Beginner's Information: May 2007 Archives

On a fairly regular basis I get email asking what I think of this or that loan calculator on the web, this or that predictive model for real estate prices or loan rates, etcetera.



Loan calculators are pretty simple when you get right down to it. Numbers go in, other numbers come out. It's just math - except that you've got to be careful about the numbers going in. Just because your balance is $400,000 now does not mean it'll be $400,000 after the refinance. It's very possible to do a zero cost refinance that adds nothing to your loan, but most people don't do it. Furthermore, I know I've said this before, but the only calculator out there that I trust is one that I know the provenance of. I've caught more than one company that had programmed its calculator to low-ball the payment. There's no way to tell for certain except using your own calculator, and if you have your own financial calculator, why are you using the web? You can cross check, however, because it's rare that two calculators will be programmed to yield the same wrong answer. Also remember to add in closing costs and prepaid interest and escrow accounts, if you're going to have one, and always figure the cost of any points after everything else is added in there, because that's what the bank is going to do. Finally, don't take it for more than it's worth. Just because they tell you, "nothing out of your pocket," does not mean there are no closing costs. They exist. Somebody is paying them, somehow. Unless you know for a fact otherwise because you've discussed it and know where the money is coming from, I'm guessing that "somebody" is you, and they're getting rolled into the balance of the new loan. I've had people bring me paperwork from other companies showing new loan balances thirty thousand dollars higher than they were expecting, with correspondingly higher payments. (I've also told people to never shop for a loan based upon payment a few times, also)



For spreadsheets, what you can get is usually an analysis of one variable per spreadsheet. I've programmed a loan comparison spreadsheet, but it only compares two alternatives at a time and it's not really suitable for use with the public, because you have to understand the limitations and GIGO factor. Just like I've got spreadsheets that answer the "rent or buy" question, among others, but you have to understand the limitations on the results imposed by your model.



As a computer programmer, I make a pretty decent loan officer. In order to compare financial information via spreadsheets, you have to understand what points of comparison the calculations are meant to compare. If your data is out of whack, if your assumptions are away from reality, or if you're trying to apply the comparison outside its design limits, what you get is useless.



I have several spreadsheets I have programmed and use. All of them have limits that need to be understood in order to get useful information out of them.



The first is a rent versus buy spreadsheet, that I first talked about in Should I Buy A Home? Part 3: Consequences. In that article, I spent a good paragraph telling you what my assumptions were in cranking the numbers. I think they are good and reasonable assumptions for the markets I have seen in my area in my lifetime, but many people might not. I just had someone make a comment to the effect that "rent doesn't increase with inflation." Well, it hasn't been keeping pace with the cost of buying of late, but that's not the same thing as not increasing roughly with inflation. Furthermore, we've gone through a period these last few years when landlords were keeping rental rates low in the attempt to have someone else pay most of the mortgage of their investment property. Judging by the "loaf of bread" or hourly wage comparisons, or anything else except the price to buy, local rents have increased by a factor very close to general inflation over my adult lifetime. Whatever you think of my numbers, though, the fact remains that they are assumptions, and if they do not correspond to future numbers, the conclusions they reach have no bearing on the real world.



The second limitation upon this sheet is that it's assuming smooth increases. This is not what happens, as anyone over the age of ten ought to know. Over longer periods of time, the data may tend towards an aggregate average, but that says nothing about any given year. In reality, some years are plus thirty percent while other years are minus twenty. Even if my assumptions for averages are good, the spreadsheet that predicts the next thirty years is useful mainly to predict overall level of the market many years out. The numbers for any particular year are so much garbage, as far as the real world goes, where a 5% differential between estimate and actual is often enough to render something worse than useless. Even if my assumptions for average return are right on the money (and if I didn't think they were pretty close, I'd use others), any particular year could be at the top of a peak or the bottom of a market trough. If you know what state the market will be in in a particular year three decades out, why the heck aren't you richer than the ten richest billionaires in the world combined? Knowing what the market was going to do these past few years is a lot easier than knowing what it'll be like thirty years from now! I have what I think are good predictions based upon good models, but I don't have any god-level knowledge of where any part of the economy will be thirty years from now, and neither does anyone else. We see the future dimly, reflected through the present and the past.



