Buying and Selling: September 2006 Archives

Many people are unaware how profoundly lending policies influence the market for residential property. So I am going to go over the various gradations in available loans for various types of property.



Pretty much everyone is familiar with the standard house, built on site, mostly by hand, from basic materials. Called "stick built" to differentiate it from other building methods, this is the default housing that everyone is familiar with. Once emplaced upon that property, there is no real way of getting it off the property intact, and therefore it is appurtenant to the land. This might come as a shock to people who concentrate on the house, but when you buy a property, you are buying the land upon which it sits - the lot - and the structure comes along because it is appurtenant - because it cannot be moved off easily. It is this type of property which has been at the forefront of liberalization of lenders loan policies, precisely because it is both universally desirable and non-portable. That land is defined by its boundaries. It isn't going anywhere. The structure isn't going anywhere that the land isn't, because in order to remove it, you pretty much have to destroy it. It's built on a several ton concrete foundation, which, if you nonetheless manage to pick it up, is still overwhelmingly likely to crack if not disintegrate, not to mention ripping out plumbing, electrical, and other connections.



Now because the land isn't movable and the structure isn't either, lenders have gotten comfortable that you're not going anywhere with that structure. Because the combination is so universally desired among consumers of housing, they have gotten comfortable with giving loans for essentially the full purchase cost of the property, knowing that it takes a special set of circumstances for them to take a loss on the property, and they can charge higher interest rates in order to insure against that. (I am using insure in the statistical, law of large numbers sense that is the essence of insurance.)



Now once upon a time, lenders treated condominiums far less favorably than single family detached housing. But it was always obvious that condominium units weren't going anywhere, and in recent years condominiums, in all their incarnations, have reached a level of acceptance among housing consumers that assures their marketability, and even the price discrimination against high-rise condominiums is gradually dying out. It is far less than it was just a few years ago. For condominiums four stories and less, the only difference their status makes to lending policy has to do with required expenses and Debt to Income Ratio: There is no homeowners insurance requirement, because the association dues pay for a master policy, but there is the additional expense of Association dues to charge against the borrower's monthly income. As far as Loan to Value Ratio goes, condominiums are precisely like single family residences, and you can find 100% loans just as easily for them, at the same rate cost trade-offs, or very close. More and more, the fact that it's a condominium is becoming irrelevant to loan officers. Many lenders have completely eliminated the "percentage of owner occupied units" guidelines that used to be such a bugbear for getting condominium loans approved. For these reasons, among others, condominium prices have taken off. In the last fifteen years, they have gone from being about half the price of a comparably sized and furnished detached home, to the point where they are basically proportional to detached single family homes, and in some areas, higher price per square foot due to the fact that they are a viable less expensive consumer's alternative due to (usually) fewer square feet to the dwelling, and so less expensive overall if not proportionately so.



The first real step away from the "stick built' house is the modular dwelling. These are piece-manufactured at factories, and assembled in pieces on site. Usually, it's something like one entire room-wall in a piece, with all the necessary plumbing and electrical already embedded in it, although sometimes it does take the form of entire rooms. Think of it like modular furniture, which is manufactured in individual pieces, but those pieces are intended to be put together so that instead of an arm chair and an ottoman, you have a chaise lounge. The important difference is that unlike modular furniture, once that modular house is assembled on that foundation, it's not going anywhere. Try to disconnect the plumbing hookups, or disassemble the pieces, and all you will likely have is much smaller pieces than you started with. Modular housing, once assembled, isn't going anywhere. It is permanently attached to that land. For this reason, lenders are in the process of phasing out pricing discrimination against modular housing as opposed to stick built homes. For some lenders, modular gets the same exact loans as stick-built, for a few, there is a hit to the rate-cost trade-off that may be anywhere from a quarter of a point to a full point. Over half of the residential lenders in my database are happy to do residential real estate loans for modular housing on pretty much the same terms as stick-built. 100% percent financing, interest only, even the horrible negative amortization loan are all available on modular homes. As a result, prices of modular homes may be a couple percent lower than those of stick built properties, but they are very comparable and the the investment potential is just as strong and there is no large amount of difficulty getting them sold due to the difficulty of getting a loan. Some lenders still don't want to touch them, but it's pretty easy to find lenders that will, and on the same terms as they do any other property, so the lenders who still will not lend on modular properties are hurting no one but themselves by dealing themselves out of possible business.



The next step away is manufactured housing on land owned by the home owner. Now technically speaking, modular housing is a subset of manufactured housing, but when most lenders are talking about manufactured housing, they are talking about homes built at the factory in entire sections, and assembled with only a few total joins at the home site. True manufactured housing is portable, where modular really is not. If you're in Idaho and decide to move that house to your property in Georgia, it's doable.



