Buying and Selling: January 2006 Archives

A search I just noticed asked the question "Who gets the deposit if escrow falls through?"



The theory of the deposit is that here is an amount of cash that the buyer is putting up as evidence of their ability to consummate the transaction.



This is a good question. I've only dealt with real estate sales in California, so I'm going to deal with it from a California perspective. California is a widespread model for real estate practices (as New York is for insurance), but I can't speak to the specifics which states are and aren't following this model and to what degree.



Most of what happens in real estate sales contracts has a default, but is subject to specific negotiation. In other words, there's a standard way of doing it, but you can change that by negotiation with the other party. CAR has a specific set of forms that are encouraged, in order to make these questions somewhat more clear cut.



The standard here in California is that the purchase is contingent for seventeen calendar days, after which the buyer's deposit will belong to the seller whether escrow closes or not. From the time the contract is accepted by both sides, the buyer has seventeen days to finish all inspections, and to obtain a commitment for acceptable financing. If they call it off within those seventeen days, they get the deposit back. If the purchase falls through later than the seventeen days, the seller is usually entitled to the deposit, within limits. The seller can't just arbitrarily cancel the transaction on the eighteenth day and keep the deposit. The time specified in the purchase contract has to have expired, there must be evidence of bad faith dealing on the buyer's behalf - something.



Let me make very clear that the seller is indeed giving the buyer something when the purchase contract is signed. To be precise, the exclusive right to purchase that property for a certain amount of time. There are expenses of selling that they must pay and that they don't get back if you can't carry through, not to mention expenses related to preparing to move, at least potentially having the house sit vacant, etcetera. They cannot conclude a purchase contract with anyone else while the current buyer's contract is going on. If I'm selling, I insist upon retaining the deposit if the buyer can't carry though. If I were to be unable to consummate a purchase, I certainly understand that the seller will retain the deposit in most circumstances.



Now the escrow company won't just give the deposit to the seller. They are paid to be a neutral third party, to stand in the middle and make sure that everybody gets what everybody agreed upon, but it is not their place to settle a dispute. For that, you're going to have to go through whatever dispute resolution process is appropriate. This can be mediation, arbitration, the courts, or possibly something else. You can spend a lot of money fighting what the contract says, but in the end you can also expect to have to live up to it, and likely to pay the other party's costs as well as your own, so better not to fight something the contract says you should have done. The escrow company will often also charge a cancellation fee from out of the deposit, by the way. They do an awful lot of work, and if the transaction gets cancelled for whatever reason, they do not otherwise get paid.



Probably the number one reason for failed escrow is loan providers leading borrowers down the primrose path. "I can do that," and no, they can't. Unfortunately, I've never seen anyone able to recover damages from a failed loan provider. So keep in mind the The Best Idea About Applying for a Mortgage, and apply for a back-up loan.



Now you can change the standard contract by specific negotiation. If you're a seller who wants to get the deposit no matter what on day 30, you can ask for that as a condition of the initial sales contract. In a hot market, this is easy to ask for and get, but in a buyer's market, you are likely to lose the buyer. If you're a buyer who doesn't want to lose the deposit no matter what, you can ask to put that into the contract you propose, but most sellers, even in a buyer's market, are going to tell you to take a hike somewhere else. No big deal if it was "Hey, let's make a bid on this and see how desperate they are!" A real problem if you fell in love with the property and just have to have it. Over-playing your hand in negotiations is as disastrous as under-playing, and I've seen people so intent on being Mr. (usually) Tough Negotiator that they diddled themselves out of an excellent transaction. In any case, being too sticky on the deposit is a good way not to get as good of a price as you otherwise might have. For a seller, you have this property and you want cash. You need somebody to agree to pay it - the cash is not going to materialize out of thin air. For a buyer, the whole idea is that this property is attractive to you for some reason, or you would not be making an offer. You are asking the seller to trust thousands of dollars to your ability to swing the deal as much as you are trusting their ability to deliver a clear title to a property without hidden defects.



Whether you are a buyer or a seller, once that contract is signed, you want to get cracking on whatever your obligations under it are. Get it Done. The alternative is that you're likely to forfeit whatever rights to the deposit you may have had if you had been prompt. Just becuase Things Take Time in Real Estate Transactions is no excuse for you to waste time. Wasting time is expensive for everyone, and one of the strongest signs of a sour transaction I know. Buyers and borrowers pay increased loan and other costs, sellers lose money from delay. This is equally true in refinancing, by the way. The loan you are quoted today does not exist tomorrow unless you act on it today. In summer 2003, when rates hit fifty year lows, many people were in no hurry. They insisted upon thinking, in the face of evidence and testimony to the contrary, that the rates would always be there, and they lost out. If rates go down after locking, a good broker can usually get you better rates. If they go up, you've got the lock. If rates go up and you didn't lock, you get the higher rates. Period.