Speaking of which, let's drag one of the standard disclaimers out and air the dirty laundry. "Past performance is not indicative of future results." Averages of past results may be the only way we have of predicting the future, but those results depend upon unknowable factors. Somebody could invent something tomorrow that utterly changes the face of housing thirty years out. You think the urban planners of the 1920s foresaw urban sprawl? I know for a fact that they didn't. What no model of the future can predict is unforeseen factors. I can't tell you what they will be or what effects they will have, but I can promise you there will be some. In 1894, Michaelson (who first measured the speed of light) said, "Our future discoveries must be looked for in the sixth decimal place." This just a few years after the formulation of Maxwell's equations, and within a year Rutherford had changed the atomic model forever, while the basis of quantum mechanics was being laid, and less than ten years later were Einstein and relativity. Michaelson was right in a technical sense that precise measurements were the key to unlocking future discoveries, but wrong in the sense he meant it, that all the major discoveries had already been made. My predictive model is more detailed than most, and I do my best to include all of the factors I see, but I have no way of including factors that I can't see, and one thing I can promise you is that there are some. It may work out that I guess right anyway, but that doesn't mean there weren't any unforeseen factors, just that I got lucky despite them. The further out the model goes, the more it is dependent upon subsequent events no one can predict. Someone could announce man-portable fusion power tomorrow, or "Star Trek" transporters, or any of dozens of new potential technologies that could alter the world, and that's just the technological possibilities. Politics and demographics will utterly change in the next thirty years (In 1977, more people were predicting the world conquest of communism than the collapse of the communist system. Mr. Carter's presidency was not the United States' shining hour).



Just because we know that the precise numbers are wrong, however, doesn't mean that those numbers have no value in predicting the future. The way the numbers will move relative to each other is much more important information. Population is increasing and will continue to increase. Demand in major urban areas and desirable areas will continue to rise faster than supply, and since such areas are where most of us live or want to live, the price of real estate will quite likely continue to increase faster than inflation. Particularly types of housing which are universally desired, such as detached single family residences sitting on a certain amount of land owned basically fee simple. PUDs and townhomes are less desirable for most folks, true condominiums less desirable yet, and below that are apartments. Offer most people the chance to move up on the ladder of desirability, and they'll take it. Since the only thing preventing most people from doing so is price, price is what's going to make it ever harder to make that transition to more desirable housing. Living space in a desirable location is a scarce good. Living space, desirable location or not, is a limited good. The only way to change this is to somehow manufacture more space or arrange to have fewer people to share it. I'm not aware of any plans to manufacture enough space to make a difference to the billions of people on earth, so I'm guessing that barring worldwide nuclear or biological warfare, population density is going to increase, demand for housing is going to increase, and supply is going to stay pretty much right where it is. Nonetheless, this is only a guess. My guess is that housing will be about four to five times as expensive as it is today thirty years out, If it's only twice, we'll all still live in million dollar houses. If it's eight times, we'll be in four million dollar houses. The wider the net, the more probability I have of being right - and the less useful the information is. Unless the price right now is something like two cents, nobody sane is going to invest money for that long without a better idea of what the payoff will be.



Whether I'm right or not is something nobody knows right now, or even how close. Actually, not being quite that much of an egotist, the question in my mind is more akin to "how far off will I be?" But the data is still useful, because it tells me that as long as my assumptions are anything like real, we're all looking at living in million dollar real estate - the only question is exactly when. It tells me what people will be need to be able to pay every month, at least in a general sense, and it tells me that more and more people are going to get priced out of real estate, or down into less desirable housing, and that real estate is therefore going to be a quite satisfactory vehicle for creating personal wealth.



On the other hand, no system of projecting the future is better than the limitations imposed upon it by limited foresight. If the population of the United States drops to 1789 levels all of a sudden - or 1607 levels - all bets are off. Of course if that happens, most of us won't be here to worry about it, and the ones that are will have bigger problems than the price of real estate. It's pointless to waste time worrying about the price of real estate in such possible circumstances, where the price of real estate will be the least of our worries.



