Value Neighborhoods, Cheap Neighborhoods, and Momentum between the Two

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Viewpoint 03/03/2010

Value Neighborhoods, Cheap Neighborhoods, and Momentum between the Two

In our last issue (the Rich get Richer) I showed how the real estate downturn has not affected all neighborhoods equally; some zip codes have proven much more resilient than others.  I explored the theory behind why this is so, and I showed a few concrete examples to prove the theories.

Today I want to look at what this means for you – how can you, as a homeowner, potential homeowner, or real estate investor, take advantage of what the statistics are showing us?

In this issue I’ll cover:

1. How can a neighborhood change its momentum to become more desirable?  What does a desirable neighborhood have to watch out for to avoid gaining negative momentum?

2. Do the neighborhoods which have been hit harder (the less desirable zip codes) have more upside appreciation potential today?  Put another way for long term owners and investors – “where should I buy?”

Changing Momentum

What causes a good neighborhood to become less desirable?  How can a bad neighborhood increase its desirability?  First I’ll walk through a couple of hypothetical examples using stick-figure drawings.

Good Neighborhood Going South

Here is an birds-eye picture of 2 streets in a nice neighborhood – house after house which all look similarly desirable.

Suddenly one of the homes (in red) stops looking as nice as the others.  Medical issues, divorce, job loss, moved out and now rents the home out, sold the home to a new owner…  Lots of possibilities, but the bottom line is the home and yard don’t look very nice anymore.

This has a direct impact on the neighboring homes (blue); the neighbors who see this home every time they open the front door.  They can stand in their driveway and see blight where there wasn’t any before.

This has a smaller impact on the other homes surrounding this home (blue dots) – they drive by this home each day, or see it over the back fence, and shake their heads.

One day the guy next door wants to sell his home; he puts a For Sale sign in the yard.  He gets plenty of traffic looking at his house, but no offers – nobody wants to pay that price and live next door to a neighbor who doesn’t take care of his house.

Eventually he takes a low-ball offer and sells his home to somebody who doesn’t mind the next-door eye sore.  This is because the new buyer doesn’t care as much about home appearances.  Pretty soon his house looks similar, and the problem spreads down the street.

A year later one of the homes on the street behind these two experiences the same problem when they sell.  The downward pressure on prices continues, and the quality of homeowner continues to fall as well.

Over time this downward spiral continues, and long-time owners are left to wonder what happened to the neighborhood they once had.

Bad Neighborhood Gaining Value

The opposite is also true.  Here is a neighborhood of less desirable homes – street after street of yuck and blah.

On one street the neighbors get together and decide to make a difference.  They paint.  They plant grass and trees.  They clean up.  They make their street look like Main Street USA.

Their efforts open eyes; potential buyers in the area want to live on that street more than any of the others.

Unfortunately for them, nobody on this street wants to sell – they’re too happy to move!  So the new buyers buy homes close to this street, and take pride in living there.  (red homes).

Some of the other neighbors notice the change.  They see the “pretty street”, and they see the new neighbors moving in and fixing their homes up.  Not everyone is motivated equally, but some existing homeowners start cleaning up their homes – fixing, painting, planting.  (blue homes)

Over time, the pride of ownership virus continues to spread.

Eventually the neighborhood is known as a nice place to live, where people are proud to live there.

** Of note – scenarios like these do not happen overnight; they can take years, even decades, to play themselves out.  But once the momentum starts heading in one direction or the other, it can be difficult if not impossible to change; the end result becomes almost inevitable.

The current Foreclosure environment is actually acting as an accelerator to the process.  More desirable neighborhoods have been dotted by vacant, distressed homes.  Less desirable neighborhoods have seen homeowners band together, and prices low enough for young energetic buyers to afford.

Of course, both of these scenarios are hypothetical and would require an almost perfect chain of events to unfold as I’ve presented them.

Other Key Factors – In real life there is more to changing momentum than just the neighbors mowing their yards.  Here is a short list of factors which can have a drastic impact on the surrounding neighborhoods, most of which are outside the homeowners’ control.  There are dozens of others not listed here.

• Employment – A new employment hub can be good for a neighborhood (high paying jobs) or bad (low paying jobs.)  A major employer leaving will generally have a negative impact on the surrounding neighborhoods.
• Traffic Patterns – new roads & freeways, widening projects, stop lights, dedicated turn lanes..  These can change the “feel” of a neighborhood, sometimes for better and sometimes for worse.  Unfortunately the law of unintended consequences often goes into effect with this one; the results aren’t known until after the change.
• Commercial & Retail – they’re building a new grocery store on the corner.  Is it a Whole Foods / AJ’s?  Is it a Fry’s / Albertson’s?  Or is it a Food City?  Will the new center have an upscale boutique, or a 99-cent store?  They won’t all have an equal impact on the neighborhood.
• Gas Prices – a couple years ago when gas was approaching $4.00 per gallon we heard a lot of people decide against the far-out suburbs.  Buckeye, Goodyear, Surprise, Queen Creek, Maricopa – some neighborhoods will become less desirable simply due to their commute times.  Of course, cheap gas &/or readily available alternative energy vehicles could have the opposite effect.
• City Development & Zoning – the city can change the “feel” of an area, for better or for worse, with the stroke of a pen.

“OK, that’s all fine & dandy.  But what does it mean to me?”  Let’s talk a little bit about where you should buy and how to take advantage of a neighborhood’s momentum.

