The Unstoppable O.C.

NEW YORK (FORTUNE) – If you want to know where real estate prices are headed in California’s Orange County, the man to talk to is Gary Watts. The Mission Viejo broker has 35 years of experience and doubles as a spokesman for the O.C.’s Association of Realtors.

But it’s his track record more than his resume that has won him serious credibility with his peers. In 1989 he earned the nickname “Scary Gary” by correctly predicting that the housing market in Southern California was headed for a tumble. Then, in 1996, he was one of the first to call the area’s rebound. Since 1997, Orange County home prices have seen a 195 percent rise. Will the good times last another year? Gary doesn’t hesitate. “Fifteen percent is pretty much in the bag for Orange County in 2006,” he says. “It’s impossible for prices to go down this year.”

Nothing’s impossible, Gary.  The very same article notes that single family home inventory in Boston has increased 79% over last year.  Foreclosures up by a whopping 45%.  Boston finds itself in one of only three states whose population declined in 2005.  Interest rates are higher, while real wage growth has lagged far behind real estate appreciation.

Perhaps Boston and Orange County are just in different time zones.

California may not be suffering from Boston’s woes, but we do have serious problems stemming from overcrowding.  No job market is going to fix the infrastructure problems we’ve got around here.  There just aren’t enough homes, roads, hospitals, or schools to deal with this many people.  It’s only unfortunate that no one thought about this when they elected to build homes 18″ from one another.

Maybe the real estate sector is just hyping itself.  Can you trust a real estate agent to provide an honest assessment of the market? There is an inherent conflict of interest, especially since this guy is a spokesman for the local realtors assocation.

I hear you saying, “Perhaps the average homeowner can be relied upon for a dose of sanity.”

Yale’s Shiller surveyed Orange County residents last year on what they expected home prices to do over the next ten years. The average expectation was a 23 percent return — per year!

My first thought was, “Has Schiller double checked his math?  Maybe they meant 2.3%.”  My second was that O.C. residents have been watching too many episodes of that dreadful TV show.

Twenty three percent!  Mr. Watts’ 15% prediction sounds like a comparative doomsday scenario.

The median home price in Orange County is currently $800,000.  If the market returns 23% per year, by 2016 the median price would be just over $6.3 million.  That’s a total return of 786% over 10 years.  From current levels.

Sadly, since I own a condominium, my place would probably only be worth $3 million.  But that’s a fair price to pay for a tiny 2 bedroom, 1 bath apartment, don’t you think?

It’s getting to the point where I turn to the real estate section for my humor fix.  Seinfeld was never this funny.  I just wish someone had told me that multi-level marketing schemes were legal again — I could have made a bundle.

Seriously, though, if you want reality, it’s encapsulated in the midst of the Fortune article with two salient points:

• Southern California has become a hotbed for “exotic” mortgages, such as interest-only and negative amortization loans
• the strength of the local economy is simply delaying the inevitable slowdown — for now

It’s as simple as that.

To my eyes, the signs of a market frenzy are undeniable.  High prices, weird mortgages, record forecosures, and of course high levels of speculation.

Last year more than a quarter of all residential home sales in the U.S. were for investment purposes, and 18% fell into the vacation/second home category.  That was the national trend — keep in mind that in California it’s much higher.

In other words, one of every three homes purchased last year was not for a primary residence.  The buyer never intended to live in the home, so they were not investing for long-term longevity, but for short-term appreciation that would allow a quick gain, or as a rental in which they’d be able to make immediate positive cash flow.

I haven’t hear this talked about too much, but it seems to me that California’s Proposition 13 is doing a lot to sustain the frenzy.  It locks in a relatively fixed basis for property tax computation.  While high prices mean high tax rates, Prop 13 eliminates a big “unknown” in real estate ownership.  Homeowners in other states have no such protection, so they are at the whim of politicans to decide their tax rates.  Their tax might be $2,000 this year and $4,000 next year.  Markets hate uncertainty, so Prop 13 gives investors a perceived edge in this state.