Caveat Emptor

The local dog target gave discounters several hundred thousand dollars of free puffery recently.



I'm not against discounters. I'm perfectly willing to do a discounters work for a discounter's price. Fifty percent for the pay for less than ten percent of the work and almost none of the liability is a real win as far as I'm concerned. The difference is that I'm not willing to pretend that you're getting the same value from me. In fact, the amount of value the buyer receives from their alleged "agent" is pretty much negligible.



Let's illustrate with a real example from last week. Some full service clients of mine had gotten interested in a property. They wanted a fixer property with potential and a view, and they asked me to check this one out. Yes, it had a view, but the view was of a high school stadium, making peaceful enjoyment of the property rather hit and miss, subject to the local sports schedule. It had some potential, true, but every surface in every room needed to be redone. It is going to take $100,000 to get that potential, and the property would only be worth maybe $40,000 more than the owners are asking. Leave out those pesky numbers and a less capable agent can make it seem like a great bargain. If all you're thinking of is that $5000 rebate check, which can be fraud for reasons similar to these, you may think you got a deal.



If they had been clients of a discounter, they would have been in escrow on the first property right now. Too bad about that $100,000 they'd have to spend to get $40,000 benefit. On the other hand, I found the same people a property not far away that needed about $40,000 worth of work to be worth $120,000 more than the asking price. What does a discounter do? Write the offer on the first property. Now you've got a property you need to put $100,000 into to make it usable, that's worth only $40,000 more than you paid. Money the discounter would have rebated: roughly $5000. If they didn't have a full service agent to compare with, it even looks like a great deal, because none of the value I provided these folks shows up on the HUD 1 form, or anywhere else as numbers on paper. The value is still there, as my clients know.



If you know enough about the state of the market, what problems look like and what opportunities look like, you may spend less with a discounter, or get a rebate, that doesn't cost you several times that difference. If you know everything a good agent does, there is no reason not to put that money in your pocket. But if you know everything a good agent does, why is the discounter making anything? Why aren't you doing your own transaction? Why aren't you in the business yourself and getting paid for your expertise?



A full service agent goes a long way past filling in the blanks on Winforms and faxing the offer. When I go out looking at 20 to 30 properties per week, I'm not just finding individual bargains. I'm also learning about the general state of the market, what things to look for in a given neighborhood, what common problems are with a given model of house. I know what's sold in the neighborhood recently, and I know what it looks like because I've been inside it, and I know how it compares to other stuff that's out there now. I have a pretty fair idea of what it's going to take to beautify properties, and I know what they'll be worth when the work is done, because I know what other stuff that already looks like that has sold for recently.



Real estate is a career. It may not absolutely require a college education, but many agents have one, and know many things you can't learn in college - because the professors don't know, either, unless they're active real estate agents. A good agent spends a lot of time and effort not only learning their local market, but keeping their knowledge base updated. This thing changes constantly, and it doesn't even change uniformly. How did La Jolla get to be La Jolla? I assure you it wasn't some random seagull anointing the neighborhood as having higher property values. Rancho Santa Fe doesn't even come close to the ocean, and it's the highest mean property value zip code in the nation. How did your neighborhood get to where it is? Is it likely to change, and how? What are the known and probable upcoming changes in the neighborhood? How is it likely to effect your prospective property? Wouldn't you like to know about that redevelopment zone - or the railroad tracks they intend to drive through the area?



Full service can be a very hard sale when all that you consider is the numbers on the HUD 1. There just isn't any space for "Agent kept you from making a $60,000 mistake," let alone, "Agent showed you an $80,000 opportunity." But people who know property know that there is a lot more to every transaction than the numbers on the HUD 1. If you're dubious, may I suggest this experiment when you're ready to buy: Find a couple full service agents willing to work with a non-exclusive buyer's agency agreements, and sign them. Then compare what happens as compared to the service of the discounter you use for properties you find yourself. There is no need to sign even a non-exclusive agreement with a discounter, by the way, as the sales contract will note the agency relationship for that transaction. Like I said in How to Effectively Shop for a Buyer's Agent, let the ineffective alternative select itself out.



