variables, that it is impossible to answer that question as an overarching conclusion. Everyone’s personal situation, financial style, and economic opinions are different. One’s personal situation absolutely factors into the answer to that question. For example, here is a list of questions you should to consider:

  1. What is your time horizon for holding the property? Silicon Valley will go through normal economic cycles like most areas. Silicon Valley is one of the world’s key technology and biotechnology centers with growing companies and constant flow of new start-up companies. Assuming you continue to believe the area remains important and attractive, the longer your time horizon, the more you will have the confidence to ride out any short term hiccups – particularly considering the recent low interest rates to finance a purchase.
  2. Do you currently own Bay Area real estate or other real estate? This speaks to diversification of your overall investment portfolio or your real estate portfolio and how much experience you have. This can be looked at in multiple ways. Some people like to have their real estate investments nearby where they live so there is property management scale and efficiencies, while others prefer to be spread out in different geographies for diversification.
  3. How much cash/capital do you have to invest in real estate? Bay area real estate is expensive relative to most of the U.S. The amount of capital you have available will help determine if you’ll be able to purchase the type of asset you want to accomplish your financial objectives and within the location you desire.
  4. How much cash do you have set aside to buy a rental property relative to your overall liquid assets? What other asset classes are you considering investing in? You may want to speak to a professional financial planner who can work with you to look at your overall portfolio situation and your financial goals. What are your viewpoints on future appreciation potential for those assets and how does that look in comparison to real estate?
  5. Would you manage the property yourself or hire a property manager? There are pros and cons to either. If you do it yourself, your returns may be better, but there is “management” – more hands on work involved. If you hire a property manager, that will be an incremental expense on your monthly cash flow.
  6. What part of the Bay Area are you considering? San Mateo is different from Cupertino which is different from Morgan Hill which is different from Oakland which is different from Tracy which is different from Pacific Heights in SF which is different from Sausalito.
  7. Are you considering Bay Area rental more as a yield play or for potential appreciation? The answer to this question will drive where in the Bay Area you should concentrate on purchasing. Yield is your near term cash flow in terms of your rents subtracting out all your expenses. Generally the stronger the neighborhood/house/city/etc., the lower your near term yield but higher the appreciation. On the other spectrum, you can get higher near term cash flow by going further away from major economic centers or in not as good neighborhoods, but the prospects from value appreciation is generally lower. Like everything, it’s a tradeoff. What makes sense for one person may be different for another.
  8. What is your viewpoint of the general economy locally? Similar and correlated to question 1 above. It is difficult to totally predict how the economy will fare, the stock market and/or real estate. Of course, if you believe we are in a bubble, you will be more likely to hold off. However, if you believe the market will continue to appreciate and/or rental units will continue to be in high demand, then you’ll be more motivated to buy sooner rather than later.
  9. Are you planning to finance the purchase or pay all cash? If you intend to get a mortgage, current interest rates will be a factor. 30 year fixed rates have increased between 50 to 100 basis points over the past couple months. It is historically still considered low. The lower you lock in an interest rate, the lower your monthly expense and better your cashflow.
  10. What is your tax situation? This factor may help drive both what type of property you may wish to invest in or whether to invest in real estate or not. Additionally, there could be some tax advantages to owning property in your overall financial portfolio as well.

There are even more considerations to factor in making how to proceed even more complex. Feel free to contact me, your CPA, and/or financial adviser if you wish to discuss your situation in more detail.

….Party like it’s 1999

In the mid-90’s, I moved to San Francisco after graduating from Columbia Business School in NYC for a fantastic job executing mergers and acquisitions for Bank of America. I was living in the Marina district of SF until 1999 when I bought my first house in the mid-Peninsula. The SF Bay Area in 1999 was a whirlwind of hot Internet companies getting major funding, going IPO and was one launch party after another – Prince’s lyric around “party like it’s 1999…” sure rang true. The real estate market along with the general frothiness of the economy saw rapid appreciation. After losing out on a couple of offers, I saw a nice 3 bedroom, 2 bathroom house in San Mateo – a small, starter home.  As I was debating how much over the list price to offer, I recall saying to many people that “this would be amongst the highest $ per square foot in the neighborhood”. After crunching a spreadsheet trying to best value the house and predict where housing prices were going to go, and comparing it with remaining a renter and putting my savings into the stock market…..I put the purchase into the following perspective that homeownership is as much a personal ‘lifestyle’ choice as it was an investment decision. Unlike investing in the stock market, one gets to enjoy the tangible product of a house and being able to call it home.

I got the house at 7% above the list price which was aggressive at the time. There is a concept called “winners curse”.  Sometimes when you win an auction in a competitive situation…rather than celebrating, one may be tempted to second guess the decision. In my situation, we quickly assimilated to the neighborhood and loved our house so we were happy with our new home even when the dot com bubble burst which temporarily affected real estate.

Since that time, I sold that house in 2006, and bought another home. During that approximately 7 years, the value increased so much even after a temporary post-dot com blip that my 1st house to this day remains one of my best financial investments ever – and we were able to enjoy the benefits of living in a house we owned. The moral of the story is that no one can predict the future with respect to the economy, the stock market, or housing prices. People ask me all the time what I believe the real estate market will do and I certainly have my thoughts. Even more specifically, the question of “should I buy/upgrade now or later?” is even a harder question to answer. That question can only be answered individually factoring in future opinions of housing values, interest rate dynamics, job situation, life stage, savings, and many other personal factors. In a rapidly changing real estate market (either appreciating or declining), having a long term perspective for owner-occupied buyers that the house is both for investment and for lifestyle purpose will make for a healthier mindset.  And in my situation in 1999 when I was unsure of either, it is a great feeling when both the investment and lifestyle choices work out well. To this day, I sometimes miss the days of 1999 when I would be invited to 2-3 Internet launch parties each week.