Buying and Selling: January 2009 Archives

If I had to pick one thing prospective home buyers need to understand and don't, that fact would be it. There is always a reason for a low asking price. Sometimes that reason is something you can deal with, sometimes it isn't, but until you know, you're risking your money on an unknown.

Look at the situation from the seller's point of view: They have this valuable property. They want to get as much money for it as they possibly can. So unless it's your mother or favorite uncle or similar family member giving you a deal on property they've owned forever, get religion about the fact that there is a reason why they're asking fifty thousand dollars less than all the comparable properties. It could be that there's a broken slab. It could be that there's a condemnation about to start. It could be the golf course is about to close, or that a chemical manufacturing plant is about to get built. It could be something you can't see that will cost loads of money down the road, such as a broken water pipe undermining the foundation. It could be any number of things. Sometimes the reason is because their agent persuaded them to put a low asking price on it as one way to get lots of suckers to come out and bid against each other and run the price up.

Usually, the asking price on properties of this sort should be even lower. It only seems low because you don't know what's wrong with it and what it's going to take to fix the problem - if it can be fixed. Lots of prospective buyers don't seem to understand this. The "get rich quick" scams never point it out - doing so would severely restrict their supply of people willing to plonk down hundreds to thousands of dollars for whatever "system" they're trying to sell. But it's true, nonetheless. There are any number of reasons for a low asking price, but there's always a reason.

Every once in a while, the reason is "because they need a quick sale." Right now this is fairly common. But just because they tell you that doesn't make it true. Even if it is true, doesn't mean it's the only reason, or that you know the reason why they need a short sale. Just because you know one reason, doesn't mean you necessarily know all the reasons for the low asking price.

If you read between the lines on MLS, you can often figure out what the reason is before you even go out to a property - or at least an agent who does this all the time can. But it takes careful reading, and thinking about what they're really saying - or what they're not saying. Keep your eyes open when you visit the property, and the reason for a low asking price usually becomes obvious - or at least one such reason does. Fairly often, there are one or more secondary issues that aren't so obvious that may well cost even more to fix than the obvious issue that leaps out and grabs you.

If you're certain you know what the issues are, and you are able to deal with them, that's what people call an opportunity. But that is a very different thing from walking in cold and taking somebody's word for the fact that the little old lady who used to live here needs to sell because the nursing home needs the next month's payment (Hint: this doesn't happen. Granny can get a Reverse Annuity Mortgage if she's that desperate, and whereas I recommend against RAMs in almost all cases, this is one exception where they are the lesser of two evils, as compared to just giving away a big chunk of equity).

When there's a low asking price, be thinking in terms of things that most buyers can't deal with. Defects that prevent some or all loans from being funded. Probate where there is no money to rectify even safety and habitability issues. Things that prevent your average buyer from actually carrying through on an intention to buy a given property.
Sometimes, as with lender owned properties, it's merely that no one knows if there are problems or not. Maybe it's just cosmetic stuff like paint and carpet, maybe it's a bad floor plan, and maybe it's something a lot more serious. Get yourself a good buyer's agent and go into the property with your eyes open. Be religious about investigating the property; you're risking the full purchase price, not just the down payment, whether you realize it or not. Plus interest due on the loan, of course. Buying a property like this is always a risk - but it's what insurance underwriters call a speculative risk. As opposed to a "pure risk" where there is only opportunity for loss, speculative risk means there is opportunity for gain, as well. Gambling is the poster child for speculative risk, and when you buy a property of this sort, there is opportunity for both gain and loss. It's never difficult to understand the opportunity for gain - people will stand in line to point those out to you. It's the opportunity for loss that you've got to watch out for. A good buyer's agent will save your backside on this score more often than most people would believe.

Caveat Emptor

Article UPDATED here

This saying comes to us courtesy of our military. They use it in the context of ten million peasants armed with stone age weapons will swarm one man, no matter how well armed or how well supported. In my work, I use it in entirely different contexts, and it is an amazingly versatile phrase for real estate. The context of the moment right now is that because price has fallen by more than enough, buyers are swarming no matter how tough the times. Requiring a low quantity of dollars will cause the buyers to come out in droves in the expectation of a deal. Quantity (low price) has a quality (buyer appeal) all its own.

A lot is getting made of the state of the economy, how many people are losing their jobs, companies closing, etcetera. The unemployment rate is up to seven percent nationally. What they aren't emphasizing is the margins between that and the best unemployment rate ever: something just over four percent. This means that ninety-three percent of the people are working in horrible times, as opposed to ninety-six percent in the best times ever. Difference: about three percent, or one person in thirty. Bad if you're that one person in thirty, but not too much difference if otherwise. Maybe a few more people than normal are also less secure in their jobs than at other times, but there's always quite a bit of that. The bottom line is that eighty to eighty-five percent of the people out there are secure in occupations that aren't going to vanish, working for companies that aren't in any danger. Unless that company decides it's worthwhile moving overseas to avoid excessive US regulation and costs of staying in business, their jobs are going to securely stay right where they are. These folks are actually sitting pretty right now, because their money is worth a lot more than it was not very long ago, and especially in real estate, much more than it will be worth two or three years from now. The difference in the economy is on the margins, and these people are not on the margins.