Now because it is portable, as you might guess from things I've said here about the prevalence of attempted scams that lenders have had issues with people dragging them off. You'd be right. Lenders file foreclosure papers on the land, and the homeowner metaphorically backs up the pick-up truck and takes that residence somewhere else, leaving the lenders with a piece of land and no residence. Because there is no longer a residence on it, it's not worth anything like what it was when there was a residence on it. Lenders have lost multiple hundreds of thousands of dollars on individual properties around here. You get burned enough times, you start getting wise. Those real estate lenders who will lend on manufactured homes require a laundry list of conditions, and even if they are all met, they won't loan 100 percent of the value, or anything like it, and there will be an additional charge of at least one full point of cost on their regular loan quotes. Cash out loans are typically limited to sixty-five percent of value, making it hard to tap equity. Furthermore, due to accounting standards and depreciation, Fannie Mae and Freddie Mac made a rule that manufactured homes were limited to twenty year loans, which drastically limits not only the type of loans available to their owners, but also has the effect of restricting what they can afford to borrow, because the payments principal has to be paid back over a shorter period.



Now because loans are more expensive, harder to get, and amortized over a shorter period of time, this has the effect that even if someone wants to purchase a plot of land upon which the primary residence is a manufactured home, they cannot afford to pay as much for it. Let's say par rate on a thirty year fixed rate loan for a stick built house or condominium is 6.25% (that is approximately where it is right now, by the way). To keep it simple, let's hypothesize that someone can afford loan payments of $2000 per month. That gives a loan amount of just under $325,000 for the stick built house ($324,824). Now because of the minimum one point hit, the equivalent rate on the manufactured home loan, even though it still sits upon owned land, is about 6.75%, and you're limited to a 20 year loan, giving a loan principal of about $263,000. The same person who can afford a stick built loan of $325,000 can only afford $263,000 for a manufactured home. This means that the manufactured home is not going to sell for as much money, because for what most people thing of as the same price (monthly payment) they cannot afford as much manufactured home as stick built. This leaves completely aside such issues that magnify this difference as the fact that because the loan terms are more favorable, it's more cost effective to improve a stick-built home, so equivalent stick built homes have more amenities and are therefore even more attractive and more desirable. Not to mention the fact that the lender will require a twenty percent down payment on the manufactured home, where they might not require one at all on the stick built. The people who are in the market for relatively inexpensive housing are first time buyers. I can't remember when the last time I encountered a first time buyer with a significant down payment (5% or more). Very few of them have down payments. This means that even if they are inclined to purchase a manufactured home, they are going to be constrained to purchase a stick built house by lending policy. That $263,000 loan I talked about earlier in the paragraph is only available if the buyer puts a down payment of $65,750 or more in addition to closing costs. For the vast majority of buyers, this limits their choice to stick-built, or none at all. For these reasons, when people go to sell manufactured homes, one can expect the prices to be more than proportionately lower than those of comparable stick-built homes, and so investments in manufactured homes do not tend to pay off nearly so well as property earlier on this list.



There is one further step down on the list: Manufactured homes on rented land. These are not, properly speaking, real estate loans at all. There is no land involved. If there is no land involved, it's not real estate. Since there is no land involved, the loans are not real estate loans. They are listed in MLS because the people are buying and selling housing, but they are not real estate loans. It is very difficult finding lenders who will lend on them at all, and those few who will mostly do so through their automotive department. Furthermore, whereas space rent might be cheap if it's your only cost of housing, it is expensive as compared to homeowners association dues, let alone property taxes, and the loans are still all twenty years or less. Because lenders don't like to touch them, because the down payment requirements are large, and because of the additional expenses imposed by space rent, prices for manufactured housing on rented land are microscopic by comparison with everything else. Even here in southern California, $100,000 buys a really nice 4 bedroom place where by comparison the lowest priced 4 bedroom anywhere in the county right now are $337,000 (manufactured on owned land, and way out in the hinterlands of east county).



Lest anyone think that this is in any way shape or form due to inferior construction, it is not. Because these buildings are manufactured on assembly lines which are largely robotic, there are many fewer problems with things like forgetting to nail at appropriate intervals, workers getting distracted, not getting corners square, and all those sorts of problems. I'd bet that a manufactured dwelling is probably of superior construction to a site built dwelling, all other things being equal. It is purely lender policy, as influenced by the history of their experiences with these kinds of properties, which is driving these differences.



