Foreclosures Are Mostly NOT Good Deals

Many people believe that foreclosures equal good deals and that good deals can be had by searching a market only for foreclosures. Nothing could be more wrong in our experience, especially in and around Houston, where most foreclosures are some of the worst deals on the market.

We have found that foreclosures, while they may look okay in photos or on the outside, most often a) need more work than an occupant can take on, b) require expertise and cash beyond what a homestead buyer normally has, and c) are often anything BUT good deals in the end.

The most effective way to find a good deal is simply to look in good neighborhoods for low prices and then figure out why the price may be low. An elderly person may be moving to elder care, it could be an estate sale, someone may just need to move quickly, perhaps a house needs updating that most will not want to do but you don't mind doing in time, etc.

Foreclosures per se are not good deals.

And don't rely on foreclosure "specialists" or workshops or special public auctions or lists you have to pay for. Remember also that almost any property can look good in a photo (think "online dating"). Nobody gets all good listings and nobody corners a market, so using the Multiple Listing Service in an area is still the best and most comprehensive way to search for prospective properties.

Some firms like mine only do foreclosures with investors. That way, we know the investor knows what they're getting into (foreclosures are riskier deals than traditional resale/new) and typically will not encounter underwriting issues and can accommodate the bureaucracy involved -- another huge disincentive for homestead buyers -- the timing can vary wildly from expectations on foreclosures and there's really nothing you can do.

Why are foreclosures often rotten deals? Well that's a trip down the rabbit hole we'll save for another time. Just know foreclosures often equal "beasts." Finding good deals takes standard old fashioned knowledgeable research and professional advice.

Seller Financing: Seller's Advantage

It used to be that financing was so easy, seller financing as a concept fell to extremely distressed properties and the shadows of usury. But no more.

Nowadays, the slightest credit blip could prevent someone from receiving an affordable, reasonable loan by a bank or other mortgage lender. In this case buyers and sellers may turn to some type of seller financing in order to buy a home. While this post is in the context of homestead purchases, seller financing is a well-known concept in entrepreneurial finance, and its distant cousins are all over typical large corporate finance.

Anyway, in a home seller financing arrangement, the seller would agree to sell her or his property to a buyer of the seller's choosing, but not accept payment at closing. Instead, the seller issues a debt instrument in the amount of the sale to the buyer / "borrower." Done correctly, this can create a first lien position for the seller just like any other mortgage lender, with the sole right to foreclose on the property as collateral.

The debt instrument is actually a mortgage issued by the seller to the borrower, or wherein the buyer is the mortgagor and the seller is the mortgagee. The seller in most every case will not be able to pass on or sell that mortgage to third parties easily, but it can be an important source of income if the seller does not need the lump sum at closing - similar to an annuity.

The seller-financed mortgage will contain all the terms of a regular mortgage as the parties agree, and it should be drafted by an attorney in the state of the transaction. Terms can include required down payment, interest rate, payment schedule, amortization schedule, term (15, 20, 30 years, etc.), and perhaps most importantly, the default terms and foreclosure procedures in line with state law. In "Deed of Trust" states like Florida and Texas, the seller will hold the Deed of Trust, which gives the seller the right to foreclose on a loan in default. In such a case where the seller believes the buyer to be in default, the seller most likely would hire a foreclosure attorney to handle the foreclosure.

But here's where things get very interesting: in the event of a foreclosure in most DT states including Texas, the foreclosing lien-holder (in this case, the seller) gets to reclaim the property and re-sell it while keeping past payments including the down payment of the defaulting borrower. Whereas foreclosures are mostly a quagmire for large financial institutions, the opportunity to charge an attractive interest rate to someone who can't or doesn't want to get a private loan along with the opportunity to reclaim the property to re-sell it in the event of default - it can create a substantial financial advantage for the seller and a fair opportunity for a buyer.

Sellers can do short-term loans to help a buyer through a rough credit patch - the 30 year mortgage is not the only arrangement. A seller could offer a buyer 2 to 5 year financing with a 30-year amortization schedule (payments based on a 30-year loan) but requiring a balloon payment of the balance in 2 to 5 years or 7 or 10 or whatever. Most buyers will not have the cash for a balloon payment at that time, but the implication is that the buyer will have to refinance in order to pay off the balance to the seller. Notice, if the buyer does not successfully refinance, then they may trigger default / foreclosure terms and lose all their past payments and equity to the seller/lender.

Sellers with an existing mortgage most always cannot do this because traditional mortgages usually have terms that do not allow it. But even for sellers who do not have their property paid in full, they may be able to tap other funds to pay off their mortgage so they can take advantage of a seller-financing opportunity.

