Ready to Roll Dice on Home Market
If there’s any doubt that Southern California’s housing market is hot, ask Jeff Stokes, a speculator who just placed his biggest bet yet.
Stokes is a Pasadena real estate agent who for years has made money buying and fixing up old homes for profit, except when the market bottomed out earlier this decade and he lost his shirt. Now, he is building a home high in the Laguna Beach hills that he hopes to sell for $1.25 million when he finishes.
“Even if we just get $1 million,” he says, “that’s still about a quarter million dollars in profit.”
Across the Southland, rising home prices once again have real estate prospectors seeing riches in tear-down houses, fixer-uppers or lots for “spec” homes.
It’s being fueled by rock-bottom interest rates, a strong economy and years of pent-up demand. And big money is being made by those with the foresight--or luck--to be selling their spec properties today.
For example:
* In Laguna Beach, builders who were nearly bankrupted a few years ago construct a large three-bedroom home on an ocean view lot for less than $600,000, stick a “for sale” sign in the ground--and sell the house for $925,000.
* In Pasadena, aging bungalows get $28,000 cosmetic face lifts and, shining with new ovens, paint and pedestal sinks, are back on the market within two months--and selling for a profit of two to three times the fix-up costs.
* In Newport Beach and Corona del Mar, “probably 65% of the stuff we’re doing, people are turning around and reselling,” says an executive at Coastal Builders, a major home remodeler. “They don’t want their neighbors to know. But they tell us under their breath.”
* On Los Angeles’ Westside, so many spec builders are vying to replace aging homes with multimillion-dollar mansions that the biggest problem is too few tear-down candidates, says Fred Sands, a longtime broker in the area who got his start fixing up little homes.
“If there’s a beat-up old house for sale, five users want to fix it up and live in it--and another five speculators want to fix it up and make a profit,” Sands says.
Spec building is real estate jargon for projects started without buyers or tenants lined up.
The big companies that produce most new homes build mainly on spec, but their experience and capital help cushion them against the market’s frequent bumps. And market research helps them tailor projects to consumers’ shifting tastes and pocketbooks, so buyers usually materialize when the paint dries.
During good times, out come smaller players in the home building game, operating on back-of-the-envelope calculations and instinct. With shakier funding, limited expertise and a tendency to bet everything on one or two properties, they can easily fall victim to economic downturns.
Indeed, some industry watchers say a proliferation of small-time spec builders can be an early warning sign that a market may be overheating.
“With prices rising, all kinds of people start believing they can be builders too,” says Jeff Meyers, whose Meyers Group is a major consultant to builders. “Your doctors and dentists and lawyers start jumping in.”
A Time of Small Speculators
For now, Meyers says, the new entrants are mainly small speculators who were frozen out during the down market a few years back. He’s seen many unfamiliar names among builders of small condominium projects and other developments on the Westside.
So far, he says, the housing recovery is in its early stages, and they have room for error: “The price increases make up for any mistakes.”
It’s when they stop going up, as they inevitably will, that the disasters occur.
Tim Somerset, an Irvine-based manager of mall renovations and other commercial projects for Charles Pankow Builders, ruefully recalls his own first attempt at small-time residential development on the side.
It’s hard to forget. He still owns the property, which he wound up renting out for a decade because his plans to sell it at a profit fell through.
Somerset bought a Torrance house for $205,000 in 1987, spent $150,000 fixing it up and building another on the same lot in 1988, and listed them for sale for $420,000 at the end of that year, hoping to make $30,000 or more.
He ticks off reasons he got stuck: not researching the area and its schools, which aren’t Torrance’s best; overdeveloping the property; limiting potential buyers to people who would want two homes on a lot. And, of course, bad timing.
“I just figured things were appreciating at 20% a year, and basically there was nothing you could do wrong that wouldn’t be covered by price escalation,” he says. “Actually, it was the beginning of the end for the market, but nobody saw that then.”
Most Southern California experts see little on the economic horizon to disturb the recovery--for now. Steve Cauley, a UCLA Business Forecasting Project real estate economist, notes that prices have yet to approach their 1989-90 peaks, while incomes are up sharply among the affluent buyers driving up top-end prices.
Cauley’s main warning is that mid-priced homes may rise less in value because middle-class wages are stagnant.
“The people who see prices going up at the top end and think they can fix up houses and make a profit in the [lower-priced] areas nearby may be disappointed,” he said.
Tax consequences also complicate the spec game, along with potential ethical problems for real estate agents.
Agents who buy property for themselves must disclose their profession to sellers, but face no other special constraints, said Gov Hutchinson, a California Assn. of Realtors lawyer.
However, he advises them not to buy their own listings to avoid potential conflicts of interest because they are obligated to get the best deal for their clients. The agents interviewed for this story say they will not buy their own listings.
Investors who buy homes and quickly resell them also forfeit the hefty capital gains tax break granted to most homeowners last year. Under the new law, up to $250,000 in profit for a single person and $500,000 for a married couple escapes capital gains taxes when a house is sold--but the owners must have lived in the home for two of the last five years.
To the speculators, that’s just part of the cost of doing business. “It’s like buying stocks,” Stokes says. “You make money, you pay taxes.”
Obvious Risks
Sands, the longtime Westside broker, says the risks of spec building are obvious, particularly in light of the early 1990s price plunge. The decline was worst at the high end--the very market segment where most small-time spec building occurs--swallowing 40% of the value of many pricey properties.
