Buying and Selling: January 2007 Archives

A few days ago, another agent in my office got an offer and brought it to me for feedback. The listing was range priced over a $30k range, and priced correctly, so there was a lot of activity on it. The offer was for $30k beneath the bottom of the range, with a note saying that this was for a single dad with three kids, and that was all they could afford, but they really loved the property, and were so excited that that they were each going to get their own room, and so on, gushing for several paragraphs.



In logic circles, this is called the appeal to pity. "Please take pity on me." However, we had every reason to believe that we would be seeing better offers on the property very soon - it hadn't even hit its first weekend on the market, and there had been roughly 15 viewings and six phone calls from agents whose clients had seen the property.



I advised them to counter hard at the high end of the range pricing. It's no concern of current owners what that buyer can and cannot afford. The first two things that ran through my mind were the large amount of activity at an early date, and the likelihood that this was a low-ball flipper's offer. It's not like there's any criminal penalties for creative fiction accompanying an offer. The next two thoughts were if they like the property that much, come talk to me about ways to stretch what you can afford. Two ideas: Mortgage Credit Certificate and Municipality based assistance programs, and both could have been applied to this property, as in it was eligible, there was available money in the program budgets, and each of them stretched the buyer's ability to pay by at least enough, let alone if applied for together. If both were already accounted for, bid on something less expensive; it's not like there is any shortage of properties for sale. Maybe somebody has to share a room; maybe there are fewer amenities, maybe they just don't love it quite as much. None of these is the owner's problem.



Yes, I'm always looking for hidden bargains, but this time I was on the side of the owner, or rather, the owner's agent, and furthermore, the property was correctly priced and seeing strong activity. Neither of those are characteristic of hidden bargains. Furthermore, appeal to pity is a bad negotiating tool.



So here's the situation: Somebody comes up to you and asks you to sell your property for far less than you can get, because they are so deserving, and you want this underdog to succeed against the odds. "Help me, I'm really in need." The appeal is no different at the root than a pan-handler's pitch.



I've given money to panhandlers in my time, too, and doubtless will again. I'm a complete sucker for the ones with kids. But that's maybe $5 or $10, possibly even $20 at the most. Panhandlers are not effectively asking for $40,000 or so out of my pocket, much less my client's pocket. My client has neither a Red Cross nor a Salvation Army Shield on their door. They are not obligated to settle for much less than they could get for a valuable property. In this case, the difference was for something like 70% of their actual net equity, and it is a violation of the fiduciary trust that my client has placed in me, and I have accepted, not to point this out. If it were several months on, and this was looking like it might be the best offer the property would get, that would be one thing. But it was a brand new listing with strong enough activity that there was even hope of a little bit of a bidding war. It's not like the prospective buyer was homeless, and even if they were, there are more logical things to do first than buy a four bedroom detached home, not to mention it would be tough getting verification of rent, which all lenders are going to want.



But I also counseled the other agent not to reject the offer completely, and not to counter until the third day. The high counter signals, in no uncertain terms, that the owner's bargaining position is very strong. It's even a good idea to explain why it's very strong. But in this market, especially, you get buyers looking for a bargain because they might be able to get one. My buyers do it. Why not others? By the third day, there might be another offer on the table. Not that the absence of other offers stops some agents from pretending that there are other offers, but I've always found that the best policy is not to lie when the truth will do, and the truth will always do, because you should tailor your response to what the truth is. This may sound strange coming from a member of the profession that describes condemned buildings as "needing a little TLC", but if you want to do well in negotiations, never overplay your hand (and tell the buyer that the building is condemned. Condemnation is a recorded instrument, so it's not like you can plead ignorance). Real estate is almost entirely public information. If there is a dissonance between how you act, what you say, and what the public information says, good agents will pick up on it. This is not poker. The other side can see most of your cards, and has the option of getting up and walking away from the table at any time, and good agents will counsel their clients to do exactly that if the situation calls for it. The idea is a willing buyer and a willing seller coming to a mutually beneficial arrangement.



So the other agent took the offer to the client, and jointly they decided to mostly follow my advice. The prospective buyer walked away, they got two more offers before the third day. And a couple days later, well, remember that first group of two thoughts I had? Well, we found out that that particular prospective buyer was buying with intent to flip; he had flipped at least four properties in the previous year or so. His low offer and all the histrionics surrounding it was simply a ploy for more profit.



Caveat Emptor

UPDATED here

A couple of weeks ago, I got an email asking Save For A Down Payment or Buy Now?, and I wrote a two part article on the subject. Part 2 of Save For A Down Payment or Buy Now? gave an alternative strategy to make affordability accelerate faster. But there was an obvious, related concern that I let go because it was a very complex calculation, and that was, "What's the effect of waiting to buy on my financial situation down the line?"



This wasn't an easy problem to program, even in a spreadsheet. I'm decent with spreadsheets, but for a lot of the calculations I had to do it by brute force repetition. Had I been able to do certain functions on spreadsheets that I used to do with matrices back in the really dim times, it would have been far easier, but the area I ended up using was three sheets totaling about 60,000 cells. Most of it was change one thing, copy and paste a row or column segment, then change another. It wasn't that hard mentally, but the finished product certainly makes a microprocessor work for a living!



I also had to make some simplifications to the problem. In order to make the problem manageable, I had to assume that you hold onto your home, once you have bought, at least until the end of the scenario, and also that you never refinance. I had to program it with smooth inflation, smooth appreciation, smooth increases in federal income tax standard deductions, and smooth increases in auxiliary prices. Anyone over the age of thirty ought to know how dangerous that is. But adding those random elements made the problem beyond the scope of what I could realistically do. I also had to postulate no major changes in income or property tax law, and I had to ignore the effects of state income taxes. Besides, the idea was to isolate the effects of the variable under consideration, how waiting to buy a home influences your financial situation down the line. I also had to choose a set period to terminate at, and arbitrarily chose 30 years.



Actually, this is two discrete problems when you really look at it, and they really are disjoint, and no matter how much the folks who sell Reverse Annuity Mortgages might try to link them, they are separate cases. What happens if you keep living there, versus what happens if you decide to sell and move somewhere else when you retire.



Nonetheless, the following simulations are all as representative as I can make them. Except for the effects of state income tax, they are in line with current California computations.