This post is meant merely as a framework for an idea and is not financial or legal advice or legal opinion. Any seller considering this opportunity in today's market should consult real estate brokers, financial advisers, accountants, and most importantly, a trusted real estate attorney.

Frankly I am surprised we don't see more seller financing in this market.

Early Indicator: Interest Rates to Rise

I received the following from a lender at Network Funding LP, but I can't figure out who owns the copyright. At any rate, very interesting headline and information.

Supply Concerns Boost Mortgage Rates

... [M]ortgage rates rose slightly during the week. The reason is that concerns about the enormous supply of debt that the government will need to issue outweighed the other factors. [emphasis added]

...This week, the Obama administration proposed a $3.6 trillion budget plan, with an estimated deficit of $1.75 trillion, which is enormous by historical standards. The Treasury will need to issue debt to borrow money to fund all of this. As the government issues more debt, the interest rate offered generally must rise to attract additional investors. Interest rates on similar investments such as MBS then move higher as well to compete for funds from investors.

Reflecting their concerns about an increase in supply, investors required higher interest rates at the large Treasury auctions during the week. The auction results showed that demand from foreign investors remained strong, which was very good news. If foreign investors should ever reduce their purchases of US bonds, then interest rates in the US would be likely to rise. [all emphasis added]

These are dynamics long discussed on this blog. Like day follows from night, so will inflation follow from the massive stimulus required to unfreeze credit and consumer markets where "scared money doesn't spend." Not to mention the very very real massive losses the banking sector faces from their catastrophic past lending practices, which further reduces available private money into the demand side of the economy.

These factors necessitate the enormous spending from the last credit-worthy entity capable of replacing all the lost demand (through debt-financed spending), namely the federal government.
Unstated in the quote however is the notion that investors/lenders require higher returns when loaning money even to the United States government because at some point, the investors/lenders begin to worry a little bit more about the government's ability to raise enough tax revenue from the economy's future production in order to pay for the national debt load (remember we're starting already over $10 TRILLION in the hole, with an actual doubling of the national debt in the last 8 years with nothing to show for it).

An important caveat: The United States will never default on its loans, that's the market assumption. But it may, if necessary, only avoid doing so essentially by printing money to pay down the debt, which only ends up causing inflation as new cash enters the system without being backed by any real production or assets. This raises prices of everything, yes, but it also reduces the real value of debt as "printed money" pays down the loan balances. Everyone loses.

To illustrate, imagine if you could pay off your mortgage not by keeping a job and making payments with the fruits of your labor or even by inheriting enough existing money to pay it off -- but rather you could just print your own money to pay it off, or successfully pay it off with a "valid" hot check. See? The only "winner" is the one printing the money, but then the printer will never get an affordable loan again either.

That's kinda the dynamic that gets figured in here, the risk level of that scenario above actually happening, as foreign and domestic investors consider issuing loans to the federal government. As the lenders' or "investors'" concerns rise, then so does the pay they demand in return for their loan -- the interest rate.

And all interest rates are related in some fashion. So when the federal government has to pay a higher interest rate for its debt, so too do individuals borrowing with mortgages, as no person or entity is seen as "more" credit-worthy than the United States government.

(In finance, the 10-year Treasury bond rate is often referred to as the "risk-free" rate.)

No, this will not be on the exam.

On "Garden Bathtubs"

I often say that home buyers have an "aspirational" orientation when looking for their next home. By that, I mean that buyers are not generally looking to buy a house that will feel like the last one and in which they will follow the same behaviors and patterns. Part of moving, psychologically, is the opportunity "step up" both in habit and status.

So one of the many curious items of value in any home on the market is the "garden tub." This tub is larger than a standard tub, deeper, and has a slanted back designed solely for a relaxing bath. Usually these are only in the Master Bath, are set in a corner, and often have windows above and ledges where people can place boutique shop candles, soaps, and little rolled up wash cloths like a fancy hotel.

But does anybody ever use them?

It doesn't matter. Regardless of whether people do use them, buyers want to imagine that they will use them. It's just a pleasant thought. We all want to think that we will manage to work in that Friday-night hot soaking bath with candles and a glass of wine. Sure, some people actually do this, and good for them. But whether someone does it or not is entirely beside the point because everyone wants to imagine themselves doing it.

And you can't imagine it if you don't have the tub. What a hope-crusher.

Even if you take a soaking bath in a garden tub once in a blue moon, you can bet that it will be a moment of great stress relief, a pleasure, and a great memory. Moreover, every morning and night when the owner is in the Master Bath, there will be the tub and the memory, and more importantly -- the hope -- that the moment will come again soon.

