NestEgg Home Buying: Bay Area Real Estate

Welcome

Buying a home is one of the largest and most important investment most people will ever make.  There's nothing like putting your thumbprint on a big mortgage to freak you out.  My wife and I recently went through process here in the Bay Area and learned quite a bit. 

We're both somewhat anal MBA's and were pretty analytical about the process.  I'm not saying that our approach is the right way buy your first house, but some of the info we uncovered might helpful.

Buying Your House (Link)

Selling Your House (Link)

Should I Buy a House in the Bay Area?--Running the Numbers

Should I buy a house or rent?  This is a pretty complicated decision.  It involves a variety of factors, one of which is the financial buy vs. rent decision.  Particularly in the Bay Area in communities such as Palo Alto, Menlo Park, and San Francisco, you'll want to run the numbers to make sure buying really makes sense.

Rent vs. Buy Analysis (Link to Model)

When we bought our house, I used the following the spreadsheet.  (blue numbers are variables you can customize to your situation).  If you're just starting and unsure of what values to use here's where you can find out:

Mortgage: Mortgage Link; Fixed or Adjustable Mortgage-Running the Numbers Link

House price: How Much Is a House in the Bay Area Going to Cost? Link

What Are Average Rents in the Bay Area? Bay Area Average Rent Stats Link, Craigslist

Let me know if you have any questions.

At a broader level the two components you should look at are:

Monthly cash flow: The attached model should help you get a sense of what your monthly cash flows might look like. In the Bay Area these are likely to be negative (even after factoring in not paying rent and the tax advantage). How negative cash flow can you take—Depends on your job situation. Smartmoney has a good calculator:

Appreciation: This is highly dependent on two things (a) your time frame (b) your location (c) interest rates. In a place like the Bay Area, this is a huge uncertainty. In the short term, no one knows how prices will act as interest rates go up and local economy recovers. 

The rule of thumb I used was: If the general area is extremely attractive and land is scarce in your neighborhood, as long as I was planning to hold for 5+ years I would be fine. There’s also research that suggests that cap rates do not directly fall in line with interest rates—spreads essentially compensate for interest rate change. This, however, is pretty academic and probably won’t give you much comfort.

Any Bay Area buyer should look at the Housing Bubble Blog just to make sure they are going in with their eyes wide open: Real Estate Bubble? Link

I think at the end of the day, as long as negative cash flows are easily bearable and you either plan to be in the area for a while or can easily rent out, you greatly reduce the risk of a huge loss. Further, if your neighborhood/ community is highly desirable and land is scarce, you should be able to expect appreciation over the long term.

Just avoid the disaster scenario which is where you will be forced to sell when you don’t want to.

If you can't afford an apartment on your own, or it just doesn't make sense based on the analysis, take a look at other options:  The Tenants in Common is a great way to get more value for your dollar. TIC Link

Finally, you should take into account other risks such as asbestos liability and earthquake risk.  These are hard to insure against and can cost you a bundle. Asbestos, Earthquakes and Other Risks Link

Real Estate Bubble-FDIC Article

Interesting article re: real estate bubble.  The net of it is that typically RE slows occur as prices stagnate (rather than decline) for long periods of time. 

"Busts within a five-year window of booms only occurred in 9 of the 54 boom episodes identified prior to 1998, or roughly 17 percent of all such events. "

Clearly, the lion's share of home-price booms have not ended in busts historically," the report states.

That leaves 45 booms that did not see a subsequent bust, according to the report"

Will this housing boom go bust?

FDIC investigates causes of house-price booms

Wednesday, February 16, 2005

By Jessica Swesey
Inman News

The rapid rise in U.S. home prices, increasing almost 50 percent overall over the last five years, has created a hot-button debate over whether Americans are staring at a possible home-price collapse. The growth in home prices over the past year surpasses any increase in the last 25 years, according to data released by the Office of Federal Housing Enterprise Oversight, which tracks average quarterly house-price changes. Some economists have raised an eye to this unprecedented run-up in prices, saying it may be cause for concern. In evaluating what the recent housing boom could mean for the nation's homeowners, the FDIC in a report titled, "U.S. Home Prices: Does Bust Always Follow Boom?" attempts to define housing booms and busts and considers what causes them. The FDIC finds that while home-price booms cannot sustain forever, not all booms end in busts. Sixty-three U.S. metropolitan areas experienced at least one housing boom since 1978, and 24 cities experienced more than one boom, according to the report. The FDIC defines a "boom" as a 30 percent or more increase in inflation-adjusted home prices during any three-year period. "Geographically, home-price booms have been concentrated in cities in California and the Northeast, which account for almost 70 percent of our 63 boom markets," the report states. The FDIC defines a "bust" as an inflation-adjusted price decline of 15 percent or more in five years. Using these criteria, some 21 cities were found to have experienced a housing bust at some point over the last 25 years. The report identifies two "major episodes" of home-price busts, the first taking place in the mid-1980s in the "oil patch" cities of Texas, Oklahoma, Louisiana and some other western states. This episode had some of the most severe price declines found in the report, with prices in one city falling by as much as 40 percent over a five-year period. The second incident of major price declines occurred in the Northeast and California in the early 1990s. The report notes that no cities are currently experiencing home-price busts. However, judging by historical events, we won't know for a few years whether the recent post-boom cities have safely avoided a bust. And according to the report's criteria for booms and busts, home-price booms "only infrequently" lead to busts. Busts within a five-year window of booms only occurred in 9 of the 54 boom episodes identified prior to 1998, or roughly 17 percent of all such events. "Clearly, the lion's share of home-price booms have not ended in busts historically," the report states. That leaves 45 booms that did not see a subsequent bust, according to the report. "In these cases, nominal home prices rose by an average of 2 percent per year during the five years after the boom ended. The equivalent figure for real home prices was a modest 2 percent per year decline," the report states. In 83 percent of the post-boom cities, prices continued to increase at a slower rate and any declines after inflation were modest, according to the report. "Home prices in these markets simply stagnated, or stalled out, following their booms rather than going bust." Housing booms that have ended in price busts were associated with localized economic stress, including recession and job loss. The FDIC noted two case studies to illustrate this point, including the case of the oil patch cities in the mid-'80s, and the busts seen in California and the Northeast in the early '90s. In the case of the oil patch cities, oil-producing areas of Texas, Oklahoma, Louisiana, Colorado, Wyoming and Alaska experienced an economic boom and population inflows while oil prices were rising in the late 1970s. That, in turn, caused the demand for housing to boom in these areas, increasing home prices. Then in 1980, when oil prices began a six-year decline, the local job markets and economies suffered. "This economic stress, in turn, weighed heavily on the housing markets in these cities. In the worst cases, nominal home prices fell by 40 percent and 33 percent in Lafayette, Louisiana, and Casper, Wyoming, respectively, between 1983 and 1988," the report states. In the case of California and the Northeast, similar elements of economic stress precipitated home-price busts, according to the report. A recession in the early 1990s, massive defense downsizing, a significant commercial real estate collapse, and a sharp downturn in population growth all were factors. Although the FDIC demonstrates that few metro-area housing booms have ended in busts historically, the report notes reasons to believe history may be an imperfect guide to today's situation. It notes changes in credit markets, such as the emergence of the subprime market, that are pushing homeowners and housing markets into uncharted territory. In addition, home buyers increasingly are taking advantage of higher-leverage mortgage products. In 2003, loans exceeding 80 percent of the home price accounted for almost one-third of all purchase mortgages. The practice of raising the total loan amount to a level very near the value of the home makes borrowers more likely to default if there is a housing market downturn. "An increased incidence of default and foreclosure could, in turn, contribute to downward pressure on home prices as distressed properties are liquidated by lenders. However, little is known as yet about the effects these credit-market changes might have on the dynamics of boom-bust cycles," the report states.

Real Estate Bubble? II-The Fed's View

Again, a real estate bust is unlikely.  Check out the attached report from the Federal Reserve Bank of New York.

