California Nightmare

I'm stumped.  Can't figure it out, never have figured it out, most likely never will figure it out.  It is California real estate. 

I have a sister, a good friend from high school, my investment advisor, and other colleagues that live in the San Francisco area.  I know nobody that lives in the Los Angeles area.  Well, a couple but one is so rich it doesn't matter and the other rents and two is not a very good statistical sample.  So we will concentrate on the Bay Area. 

My high school buddy, when asked about possible topics to cover, said "How about young people coming to grips with a million dollar mortgage?  A million dollar mortgage on a 1,600 square foot house, totally renovated but still 1,600 square feet for a million dollars.  And it sold."

First for the numbers.  A million dollar mortgage at 6.5% for thirty years is $6,320 a month.  Wow.  But get an ARM,  the realtor says.  Ok, a 5/1 is about 5.7% which is $5,804.  No, the bad voice whispers, go for interest only at 2.5% which makes a million dollar mortgage ONLY $3,951 a month. 

But no loan is going to be 2.5% for long and interest only loans are interest only for...I don't know.  Went to a couple of mortgage web sites and tried to find out but I'm probably not very good at this kind of thing or the answer is not readily available.  Probably a combination.  But one rule of finance--when you can't figure out the answer easily, you're not going to like the answer.   

So let's just say you pay interest only for a few years and then something happens.  The contract says now you have to pay full freight and you have to catch up.  Catch up means to make extra payments because you paid only interest before and now you have to start paying principal as well and to fit this all into a 30 year time horizon you have to pay additional prinicpal. 

And, by the way, interest rates are now at 9% for a 30 year conventional mortgage.  No way, you say, 9%, this ain't Argentina, you know.  Well, guess again because the historic rate is around 9%.  And don't fight history. 

Your payment is now $8,046 per month.  Not really, sorry.  The payment is actually $8,392 because you had the interest only for, let's assume five years, so now you have to pay back the loan in 25 years. 

Your payment went from $3,951 to $8,392.  Hope you got that big raise. 

And property taxes.  Proposition 13, which basically ruined the California school stystem, capped the property tax at 1% of assessed value.  So if you buy a house for a million dollars I guess your property tax is 1% of a million which is $10,000 a year so your monthly payment is now $9,225, or $110,704 a year.

Let's not even talk about insurance, or electricity, or water, or auto payments.  Or food.

But all is ok because you are living in San Francisco.

I told you at the beginning I don't understand this, this California real estate stuff.  I thought my sister was nuts for buying a house years ago in San Fransico, then nuts for selling that and buying a fixer upper in San Mateo and then nuts for buying a then rundown vacation home near Monteray and then...well, you get the picture.  And she made a lot of money.  Being a pretty good lawyer didn't hurt either.

Another argument for buying is that areas that have no more available land and are attractive to large numbers of inhabitants will continue to experience increases in house prices.  That may explain San Francisco.  It sure doesn't explain Las Vegas.

So, there you say, your sister made a lot of money so maybe that million dollar house will be worth two million in ten years, or next week.  And since there is no more available land, prices have to go up so buying makes sense.  Maybe.  I said I don't understand the market.  I admitted it.  What more do you want?

If you can afford a million dollar house, go for it. 

But if you can't, what do you do?  The traditional answers are rent, of course.  Or save up enough money so you can afford it.  If you do that then two things will happen.  The million dollar house will come down in price and you can afford it OR it will continue to go up in price and you will never afford it. 

Or you can move.

Maybe there is another answer out there.  The answer I always like is in Category 9-Buying A House Anytime For 30% Off.  I'm just not sure it applies to California.

I'm not sure that anything applies to California because I can't figure it out and that drives me nuts.  Not really because I don't live there.  But a problem without a solution drives me nuts so guess I have to remember what Sharon said--a problem without a solution is not a problem.  It is a fact. 

Comments

[Jay]

HI Uncle Bill

I can't figure it out either. I got lucky though bought in a "dip" paid only over $600k probably can sell for about $900k. Secret is - save your money - big down payment. Taxes are about 1.2% with all the local stuff. I have one friend paid $370 in '96 or so. Essentially tore it down 18 months ago and now has a mortgage of $800k (he just got a VP title). Another friend did an 80-10-10. Essentially paided 20% down, financed 80% on an interest only and then borrowed 10% back in a home equity loan. I don't know what they'll do. It's a 900sq ft house over $700k.

Who is buying. I think it is people that have successful businesses, use family money, save like crazy, or come from outside the U.S. Generally people want to live here (for some reason) and then have to buy.

Your option is to live in Tracy and drive. Look on the map and add an hour to your calculation. But that still costs you over $500k. Might as well pay the extra $300k in San Mateo and get a second job.

[the high school buddy]

Chris - exactly, and for a $1M house in Los Altos area we're paying $2200/mo, which is really upside down and tells me something is rotten here. We sold and went 'rental' last year. One friend explains it as CA being part of the Pacific Rim real estate market, and having just been to Tokyo and learning what things including housing and retail space cost THERE, it does ring true. SF Bay Area in CA is a bargain by comparison.

[Chris Yeh]

The amazing thing is that you can rent a $1,000,000 house for $2,500 a month.

Naturally, I rent.