California Housing - why spend $750K on a starter home?
August 4, 2013 8:05 PM   Subscribe

I live in Southern California, and the housing market in my area is insane. "Starter" homes here cost between $600K-1M, and these are mostly old tract homes that have 2 bedrooms, are less than 1000 square feet, are on less than 1/6 of an acre, and need ample renovations. I'm having a hard time seeing how buying one of these at that price could ever be a good investment, or something to feel good about - even though I know this is where the market is, I can't help but think that is a huge ripoff. But people are buying, and even bidding above asking price. My question is - why does anyone think it's a good idea to spend so much to get so little? Am I just out of touch and is $750K not that much money anymore?
posted by emily37 to Work & Money (35 answers total) 8 users marked this as a favorite
At the same time that we bought our first house in Northern California, my cousin bought one in southern Illinois. They paid about $125K, we paid about $750k. Their house was much larger, their yard was much bigger, everything was nicer including the mortgage. All I could was to say over and over "It is a long commute from Illinois to California" Housing markets are all local. People pay that much money because you can't find a "reasonably priced" home in the area that they want to live.
posted by metahawk at 8:20 PM on August 4, 2013 [1 favorite]

I'd argue there is still a housing bubble. However as this country grows more and more socially stratified and jobs continue to move overseas, the remaining decently paid middle class jobs are starting to coalesce in a handful in large cities, and the LA/SD area is one of them. The year round nice weather is a huge draw too. But yeah, I live in the San Francisco area and the odds of me ever owning a home are low. I'd have to be married to someone with a 100k+ income on top of my own or renting out 2 of the 3 bedrooms in a 3br home.
posted by MillMan at 8:28 PM on August 4, 2013 [3 favorites]

You don't have a choice if you want to own property in that area and for a lot of people, buying a house is one of those checkboxes they have to hit to be A Real Grown Adult. Not to mention the people that want to own houses. When I want to torment my California friends, I point out they could buy a 2000 square foot house on 20 acres of land an hour from a cool city's downtown for what they're paying for a starter house, but they point out that means they'd have to live in Texas rather than California.
posted by Ghostride The Whip at 8:28 PM on August 4, 2013 [2 favorites]

I think it heavily depends on where you live, specifically, neighborhoods, school districts, etc. There's plenty in my neighborhood that is cheaper than that, better than that, etc. But it's in East LA, which is not a desirable area.
posted by Sara C. at 8:29 PM on August 4, 2013

A fair comparison isn't between buying in the suburbs of Austin, TX. vs buying in the suburbs of LA. The fair comparison is between buying a home or condo in LA and renting a home or condo in the same neighborhood in LA. Missing from this question is how much it costs to rent a similar starter home. Owning a home may have hidden financial benefits that makes it financially sensible for some families, even if on the face it is more expensive then renting. Here's one Rent vs. Buy calculator that clarifies a lot of the hidden money issues. Additionally, either renting or buying may have hassles that are difficult to quantify monetarily, but make the other option more attractive.
posted by muddgirl at 8:34 PM on August 4, 2013 [17 favorites]

It can be a ton of money and still be a good investment -- (a) you get the benefits of owning over renting (if you can afford the mortgage to begin with), and (b) if you fix it up, it seems likely to sell for even more than you bought it for in another few years (which may or may not be a comfort, if you want to buy in the same area)...
posted by acm at 8:35 PM on August 4, 2013

If its a lot cheaper, rent. A home should be place to live, not a financial investment.
posted by alms at 8:38 PM on August 4, 2013 [15 favorites]

Missing from this question is how much it costs to rent a similar starter home.

Or if it's even possible to do so.
posted by muddgirl at 8:39 PM on August 4, 2013 [2 favorites]

There are plenty of places in Southern California where that is not the median house price. We have a 1400 square foot condo, and we paid about $220,000 for it as the market was dropping a few years ago. It's gone up in value since then, but I'm guessing getting in on a house in this area is probably low to high $300s, and a condo is mid $200s for a reasonable entry point in the market, and a place that is safe. We are a bit east of the Disneyland area. If you head much further south, you get quite a bit more expensive. So, it might be an issue of being willing to look a bit further north or east, or consider the standard of living that $750,000. Even for here, that's pretty expensive for what the median family salary is.
posted by SpacemanStix at 8:43 PM on August 4, 2013 [1 favorite]

A major component of the value of a piece of real estate is the location. Lots of people want to live where you do, so they bid up the prices accordingly. If you compare the average salary to average house price, and median salary to median house price, you'll get a good idea of whether it's a good idea.
posted by gjc at 8:43 PM on August 4, 2013