McCarthy, Jonathan, and Richard W. Peach.  "Are Home Prices the Next 'Bubble'?"  FRBNY Economic Policy Review/Forthcoming.  June 2004

Download FRBNY.pdf

Mortgage Rates: What to Expect, Where to Find

As the model shows in my post on "running the numbers" ("link to Running the numbers"),  the mortgage rate you can get will greatly influence what you can afford and the attractiveness of buying. 

How do you find out what rate you can get?

When you're considering buying a house, the best proxy for a reasonable rate is Etrade's online mortgage pricing (link to etrade mortgages).  To be realistic, add 1/2 to 1/4 point to the rates you see online. This will give you a sense of what to put in the model

How do you find the best rate when you're ready to buy?

The best rate we found was through a mortgage broker.  Initially we thought a bank would give us a better rate because there wouldn't be a middle man to take a commission.  We were wrong. The bank branch effectively acts as a middle man and recieves a commission from the corporate bank.  In fact, Bofa and Wells Fargo were generally much higher than our mortgage broker.  Things to look for in a broker:

-Low overhead:  If the guy works out of his house, all the better--lower overhead, means he'll accept a smaller commission/ spread and thus you'll get a better rate.  Just make sure you know someone has worked with him before

-High volume: Lenders will actually give lower rates to brokers that deliver a lot of volume

What Product Type?

Brokers will have better rates on certain types of loans (e.g. 5 year ARM).  The brokers will tend to steer you to these types.  If this type of loan isn't what you're interested in, you should check with other brokers for your desired loan--you'll probably find a better rate.

To find out the best product type for you, we've created an analysis on the different loans (link)

What to Look for in A Loan

There's a lot understanding what is the right loan for you.  First, you should absolutely make sure that there is no-pre-payment penalty on your mortgage.  If miraculously interests drop or you need to sell your house earlier than expected, than these fees will kill you.  Some other issues to think through:

Fixed vs. Adjustable:

Most people signup for a long loan out of default.  Making the right choice on the length of the fixed period is dependent on:

1) how long you're planning to stay in your house: if you're moving in 5-10 years, why pay higher rates for a 30 year fixed?

2) your view on interest rates: If you think interest rates are going to decrease (not likely), than a shorter term fixed loan is good because you will refinance anyway.  If you think rates will increase, and depending on the answer to #1, a longer fixed period might make sense

3) Commonness:  For some reason, 3/1, 5/1 and 30 year fixed loans are most common in the Bay Area and prices are lower because of the competition.  Whereas 7/1, 10/1, and 15/1  are more uncommon and thus you pay a disproportionate premium

Take a look at our analysis: Fixed vs. Adjustable Mortgages--Running the Numbers (link)

Points

Points are like paying a fee for a lower interest rate.  Whether it makes sense to do this depends on #1 and #2 listed above and the length of your fixed period.

The only complication is that points can be deducted in the current tax year.  Thus, if you have a spike of income and need immediate deductions, then taking points and a lower interest rate may be more attractive.

Real Estate Bubble-Bay Area Housing Crash Blog

The flipside of the argument--Excerpts from the  The Housing Crash Blog.  I think it's valuable to go into a house purchase eyes-wide open.  There's truth in this blog, and as an economist it's hard argue with some the causations that Patrick lists.  That being said, you can protect yourself quite confidently with a large down payment (lowers your debt and mortgage payment) and an expectation to stay in your house for 5-10 years. 

I guess I'm biased having bought in Menlo Park in fall of 2003 which everyone was sure was just off the peak.  That being said, the exact house with a smaller lot and closer to a busy thorough fare just sold for 35% more than we paid. 

Check out Patrick's Blog: Housing Crash Bog

San Francisco Bay Area Housing Crash Continues

Prices are down every month for Nov, Dec, Jan, and Feb. Here are dates, volumes, and prices from the Palo Alto Weekly for every sale in Atherton, East Palo Alto, Los Altos, Los Altos Hills, Menlo Park, Mountain View, Palo Alto, Portola Valley, Redwood City, Stanford, and Woodside, as reported by California REsource, which supposedly gets info from the County Recorder's Office: PA Weekly of 06 Nov 2004 has 78 sales, median price $851,000 PA Weekly of 03 Dec 2004 has 63 sales, median price $750,000 PA Weekly of 28 Jan 2005 has 57 sales, median price $720,000 PA Weekly of 11 Feb 2005 has 63 sales, median price $710,000 Palo Alto 2003 median price was reported in the Palo Alto Weekly of 6 Oct 2004 on page 15 as $1.07 million. Counting 89 sales at random throughout 2004, the Palo Alto median was $830,000 in 2004, a loss of 18%. (You can also go directly to Housing Crash Blog and reference link collection.) Interest rates going back up. When rates go from 5% to 7%, that's a 40% increase in the amount of interest a buyer has to pay. House prices must drop proportionately to compensate. The majority of loans are now adjustable, not fixed. This means a big hit to the finances of many owners every time interest rates go up, and this will only get worse as more adjustable rate mortgages (ARMs) get adjusted upward. From CBS.MarketWatch.com on 13 Jan 2005: "There is a double whammy inherent in these ARMs," said Frank Nothaft, chief economist for Freddie Mac. "At the end of fixed-rate period you face a hike in interest rates and you have to start paying principal. There is more default risk in these interest-only ARMs than in a fully amortizing product." Massive job loss. More than 300,000 jobs are gone from Bay Area in the last 4 years. This is the worst percentage drop in the last 60 years. It's worse than Detroit car problems or Houston's oil bust. People without jobs do not buy houses and owners without jobs may lose the house they are in. Even the threat of losing a job inhibits house purchases. We are still in a serious and prolonged recession. Continued on Patick's Housing Crash Blog

Assessing What's Available and How Much House You Can Afford

One of the most time consuming (and some times deflating) part of the home buying process is getting a sense for what's available, and what to expect for your money.  I'll add more in depth notes shortly, but a good place to start (for Bay Area properties) is either link below.  I think it's important to do your own leg work first before engaging a real estate broker.  A real estate broker can give you a rough sense of different neighborhoods and where to focus, but I think you should spend a couple of weekends out on your own visiting open houses.  Many people go to open houses with a broker which is certainly easier.  However, intentionally or not, the houses brokers will choose for you to view can greatly skew your expections on availability, price, and desireability.  I think it's best for you to start on your own and form an unbiased base of facts first.

What's it Going to Cost Me?:  Here are some good links to websites that will help you assess the average prices of communities you are looking at:

1) City by City Real Estate Report: I don't vouch for the services of this broker, but she put together a pretty interesting report on houses that recently sold by community: Palo Alto, Los Altos, Los Altos Hills, Menlo Park, Mountain View, Cupertino, Sunnyvale

2) Link to a Database of Home Sales:  You can search by town, street, and year for sale prices.  This is particularly interesting because it will give you real closing prices versus asking prices (which may be significantly higher or lower than the eventual sale pric

3) Link to Multiple Listing Service:  You can search for currently available houses by many different parameters

4) Craigslist Mapping Software (Link):   This will show you Craigslist for sale listings plotted against Google Maps--Very handy to understand neighborhood layouts and to plan your open house tour on Saturday

What to Look for in a House (Link)

Defining What You Need (Link)

Other Factors: In familiarizing yourself with what's available, it's also important to take in some other important factors:

1) Earthquake Risk (link): I break it down in the linked posting

2) Asbestos Risk (link)

Buying a House in a Good School District

Finding the right house, starts with finding the right town and neighborhood. You might know that you want to be within a general area, but not know what specific town or neighborhood is best for you.  Even if you don't have kids, one thing you should consider is the relevant school district.  Particularly in the Bay Area, the value of homes under $2M is highly driven by the quality of the school district.  Here's a great way to check and to get a sense for the quality of the school system. 

Note:  After you enter your address, then pick the specific school district, at the bottom of the page is a link to the "school report."  If you click on that link, you can get detailed run downs of school systems.  Just don't fill out the contact information, otherwise you will be hounded.