Upside Potential

Do the neighborhoods which have been hit harder during our current economic downturn have more upside appreciation potential?

That depends.  There’s a HUGE difference between good value and cheap.  I can’t stress that enough, so I’ll say it again – Value and Cheap are NOT the same thing!

Have you ever bought a shirt just because it was cheap?  The $10 shirt that had been marked down to $2 on the clearance rack?  You said to yourself, “duh – for $2 the joke’s on them – this is practically free.  I have to buy it.”  Then you put it through the wash and the seam ripped, right?  It was just a cheap shirt – no real value.

That’s a big difference from the $50 shirt which somehow survived all the sales & markdowns, and ended up on the $10 rack in just your size.  You pick that shirt up and have purchased a great piece of clothing at a very reasonable price – real value.

Stock investors know the value vs cheap story all too well.  In July 2008, Best Buy was trading at a lofty $40 per share, while competitor Circuit City’s shares sat at $25.  Circuit City was definitely cheaper, but where was the value?  In 2009, Circuit City filed for bankruptcy protection, and its shares are trading today on the Mexican Exchange for 9 cents each – $1,000 invested in Circuit City in summer ‘08 is worth $3.60 today.  Turns out there wasn’t any value in Circuit City’s low price – it was just cheap (and probably too expensive to even be cheap!)

And what about Best Buy, you’re asking?  Its shares are trading at $37 today – not bad considering the tumultuous market over the last couple of years.  Like a desirable neighborhood, Best Buy has managed to hold its value during a tough economic time.  And considering they rely on consumer spending via discretionary income (tech gadgets) and home buying & upgrading (appliances), they’ve been fighting a very tough environment indeed!

Upside Potential

Now back to real estate.  I think there are tremendous values sitting out there right now – both individual houses selling for good prices, and whole neighborhoods which I think have been marked down to value levels (like the good shirt on the clearance rack.)  But I also think there is a lot of cheap out there – prices which sound low today but which will also sound low ten years from now.

Is a zip code or neighborhood going to appreciate more just because its been hit really hard today?  My short answer is no.  The market has been ruthlessly efficient, and that neighborhood is cheap because its cheap.

Are there specific neighborhoods which seem to have been hit harder than they should have and which represent good long-term value?  I think there are.  I’d look for neighborhoods which may have been over-inflated in 2005, causing a large amount of bank activity in 2008-2010, but which have good fundamentals (to borrow a stock term) – an anchor nearby such as a mountain, country club, desert preserve, lake, upscale subdivisions, shopping, employment, etc.  I’d also want these neighborhoods to be close enough to the city so I’m not relying on the long-term viability of a yet-to-be developed area.

Another option is to use my “10-year test”.  As a rule of thumb, I’ve found neighborhoods tend to show their long-term direction about 10 years after they’re built out.  In other words, all new neighborhoods look great – new homes, new parks, excited homeowners – the builders’ salespeople have it easy!

But compare 2 subdivisions which are both 10 years old and you’ll see their momentum.  Do the homeowners take great care of their homes?  Does the HOA keep the common grounds clean and pretty?  Is there any vandalism present?  It takes a little while for the subtle difference to become more obvious.

Personal Example

In the area where I’ve lived since 1998, there were two similarly sized subdivisions (we’ll call them A and B) about a mile apart which were built out in 1997-1999.  At that time they were selling for almost the same price; Subdivision A was about $5/sqft more expensive than Subdivision B.  Today, 12 years later, there is a noticeably different “feel” to the subdivisions (Subdivision A “feels” nicer), and the statistics back up my subjective feelings.

In the last 5 months, Subdivision A has had 3 homes sell, with an average size of 2,017 square feet and an average price of $97.35 per square foot.  During the same 5 months, Subdivision B has had 17 homes sell, with an average size of 2,017 square feet (I’m not making that up!), and an average price of $87.63 per square foot.

The original $5/sqft difference is now $10/sqft.  And the fact that one had 6 times more sales tells me the difference is only going to grow over time – Subdivision A is obviously more desirable than Subdivision B.

Upside Potential (again)

Now let’s ask our original question again – Do harder-hit zip codes and neighborhoods represent an opportunity for better appreciation in the future?

An inexpensive house might be easy to afford (for a homebuyer) or even cash-flow positive (for an investor), but if that inexpensive house doesn’t give you something to hang your hat on – a natural anchor, a high-income employer, positive momentum, upward trending neighbors, a good 10-year test, or any of a number of other traits…  If you can’t get any of those, there’s a good chance the house is simply cheap, and not a great value.

I hope you enjoyed this e-newsletter and found something of value you can take away from it.  You can leave a comment on something you read or add to the discussion by clicking here and using the comment form at the bottom of the page.

Here’s to positive momentum.  Cheers.

Chris Butterworth

Chris & Heather, The Phoenix Agents

http://thephoenixagents.com

623-570-9940

Chris Butterworth and Heather Barr are The Phoenix Agents at Thompson’s Realty.  The Phoenix Agents are Realtors in the Greater Phoenix area, who have built a loyal following over the years by offering superior service levels coupled with a low-pressure approach.  You can visit http://ThePhoenixAgents.com online to learn more about Chris, Heather, and the Phoenix-area real estate market.  If you have real estate questions or needs, please contact us anytime; we’d love to hear from you.

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