You also have to factor in the effect of Proposition 13: property tax is limited to 1% of assessed value, the value is reassessed on transfer to a new owner, but after that, any annual increase is capped at 2%. That can create perverse incentives to buy and lock in the base assessment, and the effect is a bit like the faultlines that run through the state.
posted by holgate at 8:46 PM on August 4, 2013 [2 favorites]

I also live in SoCal in a very nice area and homes are not that expensive here at all. The houses in my neighborhood are 400-550k tops and they are newer with lots of nice features plus proximity to a lot of great shopping and fun things. Where are you looking? Could you move to Orange County or San Diego?
posted by These Birds of a Feather at 8:53 PM on August 4, 2013

I'm going through the same conundrum in Seattle, which is a little more affordable, but still underwhelming to walk through a $750k house and think, "That's it?"

why does anyone think it's a good idea to spend so much to get so little?

Don't think of it as spending $750k; think of it as investing 750k into a commodity that just happens to be something that you can live in. People pay that much for a house because they think it's a good place to store their savings.

Now, when you add in a mortgage, a lot of the value of that investment goes away, so you have to ask how much it's worth to you personally to live in a house.
posted by qxntpqbbbqxl at 8:53 PM on August 4, 2013 [1 favorite]

As someone who owns a house in Southern California (and has owned houses in other parts of the country), I challenge the assertion that I'm getting "so little." The money is not just going to square footage, acreage, wood, metal and tile. It's going to weather, proximity to things I like to do, neighborhood amenities I enjoy, friends, etc. I can afford it, and it has dramatically increased my quality of life, so I think it's well worth it.

Obviously everyone has their own priorities, as well as their own financial situations. It's undeniably hard for a lot of people to afford houses in this part of the world. And it doesn't make financial sense in a lot of cases. You have to make your own decisions about that. But that doesn't mean that those of us who can afford it, and feel that it's worth it, should not "feel good about it" or are getting ripped off. It's a conscious choice to use our money on living somewhere that makes us happy, and I feel great about it.
posted by primethyme at 8:53 PM on August 4, 2013 [6 favorites]

Best answer: Am I just out of touch and is $750K not that much money anymore?

A $750k mortgage can be safely paid with an income of $250k/yr. So if you're in a neighborhood where the household income is around $250k or so, then it's a reasonable price.

If you notice that everyone isn't making anywhere near that money and is using a combination of exotic mortgages, not contributing to their 401(k), and getting by on their credit cards while rents on similar houses are much lower than a mortgage, then there's a huge bubble.
posted by deanc at 9:03 PM on August 4, 2013 [14 favorites]

Over the last 15 years, I've been astounded to see the prices in our area of Toronto climb what your talking about (with slightly bigger homes but on much tinier lots). I never would have thought it was a good investment but it turns out that the prices aren't out of line with other major cities around the world. I guess prices will stay up as long as interest rates stay low. Our neighbourhood is sort of close to some very upscale parts of town so I think another factor is a subset of wealthy boomers are underwriting some of these purchases in order keep their grandkids close at hand.
posted by bonobothegreat at 9:30 PM on August 4, 2013 [1 favorite]

The Khan Academy has three videos on the rent vs. buy question.
posted by Dansaman at 9:49 PM on August 4, 2013 [15 favorites]

Never buy a house if you can't rent it out for enough to cover the mortgage. That should be the ONLY consideration, unless you are wealthy. Not just "good income" but wealthy, the price of this house isn't a consideration kind of money.

Stuff happens, plans change and incomes fluctuate. If rents and mortgages aren't comparable in a market the house is very likely to become an albatross around your neck when you need it the least.
posted by fshgrl at 9:58 PM on August 4, 2013 [2 favorites]

2ing the Khan Academy videos, came here to link those.
posted by Camofrog at 10:49 PM on August 4, 2013

I'm about to sell my home in the Bay Area. Partially because we've decided that it's just too ridiculous expensive here. Our 1400 sq ft, 70 yr old house cost $500k just a few years back. But out mortgage payment is comparable to local rental rates.

For some people, paying the high prices is worth it for living in an awesom location.

But mainly, in these locations, you're paying several thousand a month whether its rent or mortgage. If you're paying a mortgage, you build equity and likely put money back into your future pockets. If you're paying rent, you kiss all that money goodbye instantly.
posted by gnutron at 11:19 PM on August 4, 2013 [1 favorite]

if you hold onto socal real estate for awhile it is almost guaranteed to pay off. the market always rebounds. my mom still lives in the house i grew up in and boy was it an excellent investment, but it isn't like you have to hold onto a home for decades for it to appreciate. homes here are investments. it's LA though: great weather, some are close to the beach, major metropolitan city, a very desirable place to live despite our crappy traffic.
posted by wildflower at 11:45 PM on August 4, 2013 [1 favorite]

Something that you need to add in to your equation is your commuting distance. Mr Money Moustache goes into the true cost of your commute here - just under $800 per year per mile that you live from your workplace.

