Buying and Selling: November 2013 Archives

Once upon a time, this was a good way to get more money for your listing. This led to a classic tragedy of the commons. Because it didn't take hardly any extra time, and there was no reason not to do so, listing agents will claim there are multiple offers with practically every property. It's not like they are expected to furnish any evidence.

Because of this, in the last few months, I've had listing agents try to tell me that there were suddenly multiple offers on property that has sat on the market for months. If I don't see any evidence that there's a reason for it to suddenly have multiple offers, such as a recent massive drop in the price, I find these claims dubious at best. It might be believable if the property has been on the market for three days, and has not recently been listed before that. If it's been on the market more than three weeks, such a claim is likely to be making things up. I recently talked a pair of clients into making an offer on a property that had expired twice and been re-listed for a third time. A week prior to that, a special incentive to buyer's agents had expired. In short, there was every reason to believe that that we had a clear field, with nobody else making offers. As I always do, I included information on comparable properties that had recently sold in the neighborhood, of which I had inspected two, and the issues that this property had. The listing agent claimed there were multiple offers and gave the kind of counter I hadn't seen since the height of the seller's market years ago, demanding a "best and highest" counter. I and my clients jointly countered back that we'd agree to their conditions if they'd agree to our price, and gave them 24 hours to take it or leave it.

Before you claim that there are multiple offers, you do need to have multiple counters in point of fact. Because the flinty-eyed buyer's specialists know better. Even if they do, in fact, believe that you've got multiple offers, we're going to tell our clients that it's best to counter back as if the seller is lying. Essentially, we call their bluff. If they do have multiple offers and someone is stupid enough to play ball with them, that's no skin off my client's nose. It's not that much of a seller's market, and it won't be again anytime soon. If this seller doesn't want to be realistic, we can keep looking until we find a seller that will. This is why property sellers need to protect themselves from lazy agents.

For an intelligent buyer in this market, even if there are multiple offers upon a property, it doesn't make us willing to offer more for the property. It means we want to expedite our deadlines for the sellers to respond, and it means we're likely to make subsequent counters with a multiple offer contingency (in other words, we're making offers on multiple properties now. If another offer gets accepted before you accept ours, we're going with that one). Mostly though, it means that this seller, and their listing agent, have their heads stuck in the land of wishful thinking, and it's time to consider another property because we can't force the sellers to be reasonable. Nobody can make them sell against their will, but we can find another property where they seller isn't so far gone in denial, and where the agent has done a better job of explaining the realities of the current market. It's not like there's any shortage of choices.

Let's face it: Unless you fax over the competing offer, complete with all terms and the competing agent's name and their contact information so I can verify it, there is no reason for me to believe that you have a competing offer. If you do this, the offer is either better than my clients', or not as good. If it's not as good, the leverage is provides is minimal, in any market. If it's better than my clients' offer, it's either something my clients are willing to beat or it isn't. If it isn't, your leverage is still negligible. It's only if the other offer is better, but my clients are willing to beat it, that this trick offers you any leverage whatsoever. In this market, it's more likely to make us act like I discussed in the last paragraph - because no property is worth getting attached to before you own it. Let me baldly state that I also understand the potential benefits of collusion with your friend the agent from another office. She colludes with you on your client's property, and you collude with her on hers, each stating that they do, in fact, have clients making thus and such offers on that property. Since once again, it's trivial to convince yourself that it's in your client's best interest, even verified offers aren't going to mean a whole lot to a smart buyer's agent. The buyer's market may be less than it once was, but there are still no properties worth a buyer getting attached to them before closing. And for all the properties I've made offers on where the listing agent claimed there were multiple offers, I've never had one of them offer any real evidence.

People willing to price their properties to the market, and negotiate realistically, can sell properties very quickly due to the fact that comparatively few sellers are competing well for the buyers that are out there. In the last couple months, I've been involved in the sale of two beautiful properties - and two others that were plug-ugly, but sold quickly because the sellers and their agents had their heads in the right place. In one instance, I even had someone bidding against my clients, but we nonetheless consummated the sale quickly.

If you're trying to sell and you negotiate unrealistically, you are only hurting yourself. That buyer's agent can find them something better, cheaper, making the agent's client much happier. Even if you do have multiple offers, it might be a good idea not to particularly act like it. You can check the multiple offers box without being aggressive about it.

The property I mentioned earlier? Where the agent and seller acted like it was god's gift to prospective buyers? It's still for sale, and my clients have moved into another property. The relocation company that owns it is out roughly $6000 per month. Had they priced it to market, and negotiated reasonably, they likely would have sold. If they simply negotiated reasonably, they would have sold it to my clients. My clients have their new home - they're happy. The sellers? Not so much. They're paying about $6000 per month for an empty property. It's been on the market for a year now, and it's not like they have any real alternative to selling. That's $70,000 they've flushed down the drain to no good purpose, and it's not like there's any chance of them getting more than the property is really worth.

For listing agents who refuse to act like their clients are competing for buyer business, they are violating client interests no less than if they counseled the client to accept an offer from someone acting as a straw buyer for the agent, personally. In fact, I rather suspect this particular agent of being Sherrie Shark, but there's nothing I can do for the owners as a buyer's agent. It's not legal for me to so much as contact them without going through "Sherrie". Nor would it benefit my clients in any demonstrable way. It just gets me and potentially my clients caught up in a legal morass to no beneficial purpose. So the owners are high and dry on their own. It's our profession's problem, but there's nothing I can do about it as an individual. The only person who can do anything about it is the property owner; this is one of many reasons why it's important to be careful in your choice of listing agent. Unlike a buyer's agent, you need to commit to a listing agent for a given period of time, and if you commit to the wrong agent, you have wasted your time of highest interest, when you will get the best price for the property.

Caveat Emptor (and Vendor!)

Original article here

A few days ago, I had an agent get angry at me about an offer below a range asking price. I had submitted the offer with extensive justification as to why it was an appropriate offer. Basically, this clown had overpriced the property, and thought that because he had put a range on it, people were somehow not supposed to make offers outside the range.

Just because you put range pricing on a property, does not, by itself, mean anything. As I've said before, you can ask for any price you want for your property. It doesn't mean the asking price is realistic. It means that you own the property and have the ability to put a price on the property that you want. This doesn't do you any good if the price is above what similar properties are selling for. Having been told it's for sale, buyers have the same options the seller does - they can offer any price they would be happy paying. The seller doesn't have to accept. In fact, the seller probably won't accept. If the buyer offers less than the property is really worth, than the seller is correct to reject the offer. On the other hand, if the buyer is offering what the property is really worth and the seller doesn't accept the offer, they are hurting only themselves.

