It is hard to persuade some in California that they live in cities that are still very much in housing bubbles. We can’t paint with a giant brush across the state because some markets have adjusted and have adjusted significantly to counter any imbalances in the market including the Inland Empire. Yet when the mainstream media talks about the “housing bubble” popping it is usually referred to in the past tense. Many that live in places like Culver City or Pasadena think that the storm has pass and endless home price appreciation is only a few sunny days away. We can’t blame them. It is a fairy tale that has a mass appeal. It lured an entire nation into an epic housing mania. It is hard to reverse this psychology when you still have many people paying inflated prices. But only because someone will buy today at some inflated price doesn’t mean that trend has staying power.

Today we are going to look at two case examples right here in Southern California between a bubble city and one that has popped. Today we salute you Culver City with our Real Homes of Genius Award.

Buy at $925,000 or rent at $3,795?

It is rare to find any city in the United States that didn’t have a taste of the housing bubble. Some dabbled in it. Some indulged in it. California as a state gorged itself on the housing mania and is now paying the price of relying too much on a bubble for the source of economic growth. Some cities especially many in the Inland Empire have corrected and are showing signs of more affordable home prices. Yet affordability also relates to the local area economy. Take a look at Detroit and home prices there. They are cheap but for a reason and this can be explained by economics. If you ask people in Culver City to justify home prices you will get some emotional response that has very little connection to market fundamentals.

For example, throughout the country a really quick and dirty rule of thumb is a home is a good deal if it sells for 100 times the monthly rental rate. For example, a home that rents out for $1,500/per month is a good deal at $150,000 or less. As investors, you look for these kinds of disequilibrium. A good investor would look for an area where rents were high relative to home prices. For example a home that would rent for $2,000 selling at $150,000. These deals were hard to find prior to the bubble and once real estate got juiced, many forgot about the basic fundamentals. We are slowly going back to them.

Take for example this Culver City home:

This is a really nice home in a good area. The home is currently listed at $925,000. This is a 4 bedrooms and 2.5 baths home listed at 2,341 square feet. This place was built in 1950. Now we are seeing more of this trend where homes are listed for sale but also for rent. Let us look at the rent details:

The monthly rental rate is $3,795. You might look up at the home sale listing and see the monthly payment at $3,766. Keep in mind this assumption is based on a 20% down payment ($185,000) and a 4.56 percent 30 year fixed mortgage. That is not going to happen so this figure is much too optimistic. I’ve talked with colleagues in the industry that have stated jumbo loans are between 5.5 and 6 percent with near perfect credit and a 20 percent down payment. Keep in mind the estimated monthly payment does not include taxes and insurance that will run you another $1,000. So let us run the numbers once again:

Down payment: $185,000 (20%)

Mortgage: $740,000

PITI: $5,201 (30 year fixed at 5.5%)

The carrying cost is very different from the “best case” scenario presented online. If you were to buy this home with a 20 percent down payment, your monthly net cost out of pocket to service all your home needs would be over $5,200. Your rental cost is $3,795 a difference of $1,405. By our simple rule of thumb, this home price is too high. Culver City still has many homes valued at bubble level prices. Now if we used the simple rule of thumb we would do the following:

$3,795 x 100 = $379,500

This seems so far off from the current asking price that some will laugh. Yet in some areas of California this kind of metric is appearing. Let us take a look at Hemet for example.

Here we have a 4 bedroom and 3 baths home listed at 2,689 square feet. The place is currently up for rent for $1,400 per month. If we use our quick and dirty analysis we would find:

$1,400 x 100 = $140,000

Think we can find a similar place for close to this price point? Yes we can:

We find on the same street a very comparable home. The above is listed as having 6 bedrooms and 2 baths and is listed at 2,389 feet. It is a short sale and is currently listed at $150,000. This place is actually selling for less than the sale price in 2000 ($173,500). Hemet is 96 miles away from Culver City but they might as well be worlds apart in terms of real estate valuations. It would be one thing if the market in Culver City was able to support a $9,250 per month rent on the above place. But clearly it cannot. Why? The market is saturated with rentals and prices are just too high

“(Lanser OC Register) Veteran Orange County apartment owner and manager Ray Maggi says this the current rental market “is the worst I’ve ever seen” for landlords.

Maggi, a past president of the Apartment Association of Orange County, says in his three decades in the rental game hasn’t seen as harsh a mix of falling rents, empty apartments and rising costs.

Contrary to popular belief, we don’t make money with 90% occupancy,” he says of current historically high counts of empty units across the county that run roughly at 10 percent vacancy.

Maggi notes a 96-unit complex he’s owned in Buena Park since 1978 as a good market gauge. Before this slump, he never started a month at this complex with more than 10 vacancies — and now he’s got 14.

“Lots of hard times,” he says explaining why it’s so hard to fill up apartments.

High unemployment means that many prospective tenants are either doubled up with roommates or have moved in with family members. With landlords fighting for a limited number of customers, the winner is the renter. Last year, landlords usually offered free months of rent as lures for new tenants. This year, Maggi says, more landlords have simply slashed rents to meet tight-fisted renters who have plenty of choice.

Making matters worse for property owners is that a growing number of tenants aren’t keeping up with payments. Charge-offs have roughly tripled to nearly 3 percent of rents due.

“It’s a tough road out there,” Maggi says.”

The rental market overall is tight across Southern California. These hybrid homes for sale/rental are good indicators of any market price imbalance. The sale price is the optimal dream point while the actual market rent is really what someone can support in the current market. Culver City has enormous disequilibrium. We don’t even need to look out of state to see a more sensible market. What justifies this massive price discrepancy? Better schools? If that is the issue then just rent in this area. Sense of homeownership? Is it really worth this big of a price gap? Clearly these kinds of bubbles don’t last long. The $925,000 home sold for $185,000 back in 1993. The rate of inflation from California from 1993 to 2010 is 53 percent according to the California Department of Finance. As we have seen through many studies, real estate over the long run tracks the general rate of inflation. So if that is the case, this home would have a value of $283,000! But if the place can yield $3,795 a month it clearly has a value of at least the 100 time multiple. You can judge for yourself whether some cities are in bubbles. I think the data speaks rather clearly. It is a great time to rent.

Today we salute you Culver City with our Real Homes of Genius Award.

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