June 11, 2006
A median-priced house in Silicon Valley -2006 edition
(c) copyright, View from Silicon Valley, 2006. All rights
reserved.
Is now a good time to buy a house in Silicon Valley? Have
prices been "base-building" before another launch higher? Does a $25K median resale boost from May 02 to May
24 mean we're off to the races again? Was April's five-year low in sales volume just the calm before everybody
piles back in again?
Judging by the "we don't care about negative equity" title
on a recent spam, somebody must think there is still a buck to be made. With this week's fall in
10-year yields (and re-inversion of the yield curve), is money about to start getting cheaper? Is
the stock market's recent tank job encouraging more money to chase real estate?
Continually wondering if we should take the plunge and buy
a Silicon Valley property, we picked up a flier
for a house whose list turned out to roughly match the median: $729K.
The resale numbers this week for Santa Clara County and
for this zip code are:
Resale Homes Median$ y-o-y $/SqFt
Volume y-o-y
County $750K
+8.9% $502 1,282 -32.5%
94040 Zip $627K -15.9%
$522 20 -60.8% (May25,'06)
" $839K +11.1%
$499 35 -22.2% (Jul20,'05)
"
$808K +11.4% $527 22 -45.8% (May02,'05)
The bullets on the flier included:
"Spacious three bedroom, two and a half bath, approx. 1,424
Square foot townhome." ($512/sq. ft.)
"Cozy living room with vaulted ceilings, ..."
"Generous size one car garage..."
"Great central location, near CalTrain, parks, ships and restaurants."
"Well maintained complex with low HOA dues."
"Additional features" included:
"Great Los Altos Schools"
"Walk to transportation and shops"
among several others.
In the real world, "spacious three bedroom" and 1,424
square feet, by definition, do NOT belong in the same sentence. Doubly so for a three-story townhouse whose
1,424 includes at least two staircases. However, Silicon Valley is decidedly not the real world in this regard.
We hear alarm bells with "cozy" and "Generous...
one car garage" but, on the other hand, this is recent construction which usually sells for a
premium. Surely the owner gets used to the rumble from CalTrain located across the street and stopping
every 20 minutes? The parking lot lights and noise from all the cars visiting the nearby shopping is all shielded
by the double-pane windows, right?
The schools are, of course, vitally important. The house is actually located in Mountain
View but some parts of Mountain View actually attend Los Altos schools. This is a major feature of this property!
However, we know children do not automatically get into their nearest Los Altos
school. In many cases, a child will be "over-flowed" to a nearby, but much(!) lower-rated, Mountain
View school. Good luck fighting the school board and their multiple layers of admins and gate-keepers if you want to fight
their "process"!
Do you want to bet if the buyer learned these details from either real estate agent?
Even so, your first instinct might be that this is
at least an "affordable" house! On the other
hand, we happen to know rentals in this complex, and there are
several, list for $2,300 to $2,500 per month.
We corresponded with the real estate agent, who explained
the house had only been on the market a week and she expected to "accept offers on Friday." We couldn't get her to guess on how many or at what price. Her only question was did we want to see the inside before making an offer?
From our perspective, this alone completely extinguished any thoughts of
buying this house. Even with volume at a five-year low, they're still conducting auctions!.
The following Monday we learned the house sold for
"slightly" above the $729K list price. (14 days on market.) Just to simplify the math, let's assume
the actual number was $750K ($526.69 /square foot).
Be advised the following does not apply if the buyer has
no down payment, no assets and chooses so-called 80-20 financing.
Someone with literally no money or other assets should make an 80-20 purchase if they can. A
zero-asset buyer gets 100% of any upside or just hands the keys over to the foreclosure agent if the market
tanks.
Let's assume we have a "professional"
investor, or maybe even someone who actually wants to live in the house. (We have found precious few owner occupants
buying around here over the last 18 months. The one person we did find openly regrets buying and wishes she
had convinced her husband to wait.)
Back to the point, figure $750K minus 20% is $600K financed.
Using rates from this weekend's paper and assume
+all interest, taxes and depreciation are above the buyer's lower
IRS limit,
+the property never sits empty,
+the buyer never hits the AMT (and loses their property
tax deduction) and
+maintenance comes in less than half the typical 1% per year.
1-yr
ARM 5-yr ARM 30-yr 40-yr
(4.282%)
(5.875%) (6.5%) (6.5%)
Interest $2,141 $2,938 $3,250
$3,250
Principal $542
$542 $542 $263
RE Tax $715
$715 $715 $715
HOA
$178 $178 $178 $178
Maint @0.4% $247 $247
$247 $247
Total $3,823
$4,620 $4,932 $4,653
IRS @ 37% -$1,057 -$1,352 -$1,467
-$1,467
Net $2,766
$3,268 $3,465 $3,186
2% Dep. -$1,250 -$1,250 -$1,250
-$1,250
Net-net $1,516 $2,018 $2,215
$1,936
Rent $2,400
$2,400 $2,400 $2,400
Net-net-net +$884 +$382 +$185
+$467
On the other hand, investing $150K in U.S. Treasury
notes at 5% nets out to $400+/month.
Professionals
assume a 10% vacancy rate and 1% annual maintenance. (Of course, true professionals do not even consider deals
with negative cash flow, but that's a story for another missive.) If the buyer uses even a 5% vacancy rate
or just 0.6% maintenance costs, everything but the risky 1-year ARM scenario falls below the return on treasury
bonds.
Bottom line,
1-yr
ARM 5-yr ARM 30-yr 40-yr
(4.282%)
(5.875%) (6.5%) (6.5%)
Cash paid $45,876 $55,440 $59,184
$55,836
Cash rcvd $28,800 $28,800
$28,880 $28,800
Net Cash -$17,076 -$26,640 -$30,284
-$27,036
Even using the most-generous assumptions, a buyer is negative on cash by at least -$1,423 per
month. Yes, a balance sheet can be contorted to show a $884 per month gain (using 1-year money) or $467 (using
40-year money) but who is evaluating risk?
If the buyer is betting on the
flip, another 9% gain in the next 12 months grosses $67.5K, or a cool 45% return on a $150K down payment.
(This is where they roll credits on "Property Ladder" and other flipper-oriented TV shows.)
Subtract 5% real estate commission
and various transaction taxes mean it will "cost" ~$43K to sell, leaving $24.5K. Adding back 2% depreciation, a 15% capital
gains tax nets it all out to ~$18.5K. Subtract the $7,500 in "lost" interest and the buyer might net
$11,000 on an $817.5K sale.
Conclusion:
It makes no sense, at least for us, to buy this house. We already get the ~$10K in income deductions the IRS gives
you without spending three times that much to "earn" it. We do not buy into the story Silicon Valley real estate
prices will continue to go up from here.
The rational investment,
for us, is to stay in cash, collect our 5% (and more as rates continue to rise), let it compound --and wait.
* * * * *
The above is not intended
as advice to buy, sell or hold any stock, bond, real estate nor any other financial
product. Invest at your own risk.