Many sellers and their agents are shooting themselves in both feet by overpricing the property. When I originally wrote this, there were some special circumstances in effect - the lending panic, to be precise. It's mostly psychological, as there are any number of very solvent lenders willing and able to fund loans, but hysterical reporting grabs attention (which is why reporters do it). The net effect is that many buyers who would otherwise be in the market were still sitting on the sidelines, and so the ratio of sellers to buyers locally had ballooned to 47 to 1. Imagine yourself in a situation where the ratio of men to women is 47 to 1. The social dynamics are going to favor the women. Even if she's a fat slovenly harridan at the tail end of middle age, she's going to have her pick of men. The men, for their part, are going to have be both good looking and well off to attract even the woman in the previous sentence, and keep working hard to keep the woman around. If you're not willing to do what it takes, and keep doing what it takes, you might as well not bother. Now imagine that people who want to sell are the men, and people who are willing to buy are the women. If you're not willing to out-compete the other 46 sellers, why is your property on the market? If you need to sell, then you need to do what is necessary to out-compete those other sellers. Make it pretty. Make it cheap. And you still better be willing to work when an offer comes calling. If you're not, get the property off the market until the climate changes. I told you when I originally wrote this that I didn't think it was going to be long.

It was longer than I thought, but my market at least has changed. We now have people looking for relatively safe places to stash their cash, places that look likely to return an eventual profit, and real estate heads the list.

Range pricing a property at a value you're not willing to accept is a waste of everybody's time. There was a property on the market variable priced over $125,000 range, and my client made a very strong offer about $15,000 over the minimum. Lots of cash, good deposit, short escrow, no contingencies, etcetera. Under the circumstances, a very good offer considering what the property was really worth. Yet despite all the information we put in front of them, this seller kept countering at the same number, which was more than my client was willing to pay for that property. Net result: the whole process was a waste from the time we started driving to the property. Yes, they got a lot of activity, but since they weren't willing to sell for the price that generated the activity - or anything like that price - the property didn't sell. Since if the property doesn't sell, every penny you put into trying to sell is wasted, as is every second of your time, plus all of the carrying costs that you may incur. So the listing agent told me they'd had a dozen showings in a week - but if they're looking at the property because it's variable priced $75,000 below any offer the seller is willing to consider, well, self-stimulation may feel good but it doesn't produce anything. This entire situation is a failing on behalf of the listing agent, who is theoretically earning money because of their knowledge of the market and should know precisely how likely it is that buyers will agree to pay more than the comparable properties are selling for, which is to say, Not. In a 47 to 1 buyer's market, if you need to sell, you're almost certainly going to have to settle for less than comparable properties are asking. If you don't need to sell, get your property off the market until it changes. The sooner excess inventory clears, the sooner the turn towards sellers is going to happen. Not to mention your days on market keep climbing, and there's nothing beneficial about having a failed listing in a property's immediate past. The longer it sits unsold now, the harder it's going to be to sell for a good price later. But in a seller's market, things are different. For one thing, buyer's don't have all that power - sellers do. That's why they call them "buyer's market" and "seller's market": Who has the power.

Properly used, variable or range pricing can increase the sales price of a property. But the catch is that it must still be priced correctly. Range pricing is not an excuse for a lazy or incompetent listing agent to build owner expectations above market level. The rule of thumb is that the bottom of the range should never be lower than a good "all cash, no contingencies" offer, and the top of the range should never be more than market plus a reasonable premium for dealing with the uncertainties of financing and contingencies. Both figures should be modified downwards if the seller is asking for something extra in the way of consideration from the buyer - for example, leasebacks of more than a week or two, seller contingencies, etcetera.

When I originally wrote this, the way the market was in most of the country, I was inclining against range pricing. If it's priced correctly, that range is information I can use as a buyer's agent. Why would I want to hand the other side information I could put to use were I on the other side, especially when they already have the whip hand in negotiations? Range pricing is something that's primarily useful for sellers when the sellers have the power, and back then, it was the buyers that have the power. If it's not useful for the seller, why in the world would you want to put range pricing on a property? With blortloads of highly upgraded properties for sale then, I had absolutely no hesitation in telling my buyer clients to offer what we think the property is worth to them under the circumstances, and let the sellers decide if they want to do what's necessary to get the property sold. If they don't want to play, somebody else will. Either way, the buyers are happy. This seller can either decide they'll be happy with an appropriate amount of money, or the property can sit unsold. Which is pretty much the situation as it always is. Since then, my local market has changed - particularly with regard to what Mr. and Mrs. Average First Time Homebuyer see as an attractive property.

Range pricing is not a panacea. Range pricing is not something lazy or fearful agents can use to "buy" a listing with impunity, confident it'll work out in the end (it won't). Range pricing is not an excuse not to price your property to market, or not to negotiate hard with all of the facts at your disposal (if you don't have enough favorable facts at your disposal as to what comparable properties are selling for, your negotiating position is not strong). Range pricing is a way to offer clues to buyers and get them to the table with an appropriate offer when sellers have significantly more negotiating power than buyers. Range pricing is something to use sparingly when sellers have no power. There's nothing that says buyers have to offer you what you want. Not now, not ever. The only leverage sellers have over buyers is the fact that if this buyer won't offer something that is appropriate, somebody else will. That's very weak leverage when there's 47 properties on the market for every buyer, but it's much stronger when properties are flying off the market like they were in late 2008 and early 2009.

Caveat Emptor

Original article here

About half the listings around here do not have a single number asking price, but rather a range in which "offers will be considered". Even many agents have trouble understanding range pricing. I've seen and heard more than one agent rail against it, saying that it is essentially "repricing the home".

Range pricing began in Australia and was brought to the United States by a certain major real estate chain. That chain is not one I particularly like doing business with, but that doesn't mean range pricing is a bad idea.

Range pricing is a way of starting people talking, and to begin the negotiating process; nothing more. If there's no offer made in the first place, I can guarantee there will be no transaction. The idea of range pricing is to jump start the negotiations.

Range pricing is not appropriate for all properties, nor in all markets. In a buyer's market such as we had when I originally wrote this, I'm certainly more hesitant to use it, as it offers more information as to the owner's state of mind. In a seller's market where prices are rising rapidly and sellers have all the power, it gives an indication as to what a serious offer is and what it is not. In a buyer's market it tells some buyers exactly how much leverage they may have. I'm also more leery of using it on commercial properties.