So before you think a property is a great bargain, consider what kind of property it is, because even if you have plenty of income and a huge down payment and these concerns are irrelevant to you, when you go to sell it your prospective buyers will generally not have those things, and every time you eliminate a possible buyer from being able to consider a property, you statistically make the final sale price lower, and you statistically make the sales process take much longer. Eliminate enough potential buyers, and you're going to be very unhappy indeed.



Caveat Emptor

UPDATED here

I've been telling people that the flat spell on rents we've had locally in San Diego is going to change. Here's the first confirmation I've seen: $1,241 average reflects biggest climb in 4 years



The last few years, landlords have been buying in order to sell to a bigger fool. That has now changed. They've got to make money on their investment, and considering all of the ones that bought for too much, they are jacking rents up hoping to make enough not to lose their investment. Expect to see more of it. The article reports vacancy as being an incredibly low 1.8%. Supply and Demand. High demand, low supply. You can stay hitched to the rent escalator, or you can buy from people who have to sell right now. Yes, it'll cost more money per month, but within a few years, rent will be more than the mortgage, even without the consideration of tax breaks for buying. Your choice.



San Diego is a bleeding edge market. Most of what I predicted in Looking Beyond The Bubble: What's Next For Highly Appreciated Markets has now come to pass, on the local scale anyway. Most of the national scale stuff is still pending, but I did say

Rates have been rising of late, but there is a limit as to how far they are likely to go, if only because Bernanke and company are very shortly going to have irrefutable evidence of all of the above stuff nationwide. A nationwide economy has a lot of something analogous to inertia. Takes a while to move things in the direction you want them to go. More time, and more effort, than most folks, particularly bankers running our money supply, are likely to realize and sit still for without further pushing, which they have done a bit too much of, in my opinion, by about one full percent on the overnight funds rate

Now this was on March 31 (and one of the WSJ sites linked it on April 15th - blowing away the only Instalanche I've ever had as far as traffic is concerned).



What my point? That the next thing that starts to happen is rents rise, and when they do, more buyers move into the purchase market. We've already seen some of this. Also, some sellers have moved out of the market. A few weeks ago, I was seeing active listings total about 23,800 locally, and they're down to 22,500 now. Furthermore, the number of buyers has risen by about ten percent or so in the last couple weeks. Net result: We were at 38 or 40 sellers per buyer most of the summer. Last week it dropped to 34, and this week it's at 33. This is starting to look like it might be a trend, and when the ratio of sellers to buyers drops enough, prices are going to stabilize, the period of best deals will be over, and people are going to rush back into the market. It's got a long way to go, but where I have predicting Spring 2008 as the most likely market recovery point locally, I'm thinking now that it will more likely be some time next year, most likely early summer based upon current trendlines.



Those who are thinking that we're going to see $200,000 detached single family homes in San Diego are most likely going to be disappointed. I've said all along that the economic pricing support was there for $350,000 starter homes, providing rates stay about where I think they will, and rates going higher than I think they will (about 7 A paper 30 fixed par, where we're right at 6 now) means lenders will suffer even more in the short term in order to salvage their bottom line further out. I really don't think they will make that choice.



However long it takes, if you wait for the market to turn, you will now be at maybe 5 to 10 sellers per buyer, which is a more normal ratio, and when you don't have 30 sellers per buyer, you can't get them to work with you nearly so much. Prices will start moving back up, and if you wait for that to happen, you are hosed. It is far better to move now while prices are still moving somewhat downward. Yeah, you might "lose" a little on paper until the market turns. But you have the opportunity to negotiate a better bargain now than you will then.



Caveat Emptor

What happens if a home you signed to purchase goes into foreclosure before the closing date?

We were supposed to close on a home four months ago. On the day of closing we get a call from the seller's realtor that the sellers owe 22K and need time to figure out negotiations w/the mortgage company. We go through a series of extensions & hear a variety of excuses from the sellers realtor (sellers haven't turned in paperwork, wrong forms filled out &new ones were overnighted, etc) In June, a Lis Pendens was filed & our realtor checked it out. He talked to the sellers realtor & found out that it had been filed but has been negotiated off &was no longer in effect. On 8/9 our realtor gets a call from the sellers realtor that they have finally been in contact with the mortgage company &there is 1 more paper that needs to be completed & they are "on top of it". After not hearing anything last week, I check with the online courts to see if anything else has occurred to see that a foreclose decree was noted for 8/4. What happens now? Can we purchase the home from the bank?

Somebody has not been "on top of it". Probably at least two somebodies, and they're not exactly fulfilling full disclosure requirements, either.