But the deposit is definitely something that the buyer can owe the seller if the transaction falls through, and that's as it should be.



Caveat Emptor.

UPDATED here

Inside Larry's Head has an article that starts "Dear Housing Bubble People" where he talks about the fed having signalled that the end of hikes in rates are likely near, and speculates that this means there is no housing bubble.



Sadly, no.



There's no sense of glee in this. I would be happy to be wrong on this one. The Fed rate was 1 percent even 2 years ago. Now it is 4.25. Whereas this has no direct effect on available interest rates for consumers, it can be looked at as the cost of short term money to the bank. In turn, it influences things such as a bank's decision as to what it's prime rate will be.



The thing that's more indicative of longer term rates, the 10 year bond rates, is sitting right at 4.5. This isn't bad, and actually isn't too far from where it was two years ago. On the other hand, the two year is right at 4.375. Two years ago, it was three points lower than that. This is an extremely narrow spread. In some measurements, the two year rate is actually higher than the ten year - indicating that people may think we're in for a rough patch for a while.



Furthermore, whereas I think there are many areas of the country that will be fine, the higher priced urban areas of the country have a lot of problems not directly related to future interest rates. The incidence of short-term, interest only and Negative Amortization is over eighty percent (!) of all "purchase money" loans in the last two years in San Diego. I doubt that the rest of California is much different. It has always been something of a tradition for people to stretch and purchase more house than they should, but for the past couple of years, various members of my profession have been encouraging it via negative amortization and interest only loans. I've taken quite a hit, income wise, by being unwilling to place people in inappropriate loans - but if I won't do it, they can always find someone who will. Nor is it like the standards have not eased considerably. When I first bought, the standard debt to income limits were twenty-eight and thirty six percent of gross income. Fifteen years later, A paper backers Fannie Mae and Freddie Mac will go thirty-eight and forty-five (and occasionally higher through their automated underwriting programs), and some subprime companies will go to sixty (!) percent of gross income.



Furthermore, a much higher proportion of borrowers are using stated income as opposed to full documentation loans, and this includes people who get a regular, set paycheck and a w-2 at the end of the year, not commissioned salesfolk or the self employed. The only reason to go stated income with a w-2 borrower, where income is trivially easy to document, is if they don't really make the money. I have heard fellow loan officers call, quite rationally, for the abolition of stated income loans. I wouldn't go that far, as for commissioned salesfolk and the self-employed, they are a valid resource if not abused, but I would agree with prohibiting it for hourly and salaried borrowers.



Add it all up, and in high cost areas of the country, you have a lot of folks who've been encouraged by members of my professions to buy houses they really cannot afford, lest they be permanently "priced out" of the market later. The problem is that this demand curve has been artificially inflated by precisely this phenomenon. Families who make $60,000 per year should not be purchasing $850,000 homes. They should be purchasing a three bedroom condo, or something similar, but they've been encouraged to stretch beyond their means by the inducement of an artificially low payment. Unless their income somehow doubles, they are not going to be able to adapt when the period of artificially low payments comes to an end. Since few people already working in a stable profession have that happen, most are going to be in trouble.



As the stock market bubble of a few years ago illustrates, it doesn't take many sellers to deflate the price. After stock prices started coming down, volume of trades went way down - but those who were buying, and those who were selling, nevertheless determined the price. The same will apply to the housing market. Right now, sellers don't want to sell for what they can get, which is less than they could get just a few months ago. Buyers don't want to pay peak, or even near peak, prices for fear that prices will erode further and they will be out their investment. And when you're thinking about the next use, renting, the numbers are against it. Nobody can make a cash-flow profit renting recently purchased homes, locally.



In short, the ride was good while it lasted (especially for members of my profession), but like Chuck Yeager and the F-104 in "The Right Stuff" the plane has been milked for all of the altitude it can get, and now it has no power left and is starting to fall. And there I will leave the analogy, lest I push it too far, but however far it drops, a lot of people are going to get hurt badly by the fall, especially in the most heavily populated areas of the country.



Caveat Emptor

Most people don't stay in their first house their whole life. At some point, they want to move to a different home.



There are several ways to approach the transaction, but you have to decide which way fits you. You can approach it with an idea to maximizing profit, maximizing cash flow, maximizing speed, minimizing stress, or minimizing inconvenience. You really only get to choose one, but it's a good idea to rank them from most important to least important so that both you and your agent know where your priorities lie, and perhaps you can do some things from your lesser priorities.



Now, if this was a commercial site, looking to seduce you into listing with me, I'd probably have some corporate salespeak flack telling me to say you can have it all, but instead I'm going to tell you the blunt truth: You can't, not reliably, and any representation to the contrary is a lie, the words of a fool, or both. You can certainly do things in each of the categories (and others) but if you don't go into the transaction with a clear view of what is most important to you, chances are you won't get whatever it is that is important to you. Some people do luck out, especially in hot markets, but when the market is cooler, the fact is that you take what you can get, and the probability is better that you will get what is most important if you decide what is most important and stick to it.