One thing many agents (and others) misinterpret range pricing to mean is that any old offer inside the range should be accepted. This is the mark of an inexperienced negotiator. If they say offers will be considered between $400,000 and $425,000, that is not the same thing as saying "I want $425,000, but I'll take $400,000." There are many other terms and conditions on a purchase contract besides just the price, and there is no mandate to agree with even a full asking price offer if those other terms are prohibitive. Indeed, an agent who knows how to figure out other terms to offer in place of higher price is likely to save you far more than any commission they earn. Even price is rarely just price. For instance, if I write an offer for $410,000 cash, no contingencies, with a $10,000 deposit, most sellers should rightly treat that as superior to an offer of $425,000 with the seller paying $10,000 of closing costs and only a $2000 deposit, contingent upon financing for sixty days. Note that the seller nets over $4000 more if the latter offer actually closes, but the former is a much stronger offer and if two such offers were to come in and other things were equal, I'd strongly counsel taking the cash offer, especially as the latter offer is indicative of a not very well qualified buyer without much commitment to the idea of purchasing the property, and there would be a high probability that the transaction will not actually close. There are all kinds of terms on purchase contracts, and having a discussion as to what's important to the other side can be a way of making your offer much more attractive without necessarily raising your price. For instance, owner occupants are often understandably nervous about whether the transaction is going to close, and committing large sums to alternative housing before it actually does close. If you can think of a way to address that concern, you're miles ahead of the negotiator who can't. Every situation is different, and what works one time may not be appropriate to even offer the next.

So if I see a property with range pricing of $400,000 to $425,000, I want to educate my buyer clients that an offer of $400,000 even with the seller paying up to $20,000 of closing costs is not within the range indicated. Indeed, as I've said elsewhere for such offers, a $380,000 sales price with the buyer paying their own way is a superior offer from the seller's point of view. If they insist, I must and will submit it, but even in a strong buyer's market I wouldn't be surprised to see it rejected outright with no counteroffer.

In a strong buyer's market, those few buyers willing to purchase properties have an enormous amount of power, and this will always continue when the seller to buyer ratio gets out of whack. So in a buyer's market, I might actually offer significantly less than the asking price range, secure in the knowledge that if this seller rejects it, I'll find something just as good tomorrow where the seller will accept. Some will. So if some won't, so what? You learn to spot the sellers that have the power to refuse, and the ones who have to take anything vaguely reasonable.

Now admittedly, I don't do a lot of listings, as most sellers don't like to listen when I tell them to price their property to the current market if they want to sell. (And if they don't want to sell, why are they talking to me?) But when I'm showing them what the market is like, and what reasonable prices for properties like theirs are right now, I'll ask a couple of questions once I'm convinced they understand. Everyone knows what they want to get for the property, and by the time I'm done, they better understand what a reasonable asking price is and why it's stupid to list for more. But after that, once I've explained that there are offers and then there are offers, and the price isn't the only thing worth paying attention to, I'll then ask them, "Now that you know what a realistic asking price is, what would be the lowest price you would consider selling for, if someone offered everything else you wanted? Great deposit, all cash, no contingencies for financing, etcetera?" Next I'll ask, "How far over the realistic asking price we've agreed on would you require going if the buyer came up with some odious terms: takes possession early, no deposit or not much of one, wants a long escrow, etcetera?" Rebates or seller paid closing costs always raise the necessary price at least dollar for dollar, by the way. A $380,000 offer with no rebate is superior to $400,000 with $20,000 rebate from both buyer's and seller's perspectives. Then, depending upon how much the seller needs to sell, I'll use that information to help me figure the endpoints of the asking range (assuming I'm not just going to use a single asking price). I won't just use either number, of course. But that, together with the state of the market and how much power buyers think they have in the market at the time, will give me a good feel for what the lower number of the range should be.

There is another, entirely different benefit to range pricing is that when the search is done on MLS or its substitutes, the lower number in the range is going to trigger your property coming up on more searches. If you're a listing agent, you know that MLS and MLS substitute buyers are more likely to be aggressive, and often unrealistic, bargain hunters, as opposed to people who really want to live in the neighborhood around this property. MLS inhabitants are not my favorite buyers when I'm listing a property, for that and other reasons. But if this property comes up on their search, they might look, and if they look, they might make an offer my client is happy to accept. If they don't even see it as they're searching, I guarantee no offer will come in from them. So range pricing helps me capture these people's attention. Whether interest, desire, and action follow is anybody's guess. But they might, where without range pricing they definitely wouldn't.

This doesn't mean I should put a lower end price on it that is lower than what the seller is likely to accept. That is just a waste of everyone's time. A buyer sees a property listed for $400,000, goes to look based upon that representation, and decides to make an offer - then it comes back that the seller isn't willing to really consider anything less than $430,000. Furthermore, the seller's time has also been wasted by encouraging that buyer to view the property. If the seller is not willing to consider an offer at that amount, it shouldn't be listed for that amount. If I get offers above minimum asking price that I'm reasonably certain can consummate, I'll even suggest raising the asking price while we consider them or negotiate. If I have an offer on the table for $450,000, it's not likely to be available to someone only willing to offer $420,000, and it is not reasonable or intelligent to have it listed for $420,000.

In short, range pricing, properly done, is not repricing the home, and it is a good way to get the buyer and seller to the table. It is not appropriate for every property in every market, but for those it is appropriate for, it's a useful tool. Properly used in a seller's market, it can even help your seller get a higher price for the property than any single number asking price you'd dare use.

Caveat Emptor

Original here

It has become very trendy to ask for pre-approvals on loans, because so many escrows are falling through. Unfortunately, as I have explained in the past, Loan Pre-Approval Means Nothing, and prequalification means even less. Both are literally wasted paper. As far as actually meaning anything you can hold someone to, they're useless. Worse than used toilet paper, which was actually put to some useful purpose once upon a time.

I never trust either a pre-qualification or pre-approval unless I did it. As I've said before, there is no accepted standard for either. Furthermore, I doubt there ever will be. Agents aren't asking for these pieces of waste paper because they're concerned about their listing clients. They're asking for them to cover their own backside so they don't get sued when the transaction falls apart.

There's no way on this earth that you can promise that owner that the transaction isn't going to fall apart. Accepting any offer always has some attached risk. If the buyer can't actually get the loan funded, the seller is out of luck as far as getting that purchase price for the property, and you'll have to go back to square one.

This isn't to say that the seller is out the whole amount. The buyer risked whatever good faith deposit, which should be at least enough to pay the costs of carrying the property for a month or two. This isn't to say that the seller is necessarily entitled to the deposit or that escrow will automatically remit it to them. There's rules about that. But the contract is very carefully written to limit the amount of time before the seller is entitled to the buyer's deposit. If you're concerned that the buyer may flake, or not be able to qualify, the correct thing to do is negotiate more of a deposit and more favorable terms for it to come to the seller in the purchase contract. If listing agents were really trying to protect their seller clients from failed transactions, they'd be focusing in on larger deposits and trying to get them paid to the seller while the property is still in escrow. That's real protection for the seller. Of course, many buyers will walk away from such terms, meaning that it goes from a possibility of that listing agent getting paid to no possibility of that listing agent getting paid.