They're figuring it out, too. The areas where I work here in San Diego, the absolute inventory isn't down that much in the last few months, but what there is is selling much more quickly, and that's just at a first glance. In time terms, we're down from about eighteen weeks inventory to about ten weeks inventory here in East County, but there's a distortion in that due to the fact that most short sales stay in the "active" list all the way to the actual sale, as opposed to moving over into "pending". This in the period of the year that is usually the absolute worst for getting property sold. I don't have a crystal ball, but my projection for what happens this spring when people start thinking about moving once the kids are out of school is a little bit scary.

People can afford a lot more than could when unsustainable loans were the order of the day. I'm in escrow right now for just over $400,000 on a property that last sold for over eight hundred thousand. Another property I'm in escrow on is about three and a quarter on a property that would have been worth $650,000 at market peak, and probably would have sold for seven hundred or a bit higher. These properties are closer to being the rule than the exception. Yeah, the market comps I'm getting are about ten percent higher, but even a $360,000 property is a lot more affordable to the median wage earner than a $650,000 one, and a lot more people can afford $400,000 than can afford $819,000. Since incomes have an approximately normal distribution, a lot more than twice as many people can afford a property that's half as expensive.

Several months ago, I did a study on what people can afford in San Diego. Those numbers were based upon 2006 wages, those being the most recent I could find a distribution for, and then-current rates. Well the rates now are a lot lower. When I did that study, I assumed an FHA type loan at 6.5%, by which I really meant a tad over 7, as the FHA charges 55 basis points per annum for financing insurance. The rates as I type this are 4.75% (plus the same 55 basis points) for exactly the same loan. That person smack dab in the middle of the largest group of wage earners, who could afford the loan, taxes and insurance on a $302,000 property all by themselves at $2343 per month, is only spending $2016 per month on exactly the same thirty year fixed rate loan, taxes and insurance on exactly the same property at exactly the same price - a difference of over $325 per month. This means it's a lot easier for them to afford exactly the same property. You shouldn't make decisions on real estate based upon payment (at least not beyond a blanket rejection if you can't make the payment), but people do it. Quantity of dollars out of the monthly budget has a quality all its own, as every crook who's ever preached "Low Monthly Payments!" knows very well.

That same $2343 per month under exactly the same circumstances now stretches to a $342,000 property. The loan by itself would allow a further stretch, but those pesky property taxes keep going up by purchase price. This enables people to set their sights on more desirable areas of town, or bigger, better, more attractive properties within the same area. Instead of a 1000 square foot 3 bedroom 1.5 bath property, people can now afford a 1500 square foot 4 bedroom 2 bath property next door for exactly the same payment. Maybe it isn't quantity having a quality all it's own, but higher attractiveness and more value becoming obtainable for the same price (as these folks think about it) will also cause more folks to sign on the dotted line.

Lower rates are also allowing more people to save their property. They couldn't afford the adjusted payment at eight and half percent, but they still have equity, and their debt to income ratio supports five and a quarter percent, where it didn't support seven percent, let alone the higher adjusted rate. If they have equity, they are refinancing. If not, they are getting loan modifications - the lenders are willing to give them at lower rates when the rates are lower, and they're certainly preferable to the lender losing the money and being forced to sell the property in what has been an uncertain market. The lenders have also (finally!) figured out that if they stop flooding the market with inventory they don't have to, prices might stay a little bit higher, and recover more quickly, so they get a better price and lose less money on the properties they do have to put on the market.

The backlog of people who want to sell is dropping. The number of people who have held their property off the market was only large, not limitless. We're burning through the people who didn't or don't have any choice but to sell - the short sales with adjusted loans and lender owned properties, and I don't see another wave of foreclosures here in San Diego. People are assuming it takes three years after loan adjustment and thinking that some loans were fixed by up to five years after initial purchase before adjustment, but there just weren't many of those in San Diego - the dangerous loans were all two to three years before the payment adjusted - the exceptions are insignificant, statistically. Furthermore, people are deciding to get out now and get the pain dealt with, even though there are a lot of reasons why they shouldn't. It's been two years plus now since the last of the Make Believe Loans (January 2007), and over three years since the bottom started falling out of the San Diego market (October 2005). My point is this: of those who are going to lose the property because their loans adjusted, the vast majority of those adjustments have already hit, and people are deciding - wrongly - that the smart thing to do is stop paying their mortgage now.

Of those in other situations, where they have a choice, some people have decided to stay in their current property, while others have decided to wait until prices recover and still others are waiting for conditions to be right for a move up. These last can afford a slightly more expensive property, but some of them need a little bit more equity for the down payment on the new property. They will be in a position to get it soon, and when they are, the market is going to heat up still further.

The only thing causing prices to go down - the only thing that can cause prices to go down - is excess inventory (Conversely, the only thing that can cause prices to rise is excess demand). That excess inventory is starting to clear, at least here in San Diego. I don't know how far the rest of the country is behind us, or any given area, but it will happen, sooner than most folks probably think.

Caveat Emptor

Article UPDATED here