Searchlight Crusade

(This was originally written February 16, 2006, but it’s relevant still)

One of the occasional questions I get from people has to do with why the housing bubble got so big (or if you’re one of those still in denial about it, how prices jumped so far so fast).

This has to do with several factors. Legislation made real estate investments more attractive. Interest rates got low, and nontraditional loans proliferated. People took their money out of the stock market because of the tech bubble popping, and wanted to invest it somewhere. The feeling that the housing market could never go anywhere but up. And I will address all of these issues in the coming paragraphs, but the largest factor is and was psychological. People were simultaneously scared that if they didn’t buy now, they would be locked out of the American dream, and avaricious in anticipation of buying and flipping properties for multiple tens of thousands of dollars profit.

The first enabling factor happened in 1996. President Clinton sponsored legislation giving huge tax exemptions to gains from the sale of personal residences. There were and are good arguments for doing so, nonetheless it had the effect of making real estate a more attractive investment. When a married couple can make up to $500,000 tax free over their basis every two years, that’s a major incentive to start moving into a new house every two years in order to fix it up, or at least hope for a gain in fast growing areas. By itself, this was a minor factor initially, but by making real estate such an attractive investment (literally the best there is, considered in a vacuum), it started the bubble off. Since it hasn’t been repealed yet and may never be, the value increase from this aren’t really a bubble component, but the value increase for what was a one time systemic shift whetted appetites, even while the dot com bubble (itself a fear and greed phenomenon) was going on.

The second enabling factor was that interest rates got low. This meant prices had the leeway to rise, as most people buy homes (and other property) based mostly upon the payment. When 30 year fixed rate loans go to 5 percent, the same payments buys a lot more house than it does at 7.5 percent. If you could have afforded a loan for $100,000 at 7.5 percent, you can afford a $130,000 loan at 5 percent. Instead of a $300,000 loan, you can afford $390,000 for the same payment. $500,000 becomes $650,000. Even though rates went up after early 2004, this helped start the phenomenon.

The third enabling factor was that people had gotten burned in the stock market as the dot com boom deflated, and the real estate market was doing well. With both sides of “fear and greed” working the equation, this amounted to quite a bit of incentive to chase returns in the real estate market. “I just took a bath in tech stocks, but look at how the real estate market is going!” This is known as chasing last year’s returns, but large numbers of people do it. Consequently, quite a bit of personal wealth was dumped into the real estate market. This had negative consequences on the stock market, exacerbating that decline, and for the real estate market, dumping a couple trillion dollars into the demand side of the equation didn’t exactly hurt real estate prices. Supply and demand are always working. The important trick is to separate fear and greed, which are real but have mostly short term effects, from real long term changes to the market.

The thing that really drove the whole thing from behind the scenes was that the federal government “encouraged” lenders to expand their creditworthiness criteria. Thirty agencies of the federal government got together and used the Community Reinvestment Act (as renewed in 1995) as a bludgeon to force lenders to lend to minorities at the same rates (and rates of approval) as non-minorities. Since certain minority groups are statistically less scrupulous about doing things that maintain creditworthiness and financial stability (just as other minority groups are statistically more scrupulous), that meant relaxing standards. The loan market controls the real estate market. When practically anyone could get a no income documentation loan they couldn’t afford for 100% of value, macroeconomic constraints upon price vanished.

Members of my professions, meanwhile, did absolutely nothing to slow the madness. Indeed, they added as much fuel to the fire as they could. As I have said elsewhere, buying a home really is a fantastic investment, all things being equal. It literally clobbers renting and investing over the long term, with those last four words being the critical part. There are limits, and many agents and loan officers went over them and three states beyond. Anybody who takes any real estate agent’s unsupported word for investments and sustainability probably needs a guardian. Reality check: Here’s a person who makes thousands of dollars if they tell you you can do something, and nothing if they tell you you can’t, and has very little responsibility in the law for telling you lies. They’re not financial advisers, after all. What do you think the average person will tell you in this position? (And before anybody sends me email or comments about the “superior ethics of Realtors®” they were just as bad statistically and worse morally, because they were holding themselves out as ethically superior, thus using the propaganda to allay legitimate concerns. I’ll believe Realtors® offer some ethical advantage when I start seeing the Boards of Realtors® imposing some real disciplinary measures upon significant numbers of scumbags that the state regulators don’t. Aside from advertising to build brand awareness, I haven’t seen anything that the Boards of Realtors® contribute to real estate practice, and they actively work against consumer interests in significant ways.)

So there we are, with these factors doing everything they can to drive values up. This goes on for a little while, and now psychology starts becoming a real factor. “They’re not making any more land!” making a scarcity argument. “Real Estate always goes up over the long term!”, making a safety argument, and ignoring any number of past bubbles and downturns. Heck, I remember four previous ones in southern California! “You can always sell for a profit!”, ignoring transaction costs, which are significant, and flat out misrepresenting liquidity. Real Estate can beat anything else, investment-wise, but it is certainly the least liquid class of investment that comes to my mind, as well as being sensitive to many factors beyond your control.