Buyers understand the deposit in cash terms. They scraped and saved this money in real time, dollar by dollar. It's real to them, and they don't want to risk it. You've got a better chance of getting $10,000 more on the price with most buyers than of getting a $1000 higher deposit, or more favorable terms for forfeiture. Of course, a lot of buyers choose to go unrepresented or use the listing agent to represent them. Both are silly, when you understand what's really going on. But demanding a high deposit, or harsh terms of forfeiture, is a good way of scaring off potential buyers. Savvy agents understand that an increased deposit is a way to get a better price for their buyers. If you require a high deposit and harsh terms of forfeiture, you are discouraging certain buyers, shrinking the pool of potential purchasers, thereby lowering the likely eventual price.

Of course, being able to negotiate a good contract is a major part of what an agent's getting paid for. In some circumstances, high deposit will be appropriate. For instance, if the buyers are getting a really good price. If I'm getting a property $100,000 cheaper than comparables around it, I shouldn't mind putting up a bigger deposit, or agreeing to more stringent terms for forfeiture. On the other hand, if I'm paying top dollar for the property, I'm going to be a lot more guarded. Mind you, I don't make offers without evidence that my clients can qualify for the necessary loan, but I'm going to want that seller to assume more of the risk of the transaction falling through. If they're getting a good price, they should be willing to. If they're not so willing, they're basically saying that the transaction isn't worth the increased risk. Remarks about having your cake and eating it too apply. I'm certainly willing to persuade my clients to offer a better deposit to get a lower overall price. But I'm also perfectly willing to tell an overaggressive seller to go jump in the lake if they want harsh terms for the deposit without my client getting something tangible in return. The reverse of each applies when I'm listing a property. If the buyer is offering - or willing to offer - a large deposit or terms that are generous to my client, I may counsel acceptance of such an offer where I wouldn't of an identical offer with a smaller deposit or less generous terms for its forfeiture. It tells me that the buyer is willing to risk something real if they can't qualify after tying up the property.

There is another alternative, if you are or have a loan officer that you trust. Get their credit information. After all, a buyer is in a position where the sellers are in fact considering extending credit. Income, FICO, credit score, other debts. Ask your loan person if they could do a loan for this buyer. Of course, if your loan officer is a bozo, or if the buyer's is, all bets are off under this option. Under RESPA, you can't make them so much as put in an application with any loan provider not of their choosing.

If the sellers are not concerned enough about the buyers' ability to qualify to be willing to accept a lowered sales price for better terms on the deposit, I'd say it's not very important to them. If they're not willing to keep looking for another buyer, they want to do business with this one, and they must be getting something worth their risk out of the prospective transaction.

I recently had an agent tell me that requiring a pre-approval was part of their due diligence. Nonsense. I'll go so far as to say it's preposterous. The deposit is real. Information on creditworthiness is real, if subject to more interpretation. Pre-Approvals and Pre-Qualifications are a waste of space in the file, approximately equivalent in worth to an attestation that there is indeed a screen door in this submarine. There is no rational reason to choose one buyer over another, or accept one offer and refuse another, that has its roots in the pre-qualification or pre-approval. There's nothing there that you can hold anyone responsible or accountable for if the buyer does not actually get the loan funded, and if there's nothing there you can hold anyone accountable for, it's not anything real. Which makes it purely a CYA on the part of agents. Some of them may think it means something real, but it doesn't. Those agents need to be educated.

I'll admit I hate being asked for pre-approvals, even though I should probably love it as the sign of an agent that doesn't know what they're doing. But all too many times in the current market, a listing agent that doesn't know what they're doing is a sign of not being in touch with the current market, that I'm spinning my wheels in any negotiations, because the listing agent has no idea what properties like this one are actually selling for. It feels like you're trying to get useful work done on a computer that's frozen up and gone to blue screen of death. Not useful, and not helpful to either my client or theirs. You do have the option of behaving like a recalcitrant mule. Nobody can make you stop, but it's not likely to be beneficial to your bottom line.

Caveat Emptor

Original article here

I just came across your article on unpermitted additions. I am having a really difficult time. We own a home in DELETED that we bought in 2006. It was listed as a 3/2 1400 sqft. We are now trying to sell it, had many offers, however, we found out that it is on file with the county as a 2/1. The city came and sent an order to comply telling us that basically 1/2 the house needs to be demolished! That it was not permitted. What does one do if the seller never disclosed? Is it possible that he never knew? Then what? Shouldn't our agent when we bought it have alerted us to this? We hate to fork out more thousands of dollars into this money pit. We bought for 700k and were listing it for 540k - so we are already losing a ton...then this happened. These additions were done 21 years ago - 4 owners ago! I know this is asking a lot, we are so desperate to find a solution, and nobody seems to know. Any advice or

Unpermitted Additions are a rat's nest of problems, and you are never certain of how it is going to work out because so much of the response is within the realm of bureaucratic discretion. You can't control what individual human judgment is going to make of your situation and how it will respond. I have seen situations where I thought there was no reason for doubt refused, and situations where I would have bet serious money against acceptance approved. I don't like it, but there are unavoidable risks you take in dealing with unpermitted additions. There is money to be made in dealing with unpermitted additions and making them legal, but you have to have a very clear understanding that there is a risk of major loss involved.

Your Buyer's Agent failed of due diligence not to inform you of this and the possibility of what you have now encountered in writing in a timely fashion to enable you to make an informed decision as to whether or not to continue the transaction before adverse consequences ensued. 99%+ of the time, I spot additions while looking at the property and 90%+ of them I can tell whether they were permitted.

Had you known before the transaction happened, or even when it closed, there would have been many actions you could have taken to protect yourself. Now, your options are far more limited. The only advice I can legally give you at this point is to talk to a real estate attorney. Chances are good you can sue the brokerage who represented you. Even if they were representing the sellers as well. You may also be able to sue the sellers and their agents because they should have been aware of the issue and properly disclosed it to you.

Had you known of the additions at the time you purchased the property, California at least has an innocent purchaser law. It won't protect you from having to remove additions that are unsafe or cause unsafe conditions (e.g violating setback requirements) but it will prevent your property from being re-assessed upwards. You bought a 1400 square foot 3 bedroom 2 bath, and your purchase price was for a property of those characteristics, so you should only be billed for taxes based upon your purchase price, rather than an additional amount representing what would be in another property additional square footage. Furthermore, they tend to work with innocent purchasers who bring the situation to their attention to see what can be done to bring the property into compliance rather that requiring the removal of the addition. But my understanding of the innocent purchaser provisions is that it has to be done within 3 years at most of the date of purchase (and not being a lawyer, I could be mistaken, so talk to a lawyer).