Example 1: Suppose you're talking about a San Diego Condo. $300,000 present purchase price, no down payment but you can save $500 per month for a down payment in the future if you don't buy now, and this amount increases proportional to salary increases. The property continues to appreciate at 4.5% whether you buy or not, association dues are $250 per month and general inflation is 4%, and you can get 7.2% return, net of taxes (10% minus an assumed marginal tax rate of 28%), on the money you save for a down payment. Whenever you buy, you can get a 6% first mortgage, and a 9% second if you need it. I'm also going to assume that in order to see any financial benefit, you're going to have to sell at a cost of seven percent of value. Furthermore, you're stable in your profession, seeing a 3% compounded annual raise in income, and equivalent rent is $1400 per month currently.

Year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

purchase price $300,000.00 $313,500.00 $327,607.50 $342,349.84 $357,755.58 $373,854.58 $390,678.04 $408,258.55 $426,630.18 $445,828.54 $465,890.83 $486,855.91 $508,764.43 $531,658.83 $555,583.48 $580,584.73 $606,711.05 $634,013.04 $662,543.63 $692,358.09 $723,514.21 $756,072.35 $790,095.60 $825,649.90 $862,804.15 $901,630.34 $942,203.70 $984,602.87 $1,028,910.00 $1,075,210.95 $1,123,595.44

still owe * $24,489.73 $46,429.89 $67,745.37 $88,445.34 $108,534.07 $128,010.82 $146,869.63 $165,099.15 $182,682.37 $200,029.06 $217,296.63 $233,893.12 $249,747.93 $264,783.31 $278,913.68 $292,045.12 $304,074.62 $314,889.39 $324,366.10 $332,370.01 $338,754.10 $343,358.06 $346,007.30 $346,511.78 $344,664.85 $340,241.87 $332,998.90 $322,671.15 $308,971.35 $291,299.48

housing* $1,354.26 $1,514.40 $1,659.59 $1,801.37 $1,939.80 $2,074.91 $2,206.72 $2,335.19 $2,460.26 $2,581.85 $2,702.41 $2,822.91 $2,939.80 $3,052.67 $3,161.06 $3,264.47 $3,362.35 $3,454.09 $3,539.04 $3,616.45 $3,685.54 $3,745.43 $3,795.18 $3,833.75 $3,860.02 $3,872.76 $3,870.64 $3,852.21 $3,815.90 $3,760.00 $3,680.93

waiting $0.00 $160.15 $305.33 $447.11 $585.54 $720.66 $852.46 $980.93 $1,106.01 $1,227.59 $1,348.16 $1,468.65 $1,585.54 $1,698.41 $1,806.80 $1,910.21 $2,008.09 $2,099.84 $2,184.78 $2,262.19 $2,331.28 $2,391.17 $2,440.92 $2,479.49 $2,505.76 $2,518.50 $2,516.39 $2,497.96 $2,461.65 $2,405.75 $2,326.67

savings* $3,186.50 $3,026.35 $2,881.16 $2,739.39 $2,600.96 $2,465.84 $2,334.04 $2,205.57 $2,080.49 $1,958.91 $1,838.34 $1,717.85 $1,600.96 $1,488.09 $1,379.70 $1,276.29 $1,178.41 $1,086.66 $1,001.72 $924.31 $855.22 $795.33 $745.58 $707.01 $680.74 $667.99 $670.11 $688.54 $724.85 $780.75 $859.82

*Still owe 1 final payment after thirty years if you buy today. "Housing" is how much your costs of housing will be in 30 years if you bought at the indicated time is, and assumes you refinance for zero cost into the same rate you have now. Waiting cost is as opposed to buying now. Finally, the savings column has to do with how much you are saving per month over what the equivalent rent will be in 30 years, namely $4540.76 in this case.



Please keep in mind that the table is the net result 30 years out; the only time variable in the equation is precisely when you bought the exact same condo. Now there is some mildly strange stuff that goes on. For instance, starting 25 years out, there's a period where, under the stated assumptions, your saving for a down payment actually starts to increase in value faster than the property. But by that point, you've missed the optimum time to buy by, well, 25 years. Keep in mind that money will be worth less than a third of what it is today in thirty years ($1 then will be worth 30.8 cents now), but you are still saving significant amounts of money on your future housing payments by buying as soon as practical.



Now let's look at the situation if you decide to sell your home and go live somewhere else:

Year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

purchase price $300,000.00 $313,500.00 $327,607.50 $342,349.84 $357,755.58 $373,854.58 $390,678.04 $408,258.55 $426,630.18 $445,828.54 $465,890.83 $486,855.91 $508,764.43 $531,658.83 $555,583.48 $580,584.73 $606,711.05 $634,013.04 $662,543.63 $692,358.09 $723,514.21 $756,072.35 $790,095.60 $825,649.90 $862,804.15 $901,630.34 $942,203.70 $984,602.87 $1,028,910.00 $1,075,210.95 $1,123,595.44

net equity $1,043,032.82 $1,020,454.03 $998,513.87 $977,198.39 $956,498.42 $936,409.69 $916,932.94 $898,074.13 $879,844.61 $862,261.39 $844,914.70 $827,647.13 $811,050.64 $795,195.83 $780,160.45 $766,030.08 $752,898.64 $740,869.14 $730,054.37 $720,577.66 $712,573.75 $706,189.66 $701,585.70 $698,936.46 $698,431.98 $700,278.91 $704,701.89 $711,944.85 $722,272.61 $735,972.41 $753,644.28

liquidation $7,079.98 $6,926.72 $6,777.79 $6,633.11 $6,492.60 $6,356.24 $6,224.03 $6,096.02 $5,972.28 $5,852.93 $5,735.18 $5,617.97 $5,505.32 $5,397.70 $5,295.64 $5,199.72 $5,110.59 $5,028.93 $4,955.52 $4,891.20 $4,836.87 $4,793.53 $4,762.28 $4,744.30 $4,740.87 $4,753.41 $4,783.43 $4,832.60 $4,902.70 $4,995.69 $5,115.65

net benefit $594,459.84 $531,782.24 $526,736.25 $495,140.59 $448,046.96 $435,547.19 $407,644.83 $380,733.08 $354,624.01 $329,944.53 $301,836.93 $269,957.25 $239,420.18 $210,196.49 $182,428.96 $155,944.29 $130,741.38 $106,921.94 $84,296.01 $63,087.55 $43,073.74 $24,442.68 $7,100.56 ($8,932.23) ($23,548.85) ($36,736.02) ($48,455.14) ($58,627.44) ($67,101.14) ($73,746.48) ($78,651.68)

waiting cost $0.00 $22,578.79 $44,518.95 $65,834.43 $86,534.39 $106,623.13 $126,099.88 $144,958.69 $163,188.21 $180,771.43 $198,118.12 $215,385.69 $231,982.17 $247,836.99 $262,872.36 $277,002.74 $290,134.18 $302,163.67 $312,978.45 $322,455.16 $330,459.07 $336,843.15 $341,447.12 $344,096.36 $344,600.84 $342,753.90 $338,330.93 $331,087.96 $320,760.21 $307,060.41 $289,388.54

