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9-28-18: Are there any Propositions on the November ballot that are real estate related?

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Question of the week:  Are there any Propositions on the November ballot that are real estate related?

 

 Answer:  With the election just over month away, and your absentee ballot available in ten days, and the onslaught of television ads just starting, now is a good time to review some of the propositions on your ballot.

 

A brief bio break before I get into the ballot measures. I have a Bachelor of Arts in Economics and Political Studies from Pitzer College (1984) and have continued to be a student of both disciplines. My philosophy is that economics is the foundation of most personal, organizational and political decisions—if you cannot afford it you cannot do it, and if  you do the long-term consequences will generally not be positive. With that out of the way let’s look at the real estate related propositions on your November ballot.

 

There are four ballot measures that in some way involve real estate in California, Props 1, 2, 5 and 10. Here is a brief description of each and my position (if you are so inclined to care).

 

Proposition 1: Affordable Housing Bond If passed this measure authorizes the state to borrow $4 billion in bonds for affordable housing. The funds would be broken into different areas of expenditure with the largest amount being for the building and renovating of rental units. Other funds would be used to provide home loan assistance to Veterans, housing construction in densely populated areas, down payment assistance programs for low and moderate income potential homebuyers and housing development for agricultural workers.

 

Understanding that more affordable housing is needed in the state I do not feel adding $4 billion in bond payments to our budget and cycling the money through state and local bureaucracies is the way to provide more affordable housing. Supply and demand create prices, some of these funds are targeted in a manner to increase demand, which increases prices, and other funds are targeted to rather ambiguous objectives that appear to expand the power of the government in the market place. I feel that local ordinances and applying tax benefits to developers and property owners would be a more efficient way to create more affordable housing. Dumping government funds into a market has never been shown as a way to lower market prices. I will be voting No on Prop 1. I expect this measure to pass given the lack of a unified opposition and the funds coming into the “Yes” side of the ballot.

 

Proposition 2: Mental Health Housing If passed this measure authorizes the state to re-allocate funds currently directed to county mental health services across the state to fund supportive housing for those suffering mental illness. With a directive and the funding the state can make strides in providing long-term solutions to mental illness sufferers and provide blueprint for counties to help with their homeless problems. Across levels of government funds have been allocated for the homeless with no impact on the problem—it seems to be getting worse. By creating housing for the mentally ill that includes on site social services and medical services this proposition is the best solution I have seen proposed so far at any level to start to make a dent in the issue. I will be voting Yes on Prop 2. I expect this measure to pass given its purpose and how much the issue has been one of top concern to most of the state’s residents.

 

Proposition 5: Residential Property Tax Portability If passed this measure would expand the current property tax transfer rules of Props 60 and 90. Under current rules if homeowner over 55 sells their current residence and purchases a new residence of lower value the homeowner can transfer their current tax base to their new home. The portability of the current tax base is limited as only a few counties in the state allow those otherwise eligible to transfer their current tax base into their county (i.e. homeowner selling Orange County could not transfer tax to new home in Shasta County). As well the current laws allow only a one-time transfer.

 

If Prop 5 is passed the one-time transfer limit is eliminated and the purchase price of your new home does not eliminate your ability to transfer your tax base to lower your taxes if your new home costs more than the home you sold—your tax base will go up but not to market value. As well if you purchase a home for lower value than the home you sold your tax base will be lower than your current tax base. Here are two examples to hopefully clarify how the measure will work if passed.

 

Buying more expensive home:  A couple that qualifies for the property tax transfer owns a home in Los Angeles County they purchased many years ago for $110,000. Today the taxable value is $200,000 and their base tax is $2200 per year ($200,000 x 1.1% state property tax rate). They sell their home for $600,000 and purchase a new home in San Luis Obispo County for $700,000. Their new property tax base is calculated by subtracting the sales price from their prior home from the sales price of the new home and adding the result to the tax base from their prior home:

 

New home price minus prior home sales price: $700,000 – $600,000 = $100,000

Price differential plus prior home tax base: $100,000 + $200,000 = $300,000

 

The new tax base is $300,000, for annual property tax base of $3300 ($300,000 x 1.1%). Without Prop 5 the tax base would be $7700 per year (market value $700,000 x 1.1%), the homeowners are saving $4400 per year.

 

Buying less expensive home: This gets a little more complicated as the new tax base is reduced by a percentage based on the difference between the old property value and the new property value. Same couple sells same home for $600,000 with $200,000 tax base. They purchase a new home in San Luis Obispo County for $450,000.