Practically speaking, garden tubs are a status symbol because they are a luxury of space. With a garden tub, the Master Bath will also feature a separate shower, and so the package creates a "luxury of space," not economy of space as would be a standard tub and shower together. The tub creates additional open space from the bottom of the tub (the floor) to ceiling that always remains open, and so opens up the feel of the Master Bath. Tub/shower combinations with a curtain or sliding doors close off the space, kill any hope of a relaxing bath, and close out light -- a triple-whammy.

So sometimes buyers' desires and choices may not appear logical. But usually upon sufficient reflection (and after witnessing the same choices and desires time and time again), the underlying logic of human nature can shine through.

Not All Tax Cuts Are Bad

While "tax cuts" in the abstract are proven (yes, proven) to be less effective than "spending" for turning around an economy with cratering demand (more on that later), it is worth noting that not all tax cuts such as those included in the Senate and House versions of the stimulus bill are bad...

It's worth noting that many middle class earners who would get tripped by the AMT are not expecting to pay the AMT because they have not had to pay it in the past. So if the AMT were not eliminated, it would result in several million earners to have withheld too little in taxes and therefore come up short, or would have to withhold more in taxes from paychecks, thereby reducing disposable income.

So delaying the AMT is good policy. Tax cuts that produce immediate spending that otherwise would not have happened is still spending, and it's still good policy.

Tax cuts however that simply benefit the rich and would simply result in additional money cut from the government and staying protected in fat bank accounts would continue the economic crisis.

Another great good policy example: $15,000 refundable tax credit for (qualified) home buyers to get people buying new homes now and not waiting until it's too late.

Another great example: a multi-thousand dollar tax credit for anyone who gets a new air-conditioner (which will have a higher SEER rating, more efficient) or replaces single-pane windows, etc. This will cause middle and lower-class owners to consider replacing old A/C units for example that are at the end of their useful life and they will see a huge spike in efficiency in their bills and energy use -- not to mention getting a great break on a system that will need replacing regardless and creating jobs/saving jobs for the manufacturers and installers, etc. Not all tax cuts are bad. Not all public spending is good. Blah blah blah.

Homeowners and Landlords would do well to study the final bill (when it gets done) and take advantage of all provisions that give incentives for pulling forward spending that otherwise would be put off. This could include replacing old A/C units, replacing single-pane windows, replacing an old car (with a more efficient car at a low interest rate), and yes even buying a new house at a potentially lower-than-future market price and historically low fixed interest rate.

Not everyone has the ability to spend right now, and that's fine. But this nation desperately needs those who can spend to spend... without delay. Anything that causes spending right now, including pulling forward public spending for infrastructure, as well as private spending, etc., is going to help turn things around.

Right now (not in the long term): if we're spendin', we're survivin'.

Just sayin'...

Why Buyers Need Smart, Full-Time Professional Real Estate Brokers

Today's New York Times has a story about the new financial regulations under development in the new administration.

While there is a ton of badly needed regulatory reform that will address many of the problems already laid out on this blog to be included in the package, I will focus in this post on the impact of these wide-ranging changes on the real estate buyer. But first, an example of the broader much-needed reforms:

The administration is also preparing to require that derivatives like credit default swaps, a type of insurance against loan defaults that were at the center of the financial meltdown last year, be traded through a central clearinghouse and possibly on one or more exchanges. That would make it significantly easier for regulators to supervise their use.

Now to return specifically to real estate buyers. First and foremost, buyers will have to navigate a very new landscape of mortgage financing without necessarily understanding the recent history and context of the changes, which could lead to frustration and confusion. To wit:

Aides said they would propose new federal standards for mortgage brokers who issued many unsuitable loans and are largely regulated by state officials. They are considering proposals to have the S.E.C. become more involved in supervising the underwriting standards of securities that are backed by mortgages.

Now more than ever before, financing is a huge complex piece of any real estate transaction. While it always should have been the starting point for buyers, in recent years when money was flowing freely, few people in the industry ever had to be concerned about a client getting financing for a deal, so long as the client had a pulse. Of course, things have changed dramatically, and directly as a result of that free-flowing period.

Therefore real estate brokers and agents of residential or commercial orientation, in order to fulfill their "market making" roles, will have to become far more involved in an ever-increasingly complex mortgage and finance environment to help buyers make their way through the complexity. We brokers can no longer just refer a buyer to certain lenders and leave them on their own. Doing so in this environment is a profound disservice.