Net equity is what you have left after 7% costs of selling, liquidation assumes that you are taking out 360 equal monthly payments based upon the same return I assumed your money could earn before you bought. Net benefit is the number of dollars difference it makes to your financial position in the future 30 years from now if you buy at the indicated time. Notice that starting 25 years out, it actually hurts you to buy from then on out, as opposed to just letting the investments you were saving for a down payment run. Waiting cost is how much it hurt your future financial position to delay purchase by that much, so if you wait five years, you end up with over $100,000 less in your pocket.



Now let's do a second example: Still in San Diego, but you're going to buy a starter single family residence that would cost $450,000 today. Nudge assumed appreciation up to 5.5%, cut association dues out but raise property taxes and insurance costs appropriately. Oh, and the equivalent rent now starts at $2000, and general inflation I'm going to assume to be 3.5%. Actually, based upon the past seventy years, everything that has happened has been, over time, more favorable to home ownership than this.



Once again, let's look at the situation if you keep living in the property after 30 years first.

Year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

purchase price $450,000.00 $474,750.00 $500,861.25 $528,408.62 $557,471.09 $588,132.00 $620,479.26 $654,605.62 $690,608.93 $728,592.42 $768,665.01 $810,941.58 $855,543.37 $902,598.25 $952,241.16 $1,004,614.42 $1,059,868.21 $1,118,160.97 $1,179,659.82 $1,244,541.11 $1,312,990.87 $1,385,205.37 $1,461,391.66 $1,541,768.21 $1,626,565.46 $1,716,026.56 $1,810,408.02 $1,909,980.46 $2,015,029.38 $2,125,856.00 $2,242,778.08

still owe * $37,403.63 $72,247.27 $107,464.64 $143,121.84 $179,283.73 $216,014.10 $253,375.62 $291,429.94 $330,237.68 $369,858.41 $410,350.66 $451,771.89 $494,178.40 $537,625.32 $582,166.43 $627,908.86 $675,787.71 $724,872.44 $775,183.89 $826,740.19 $879,556.33 $933,643.75 $989,009.82 $1,045,657.39 $1,103,584.13 $1,162,781.95 $1,223,236.28 $1,284,925.33 $1,347,819.27 $1,410,482.12

monthly $1,151.93 $1,404.15 $1,641.99 $1,883.05 $2,127.79 $2,376.60 $2,629.93 $2,888.18 $3,151.75 $3,421.06 $3,696.50 $3,978.46 $4,267.34 $4,563.52 $4,867.37 $5,179.28 $5,499.92 $5,834.96 $6,178.89 $6,531.86 $6,894.07 $7,265.65 $7,646.73 $8,037.44 $8,437.84 $8,847.99 $9,267.92 $9,697.62 $10,137.03 $10,586.05 $11,036.15

Wait cost $0.00 $252.22 $490.06 $731.13 $975.86 $1,224.68 $1,478.00 $1,736.25 $1,973.99 $2,178.71 $2,388.07 $2,602.37 $2,821.91 $3,046.98 $3,277.86 $3,514.85 $3,758.46 $4,013.04 $4,274.35 $4,542.51 $4,817.67 $5,099.93 $5,389.39 $5,686.13 $5,990.21 $6,301.66 $6,620.52 $6,946.75 $7,280.32 $7,621.14 $7,962.68

savings $4,461.66 $4,209.44 $3,971.60 $3,730.53 $3,485.80 $3,236.98 $2,983.66 $2,725.41 $2,461.84 $2,192.53 $1,917.09 $1,635.12 $1,346.24 $1,050.07 $746.21 $434.31 $113.67 ($221.38) ($565.30) ($918.28) ($1,280.48) ($1,652.06) ($2,033.15) ($2,423.85) ($2,824.25) ($3,234.40) ($3,654.34) ($4,084.03) ($4,523.44) ($4,972.46) ($5,422.56)

Equivalent rent would be $5613.59. Once again, the last three columns are all monthly streams, and they do have a steady worsening the entire time, mostly because your saving for a down payment does not start to catch up to the increase in property values during the simulation period. In other words, the longer you wait, the worse it gets. Indeed, affordability is monotonically decreasing the entire time. That's math geek for "Quit waiting, it only gets worse." Even though a dollar then is only worth 35.6 cents now, wouldn't you like as many 35.6 cents in your pocket as possible?



Now let's examine if you decide to sell this starter home in retirement, and go live somewhere else.

Year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

purchase price $450,000.00 $474,750.00 $500,861.25 $528,408.62 $557,471.09 $588,132.00 $620,479.26 $654,605.62 $690,608.93 $728,592.42 $768,665.01 $810,941.58 $855,543.37 $902,598.25 $952,241.16 $1,004,614.42 $1,059,868.21 $1,118,160.97 $1,179,659.82 $1,244,541.11 $1,312,990.87 $1,385,205.37 $1,461,391.66 $1,541,768.21 $1,626,565.46 $1,716,026.56 $1,810,408.02 $1,909,980.46 $2,015,029.38 $2,125,856.00 $2,242,778.08

net equity $2,082,917.20 $2,048,379.98 $2,013,536.35 $1,978,318.97 $1,942,661.78 $1,906,499.88 $1,869,769.52 $1,832,407.99 $1,794,353.67 $1,755,545.93 $1,715,925.21 $1,675,432.96 $1,634,011.73 $1,591,605.21 $1,548,158.29 $1,503,617.18 $1,457,874.75 $1,409,995.90 $1,360,911.17 $1,310,599.72 $1,259,043.42 $1,206,227.28 $1,152,139.87 $1,096,773.79 $1,040,126.22 $982,199.48 $923,001.67 $862,547.34 $800,858.28 $737,964.35 $675,301.50

