Southern California Real Estate

In The Kelly Letter, I focus almost exclusively on stock market investing. Recently, however, I’ve supplied subscribers with a five-part series on investing in property as a way to diversify outside of the stock market. The following, Part Three, was sent to subscribers on May 19:

I spent this week in southern California. I’m writing to you from Los Angeles, where the weather has been cloudy in the mornings and sunny later in the day.

That pattern seems to be one that’s held for real estate here as well. The housing market has supposedly been primed for a crash since 2004. Rather than crashing, though, prices have been rising. Every homeowner I spoke with says they expect the value of their home to begin shrinking any day now, and that they’ve been expecting that for more than two years.

There’s a disconnect between what the media is reporting and what’s actually happening. It’s as if they’ve run the “collapsing bubble” story so many times that they believe it themselves and keep ignoring numbers to report it again. Meanwhile, the real estate buyer sees it nowhere.

Just this week, the L.A. Times reported that “Home Sales Hint at Longer Slump Ahead,” as if a slump were already underway. The paper reported that home sales in April “plunged to a 12-year low, suggesting that the region’s real estate slump is far from over.”

Yet, in the same story, we find evidence that no slump has even begun. “Prices were up overall, rising 6.1% from a year earlier to a median of $505,000,” wrote Times Staff Writer Annette Haddad.

Huh? Rising prices do not happen in a slump. Prices go down in a slump. When was the last time you read about the stock market that “the Dow slumped to a new high this week”? Never. Prices “slump” lower and “surge” higher.

Nonetheless, housing commentators stuck to their scripts. “Demand is not there and supply is greater; prices are bound to go down,” said Esmael Adibi, an economist at Chapman University in Orange. “No question that the bottom of the market hasn’t hit yet.”

I should hope not, considering that it’s still going up! He should be saying that we’ve hit the top of the market or that we haven’t seen the top yet, but he’s talking about the bottom. I tell you, if this is a housing market crash, I can’t wait for the boom times.

As ever, real world research cuts through the haze.

For years, I’ve eyed a community called Toluca Lake for potential bargains. It’s a modestly upscale neighborhood nestled against the hills below Universal Studios, within the city limits of both North Hollywood and Burbank. A lot of show business executives live there. From most of the homes of interest to me, residents can walk to the Lakeside Golf Club. The streets on the way are flanked by gorgeous flowerbeds, reaching palms, and a variety of home styles. It’s a quiet, pleasant place to live, and has easy access to freeways for getting around the big city.

Back in 1999, when I bought the rental home I wrote about last week, homes in Toluca Lake went for $400k to $500k. This week, I returned to the area and walked around looking for an abundance of “For Sale” signs and evidence of people doing whatever it takes to sell. After all, if what the media has been reporting for the past few years is true, we should be seeing signs of fallout.

There are no more signs than before. Prices are triple what they were in 1999. The best indicator, however, stared at me from beside a showcase home on the corner of two main streets.

The house next to it had dirt and dead grass where the rolling green lawn should have been. The paint was peeling. The front window was bent inward in some places and curved outward in others. There was rust on the front step handrail. Parts of the concrete driveway were pockmarked. This was the proverbial lump of coal in a bag of diamonds.

I have nothing against lumps of coal among diamonds. In fact, I’m a collector of such. It’s better to own the worst looking place in an area because that one’s value will be lifted by the appeal of the others. There was a “For Sale” sign pounded into the packed dirt of the front yard, so I called the realtor from in front of the house.

Remember, I don’t use realtors when buying or selling real estate, but when a sign with a phone number hangs in front of a house of interest, calling is the fastest way to hard numbers.

He told me that the house was listed at $1.3 million, but that it was already in escrow. It had been on the market for only a week, and a bidding war among buyers sent the final price to “well over the asking, which is often the case.”

A bidding war? A final price higher than the asking? These are not factors consistent with a buyer’s market, and a buyer’s market is what we should be finding after years of oft-predicted housing collapse. Remember what economist Esmael Adibi of Chapman University told the L.A. Times earlier in the week: “Demand is not there and supply is greater; prices are bound to go down.” Really? A bidding war and a price paid higher than list show a great deal of demand and no excess of supply.

“What should I expect to pay for, say, a 2,000-square-foot home in Toluca Lake?” I asked the realtor. Around $1.5 million, but up to $2 million if it’s fairly new and well kept. The realtor was happy to tell me about the new place he’s listing along the lake for $8 million.

Perhaps this was a case of Toluca Lake defying the odds, I thought. Maybe the affluent execs at Disney and Warner could keep their areas flush by buying and selling to each other on the backs of lucrative bonuses while the rest of the real estate market floundered.

Not true. Lower income neighborhoods have become what Toluca Lake used to be. You can’t move into Eagle Rock between Glendale and Pasadena for much less than $500k now, and it looks nothing at all like the Toluca Lake of that price range just eight short years ago. Eagle Rock is a collection of small houses scattered on hillsides with old cars parked in front and portable basketball hoops wheeled onto streets. It’s in a process of gentrification, but to my eye nowhere near justifying current asking prices.