 

New home price divided by prior home sales price: $450,000 ÷ $600,000 = 75%

Old tax base times price differential percentage: $200,000 x 75% = $150,000

 

The new tax base is $150,000 for annual taxes of $1650 per year, a savings of $550 per year over what they are currently paying.

 

I think the best tax law in America is California’s Prop 13. We pay some of the highest income and sales taxes in the country, but homeowners have the best property tax protection from the state of any state in the country. Prop 5 makes the Prop 13 even more generous to homeowners over the age of 55. Because of the over-generosity of Prop 5 I will vote No. If Prop 5 were to mirror Prop 60 and only eliminate the inability to transfer tax bases over any county lines in the state and enable more than one transfer, particularly in cases of divorce or spouse who have passed away, I would vote for Prop 5. As it is written with homeowners purchasing a new home and being able to lower their tax base to me is not equitable to the counties, state or other tax payers and is not needed. And most importantly, if Prop 5 does pass I see it as a strong rallying issue for those who want to eliminate Prop 13 or severely alter it so that higher property taxes result in the future. I expect this measure to fail.

 

Word has it that the California Association of Realtors is already working on a revision to Prop 5 for the 2020 ballot should the measure fail this year. I hope they do as I would like to see the current Prop 60 benefits available to be transferred across county lines. Were I to be asked to craft a revised proposition I would make the changes I suggest changing the calculation on purchase a new home for a higher price to increase the tax base from formula in Prop 5, eliminate ability to lower tax base by purchasing a new lower priced home, eliminated unlimited ability to transfer the tax base but enable additional transfers due to divorce and/or spousal death, and finally I would raise the age of eligibility to 60 from 55.

 

 

Proposition 10: Local Rent Control Initiative If passed this measure will roll back a 1995 law that limited the use of rent control in California (Costa-Hawkins) and enable greater ability for local government to pass, and/or expand, rent control in their jurisdictions. Costa-Hawkins disallowed cities from enacting rent control on properties first occupied in 1995 and single family dwellings (including condos and townhomes). If passed Prop 10 would enable rent control on all rental units, including single family dwellings—and room rentals inside a single family dwelling.

 

Any rent control imposed by government on landlords benefits a very narrow group of residents: those already renting. Wherever rent control has been enacted rental prices are higher than similar geographically nearby markets. Rental units are scarce in rent control communities as tenants do not move to preserve their low housing cost. Because of the scarcity of available units with a rent control unit does come on the market the landlord is able to get premium rent for the unit since there is little competition. Over time as each generation of rent controlled tenants vacate units the rents in the market climb disproportionate to the surrounding markets.

 

According to a spokesman from the California Business Roundtable there are currently 12,000 rental units across the state approved for construction. Every project is on hold until after the November election. Should Prop 10 pass the projects will not start building as the investors/builders do not want their investments to be restricted from market returns by local governments enacting rent control. I will vote No on Prop 10. I expect this measure to fail.

 

There have been many great benefits to Californians as a result of the ballot initiative process, ad many great detriments as well. It is our duty to study the issues, and candidates, presented and understand both sides before casting our ballots. I hope the above comments on the propositions involving real estate provide you with a decent perspective and spur you on to study these and the other propositions more thoroughly.

 

 

Have a question? Ask me!

 

A busy week for mortgage rate impacting news. First, and most expected, the Fed increased it Fed Funds Rate by 0.25%, as expected. The immediate result was the prime rate, and therefore rates on Home Equity Lines of Credit, also increase 0.25%. Prime rate is now at 5.25%, up one percent from one year ago. The Fed announcement also indicated it is sticking to schedule of one more increase in rates this year and three next year. The news is mortgage rate neutral since the rate increase was expected and the Fed did not announce they anticipate more increases than previously announced.

 

Second quarter Gross Domestic Product went through its third and final evaluation and there was no revision made to the prior revision putting the growth for the quarter at 4.2% annualized. With no change to the growth number there was no impact on mortgages.

 

Last Friday of the month gives us important data on consumers as personal income, consumer consumption and inflation data are released. Good news on all fronts for mortgage rates as personal income matched last month’s increase of 0.3% and the core inflation rate dropped from 0.4% in August to flat this month—meaning those higher wages will go further. Consumer increased spending by 0.3%, lower growth than previous months but still the sixth month in a row of positive spending growth and the eleventh of the past twelve months and 3.8% overall gain in spending from last year. Overall the news should be somewhat negative for rates as it shows economic strength is continuing and should continue through the third and fourth quarters absent some catastrophic event.