liquidation $14,138.60 $13,904.16 $13,667.65 $13,428.60 $13,186.56 $12,941.10 $12,691.78 $12,438.17 $12,179.86 $11,916.44 $11,647.50 $11,372.64 $11,091.48 $10,803.63 $10,508.72 $10,206.38 $9,895.88 $9,570.89 $9,237.70 $8,896.20 $8,546.24 $8,187.73 $7,820.59 $7,444.77 $7,060.25 $6,667.05 $6,265.23 $5,854.87 $5,436.13 $5,009.21 $4,583.87

net benefit $1,681,408.70 $1,527,603.06 $1,482,514.85 $1,390,228.98 $1,262,990.98 $1,218,788.65 $1,139,516.49 $1,064,002.28 $991,242.90 $921,953.98 $854,914.46 $790,327.87 $728,045.15 $667,919.78 $609,807.59 $553,566.46 $498,733.07 $440,202.91 $383,770.99 $329,344.94 $276,837.21 $226,165.09 $177,250.78 $130,021.48 $84,409.45 $40,352.17 ($2,207.48) ($43,321.12) ($83,034.61) ($121,387.80) ($156,994.47)

wait cost $0.00 $34,537.22 $69,380.85 $104,598.23 $140,255.42 $176,417.32 $213,147.68 $250,509.21 $288,563.53 $327,371.27 $366,991.99 $407,484.25 $448,905.47 $491,311.99 $534,758.91 $579,300.02 $625,042.45 $672,921.30 $722,006.03 $772,317.48 $823,873.78 $876,689.92 $930,777.33 $986,143.41 $1,042,790.98 $1,100,717.72 $1,159,915.53 $1,220,369.86 $1,282,058.92 $1,344,952.85 $1,407,615.70

Now it is to be noted, as you may have seen under the first table, a point in time exists starting 26 years out where you will be better off just keeping your down payment money socked away in alternative investments, as opposed to actually using it to buy your home.



I'm planning to start using this sheet with prospects, under assumptions they can set - If they think inflation is going to average 7%, or appreciation only 3%, the sheet can accommodate that. I've played with the sheet over a few dozen simulations, and due to leverage, the numbers appear quite powerfully in favor of buying the best home that you can actually afford, right now. Interestingly enough, however, these number also strongly suggest that as close to 100% financing as you can manage initially will outperform larger down payments, and that's something that seems quite counter-intuitive to the usual run of financial planning. Instead of using it for your down payment, financing 100% of your purchase if you can seems to make your money work harder. Well, I can put a lot of caveats on that, because metaphorical bumps in the road happen, and nobody knows exactly when or how these disasters will strike. If you do, you can plan for it, and could you please drop me an email in warning? When you're just looking at the raw numbers, however, the advice they give is quite strongly to buy the best property you can afford as soon as you can, putting down as little of a down payment as you can, and making the minimum payments while salting away the rest for a rainy day. But be very careful not to stretch too far, because one thing you can count on, even in Southern California, is that it will rain sometimes.



Caveat Emptor

UPDATED here

I just went out doing some general market scouting. Looked at ten properties, and at least three were of a sort that I've started calling "vampire properties." One more reason you want a good buyer's agent.



Like a mythical vampire, these properties are very charming on the surface, luring in the innocent victims with brand new flooring, new roof tiles, and new paint. All the relatively cheap stuff that inexperienced buyers love. There might even be a new spa in the back yard. They call the listing agent and fall in love with the property. They put in an offer, which is quickly accepted, buy the property and move in.



Then the troubles start. Those brand new roofing tiles get ripped off the rotten substructure the first time a good wind comes up. The new owners notice that the travertine floor tiles are separating, and eventually, when one comes loose, find that there's a two inch wide crack in the foundation that runs the width of the house. That beautiful new tile in the bathroom has to come out because they discover the green board is rotten, and the framing boards as well.



It'd be better if the property was sucking your blood. At least that's covered by health insurance if you've got it. But it's got its fangs permanently embedded in your bank account, instead. None of this stuff is covered by home owner's insurance, new home warranties, or anything else. Your home owner's insurance might replace the roof tiles (pulled off by wind, which is usually a covered peril), but the rotten structure underneath is your problem, caused by the normal wear of time.



In most cases, I find it hard to believe that the previous owners didn't know about this stuff. That's what the brand new facade is about. They figured a quick surface fix - the home owner's equivalent of a cheap paint job over a rusted car body - and they unload the lemon on some unsuspecting chump and walk away. Quickly.



For any of those sort of people reading this, I've got to tell you that the lawyers will find you. But for the buyers in the situation, the lawsuit - which will take years, even assuming that they win and if the judgment is paid - is a poor substitute for not getting into the property in the first place. Particularly if, as seems to be the usual case, they stretched to the extreme limit of their budget or beyond in order to afford the property.



It is far preferable, to all parties, to have the issues dealt with before the sale is consummated.



Now most buyer's agents aren't licensed inspectors, and I'm not one of the few. You still want an full-on building inspection. That doesn't mean agents can't spot stuff before you have a purchase contract, come up with a deposit, and spend hundreds for an inspection. All of this is called "buy in," and works off of a phenomenon psychologists call cognitive dissonance. You've said you want it, you work really hard and jump through all of these hoops to get it, and when you find out how bad it really is, you keep going because you are so mentally committed, because you've done all this stuff. If it's something I can spot, wouldn't you rather find out before you do all of that work?



The listing agent certainly won't tell you. They'll have you sign a standard disclaimer advising you to get an inspection. Yes, they have to help fill out the disclosures, but if they're not licensed inspectors, they can't be blamed for not knowing, can they? Their responsibility is to get the best possible deal for the sellers. They have very little responsibility to the buyer. You can't blame listing agents for doing their job (You can blame them for lying).