Couple this with a couple of years worth of twenty percent returns, and the feeding frenzy really kicks in. There starts being a real fear factor – people get afraid that if they do not buy now, they are never going to be able to afford a home. When prices rise by 50 percent in two years and wages rise by six, who can really blame them? Most people do not have the economic background to sit back and consider who buys houses, and what controls housing prices. So the mentality of “buy now or rent forever!” took hold, further exacerbating the rise. People were willing to do literally anything they could to qualify for a home, lest they be unable to qualify forever. And with the thinking detailed in previous paragraphs, they were told that “Even if you have to sell in a year, you’ll still come away with a huge profit!” Yes, that’s greed again, rearing its ugly head.

Up until this point, things were within reason. But into this situation stepped the lending community, particularly the sub-prime lending community, driven by the federal government breathing down their necks. More and more lenders started being willing to loan 100 percent of the value of the home. “Hey, why risk your own money when the bank will lend theirs?” This drove market leverage to never before seen heights. Furthermore, in an effort to sustain volume, lenders started a trend of competing ever harder for the most marginal case. Stated Income, Interest Only, and short term hybrid ARMs proliferated (The most common sub-prime loan is only fixed for two years). Finally, lenders started pushing the Negative Amortization loans, for those borrowers who couldn’t really make even the payments required on the short term interest only alternatives.

Lest anyone think otherwise, the community of real estate agents was fully on board with this. Always higher, and fast increasing, prices meant they made more money in commissions from selling the same number of homes, and the apparent virtues of real estate as an investment of the moment kept seducing those who did not know any better. Those few voices of sanity were drowned out, and many left the business. There just aren’t that many people who really qualify to buy homes at the peak prices we had based upon the traditional metrics, even relaxed as they have become, and if you won’t put them into something they can’t afford, somebody else will. Furthermore, during this period, more and more real estate agents were starting to do their own loans, further isolating any voices of sanity in the loan community. Speak the truth that a client probably cannot afford a loan once, and the real estate agent will never bring you another client again, and will try everything they can to pry any clients that they can away from you. After all, you ‘cost’ them a commission once. Interest only, and negative amortization loans further proliferate, as agents try to persuade prospective clients that they “really can afford those payments.” Forty year loans start making a comeback, where they were all but extinct, and fifty year loans are introduced. Sub-prime underwriting standards are loosened until they ignore what happens when these hybrids adjust (or Option ARMs recast) and concern themselves only with the minimum starting payment. A larger and larger portion of purchasers is forced into the sub-prime market if they want to qualify. And still property values rose.

Or, more correctly, prices rose. The actual property value certainly wasn’t growing that fast, only the common perception of value, aka price. People were getting away with these terrible loans, complete with prepayment penalties, because even though they weren’t able to make their payments in many cases, prices were still increasing fast enough such that even if they sold relatively cheap, in order to unload the property in a hurry, and paid a prepayment penalty, they were still coming away with money, further aiding the illusion that there was no way not to make money. When workers are making more money buying a house and holding it for two years then selling than they are at their jobs, that’s an incentive to keep doing it. That’s an incentive for more and more people to get in on the act. And the feeding frenzy builds. Fear and Greed. When someone holds a house for two years and sells for a huge profit despite the fact that they did nothing to enhance the home’s value, that has the appearance of easy money. When people start buying with the intention of short term flipping without doing any work (We call this “Hoping for a bigger fool”), and when they’d call to see if I knew of any such properties and hang up when I’d start telling them about properties that really were good investments but needed work, I knew the end was coming very soon.

The first group to holler “enough!” was not the lower income folks who were getting priced out of stuff even at the lowest end of the market. It might be what you’d expect, but it wasn’t the case. My theory is that those people simply don’t know any better, and didn’t think they could afford to wait. It was the better paid, more economically savvy buyer at the higher end who first called “Bull****!” At least here locally, higher end McMansions and such were the first to start sitting on the market. These prospective buyers made plenty of money, and knew they weren’t on the verge of being priced out completely. If they were right, they’d buy a better property when things fell apart. If they were wrong, such is life, and they could still afford something. Meantime, they were going to rent.

Lessons here: Always separate psychological factors from real market shifts. The general rule is that once they find an investment that appears to be working right now, the crowd always overreacts. Many times you will make more money in the long term by bucking the obvious trend, particularly if that trend is Fear and Greed driven.

When I first wrote this piece in early 2006, the advice I gave was these two paragraphs:

“If you are in an untenable position with your loan right now, whether because it’s negative Amortization or interest only or just about to start adjusting: Either sell now for what you can get, refinance into something fixed for at least five years right now, or be resign yourself to disaster. With the yield curve inverted right now, there is practically no spread between the five year ARM and the thirty year fixed rate loan. Even someone who is as huge a fan of the 5/1 ARM as I am has to admit that, at the moment, the thirty year fixed rate loan is looking very attractive by comparison. When you get a much better guarantee of the rate not changing, for the same price, and the the loans are otherwise identical, what’s not to like? As I’ve said before, you can survive and prosper when you’re upside down on your home, as long as you have the right loan for it.