School Districts Link

Defining Your Wants and Needs

Buying a house is a long term investment.  Make sure that the house you buy fits your goals and lifestyle.  For example, my wife and I love to entertain.  Only after moving in, did we discover how incredibly frustrating to us that we have no formal dining room.  As a result, I think you should really take the time to figure out what you need and want in a house.  I've put together a workstream below that should help you define what you're looking for

Town/ Neighborhood Factors   

• School system                                  

• Prestige                                 

• Strength of community                                 

• Proximity to current or future employment

• Resale value                         

• Building/ zoning restrictions

• Access to highways/ thorough fairs, shopping and services, public transportation

• Public amenities (parks, pools, libraries)

• Local taxes   

Lifestyle Factors

• What are your functional need (e.g. family plans, storage needs--# cars, etc.)

• What do you enjoy doing? (e.g hobbies, entertaining, gardening, running etc.   

• What are must haves in your new home?                                              

What are the Specific House Requirements?

Location

Openness and flexibility of floor plan

No. of bedrooms                                           

No. of bathrooms                                         

Living room                                        

Dining room                                      

Family room                                      

Updated kitchen                               

Finished basement                                      

Air conditioning                                

Updated heating                                           

Updated wiring                                  

Updated plumbing                                        

Fireplace                               

Storage space                                  

Garage                                  

Big yard                                  

Mature landscaping                                     

Deck/patio                                        

Swimming pool                                

Disability access                                           

Move-in condition                                         

Room to add on                               

Quality schools                                  

View                                      

Avoiding Capital Gains on Your House (1031-121)

Based on new tax loop holes, when you sell your house you can now:

1) Take $500K (assuming married couple) of gains tax free

2) Roll-over your capital gains above $500K in a tax deferred basis into another investment property. 

Here's a series of links with a WSJ article and an analysis of the tax code: Link to Article

Asbestos and Other Risks

Last thing you want to do when buying a house is to expose your family and loved ones to asbestos.  Exposure to Asbestos can cause lung and other various forms of cancer.  The bad news is that it rarely curable.  The good news is that mesothelioma abestos injury is 100% preventable.

Below is a blog that outlines who is most at risk, how to evaluate a house for asbestos, and what to do if asbestos was used as a building material in your house.

How to Evaluate Your House for Asbestos (link)

Shorting Real Estate in UK

If you're going to put 50%+ or your networth in down payment and take on a huge mortgage, wouldn't it be great if you could hedge against a bubble. 

Here's a article on shorting real estate in London:

SECTION: Features; Money; 1

LENGTH: 949 words

HEADLINE: High-risk gamblers bet the house on it

BYLINE: Joe Morgan and Alex Hawkes

BODY:

SPREAD-BETTING used to be largely the preserve of thrillseeking City traders, taking punts on anything from the ups and downs in the FTSE 100 index of leading shares to fluctuations in oil prices, or Kevin Keegan's tenure as Manchester City manager.

But this highly risky form of gambling, where you "buy" or "sell" the movement of a market or an index, has recently gained a new following among people that do not have a view on the outlook for Brent Crude, but who do feel they can back their hunches when it comes to property.

Spread-betting on the housing market is a growing craze, with most players speculating that prices in

London

and the South East are set to slide. This is known as "shorting the market". The recent wave of betting was sparked by recent warnings of falls in the property market.

The new property spread-betting gang includes women who would never venture inside a high street bookmaker's shop: you can place your spread-bets online or over the phone. Another attraction is that any profits are tax-free, supposing that you make a profit. The appeal of property market spread-betting also lies in the ability to make money out of bricks and mortar without hassle.

The price to pay for this convenience is that spread- betters who get it wrong can find themselves facing unlimited losses, for which there is no compensation.

IG Index, the spread-betting firm, prices its property market bets using data from the Halifax House Price Survey. Punters can bet on the prices of houses nationally, or in a specific city or region, and have the option of capping their losses.

The firm is predicting that the average price of a

London

house will fall 5.6 per cent from £244,600 in June to £230,900 next June. But some contrarian gamblers are determined to defy the property pessimists by taking a punt on the market in the capital remaining resilient. IG does remain confident that the Scottish market will stay buoyant, with average prices climbing from £95,700 to £102,400 by next September, a rise of 7 per cent.

As we explain below, the property market is just one area in an ever increasing range of spread-betting opportunites. All are complex and dangerous. Anyone who cannot afford to lose money should read and marvel, but stay away.

Currencies Currency trading is becoming more popular, according to such firms as Finspreads and Capital Spreads. Simon Denham, of Capital Spreads, says: "Spread-betting on currencies is as close as private investors can get to trading the inter-bank rates used by financial institutions."

Further information can be found on websites such as onewaybet.com.

Binary bets Although technically not a spread-bet, binary bets are the latest craze among clients at IG Index. Structured to give gamblers the chance to profit from short-term market fluctuations, a binary bet is typically placed on the probability of movements in markets such as the FTSE 100 index. This may sound simple, but the workings of the binary bet system are anything but.

IG Index will take a view on how likely it is that the FTSE 100 will move in a certain direction. Odds of 50 per cent imply that the market will stay flat. If the firm offers a 90 per cent chance that the index will rise, this means that it is likely that the index will close higher. Say the FTSE 100 has been 11 points up all day, suggesting that the market will close at a higher level than the previous day, IG Index could decide that there is a chance of between 6 per cent and 9 per cent that the index will fall and close at a lower level. If you believe that the firm is wrong, and the index will fall, you buy at 9 per cent.

If, after you have made your bet, the FTSE 100 falls, IG will change its odds. The firm now believes there is a 40 per cent chance of the index finishing lower than the previous day. Your profits will derive from the difference between the original 9 per cent chance and the new 40 per cent chance.

US

stocks Spread-betters have been looking at US shares for opportunities in volatile stocks. Google, the internet search engine, has topped the list of must-have stocks after its flotation on Nasdaq. Will Armitage, of IG Index, believes that many spread-betters realised the potential of US stocks when they saw investors shorting Google shares in the unofficial grey market before the company's flotation last month.

Cantor Index, another spread-betting firm, says that the recent upturn of the S&P 500 and Dow Jones industrial average has buoyed gamblers, with Wal-Mart, Sears and Nike all attracting attention.

* Spread-betters gambling on stock markets "buy" or "sell" at a bookie's spread of possible future levels of the market.

* If you buy, and the market goes up by more than the bookmaker's top "buy" price, you win your stake multiplied by the difference between that price and the final level.

* Spread-betters on the housing market predict how much more or less expensive houses will be at a future date.

* If house prices rise by less than the bookmaker's "buy" price, or fall more, and you bought in the hope that prices would move above the "buy" price, you lose the difference between the price you paid and the final price. Every thousand pounds you are out is multiplied by your stake.

Bay Area Prices Rise 20%

Good article in some part to counter the bubble theory.  While US employment trends, interests rates, etc. point to unfavorable dynamics, the Bay Area in particular is driven by a wider pool of demand.

Bay Area home prices increase 20%, sales skyrocket;

Low interest rates, overseas buyers lift market even higher

SOURCE: Chronicle Staff Writer

BYLINE: Kelly Zito

BODY:

The unrelenting Bay Area real estate market kicked off 2005 in high gear, as home prices in January soared 20 percent from a year ago and sales reached the highest level for the month since 1989.

Though the start of the year is typically the slowest time in the real estate market, abnormally strong demand, relatively short supply of properties and an influx of international buyers pushed the median price for a single-family home in the nine counties to $556,000, just below the record of $560,000 set in November but a whopping 20 percent more than the year-ago price of $463,000. It was the strongest year-over-year appreciation rate in four years.

The housing market's continued robust performance defies well-worn predictions of a slowdown. Following the technology meltdown and the loss of hundreds of thousands of jobs, many economists expected the region's real estate sector to suffer. But after a decline in sales of high-end homes in 2001, the market rebounded -- and then some -- driven by low interest rates, consumers' reluctance to plow money into stocks and newly flush trade-up buyers.