The problem for Southern California, in this respect, is that it may have a lot of well paid jobs - but the commuting distances are large, the traffic is dense and the low cost public transport options are not there.
posted by rongorongo at 2:41 AM on August 5, 2013

The essential issue here is that the land is what is costing so much money, but you are evaluating the "worth" based on the house built on that land. It completely makes sense there is a disconnect.
posted by smackfu at 5:02 AM on August 5, 2013

The NYTimes has a fantastic Rent versus Buy Calculator that can help you figure out which is the better option in your market. Make sure you go into the advanced panel to see what happens when you tweak things like the return on your other investments.
posted by grudgebgon at 5:08 AM on August 5, 2013 [2 favorites]

A $750k mortgage can be safely paid with an income of $250k/yr. So if you're in a neighborhood where the household income is around $250k or so, then it's a reasonable price.

Just nitpicking, but buying with 0% down is not especially common, nor is it a great idea IMHO. If you buy a $750k house, you should not have a $750k mortgage. With a 20% down payment, you'd have a $600k mortgage. Calculate payments based on the size of the loan, not the size of the house.
posted by primethyme at 5:12 AM on August 5, 2013

....of course there comes the question how one gets $150k liquid for a deposit for starter house + another 5%-10% liquid for closing costs, initial repairs etc......
posted by lalochezia at 5:32 AM on August 5, 2013 [1 favorite]

A major component of the value of a piece of real estate is the location.

You're really paying for the land, in my opinion. That doesn't mean just square footage, but also location to things people find attractive to live near.

I also wouldn't be surprised if the historically low mortgage interest rates over the past couple years have been tipping the scale in favor of buying in the area. We're not in your area, but had several years of dropping interest rates on one side and rising rental prices on the other, so it just made more sense to us to switch from renting to owning - we live in essentially the same neighborhood, have basically the same size condo as our old apartment, plus a couple of extra niceties that the apartment didn't have, and spending no more than we were in a rental (and probably saving money now that rents have gone up again).
posted by backseatpilot at 5:37 AM on August 5, 2013

You are not out of touch, your brain is telling you what is real and true. What you are seeing is another housing bubble.

I wouldn't buy real estate in California. I think the property tax structure is insane and it's caused the public schools to go from being outstanding to being warehouses of children.

I wouldn't buy real estate in California because it's expensive for no reason. Not only that, you are vulnerable to a shit-ton of natural disasters and insurance won't cover them all. (Check out Earthquake insurance if you don't believe me.)

If you're buying a "starter home" that means that it's not even a house that's 100% of what you want, it's the house you can barely afford. What if you end up stuck in that house for the rest of your life?

It used to be that you'd climb the property ladder. You'd start out in a modest home, and then trade up as you married, had children, were paid more, etc. Each time, you'd sell for a profit and put the profits into the next home. At the end of it, you'd have a large executive/family home, and you'd sell that as empty-nesters, and move into a smaller home in a retirment community. The American Dream. The whole transaction was predicated on being able to sell for a profit. There's no guarantee that will be the case going forward.

The housing market has changed, perhaps forever.

In the distant past, one would buy one house in a life-time. You'd get a 30 year mortgage and you'd stay there until you were too old to keep up with it. The benefit was that you'd lock that mortgage payment in at a particular level and that was it. After 30 years, you owned it free and clear. It was more than an investment, it was roots and community and family nearby.

We don't live like that anymore. We don't work for one company forever, we don't marry one person forever, we don't stay in a community forever.

Houses are just places where we keep our shit.

We are selling our house and moving into an apartment. We're doing this because I can't deal with the maintenance and upkeep anymore. I can't handle the question mark of "what else is going to need replacing?" I can't keep writing checks for $10,000. Uncle.

If you feel you must buy a house, don't do it unless:

1. You can put 20% down.

2. You can pay your own closing costs.

3. You have 6 months worth of expenses in an 'Emergency Fund'

4. You have at least $10,000 in a "shit gonna break" fund, because shit gonna break.

5. You plan on staying in that domicile for at least 7 years.

6. Your financial plan doesn't depend on having to sell that house for a profit.

Frankly I am looking forward to being a renter. I'm not going to look around my place thinking of my next project. I'm just going to live. Shit, in our new place we don't even have to replace the batteries in our smoke detectors (but I will because...yeah, I think I can manage that much.)

Don't buy into the maddness. You may lose out on making money in the market, but real estate can be as risky as the stock market. There's no such thing as a sure thing.
posted by Ruthless Bunny at 6:39 AM on August 5, 2013 [14 favorites]

It kinda sounds like you're describing the part of Santa Monica where I used to live. We just sold our house there after just over three years of owning it and made well over $100k in profit. People pay these LA prices because everyone knows someone who timed their purchases and sales right and wound up with a great payoff.

