Friday, August 18, 2006

Downtown Luxury Condo at the Meridian #1408

The Meridian is downtown's original luxury tower. Unit #1408 is the first property from Meridian to join the list.

This property was purchased in January of this year and relisted shortly thereafter.

Is this a flipper investment gone awry?

Price cut history:
Price Increased: 04/13/06 -- $735,000 to $739,500
Price Reduced: 05/18/06 -- $739,500 to $699,000
Price Reduced: 06/14/06 -- $699,000 to $675,000
Price Reduced: 08/11/06 -- $675,000 to $650,000

Type: Listed on MLS(#066030286)

Resale Price: $650,000
Cost: $687,000

Loss@6% Sales Expenses: $76,000
Loss%: 11.06%

Purchase Date: 01/19/2006
Holding Period: 7 months and counting...

Purchase Details: view


Sven said...

(I posted the on one other blog, but it took so long to write, that I felt like sharing it on here too ;)

I look at it like this. Back in the middle of the year 2000, everyone was touting that the stock market had finally bottomed out after these record setting years.

We all know what happened next.

Thing is, when a market is very strong (like housing was 2 years ago), people invest in it merely because it's strong. Let's look at the numbers 40% of the home buyers last year were spec buyers (investors). I personally knew a lot of people that were scrambling to purchase places so they could get into the "flipper" mindset and make money.

Let's get to the fundamentals. The purpose of a property is to have a place to live (or visit). This is like saying that the purpose of a stock is to own a piece of a corporation so you can share in its earnings and wealth. The best comparison for this is to look at rent vs mortgage. (and not some crazy neg-am or interest only mortgage, a simple 30-year mortgage). Historically, rents and mortgages used to be very close together. The concept here is that if you can buy a place, you might pay a little more to eventually own it. In the last 5 years, the gap has widened incredibly between the two numbers, and, if housing prices were to stay the same and rent inflation (which is supposedly down this last month) was to stay at last months rates (higher), it would take over 12 years before rents would catch up with mortgage payments on a median house in the county. The gap in an area like downtown is even larger.

Assuming prices don't go down anymore (which they probably will), it is still dramatically better to simply rent and put the difference in a money market. The only thing that would offset this is a continued significant increase in prices, which I just don't see happening any time soon. (most optimists say it will stay flat for a long time, the pessimists say it will go down). Here's how to calculate the difference:

Assumptions (you can adjust these assumptions based on what you believe the values really should be):
1. You purchase a condo downtown for $900,000.
2. Rent for the same condo would be about: $2600 a month (It might even be less, rents aren't that bad, I live in a great place for under 2k)
3. You get a fixed 30 year mortgage at 6.5%, 100% financed), this gives you a mortgage payment of $5,688. This is low because 20% of that financing would probably be a 2nd mortgage at a higher rate.
4. After 10 years, you decide that you want to sell it and see how you would have fared in comparison.
5. Prop tax of 1,000 a month and HOA of 500 a month. (these are lower than they would really be for a 900k place)
6. Housing prices do not change during that period (although many believe that it would go down and some think there would be a small increase, you can do the calculation yourself with whatever increase/decrease you think would happen)

(after 10 years)
Buy the condo:
You have accumulated about $128,000 in equity from principle payments. You have paid out $672,000 in mortgage payments and $180,000 in HOA and tax. Let's assume you are in the 25% tax bracket so we get the tax savings of $136,000 in there. So, it cost you $716,000 total to have $128,000 in equity. So, a $588,000 loss (or $58,000 a year to live in that place). You take a risk that your income will go down and you'll have to sell/foreclose or that the market in San Diego might go down.

Rent the condo:
$312,000 paid in rent, $360,000 deposited (the difference so that your cash out is the same if you rent or buy).

You put the difference of 3,088 a month in CD's earnings 5.5% (100% secured, no chance that you will lose your money, naturally you could go for a low risk mutual fund and possibly get closer to 10%, but that's not guaranteed). This compounds monthly and leaves you with $492,000 after the 10 year period. So, it cost $672,000 and you have $492,000 at the end. This means it only cost you $180,000 or $18,000 a year to be a renter with the same cash out of your pocket and a LOT less risk.

In other words, unless the market is poised for explosive growth again, cd interest rates crumble, or rents skyrocket, you are MUCH better off just renting and investing the difference. A lot less risk, a lot less hassle, a lot more freedom, and a likely to have a lot more money at the end of this.

Mr. Brightside said...

I think the rent versus buy ratio is seriously out of whack for first time home buyers.

In my view this relationship is a major indicator that prices will change, be it real prices for real estate will go down or rents have to go up. Since rents aren't goosed by cheap and easy money flowing from the bond market like the purchase market is there simply isn't the same driving force behind rents.

In other words prices will come down to bring this ratio back inline.

I also have to wonder about rents going down too, given the economy is slowing, the supply bubble in housing and the predictable consumer response to reduced real estate purchasing in a real price declining market there will likely be more units on the rental market than previously expected.


Mr. Brightside

Sven said...

Yeah, I noticed myself when I looked for a new place a few months ago that you just seemed to get a lot more for your money renting than about 2 years ago. A lot of conversions have gone back to renting, a lot of people left to live in a place they were buying, and we have a lot more units to live in now.

The only annoying thing lately has been the 100's of "Open House" signs you trip over trying to go anywhere.

Mark in San Diego said...

Sven - yes, very good post - I always invest in fundamentals, be it stocks, bonds, or housing. I did buy a rental condo in 1992 in the Bay Area, because I could get $1000 a month rent, and paid out only $138K for a 2bd/2ba. That is 38% over the fundamental 100 times rent = price of rental. . .but today, I rent a condo for $1500 here in SD that the owner paid 400K for. . .by standard investment standards, it should be selling for 150K to 200K (let's be kind and give it 50K for the "sunshine" factor of SD). Like internet stocks selling at 300 times earnings (if any earnings) prices need to come done to historic standards. I use Lucent Technology LU as a good indication - selling at $2.30 a share - during the internet bubble, it was the darling selling at $70 a share.