“You either make a fortune or you lose a fortune,” Sands says. “It all depends on timing.”
He thinks the market is far from the top today, saying that the chance of high interest rates is so remote, and the region’s economic engines, especially entertainment, so powerful that the spec deals make sense--even “tear-downs” that can easily take a year and a half to complete.
“I’m more positive now than at any time since 1979,” Sands says.
And for now, at least, a bullish new generation of fortune seekers are betting with him that they can profit from the hot market.
Winners and losers at the game offer similar advice: painstakingly study what sells best in your market, don’t over-improve property, supervise all work closely--and get the deals done fast before the market can change.
Pasadena Realtor Michael Dilsaver says old homes are the best bet in that city because buyers there are attracted to its historic districts. In neighboring Arcadia, by contrast, newer, modern-looking homes are more in demand.
After several years helping clients fix up and resell homes, Dilsaver is trying it himself, successfully so far.
He upgrades old Pasadena homes with new paint inside and out, refinished hardwood floors, and about $8,000 in kitchen work--white tile with dark “rope” trim, black or white appliances, white-lacquered European-style cabinets from Home Depot. Bathrooms get about $3,500 or $4,000 in work, including travertine counters and pedestal sinks.
Dilsaver says he bought a home last June for $187,000, spent $28,000 on upgrades, and sold it in September for $276,000. He bought another in August for $161,000, put in $27,000, and sold it in October for $275,000, clearing $70,000 after sales fees and other costs.
“I’m a firm believer that in any market top condition will bring top dollar,” he says. “It’s not just a function of the rising market--even in the ’91 market people could make money on remodels if they had the right product.”
Buyers of these fixed-up homes generally lack the time and inclination to rehabilitate old houses themselves--and will pay extra for someone else’s work.
After enduring a major home remodeling in South-Central Los Angeles, Aldra S. Herman says the last thing she wanted when she moved to Altadena last year was a fixer-upper. She bought a home that had a new roof, new paint and even new grass on a cul-de-sac of tidy houses.
“We felt like we really didn’t have to do anything,” says Herman, who works for Inglewood’s housing department.
But she later learned one annoying fact: the home she and her husband bought for $235,000 in December had been purchased earlier in the year for just $135,000 by buyers who did a cosmetic overhaul and put it back up for sale.
“They made $100,000 off of us. I didn’t do my homework,” she says, noting that the fix-up was minor and didn’t even include updating the bathroom tile. “This is just a 1950s house with some new knobs and carpets. That’s about it.”
Still, she notes, there were three other bids on the house and nearby homes are being listed for similar prices.
Good and Bad Timing
The big winners this time are those who timed the market perfectly by making their bets a year or two back, when the real estate recovery looked much less certain.
Spec builders Bob Miner and Victor Jasniy know all about timing, good and bad. Their San Gabriel Valley-based business, started in the 1980s, was battered by losses this decade, including the forced sale of a supposedly $1.2-million Glendora estate home for $600,000.
Then they heard about a 7,000-square-foot lot in Laguna Beach on Skyline Drive, where the 1993 firestorms had destroyed the home. “We looked at the numbers, and we did a double-take. It looked too good. But it worked,” Jasniy recalls.
They paid $220,000 for the lot in October 1995, got a $350,000 construction loan, and, to reduce costs, did most of the work themselves. They quickly got four offers when they put it on the market last fall, including the $925,000 bid they accepted.
Their Miner & Jasniy Enterprises Inc. has now teamed up with Stokes to build on his newly purchased lot, a bit farther up Skyline Drive. Stokes hopes the deal is only the first in a series that will free him from his job as a Realtor.
“It’s less stress than schlepping buyers all over the San Gabriel Valley, and making $4,000 a house,” he says.
Building on Spec
Spec building as stress reduction? Not according to Neville Pearson, president of Los Alisos Development in Irvine, a commercial developer that recently completed its first spec house--a 7,200-square-foot Mediterranean mansion on a half-acre above Newport Harbor.
Pearson and his partner, longtime spec builder Dave Busk, dubbed the home Castello Miramare, and put it on the market for $4.25 million.
“The people with money are out there,” Pearson says. “You’ve got to find those people who don’t want to go through the three years [to build a custom home] themselves.”
But their ready-to-move-in castle sat unsold for nearly four months. And despite Busk’s reassurances that someone would fall in love with it, Pearson fretted as 90 prospects paraded through--and passed on buying or couldn’t work out financing.
The home finally sold last month for just over $4 million, said Allison Seesemann, a Newport Beach real estate agent who represented the buyer, a woman from out of state.
A relieved Pearson says he would have long discussions with his board of directors before undertaking another spec home. Counting finance costs, “I probably could have made just as much money by buying a couple of mutual funds,” he says.
Somerset, who was unable to sell his Torrance spec homes, believes that any time real estate becomes frenzied, plenty of people will repeat his mistakes, and worse. Especially at risk, he figures, is anyone who takes on multiple projects.
“They’ll have three lots building, they’ll be overextended at the end of the cycle and they’ll end up toasted when people stop buying,” he says.
Yet the allure of spec building is great, and he’s considering trying it again himself--more carefully this time, and in an affluent city like Laguna Beach, where his own home, purchased last year, has shot up sharply in value.
“I’d like to build a place,” he says. “I might be stupid, but I think you can make money if you do it right in Laguna.”
