Flippers Flee, Long-Term Investors Hold On

Thursday, Sept. 14, 2006 | Dennis Balagtas doesn’t flip over get-rich-quick schemes. A land surveyor by day, real estate investor on the side, Balagtas has a long-haul attitude about the four properties he’s purchased in San Diego and South Carolina since 2001, and the two in Colorado currently in escrow.

“I don’t anticipate selling any of my properties,” he said. “Ever.”

Balagtas’s long-term perspective hasn’t typically defined San Diego real estate investors, at least not in the recent boom. Periods of rapid appreciation in the housing market in San Diego a few years ago spurred a wave of investors looking to “flip” houses or condos – to buy pieces of real estate, fix them up, sell them soon after for a profit and then move on to the next piece of property.

Now, in a depreciating market – home prices year-over-year have begun to drop – investors know they’ll lose if they don’t learn to hold on.

As prices have declined, sales have slowed, and inventory levels have risen in recent months, the get-rich-quick, house-flipping days seem to be over for a while. But that doesn’t mean all forms of real estate investing are dead in San Diego – they’ve just changed.

A little more than a year ago, when Money magazine wanted to investigate the booming culture of real estate investing, reporter Stephen Gandel looked to San Diego as the poster child for the phenomenon. Designated “America’s scariest housing market” on the June 2005 cover, San Diego was touted as a place where real estate “makes everybody rich” due to annual property value appreciation of 15, 20, 25 percent in some places – a trend that proved too good to continue. Gandel spoke with six San Diego investors, all of whom had stumbled into real estate investing and found it to be the best bet of their lives.

Ted Donovan, and his wife, Angie, were one of the couples featured in the Money piece. When the story was written, they’d just bought a 1,900-square-foot home in La Mesa, with intentions of fixing it up – the front door didn’t even open – and selling it at a profit.

It wasn’t their first investment property. Angie had been investing in real estate and turning profits before she and Ted met. They sold two condos downtown right before the market started slipping.

“We got real lucky,” Donovan said this week about the timing of those sales.

More than a year after the article ran, Donovan said the right combination of luck and observation skills helped them make the well-timed decision to sell when they did. And, he said, their realistic attitude about the investments helped, too.

“I’m an Internet consultant, and my wife’s an occupational therapist,” he said. “We’re not the flippers – we’re not buying 20 houses a year. We look at one, two, maybe three a year.”

Donovan said he has friends who didn’t do so well.

“I know of other people who’ve had their homes on the market for 120, 160 days,” he said. “In that case, [buyers] are usually going to lowball.”

The Donovans didn’t count on falling in love with the La Mesa fixer-upper, but once they landscaped the half-acre property, they decided to make it their home for awhile. Now they’re going to stay in that house, continue to rent out the condo they have in Mission Valley, and watch the market to “go down a little bit” before finding another project.

“We’re going to make sure we do our homework and pay a fair price,” he said. “The market is eventually going to come up.”

It’s that long-term perspective that Peter Dennehy, vice president of Sullivan Group Real Estate Advisors, says separates the successful real estate investors from those who got burned.

The flippers are the type of investors that skewed the market during the red-hot days, Dennehy said. The flipping fever drove people to buy, buy, buy – regardless of location – and to bid each other up so that eventually, prices spun into a realm almost completely detached from the home’s “actual” value.

“They were very prevalent,” he said, referring to flippers in the boom of a few years ago. “They’re the ones who are gone.”

Dennehy thinks people should buy the house that they live in and not much more, so as not to disturb the supply-and-demand cycle that keeps the economy stable.

“You do not need to get on a bus and go to Phoenix with 40 people to buy condos,” he said. “That skews markets. It’s not real demand.”

“When everybody does it, it’s over,” he added. “They had a good time until 2005 or so.”

Dennehy purchased a home himself earlier this year, and trusts its potential for long-term appreciation, despite any short-term fluctuations its value may sustain. He said historical data show that values for San Diego housing, when viewed in 10-year chunks, have always increased, even though they may have seen some ups and downs.

“I’m confident that my house will go up in 10 years,” he said. “I’m not so confident that in 12 months, my house is going to go up.”

The warning from Money magazine that San Diego is “America’s scariest housing market” didn’t faze another of the article’s featured homeowners, Kelly Pearson. A then-24-year-old, Pearson had purchased a four-bedroom, 1,450-square-foot rancher near the airport for $580,000 in 2004, and had seen a smaller home across the street sell for $740,000 in 2005. Her plan, at the time the article was written, was to borrow more money and invest in a condo.

In that article, she marveled, “Where else can you turn a huge profit on a house in eight months?” and added, “The possibilities are unreal.”

Pearson was out of the country and couldn’t be reached for an update on her current attitude on the San Diego housing market, but a roommate confirmed that Pearson had bought a condo – a three-bedroom unit in Solana Beach, west of Pacific Coast Highway.

Leslie Howard, Pearson’s roommate in the Solana Beach home, said Pearson still owns her downtown home and rents it out. A mortgage broker, Howard arranged Pearson’s financing for the condo and said as far as they know, both homes are still appreciating.

Financing for these investment properties has caused some to worry about investors’ ability to hold on should their homes lose value.

Many homeowners tapped the soaring equity of their primary homes during the boom in order to finance their purchase of another property – as a second home or an investment. That is, they refinanced their first mortgage, taking some cash out of that home to make a down payment on a second property.

These cash-out refinancing options were often adjustable-rate mortgages that gave borrowers the option of paying only the interest or a smaller portion of the interest accrued each month – the latter is called “negative amortization” because the debt actually grows during the beginning stages of the loan.

These mortgages would allow more people to shoulder two (or more) mortgages with lower payments for a stated period. And because home values were going up so dramatically, many people counted on being able to use the mounting equity (again) to refinance both of their mortgages before they reset, or bumped up to substantially larger, principal-included payments.

So the worry that comes now, in San Diego’s cooling market, is that some people may be caught with two or more mortgages due to reset in the coming months who didn’t expect to have to deal with the substantial payment increases.

Balagtas has used adjustable-rate mortgages on all of his properties, a decision he said he researched extensively before making. He said the payment options allow him some breathing room if another of his mortgages adjusts.

“You have to ask, ‘Do you have enough cash reserve to make the payments?’” he said. “The reason I’m not as worried about it is because I have expanded to other markets.”

That advice came to Balagtas from Lisa Vander, president of Pacific Blue Investments in Solana Beach. She said the slowdown in the housing market of late hasn’t dampened her estimated 3,000 clients’ enthusiasm for investing in real estate.

“I have been touting conservative investing – get out there but make sure you know what you’re doing,” she said. “Take the money (home equity) out safely and strategically.”

Vander said much of that strategy she teaches focuses on weathering the market – in good times and bad. She attended some wealth-through-real-estate workshops in 1989, got fired up about investing, and then found herself struggling when the market dropped the next year.

“I was sitting there as a good student, upside-down,” she said. “That’s not how wealth is generated. It’s not to sell and get out.”

Dennehy said he thinks the dramatic boom left many people counting on the fact that they’d always be able to sell their homes for more than they paid – no matter how quickly they sold again.

“There’s a gradual realization now that they can’t sell their home,” he said. “That train has left the station.”

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