It's almost inevitable that the owners of vampire properties price the property like something out of Big Al's Discount Used Car Lot. "Cream puff, baby! One owner, a little old lady who only lived in it on Sundays." They want top dollar and then some. I understand, but I'm not going along and neither are my clients if I can help it. I saw one today where the list price was $40,000 more than it should have been if it wasn't a vampire. The agents should know better, assuming they are not deliberately "buying a listing." Price it to market if you want to move, and that includes a hefty discount for not being the one who has to hassle with fixing it. If you want that money in your pocket yourself, fix the problem yourself. You'll also interest a better grade of potential buyer, not to mention more buyers than just the simpleton who happened to win the lottery.



I'd rather deal with a property where the issues are out in the open. I also found one property today that has a crack across the living room floor, out in the open due the aftermath of an obvious flood, but I can find buyers who know how to deal with that (If the lot is level, it's not such a big deal, and can often be fixed surprisingly cheap). You don't have a listing agent pretending to drool over beautiful flooring that is going to have to be replaced anyway. Furthermore, it indicates that the listing agent, at least, doesn't have their head stuck in the Land of Wishful Thinking, so if I take a client who is interested despite the flaws out to the view the property, we're all pretty much on the same page as to what's going on with the property, and we have the makings of a reasonable negotiation. If the listing agent is in the Land of Wishful Thinking, I'm wasting my time to look and the client's also if I show it to them.



Vampire properties are out there. In markets such as this one, they are both increasingly common and deadly to your financial future. You want somebody whose job it is to look past the beautiful surface to the very real issues beneath. If you buy a vampire, it's worse than a disastrous marriage, because the financial consequences are likely to follow you long after your abusive partner is history.



Caveat Emptor

UPDATED here

What's negotiable on a purchase?

The short answer is everything.

There may be standards and traditions in your area, the same as there are in mine. That doesn't mean they are not subject to amendment by specific negotiation. Once you get outside legal requirements, anything is subject to negotiation. As long as both (or all) parties concerned agree to it, that's the way it's going to be.

This is not to say that some things aren't better left alone. For example, if I was buying a property and the seller didn't want to pay for the policy of title insurance, as is traditional, I'd certainly think long and hard before continuing with the transaction. Furthermore, such behavior would certainly cause the price I'd be willing to pay to drop dramatically. If I'm helping clients, the same applies even more strongly. I'm going to tell them that this may mean the seller may not be able to deliver clear title.

This is also not to say that there may not be consequences as the result. For example, if I or my client is selling the property, and someone asks for a $10,000 credit towards closing costs, the lowest offer I'd accept would be at least $10,000 higher, probably $11,000, maybe more. Why? Because commissions and transaction costs are based upon the official sales price, not the sales price less that rebate to the buyer. The bottom line is that it costs at least $10,000 to rebate $10,000 thusly. A $400,000 offer that requires $10,000 in rebates isn't a $400,000 offer. It's a $390,000 offer at best.

In order for it to be a valid contract, the two parties have to agree in every particular. If there is not complete, total, 100 percent written agreement as to what is going to happen, there is no contract. Two parties haggling over whether one light bulb gets replaced do not have a valid contract any more than two parties haggling over whether the price will be $200,000 or $500,000.

Nonetheless, except for those very few things mandated in law, it's all negotiable. Specific negotiation can change anything that's not legally mandated, and most things with defaults specified in law. If you've got a gold bathroom faucet that you want to keep, a normal sales contract says that it stays by implication (it's a furnishing attached to the property and required for the property to function normally). But you can change this by specifying that you have the right to remove it in the contract. Now if they buyer is only buying the home because of that gold faucet, they can walk away or counter offer that it stays. Let's say you eventually agree that it will be replaced by another gold faucet. That's specific negotiation. The replacement will be required to be installed, equal in functionality and free of defects - unless you change this by more specific negotiation.

I've seen negotiation for personal property to remain, furnishings to leave, the disposition of existing tenants, allowing leasebacks to the prior owners, and just about everything else under the sun. If there's something about the standard contract you don't like, or something specific to this situation or this property, specific negotiation is how you deal with the issue. Furthermore, even if you don't want to change anything, the other side might. Indeed, probably more properties have further negotiations due to problems or issues raised by inspections than don't. Something is revealed to be not quite right, and the seller either has to make it right or negotiate with the buyer for acceptance in the current state.

This is not to say that as long as the transaction records the seller is golden, by the way. If the buyer can show reasonable evidence that the seller knew of the issue but failed to disclose it, that's a bone for the lawyers to fight over when it's discovered. Some sellers fight a losing battle over issues like this for years - and it ends up costing them far more money in the longer term. The buyer finds out something you should have told them after the transaction, that's a bad situation for a seller to be in. Better to disclose right away and be done with it. When the seller can prove the buyer knew the full extent of the issue and bought anyway, that's much better protection.

So make sure that if there's some issue you want resolved, the purchase contract resolves it completely and unambiguously. That contract is how the transaction is going to happen. If it's not there, you're at the mercy of the other party. They might see it your way. Then again, they might not.

Caveat Emptor

UPDATED here

(click for Part 1 of Save For A Down Payment or Buy Now?, which deals with the basic question of how well saving for a down payment increases affordability)



But suppose, instead of waiting because you can't afford the payments now, you buy a $250,000 condo now - and then sell it for your down payment later. In other words, you buy what you can afford right now instead of waiting and saving until you can have the home of your dreams. Then at some later time you sell the condo for the down payment on the home you really want.



Let's look at the trade-offs for the condo. I'm going to assume that the condo's equity is the sum total of the saving you are doing, and I'm going to manipulate rents until I get $833 per month cash flow difference (you $10,000 per year savings). This yields a monthly rent of $977.46. You can't rent $250,000 condos around here for $1000 per month, but we'll stick with the situation I figured even though the argument in favor of buying the condo is far stronger. Let's also assume it costs 7% of the value to sell the property, make allowances for property taxes, HOA fees, etcetera. It'd be a bear if I didn't already have the spreadsheet done, but here are the results:

Year 0 1 2 3 4 5 6 7 8 9 10

Value $250,000.00 $262,500.00 $275,625.00 $289,406.25 $303,876.56 $319,070.39 $335,023.91 $351,775.11 $369,363.86 $387,832.05 $407,223.66

Monthly Rent $977.46 $1,016.56 $1,057.22 $1,099.51 $1,143.49 $1,189.23 $1,236.80 $1,286.27 $1,337.72 $1,391.23 $1,446.88

Equity 0.00 15,431.56 31,674.53 48,772.18 66,770.15 85,716.58 105,662.21 126,660.56 148,768.08 172,044.30 196,552.03

Net Benefit -17,500.00 -13,443.41 -9,518.73 -5,769.20 -2,244.10 1,000.56 3,901.27 6,386.11 8,373.86 9,772.91 10,480.08

Now, I have to admit this seems marginal. You've only got an extra $10,000 in your pocket after 10 years. So you sell the condo and buy your house, and plugging these numbers into the affordability spreadsheet improves the affordability of the house you really want by 8% in only 8 years. Nonetheless, this is 2.5 times the affordability increase afforded by investing the money.



