Flipping ain’t an easy job and someone has to do it. This spectacular 2 bedroom 1 bath home is what we call in Los Angeles, posh living. With 768 square feet, you’ll be wondering what to do with all the extra space. In fact, we are told that this place has an “open kitchen that flows into the living room.” I’m not sure if that means you’ll be able to watch TV in your recliner while reaching over to open the refrigerator to grab a beer, all without getting up. This place according to the ad is a “fixer” so you can mold this place into your ideal dream home. The price tag? Only $324,900 or $423 per square foot. Look at the bright side, this place now qualifies for FHA financing. Are you sold? Well let us look at the previous sales data:
This is where you see the symptoms of the housing mess we are currently living in by jumping into the trenches. First, the home was artificially high in 2005 for the area. Then, 6 months after the purchase we have the fabled housing ATM machine being used for mortgage equity withdrawals. These folks probably realized that they bit off more than they could chew so what do they do? They simply listed a price that would cover the mess, sort of like sweeping dirt under the rug. Don’t think this is the case? Let us do the math:
Since they probably went zero down with some sort of banana republic financing the math works out as follows: Mortgage #1 ($340,000) + Mortgage #2 ($47,000) + 6 percent selling cost ($24,900) = $411,900
Hey, this figure is really close to the sales price in 2006, what a shocker. Since we were living in Wonderland and people simply priced homes at whatever they needed to get out of their chaos, this tactic worked in a bubblicious environment. In this example, these folks actually made a few thousand dollars even though they were digging deeper and deeper into debt. They had the benefit of being at the right place at the right time. This isn’t the case for the buyer in 2006. Some lending institution thought it would be a brilliant idea to lend $415,000 for a home that would rent for $1,100. Does this make sense? Of course not. You don’t need your Ph.D. in Finance to know this deal is not going to work. In fact, let us take a look at the neighborhood statistics:
Average Annual Household Income: $48,991
Let us run the hypothetical numbers of the average family in this neighborhood buying this home with conventional financing:
Monthly Net Income: $3,324 (Filing Married with 2 Exemptions for Federal and State).
PITI: $2,864 (5 percent down payment of $20,750, 95 percent LTV)
So this family has monthly disposable income of $460 for a 768 square foot home built in the Great Depression! What about automobile costs? Food? Healthcare? After all, they are only spending a mind numbing 86 percent of their net income on their home! And we aren’t including maintenance cost such as gardening, trash, and other fees that sneak up on property owners. Is it any surprise foreclosures are exploding in California? Who in their right mind didn’t see a disaster like this coming? Now, the home is priced at $324,900 or $90,100 less. This is a whopping 21.7 percent decrease in one year, and that is assuming it sells for the current price which is doubtful because someone can rent a similar place for $1,100 as opposed to carrying a nut of $2,336 (at the current price). And why would a real estate investor buy this place? They would be negative cash flowing by $1,236 in a market where prices are trending downward. Is it becoming apparent why this housing market needs to correct and this is no minor bump in the road? Do you still think that a bail out is a smart idea? If it isn’t obvious that prices need to drop in certain areas by 40 to 50 percent then we may consider investing in an introductory finance course. Unless incomes in the area increase by 100 percent, prices will adjust lower now that lenders are being forced to use more conventional financing. In other words, prices have to reflect the income reality of the people in the immediate area. And reality is so passé after living in a fantasy world of easy credit and hyper speculation.
Today we salute you Paramount with our Real Homes of Genius Award.
Did You Enjoy The Post? Subscribe to Dr. Housing Bubble’s Blog to get updated housing commentary, analysis, and information.