Last month's sales count of 7,509 was the highest for any January in at least 16 years, said DataQuick, a La Jolla (

San Diego

County

) real estate market research firm.

"I'm surprised," said DataQuick researcher John Karevoll. "I keep thinking demand will ease back, but it hasn't."

January sales

January's sales total, though 5.7 percent higher than last January's count, was down 32 percent from December's unusually strong sales tally. But Karevoll noted that a decline of about 30 percent between December and January is typical.

The median price for a single-family home has hit a record in nine of the past twelve months, according to DataQuick's research, which is based on filings with county recorders' offices and represents sales initiated 30 to 60 days prior.

In

San Francisco

, a typical single-family home now runs about $713,000, up a stunning 23 percent over last January's $580,000.

Marin

County

had the highest median at $850,000;

Solano

County

had the lowest at $389,000. The median price for a Bay Area condo was $410,000, up 21.3 percent year over year. By contrast, the nationwide median price for an existing detached home is just under $190,000. (The median is the midpoint; half of sales were below and half were above.)

Still, Karevoll -- who noted that January and February statistics are somewhat atypical and can't be used to predict trends -- believes higher interest rates could take some starch out of the market by making monthly mortgage payments less affordable. The typical Bay Area buyer committed to a monthly mortgage payment of $2,344 in January, up from $1,940 one year ago but below the peak of $2,450 in June.

Though interest rates have remained low in recent weeks, many economists expect rates to trend up through the year, with the 30-year fixed rising from its current 5.57 percent to about 6.5 percent by December.

Even if rates do rise and put pressure on home prices here, local real estate agents believe desirable areas will remain just that -- desirable. They point to the fact that attractive properties in good locations fetch many offers and sell for well over the listing price. Part of that stems from what real estate agents describe as a slim inventory of homes for sale.

During the weekly real estate agents' tour of newly listed homes on Tuesday, Jan Small showed a one-bedroom

Pacific

Heights

condo listed for $729,000. Small, an agent with McGuire Real Estate, said a "normal" tour list is about 60 pages long. This week's was 18.

"I've been in this business 16 years and I've never seen so little inventory," Small said, adding that a

Bernal

Heights

cottage recently garnered 40 offers. "I feel sorry for the poor buyers."

Overseas buyers

For overseas buyers, however, Bay Area prices are bargains. And those buyers may be playing a key role in bolstering the market.

Lee Julien, an agent at Herth Real Estate who Tuesday was showing a Hayes Valley Victorian listed for $1.2 million, said easily 10 percent of his buyers are from outside the

United States

.

"I can't tell you how many buyers I have from

Singapore

or

London

," Julien said. "They come here and they look at a house like this and they say, 'This in

London

would cost $4.2 million.' "

Other observers are more skeptical of the market's health.

In a study of 99 metropolitan areas, Richard DeKaser, chief economist of Cleveland-based bank

National City

, found that 20 markets had housing "bubblettes" and may be vulnerable to price corrections.

According to his research, which compensated for differences in income, interest rates, population and historical price trends, DeKaser said home prices in

San Francisco

were "overvalued" by 30 percent. Prices in

Stockton

are 34 percent higher than they should be, and 32 percent too high in

Los Angeles

, he said.

"While overvaluation in home prices presents a risk of future declines, these risks may well go unfulfilled," DeKaser said in his report last week. "The true test of today's premiums in these markets will be the economic environment, especially incomes and interest rates, in the years ahead."

Tenants In Common Option

There's adage in real estate investing:  You make money by buying big, dividing, and selling small.  As per this real estate adage, you get a lot more for your money if you buy big.  Tenants in Common is a good way of doing this.

If you're looking to buy an apartment San Francisco, one of the ways to get the most for your money is to buy a large apartment building with other friends and investors in a structure called a Tenants in Common. 

I have a group of four friends who bought a small apartment building in Portrero hill that had three 2 bed, 2 bath apartments and a basement studio for $650,000 in 2003.  Even if you don't count the basement studio which they could rent out, there's no way you could buy a 2bd/2ba apartment in Portero for $225,000.  In addition, they got to control who their neighbors were and were able to afford an apartment with a good yard out back. 

Overview of Types of Real Estate Ownership Link

Risks: LInk to Good Article on Risks of TIC

When TICs Go Bad

Go Article About the Risks of a TIC

HEADLINE:

Overlapping Lives;

When TICs go bad, and when they don't

SOURCE: Special to SF Gate

BYLINE: Carol Lloyd

BODY:
"She wants all these things," my friend whispers in her kitchen. "And I don't want to give them to her. Before, it was different. We were getting along.

"But now," she says with a shudder, "it's driving me crazy. I can't believe I've gotten myself into this."

If this sounds like just another episode of "The L Word," tamp down your imaginations: There's no angry lover stomping around the hallway half naked. My friend lives in her apartment all by herself; nevertheless, she still fears the wrong someone might hear her.

Why? This isn't a torrid romance gone wrong, but a far more banal, if equally tortured, scenario: a tenancy-in-common (TIC) gone bad.

Entering into a TIC is an increasingly popular method of co-ownership in which two or more parties buy a single piece of property and draw up a contract that apportions a percentage of ownership to each party. It might consist of shared rooms in a giant Victorian or a community of yurts in the mountains, but, in the Bay Area market, where single-family homes sell at an absurd premium, TIC units tend to be bought, sold or occupied as a percentage of an overall building. And, as partners in TICs, co-owners are on the same loans together.

As the demand for properties available at the bottom of the market -- be they located in Bayview or Belmont -- has intensified, the TIC, once the ugly step sibling of the condo, has moved out of the margins and into the mainstream. TICs now comprise about 25 to 30 percent of "Category 2" of San Francisco's Multiple Listing Service (which also includes condos and co-ops) -- a far proportion than a decade ago, when they were fairly rare.

Another measurement of the increased prevalence of TICs is the number of condo conversions, in which TIC units are turned into condominiums: More than 700 condo conversions occur in San Francisco each year, reflecting only a small percentage of all TICs citywide. To support the interests of this burgeoning population of homeowners, new organizations and businesses have sprung up. The San Francisco Tenants in Common Coalition, for example, was formed to lobby city hall to ease condo-conversion laws, and City Living operates a matchmaking service for TIC partners.

According to Andrew Sirkin, a San Francisco attorney largely responsible for popularizing the once obscure legal arrangement, TICs are also becoming more prevalent outside the Bay Area in regions where home prices have far outstripped the budgets of ordinary first-time buyers: He has written TIC contracts for intentional communities in the Sierra Nevada foothills, Laguna Beach apartment buildings and vacation homes in Buenos Aires and at Lake Tahoe.



Despite the rise of the TIC, many home buyers still fear them, and many real estate agents openly despise them. "I'll do anything in my power to steer my clients away," says Alex Clark of Hill & Co. Real Estate. "There are so many things that can go wrong, pre- and postsale." He attributes the increased popularity of TIC to "sheer desperation" on the part of first-time home buyers.



And when someone posted a query about TICs on craigslist's housing forum, the board was overrun with discouraging words.

"Why do you want to get into bed financially with people you do not know?" wrote one poster. "Even if you are forced to buy a smaller place, I personally would shy away from a TIC... I've heard horror stories."

Of course, I've heard anecdotes, too, and I tried mightily to get some of the folks who are the sources of these accounts to go on the record with their tales of domestic woe, but all were afraid of the ramifications of further alienating their TIC partners. One woman I know had a falling out with her downstairs partner when the other woman accepted a date from their condo-conversion contractor, igniting a bit of romantic rivalry that cooled to a litigious cold war over who was responsible for repairing the dilapidated stairs, the noisy garage door, the uncarpeted second-story stairs. Their chief problem was that the two women, whose friendship was close but not long standing, had failed to draw up a TIC contract -- and, so, when push came to shove, their emotions muddied their shaky legal relationship.