If you can make the real payments on such a loan, I would do it now while appraisers still have the ability to appraise your property for near peak values. If you lose the ability to appraise for near peak values, then you may well be a member of that rather large group in many parts of the country where the market will no longer bear a price greater than the loans on your property. When you owe more on the property than the market appraisal, then for all practical purposes you are stuck in your current loan. If it adjusts, amortizes, or recasts, you’re suddenly going to be making much larger payments. If you qualified under one of the less sustainable programs I noted earlier, when this happens you are going to be in a world of hurt, and probably unable to refinance. Most common result: Losing the home, credit ruined for years, and a 1099 from the lender that says “we lost money on you!”, for which the IRS will demand taxes. If your loan is going to start asking for higher payments soon, and you can not refinance, or cannot afford to refinance, it’s time to sell, right now.”

Very few people took this advice then. Lots of people wish they had now. Now, my advice is significantly different,

Caveat Emptor (and Vendor)

I’ve seen many new home developments with vaulted ceilings, mini-vineyards, huge houses on little tiny lots…Why can’t some developer built some homes for us regular people?
A normal sized home with plenty of closet space and a decent (not designer) kitchen that is set more than 3 feet from the neighbors house.
I realize that they need to make money, but more people could afford homes in this state if the builders weren’t catering to people who already own 2 and 3 houses.

The developer has have a certain amount of LAND for a development. That’s all they have, and they are not getting any more. For this, they paid a set amount of money. Furthermore, once they have it, it’s likely to be years going through the permit process before they can even build. That money they invested in the project, both upfront and as the project goes along? If they wanted to invest it in say the stock market, it’s be earning income – for years – before the first spade of earth gets dug. If it’s three years from purchase to completion, that’s a 33.1 percent necessary return just to break even from the opportunity cost (at ten percent per year – very doable). If it’s five, as is more likely, they need 61 percent. If it’s seven, 94.9 percent. To this, add property taxes as they go, the costs of environmental studies and obtaining the permits and paying for inspections and certifying everything. If there’s a loan going on, they have the cost of interest going on as well. Now there are ameliorating factors as well, but given the sheer amount of work that has to be done before they nail the first two boards together, a rational person could maybe be forgiven for thinking that society wants housing to be prohibitively expensive.

Furthermore, it’s silly, but people buy a property based upon the structure and the amenities. Well, it’s not silly to make that one of the factors, but people go overboard. They will buy a 5 bedroom 2800 square foot house on a 3000 square foot lot before they’ll buy a 3 bedroom 1800 square foot house on a 20,000 square foot lot. The same structure is really worth a lot more when it’s on a bigger lot, and even a lesser structure may really be worth more if it’s on a bigger lot, as is likely to be the case here, but for most folks, we’re talking emotional appeal, not rational thought process. In other words, like many people looking for a mate, they see the gorgeous sculpted toned and tanned member of the opposite sex, and ignore the abusive personality behind the beautiful exterior. I’m not certain I’ve ever met someone who wanted to live in such a development, but they sure sell like hotcakes! Add travertine and granite countertops and the fact that it’s new to the 2800 square footer, and you’ve got people willing to pay $800k for the first property as opposed to maybe $550k for the second. In their mind, the first property might be a “flipper’s investment” while the second is “the keeper” that they are going to make improvements on for the rest of their lives, but economically, we vote with our dollars. If you opened your wallet for the house where you don’t have any land, guess what? You’re voting for developers to keep building them. You know something else? That brand new cheek-by-jowl development isn’t going to be new forever. Considering market returns, that older $550,000 3 bedroom on half an acre is a better investment, even if it needs updating. Curb appeal and house bling and “ooh, it’s new!” are the best ways I know of to sucker buyers into paying too much money.

The developer knows this at least as well as your average real estate agent. The developer has all of this researched down the the last centimeter of the lot lines. They are not in business to build wonderful homes that people are going to be happy in forever; they are in business to make money, and the blinged-out houses on the smallest possible lots bring in the most money for that developer. The fact that you’re the very first person to live in the house is a further attraction to the kind of person who buys new cars, which is to say, most of the population, and it’s worth serious money to that developer’s bottom line, although it will cost you money in the long term.

Nor is the developer alone in this endeavor. They wouldn’t make the most money from homes like that if people didn’t pay the most money for homes like that. You want the real culprits in this scenario, look around you in any large crowd. It’s all to easy to blame the developer, but the desires of the average home buyer and the regulatory environment both played huge factors in getting the state of new housing to where it is now.

There are ways to potentially fix the problem. They start at real consumer education, easing environmental restrictions and the permit process, particularly for high density housing, which may not be desirable, but when your front yard is the size of a postage stamp and most people wouldn’t use it anyway, doesn’t it make more sense to put all the community lawns together in one park that someone can actually get some use out of? Say, a place for kids and dogs to play? People say they hate condos, but condos townhomes and row homes are all that’s available if the price of land stays where it is. Environmental regulation and slow growth policies are fundamentally at odds with affordable housing in high demand areas. I’m not saying throw them out entirely in the name of putting up cardboard shacks, but I am saying that we can certainly choose a point friendlier to low cost housing than we have chosen. I can only conclude that society must value the environmental status quo more than it values lowering the cost of housing, in which case the status quo is the correct choice.