If you choose to maximize profit, move out of the old property and into a rental unit, and make whatever cosmetic alterations you're planning before the property hits the market. Newly renovated vacant units show better, and therefore sell better, than anything else. Your time of highest interest is typically for the time period immediately after it hits the multiple listing service. Particularly if you have pets or children, who are both highly efficient entropy generators, you want to move out if you can afford to. Since this is very costly in terms of cash flow, many cannot afford it. Nonetheless, in most markets under most conditions, the return you will get will repay your investment, as there are few obstacles and conditions to your prospective buyer moving in as soon as they can consummate the sale. Furthermore, because the property is vacant, they can more easily picture themselves living in it. Ask any artist which is easier to work with - a blank canvas, or one that already has a painting on it? Then consider that the average buyer has the imagination of a rock, which is why properties with just a little more oomph are much easier to sell. The less of your family there is in the property, the more potential buyers can picture theirs in it.



Staying in the property causes not only stress from whether the property is clean enough to show every day, but also from prospective buyers and their agents having both a window of observation on your life and the potential opportunity to debark with some material piece. I imagine it happens, but not nearly so much as to warrant the stress sellers put themselves through on this point. As an agent, I'm always aware that my good name is on the line as well, and I'm always watching prospective buyers, even though I've never had anyone attempt to remove anything (that I'm aware of). Nonetheless, many sellers insist upon being physically present, which often has the effect of chasing people away that I, as the agent, could have sold the property to given a freer hand. Given real estate practicalities, your concern over a couple of $15 CDs that might have potentially wandered off could have just cost you tens of thousands. So if you're concerned, move anything valuable or irreplaceable like jewelry and heirlooms out, and resign yourself to replacing anything remaining. You'll likely come out ahead in the end.



If you're looking to maximize speed, moving out is a good idea also, but you're also going to want to price your property significantly lower. The higher the price, the harder it is to sell the property, the fewer people that can be expected to look at it, and the harder it will be for them to qualify. If you're priced 5 percent above anything comparable, the appraisal probably going to come in lower than the sale price, and not many people want to pay a premium for a property. It's going to take longer to sell. If you're priced a tad below the comparables, however, well everyone wants to buy homes with some built in equity, and the bank sees their loan as being less risky, so it's a little easier to qualify (They're still going to stick with the LCM principle, but from experience, they're less sticky about the little stuff if the appraisal is a little above the price).



If you're concerned about cash flow, on the other hand, moving out is not the way to go about things. For one thing, you don't have the money, or if you do, you're going into stress mode about whether some short deadline is going to be met, which can cause you to be forced to accept an awful deal that you would not otherwise have considered because you're running out of money to pay for all the extra stuff you weren't paying for before. If you think ahead, and make your agent aware of your concerns, you've got a better chance to come out ahead in the end.



Suppose your priority is to minimize stress? Then you typically stay put while researching other properties, and ask for a contingent sale, possibly with a leaseback that gives you a certain amount of time to find alternative lodgings. Alternatively, if cash flow isn't an issue, you might start looking right away, either with or without a "bridge loan" (cash out against your current property, as a down payment on the new one). Bridge loans are great, they are wonderful, they can do all sorts of things for you, but they are aren't cheap. Before you do one, consider whether there is a real need. If you have some cash and are a good credit risk, the better option may be to borrow more against the new property. Perhaps the better option is to split finance the new property and pay off the second loan on the new property when the current property sells. Because "bridege loans" are cash out refinances, then all things being equal, it's probably a better idea to get the money through a purchase money loan. It's even possible (albeit rare) that despite paying for two loans, the math may favor getting some money via a bridge loan, and borrowing the rest through the purchase loan on the new property.



If you want to minimize inconvenience, you probably want to stay in the property until it sells, and quite probably for a while thereafter, so you're going to want a short term leaseback as a condition of the sale. Many people do this to avoid moving the kids out of school in the middle of an academic year. If they're staying, it also gives them some time to find another property in the same district, or even that attends the same school. But here again, remember that you're limiting your buyer's options, which has the effect of possibly scaring off the ones who would otherwise have offered you the best price, or causing them to not be willing to pay so much for it ("Darn it, my kids are in the middle of a school year, too!") If it's a buyer's market, you're likely to pay a certain price - or rather, your buyers are likely to be willing to pay less - but if it's worth it to you, you also get what you pay for.



There are other potential factors, certainly, and other strategies to maximize the blend of "goods" that's best for you. But these are the ones that most people need to think about ahead of time, and these are the ones where failing to consider them ahead of time will reliably cost you the most.



Caveat Emptor.

UPDATED here