Had you known before you made an offer and been properly advised, odds are that you would not have made the offer unless you were getting a price that was simply too good to pass up. I hate discussing the possible upsides and downsides of unpermitted additions with clients simply because even in the most routine cases there is so much uncertainty that I can't offer even probability estimates of what will end up happening. It is a consequence of that individual bureaucratic discretion I was writing about earlier. Its probably better than any of the politically possible alternatives, but it removes predictability from the equation and is certainly provides motivation and opportunity for corruption.

Furthermore, because it is a source of uncertainty and risk, dealing with that uncertainty and risk and turning it into a certainty - in other words, a property that is fully approved as it sits - is an undertaking worthy of compensation. Lots of compensation in some cases such as this one. A property that's only permitted as an 800 square foot 2/1 is worth considerably less than the fully permitted 1400 square foot 3/2 next door even if they are otherwise identical, precisely because of the risk of precisely what happened to this person. Until the relevant agencies have fully permitted the additions, there is always the possibility that you will be forced to remove them. In extreme cases, I have heard of them condemning not just the additions, but the entire structure. I should also mention that even if the addition was completely to code when it was built, what governs whether the permit is granted retroactively is the code now, and I shouldn't have to mention that those codes have become progressively more restrictive.

Some additions are old enough not to require permits. Until about 1972 around here, this was the vast majority of all additions that happened. Unfortunately, it can be difficult to prove that the work was done before that date. If you bring the discrepancy between records and actuality to the attention of the assessor, you are more likely go be believed than if the assessor finds out through other means, but "likely" is not a guarantee and most people choose to hope the situation goes away on its own.

This is one of many situations that buyers get into because of the "store" mentality. You want to buy a refrigerator, you go to the refrigerator store. You want to buy a sound system, you go to the electronics store. People think this carries over to "I want to buy the house, so I'll go to the agent who has the listing" (i.e. the real estate "store"), not realizing the pitfalls of such an approach in real estate. The fact is that the first thing you need to find when you decide to buy real estate is a good buyer's agent, who will prevent the vast majority of these problems from biting you. And these problems do happen, a lot more often than most people realize.

Caveat Emptor

I wouldn't have believed this one if I hadn't been there when it happened.

Another agent in my office had a listing where the property went into default. We just happened to find out about it; the seller tried to keep it a secret because they were embarrassed. Silly because default is a matter of public record, but it happens. Suddenly, the sharks started swarming, of course.

One agent brought an offer in. Among other things, that offer called the property, "a dog." It's not a dog. It's not a place where I'd expect to find a billionaire living, but if someone gave it to me, I'd have no problems either living there as it sits, or renting it out.

Never insult a property you're interested in. It's smart to explain the facts of the situation that are in your favor, but calling the property "a dog" conveys no information, is completely subjective, and is usually construed by the owner as a direct personal attack. If you want them to agree to sell you the property - which should be the reason you made an offer - it's a great way to sabotage that goal. If the property has holes in the wall or cracks in the foundation, by all means remind them. Be specific about the faults, but don't get personal and don't make subjective judgments.

Then this clown not only sabotaged his argument, but violated his fiduciary duty, by bringing in a competing offer.

This just blows my mind. Not only is the property now obviously not a dog, since you have multiple people clamoring to buy it. How many buyers can one agent work with at a time, anyway? My absolute limit is six. If two of them want the same property, there must be something pretty darned attractive about it.

This also increases the leverage the seller has, raises the sales price for the one that gets the property, and means that one of them doesn't get the property. How can this not be in violation of fiduciary duty of that buyer's agent?

No matter how good the bargain, as a buyer's agent, I never ever initiate showing a property to someone else until the first buyer has told me they're not interested. I can't stop them from seeing the property, but I can avoid personal responsibility for encouraging someone else to make a competing offer. Especially now - it's not like there's any shortage of bargains out there. Sure, the incidence of multiple offers has risen dramatically, and properties that are priced competitively are moving (both of these are signs of a buyer's market that's about to turn, by the way). Nonetheless, there's a lot of good stuff out there if you know what's really important and how to look. A buyer's agent should know both. That knowledge is a significant fraction of what we're selling. When I originally wrote this, I had found four great bargains, even considering the market, which was the last time I got out just on a general search, not associated with any particular client. All I had to do was get off my backside and out of my office and look. I don't accept clients if I haven't got the time to look for them.

This clown of an agent was thinking about getting paid, not the client's interest. Furthermore, unless he told them, which I will bet he didn't, those two sets of clients have no way of knowing that the agent has hosed both of them. The property was one heck of a bargain as it sits. Either one of them should be ecstatically happy with it and a good bet to come back on their next transaction - provided they don't know how the agent hosed them.

In the case of this particular property, both the MLS and the foreclosure list are public knowledge. It's not like there's any deep dark secret about it. Perhaps this agent is even selling foreclosure lists as a way to procure business, and both clients independently spotted the property and asked about it. He still owes it to the client who put in the first offer to do what he can not to sabotage them. This is the one exception I can think of to Agents Refusing to Make an Offer on Real Estate. As a buyer's agent, I have a firm policy of one outstanding offer per property (As a listing agent, I love multiple offers and do everything I can to encourage them). It's a minor encouragement for fence sitters to pull the trigger now, when I tell them that if another of my clients makes an offer, I will decline to submit an offer from someone else until that one is off the table. This protects both clients by keeping them out of a bidding war I would have facilitated. I'll find the second client something else. Doesn't matter how hot the market - There are very few properties so good they're worth getting into a bidding war over, and even fewer prospective buyers with the wherewithal to withstand a bidding war.

Caveat Emptor

Original article here

Good Evening!

My name is DELETED and my wife and I recently signed papers to purchase a property from DELETED in DELETED, CA. After our options, their lot premium, and the elevation charge, the house is listed at 425,000. We have 90,000 in incentive money to spend which we would like to lower the overall cost of the home to 335,000. We only receive the incentive money if we get the loan through (their in-house lender). We were interested in a 30yr fixed rate mortgage that is 100% financing and will pay the closing costs out of pocket. I feel like I am being stiffed by their loan guy. Back in late May or early June, he told me that we could get 30 yr 100% financing with HOA, Mello Roos, PMI, PITI out the door for $2889 on some 6.75 percent loan (which still seemed high to me) but just last week he told us that we are now looking at 7.8% with out the door payment of $3250 because 100% loans are harder to finance now. I guess my question is how do I not get stiffed by their loan agent and what proper steps do I take to ensure the best loan and rate for us? I think that 7.8% is ridiculously high for this market! Here is some background info on us:

Credit scores of 750-780 for both of us
21,000 in bank accounts
2 car loans with 3 yrs remaining on each (238 and 210 per month)
Current renters with 80k gross yearly combined salary
1st time homebuyers

Any help regarding this matter would be greatly appreciated! Thank you for your time and consideration. If there is any other information you need us to provide I would be more than happy to provide it.