I'm perfectly willing - happy, even - to do discount work for "discounter" pay. I only make half the money, but I can service a lot more than twice the clients for a much smaller level of risk and still be home in time for dinner. I'm even a better negotiator than dedicated discounters, because unlike them, I know what's really going on in the areas I serve. However, saying "full service at a discount price," does not make it so, and I refuse to pretend that it is. Furthermore, the people who approach me for discount work usually end up understanding that a real professional is worth a lot more than the extra money I make, and are happy to pay it. Most people have no problems understanding that the reason a good car commands a higher price than a bad car, let alone a skateboard, is because a good car provides more value. People will pay $100 per seat for decent - not great - musicians in concert when you couldn't pay them enough to attend a garage band practice session. Why should this principle holds any less true for expert help in what is likely to be the biggest transaction of your life?



Caveat Emptor

I keep getting search result hits for the string "fsbo horror." It's an amalgamation because I haven't done any postings on this specific subject.



Both buyers and sellers have problems relating to For Sale By Owner issues.



For sellers, the largest issue seems to be properly disclosing all relevant items to satisfy the liability issue. There are resources available, but the question is whether the you took proper advantage of them and made all the legally required disclosures on any issue with the property there may be. If you have an agent that fails to do this, you can sue them. If you are doing it yourself, the only one responsible is you. You are claiming to be capable of doing just as good a job as the professional, and if you didn't do it right, the buyer is going to come after you.



Now I'm going to leave the marketing and pricing questions out of the equation, because with a For Sale By Owner most folks should understand that in return for not paying a professional to help you, you've got to do it yourself. What many For Sale By Owner folks seem to fail to understand, however, is that if you haven't met legal requirements, the real nightmare may be just beginning when the property sells.



Let's say it was something fairly innocuous, like seeping water from a slow leak you didn't know about. A couple years pass, and now there's mold or settling. Perhaps the foundation cracks as a result of settling. Bills are thousands to hundreds of thousands of dollars. Your buyer goes back and finds that your water usage went up by fifteen percent in the six months before the sale. He sues, saying that even though you didn't know, you should have known based upon this evidence. Court cases are decided based upon evidence like this every day. A good lawyer paints you as maliciously selling the property as a result of this. Liability: Steep, to say the least.



Now, let's look at it from a buyer's prospective. You have a choice of two identical properties. In one, a seller is acting for themselves, in the other, they have an agent. The price may be a little cheaper on the for sale by owner one, or it may not. One of the reasons people do for sale by owner is they are greedy. But when I'm looking at a for sale by owner, the question that crosses my mind is "Are they rationally greedy, or are they just greedy?" Are they going to disclose everything wrong or that may be an issue with the property? At least here in California, the agent has pretty strong motivation to disclose if something is wrong that they know about. If they don't, they can lose their license, and even if they don't, they have potentially unlimited personal liability. If they did disclose, they're probably off the hook, and even if they aren't, their insurance will pay for the lawyers, the courts, and any liability. If there's one thing all long term agents get religion about, no matter their denomination, it's asking all of the disclosure questions.



This is not the case for many owners selling their own property. Some are every bit as good and conscientious as any agent. A good proportion, however, are intentionally concealing something about the property. What's going to happen when it comes to light? If there's an agent, there's a license number, a brokerage who was responsible for them, and insurance. The latter two are deep pockets targets for your suit, and you can find them. Once that owner gets the check, you can find them unless they're dead, but they may not have any money. Even if they do have money, it may be locked up and inaccessible via Homestead or any number of other potential reasons.