Yet, Eagle Rock is the new Toluca Lake, while Toluca Lake is the new San Marino, and San Marino would be the new set for Lifestyles of the Rich and Famous, if it still aired. You can’t touch San Marino’s grassy, tree-lined paradise unless you just signed a commercial contract with Nike or write books about a wizard kid named Harry. In all fairness, San Marino has always been as green with money as it is with grass, but it’s a whole lot greener than it used to be.

The point is that neighborhoods considered cheap less than ten years ago are catching up. Their prices are still rising. There’s no sign of slumping anywhere, despite its widely reported presence.

The National Association of Realtors reported Tuesday that existing home sales across the country fell 6.6% in Q1, and that the median price dropped 1.8% to $212,300. If a drop of less than 2% has economists already making references to “the bottom,” this is one shallow barrel we’re talking about.

After my walking tour of Toluca Lake and my drive-through of other neighborhoods including a trip to San Diego, I called up an old friend of mine who works at the heart of southern California’s mortgage business. He’s vice president of a major mortgage servicing company and he’s been working overtime as the sub-prime mortgage market melted down. He didn’t want me to use his company’s name because lawsuits are still flying.

He told me that in April 2006, his company received 40,000 loan applications from sub-prime lender Ameriquest. Last month, they received 400. That’s a gutted industry, and onlookers have been expecting spillover or
fallout or something bad to come of it. On May 14, NPR’s “Morning Edition” featured confessions from former Ameriquest mortgage employees that included these gems:

  • Customers were told that their mortgages were fixed for “as long as they wanted” when they were fixed for just two years.
  • “Sending papers to the Art Department” was slang for doctoring up the income numbers on W2s and other forms.

More than 30 sub-prime lenders have gone bankrupt already. However, the only “fallout” I see is that the ones left standing have implemented tougher lending standards. This has not been a crisis at all, but merely a slight negative for the greater economy and one that’s already on the mend. Heck, the sub-prime fiasco has not even had much of a negative impact on the housing market, as evidenced by still-rising prices.

I wrote a couple of weeks ago that housing prices in Colorado were no bargain. Now I see that they’re no bargain in southern California, either. The popping of the bubble, the bottom of the market, the slump, or whatever else the media wants to call their phantom news story about housing’s demise, is nowhere. True bargain hunters are holding cash, because bargains are hard to find.

I had dinner with another friend of mine, a fairly wealthy investor who’s always on the lookout for something new. His circle of friends, he told me, are watching real estate and waiting…and waiting…and waiting. They’ve been waiting for three years. The media keeps reporting a fire sale, but nobody’s seen any smoke.

What I’ve concluded is that the general real estate market is NOT a buyer’s paradise. Pay no attention to stories of the end of a bubble or the slow motion train wreck underway. I don’t know why it’s being widely reported, but it is, and it’s wrong. The beauty of researching investments is that reports are so easy to see through. Just get to the numbers. In this case, the numbers are high.

However, that does not mean there aren’t bargains to be had. There are always bargains. Next week, I’ll look at one of my favorite ways to find them: REOs. That stands for real estate owned, and it refers to a property that a bank owns on its books after the borrower defaulted and the property failed to sell at auction. The bank needs to sell it, and will often do so at a substantial discount.

There probably aren’t many more REOs now than at any other time, despite the reports, but there must be some. I’ll be checking in with small, local banks in California and Colorado to see what’s waiting to be scooped up.

If you’d like to read about REOs — the article I sent just yesterday to subscribers — and the rest of this real estate investment series, please sign up for a one-month, one-cent trial to The Kelly Letter by clicking here.

My drive from Colorado to California and back again was gorgeous. The light greens of spring covered the Rockies over the continental divide and down the western slope, slowly giving way to the rolling hills of western Colorado, the canyon lands of Utah, and the mesmerizing desert of Nevada leading to Las Vegas. I finally had a chance to see the wonder that is Wynn Las Vegas, Steve Wynn’s newest resort on the strip, but now second fiddle to his crown jewel in China’s Macau, the world’s largest gambling location.

Southern California afforded the excitement that I’ve always loved about it, bringing far more to the table than the traffic and pollution that everybody talks about first. The show business restaurants, Venice Beach’s motley crowd on Sunday, the botanical gardens, the comedy shows, the flowers, the weather, and my favorite little watering holes all rose up to welcome me back.

On the return to Colorado, I stopped in little cafes to talk with locals about gas prices and the value of their homes. They told me. I love that about Americans. We talk, about real subjects in a depth that’s not always available in other countries where strangers get courtesy, but that’s all. I heard about farm prices in Richfield, immigration in Colorado, and the changing face of gambling in Nevada. Where are the $2 lobsters, locals wanted to know. Their absence, more than gas prices, is a sure sign of inflation I was told.

What a great country this is. Do you know that the same drive on Japan’s toll roads would have run me $500 round trip? It’s true. That puts gas prices in perspective, especially when you consider that gasoline in Japan is already $4 per gallon. Motorists there pay that in addition to highway tolls.

I’m lucky to be American. Today, we remember those who died to keep roads open through wondrous lands, gasoline widely available, a robust economy in action, property private for buying and selling, and any church of your choice in full view and wide open for entry.

A special thanks to your relatives and mine who died for this country, with a hope that no more need do so.

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