 

 

Rates for Friday September 28, 2018: Intra-week rates had a bounce up and then down and the result is the conforming rate is flat from last Friday and the high-balance rate is down slightly for the week. Many analysists are hinting at a possible decline, very small decline, in rates in the next week or so; however, this analysist is not convinced of the underlying factors that would make a such a prediction a strong one.

 

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            4.625%    Flat

30 year high-balance conforming                      4.75%     Down 0.125%

 

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

 

 

I have a pretty strong background in politics and economics, which perhaps comes through in my WR&MU. My mom grew up in a very politically connected household in Sacramento. Her father was an attorney and lobbyist and her mother was socially active in political circles. My mother continued the family behavior. When my sister, brother and I were growing up we did so with campaign pins and bumper stickers, meet-and-greets with candidates and seeing our mom very briefly on the television from the 1968 Republican National Convention in Miami.

 

Growing up my goal was to become and attorney like my grandfather and both uncles and I majored in economics and political studies in college. My study habits my last few semesters were not great so I put law school on hold to get some discipline. I started earning money, found the mortgage industry and law school was permanently in the rearview mirror. However, my interest in the two disciplines that comprised my major has never left me and I continue to study and read history, economics and political books, articles and journals. For those wondering, the basis of my personal philosophy is that economics is the overwhelming factor that influences politics and therefore history, be it within a family (microeconomics) or nation (macroeconomics). As I often say, take care of the economics and most other issues sort themselves out.

 

Whatever your interest I hope you are able to spend personal time daily, weekly, monthly to indulge in your interest and continue to expand your scope of knowledge and understanding.

 

Have a great week,

 

Dennis

8-31-18: Should we buy a rental property?

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Question of the week:  Should we buy a rental property?

 

 Answer:  This is a common question for those of us in the real estate industries, as well as for professionals in other industries such as family attorneys, accountants and financial advisors. Looking to secure a long term investment many families would like to purchase a property to rent out for investment income and long term value appreciation.

 

Is it right for you?

 

As you can imagine, there are several factors to consider before deciding to purchase rental property. Here are some that come to mind, but certainly not a complete list.

 

The first question you must answer is, what are my expectations? Do you want positive monthly cash flow? Are you most concerned about long term appreciation and growth of your initial investment? Do you want a loss on your tax returns to off-set income? Each of these factors can be obtained, but each also has different requirements for how you purchase the property.

 

Positive cash flow can be very challenging in the California, especially if you are in a county that touches the Pacific Ocean. Cash flow is determined by what income the property will generate from rents minus the expenses of ownership: mortgage, taxes, insurance, maintenance and vacancy. Because real estate prices have grown it takes substantial down payment to achieve positive cash flow in most properties. For instance, if you are looking at purchasing a $500,000 home as a rental in an area where the market rents for the property are around $2500 can you achieve positive cash flow? The minimum down for a single family residence non-owner occupied loan is 20%, and today the rate is about 5.125% with that down payment. The monthly PITI is almost $2800—your cash flow is not positive. Putting 25% down the rate drops to 4.875% and your PITI drops to $2500 so you are cash flow neutral before maintenance and upkeep. Before closing costs you have invested $125,000 for neutral cash flow.

 

That said, if the property increases in value an average of 3% for the next five years your property has increased in value about $80,000 so on paper you have seen your initial down payment increase about 65%, from $500,000 to about $580,000. As well you have likely had depreciation on your taxes, that provided you with a loss on your tax returns for the property (if you are eligible to claim real estate losses) which has saved you tens of thousands of dollars in income taxes. So your monthly cash flow is neutral, perhaps slightly negative, but you have seen your investment grow in value and gained cash flow with your tax deductions.

 

Keep in mind the above scenario is based on finding a home for $500,000 in an area that rents for $2500 per month and would increase in value an average of 3% per year over five years. That said it appears this type of scenario checks the boxes for cash flow (after taxes), appreciation and deductions on your tax returns.

 

What are other factors to consider? Costs is a very important consideration. It costs money to purchase real estate, the rule of thumb is about 3% of the purchase price, and it costs money to sell real estate, the rule of thumb is about 8% depending on real estate commissions. So in the above scenario you have about $15,000 on top of your down payment to close the transaction and if you sell at the end of the five years your costs of sale are about $46,000. For your total investment of $140,000 your next gain in equity from the market is about $34,000 which is a  nice 24% return over the five years.