Now let's consider the situation as it really exists. That $250,000 condo rents for about $1300, which makes a big difference to what you save. It's like taking the previous situation, and adding $322 per month to your investments as well. Here's the numbers for the condo, adding the investment, and coming up with a total.

Year 0 1 2 3 4 5 6 7 8 9 10

Value $250,000.00 $262,500.00 $275,625.00 $289,406.25 $303,876.56 $319,070.39 $335,023.91 $351,775.11 $369,363.86 $387,832.05 $407,223.66

Rent $1,300.00 $1,352.00 $1,406.08 $1,462.32 $1,520.82 $1,581.65 $1,644.91 $1,710.71 $1,779.14 $1,850.31 $1,924.32

Equity 0.00 15,431.56 31,674.53 48,772.18 66,770.15 85,716.58 105,662.21 126,660.56 148,768.08 172,044.30 196,552.03

Savings $0 $4046.11 $8515.91 $13453.74 $18908.64 $24934.73 $31591.84 $38946.03 $47070.31 $56045.30 $65,960.08

eq+sav $0.00 $19,477.67 $40,190.44 $62,225.92 $85,678.79 $110,651.31 $137,254.05 $165,606.59 $195,838.39 $228,089.60 $262,512.11

Now let's paste these last numbers into the affordability sheet and see what we get:

Year 0 1 2 3 4 5 6 7 8 9 10

available $0.00 $19,477.67 $40,190.44 $62,225.92 $85,678.79 $110,651.31 $137,254.05 $165,606.59 $195,838.39 $228,089.60 $262,512.11

price of house $500,000.00 $525,000.00 $551,250.00 $578,812.50 $607,753.13 $638,140.78 $670,047.82 $703,550.21 $738,727.72 $775,664.11 $814,447.31

payments $3,631.97 $3,670.64 $3,709.34 $3,747.86 $3,786.00 $3,823.49 $3,864.42 $3,928.79 $3,993.62 $4,058.65 $4,123.58

affordability 1.00 1.02 1.04 1.06 1.08 1.10 1.12 1.14 1.15 1.17 1.18

So we see that this strategy has increased the affordability of the house you really want by 12% over only 6 years, holding background assumptions constant. This is twice again the affordability increase rate from the last example (2%/year as opposed to 1), and so almost five times the affordability increase rate of just saving for a down payment. Furthermore, those payments on your condo are mandatory, and the increases in value happen of their own accord, whereas most saving programs run by individuals falter a bit over time, nor is there any such thing as a 10% return per year tax free. In short, I'm comparing a real world real estate investment with a hopelessly idealized other investment. Saving for a down payment makes comparatively little sense unless you are not yet in a position to buy, either due to stability, insufficient income to buy anything, or because your situation does not permit 100% financing.



Taken all together, this forms a powerful argument for not waiting until you can afford your dream house, but buying what you can afford as soon as you are in a position to do so with the intention of trading up later. Delaying means you cut the later years off of the results, not the earlier. The benefits to real estate don't start until you put your foot on the ladder. If I had known this when I was in my twenties, I'd be millions of dollars better off today. So plan ahead, and start working towards your goals now. You can never go back in time with what your figure out later, or with the effort you expend later.



Caveat Emptor

UPDATED here

An email asked a question I should have thought to answer a long time ago, and the answer may surprise a lot of folks. I've been vaguely aware of this for a couple of years, but I was amazed how strongly the numbers solidified my views!

My wife and I aren't ready to buy a property yet, but we are trying to plan how much to save for our down payment. You've mentioned that there's a spectrum from nothing down to 20+% down broken down by 5% increments, but how do you choose where to be on that spectrum? I can see that there are tradeoffs between the amount you have to save, the cost of your mortgage and the like, but I don't have a good way of thinking about those tradeoffs. And, since we're in the DELETED area, 20% down could easily get into the six figures, so it can be quite intimidating.

Given the way leverage works in even a slightly appreciating market, it is generally to your advantage to buy as soon as 1) You are sufficiently stable in your employment and expect that you're going to be in the area at least another three to five years, 2) You have enough of a reserve that the first minor bump in the road will not lead to disaster, and 3) You make enough to afford the payments. However, what usually happens is that people get a raise, a promotion, or a new job, or more often, they get married or have a baby and that is what sets their thinking on the road to buying a home.



Let's consider a $500,000 property and an 80% first trust deed with an appropriate piggyback 30 due in 15 second if needed, since that is generally returning more favorable rates than a Home Equity Line of Credit right now. Picking a random lender from a couple days ago and thirty year fixed rate loans, I've got 5.875 for about 9/10 of a point plus closing costs, or about $7100 total cost. But there are potential adjusters - and relevant to this situation, having subordinate financing for 100% CLTV adds one full discount point ($4000 in this case) to the first mortgage, or you can drop down to 6.25 for the same cost. 95% financing only adds 1/4 of a point in the same situation, or you can get a 6% even for the same cost. At or below 90% CLTV, there is no add to the first mortgage. If we're at 80% with a $100,000 (20%) down payment, the 5.875 first is all there is. Taking dead average credit scores (720) with this same lender, the closing costs are $500 (flat) when you do the second concurrently. 85% CLTV would be an 8% second on $25,000 for a down payment of $75,000 (15%) plus closing costs. 90%CLTV would be $50,000 down payment (10%) and leave you with a $50,000 second at 7.375%, benefiting from a bump down in rate for hitting a certain dollar value. 95% CLTV requires a $25,000 down payment and leaves you with a $75,000 second at 7.75%. 100% CLTV (no down payment) leaves you with a $100,000 second at 8%. It would be 8.25, but you've hit another economy of scale break point.



