Philip Maise

Many people are now asking themselves the question...why should I buy a house in a particular area...if the price of houses around it continue to fall? Where will I be when I try and sell? Will I be faced with suffering a loss because everything has gone done in value?

If you have flexibility with where you can live or own investment property, certainly you should be asking these questions since it will greatly effect your future wealth.

The biggest mistake to avoid is to think that a house in a particular area is a good deal now, simply because that same house used to sell for a much higher amount a short while ago. If you do this you are trying to base future value on factors that are radically different.

The second biggest mistake is to look around for areas where there is strong current supply and demand. This ignores the fact that future supply and demand may change.

Therefore, the best indicator you should be looking for to see if the home you buy will retain value is to examine factors that will drive future supply and demand.

Here are the big questions to consider:

#1 - Can a cheap supply of future homes be built nearby

#1 A) Is there an available supply of vacant land that can be used to build these new houses? If so, is that vacant land expensive? If it is, and the value of the land goes down and contractors can buy the vacant land cheaply, they may be able to build new houses nearby for less then you paid.

Here is a good example of this potential problem. On the West Side of Hawaii Island there is a neighborhood with 18 lots and 4 are vacant. They are priced at $1,200,000 each. A builder is currently offering to build a home on the lot of your choice for a total of $3,495,000. Assume the builder's cost to construct is $2,000,000. If next year, the vacant lot prices drop in value, and someone picks up the lot for say $600,000....then someone can build a house with another builder for a total of $2,600,000. That means if you bought the $3,495,000 house, you may face a home next door that someone can afford to build for only $2,600,000. In this case value dropped 25%.

Now lets compare this to the East Side of Hawaii where a typical new 3br 2ba home on 1 acre of land sells for only $250,000. Lots in this particular neighborhood are selling for $40,000. Assume the cost to build a similar house next year is $190,000. If vacant land prices fall 50%, a builder could buy a similar lot for $20,000 and has a total building cost is $210,000. That means on a worst case basis of 50% drop in land prices, you would face a similar home nearby built for only 16% less.

Note: I'm from Michigan and watched "Estate Size" lots sold in high-end gated communities that used to be corn fields. Guess what was right next door? Another vacant corn field.

#1 B) How much profit were contractors making on houses they were buiding. If during the boom, they were making very high profits, then during the bust, they will most likely accept a far lower margin just to keep in business and their crews working. For this reason you may find new homeowners able to buy similar brand new homes around you cheaper then you paid, simply because the contractors reduced their profit margin.

#2 - Where is the future demand going to come from? If you are looking to buy in an area where people are losing jobs, or moving away, future demand will be lower. In situations like this, house prices may drop far below the cost to rebuild the house. If there are lots of houses on the market, then there is no limit to how far house prices may fall. People in many areas are buying houses for 1/2 the cost to rebuild them or less.

#3 - How bad is the current over supply? You may find that the area you want to buy is so overbuilt that demand won't catch up to supply till many years after it becomes time to sell. If the number of vacant homes in the area are measured in the tens of thousands good luck!

#4 - What type of buyers came before you? If the housing market you are buying into was largely driven by spec buyers that wanted to flip homes, use them as second homes, or investment properties, you are in for trouble. These buyers tend to have purchased the home on stated incomes, or pay option ARMS and will default far more then primary homeowners.

#5 - Is there a specific type of home you are interested in? For example if you want a high end home with a pool, you will automatically be counting on future buyers that want high end homes with pools. If there is a large supply of these homes already in the area, or they go out of favor, you will find yourself selling in a future market with either an over supply of similar homes or a market that doens't want these homes anymore.

Use these 5 different questions in any market you are looking and you should get a pretty good idea whether it is safe to buy or not.

I am a homeowner in Hawaii and in particular the East Side of Hawaii Island. Here is how I view this area in regards to each question:

#1 A. Land prices on the East Side of Hawaii have already dropped by about 50% and are almost back down to where they were a few years ago. Land prices here was never very expensive and 1 acre lots can be purchased for as little as $20,000. For this reason further errosion in land prices will not effect prices.

#1 B. Contractors on the East Side of Hawaii tended to be very small, and a very large amount of homes were built by owner builders on the vacant piece of land that was in the family name for years. When the market slowed, these contractors were squeezed, and squeezed bad. Therefore, most have had to get out of any spec homes they built at cost or even below cost.

For reasons #1 A and #1 B no one is going to be able to build a similar home cheaper then you can now buy it.

#2 Future demand for houses in Hawaii largely depends on baby boomers that are retiring by the thousands. Many are no longer looking to move to Florida due to recent hurricances that drove up insurance costs. (See my blog on hurricane insurnace in Hawaii). The reasons they like Hawaii is not going to change, so future demand for Hawaiian homes looks like it will remain strong.

#3) There is indeed an over supply of brand new homes on the market in East Hawaii. However, the biggest difference between over supply in other areas is our over supply is measured in a few hundred homes. A huge percentage of these were owner builder spec homes, or contractor spec homes and financing for these types of construction is gone. Therefore, as soon as this small over supply clears out, demand here will outstrip supply.

