(Jim is not in the real estate business and has no stake or interest in any of the homes mentioned in this column)

The Way Things Are

Firstly, according to Realty Times (realtytimes.com), 30-year mortgage interest rates experienced their first weekly drop in five weeks, from an average of 6.79% to 6.74%. One year ago, the average was 5.66%. Fifteen-year mortgages – the best deals around – averaged 6.37% versus 6.44%; last year the average was 5.25%. But, interest rates and their concomitant costs are only part of the equation; more importantly, whereto house prices?

When this paper was launched (by this humble scribe) 11 years ago, we trumpeted the fact that prices had taken such a tumble from 1989 through 1995 that it had become cheaper to own than to rent. Many local brokers, whose slogan had become “stay alive through ’95,” welcomed the sentiment and one could actually pinpoint the bottom of the market as perhaps the spring or early summer of ’95. It was up, up, and away from there but by 2001 the market was getting tired as 30-year-mortgage rates hovered around the 7% range (source: Mortgage Bankers Association Freddie Mac Weekly Survey, 2001); longtime real-estate mavens concluded that the normal “seven lean years followed by seven fat years” were back in play.

But, then came 9/11, causing at first a nearly complete halt in real estate sales, and in commercial activity of all kinds. The fed acted quickly, dropping its overnight rate from 3% to 2.5% on October 2nd, 2001, to 2% on November 6th, until finally down to 1% by June 2003. Many analysts now conclude it was that interest-rate plummet that resuscitated the housing market, giving it perhaps three years additional life over what it otherwise might have experienced.

Now that interest rates have risen to more historic norms, high monthly payments have put a cap on housing prices. Curiously, those higher rates are hitting California and other high-cost-of-housing areas harder than the less-expensive-cost-of-housing states. Monthly mortgage payments, after all, on a $250,000 30-year mortgage would be $1,622.50; on a $275,000 mortgage (a 10% rise in purchase cost), monthly payments rise to $1,784.75, a painful but manageable $162.25 (10%) difference. Property taxes would be commensurately low, say in the range of $2,500 to $4,000 a year, or $208 to $333 per month.

In this part of the world, where the average home sells in the $1.1 million range, a 10% differential ($110,000) at 6.74% costs a whopping $713.90 more per month. As interest rates rise, so will that figure; at 7.25% it goes to $750. And, on a $1.1-million home, property taxes begin at $11,000 a year ($917 per month). After 10% down, a million-dollar 30-year mortgage costs a homeowner $6,490 a month. Add property taxes of $917, and an average wage-earning family is facing a $7,407 monthly nut, or nearly $89,000 a year in mortgage and property tax payments. Then, one must begin to add in home insurance, car insurance, utility payments, and etcetera. No matter how you do the math, it begins to get really ugly. It currently is way cheaper to rent than to own.

Which is why, I believe, prices will probably stagnate at these levels for some time, perhaps for even the next six or – dare I say it? – seven years.

Those hoping to jump in during a nasty downturn, however, are likely to be disappointed. There is an overwhelming demand for housing along the Central Coast, and governmental powers are doing their best to keep those prices high by creating cost controls on a large proportion of new units being built. By removing such a high percentage of what would otherwise be market-based homes from local inventory, governmental entities not only help keep prices higher than they would otherwise be, but also put a brake on any downward spiral.

Montecito Millions

While subject to similar forces, the Montecito market really is different. Montecito is a lifestyle choice, and for a high percentage of buyers in the over-$5-million price category, it is also an end-of-life choice. This is where they have chosen to spend the rest of their days, damn the expense. Anyone with a net worth of, say, $20 million – and you’d be surprised how many there are – has not been frozen out of Montecito, although it must be admitted that someone with less than $5 million in liquid assets would have to be choosy around here.

Here’s something else: nearly 80% of Montecito buyers are from the Los Angeles area, and according to a recent (March 29 2006) article by Jeanne Sahadi based upon a TNS annual Financial Services report, there were 262,800 millionaires in Los Angeles County alone, some 8.9 million in the entire United States. Average net worth of those millionaires is nearly $2.2 million, excluding any equity in their principal residence. Based upon that, one must suppose that of those 262,800 millionaires living less than 100 miles from here, some tens of thousands of them are probably worth upwards of $20 million. Add in another 100,030 millionaires in San Diego County, 113,299 in Orange County, and 75,371 in Santa Clara County, and you have plenty of competitors for those 240 or so homes that come on the market each year in Montecito.

Even a $10-million bank account ensures the ability to spend $3 to $5 million on what would seem to those living in other areas of the country, a rather modest home. And, those buyers – and most make all-cash home purchases – would have plenty of income left to lead the lifestyle they’d chosen.

So, even though prices in the lower range are likely to remain at these levels, or slightly lower (10% lower?) over the next few years as rental rates catch up to ownership costs, the pressure at the higher end is unlikely to abate, although prices at that end will not see the appreciation that has occurred over the past decade. However, don’t be surprised if they keep rising, albeit slightly and/or slowly.