Of course, everyone also knows someone like my parents, whose place was hit by the double whammy of the defense sector's total collapse in their area and the Northridge quake and took 20 years to command a price on the market anywhere close to what they paid. But nobody wants to think that'll be them.
posted by town of cats at 8:04 AM on August 5, 2013 [2 favorites]

The real estate market in southern California was one of the major reasons Mrs. usonian and I could never seriously contemplate settling there permanently; we rented an apartment for six years and even if we had been able to comfortably afford a house, we couldn't have spent the money in good conscience based on what we hoped to get out of owning a home.

But: rongorongo's point about the true cost of commuting is a good one, and I think that is probably a major factor in why prices in desirable areas are so high; there are just too many cars in southern California, period. Traffic and lack of decent public transportation is not a solve-able problem, so the next best thing is to live close to where you work. (I had coworkers who lived in the desert and spent 4-5 hours a day in the car commuting to and from the valley, which is just insane. Given the choice between a two hour commute and a huge mortgage, I'd go for the mortgage if I could afford it.)
posted by usonian at 8:58 AM on August 5, 2013 [1 favorite]

L.A. is really far out there in terms of unaffordability. Have a look at a graph showing median house price as a multiple of median household income for LA, Miami, New York, Chicago, and Kansas City from 1989-2007. (These are metro areas, not necessarily the cities proper.) Even during the lowest point, L.A. was almost a full year's income above the national median. At the peak of the bubble the median house was over 10x the median income, and it hasn't come down that much since. 10x is certifiably insane. It takes into account higher incomes, because it is based on the median income. Some of that can be explained by lower interest rates because that lets you leverage your income more, but the reality is that only the wealthy or the old can afford to own. During the mortgage bubble, middle-class people were "buying" houses in L.A. but they couldn't afford to own them either. New York is another famously expensive area, but it's nothing compared to L.A.

Normally, you would start to see development in the face of such overwhelming demand for housing, but L.A. and the surrounding inner suburbs have steadfastly resisted adding even a fraction of the units required. They got theirs, but you are, ahem, out of luck. Apartment building is a dirty word, so instead everyone plays "drive till you qualify" and lands in the Inland Empire, where housing is affordable but there are no jobs so you spend 1/4 of your waking hours in the car.
posted by wnissen at 9:35 AM on August 5, 2013 [1 favorite]

Mod note: Comment removed, sarcasm doesn't make for helpful answers.
posted by cortex (staff) at 9:54 AM on August 5, 2013

And BTW, we sold that house and used the proceeds to buy another one in Santa Monica, so I'm not going to pretend we learned any valuable lessons. People pay through the nose to live west of the 405 because getting from anywhere east of the 405 to west of the 405 for your job is a nightmare most mornings. They are making a bet that that won't change anytime soon. In my family's case, too, we're paying for not having to worry about the LAUSD or private schools. It was worth it to us to pay a huge premium for Santa Monica real estate because we love the idea of sending our kids to our neighborhood public school and knowing most of the kids from the neighborhood are going there too.
posted by town of cats at 10:53 AM on August 5, 2013

In places like LA, the standard analyses of affordability don't tell you anything useful about the price of houses in nice neighborhoods.

Southern California is full of very poor people crowded in shabby apartments or in houses in high crime neighborhoods, and working class people living and working on the outskirts or doing unimaginably long commutes from the outskirts to the core.

The people who are buying single-family houses in nice neighborhoods -- even small houses -- are drawn from the small subset of the population which consists of couples with professional incomes of $200k or more (sometimes much more), or are bringing cash from abroad where the housing is relatively even more expensive. The need for renovations is relatively speaking a bargain -- you get to have your house AND design your own new kitchen and master bath, too.

Proposition 13 is a huge asset to buying homes, and so is the state of the schools. In the good districts, rising real estate prices means mid-priced apartments being replaced by high-end condos and low-priced apartments opting out of Section 8 and going mid-priced, which means better student bodies (given the correlation between parental resources and student performance). Outside the good districts, no one is expecting an improvement, so the chance that an improvement can occur is simply a free option. (The impact on home price of the neighborhood LAUSD school going from all free school lunch to attractive for local professionals is pretty amazing.)
posted by MattD at 11:42 AM on August 5, 2013

The median price to income ratio has come down quite a bit for LA over the last four years. Here's a table for Q4 2012. You can however, see that it's always been crazy by comparison to anywhere other than San Francisco and San Jose.

We started looking about six years ago, and only bought last year. The place dropped by more than a third in that time. House prices never go down they told us. You have to get in early they said.
posted by inpHilltr8r at 12:39 AM on August 7, 2013 [1 favorite]

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