One of the reasons that I, as a buyer's agent, am always leery of a for sale by owner property is that I have to figure that first off, there's a larger than normal chance that this property has something wrong that's not properly disclosed. When that happens, my client is going to be unhappy. When my client is unhappy, they are going to sue. The first target is the seller, but if they're gone or broke, who does my erstwhile client come after? Me. So I have to figure that not only is there a larger chance of there being something wrong, I have to figure there is a larger chance of me being held responsible for something I took every step I legally could to avoid. For Sale By Owner properties usually have to be priced significantly under the market in order to persuade me that not only am I doing the right thing by my clients in trying to sell them this property, where my clients have to pay my buyer's agent fee out of their pockets rather than out of the selling agent's commission, but also that the heightened risk of future problems is worth more than the price differential to my clients. Unless the answer is a strong solid "yes" that I can document in court if I have to, I'm going to pass it by in favor of the agent-listed property next door or down the street.



Caveat Emptor (and Vendor).

July first marks one of the turning points in the year for California real estate, as property taxes are collected for a period running from July 1 through June 30. They are paid in two installments, the first due due November 1 (past due December 10) that covers the first six months, from July 1 to December 31. The second is due February 1st (past due April 10th), and covers the second six months, from January 1 to June 30. Other states have different set ups. For instance, Nevada property taxes are paid quarterly.



Now it happens that most folks don't actually pay their taxes until just before the "past due" date. If you have an impound account, the bank doesn't send the money until sometime around December 8th and about April 5th. But they are due and payable on the dates above, and whether you are refinancing or selling or buying, if they are due they need to paid either before the transaction is consumated, or through escrow. Prorated taxes aren't part of refinance transactions. If they're due, they have to be paid, and the current owners need to pay all of them. But for sales, what happens is the property taxes are paid past the date of the sale, or not paid up until the date of the transaction.



Let's pick a date the transaction closes. Say June 15th. The taxes were paid back in April through June 30 by the seller. But the seller didn't owe taxes past June 15th; they don't own the property any more after that. The buyer owes the other fifteen days worth. So the way it is handled is that the buyer comes up with, in addition to the purchase price, fifteen days of property taxes and pays those to the seller as part of the transaction.



If the effective date of the sale was, on the other hand, July 31st, and the seller has paid only through June 30th, then the seller will owe the buyer for taxes for the month of July, because the buyer will be paying those come November. So thirty-one days worth of taxes are taken off of the sales price by escrow and given to the buyer because they will be paying for those thirty-one days worth of taxes in November.



Prorated sales taxes are part of most sales transactions. The only exceptions are those taking place within the periods from November 1st to December 10th, and February 1st to April 10th, where taxes are paid through escrow, and not even those if the current owner already paid the taxes. Be advised that the last couple of days can be tough, especially if you have to walk them in, so if the transaction hasn't recorded at least three or four days before the end of the grace period, you want to go ahead and pay the taxes. If the transaction doesn't close, the government doesn't care why they weren't paid before the end of the grace period; you'll have to pay a penalty for being late.



Caveat Emptor.

The first thing you need to understand in reading any property advertisements is that agents write them to get people to call. They are trolling for clients. Except in the case of someone who doesn't accept dual agency advertising a listing they actually have, they are written purely with the idea of dangling something out there that clients want. Since most agents like dual agency just fine because it means they get paid twice for the same transaction, understand that only a tiny percentage of the ads that are written out there are written for any purpose other that to get potential clients to call.



Keeping this fact firmly in mind, there are two sorts of places where people go to search for property: Some that are based on MLS, and others that are not.



If it's in MLS or coming from MLS, it better be good information. I can (and do) file violations on liars in MLS. So do others - every time somebody wastes our time by saying the property has something that it doesn't. Filing violations in MLS is simple, it's effective, and after a certain low number of violations, the offender's input access gets restricted. They can't put properties in MLS and they might as well be out of business. Note that they can still "puff" a property significantly; but number of bedrooms, square footage, anything with a number or a yes/no associated with it had better be right. The big violation I'm finding most of recently is advertising it in MLS as "fee simple" when it should be either "PUD" or "Condominium". If it's got homeowner's association dues, it's not fee simple.