In another case, a couple's relationship with their TIC partners foundered when they began having children and the sweet patter of little feet turned into an insomniac's nightmare for their downstairs neighbors. The members of another family I heard about found themselves virtually hostages in their home ownership when their partner made it clear he wouldn't cooperate with their intention to sell their unit, because he wanted to buy it at a better price. The fear that he would sabotage their plans essentially kept then in a state of limbo.

For the most part, however, the TIC folks I interviewed had few complaints about their partners. For one happy family, the shared ownership had fostered a sense of community that resulted in combined meals and child care.

As a partner in a TIC for a four-unit building for the past seven years myself, I've had a lot of experiences that fly in the face of less felicitous TIC relationships. We partnered with a stranger, and there was never a problem. Our partner let us put solar panels on the roof, and we let him take over the garden and turn it into an urban oasis. When we decided to move but keep a couple rental units, we easily sold our flat (without an agent) to a nice woman who fit with our partner's quiet lifestyle. In the process, I discovered that, when they work well, TICs actually lighten the responsibilities of home ownership -- we split expenses and share the work of finding a plumber, choosing paint colors and doing mortgage and tax paperwork.



So, the TIC relationship need not be fraught with risk, complication and bad blood. Andrew Sirkin, who over the last three decades has turned writing TIC contracts into a lucrative cottage industry, says that "well under 5 percent" of people involved in the TIC partnerships he arranges seek legal counsel for conflicts and that the vast majority of the complaints revolve around mundane issues like noise and pet excrement, stuff that could just as well arise in condos or co-ops. He adds that realization of the great fear -- that a partner might not pay his or her portion of the mortgage -- is extremely rare. "The theoretical risks -- those of shared financing -- generally don't materialize into conflicts, as long as they have an agreement in place," he says. (Indeed, in an appreciating market, if one TIC partner defaults, the others will become the owners and will only profit by the first partner's misfortune.)

Sirkin does offer words of caution for potential TIC partners, though: "I tell all my clients that they need to be extra considerate about their neighbors. If there is something that is bothering them, then speak up right away and don't let it fester and build inner resentment."

Many first-time home buyers say they would enter into a TIC only with someone they know, but Sirkin contends that this comment points out a common misconception about TICs. "Contrary to most people's assumptions, TIC partnerships among friends lead to far more conflicts than those between strangers," he says. "And the larger the building, the fewer conflicts or problems."

Still, these observations don't mean TICs are for everyone. They are complicated.

For one thing, they are considered politically incorrect for turning rent-controlled housing stock into ownership housing, so tenant advocates have attempted -- so far unsuccessfully -- to pass laws that make them more risky. Moreover, buying inexpensive TIC units may take a moral toll on you, because the only way you can occupy them is to turn current tenants out with an owner-move-in eviction.

Also, the condo-conversion laws, besides being rapidly subject to change according to political winds, are a tangle that even real estate agents can't keep track of. In an oversimplified nutshell: Two-unit buildings that have been 50 percent owner occupied for one year may undergo condo conversion, but three- to six-unit buildings can enter the condo lottery only after 51 percent of the units have been owner occupied for three years. And odds on winning the lottery are slim -- it usually takes six years. Finally, the whole matter of starting a TIC is a bigger logistical hassle than purchasing a condo because it involves setting up a system for coordinating property taxes, mortgages and building repairs. But these complications, by themselves, amount not to "horror stories" but to a different way of owning a home.

In part because of such complications, condos -- buildings or developments legally divided into separate pieces of property wherein owners obtain their own financing -- are still the first choice of dwelling after single-family homes. Once thought to be a risky concept, the condo has become the standard model of new home ownership across the state -- an estimated 80 percent of new home-ownership developments are now built as condos, and even many single-family-home developments now are legally conceived of as condominiums with shared property, as well as rights and responsibilities established by homeowner associations and covenants, conditions and restriction (CCR) agreements.

But in this market, even with all the complications, the rise in popularity of the TIC makes perfect sense. Entering into a TIC remains one of the few ways to buy a still habitable -- and, dare I say it, damn nice -- place for around $500,000. On a recent TIC search on craigslist, for example, I found a plethora of offerings, including everything from an investor looking for TIC partners for a large apartment building in the Richmond with units priced around $375,000 to a large two-bedroom Victorian flat in the Panhandle with a huge yard and parking for $499,500 to a swank two-bedroom unit on Telegraph Hill four blocks from the Bay for $540,000.

Although I won't contend that these prices qualify as affordable, they're not in the same ballpark as the costs found in the single-family-home market. Case in point: a one-bedroom cottage in Bernal Heights (with a tiny "second bedroom" without drywall accessible only from the outside on the basement level) sold last week for $801,000. When single-family homes are still turning otherwise sane people into bidding maniacs, it's no wonder that the American dream, that symbol of free-standing independence, is morphing into something that overlaps our lives into an arrangement that looks almost communal.

Carol Lloyd is currently at work on a book about Bay Area real estate. She teaches a class on buying your first home in the Bay Area, and another class based on her best-selling career counseling book for creative people, "Creating a Life Worth Living." For more information, email her at surreal@sfgate.com. THIS STORY RAN ONLY ON SF GATE

WSJ on Shorting Real Estate Indexes

Now if they could only do this on a regional basis and create an index for the Bay Area.

Capital: New Futures Could Help Folks Insure Against Economic Risks

By David Wessel. Wall Street Journal. (Eastern edition).

New York

,

N.Y.

: Sep 5, 2002. pg. A.2

BEGINNING NEXT MONTH, speculators bored with trading mortgages, credit-card receivables and heating-oil futures will be able to bet directly on the number of Americans who have jobs.

At first, this sounds like a bad idea, one that strips away all subterfuge and truly turns Wall Street into a betting parlor. Imagine the bearish trader celebrating as wire services report that

U.S.

employers cut their payrolls in September. The more layoffs, the more he makes. He cheers. Cue the angry mobs.

Although individual investors won't be able to participate just yet, this may be a step toward something more socially useful: a way for ordinary Americans to insure against risks such as falling home prices, a sinking economy or a resurgence of inflation.

"The sharing of economic risk is one of society's deepest concerns, and rightly so,"

Yale

University

economist Robert Shiller says. "To the extent that inequality is created by pure luck, it's not only painful, but a shame." Sharing harm from bad luck is the reason for life insurance and government insurance against temporary unemployment. Global financial giants offer big companies ways to hedge the risks of unwelcome turns in interest rates, currencies and commodity prices. So why, Mr. Shiller asked in a 1993 book, doesn't our increasingly sophisticated market system allow more ordinary folks to share their largest economic risks?

The short answer: No one institution is wealthy enough to shoulder these risks, and most early attempts to develop markets to spread the risks have flopped. The Coffee, Sugar and Cocoa Exchange's attempt to establish a futures market in the consumer-price index, essentially insurance against inflation, died in the early 1980s as a result of lack of interest. The London Futures and Options Exchange's experiment with betting on real-estate prices collapsed in the early 1990s amid reports that false trades had inflated trading volume.

A few innovations succeeded. The

U.S.

government now sells inflation insurance in the form of Treasury bonds that pay more if inflation rises. Property insurers sell homeowners' policies that automatically increase coverage with rising construction costs. A few communities have followed

Chicago

in offering insurance against declining house prices to encourage home buying in changing neighborhoods.

Growing anxiety about the riskiness of economic life and the potency of information technology are fueling intriguing new innovations. In

London

, where signs of a housing-price bubble are proliferating, two firms, City Index and IG Index, are taking bets on housing prices. They offer a way to speculate on real estate without owning anything, and a way to hedge against declines in the value of one's house; trading volumes are still light.

Mr. Shiller, enjoying new public attention because of his prescient warnings about the stock market, is pressing the cause. He has a new book on all this coming out in March and has started a company that is trying to get stock exchanges and investment bankers to trade real-estate price indexes.