First off, check with your local authority to see if you qualify for a Mortgage Credit Certificate. It looks likely. Whether or not the developer's lender participates is a question, but it's a question that needs answering.

Now this is definitely a situation where you needed a buyer's agent to deal with a developer. Unfortunately, at this point it's too late to get one involved, as you've already signed the contract. The work a buyer's agent does is pretty much moot. You've already signed that developer's contract. I'll bet a nickel they'll be able to keep your deposit if you back out, and likely sue for more. They are now in a win-win situation.

Here locally, I could tell you if it was a good idea to pay that developer's extra charges or just take their basic unit. Elevation premium? What's the view now, and is it likely to stay that way? Lot premium? How many extra square feet are you getting - or is it just a junk fee? You're not local to me, so I do not know.

What I can assess is numbers. This article is a reprint and rates are lower now, but when I originally wrote this I just picked a rate sheet at random which had an 80% first with zero points and no pre-payment penalty at 6.75%. On $268,000, that's $1738. The 30 due in 15 second would be at 7.75%, with a negligible cost, for a payment of $480. Assuming that your official purchase price is $425,000, add about another $443 for California property taxes and just a guess of $100 for homeowner's insurance, and that's a payment of $2761 plus Mello-Roos and HOA, which I have no way of knowing. Never choose loans by payment, but this would cut your cost of interest more than it cuts your payment.

However, at $425,000, you've got a first of $340,000 and a second of $85,000, giving us payments of $2205 and $609, respectively, and that's what we'd be looking at if you came to me for the loan the day I originally wrote this. Add that $543 taxes and insurance, and your payments would be $3357. Not having that $90,000 in your balance makes a huge difference, and not just to the payment, but also to the cost of interest.

Here's another point on which developers hose unsuspecting buyers. Is that property, as it sits, going to be worth $425,000? Is it going to worth $335,000? If I were in your shoes, I'd hire an appraiser right now. here's one easy place to find an appraiser in California. That approximately $400 they'll cost is looking like a really cheap insurance policy, right about now. And you do want an independent opinion. The chances of that developer's appraiser rocking their boat are nil.

Here's one thing to seriously consider: Take their financing offer, even if it includes a pre-payment penalty, which I'm betting it will. Of course, if they offer you the option of buying it off with a higher rate, that's something you're going to want to do in this scenario. Then, providing the property is really going to be worth enough, refinance immediately. That pre-payment penalty isn't going to be $90,000, even with the costs of the new loan included. But you want an independent appraiser's opinion before you jump into this, to find out if it's likely you'll be able to refinance.

What you'd be doing is taking the $90,000 incentive money and then paying a toll of about $13,000 for the pre-payment penalty plus whatever the costs of the new loan are (the ones I outlined would be roughly $3000 if you accepted a 3 year penalty of $500 on the second, or $500 higher if you didn't). Net to you: roughly $73,000 - if the value of the property will cover the refinance, and you'll get better terms if the value is actually $425,000, because the Loan to Value Ratio won't be 100%. It'll be about 83%, which translates to an 80/5. Provided, of course, that the purchase contract says $425,000. If your official purchase price is $335,000, your monthly property taxes will be about $349, but then we're dealing with whether or not the lender will believe your appraisal. A paper lenders quite likely won't. Most of the time, your official sales price will be the full amount, but every once in a while developers like to throw a curve in. On one hand, a lower sales price reduces your property taxes, while on the other it means that you'll have difficulty refinancing for a while.

If you had a good buyer's agent, you'd likely already know the answers to all of these questions, and you likely wouldn't have fallen into a couple of traps, but that's water under the bridge. We have to deal with the situation as it exists, and figure out the best way to deal with the facts looking forward. If an appraiser tells you the value is there, I'd take their loan on a short term basis for the incentive money. If the appraiser tells you the value is not there, it's probably time to see a good lawyer about getting out of that contract. If you lose your deposit, that's usually not as bad as spending more than the property is worth and getting stuck with a rotten loan you can't refinance out of.

Caveat Emptor

Original article here

I've been answering this question for a long time. Whose interests do we need to be concerned about, in a "If they are harmed, we've got a problem" sort of way? Who has a primary stake in a real estate transaction, and who does not? Whose interests must be served by said transaction? Whose interests are critical, and whose are not? I never really went into an explicit answer. But some nasty emails and deleted comments of late have made an explicit answer important.

For as long as I've been thinking about the question, I've been answering it the same way. Depending upon the transaction, there are two or three parties with a primary stake: The buyer, the seller, and the lender if there is one.

The buyers interests are the most important and the most critical. They are giving up a very large sum of money in order to purchase real estate. Money is liquid; real estate is not. You can do anything with money; real estate, not so much. Therefore, there must be a compelling arguments made why it is in that buyer's interest to part with that much cash in order to buy that property. I've made a fair number of said compelling arguments, but you always have to be able to make it. Every time. If they're getting a loan, you also have to build an argument why it is worth them taking out a loan, which forces them to pay out a given amount of money every month for the next thirty years in most cases. Money that the buyer hasn't earned yet, and in most cases couldn't pay back right now if they had to. You've got to build a compelling argument for why that buyer giving that seller however many thousands of dollars in order to buy that property is in that buyer's best interest. If you're a real estate agent and you can't do this from the ground up, you're in the wrong business.

The seller's interests are also critical. There's got to be a compelling argument made as to why it's a good idea for that seller to agree to sell their property for that price. If not, they shouldn't be selling it. Real estate may be illiquid, but nobody is creating any more of it. Not the Dutch, not the UAE, not anybody, not really. So why, to paraphrase the immortal words of Roald Dahl, would someone willingly exchange something of which nobody is making more of for something which they're printing more of every day? Again, if you're an agent and you can't do this, you're in the wrong line of work.

The seller's interests and the buyer's interests are different, of course. Without those differences, nobody would ever trade anything to anyone else ever again, and that includes trading for money, or sales as it is usually called. But you've got to be able to make compelling arguments for both sides, and you've got to be right, as real estate transactions are not readily reversible in the general case. There may be occasional exceptions, but you can't go back afterwards and say, "Let's call the whole thing off!".