None of this has any measurable political support. Everybody is for lowering the cost of housing, at least for the poor, but put it on the ballot against loosening environmental protections and it loses. There are a certain number of addition reasons why this happens, of course. Multimillionaire developers are not politically popular, but Least Tern environment is. Rarely do people stop to consider that by constricting the supply of housing, you unavoidably increase the price. Nor can you do anything by governmental fiat to fix the problem that doesn’t price even more people out of the market. Demand is a given – it not directly controllable. There are 300 million Americans and they all want housing they can afford. Even kicking out the estimated 11 million or so who are in the country illegally wouldn’t do a whole lot to really solve this problem. The only way to treat the issue is by increasing the supply, which does seem to include being nicer to those multimillionaire developers, but in this case the issue is more affordable housing for everyone, and being nicer to the developers means that you get more housing units, which drops the price of housing from whatever it would have been without being nice to the developers. Because any time someone else enters the United States, whether legally, illegally, or simply by being born, you create a housing need. Every time there is a new American without another place for that American to live, we create somebody without a home. We price somebody out of the market. We now have an American who cannot afford to buy a home.

Now how to handle this issue until such time, as any, as society changes its mind and decides to make housing more affordable? Your best bet is to find a good buyer’s agent to defeat the problem on a retail level, that is, for yourself, because wholesale solutions are not likely until people get rational about solving society’s problems. You can’t make people build the kind of housing you say you want. But you can make informed choices between what’s out there now, and a good buyer’s agent will look as far out as you tell them to.

Caveat Emptor

<blockquote>

Hi–I just found your site today. The best I’ve ever seen/read, etc. Thank You!!

I do have a question I didn’t see addressed regarding our current situation/dillemma:

Our present home, which we’ve lived in for 8 years, is worth around $180,000 (yes, it’s a small town…), and we owe $105,000. My husband has been working for about 5 years now, & has a pretty good salary (around $100K) but we have a LOT of debt –mainly a result of having had 2 babies while in school. We have about $40 K in credit card debt, a $775/mo. student loan payment, & a $500/mo car loan which will be paid off in 18 months.

We’ve been planning on moving across town for a few years (MUCH better schools there), but had been holding out as long as we could with the idea that the longer we waited, the better house we’d be able to afford. And besides, the kids are still young, & their elementary school isn’t intolerable, etc.

The problem is that the school situation DID become intolerable about 3 weeks ago, at which time I began to homeschool them, which is also intolerable! So we need to get this moving across town show on the road!

My question is this: I know we need to at least take out a home equity loan so that we can pay off the credit cards. Some of the rates are outrageous, and I’m sick of fighting with them. That would put our equity at $35,000. But since we want to move ASAP now, I assume we could just use the sale proceeds of the house to pay off the cards, & use the remainder as a down payment. Or, am I wrong? Our current debt to income ratio is so poor–will the lenders even consider our current plan to pay off that debt using sale proceeds, or will we have to refinance now & wait a period of time before pursuing a new house to show them that we’re not just going to rack the debt up again? Oh, but we haven’t incurred any new debt or put any new charges on the credit cards in about 3 years–does that make any difference?

Also, the houses in the neighborhoods we are looking at are around $300,000. I’d sure appreciate your advice on this. We really want to move immediately, but not if waiting until later, like this summer, would be be better… </blockquote>


Your situation is a classic example of the urge to hurry a situation, and how to come out better if you don’t.

You don’t mention how the market is in your area, or what your credit score is like, and yes, it does take a while for bills to show as paid off. It can take over sixty days. I see some options for you, all of which have drawbacks. This is a complex situation, and I don’t have nearly all of the information it takes to recommend a particular solution.

You can refinance, sell, or do nothing with your current residence, and you’ll want to rent it out if you don’t sell. You can rent or buy a new property, although you do want to buy before long. There’s some issues that need to be dealt with, and they take a little time to deal with them properly. You can rush the situation, but doing so will cost you some big bucks.

You don’t mention what rents are in your current area. By the time you pay for the refinance, my guess is your balance would be $150,000, maybe a bit higher. I’m as certain as I can be without full workup information that you’re in a sub-prime situation, which means you can choose a very high rate or a prepayment penalty that’ll run you about another $5000 if you sell while it’s in force. The high rate is the better choice, because it’s only for a few months, but it also has implications for your debt to income ratio. The reason I ask about rents is that I’m wondering if they’ll cover your mortgage on the place. The rate you’ll get might be higher or lower, but let’s assume seven percent. That’s principal and interest of about $1000 per month, plus taxes and insurance. Now your husband makes plenty to afford some negative cash flow on the property if you folks have to and the rest of your debts are gone, but not a huge amount of it. You’ll only get credit for seventy-five percent of the rent, as opposed to all of the expenses, but better to have it rented for a little bit of a theoretical loss than not to have it rented.