As new regulations get rolled out, real estate brokers must stay at the leading edge to comprehend not just the rules, but their implications in any specific market. We must also help clients with their due diligence efforts when finding qualified lenders to help ensure clients find competent, informed, and ethical lenders with solid reputations. Bad financing is by far the most common reason a deal fails. This is a larger and far more complex obstacle than ever before.

The proposals that will come to pass in specific form are aimed, according to officials, at core regulatory problems and gaps:

They include lax government oversight of financial institutions and lenders, poor risk management efforts by banks and other financial companies, the creation of exotic financial instruments that were not adequately supported by their issuing companies, and risky and ill-considered borrowing habits of many homeowners whose homes are now worth significantly less than their mortgages.

Even high level regulations that affect lending way upstream will have to be understood by real estate brokers, not just mortgage brokers, as we move forward to manage fully the implications for buyers on the ground.

The new trading procedures for derivatives could also enable regulators to impose capital and collateral requirements on companies that issue credit default swaps that would make them safer investments. American International Group, one of the largest issuer of such swaps, never had to post collateral and nearly collapsed as a result of issuing a huge volume of such instruments that it was unable to support.

Going forward, real estate brokers and their agents who cannot understand the implications of such complex reforms for their clients in their specific market, and who cannot fully explain those implications to their clients if necessary, those brokers and agents will surely lead their buyer clients to failure, and that will undermine the market for everyone.

Bottom line: Brokers and their agents can no longer blindly refer buyer clients to a cadre of lenders they've used in the past. A higher standard for due diligence is required in this market, and while that responsibility falls principally on buyers, everyone assisting the buyer must support that effort. Those who don't understand the critical times and adaptation they require will not only be doing their clients a profound disservice, they will impede the progress and recovery of real estate markets for everyone.

New Rule: Sell Low, Buy Low

Recently at a good friend's holiday party I met a very nice woman who wants to leave her house of 20+ years where she raised her children to move into a single story, smaller house. She has a very common problem: she no longer can climb the stairs to and from her master bedroom and bathroom every day without difficulty.

For many young families, floor plans with all bedrooms up offer a very good value -- they get a functional layout downstairs for family activities and 4 bedrooms or so upstairs including the master, which also usually keeps the footprint of the house small so that it fits well onto a small but affordable lot. Using upstairs space for livable square footage is also a good value because upstairs square footage is much less expensive to produce, since a house only has one foundation, one roof, one set of plumbing stacks, etc. On a per-square-foot basis, single stories are often priced higher than comparable two-story homes for this reason (and a few others).

Some young parents also feel reassured sleeping close to their young children.

[An often overlooked advantage to having a master suite upstairs is that it typically allows for a much larger master suite.]

But in a few decades, those young parents become empty nesters and their many years of hard-work may leave their bodies a little less forgiving with the stair climbing up and down all day every day.

So the lady at the party with whom I was speaking felt like now is not a good time to sell in the market, particularly because she paid at the high end of the market cycle in the early 80's and it's difficult to face a lousy investment return on a house, even though the house has served as the main family stage for those many years. Memories aside, the simple numbers are disappointing. I get it.

So I asked her if she wanted to stay in the same area, and she said yes because her adult children still live in the general area.

"No problem, " I said. "You may sell your house for less than you might have a few years ago, but you're also going to pay less for your next house."

This is the new rule for taking advantage of the current housing market: sell low, buy low.

So for many people who might want to downsize or even buy a bigger house, if the goal is to stay within the same general market area, then it would hold that however much the market may be depressed, it's depressed on both the selling and the buying side. So yeah, you might not get to sell for as much as you would like (nobody ever does in Houston), but you will get to buy for less in the same market!

Not to mention the historically low interest rates right now for qualified buyers. (Well qualified buyers have no excuse not to be in the housing market right now. Move up, refinance, whatever, but now is your time.)

Think of the California market circa 2005, for example. What use would it serve for a couple to sell their 1200 SF home for $1.5 million if all they could do was buy another comparable 1200 SF home for $1.5 million?!? This is why Texas saw so many people relocate from California and other areas, because cashing out was only possible by selling in the high market and moving to buy in a market that wasn't so wildly out of control (ie, Houston).

It occurs to me that the reverse is now true in most housing markets. Sure prices may be a little down year-over-year, which makes the thought of selling daunting if one doesn't have to sell. However the market also has good buying opportunities coupled with historically, ridiculously low 30-year fixed interest rates.

In conclusion, it is not a buyer's market. It is not a seller's market. The forces affecting each side are relatively balanced when you think about it. So it's not a bad time to sell if what you want to do is turn around and buy. So don't give up, the opportunity to get what you need or want is still very much available in this market.

Funny How You Always Find Your Car Keys...