The lender, if there is one, also has a compelling primary interest in a real estate transaction. They are putting up many thousands of dollars of money they have already earned or gotten in some fashion in order so that the seller gets cash from the buyer rather than having to wait thirty years for the last bit to trickle in. In most cases, the lack of a lender will prevent the transaction from happening at all because that seller needs cash in order to pay off their own lender, or cash for the property in order to accomplish their reasons for selling it, not monthly payments trickling it over the next thirty years. Therefore, without the lender, the seller's interests could not be met, and therefore the buyer's interests would not be met. But the lender doesn't have a direct interest in the property investment, only that it can be sold to pay off the debt if the borrower defaults. What they do have an interest in is whether the buyer can pay them back, and, failing that, if they can get their money out of selling the property if the buyer does not.

The seller is usually paying almost everyone who works on the transaction, the buyer's money is the reason why the seller is able to pay everyone, and the lender's money is what is used so the seller can pay everyone right now (including themselves). These three parties have legitimate, primary interests in the transaction. If their needs and criteria are not being met, they can call the entire transaction off. As strange as it may be to see a real estate agent writing this, these three parties should call the transaction off if their interests are not being met.

Everyone else is working for a paycheck: Agents, loan officers, escrow, title, appraiser, inspector, notary, ad nauseam. We make our money by being able to help one of the above three "people" consummate the transaction. Our interests lie in that paycheck, not in the transaction. We are worthy of our pay to the extent we help one or more of the primaries serve their interests, or serve those interests better. If we can't do that, we shouldn't be part of the transaction. We only make money by serving the interests of the primary stakeholders, and if we're not doing that, we shouldn't make money.

If you cannot agree with this, you and I have nothing further to talk about. I make my money by putting my clients into a situation that's better than it would have been without me. If that's not the way you make money in real estate or any other business you might be in, then you are trying to be a tollbooth, and the dynamics of the market are going to do their best to route around you. In other words, if you cannot show a value to those you serve that is at least as great as the money you make from providing those services, the market evolution is going to put you out of business as soon as it can. This knowledge goes back at least to Frédéric Bastiat, but it's nothing that despots the world over haven't known for millennia, who have been getting increasingly sophisticated about not getting put out of business as the markets have gotten more sophisticated about what adds value and what does not. I have absolutely no sympathy for any argument that concludes you must pay someone because the law says you must. To the extent it relies upon "because I said so!", the law is an ass.

That doesn't mean there aren't legitimate economic reasons to choose to use a real estate agent, a lender, a notary or whomever. There are quite powerful ones, in fact. But to the extent the law forces you to use one, the law is a tyrant, engaging in rent-seeking behavior. Healthy economic organisms interpret rent seeking behavior as damage, and seek to route around it. Eventually, they will succeed. It may take a while, but they will succeed.

So now you know why I am always looking at "What is the consumer's interest?" and "How can the consumer benefit?" and "Does this benefit the consumer?" It isn't altruism. It's enlightened self-interest. By providing value for the consumer, even if in the context of specialized knowledge or judgment that consumer may not have, I am showing an economic reason why it is in that consumer's best interest to put money in my pocket. If $1 in my pocket means more than $1 in theirs (and it does), consumers will freely choose to line up at my door for the privilege of paying me. Some consumers may not agree, and that's fine. There's plenty who agree do to keep someone who is so oriented hopping for as long as I am willing and able to work. That's the best income insurance there is or ever will be.

But if you are not so oriented - and I am looking here at any alleged professionals who think in terms of their own benefit, rather than the benefit of consumers - then it's only a matter of time before the market figures out a way to route itself around you. I and others like me are going to be working forever. Those who take the tack that "you pay me because you have to!" are going to find yourselves in declining industries, and no amount of regulation (e.g. this) is going to do anything other than delay the tide until someone figures out how. And acting self-righteously as if you have some kind of "right" to that money as you lobby the government for them to force people to do it your way will only make you more and more contemptible, more and more an object of ridicule.

Caveat Emptor (and especially Caveat Vendor)

Original article here

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

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

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

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

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

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

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

The number one reason for failed escrow is loan providers leading borrowers down the primrose path. "I can do that," and no, they can't. Unfortunately, I've never seen anyone able to recover damages from a failed loan provider. I used to advise people to get back up loans, but due to changes in the loan market, nobody can offer those any longer. For sellers, look for a qualification letter that you can take to any loan provider to find out if this buyer is qualified.

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

Whether you are a buyer or a seller, once that contract is signed, you want to get cracking on whatever your obligations under it are. Get it Done. The alternative is that you're likely to forfeit whatever rights to the deposit you may have had if you had been prompt. Just because Things Take Time in Real Estate Transactions is no excuse for you to waste time. Wasting time is expensive for everyone, and one of the strongest signs of a sour transaction I know. Buyers and borrowers pay increased loan and other costs, sellers lose money from delay. This is equally true in refinancing, by the way. The loan you are quoted today does not exist tomorrow unless you act on it today. In summer 2003, when rates hit fifty year lows, many people were in no hurry, and rates shot up a full percent and a half over a couple weeks. Today, rates have been even lower for years, but they've been slowly climbing these last several months, and you can see signs that they're going to rise further even if the economy dies completely. They insisted upon thinking, in the face of evidence and testimony to the contrary, that the rates would always be there, and they lost out. This happens constantly on smaller scales, and recently happened again on a bigger one. If rates go down after locking, a good broker may be able to get you better rates. If they go up, you've got the lock. If rates go up and you didn't lock, you get the higher rates. Period.

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

Caveat Emptor

Original here

(This article was originally written in August 2006. The market and loan rate figures have changed, but the basic information is the same)

Okay, you might expect a Real Estate Agent to have a post with that title, but I'm going to surprise the doubters by hauling out a spreadsheet and proving it with numbers.

When I originally wrote this, if you had moderately decent credit you could have qualified for 100 percent financing. The more you had for a down payment, the better your interest rates and the lower your payments, but even so, you could have gotten it. Now, not so much unless you have VA loan eligibility, but FHA loans allow 96.5% financing, which most folks should be able to swing by borrowing against a 401k if nothing else.

The first thing to remember is that you have to live somewhere. When you buy, you place your cost of housing forevermore under your own control. Inflation means nothing to the housing costs of someone who's already bought. Rising rents means nothing - unless you've bought an investment property to rent out, also. We are currently facing a period wherein rents are likely to rise precipitously. Why? Low vacancy rates, and many landlords facing adjustable rate mortgages that are going to adjust upwards at some point. It doesn't matter that your landlord has been nice up to now. They were banking on selling for a profit and right now, they can't. When the monthly outlay goes up, they're going to raise the rent. They will get it, too. If you won't pay it, someone else will.