Yes, an Notice of Default adds thousands of dollars to fees due. But what do you think the lender would rather have: An already negotiated sale that is consummated and they get their money, or go through that whole dismal foreclosure process, not knowing if anyone else will put an offer in?

So what is going on here is an undisclosed short sale. What this means is that the lender isn't going to get all of their money, or the transaction would have closed by now.

So what's most likely going on is that the bank is taking their own sweet time about approving it, but your realtor has allowed the selling realtor to feed you a line of BS. Indeed, they've probably actively cooperated. They're probably afraid of losing the commission, but if they keep it open "just a little longer" maybe the lender will approve it.

It's the listing agent's job to talk the lender into approving the sale. Perhaps the bank is imposing some conditions that the seller can meet, but does not want to. Perhaps the bank is demanding some money, or that the realtors reduce their commission, and they don't want to Perhaps the listing agent just clueless, but I doubt your agent has exactly covered themselves in professionalism either.

The person with the power to break the logjam is you. Talk with a lawyer, but if you put in a 48 hour notice to perform, the lender is likely to suffer a sudden attack of rationality, especially in this market. They'll likely net more money through the sale than through the foreclosure process, but if you allow them to go on ad nauseum they will keep the transaction open as long as possible. You see, once the transaction closes they can't get their money back if a better offer comes along. Therefore, they are trying to put you off for as long as possible in the hopes that such a better offer will come along. From their point of view, they have this transaction well in hand, they are just hoping to get more money from someone else, and the longer you allow this to go on, the higher the likelihood they will. If you don't force the issue, the only possible resolution is unfavorable to you. There are possible issues with the deposit, and damages they could owe you and you could owe them, which is why you need to be careful. But putting them on Notice to Perform is the thing that is going to break the logjam one way or another, and your agent should probably have done it months ago. You're stuck with them for now, but if this transaction doesn't close you should probably find a new agent. Good agents know that if they are willing to risk losing a particular deal, they will not only better represent their clients interests, but also that they will end up with more deals overall. Approached correctly, it's a way to have even the client whose entire family has their heart set on a particular property that you are acting on their behalf, not just looking for a commission, and they will send you their friends, and they will come back to you when it's time to sell, or to buy another property.

Caveat Emptor

UPDATED here

Is it unwise to use the listing realtor as your purchase realtor?

A house I'm interested in purchasing is being sold by the realtor selling my house. Although she's done a decent job selling my house, I fear she won't negotiate well on my behalf if she has to divide her loyalties between these listers and me (a potential buyer). How awkward would it be not to use my listing realtor to purchase a new home?

I would not undertake dual agency myself. If I do find a buyer for one of my listings, I'll refer them to someone else for negotiations. Everyone in the industry whom I respect agrees with this position. Too often, there is a conflict of interest between buyer and seller. Anybody who tells you otherwise is trying to rationalize money in their pocket.

It'd be fine to use her for any property she's not listing. If you want that one, however, go find another buyer's agent.

In every transaction, there is a tension between the interest of the sellers and the interest of the buyers. It is in the interest of the sellers to get the most money possible for the property. It is in the interests of the buyers to pay the lowest possible price. Except in the highly unlikely case where the most that buyer might possibly have paid is the exact same number that is the least that seller might have accepted, and that is in fact the sales price, such simultaneous duties cannot both be met. Since such happenings would be freak coincidence, and not only are they not known until afterward, any such lookback is prone to an agent indulging in what psychologists call confirmation bias.

Furthermore, there is tension between the interests of the buyer and the interests of the seller in other matters as well. Not far from here is a condo conversion project, currently being sold out. About 1993, there was a resident of that complex arrested on suspicion of serial murder. I am unaware of whether he was eventually convicted, but I do know they dug up several bodies as I was unfortunate enough to drive by when they were removing them. California law requires the disclosure within three years of anyone dying on the premises, but at three years and one day there is no requirement for disclosure that I am aware of. Nonetheless, if one of my clients wanted to buy one of those units it would be part of my duty of care to that client's interests to make certain they were informed. Would you not want to know about your building being used as an impromptu cemetary for several bodies? But acting as a seller's agent, I would be forbidden from making that disclosure. Which client's interests do I follow?