 

Keep in mind that $34,000 will be taxed as capital gains and any depreciation you claimed will be “recaptured”, a fancy term for taxed. Check with your tax preparer but depending on your income the taxes could exceed $10,000.

 

You can avoid the taxes by participating in an IRS tax deferred 1031 exchange, which entails selling the property and having the proceeds transferred to an escrow to purchase another property. You avoid the taxes, but you are not benefiting from the capital appreciation as it has to roll over into another property.

 

One mistake many first time investors, and some experienced, make with investment property is they care too much. Too often they want to purchase property they would want live in, or spend too much money on the property. I have seen clients spend tens of thousands of dollars to upgrade kitchens, bathrooms, floorings, etc, to be of the type and quality they would want, but for tenants who generally do not treat their homes the way they would if they owned it. If you want to get in the real estate rental market as a landlord you must remember that it is a business, you are buying an investment not a home and as such your objective is to provide a clean, safe property for rent. Putting in granite counter tops and solid oak cabinets will not increase the rents you can collect, perhaps it puts you at or near the top of the market for the area you are in, but if the market is $2500 you won’t be able to rent for $3000 just because of the nice kitchen.

 

Which brings me to the most popular way most families obtain their first piece of rental property: convert your existing home to a rental when you purchase your next home. This has many advantages. First, you save on closing costs. Second, you do not need a cash investment for the purchase of the property—though you will need one for the purchase of your new home. Third, the loan is already in place and likely at a lower rate than the current market for non-owner-occupied financing. Fourth, if you sell the property within three years of converting it to a rental you probably can avoid capital gains tax should the property appreciate.

 

Should you purchase a property for rental income and investment? The answer requires a lot of thought and research as to the short and long-term consequences. Before you make the decision consult with your tax preparer and investigate other options with the money you would be investing.  Compare possible rates of return in cash flow and appreciation, costs of acquisition and divestment, on-going costs of maintenance and loss of income, and the potential tax liabilities.

 

I am happy to be part of your investigation by running numbers and scenarios for different sales prices, down payments and types of properties if you are considering purchasing rental property.

 

Have a question? Ask me!

 

Lots of major economic news this week. On Tuesday the Conference Board reported that consumer confidence is at its highest level since October 2000. The higher confidence is supported by increases in personal spending and earnings in July. Spending increased 0.4%, the fifth month in a row for the primary economic engine for the country. The increase in spending was greater than the increase in personal incomes, which rose 0.3% in July, causing a slight downtick in the savings rate. The higher earnings, increased spending and tighter labor market caused prices measured by the PCE index to increase 2.3% in July, the highest level in six years. More importantly the index used by the Federal Reserve to gauge inflation, the PCE price index stripped of energy and food to reach 2.0%. The different pieces of data are each supportive of higher interest rates and collectively provide a strong push for higher rates.

 

Also putting upward pressure on rates, was the revision of 2nd quarter Gross Domestic Product released this week showing growth of 4.2%, revised upward from the initial report of 4.1%. A combination of tax cuts and consumer spending pushed corporate profits higher for the quarter helping push GDP growth.

 

Rates for Friday August 31, 2018: My economic training and experience is telling me that rates should have gone up this week based on the data. They are flat from last Friday, and have remained flat since the first Friday in August. Investors are tempering their decisions on bonds and mortgages waiting to see if a big shoe drops from the White House on tariffs with China and other nations. Earlier this week there was an apparent understanding with Mexico to revise our trade agreements, perhaps the same can occur with Canada, which would alter NAFTA. We will see how those negotiations and others go. If the result is positive in regards to no tariff wars and updated agreements we will definitely see rates go up–absent some other major issue or crisis.

 

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            4.375%            Flat

30 year high-balance conforming                      4.50%               Flat

 

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

 

 

To slightly change the famous Alice Cooper song, Schools In ‘Til Summer. Our Long Beach Poly junior was a bit grumpy in the early hours of Wednesday morning seeing the wrong side of seven o’clock for the first time in months, I’m sure she was the only teenager or younger in the city in that frame of mind.

 

Hoping all your students have a successful year!

 

Have a great weekend,

 

Dennis

1-26-18: The tenant is still in the property, should we close

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Question of the week: The tenant is still in the property, should we close?

 

Answer:  With real estate values up many investors are selling properties they have been holding onto and renting for several years. As a result we have some issues pop-up on home sale transactions that do not present themselves when sellers are owner-occupants.