IN THIS LATEST EXPERIMENT, Goldman Sachs Group Inc. and Deutsche Bank AG next month will begin selling what they call "economic derivatives." The first auction, set for Oct. 1, will allow hedge funds and other institutions -- no individual investors welcome -- to place bets on whether the Labor Department will report on Oct. 4 that payrolls fell by 150,000 workers in September or rose by 250,000 workers, or any increment of 50,000 in between. Think the market is much too gloomy about the economy? Then put down $6.30 and get back $1 for every 1,000 jobs added in September above a threshold of 150,000 jobs. If the number comes in below that, you lose your money; if it comes in above 156,300 jobs, you get back more than you put down.

The actual payoff will depend on what other players are putting down. Just as at a horse track, the odds change as bets are placed. At a horse track, you put down $5, and the payoff depends on the odds. In this economics-derivatives market, the payoff is fixed and the sum you put down reflects the changing odds. The whole operation is a sophisticated form of parimutuel betting, developed by a

New York

start-up called Longitude Inc. There isn't any limit on the size of the bet that can be placed, but there also isn't a guarantee that every order will be completely filled.

In ordinary futures markets, an investor places a bet, a market-maker such as Goldman takes the other side and then looks for a buyer. In this market, there isn't any need for a market-maker. Like the owners of a racetrack, Goldman and Deutsche Bank make their money by taking a slice of the action. The backers hope this structure will lure more players and help the market grow, unlike previous failed attempts. Later this year, Goldman and Deutsche Bank plan to take bets on the

U.S.

government's monthly tally of

U.S.

retail sales, the monthly manufacturers' purchasing-managers index and

Germany

's IFO business-confidence index. Their primary interest isn't in Mr. Shiller's grand social goals, but in making money by offering big companies new ways to hedge, perhaps selling a big retailer a way to cushion the pain to profits if consumer spending sags in the next six months.

But Mr. Shiller argues such new markets often begin by serving sophisticated traders who provide liquidity and a base for future growth. Only later will insurance companies and other retail financial institutions create insurance policies that ordinary folks can use. A labor union, he suggests, might someday bargain for insurance that pays off if the national -- or, someday, the regional -- hiring picture sours. Or property insurers might offer, along with fire, flood and theft insurance, policies that pay off if your house turns out to be worth less than you paid for it.

Human beings tend to minimize the risks in their lives; insurance is often a hard sell. But over time, the coupling of Wall Street's savvy and lust for gambling with the marketing prowess of American finance could make life less painful for the unlucky among us.

Protecting Your Downside New Hedging Indexes

Here's a slightly dated article on new instruments that Robert Shiller, an economist out of Yale, is creating to hedge against real estate price declines.  The indexes will be listed on the Chicago Mercantile exchange and rumor is that LA will be the first test market.  Can't wait until they create one for the Bay Area!

Another set of derivative products linked to home prices was introduced in October by HedgeStreet, which specializes in online trading of pint-sized contracts it calls ''hedgelets" for each of six cities: New York, Miami, Chicago, Los Angeles, San Francisco and San Diego.  However, these "bets" are only for $10 which, unless I'm missing something, make them all but worthless

======================================

December 12, 2004 Sunday Times

IF you have owned a home for several years, you may be sitting on a sizable increase in equity. And if you are worried that the run-up in housing prices can't last much longer, you may think the only choice is to call a broker, rent a moving van and head for the (less expensive) hills.

But through an increasing number of new investments, you may be able to limit future erosion of your home's value.

Macro Securities Research, a company affiliated with Robert J. Shiller, the Yale economist, has reached an agreement with the Chicago Mercantile Exchange to list pairs of derivative instruments that are essentially index funds linked to home prices in certain markets. One instrument in each pair will rise as its market index rises; the other will rise as the same index falls. That will let investors bet on the direction of housing prices. Similar, but less sensitive, vehicles are being offered by HedgeStreet, a firm in San Mateo, Calif., that offers small-scale derivatives speculation online.

For homeowners looking for alternatives to the risks and complications of derivatives trading, there are also insurance policies that pay out if home prices fall, but they are only available in certain areas, and the conditions for collecting are highly restrictive.

In fact, none of these approaches are likely to provide anything close to a perfect hedge, eliminating all risk of loss. And while the options available to nervous homeowners are growing in number and sophistication, some advisers warn that they may provide minimal protection from the vicissitudes of the real estate market.

But other, simpler strategies may help you prepare for a softening of the market, they add. One is to avoid variable-rate mortgages before any serious increase in interest rates -- an event regarded as a possible trigger for a reversal in home prices.

Macro Securities hopes to list its instruments in Chicago before such a reversal, but the exchange's announcement this month was short on details, like a starting date. Mr. Shiller, the company's chief economist, said that his securities would track home price indexes in cities yet to be chosen, although strong candidates include New York, Los Angeles and Las Vegas, he said.

The minimum investment for the securities and the amount of leverage built into them are also not yet known. A one-percentage-point move in the index, he said, may produce a change of two percent or three percent in the value of the securities.

An important feature of the Macro securities, he said, is that they will come in twos -- one moving in tandem with the index and the other in the opposite direction. Having a single index fund would require a hedger to sell short, raising the theoretical prospect of an infinite loss. (That could happen only if housing prices rose to infinity -- not a far-fetched idea to many people who are looking to buy a co-op in Manhattan.)

Another set of derivative products linked to home prices was introduced in October by HedgeStreet, which specializes in online trading of pint-sized contracts it calls ''hedgelets.'' Each is a yes-or-no wager that a housing index will be in a certain range on a given date within three months. After that period, the contracts expire, and losing bets are worthless.

There are three residential property bets, representing percentage moves in an index whose level may be higher, lower or even with the recent trend in home price movements, for each of six cities: New York, Miami, Chicago, Los Angeles, San Francisco and San Diego.

But the value of each contract is a paltry $10, and they are infrequently traded, at best, so unless you live in a matchbox, it would be difficult -- and very expensive -- to buy enough of them to provide a practical hedge.

Russell Andersson, a vice president of HedgeStreet, said that the products were new and were still seeking an audience. He conceded that their three-month life span was too fleeting for use by many homeowners and said that HedgeStreet was planning to introduce vehicles that would trade much like futures contracts and last for one and three years.

''With a combination of these two products, you can hedge out very aggressive short-term movements as well as longer-term movements,'' Mr. Andersson said.

Mr. Shiller says his approach to defending against price declines is meant to be useful even for people with modest incomes. ''We're looking for a vehicle with widespread acceptance,'' he said. The device of two separate funds is one way to gain it, in his opinion. ''It means there is no loss beyond the initial outlay, no margin calls,'' he said.

That may not be true if leverage is built into the instruments, as Mr. Shiller envisions. But homeowners looking for further protection may consider borrowing against their equity, knowing that it will rise enough to make up any decrease in the fund's value, he said. Should home prices fall, the value of the fund that is inversely correlated to the housing market will rise, mitigating the loss.

''Volatile markets are increasingly becoming a part of our lives,'' Mr. Shiller added. ''The home market itself is becoming more volatile. We're in the biggest real estate bubble in history, I believe.

''We haven't seen a swing down yet, but it could be coming,'' he warned. ''There are people with big houses and big mortgages who are going to feel the pinch.''

Jonathan Golub, a strategist at J.P. Morgan Fleming Asset Management in New York, agreed. The culprit in a downturn, he believes, will be big mortgages, more than big houses. Variable-rate mortgages, in particular, could be a problem.

When interest rates are low, buyers can afford more house for the same monthly payment, said Mr. Golub, who himself is a renter in Manhattan. He said that any holder of a variable-rate mortgage must understand that ''if interest rates drop, the house is worth more to me, and vice versa; if rates rise, I'm toast.''

Burned on both sides, too, because the higher mortgage payments tend to depress home prices. ''You get hit with a double whammy,'' he said. ''The cost of carrying goes up and the value goes down.''

NATIONWIDE, he noted, home prices rose 7 percent a year, on average, from 1999 to 2003, roughly double the rate for rental prices. Over the previous 15 years, the two rose more or less in tandem, with one outpacing the other for a while before the pattern reversed.