Once you have bought, you step off of that one way escalator of rising rents. Rents increase at a yearly rate about comparable to inflation in most cases, and rents never drop. I have never heard of a rent decrease except in areas that were so far gone they might as well have been war zones. You only borrowed $X when you bought, and unless you take cash out (which is under your control) you should never owe more money next year than the previous one.

So buying stops your situation from getting worse. What about making your situation better? First off, I need to observe that with rising rents, your situation will always get worse until you do buy. But buying really does make your situation better. Not immediately; there's always a hit for buying, and it always costs money to sell. But within a couple of years the average person will be above any reasonable return they can earn any other way, and the reason is leverage.

Fact one: you always need a place to live, and the options are to rent or to buy. Renting typically requires less cash flow, but returns nothing. Once you have bought, all that lovely appreciation belongs to you and nobody else but. Let's look at an actual scenario for San Diego, one of the highest priced places to buy.

When I originally wrote this, I had looked at one particular property that day with an asking price of $450,000. We're going to leave aside the issue that with the market as it was, $410,000 would be a really terrific offer, and use that $450,000 asking price. The most comparable rental in the area was $1700 per month. For people with dead average national median credit scores, I had 6.125% on a thirty year fixed rate loan for the first 80% of the loan, and 8.75% on the second mortgage. Yes, I'm assuming a 100% loan. Total loan costs, one point and approximately $3400 in closing costs. With sellers outnumbering buyers 36 to 1 at that point, it was an idiotic seller who wasn't willing to pay your closing costs. Your payments on the two mortgages are $2187 and $708, respectively. Call it $2896 with rounding. I assumed you're married, which means you got a $10200 standard deduction on your federal taxes for 2006. Furthermore, property taxes are about $470 per month, and homeowner's insurance costs about $110 per month at the high end for an HO-3 policy, the best there is. Total cost of housing: $3476 per month. Over twice your cost of renting, yes. But $400 of that goes straight into your own pocket, in the form of principal you're paying off from month one. Furthermore, $2960 per month is a tax deduction, from which you'll get a benefit of $(2960*12)-10,200 (standard deduction), or slightly more than $25,500 per year, from which someone in the 28% tax bracket will see a tax reduction of about $7145, returning another $595 per month to your pocket. $3476-$400-$595=$2481 net costs per month to own that property. Less the $1700 rent, works out to $781 extra you're spending. Furthermore, if you turn right around and sell it, you're going to be out about 7% of that sale price. Assuming it's the same $450,000, that's $31,500 you're down.

However, property values don't stop rising just because the renters of the world would like them to. Let's assume you're going to make a slightly below average for this area 5% per year in absolute terms - not inflation adjusted. Most of California has been averaging seven percent per year for the long term, over cycles and cycles of pricing. The CMA for the first property I bought, at the peak of the last cycle fifteen years ago says $320,000, an 8.8 percent per year average increase. So 5% is definitely on the low side. Let's assume you have a twin who continues to rent, and invests that $781 per month, tax free, while you take it and buy a property. Actually, let's go ahead and give your twin the full net cash differential of $1143 per month.

One year later, he's got about $14,400, while your property is worth $472,500. You've got about $27,000 in equity. On paper, you're ahead of him, but remember that real estate isn't liquid and there are always selling expenses. You're really still down by about $20,000 as opposed to your twin. Darn! Just when you had a really good brag going. But wait! Now your twin's rent is raised to $1768 - right in line with 4% inflation. But your mortgage costs are fixed.

Run it out another year. Your twin has about $29,700 in that account. Looking pretty good, right? Well, you've now got a value of a little over $496,000 and you have about $56,000 in equity. You're not really ahead yet, but deducting the 7% costs of selling net you about $461,400. You've made over $11,000, net, not counting the equity you paid down! But your twin has almost $30,000. Why is renting for suckers, you ask?

Go out one more year. Your twin's rent has gone to $1838 per month, but even so his investment account still has a tad over $46,000 in it. Looks like he's pulling away! Or is he? Your property value has gone to almost $521,000, and you only owe $434,000. You're up almost $87,000, and even allowing the standard 7% for costs of selling, you're would now have over $50,000 in your pocket, several thousand dollars more than your twin.

Every year from then on, you pull further ahead. After ten years, when his monthly rent is over $2500 per month, you've got $350,000 in equity, and even after the costs of selling, are over $100,000 ahead of your dimwitted twin.

Lest you think that if your twin started with $45,000 due to a ten percent down payment it would make a difference, the answer is not really. It cuts the lead, but not the essential facts. I could cut the rate on the second mortgage a bit, but let's leave it at 8.75% for the purposes of this exercise. True, after three years you're still lagging your twin in this scenario, as that investment account is $95,000, but only by a few hundred bucks. Your equity is $130,000, of which $94,300 would be left after the expenses of selling. After ten years, he's $80,000 behind you, net of the cost of selling.

Suppose you start with a full 20% down payment? You're still $55,000 net ahead of the game after ten years. Your twin started with $90,000 earning ten percent, but not only do you not have that expensive second mortgage, you've got $450,000 earning 5%, and it's all yours and then some. This is the concept of leverage. That loan turns out to have been a good thing, as it enabled you to leverage your down payment into a much larger appreciating asset. So you only earned half the return - it was on five times the principal! It translated into a much bigger number. By the way, your twin only has the edge on you in cash flow by about $120 per month at this point, and he's going to be negative next month.

Now the real estate market doesn't earn nice smooth returns like this. Neither does the stock market, or anything except maybe bank CDs or the money market, at a fraction of the return illustrated here. Furthermore, it reliably and unavoidably takes about three years to come out ahead on a real estate investment. There are always the twenty percent per year markets, but those don't happen very often and never predictably. What I'm talking about are is making money in the slightly below average market years also. Note that you'll still make twenty percent in the years the market does. Sometimes you get lucky. But "time in" is so much more important than timing that they don't even play in the same league.

You don't have to be a genius, you don't have to have perfect credit, and you don't have to make a mint. You do have to pick properties that you can afford to make the payments on, and you do have to make the decision to accept a couple of tough years for cash flow. There just is no avoiding this hard fact. There are loans that promise otherwise, but they have bitten everyone I've ever met who tried them. Once you have made the decision to accept those lean times, however, the good times seem to flow from them for the rest of your life. The sooner you make the choice to accept them, the better off you will be.

Caveat Emptor

Original here

In the interests of fairness, I've also written a companion article, When You Should Not Buy Real Estate