Here's a table:

CLTV 80 85 90 95 95 100 100

1st TD 5.875 5.875 5.875 5.875 6.000 5.875 6.25

2nd TD n/a 8.00 7.375 7.75 7.75 8.00 8.00

Cost $7100 $7600 $7600 $8600 $7600 $11600 $7600

1st pay $2366.16 $2366.16 $2366.16 $2366.16 $2398.21 $2366.16 $2462.87

2nd pay $0 $183.45 $345.34 $537.31 $537.31 $733.77 $733.77

interest $1958.33 $2125.00 $2265.63 $2442.71 $2484.38 $2625.00 $2750.00

So you see that having a down payment is a very good thing. Now this is for a fairly ideal situation. If you are in a stated income situation, the rates are slightly higher and step somewhat more steeply. If your credit is significantly below average, the rates start higher and step up more steeply still. It gets rough if both apply.



However, this doesn't take place in a vacuum. Let's say you can save $10,000 per year, and earn 10% tax free on what you save. But while you do, housing prices are still going up. Let's assume 5% per year on average. We will also assume that you can get a 6% for the first and 8% for the second whenever you buy, and that taxes at 1.2% of value per year, here's the projected situation:

Year 0 1 2 3 4 5 6 7 8 9 10

down $0.00 $10,500.00 $22,050.00 $34,755.00 $48,730.50 $64,103.55 $81,013.91 $99,615.30 $120,076.83 $142,584.51 $167,342.96

price $500,000.00 $525,000.00 $551,250.00 $578,812.50 $607,753.13 $638,140.78 $670,047.82 $703,550.21 $738,727.72 $775,664.11 $814,447.31

CLTV 100.00% 100.00% 100.00% 95.00% 95.00% 90.00% 90.00% 90.00% 85.00% 85.00% 80.00%

payments $3,631.97 $3,736.52 $3,842.45 $3,949.44 $4,057.11 $4,165.04 $4,272.73 $4,379.60 $4,484.99 $4,588.14 $4,694.16

Where payments is the total of mortgage and monthly tax payment pro-rated when you buy. Examining that column, we see that this is an argument against waiting. In fact, assuming a 3% (compounded) raise per year, the property is only 4% more affordable in year 10 with a $167,000 down payment! This neglects rises in rents and other costs of living!

UPDATED here

(Here is Part 2 of Save For A Down Payment or Buy Now?, which tells one way to increase affordability more and faster)

A while ago a reader gave me a heads up that Illinois HB 4050 was hurting residents of certain poverty stricken Illinois Zip Codes. Now I have to pick on my own state:

California law generally requires special handling of sales transactions to protect homeowners in foreclosure. This law, called the Home Equity Sales Contract Act, generally applies to transactions that meet all of the following four conditions: the property is one-to-four family dwelling units; the owner occupies one of the units as his or her principal place of residence; there is an outstanding notice of default recorded; and the buyer will not use the property as a personal residence. The Home Equity Sales Contract Act does not apply if one of these four conditions is unmet. If, for example, a seller occupies a property in foreclosure, but the buyer will be occupying the property as his or her personal residence, the home equity sales law does not apply.



If all four conditions are met, however, the buyer must use a home equity sales contract, such as the C.A.R. standard form "Notice of Default Purchase Agreement" and attachments. This agreement gives the seller, among other things, a five-day right to rescind the contract. Furthermore, the home equity purchaser cannot be represented by an agent. More accurately stated, the law requires a buyer's agent to be bonded by an admitted surety insurer, but C.A.R. is unaware of any insurer currently offering the bond.

Actual Code Here



This is so brain damaged it has to be the idea of some clueless person out to save the world without first stopping to consider the Hippocratic Injunction to "First, do no harm."



Now, in the business, the term "equity sale" or "equity purchase" is most commonly used in conjunction with a sale subject to existing trust deeds. So this is a significantly different meaning to a similar phrase. Keep in mind that there are four conditions that need to be met:



1. Residential property (1-4 units)

2. Owner occupies one unit

3. Notice of default recorded

4. Buyer does not intend to occupy.



But what happens with such properties? Who buys them? Investors, that's who. Guess what? The owners want them sold! What happens if they don't sell? They go to auction, and the owner basically gets nothing, whether the property sells at auction or it doesn't, in which case the lender now owns it.



Furthermore, they're requiring that the buyer's agent have a bond that is not available, and has not been for ten years. So if whether they're working with a shark or with an investor who is actually going to give the people a decent price, the buyer's agent cannot be compensated. So what are most buyer's agents going to do? Answer: Wait until after the trustee's sale! As the buyer's agent, they have no fiduciary responsibility to that seller, and no ability to get paid. But the owner wants to sell before the trustee's sale. The chances of them getting anything from a trustee's sale or afterwards are about equal to one my grandfathers giving birth to triplets.



Now, this does theoretically create an opportunity for certain people who might be willing to live in the property to buy for lower prices, since investors are (mostly) out of the picture. So we are robbing Peter (the current owners) to pay Paul (in search of new housing). There are also some truly outstanding issues. What happens if my buyer client is lying to me about whether they intend to live there? The contract is already written, the terms of the transaction set, and the buyer's agent can't back out at the last minute when they change their mind about whether they're going to live there. Also, what happens if everything is fine when the contract is written, but the lender drops a Notice of Default on the sellers they day we're set to close?



In the current market, most of the folks in default do not have large amounts of equity. Matter of fact, the typical seller who is delinquent is really hoping that the lender will sign off on a Short Payoff. This is not shark investors swooping in and buying granny's $500,000 property for $80,000. With the number of people there are pushing Reverse Annuity Mortgages, that's not going to be the case any time in the foreseeable future. Granny can get a RAM, after which she can last long enough to sell for a good price. Instead, what's going on is that the properties are going to foreclosure, costing the lenders more money, adding to the fees the owners pay, and lengthening the odds against the current owners coming out of the situation with anything. They want buyer's agents on the job, finding these bargains for their clients so that the sale gets made before the trustee's sale. Keep in mind that the seller is always allowed an agent, and the seller can always say "no," to the offer. Which is preferable: Not getting as much as you might have gotten for a sale under ideal conditions, or getting nothing?



