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.

When Liability Insurance Attacks: For Home Sellers

Our insurance adviser tells us that one of the highest liability risk periods for any home owner is when they market the home for sale. This makes sense because hopefully a lot of interested buyers will be coming onto the property to see it -- most of them strangers. If someone falls, etc., it's like any other time basically -- there could be a liability claim against you. A standard Listing Agreement with any real estate broker should cover this in some further detail, however your best protection on all of these issues is to speak with your insurance agent.

We have even been advised that some home owner insurance carriers will not even establish a new policy while a house is on the market for sale because of the increased risk. Also, as with any insurance policy, the beast is in the exceptions listed in the policy, not to mention insufficient coverage compared to the likely liability cost a covered incident provides for in the policy. (For example, if you only have $5,000 for injury liability but someone breaks a leg, you could well be on the hook for way more than $5,000.)

Cheap insurance quotes are like discount real estate brokers in my opinion: you think you're saving money (and most times you're really not) -- and you better hope you never need them.

Another scenario: I have a pit bull and so am very aware that many home owner liability policies will either a) not cover pets, or b) not cover certain breeds from the liability policy. So every pet-owning home owner must be clear on that aspect of their policy. Even if your pet's actions are covered, you want to be sure the coverage is sufficient for any likely claim scenario - as with the above example, a dog bite could put you on the hot seat for way way more than $5,000 if that's the limit in your policy. Nothing stops anyone from suing you for more than your insurance coverage. If that person were to win in court, the plaintiff can pursue your other assets. Anyway your insurance agent can speak to all of this, and if anything in this post is news to you, you should call that agent right away.

Other critical items in my view to discuss with your insurance agent:

• Whether you need a business rider on your car insurance. Without it, if the insurance adjuster determines your car was being used for business in a collision, your coverage could be denied.
  

• Establishing or raising the value of an umbrella insurance policy to enhance your coverage limits. Think about it: if you have a catastrophic car crash that's your fault, if you have minimum coverage, your insurance carrier has every incentive to write a check for $25,000 (if that's your limit) and walk-away, leaving you with potentially hundreds of thousands in additional liability in the incident. Proper coverage including affordable umbrella coverage at $1 million, for example, could put your insurance company on the hot seat for up to $1.5 million in such an incident -- that's a sure calling card for their A-Team lawyers to come to your defense with that much of their own money on the line.

• Whether your carrier is a mutual company, meaning its policy-holders own the company, or whether your carrier is a publicly traded corporation whose shareholders own the company. This basically gets to one important aspect: making sure your carrier, no matter how it's structured, has a good reputation for being fair about pay-outs on claims. In this Google era, you can do some private due diligence of your own as well.

Like I said, insurance is more than just a cheap quote. Sometimes you get what you pay for, and -- as is the case with my own professional role as a real estate broker -- sometimes the right adviser with the right ethics, experience, and expertise can get you far better results for the same "low price." At any rate, if you just go with the cheapest quote on anything in life without examining what's behind it, then whatever it is, you better hope you never need it.

Houston House Prices: Still Pretty Good

From the new Houston Association of Realtors press release on recent home sale data:

Single-Family Homes Update
At $182,316, the average sales price for single-family homes dropped 10.5 percent from February 2008, when it was $203,797. However, the figure is up $18,000 from January of this year. The median price of single-family homes in February was $138,970, off 8.0 percent from one year earlier, but up about $10,000 from January. The national single-family median price reported by NAR is $169,900, illustrating the continued higher value and lower cost of living that prevail in the Houston market.

Now I can tell you we are not seeing those kinds of declines in value on the far north side of Houston in quality neighborhoods and with quality homes. The decline there, if any, is hardly noticeable.

But really, this chart contained in the release is all you need to see to get a simple read of the situation in Houston:

Look at the trend lines. Both the average price (skewed higher by expensive homes) and the median price (half of all sales are priced higher, half lower) -- both average and median trend lines show something very important that you can clearly see just by eyeballing it:

Prices in the Houston area are at mid-2007 levels right now.

In case anyone missed it, 2007 was a pretty darn good year for housing in Houston.

Uptick or Upstart? New Home Starts: UP

Just out, The Commerce Department reports this morning that:

The Commerce Department said the jump in housing starts to a seasonally adjusted annual rate of 583,000 units was the biggest percentage rise since January 1990.

That was also the first increase since April last year, when they advanced by 1.6 percent.

And the kicker? This is not what "the markets" had expected. Market analysts were expecting a smaller number.

Analysts polled by Reuters had expected an annual rate of 450,000 units for February.

The question now might be: with so many months of sinking new start numbers, is this just a natural uptick quirk within the larger trend, or is this a new inflection point that will reverse the trend?

Rest assured we are watching very very closely.

On a separate but related note, producer prices were announced at .1% rise, below market expectations. However the markets watch the "core" number, which excludes the traditionally more volatile energy and food costs. Those prices were slightly higher than expected. All said, this is very good news this morning. But with so much debt-financed stimulus, we have to keep an eye on inflationary dynamics. This isn't enough to be concerned this morning.

U.S. producer prices rose by less than expected in February as the pace of energy price increases slowed, government data on Tuesday showed, but prices excluding food and energy came in a bit above forecast.

Houston #1 Corporate Growth In The United States

From the Houston Business Journal, a report about Houston at "the No. 1 spot for the first time on Site Selection magazine’s list of Top Metro rankings for corporate location and expansion activity."

Eat that, Chicago (#3)!!

And coming in at #2 behind Houston? Our little sister to the north, Dallas.

Site Selection said Houston clinched the top spot after scoring 179 corporate real estate deals in 2008, unseating three-year incumbent Chicago-Naperville-Joliet.
Dallas-Fort Worth-Arlington finished No. 2 with 156 projects, and Chicago came in third with 138.

Last year, Houston was No. 4 behind Cincinnati and St. Louis for cities with more than 1 million in population.

“Site Selection ’s award adds to the long and growing list of distinctions the Houston area is earning for our business recruitment, business retention, job creation and economic growth efforts,” Jeff Moseley, president and chief executive officer of the Greater Houston Partnership, said in a statement. “We will continue to show that the Houston region is the most attractive place to locate or expand your business in the United States.”

There is no place in The United States that I would rather own real estate right now than in and around the Houston metro area and definitely in the rightfully proud great State of Texas. (That's why I do, of course.)

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.

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.