Everywhere else, everything that is not based on MLS, take all advertisements with a respectful amount of caution - Like at least equal in weight to the building. Once you get outside the domain of MLS, there are few sanctions possible for even the most outrageous puffery - or even advertising a property you do not, in fact, have. Or anything remotely similar. Some agents won't put anything out there that isn't as close to gospel truth as they can make it, but others are not nearly so fussy, and you really want to avoid the latter sort.



Non-MLS based property advertisements may now be pending, it may be sold, or it may in fact never have existed. The agent put that ad in trolling for buyers. What they want is your signature on an exclusive buyer broker agreement, so they can lock your business up. We know you shouldn't sign exclusive buyer's agency agreements, because that's a poor way to get a good buyer's agent, but most people don't know that and most agents are laying in wait for the ignorant.



Quite often, I have clients who should know better, as I've explained this to them - often more than once - ask me about this fantastic possibility they see somewhere else. About as surprising as gravity, they turn out to be in some way non-factual. 2 bedrooms when it's really one. 1 bedroom when it's really a studio or loft. And sometimes, they actually had it, at that price, six years ago. And then I call the agent listed on the ad, look it up on MLS, and voila! the deception becomes apparent.



There's nothing wrong with responding to such ads, and there's nothing wrong with working with the agents who advertise them, so long as you limit yourself to a nonexclusive agreement, so you can get rid of them when it become apparent they're not guarding your interests. But even with a non-exclusive agency agreement, I'd be asking myself "If they lied to get get me to call, what else are they going to lie to me about?"



I just had a client send me three prospects from one of the non-MLS based search services. All three of them were non-existent, posted by a lead generating service as bait so they could sell everyone who respondended as a lead to agents. They didn't have it, they never did have it, it wasn't even for sale, and hadn't been for over 10 years. But that's how they get leads, which they then sell to several agents.



Here's another sneaky trick: Services advertising themselves as foreclosure specialists go around to all the properties that have a trustee's sale happen. They illegally put a sign in the yard, relying upon the fact that the property is vacant, directing passersby to a phone number. On the phone number, they put the puff description from whatever the last time was that it was in MLS, whatever they can see, or something they can pull from assessor records. They say they have an exclusive listing. What they really have is nothing. I've tried contacting lenders before their new lender owned property gets listed. Even if I have a buyer willing to make an offer, they usually don't want to hear about it. What the places who claim they've got "foreclosures before they're listed" are doing is trying to get suckers to call - in other words, trolling for clients. They simply know that the lenders are eventually going to put 99.999999 percent of these on the market within a few weeks, and they can fend you off until then. They aren't offering anything real. They don't have anything real. They are doing nothing beyond trolling for clients who will generate easy commission checks. They don't have to even sell you that one. If they had anything real, when I call for a client they should be falling all over me, like the agents that really do have foreclosures. Those agents who really do have lender owned listings are falling all over themselves to get back with me. The troll services take my information and say, "We'll have to call you back," and they just don't. I call again, they do the same thing. I ask who's the listing agent responsible for a property and what number to call to contact them, they don't have an answer. Then it comes up on the MLS, and the agency that's been advertising it is nowhere in sight. This is different from people who are buyer's agents who have legitimately gone out and found bargains - because they'll tell you they want to act as buyer's agents. In the first case, they are claiming to have a listing that they do not, in fact, have. In the second case, they are claiming to have found a bargain, and are telling you quite straightforwardly that they are looking to represent buyers. that's what I do. But when you're acting as the agent for the seller, you're not supposed to say anything that violates a fiduciary relationship - in other words, a listing agent is supposed to pretend this property is the greatest bargain since the Dutch bought Manhattan. It's in the job description, not to mention the contract.



So be aware before you respond to property advertisements that quite often, advertisements don't exist. To avoid leads services, look for specific names of the agent in the advertisement. To avoid problem agents who require an exclusive agency agreement before showing, simply refuse to sign exclusive agreements. Dual Agency is a very bad idea for buyers. If they have the listing, they're going to get paid when the property sells regardless of whether you signed that agreement. If they don't have the listing, they still risk nothing with a non-exclusive buyer's agency agreement.



Caveat Emptor