Mr. Golub says he expects home prices to hold up until mortgage rates rise further, so there is time for homeowners to prepare. His advice is to ''lock down that fixed-rate mortgage.''

As for the hedging vehicles being offered, he has doubts about their utility for most current and prospective homeowners. ''The adviser who would sell them won't be able to understand them,'' he said. ''They're the kind of thing you see pushed at the top of a market.''

For someone considering buying a home now, ''the smart thing to do is rent,'' he said.

''It probably does not make sense for someone who owns a home and plans to stay there to sell it and rent it back,'' he added. ''But what probably makes sense is for that first-time homebuyer or guy planning to retire to Florida to rent instead of buy.''



URL: http://www.nytimes.com

The Earthquake Risk

The big risk that you can't hedge against in the Bay Area is the earthquake risk.  In San Francisco, earthquake insurance is unavailable or prohibitively expensive.  In the pennisula, some townhouses/ house association associations can provide earthquake insurance, but most don't. 

Here's some good information from the Dept. of Geological Engineering & Sciences, Michigan Technological University about earthquakes:

1) Where to buy to minmize earthquake dangers: Earthquake hazard map link

2) How to assess the sturdiness of a house:  Earthquake house link

3) Earthquake insurance: Earthquake insurance link

4) How to make your house safer:  Earthquake safety link

Stay or Sell

As a home owner in the Bay Area, I ask myself that question 2.5 times a day. I can't help you with the personal reasons to sell or stay, but in terms of the financial analysis here are some of the things I think about.  Obviously, I haven't come up with any silver bullets, but perhaps some thoughts might help.  Some factors I would consider:  I'll try to put the relevant factors below in a spreadsheet model, so you can model out different scenarios.

How much is my house really worth?:  See my page on getting comparables. (Link).  Then actually visit the most recent and directly applicable comp.  You should know what gain you can expect

View of the market going forward: This is the toughest nut to crack.  A lot pundits, academics, and investors think their is a significant bubble (Crash blog link), yet prices are still rising (Link).  With such disparity in views, I don't think there's clear answer.  So how do you come to gripes with this uncertainty? Some thoughts

1)  My guess is that price growth rates over a 3-5 year period will not go negative.  Look at the Bubble Section of the blog.  Likewise, if you look at house pricing history in San Francisco since 1982, there has not been a meaningful decline (link to graph)

2)  In a decline, pricing will be highly dependent on location and type of house.  My guess is that entry-level single family residences in attractive, heavily developed communities such as San Francisco proper, Menlo Park, and Palo Alto will be fine.  There's too little land, and too much demand.

3) Run sensitivies:  If you can't come up with a single appreciation number, run a range to understand the implication of different growth rates

Time Horizon:  Similar to buying a house, selling a house astutely requires a long time horizon.  If you know you will need to sell on a short horizon (either because of job change or financial need), you might as well sell now to lock-in your gain and not risk the downside of a crash.  Why risk a big gain for a couple more months of appreciation?

Tax implications:  If the house has been your primary residence for over two years, you can take the capital gain of $250K, $500K for married couples, tax free

Cash flow:  Would renting have cash flow advantages to owning?  (See link for full analysis)

Alternative investment opportunities:  If you were to sell your house, what return could you expect from alternatives such as stocks or bonds (linked to T-bill yields)?  Remember, you need to compare the returns on an after tax basis

Put all these factors together into a spreadsheet, mix well, and analyze (Link to Spreadsheet coming soon)

Amazingly Prices are Still Rising, but Slowing

Amazingly, prices are still rising, but the price increase are slowing.  Confusing?  Read the full article below

Prices of lower-end homes in the Bay Area appreciated at a healthy clip in the fourth quarter but rose more slowly than prices in the central and southern parts of the state, according to a federal study that tracks repeat sales of such properties.

The quarterly survey of 245 U.S. metropolitan areas by the regulator of mortgage giants Fannie Mae and Freddie Mac found prices in the San Francisco- San Mateo-Redwood City area rose 13.8 percent between the fourth quarter of 2003 and the fourth quarter of 2004.

Prices increased 13 percent in the San Jose-Sunnyvale-Santa Clara area, 16 percent in Oakland-Fremont-Hayward, 17.7 percent in Santa Rosa-Petaluma and 20.5 percent in Vallejo-Fairfield in the same period.

Link to Full Article

Great New Home Buying Tool

The old cliche: "location, location, location" is key to home buying or any real estate investing.  Values change by neighborhood, street, even within 100 yards of proximity to a major road, park, etc. So, when you see houses on MLS and are trying to understand the going rate, it's really important to quickly understand each listings' location.  My wife did this in 2003 by manually typing a listing address into Yahoo Maps.  I just found a better tool that I think will save you a lot of time (at least for Craigslist listings).  Hopefully they'll be able to integrate into MLS:

Link to Home Listing Mapping Tool

What to Look for In a House

Home buying is a personal decision and people have different tastes, needs, etc.   However, from a purely financial perspective, here are some things you want to think about:

*Location, Location, Location:  Stupid cliche, but true.  So start with the town and work down to identifying neighborhoods that suit you.  If you're conservative stick with the "branded neighborhoods" (eg. in Palo Alto or Menlo Park:  Professorville, Baron Park, Allied Arts, etc).  Snobby folks generally have money and will always pay a premium. 

*Townhouse/ condo vs house:  This is a little different in the city, but generally in the suburbs, houses always appreciate faster and are worth more per square foot.  As an entry level buyer a lot of times you're face with buying a sweet new townhouse vs. an 50 year house.  The townhouse may be more fun, but the house will always out appreciate the townhouse.  The big difference--ownership and ability to build on the land.  Which leads to...

*Land: Always go for the big plot size.  We got our house assessed after we bought--70% of the value of house was in the land.  Buying a small house on a big plot in a good neighborhood is the way to go.  The math is as follows.  It's about a $150-200 per square foot to build a new house.  Houses in the Bay Area are priced in part by the potential to build a big fat new house on top of the plot of land. 

*Zoning:  Likewise, find out about the zoning restrictions (which are gnarly in many Bay Area suburbs).  This will affect how big a house you can build on the lot and other important issues.  Also, things like an R2 zoning always add intrinsic value, because you can subdivide and build two units on your lot.   

*School districts: Good schools are in short supply in CA, so towns with good schools hold their value.  Be careful in determining exactly what school district a given house is in.  Districts vary by town and sometimes by neighborhood.  Further, there are un-incorporated districts that don't have guaranteed spots at the local schools.  For more on this, check out:  School link

*Inter-neighborhood dynamics:  Although it's  blow to the ego, always be the smallest, oldest house in the neighborhood.  Your house value is partly driven by your neighborhood. You can renovate your own house, but you can't force your neighborhoods to do the same.

*Special bonds or taxes:  Some neighborhoods have raised special bonds or taxes that vary by neighborhood.  Don't get surprised by your first property tax bill.  Find out from town hall about these bonds.

*Noise & Nuisance: After getting outbid on 10 houses, it's real easy to start ignoring things like road noise, traffic patterns, etc. Don't.  You can't change these things and they will affect your enjoyment and ultimately your resale value.

*Parks, downtown areas within walkable distances

*Freeway access

Buffett and Munger on the Real Estate Bubble

Because there are so many of them, I shifted articles on the Bay Area real estate market and home mortgage interest rates to seperate blogs:  Bay Area Real Estate Watch (link) and Home Mortgage Watch (link).  However, I have so much respect for Buffett, I thought I'd also post it here:

Buffett: "A lot of the psychological well being of the American public comes from how well they've done with their house over the years. If indeed there's been a bubble, and it's pricked at some point, the net effect on Berkshire might well be positive [because the company's financial strength would allow it to buy real-estate-related businesses at bargain prices]....