A friend of mine pointed out recently:

Funny how you always find your car keys in the last place you look.

True that.

But the same cannot be said of looking for homes. I've never heard anyone say after finding their car keys, "Well maybe I should keep looking, just to be sure."

Occasionally people know it when they see it, but for most, it's not that easy. Or romantic.

Repeat: Houston is the Exception

Okay, another press release, another frightening headline. But repeat and repeat again: "Houston is the exception." Let me cut to the chase, which is the last line in this Reuters article:

"The bear market continues; home prices are back to their March, 2004 levels," David M. Blitzer, chairman of the Index Committee at Standard & Poor's, said in a statement.

Okay, now as anyone can remember who was in the market in 2004 as a seller: those were not hard times in Houston.

So while other economic metrics mentioned in the article are at multi-decade lows, home prices in Houston remained relatively stable in comparison, down year-over-year in November by about 7%, but that's on much much lighter activity overall. Basically, sellers are afraid to sell, and buyers are afraid to buy, and so we mustn't be too serious about the price figures, which only reflect a small set of data due to the overall inactivity in the Houston market. (Note an important corollary: many would-be area sellers are also would-be area buyers. They are coupled, and so are the market effects.)

In other news, while the article says that a turnaround in housing is required for an overall economic turnaround (true enough), it also reports an important jobs figure:

Chief among consumers' woes has been spiraling job losses in recent months.

U.S. employers axed 533,000 jobs from payrolls in November alone, the most in 34 years, according to Labor Department data released earlier this month.

The Conference Board data reflected this, with its "jobs hard to get" index rising to 42.0 in December -- the highest since December 1992. That was up from 37.1 in November.

As we've discussed on this site again and again, the real indicator of an economic turnaround will be a stabilization of job losses. Without jobs, the economy can go nowhere for 99% of Americans. If you want a good housing market, you must have a good jobs market.

Repeat ad nauseum.

New Home Buyers Beware & Be Aware

Often when we brokers get the chance to work with new home buyers who buy a house to be built for them by a production builder, we see a standard set of issues arise. The most important mistake we see in the market, over and over again, is that buyers do not realize that if they do not use a licensed agent or broker to represent their sole interests, they are on their own essentially because everyone on the builder side, sales counselors included (who are not licensed in the state of Texas), they all work for the builder and in the builder's interest.

That is not to say that buyers cannot have a wonderful and satisfying experience with home builders, however the process is fraught with complexities and potential problems that an experienced agent or broker can help avoid.

Sometimes potential buyers who do their homework may find complaints about a builder somewhere online. While this is important information, it should not be conclusive.

I like to take a look at the buyer complaints on record and analyze them. It doesn't entirely surprise me to find online complaints about any major builder because one of two things might be happening, or both, particularly with production builders who cater to first-time or inexperienced buyers:

i) the builder may be a bum builder and perhaps takes advantage of its mostly first-time buyers, and/or

ii) I've found that many first-time buyers are not accustomed to the process, and if they are not properly advised by an independent agent or broker representing the buyer's sole interests, then buyers can be disillusioned by basically standard operating procedures by builders. Most new buyers do not use an agent to represent them, only because they don't know to do so, and the sales counselors work exclusively for the builders. So any conflicts are generally settled in favor of the builder, much to the frustration of the buyers.

New buyers therefore can easily be misled. A common example is during the build process, the buyers may make a request of the sales counselor, such as to change their carpet choice for instance, and the sales counselor will tell them "no problem." The clients think there's no charge but then later come to find out that there could be a "change fee" or a charge for removing existing carpet and/or an upgrade charge.

This is standard procedure in general, but the mismatched expectations and poor communication on the part of the sales counselor / superintendent can leave many people raw. Sometimes weather delays also incense people.

Structural problems however are always inexcusable, such as faulty workmanship, plumbing problems, etc. But most of those things are covered under the standard builder warranty, headaches though they are. (An independent inspection prior to closing can help alleviate any major problems - something else a buyer agent/broker can facilitate.)

Another important part of buyer due diligence is to drive the new neighborhood and see how many homes are already being lived in by former buyers. The more there are, and the longer the neighborhood has been under development, the better the indications are.

Also, it's always advisable for potential buyers to stop and talk with residents in any neighborhood they're considering while being careful not to put too much importance on any particular resident with whom they speak.

But bottom line: a) buyers should not do anything that makes them uncomfortable, but b) remember that an experienced agent or broker can represent buyer interests exclusively and will be the buyer representative with the builder, and that agent or broker, if experienced and reliable, should be able to interfere with most potential problems when building a new home.