Henry David Thoreau had some words on this situation:

If I knew for a certainty that a man was coming to my house with the conscious design of doing me good, I should run for my life, as from that dry and parching wind of the African deserts called the simoom, which fills the mouth and nose and ears and eyes with dust till you are suffocated, for fear that I should get some of his good done to me -- some of its virus mingled with my blood. No -- in this case I would rather suffer evil the natural way.

Caveat Emptor

UPDATED here

This is something that often happens with highly appreciated properties where the owner can no longer keep up the payments, they get hit with a notice of default, and along comes Joe or Jane seemingly riding to the rescue on a noble white steed, offering to buy the owner out of the property "subject to" existing deeds of trust.



This is a terrific position for the buyer to be in, and a rotten position for the seller. Nor are the prices usually very good for the seller - that white knight usually ends up looking a lot more like a thief. So why does it happen? Why does the seller agree to it?



Here they are sitting on this highly appreciated asset, with loads of theoretical equity, and they cannot make the payments. If they go through the foreclosure process, chances are better of flying to the moon by flapping your arms than of getting any of the equity back out. Yes, in California it's got to sell for at least 90% of appraised value or it doesn't sell at auction, in which case the lender owns it. But those appraisals are intentionally low, because the lenders don't want to own them. Furthermore, all of the payments that weren't made, and the interest on them, all gets piled into the loan, as do fees for the default process and the trustees sale. If you have a mortgage loan, read your contract. Sight unseen, I'll bet you a penny there's a clause in there saying they can sock you for "reasonable" fees in the event of default or foreclosure.



So you have a $450,000 property which you paid $120,000 for and owe $320,000 on, but something has happened and now you can't make the payments. You put it on the market for $450,000 and don't get any takers. Then along comes someone and says, "I'll take over your payments and pay you $20,000 if you sign the property over to me."



This is certainly a gray area, legally. The loans have "due on sale" clauses, and the lender can call the notes as due in full in such situations. The buyer basically tells them, "tough", knowing that if they foreclose, the lender ends up in the situation they didn't want to be in in the first place, of owing the property, not to mention that the person who bought "subject to" can cost them a lot more money by delaying it in court, and there's a good chance they can win the case. Meanwhile, if they don't act quite so hard-nosed, this new owner is making the payments. They have the option of refusing the payments, but then we're dealing with the foreclosure process, and in the meantime, the checks for payment are there every month. What do you think most lenders will do? They will accept the payments!



Notice, however, that I didn't say the payments get there on time. This is the second raw deal that the seller has to swallow. The buyer's cash flow is a little tight, and the payment gets there 40 days late on a consistent basis. Who gets marked late? Whose credit gets dinged every time this happens? Not the buyer's. That buyer never applied for a loan with that lender on that property, the lender doesn't have their signature on a contract that says, "I agree to pay..." It's the seller's credit that gets hit. Kind of a nice situation to be in, no? Make a late payment any time you feel like it and your credit doesn't suffer! Not only that, but since the loan is still in the seller's name, the payments don't hit the buyer's debt to income ratio, allowing them to qualify for more loans, with larger payments, than they really should. Trying to leverage their investments like that is one reason why the folks who make a habit of "subject to" deals usually have tight cash flow. They don't want to let the property go into default, but as long as they don't get to the stage of being 120 days late (90 in some places), they have the best of all possible worlds!



Suppose, for whatever reason, it becomes a short sale? Well, since the seller is the one that violated the loan contract, there will be recourse on them, not the buyer. Many times the buyer makes side deals for "pay me" type stuff and manages to make money, or at least get their money back, even though the property doesn't sell for enough to pay off the existing liens.



If you are getting the idea that agreeing to a "subject to" deal isn't the smartest thing in the world, why do buyers agree to them?



Desperation and Panic. They listened to the agent that told them that they could get more money than was likely by market conditions, or they listed with the cheap bump on a log agency that really doesn't do anything to market the property, or they just sat in denial until far too late. Nothing happens instantly in real estate; it always takes several weeks at a minimum to get a property sold, even if you get a fantastic offer on the very first day. In some cases, I can get a loan done in one or two days, but that's not a situation you want to be in, because I don't know anyone who won't charge more in such a situation, and all of the usual loan caveats apply. But for whatever reason, the owners let the situation go too long, let themselves get behind the power curve, and suddenly realize that they are not going to catch up. They are looking at losing the property and getting nothing, so they panic. This is only one of the many reasons why staying ahead of the situation in real estate is so important. At the point where you're looking foreclosure square in the face ten days from now, there's not much else that can be done. I can offer you entire supertankers full of sympathy, and it won't make any difference. So if you're in this kind of situation, get the property on the market quick, price it attractively, and find an agent who will market it effectively, so that you avoid getting into the situation where the shark's offer is the best one you're going to get.



Caveat Emptor

UPDATED here

Must you sell if you list at a specific price and the broker comes up with a qualified buyer?

in the US in general, no you do not have to sell, but you could still be liable to the broker for their commission. You might also need to justify why your decision was non-discriminatory (assuming that it wasn't), but if (for instance) your broker brings you someone you have had business dealings with in the past, and they have tried every manouever possible to scam you after reaching agreement in those past dealings, you are (usually) quite justified in refusing to do business with them.

Talk to a lawyer, but generally speaking, if you do not have complete and perfect agreement between the parties on the contract, you do not have a valid purchase contract, and if you didn't want to do business with (say) Bill Clinton or George W. Bush, such is your right as long as you refuse to do so on the basis of them being a particular individual, not based upon them being members of a class protected under anti-discrimination law.

In general, nobody can force you to sell. But it can be expensive not to. I am not familiar with any cases where a real estate agent, listing or buyer's, was awarded a commission even though there was no transaction consummated, but that doesn't mean it couldn't happen. Refusing to sell on the basis of race, sex, religion, sexual orientation, or lifestyle is setting yourself up for a lawsuit.

On the other hand, just because someone offers you full list price does not mean you have to accept it. If the other terms are onerous, if it comes attached with conditions you don't care to accept, or if it is merely from an individual who you have done business with in the past and are unwilling to be involved with again, you are usually within your rights to refuse the offer.

Caveat Emptor

UPDATED here