HITTING HOME : Real Estate Equity, Once an Important Source of Start-Up Capital, Has All but Vanished, Sandbagging the State's Recovery

By PATRICK LEE and JESUS SANCHEZ

Nov. 12, 1995 12 AM PT

TIMES STAFF WRITERS

When Wayne Adelstein started his publishing company in 1987, housing prices were going up and he was accruing equity in his home at a torrid pace.

Adelstein took out a $20,000 second mortgage on his Agoura Hills house to start Decision Communications, which publishes the Valley Business Journal. It was the latest of several ventures he had launched over the years using money pulled out of his real estate.

But since 1990, Adelstein has seen the value of his property fall precipitously, as have many of his neighbors. Now his property is “upside down”--that is, worth less than the loans on it.

“If I were to try to start my business today, I would not be able to refinance my house and never would have been in business,” the 46-year-old entrepreneur said. “I wonder how many businesses aren’t being started out there that could have been.”

It’s a haunting question to economists and business people looking at the sluggish recovery in California. Many feel that the state’s stagnant housing prices are acting as a major anchor on the economy. The reasons:

* Depressed housing prices make people reluctant to sell their homes and unable to move up, hurting the real estate market and the construction industry. That in turn damages a variety of other industries, ranging from retail sales to furniture manufacturing to landscaping.

* As long as real estate prices remain flat, consumer confidence will remain weak, some economists say. That’s because much of a California homeowner’s wealth is tied up in real estate.

* Declining home equity means less credit-worthiness. “That can have a direct effect on borrowing to buy a car or getting a home equity loan,” said Howard Roth, senior economist at Bank of America in Los Angeles. Falling real estate values can also affect the ability of entrepreneurs such as Adelstein to start up businesses.

“Nowhere else in the country views real estate the way Californians do, and justifiably so: No other region has experienced the kind of appreciation that California has in modern times,” said economist David Hensley at Salomon Bros. in New York. “I think it’s been very disheartening [for Californians] to have their house prices fall because they viewed it as savings and because they were sacrificing so much to buy a home.”

The effect of flat real estate prices is hard to measure, and most economic indicators show that California is in a second year of recovery, with state employment actually growing at a faster annual rate than that of the nation as a whole.

“I think there are enough positive things going on now, particularly in job creation, that outweigh [depressed real estate prices] at this point,” Roth said. “But we would have a stronger recovery on our hands if we could get the housing sector turned around, and if people were convinced they’d seen the worst of it.”

California real estate is one of the few industries (along with aerospace) that has yet to recover.

Housing prices have fallen generally in the state for the fourth year in a row, and home values are an average 17% less throughout the state compared to 1990.

In Los Angeles County, values are even more depressed: Prices have fallen 24.7%, according to La Jolla-based DataQuick Information Systems and KPMG Peat Marwick. According to a Times computer analysis of statistics provided by DataQuick, the most devalued neighborhoods in Southern California by the second quarter of 1995 included the 90036 ZIP code of Hollywood, which has seen its median price fall 38% from its peak; the 90272 ZIP code of Pacific Palisades, where the median price was off 36% from its peak, and the 91107 ZIP code of Pasadena, where the median price was down 30% from its peak.

The worst may be over: Some of the communities are starting to see prices creep up. Year over year, according to the Times analysis, the 90274 ZIP code of the Palos Verdes Peninsula was up 21%; Pacific Palisades 90272 was up 13.6%, and the 90045 ZIP code of Hawthorne was up 5.6%.

But the evidence of price recovery is still spotty around the state, according to First Interstate Bank.

As a result, many residents are still fearful about their economic futures. For many homeowners, the investment in their house is their most important connection to the economy as a whole. When the home’s value remains stagnant or falls, it is natural for the mortgage payer to see it as a sign that the entire economy is in bad shape.

A recent Times Poll found that California consumers were more pessimistic about the future of the economy than they’ve been since 1993.

“When prices are going down, they feel less wealthy, their portfolio of assets is not worth as much, so they don’t buy as much, or feel they have to save more money . . . which translates into less economic activity,” said Chris Taylor, an economist at Wells Fargo Bank in San Francisco.