"Certainly at the high end of the real estate market in some areas, you've seen extraordinary movement.... People go crazy in economics periodically, in all kinds of ways. Residential housing has different behavioral characteristics, simply because people live there. But when you get prices increasing faster than the underlying costs, sometimes there can be pretty serious consequences."

Munger: "You have a real asset-price bubble in places like parts of California and the suburbs of Washington, D.C."

Buffett: "I recently sold a house in Laguna for $3.5 million. It was on about 2,000 square feet of land, maybe a twentieth of an acre, and the house might cost about $500,000 if you wanted to replace it. So the land sold for something like $60 million an acre."

Munger: "I know someone who lives next door to what you would actually call a fairly modest house that just sold for $17 million. There are some very extreme housing price bubbles going on."

Full Article: http://money.cnn.com/2005/05/01/news/fortune500/buffett_talks/#realestate

Cracking the Real Estate Code

Great article in Wired on the conflicted incentives of a real estate broker on the sales side.

It's one of the biggest bets you can place on another person: You hire a real estate agent to sell your home.

She sizes up its charms, snaps some pictures, sets the price, writes a seductive ad, shows the house aggressively, negotiates the offers, and sees the deal through to the end. Sure, it's a lot of work, but she's getting a nice cut. On the sale of a $300,000 house, you'll typically pay a 6 percent agent fee of $18,000. That's a lot of money. But you tell yourself that you never could have sold the house for $300,000 on your own. The agent knew how to - what's that phrase she used? - "maximize the house's value." She got you top dollar, right?

A real estate agent is every bit the expert. She is better informed than you about your home's worth, the state of the housing market, even the buyer's frame of mind. You depend on her for this information.

As the world has grown more specialized, countless such experts have made themselves similarly indispensable. Doctors, lawyers, contractors, auto mechanics: They all enjoy informational advantage. And they use that advantage to help you.

Right?

Information can be a beacon, or information can be a cudgel; it depends on who wields it and how. In any transaction, it's common for one party to have better information than the other. In the parlance of economists, this is information asymmetry. There's value in asymmetry; it's the reason why someone, such as a consumer, will pay someone else, an expert, for his knowledge.

Of course, sometimes an expert might manipulate his advantage for his own benefit. If your doctor suggests that you have an angioplasty - even though current research suggests that angioplasty often does little to prevent heart attacks - your first thought won't likely be that the doctor is using his informational advantage to make a few thousand dollars for himself or his buddy. But as David Hillis, an interventional cardiologist at the University of Texas Southwestern Medical Center in Dallas, explained to The New York Times, a doctor may have the same economic incentives as a car salesman or a funeral director or a mutual fund manager: "If you're an invasive cardiologist and Joe Smith, the local internist, is sending you patients, and if you tell them they don't need the procedure, pretty soon Joe Smith doesn't send patients anymore."

Or consider these findings of a 1996 medical study: Obstetricians in areas with declining birthrates are much more likely to perform cesarean section deliveries than obstetricians in growing areas - suggesting that when business is tough, doctors may try to ring up more expensive procedures.

The Internet, of course, is all about smoothing over these asymmetries; in one industry after another, from life insurance to used cars, the Web has eliminated the expert's upper hand by giving once-exclusive information to the online masses. But some industries have been slow to change - real estate among them.

The best way to observe information asymmetry at work is to measure how an expert treats you versus how he performs the same service for himself. Real estate provides the perfect opportunity, since housing sales are a matter of public record, and real estate agents often do sell their own homes. Recent data covering the sale of nearly 100,000 houses in suburban Chicago show that more than 3,000 of those houses were owned by agents.

Before plunging into the data, a question: What is the agent's incentive when selling her own home? Simple: to make the best deal possible. Presumably, this is also her incentive when selling your home; after all, her commission is based on the sale price. And so your incentive and the agent's incentive would seem to be nicely aligned. But commissions aren't as simple as they seem. First of all, a 6 percent commission is typically split between the seller's agent and the buyer's. Each agent then kicks back half of her take to her agency. Which means that only 1.5 percent of the purchase price goes directly into your agent's pocket.

So on the sale of your $300,000 house, her personal take of the $18,000 commission is $4,500. Still not bad, you say. But what if the house was worth more than $300,000? What if, with a little more effort and patience, she could have sold it for $310,000? After the commission, that puts an additional $9,400 in your pocket. Yet the agent's additional share - her personal 1.5 percent - is a mere $150. So maybe your incentives aren't aligned after all. Is the agent willing to put out all that extra time and energy for just $150?

There's one way to find out: measure the difference between the sales data for houses that belong to real estate agents themselves and the houses they sold on behalf of clients. Using the information from those 100,000 Chicago homes, and controlling for any number of variables - location, age and quality of the house, aesthetics, and so on - it turns out an agent keeps her own home on the market an average of 10 days longer and sells it for an extra 3-plus percent, or $10,000 on a $300,000 house. When she sells her own house, an agent holds out for the best offer; when she sells yours, she pushes you to take the first decent offer that comes along. Like a stockbroker churning commissions, she wants to make deals and make them fast. Why not? Her share of a better offer - $150 - is too puny an incentive to encourage her to do otherwise. So her job is to convince you that a $300,000 offer is in fact very good, even generous, and one that only a fool would refuse.

Full Article:  http://www.wired.com/wired/archive/13.05/realestate.html?pg=1&topic=realestate&topic_set=

Fixed vs. Adjustable Mortgage--Running the Numbers

Should I lock-in the low interest rates with a long term fixed rate mortgage?  Or should I take a lower cost 3 year or 5 year adjustable mortgage rate?  It all depends.  It depends primarily on how long you plan to be in the house (or refinance your loan), and it depends on what your view on the future mortgage rates to be. 

To help you decide, I've put together a mortgage interest estimate spreadsheet.  Assumptions are in blue.  To use this spreadsheet, populate the current rates on the different mortgage products by going to the following link.  In terms of the floating rate, most loans are based off a spread + LIBOR. I estimated this "floating rate" by assuming that the FED was going to continue to raise rates at 1/4 point each quarter, or 1 point a year (see mortgage watch link) for a couple years before the rate leveled out at 7% going forward. 

The lowest or least expensive mortgage is highlighted in bold with a yellow background.  Note that products such as the 7 year adjustable are never the least expensive product for this case of assumptions. 

Click to download the spreadsheet here: Download mortgage_interest_estimator.xls

A Good Landscaper

We've tried a bunch of different landscaping companies, and by the far the most reliable has been Mauricio's Landscaping Service.  Mauricio has been a super responsive landscaper and guy I want to support.  Right after we bought the house and we were a little cash constrained, Mauricio was really helpful in telling me which projects I could do myself (and how) and always tried to keep his projects as cost efficient as possible.  He also planted a bed of flowers pro-bono for our wedding rehearsal dinner banquet.  He now manages work for my sister and parents (both in Palo Alto).

I helped Mauricio build a corporate website (www.mauricioslandscaping.com).  I obviously need to work on my basic webdesign skills, but the website should give you contact information and background on his company.

The "Google Effect" on Bay Area Real Estate Prices

The Google Effect--the effect of 1,000 newly minted milllionaires created by the Google IPO-- is often bandied around in casual conversations and the media.  However, I never saw a really thoughtful analysis of its potential impact on local real estate pricing.  Just came across one.  Good stuff in the report linked below. Looks like all Google's disrupting more than just the technology markets.

Analysis of the "Google Effect" on Bay Area Housing

New Rent vs. Buy Model

A friend is going through the rent vs. buy question, so I did a revamp of my rent vs. buy analysis.

Some good new features I added:

1) Sensitivity tables at the bottom: Basically, what is the "true cost of ownership of home ownership under different appreciation and house price scenarios

2) I incorporated the ceiling on interest deductibility (max deductible mortgage is $1m, actually $1.1M if you use an incremental $100K home equity line)

3) I incorporated the various opportunity costs on the down payment and the ceiling on tax free capital gains.

Hope this is helpful and look forward to your comments

New Rent vs. Buy Analysis (Link to Model)