Suppose my client is having difficulty qualifying for a loan. Okay, obviously I'm not doing the loan, but I cannot force clients to do their loans with me and the only thing I can offer is carrots, never sticks. But suppose that I, as buyer's broker, find out from the loan officer on day 24 that they've been disqualified because the processor told the underwriter something they shouldn't have, and the loan is back to square one. If I am acting as listing agent as well, my duty to the seller requires me to inform my client of this difficulty. But my duty to the buyer is equally clear about in being a violation of my other client's best interests. Whose interest is paramount? Whose interest do I disregard? These interests are in direct conflict - there can be no compromise resolution. Indeed, as a listing agent I will demand information that it it may not be in my buying client's best interest as buyer's agent be disclosed, and vice versa. If they agree of their own volition, or some other agent talks them into it, then we have a willing buyer and a willing seller and full disclosure from my end and best interest of the client in furthering the transaction and so on and so forth. If I fail to ask because I am also representing the other side, I have not represented my client's best interests. If I talk either client into it when I am representing both, then I have, ipso facto, violated that client's best interest by getting them to agree to something which is not in their best interest. Did I do it because such was in their best interest, or the best interest of my other client? Even if I did act in their best interest, can I prove it? Probably not. Can I prove it in a court of law? Definitely not.

I like to make more money as well as the next person. But accepting dual agency is logically and provably a violation of my duty of care to someone in every case, no matter how the transaction turns out. No matter what you do, it's kind of like the old joke about someone playing chess with themselves. Sure you always win. But you always lose as well, and when you have a fiduciary duty to someone else, setting up a situation where you are guaranteed to lose is in itself a violation of that fiduciary duty.

So I urge you in the strongest possible terms to go find another agent to represent you. There's absolutely nothing wrong with using the same agent to represent you in multiple transactions, even simultaneous transactions. But I would never use the listing agent for a property as my buyer's agent, and I would not allow an agent I was listing a property with to act as buyer's agent. Force them to pick a side and stay on it, and since they've already got a listing contract, they have already made their choice.

This is incidentally another argument against Exclusive Buyers Agency Agreements. If they show you one of their own listings under an exclusive agency contract, they are the procuring cause and you must pay them. Nonexclusive contracts should also have explicit releases if the agent is also the listing agent.

Caveat Emptor

UPDATED here

I get occasional questions about the difference between these three kinds of activity. Well, there are subjective parts to the answer, but here are some general guidelines:



A true flipper is looking for a quick turn on the property, usually without much work done to really improve the property. They don't typically keep the property and rent it; they're not willing to accept the work of being a landlord. They make their money off of desperate sellers and getting a very low price for a property. Typically, their profit comes from how far down they can drive a desperate seller.



A fixer is someone who is looking to make a profit by making the property more attractive. By making it more attractive, they are able to sell for more money. They typically sell when the renovations are done, although many will wait for a full year to gain better tax treatment. They do not typically rent the property out, although they may live in it while it's being renovated.



An investor has the idea of buying and holding for a certain period of time, usually leveraging rent to make the payments, sometimes breaking even, preferably with positive cash flow, usually while eventually hoping to cash in on capital appreciation, but always holding for periods that start at two years and go up from there.



Now I've heard a lot of folks who are really fixers call themselves flippers, but I've never heard a flipper call themselves a fixer. Why? Because the general perception admires flippers more, because they theoretically make money by their wits instead of by the sweat of their brows. It's more status to call yourself a flipper, although why people think it's better to tell people they make their living by shorting people who really have no choice, instead of by actually creating value by improving the properties they purchase, is beyond me. But due to the huge long swell of the seller's market that concluded recently, many people got addicted to the fact that it enabled people who didn't really know what they were doing to buy properties for too much money, and six months later sell for a profit despite not having done anything to improve the property.



Right now, the local market does not support flipping, due to the fact that no matter how good the bargain they buy the property for is, as soon as the flippers go to sell it and actually make a profit, they become one of the thirty-odd sellers for every buyer out there right now. Indeed, I know of a couple of properties out there on the market that have been through more than one sale from desperate flipper to optimistic flipper, and then the optimistic flipper gets desperate and sells to another optimist. Indeed, with most properties on the market, it's a gamble as to whether fixing will yield a profit after expenses in the usual fixer's time frame. There are quite a few out there that are suitable, and many more that are not. With the ratio of 40 buyers to every seller this last week, the odds are against it in all but a very few properties.



Investors who buy now will do very well. There are a lot of desperate sellers out there, and so long as they've got positive cash flow in a sustainable situation, all they've got to do is wait for the market to move in their favor. Until then, they are making money. Real investors never turn into desperate sellers, because they always have the option of hanging on to it. It might not be their most preferred option, but it is there.



I love working with fixers. It's a lot more work to find suitable properties right now, but that's fine. And, of course, families who buy for a personal residence in the current market will do very well in the long term. But flippers are basically wasting their time. The market isn't there to make them happy, and I can't say as that causes me any grief.



Caveat Emptor

UPDATED here