The dour mood is also attributable to years of bad economic news. Even though most indicators show that the worst is over, it’s difficult for many recession-battered consumers to believe it completely.

“It will take some time for people to understand that Southern California and the state did not fall off the edge of the economic world,” said Stephen Levy, an economist and director of the Palo Alto-based Center for Continuing Study of the California Economy.

And the bad expectations can be self-fulfilling. Weak consumer confidence augurs meager Christmas gift buying, investor reluctance to finance new businesses, and an unwillingness to put homes on the market.

“Housing is very subject to confidence,” Levy said. “As people believe and understand the recovery story, we could see quite a turnaround in housing.”

Weak equity values also put downward pressure on the number and size of home equity loans, which in turn are often used to finance businesses or buy consumer durables. The number of home equity loans taken out in California has varied widely in the last several years, but even at most have been nowhere near the levels of the boom years of the 1980s, according to DataQuick statistics.

The effect of all this is not entirely black-and-white: There are clearly factors beyond real estate prices playing a role in consumer confidence. Auto sales, for example, are increasing. And the Conference Board’s consumer confidence index for the Pacific region, which includes California, showed a slight gain last month, with confidence at its highest level since May.

“It looks like consumers are a little more optimistic about future conditions in the next six months or so,” said Lynn Franco, an associate economist at the Conference Board in New York.

Low housing prices can also spur first-time home buying if coupled with low mortgage interest rates and pent-up demand. Indeed, First Interstate forecasts that housing sales should grow in 1996 and ’97 after having fallen in 1995.

But the low prices also keep many homeowners trapped in the houses they’re in.

“The problem is in the trade-up market,” Wells Fargo’s Taylor said. “When values are flat or going down, it’s difficult for people to sell their homes for prices they think they’re worth, and that constrains their ability to trade up to a better home or better-located home. That’s what we’ve seen in the California market for the past couple of years.”

A lower level of such transactions means less economic activity overall, she said. “When people buy a new home, they buy furniture and appliances, redecorate and do landscaping; that all filters back to the economy in greater retail sales and services, often enough to create new jobs.”

The lower number of home sales has also hurt the construction industry. Home building in California is at historically low levels, exacerbated by excess inventory and high levels of foreclosures, First Interstate Bank reports. The bank expects 9.5% fewer residential building permits to be issued this year than last year.

Quentin Merriman, 61, a social studies teacher in Los Angeles schools, wanted to sell his house and use the proceeds to boost his savings and move to Atlanta after he and his wife, Carolyn, 55, also a school employee, both retired recently.

Before the recession, the house had been appraised at $295,000. They put the house on the market at $265,000 in February. By July, the price had dropped to $250,000. “I’ll be lucky I if I’m in Atlanta before the Olympics,” he says now.

With the sale of his house delayed, he and his wife have cut back on spending. They eat out less. “My wife just snatched my charge card from me,” he said. “I had to take my son’s gas card away from him too.”

Before they put the house on the market, Merriman thought they had $200,000 in equity. Now, he figures that has dropped by $30,000.

“That was supposed to be a nest egg for us that we were supposed to draw down,” Merriman said. “It’s like reading a book and getting to the last chapter and finding out it’s missing.”

Some homeowners are paying now for the excesses of the 1980s, especially if they yielded to the temptation to tap their rapidly rising home equities.

“People were sitting on big equities and it was burning a hole in their pocket,” said Kathy King, owner of King Realty in Sherman Oaks. “They see friends buying and selling and making money, pulling their money out. So it became, ‘God, honey, we should be doing something with this equity, not just sitting on it.’ ”

Say you bought a house in 1982 for $300,000. By 1990, that house was worth $800,000. You could have mortgaged up to 80% of that, spending the money on new cars or college tuition.

When prices dropped, “pretty soon it’s down to $550,000 and I owe $640,000,” King said of a hypothetical buyer. “It’s not that I bought at the wrong time. I’m in this predicament because I took all my equity out already.”

For others, the drop in real estate values means difficulty making a living now.