 

Over the weekend I got a call from clients who had just finished their final walk-through on a condo unit they were purchasing for mom and we were scheduled to fund and close on Monday.

 

The sellers had retained the condo as a rental years ago when they had purchased a new home. As part of the sales contract the seller agreed to have the property vacated by the tenant at least 10 days before closing. The buyers were calling because the tenant, and a fair amount of his possessions, was still in the property.

 

“What should we do?”

 

Don’t close.

 

I let them know that as soon as we concluded the call I would be notifying my office, the escrow officer and agents that because the tenant and his possessions were still in the property that we would not be funding on Monday unless the buyers contacted me to let me know the property was vacant.

 

Why?

 

Once you take ownership of the property the tenant becomes your tenant. And your problem. If the tenant decides to stay a while longer, or does not remove his possessions, you as a landlord are very restricted as to actions you may take due to tenant’s rights in the State of California. To remove the tenant you would have to go through the formal eviction process, which includes many filings and trips to court and if necessary engaging the county sheriff’s office to force eviction. Should the tenant fight the eviction and employ many of the legal delays available it can take up to a year to evict the tenant. I will not delve into the possible condition of the property once the tenant does vacate, voluntarily or involuntarily.

 

My advice to the client was to not proceed with funding the loan and closing the property until they made inspection to show that the tenant was no longer in the property or any of his possessions. Once that was confirmed they needed to change the locks as well as the code on the garage door opener to prevent his being able to re-enter the property.

 

On Monday morning the client called and said the tenant was out but some possessions were on the other side of a shared garage. Since the garage was shared with another unit, and that unit is vacant, my advice was to not close until those possessions were removed as it could still be construed as possession was with the tenant.

 

That evening the buyer called and let me know that the seller had removed the possessions, changed the locks and re-coded the garage door opener.

 

We funded the loan and closed on Tuesday on a vacant property that became full possession of the new owners.

 

Over the years I have been involved in a few nightmare scenarios involving our clients purchasing properties they intend to occupy with tenants still in residence because they closed with the tenants in possession. In every instance the buyers took the word of the seller, the tenant or the agent(s) that the tenant would be out of the property by closing. In one transaction the tenant left a few days after closing, but not before taking the appliances that were included in the sale. In another the tenant was still in the property one month after close and a pay-off was negotiated whereby the new owner gave the tenant a few thousand dollars to leave, giving him a cashier’s check in the street once the property was verified to be empty; the locksmith was there as well changing the locks while the transaction took place.

 

These are not the normal experiences of purchasing a home that has been used as a rental, however they do occur. If you are purchasing a home, or property, and you want it vacant at the time of closing, do not close until you verify it is vacant. No excuses, no promises, you want the property vacant when you take possession and once you do change all the locks and codes to enter the property.

 

If anyone wants an idea of the rights of tenants in California I suggest getting “Pacific Heights” from Netflix or Amazon. A bit extreme but…..

 

Have a question? Ask me!

 

Gross Domestic Product data for the 4th quarter of 2017 were released today and the report is positive once you dig into the data. Overall the economy grew at 2.6%, below the expectations of 3% or greater growth, and lower than the 3.2% growth in the 3rd quarter. Diving into the numbers GDP growth was restrained due to net exports which showed a $652 billion deficit (America imported $652 billion more in goods than it exported). This trade deficit pulled back what would have been a very strong GDP reading mostly due to the strongest quarter of consumer spending since 2015, up 3.8% from the prior quarter. With consumer spending being approximately 65-70% of our economy strong spending by consumers drives a strong economy. Another positive in the report was 2.4% increase in prices, also indicating economic strength. Just the headline number has a neutral impact on mortgage rates, digging into the numbers showing the strength of consumer activity is negative on mortgage rates and puts upward pressure on them in the short and long term.

 

Rates for Friday January 26, 2018: Rates bump up this week, and the conforming rate hits 4% for the first time since the last week of March 2017. With positive economic news we can expect more upward pressure on rates. If you are waiting for rates to dip back down you may have missed the opportunity. Lock your rate when you can!

 

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            4.00%       Up 0.125

30 year high-balance conforming                       4.25%        Up 0.125%

 

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

Throwback night for Leslie and I as we take the girls to the Honda Center for the Totally ‘80’s concert featuring many bands we listened to, well in the ‘80’s. Everyone is excited for the show and last night there was some impromptu warbling of some of the songs we may hear.

 

You know you are getting old when the songs you listened to after college, well after, are being played on the “Oldies” stations!

 

Have a great week,

 

Dennis