#4) Unlike mainland lenders, I can count on one hand the number of homeowners I worked with that requested ARM's. People in Hawaii are very conservative, and people moving to retire here are too. For this reason, almost every single loan I did was a 30 year fixed rate mortgage. For this reason far fewer current homeowners are in trouble. Yes there were some spec buyers, however, nothing like the rampant spec buying that created entire neighborhoods with no homeowners on the mainland.

#5) Here on the East Side of Hawaii very few builders built luxury homes. Most of our new homes are just plain jane 3br 2ba houses under 1500 ft2. Sale prices range around $225,000 to $275,000. Therefore, anyone that wants a larger home with a few luxury items like a pool, will find a limited supply. I like comparing this situation with the gated community my brother lives in. He lives in a community in Florida with about 2 thousand homes. Every home is 3500-4500 ft2, 4-5 bedroom, and air conditioned. About 1/2 have pools. If future demand wants smaller more economical homes, these homes will sink in value.

Philip Maise

Sound Mortgage

Hurricanes Dot (1959), Iwa (1982), and Iniki (1992) hit the island of Kauai. Lots of damage!

Based upon this historical view, and a look at other storm tracks in the figure above, hurricane insurance for any residence on the Hawaiian Island of Kauai looks prudent.

For a damaging hurricane to hit Oahu and Maui, you have to look back to 1986 when Estelle produced some good size waves that damaged a handful of ocean front homes. Whether hurricane insurance did these homeowners any good is unknown, since the damage my have been attributed to flooding and not wind. For any significant damage on Oahu, you need to look all the way back to 1957 when Hurricane Nina produced record winds in Honolulu. Certainly, Nina caused some damage, however, almost all houses since that time been either built or retrofitted with hurricane clips to minimize damage.

For a more complete list of hurricanes in Hawaii's history see: http://en.wikipedia.org/wiki/List_of_Hawaii_hurricanes

Frequently, people cite that the Big Island of Hawaii has never had a recorded direct strike by a hurricane. This appears to be true. Normally the trade winds blow steadily from the east, scooting Pacific storms along a track that passes well south of Hawaii.

A recent exception was Hurricane Flossie in 2007. This Hurricane was downgraded to a tropical storm after brushing past Hawaii's coastline. Despite concerns about flooding and wind damage, the storm brought little more than roiling waves and steady rain as its eye moved about 95 miles (153 kilometers) south of South Point on Hawaii's Big Island—the closest to approach the islands in 15 years.

The most common theory why the Big Island of Hawaii seems to be immune to Hurricanes is upper-level jet stream winds tend to rip the tops off the hurricanes and disperse them. These winds travel from West to East, and the normal Hurricane path is East to West. Therefore, the closer a storm approaches the Big Island, the more the top is ripped off and the power of the storm lost.

Examine the following photo closely:

Notice that as Flossie came close to the Big Island of Hawaii it changed from the typical round spiral shape to the one you see above. This view captures Flossie being ripped in half as its top clouds are sheered off and sent to the Northeast and the lower clouds continue to the West.

My conclusions are personal ones. I will let you draw your own. Should you care to know my personal opinion.

#1 I consider hurricane insurance for homeowners on Kauai a good idea.

#2 I think hurricane insurance on Maui and Oahu to be of very questionable value.

#3 I strongly believe hurricane insurance on the Big Island of Hawaii to be a waste of money.

Some mortgage companies force all homeowners in Hawaii to obtain hurricane insurance before they can get a loan. We do not. Therefore, keep in mind if you obtain your loan with another company...you are most likely going to pay for hurricane insurance whether you like it or not.

Please note I used the phrase "we do not". A loan I do for you may eventually be sold to another firm that believes you should have insurance. Unfortunately, they get to decide what is an adequate level of insurance and may require you to get it after your loan closes. However, with my firm you most likely would save at least one year of expensive hurricane insurance if you didn't think it was needed in your situation.

Ask me if you have any questions. If you are a bank that still forces all Hawaii residents to buy hurricane insurance..I would welcome a rebuttal.

The Island of Hawaii is made up of 5 volcanoes:

Kohala Considered Extinct

Mauna Kea Considered Extinct

Hualalai Currently Not Active

Mauna Loa Actively Expanding and "Due Soon"

Kilauea Currently Erupting

As a loan officer, I am frequently asked by clients if their home is covered in the event of a lava flow.

Surprisingly, even though the policy a firm gives you may say you are not covered, you really are covered.

In order to sell insurance policies in Hawaii firms must agree to abide by the laws of the State of Hawaii that prohibit this exclusion.

If you doubt me, check with our local Hawaii insurance commissioner.

Disclaimers:

1. Laws are subject to change, so this information is based upon my current knowledge.

2. When a volcano erupts, it may also shake the ground causing an earthquake. Homeowner insurance typically doesn't cover for earthquakes.

3. If access to your home is cutoff due to a lava flow and the home itself suffers no damage, you are typically not covered.