Now whether you refinace or sell, it’s going to take a grand total of about three months to get your bills showing as paid – one month to get the refinance done, two months for your current finance companies to get off the dime and report the accounts as paid. It might be longer if you sell, depending upon how long it takes to get a good offer made and the sale consummated, then add two months. On the other hand, if your property is in good shape, vacant properties in good condition show very well.

Now, with your new property, your debt to income ratio is going to sink your loan if your current bills aren’t paid off. Unfortunately, A paper has an issue with paying off bills after your initial credit is run. If it’s a credit card or other revolving debt, guidelines have issues with paying them off in order to qualify. If you pay off a credit card, the wisdom goes, you could turn it right around and charge it up again. Even if you pay it off and close it, the reality is that you could get another. So they qualify you based upon your current situation. Even paying off installment debt to qualify is at the discretion of the underwriter, and I have seen them turn it down. So you want to have the debt paid off, and showing as paid off, before you make the offer for a new place. That can take up to two months after they actually are paid off.

So you’re going to want to wait at least two months after you pay the debt off before you make your offer on the house you want to purchase. This means either staying where you are for now, which I can see is unacceptable, or interim renting something in the area you want to live, which is likely to be better, and you might get a line on an extra-good deal if you are living in the area. Yes, you want to buy, but you don’t have to do it all in one step.

So I’d most likely go rent a place – which gets you into the new school district now – while I tried to sell or refinance the current place. If you’re not living there, be advised that a refinance is a cash out investment property loan, which carries higher rates and more difficulty. I’d probably try to sell instead, but that does place you at the mercy of the market, and not only do I not know your market, but we’re coming up on the worst time of year for sellers. Which means settling for a lower price than you might otherwise get, but you will be rid of the debt without the headaches of being a landlord at a stressful time in your life. You can learn that situation later.

Now, if you sell, you get a downpayment for the new place. If you refinance, you probably don’t. Your credit score may dictate the sale option; I don’t know. It should improve after everything is paid, but I can’t guarantee that, and I definitely can’t say by how much. Better to plan on the status quo than to bet on it improving.

Now, a couple of months after the debts are paid, you’ll be a a position to make an offer on home you want to raise your family in. If you have a decent credit score (580 or above, with 640 making things easier and 680 better yet), 100 percent financing is no big deal deal (At this update, 100% is difficult, period). If you’ve got serious credit issues, you’re going to need a down payment. For the school year, you may want to delay until late spring or summer to give the kids some stability for the rest of the year. Worst time to buy, but you’re looking at moving again in February if you get on the stick right now.

Now it’s a real pain to move a household once, and here I am telling you to plan on moving twice. Let’s look at what happens if you risk the solution that cuts the Gordian Knot.

Your husband is an attorney. I don’t know what attorneys make around your area, but around here they can make several times $100,000. So somebody advises you to do stated income, state that you make several times what you do, and just make a bid right now on the home you want to raise your family in, while putting your current home up for sale. And if your credit score is decent, I could get such a loan done pretty easy. But let’s consider what happens next.

Now you not only have your current debt load, but you also have the payments for a brand new $300,000 loan on a $300,000 house. In California, with good credit, that would be 6.125% right now on the first, maybe a little under 10 percent on the second. $1460 on the first, $530 on the second, plus property taxes (California would be about $315 per month) and insurance of about $100, more or less. Total obligations added: about $2400 per month, on top of what you’re paying now.

You don’t say, but if you weren’t struggling at least a little bit, you would have paid those debts off by now. So you are fairly close to the edge. My best guess as to your reserves: Non-existent. Now you have to come up with another $2400 per month. Where can it come from? Borrowing is the only thing that comes to mind. Charge up the credit cards, personal loans, payments start getting behind, your credit score drops – and it won’t come back quickly if you start making those payments on time. Especially if mortgage payments on either place end up being late. Meanwhile everything is compounding, eating up your equity, even if the house sells fairly quickly. As I’ve said, we’re coming up on the worst time of year for sellers. Its entirely possible you won’t sell until Spring, no matter how good a job your listing agent does. In short, things get desperate quick. Not only is your cash flow unsustainable, you get motivated to sell for a lot loss money than you might have otherwise. With everything compounding, it’s very possible that you end up selling to a shark for less than you need to get out from under your debts. This perpetuates the situation you’re trying to get away from, and makes it worse because your credit is likely to take major hits.

So tempting as it is to take the situation at one go, you eliminate a lot of risk and stress by taking it in stages, and you render yourself a lot less of a target for the sharks of the real estate world. Yes, it adds something to your cash flow to go rent for a while, but not nearly so much as if you just bought straight away, and you give yourself a line of retreat if you have to take it.

There are a lot of things that could change this. As I’ve said, there’s a lot of stuff I’d need to know before making a final recommendation for a client, but I’ve sketched out the major stuff that needs to be considered.

Caveat Emptor

One of the most common things I’m seeing as I roam about the East County looking for bargains: Agents not doing their jobs.