“There has always been a traditional link” between real estate prices, the economy’s health and entrepreneurship, said Jon P. Goodman, executive director of USC’s Annenberg Incubator Project, aimed at stimulating entrepreneurship.

In addition to savings or family money, “there is significant evidence that start-up money comes from home equity,” she said. Now, “people no longer have the easy [access] to that money. . . . Not only because the real estate market was destabilizing, but also because banks were the first ones to get into trouble with [real estate loans]. . . . Banks took the hit before consumers did, which caused money to dry up.”

“The price of real estate does have a strong bearing on the amount of equity that people have that they can use as collateral to borrow for their businesses,” said Tana Davis, president of the accounting firm Davis & Dash in Encino.

One longtime Crenshaw district merchant, who spoke on condition of anonymity, is frustrated at his inability get a $40,000 line of credit to refurbish and expand his retail store.

He has been refused credit unless it is collateralized by his home, he said. But the value of his Crenshaw home and adjacent property has dropped sharply since the recession began, and that restricts his ability to qualify for credit, he said.

“They won’t lend you a nickel for your business,” he said. “It seems strange. I own everything in the store, and they still won’t give me a loan.”

He is now seeking credit, secured by his house, from a special loan program set up by USC to aid small businesses.

Some banks and other lenders, aware of the equity problem, have created small-business lending programs that are based on an entrepreneurs’ record or other criteria.

But many businesses are still struggling to find credit.

Three years ago, Mary Schnack, 39, wanted to take out a second mortgage on the Santa Monica house she has owned for 10 years to open a retail store in Marina del Rey.

The house had once been appraised at $450,000 and had a $200,000 loan, so she thought she could easily qualify for a new loan. But a new appraisal came in at $300,000. And knowing that the loan would be used to finance a new business, the bank said she would have to have more equity than that before it would approve the loan.

So she abandoned the quest for an equity loan. If not for a loan from her family and cash advances on her credit cards, along with her savings, she said, she would not have come up with the $60,000 necessary to open her retail sign and banner shop, called Signmasters.

Business is good now, and she still owns the house. But she said she is afraid to find out what it’s worth. “Hopefully it’s gone up from that $300,000, but I don’t think it’ll ever go up to $450,000 . . . and I haven’t taken out a loan on the house since then.”

Even if the worst is over for California real estate--and forecasts from the Bank of America, First Interstate Bancorp, UCLA and Levy’s center for California studies all agree that it is--it’s not clear the recovery will come soon enough for business people like Cam Davis.

Davis, 42, and his partners in the accounting firm Weil & Co. in Santa Monica are seeking financing to expand their successful 40-employee practice by acquiring another firm. The hope is to do so with bank loans, collateralized with the firm’s receivables and three partners’ personal assets, including residences.

The problem is that the value of two of those residences has fallen so much that “in general there’s very little equity,” Davis said.

“Our individual net worths have declined drastically,” he said. “That’s not just because the value of our personal residences has declined. Our investments in real estate have virtually disappeared. We had invested as a group in a number of apartment buildings and condo projects, all of which have been losers. . . . Certainly if we had more equity, expansion would be easier.”

Davis’ own Pacific Palisades home has appreciated since he bought it in 1993. He is now hoping to sell the house. Whether he gets his asking price is another matter, however. “The proof is in the pudding,” he said. “No one has rushed up to give me my asking price--yet.”

Times staff writer Jesus Sanchez contributed to this report.

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Still Waiting ...

Housing prices in California have failed to recover from the recession, creating a drag on the state’s otherwise healthy economic recovery. In general, Southern California has suffered more than Northern California, and certain ZIP codes have been especially depressed. The flat or falling equities in houses have led to a falloff in the number and value of home equity loans since the boom years of the 1980s, though there have been wide fluctuations in recent years.

Value of equity loans in California, 1988 to present:

Sept. 1995: $577.74

SOUTHERN CALIFORNIA

September 1995

Los Angeles County

Pacific Palisades; 90272: $625.00

Hollywood; 90036: $285.50

Norwalk; 90650: $143.00

Orange County

Irvine; 92714: $244.50

Westminster; 92683: $170.00

Santa Ana; 92704: $155.00