It's been a great run. Back in late 2011, we were pounding the table for investors to buy a single-family home in San Diego County, especially in what we called "Blue Collar Beach Towns". Then, you could purchase a single-family detached property for $250,000. We were nervous so we advised investors to put at least 25% down and only buy a property where the rent could cover the pre-tax housing expenses (mortgage, taxes, insurance, estimated maintenance). If you were one of our investors, you are probably sitting on over $100,000 of profit today. That means you will have almost tripled your investment in a period of about 5 years or earned an internal rate of return in excess of 27%.
It's been a great run but it looks like the party is over. We think the first half of 2017 is going to be a good time for investors to take some money off of the table, especially if they have a plan for that money in the next 3-4 years. This doesn't mean we think the market is going to crash, like it did in 2008-2012 but we think the prices are going to soften and perhaps decline 10-15%.
The three reasons we loved San Diego single-family homes, as an investment in 2012, are the same reasons we don't love them today: median price and median income, price-to-rent-ratio, and mortgage rates direction. We still like single-family homes for owner occupants but we just don't love them as investments.
The 2016 median income in San Diego County is $73, 500 for a family of five. This translates to a maximum monthly mortgage of approximately $2050 (PITI) or a $344,000 mortgage. Add a 20% down payment and the family of five, earning the median income in San Diego county, can afford to purchase a home for $430,000. A median-priced home, in San Diego county, was $495,000 this past summer. That's a 15% premium.
Keep in mind that. back in late 2011/early 2012, a veteran could purchase a single-family home, in Oceanside CA, for zero down payment and her mortgage payment would be cheaper than rent. Today, if that same veteran purchased a median priced home in San Diego County, the mortgage payment would be $2800. There are tax benefits to owning versus renting so let's make the after-tax costs of owning a home $2500. That same home can be rented for $2200; this is after a rental shortage in San Diego County spiked rents these past few years.
Look at 3792 Atlas Street as an example. It is being offered for rent at $2200 and the Zillow Zestimate is for a $528,100 value. Even if a home buyer had 20% down payment, their after-tax mortgage cost would be about $2300; $100 month more than they could rent the property. It still makes sense to own that property, if you intend to live in it for 7-10 years but it just isn't a compelling investment when looking at the price-to rent ratio anymore.
Finally, we think the carrying costs for real estate (aka mortgage rates) can only go up from here. Interest rates may start climbing in a couple of months or it could take as much as a year for mortgage rates to rise. Eventually, mortgage rates are going to be 1-2% higher than they are today. More importantly, the threat of higher mortgage rates is starting to affect pricing now. Back in 2014, people still thought rates could come down so they weren't too particular about paying 5% more than last year's prices; they figured they could refinance into a lower rate soon enough. Today, the opposite is true.
What does this all mean to you?
If you are a real estate investor, it might make sense to sell that San Diego County investment property, especially if you plan to use the money in the next 4-5 years. If you don't plan to use the money, and want to avoid paying capital gain taxes, I have two ideas for you:
1- Consider the Greater Phoenix area. You will increase your income (the capitalization rates are better) and there is still some upside appreciation to be gotten there (not a ton but better than San Diego County). We refer our clients to Greg Swann of Bloodhound Realty.
2- Consider placing the proceeds from the investment property sale into a Delaware Statutory Trust. This is a security so we don't handle these transactions but we refer our clients to investment adviser Tony Krvaric of Krvaric Capital.
What if you just want to buy a home to live in?
There is no greater place to live (in my opinion) than San Diego County. We have beaches, mountains and deserts. Our climate is second to none and our business environment is relatively robust. Unemployment, in San Diego County, is less than the rest of California and the rest of the country. San Diego County is a great place to own a home.... BUT....
...we think the short-term prospects of higher prices are unlikely. Even with the Great Recession, if you bought and held a home fir ten years, you made money in San Diego County. Our advice then is to be judicious when buying an owner-occupied home in 2017. We suggest that you do three things:
1- Establish your holding period. If you plan to move in less than 7 years, you could lose money. If you plan to live in the property for at least ten years, you should make money.
2- Call us to run a rent v. own scenario for you. This is where we analyze the price-rent-ratio. For traditional, 20% down payment transactions, it can still make sense to own for the long-term in San Diego County.
3- Negotiate, be patient, and shop around. You don't have to get a home at 15% under list price to get a good deal but we don't' think you have to pay list price to get a home in 2017. Sales have slowed in San Diego County, ever so slightly, but they have slowed.
Inventory is still under three months which suggests that this is a seller's market, That could all change once prices start softening (they are showing signs of that now). If you are an current investment property owner, the first six months of 2017 will be an excellent time to sell and realize your profits. If you are a potential home buyer, we think you are going to have more options next year than you do today.