Now single family detached homes that are priced appropriately are selling, and for appropriate prices, even at 37 sellers per buyer. Condominiums aren’t moving unless they are brand new with lots of glitter, but appropriately priced detached homes are selling. I can find all of the evidence of this you would care to see, because I’ve already seen it. Willing buyers and willing sellers. It’s just that what an appropriate price is has shifted.

Let’s change mental gears here for a moment. Here’s the real differences between sellers markets and buyers market: Competition. Specifically, which side of the sale is competing. In seller’s markets, which is the mindset most sellers and most listing agents are still in, buyers are competing to buy the properties that are for sale. Because of this it is the buyers who have to compete to look attractive – highest offer, quickest offer, fewest contingencies. They have to offer more money or a bigger deposit or something else that the seller needs and nobody else wants to do. With the buyers market we have now, it’s the sellers who have to compete, and most of them are not doing it very well.

I want to make very clear that sellers are always competing against other sellers, even in the strongest seller’s market possible. But in a buyer’s market, it’s not enough to have your property “out there.” In a seller’s market, the prices will often catch up to unrealistic asking prices, given time. In a buyer’s market, prices are not increasing, and in this strong of a buyer’s market, they are going down. In other words, the longer it takes, the worse you look. You have to have some stand out aspect to your property. It can be physical attractiveness, or it can be low price. Price will get buyers in the door, but it takes a strong agent to sell a fixer to the average buyer, no matter how attractively priced, because the scumbag with the office down the street will show them something a little more attractive that they really cannot afford, but with a negative amortization loan, done stated income, they can make it look like they can afford the payments, and a buyer who hasn’t had this explained to them ahead of time will think they’ve just gotten the Taj Mahal for the price of a dirt floor shack, except of course, they haven’t. And the other way to stand out is to be priced the same, but more attractive. Don’t tell buyers you’ll give them a carpet allowance, replace the carpet. Don’t tell buyers that all they have to do is spend two months and $20,000 fixing it and they’ll have a property worth $20,000 more. That won’t wash in a buyer’s market, if it ever does. The party who does the work, even of engaging a contractor, gets the payoff. Why should your buyers take the risk and do all that work and spend $20,000 cash that most buyers don’t have (and cannot be part of the purchase money loan) when they can go down the street and find all of that work already done for maybe $10,000 more – or even the same price? I assure you it’s happening all over San Diego County right now. Some seller just out-competed you for that buyer’s business. The only good news for sellers is that most of your competition isn’t trying very hard yet, so small bits of competition can look very attractive.

Even lenders are still in denial for their owned properties, and they are the ones with the hardest issues of all. They must get rid of the property. They don’t have any choice. Even if it was in the same shape as surrounding properties – which it rarely is – they have a deadline to get rid of that property, and everyone knows it. They also have other constraints that other sellers do not. These make the property worth less, as they rule out certain buyers and make others less willing. In a buyer’s market, every buyer counts. I had two clients putting in offers on different lender owned fixers in the last two weeks. One might comp out at the asking price of $450,000 if it wasn’t lender owned – which automatically makes it worth about ten percent less than the comps. Add the fact that it’s an ugly fixer that would be worth maybe $400,000 at most if it wasn’t lender owned, and they will be extremely lucky to see $360,000 out of it. Not supposition, not guesswork, fact. The fact is that there’s a beautiful owner occupied comparable on the same block asking $459,000. It’s even a bit larger. There is no doubt in my mind whatsoever that the beautiful comparable would take $450,000. Actually, I just checked again and the beautiful comparable is in escrow now. One owner that competed well, one that is not competing well. I told the agent for the lender’s fixer this, and she said, “I’ve been in this business forty years and I know what I can get for that property!” I offered to bet her $10 she couldn’t close escrow on it within ninety days for over $390,000 net – essentially a zero risk bet from my point of view. From hers also, if she thought the property was really worth more. She wouldn’t take me up on it. Furthermore, she’s violating her fiduciary duty by not explaining this to her client. Doesn’t matter how long she’s been in the business. What matters is whether she reacts well to this market.

About five miles away, another lender owned fixer asking $480,000 because that’s what the lender is on the hook for. And you know, it is a better neighborhood. Unfortunately for them, just because you were silly enough to lend them that much two years ago when the market was peaking doesn’t mean someone else will pay you that much for it now when the market is in the tank. What matters is the comparable properties, and there’s one just around the corner that anyone would rather have listing for $470,000. Above par house for a below par price. Hasn’t gone into escrow yet, but it will go fairly soon, unless someone else lists a better property cheaper, and they might even get a little bit of a bidding feud on it, despite the strong buyer’s market. This lender owned fixer is in rotten shape and has several issues that turn the average buyer off. I initially thought my client’s offer was lower than it should have been, but the more I thought about, the more I think my client came closer to the mark than I did initially. Horrible floor plan, necessitating major work to make it attractive. Yard not suitable for children, despite the fact that there’s a school on the same block that the agent is using as a “come-on”. These people will be lucky to get anything over $350,000 for it, but the agent sent me a blanket, “Anything less than $400,000 will be rejected without counter,” despite the fact that I explained how much work it will be to bring it up to the neighborhood standard. I left her some messages, and she didn’t respond. The implication to me was clear: She is in denial, and doesn’t want to hear plain facts explained. She’s got dozens of REO listings – maybe because she was a great bargainer in seller’s markets, maybe because she knows someone, maybe some other unknown factor. She’s not dealing well with this market. I don’t know if she doesn’t know market conditions or just acts like she doesn’t. If nobody puts an offer in good enough to get past the blanket rejection, it doesn’t make much difference, does it?

This the times when good listing agents really earn their money, as the gentleman listing the $470,000 comparable is. It may not be the great publicity of getting the highest price ever in the neighborhood, but getting it sold quick and for something like asking price in this market is a real achievement. Especially with as many distress situations as are out there – people that have to sell, for one reason or another. (I’m doing very well for my buyer clients, but it’s depth-charging fish in a barrel. You really find out how good someone is when the market favors the other side of the transaction.) There are dozens of FSBO and discounter listed properties in the neighborhood, sitting on the market for months. The last six months of Canceled, Withdrawn, and especially the Expired sections of MLS have all that and more, but that one property is going to sell quickly, and sell for a good price. That agent has already earned every penny he will get paid, and it isn’t even in escrow yet.

The person who “buys” listings, telling the people that they can get them more money than anyone else, more money than the market will support, had a nice long run. When prices are moving up strongly and there aren’t many houses to be had and everyone wants one, well a monkey could sell that house at that price given enough time, because given a few months the market will catch up to all but the most egregious of overpricing.

That is not the way things are now. Buyers have all the power, and they know it, because buyer’s specialists like me have told them if nothing else. Inventory is over nine months worth of sales at the current pace, more properties are coming on the market and the worst time of year for sales is approaching. Given these facts, What do you think is going to happen? Where do you think the market is headed, at least in the short term?

(and incidentally, what kind of bargains do you think those few buyers willing to get off the sidelines can drive?)

The longer listing agents wait to talk some sense into their sellers, the worse it’s going to be. The more days on market, the further the market falls, the more the sellers will have to move to meet it – and the more unhappy they will be with their listing agents. The agents I respect will refuse a listing rather than ask for a price they aren’t going to get except by freak coincidence. They get the same no transaction either way, but if they refuse the listing, they haven’t created unreasonable expectations, they haven’t failed to live up to those expectations, and neither party has wasted months finding out what that agent should have known in the first place.

Now, I’ve seen agents telling people that because interest rates have stabilized or even moved down, that will revive the market. This is complete and utter nonsense. I initially wrote something stronger, but my internal censor really wants to keep this family friendly. Yes, payments drive the market – when it’s a seller’s market. Buyer’s markets are driven by the bottom line, because there are lots of sellers and only a few buyers and if this seller won’t cut them a deal, the one down the block who is a little more motivated will. When every listing gets three offers within a week and buyers are getting desperate, they’ll bite off on another $1000, $5000, or $10000 because “It’s only $10 (or $50 or $100) more on the payment. They shouldn’t, but they will. When buyers have the power and they know it, they’ll tell the sellers to pay that $10 per month, because they’re not paying the extra in the first place. It is the sign of someone who does not understand supply and demand to think otherwise, and I certainly wouldn’t want that sort of numbwit as my agent. Your agent is your expert. If they are not an expert, why are you hiring them?

Now, looking forward. What’s going to break the logjam and get the market moving? Well, absent sudden 25% inflation or something else equally unlikely, the current market has the effect of adding to inventory while those who can afford not to sell drop off. We’ve had over a year of this now, and a lot of would be sellers have discovered that they don’t have to sell. They can stay in the home, or they can rent it out or let some family members use it. The ones left are looking an awful lot like a listing interview I helped another agent with today. Negative Amortization loan, darned near a $4500 real monthly cash flow requirement, equity all gone, and the comparable rentals are all around $1800 per month. There is no way on earth these people are coming away with any money, and the longer it goes the worse it will get, but he said another agent told him they could get an amount that’s at least $60,000 over market, just by comparable listing prices, never mind what they’re actually going to get an offer for. No, he didn’t sign up with us, quite predictably. He’s been told what he wants to believe, and this other agent is going to put him another $10,000 or $20,000 in the hole, and nobody would be happier than me if that other agent had a liability for what they’re going to do to this client.

So with more people that have stronger reasons to sell, very large inventory with more coming onto the market, and buyers quite aware that they have a level of power they haven’t seen in over a decade, what’s going to have to happen in order to change this? Basically, that inventory is going to have to clear. It can go one of three ways: the owner finds an acceptable alternative (increasingly unlikely), the owner decides to get serious about competing for a buyer’s business, or the lender takes it over. I’ve mentioned that the lenders are evidently still in denial, but they have legal requirements to dispose of those properties within a certain amount of time. The closer they get to that time expiring, the more desperate they’ll get. Once the regulators climb onto that lender’s back, they don’t climb off cheaply, nor easily. Quite frankly, if I were a major lender, I’d take the entire thing as a write off if someone offered me a dollar any time in the last week, and I think some lender’s listing agents are going to have rude awakenings before this is all over. I’m strongly considering sending my agent’s resume out to some lenders. But my real point is this: Sellers can compete on the individual level any time they want to, and the sooner they want to, the better off that individual is likely to be. Eventually, the seller’s aggregate is going to have to compete much harder for the business of the buyers that are out there, and for the buyers they want to lure off the sidelines. It took a long time to sink in, but the fact has sunken in to prospective buyers that the market got overextended. You can ameliorate your expectations and come out as well as possible, you can hope for the bigger fool of a bygone day, or you can take it off the market, if you have a sustainable situation. There aren’t a lot of sellers with sustainable situations out there right now.

One word about rapacious buyers before I go. I know I’ve said you’ve got the power. But if you or your agent has done your homework, when you settle upon a property that you’re going to make an offer on, that usually means it’s more attractive to you for the money than anything else. There is a strong temptation, given the current market, to low-ball just a little too hard. Don’t do it. Everything I’ve said about unrealistic sellers ending up with no transaction applies to you also, albeit less strongly. There is a point below which every seller out there will tell you to take a hike, no matter how desperate they are. If they owe $350,000 altogether on a $450,000 property, sure, they could it to you and be out from under at $350,000, but the vast majority of folks will see that you want every last penny of the equity they thought they had, and they’re going to tell you to do something rude, vulgar, and otherwise unprintable in a family friendly format. They will lose the house outright, and take major long term hits to their credit, before they do that. In this case, you end up with what the unrealistic seller gets: Nothing. Exactly how much should you bid? Ah, that’s part of the Art of Buyer’s Agent-Fu. In other words, it varies, and it takes more information – sometimes a lot more information – before I can give a good answer in a specific situation. The answer is never guaranteed, which is why it’s an art, not a science. But I can guarantee you’ll find out about the downsides of poisoning the well in this fashion if you step over that ill-defined line.

Caveat Emptor

I sold my house in (state) in august 2001 I hired a title attorney whose (local company X) acted as a agent for (national company Y). The facts are that there were errors and omissions which led to negligence in the performance at the closing of the property. The property taxes for the year 2000 were not paid. The title company did not do their duty and gave clear title to the buyer. Now, more than 5 years later Company Y is claiming I owe them these back taxes plus accrued costs. I would kindly appreciate some feedback

Yes, you owe the money.

The title insurance policy you bought insures the person who bought the property. Property taxes are part and parcel of all land ownership. A reasonable person should have paid those taxes. But they didn’t get paid.

This doesn’t mean that someone didn’t screw up. Every title search needs to include a search for unpaid liens that includes property taxes. That’s just the facts of the matter.

However, this does not relieve you of your duty to pay those taxes in full and on time. If it was an obscure mechanics lien recorded against your property for erroneously for work that was never done, you’d have a great case. If it was for stuff that you paid, and had reason to think you paid in full even though you were short, you might have a case. But not stuff that every reasonable property owner knows has to be paid, and didn’t get paid at all.

Let us consider what would have happened if you still owned the property. The county would be sending a law enforcement official around with delinquency notices, which would include interest and penalties for late payment. If those weren’t paid, they’d send law enforcement around another time with a tax foreclosure sale notice. You would have to pay those taxes.

It’s no different because you sold. Because it’s a valid existing lien on the property, albeit one they missed during title search, they paid it to clear the buyer’s title, as the policy requires them to do. On the other hand, when an insurance company pays a bill like this, and title insurance is insurance, they acquire the right to collect payment via subrogation. This fancy word just means they paid the damage on behalf of someone, and now they have the right to collect payment, just like auto insurers who pay for the damage to your vehicle and go sue the party at fault, for which that person’s liability insurer usually pays. The person with the liability to pay that property tax bill is you. Now, I’m not an attorney, so I don’t know, but there might be a case you can build against the person who did the title search for the interest and penalties that have accrued since the search. Before that, the bill was all yours, and given that it was for 2000, should have been paid before August 2001. On the other hand, that title company might not have had a duty of care to you, despite the fact that you were the one who paid the bill, as the insured was your buyer, not you. Furthermore, the cost of paying the attorney can often go to several times the cost of paying the taxes and penalties. You’d need to, you know, talk to an attorney for more information. You might want to call company Y and ask if they’ll settle for the bill as of the sale date, because they don’t want to pay for an attorney any more than you do, and they did screw up, and if they hadn’t, you would have paid the bill back then, right? Company Y can then recover the balance from their agent, company X.

Any lien that exists before the sale, discovered or not, is your responsibility. The only time that I think you are going to get off the hook is if you are dead and your estate probated and distributed before the lien is discovered. Basically, you’ve got to die to get away with it. Perhaps intervening bankruptcy might do it as well. I don’t think so, but I’m not a lawyer. If you had died, the title company would still have paid, as the policy requires to protect the buyer, but would have had no choice but to eat whatever amount they paid, because there would be nobody alive who they would have a valid claim against.

Caveat Emptor.