Beginner's Information: December 2007 Archives

At a very young age, my parents bought me a book of Aesop's Tales. Aesop has gone out of style, probably because these are stories with a moral lesson, and it seems the modern society is actively averse to moral lessons. But one of the ones that has stuck with me was the tale of the dog with a bone and the reflection in the water.

It happened that a Dog had got a piece of meat and was carrying it home in his mouth to eat it in peace. Now on his way home he had to cross a plank lying across a running brook. As he crossed, he looked down and saw his own shadow reflected in the water beneath. Thinking it was another dog with another piece of meat, he made up his mind to have that also. So he made a snap at the shadow in the water, but as he opened his mouth the piece of meat fell out, dropped into the water and was never seen more.

It is precisely this mistake that I'm writing about, and it applies to all real estate transactions. The dog's mistake wasn't that he wanted more. That's normal and natural, and I've certainly never done business with anyone who didn't. The dog's mistake was wanting the other benefit as well as his own, and not realizing he placed the benefit he thought he already had on the line in order to obtain it. But, as he discovered, the goodie that the dog in the water had was only a reflection of his own goodie. In order for the dog to have his own goodie, the dog in the water had to receive his. They are mirror images of the same thing, and one cannot exist without the other.

A lot of what gets written alleging to be good financial advice violates this very simple lesson.

Some things are a cost of doing business. If I don't pay for all the things that enable me to serve my clients, I'm out of the real estate business. Yes, they cost money, but if I didn't spend that money, my income would be zero. For consumers, this includes things like property taxes and HOA dues and Mello-Roos. If you want that property, they are inseparably attached. It is correct to include them in calculations as to whether a property is worth acquiring or worth keeping; it is not only pointless but counterproductive to try and get out of paying them.

This applies to the costs of acquisition and selling, as well. Be certain you understand the real costs involved. They may be large, or seem large, but doing without any of the professional services that have evolved is likely to end up being a lot more expensive in the end. If one is cheaper than another, there is a reason. Find out why; and while it may be that someone is just comfortable making less money, other explanations are such as they do not provide important services that really do make a difference are more likely to be closer to the truth. Don't expect them to tell you this, though, especially since most people will just believe fairy tales like "full service - discount price", and won't investigate why prices or loan quotes are lower. It shouldn't surprise any adult that sometimes it's worth paying extra. If this were not true, none of us would have our own cars, let alone seven seat luxury model vehicles. Cars are about the most expensive mode of transportation there is, but the vast majority of all adults in this country own and drive at least one. Including me. The reason is because the abilities they convey are more valuable than the costs they entail. if you don't pay the cost, you don't get the benefit, and yet many people will fool themselves into trying.

Most importantly, though, the lesson applies to negotiations for the sale of real estate. There's nothing wrong with making the best deal you can, but once you have the contract, honor your end of the bargain. Negotiate issues revealed later reasonably, and in good faith, based upon their own merits. It sometimes happens you find out the other side is getting something fantastic out of the deal. That's not a problem. It's a benefit. Insurance they're going to carry through with their end of the deal, which is a good thing because you wouldn't have signed off on it unless you thought you were getting about the best deal possible, right?. Real estate transactions are based upon making both sides happy with their side of the deal. You can't force someone to sell a property to you or buy it from you. Even attempting that is a felony. There can be circumstances that make it more likely someone will accept a proposal that they might not in other circumstances they would not, and very few people have unlimited time, money, or energy for a transaction to happen. But whatever the other person - other people - in the transaction are getting out of it, those benefits belong to them, and if it appears as if those benefits are in jeopardy, the other side can usually get out of a purchase contract. It may cost them something in some instances, such as the deposit, but successful suits for specific performance are rare, and more so where there's a competent agent involved on that side. Not to mention all those court costs.

The practical upshot of all this is that if you fail to act in good faith, that good deal that you thought you were getting is completely gone, and there's a significant chance you'll end up spending thousands of dollars on legal action as well. Figure that if the other side wants out, they can get out. In fact, many over-aggressive later negotiations give the other side grounds to exit the contract without penalty. Nobody's going to buy a property where they can't run the water or flush the toilets, but once the sellers agree to fix that problem in an acceptable manner, don't try to get anything extra out of them. If the septic system is bad, they can either install a new one, (maybe) fix the existing one, or hook the property up to the sewer. Asking them to re-plumb the entire house is not (usually) reasonable, and asking them to re-wire the entire house is, in the immortal words of Monty Python (Book of Armanents, chapter two, verses nine through twenty one), right out. If you find out you're not getting such a great deal, then you're likely to be the one looking to exit the contract, and if they fail to give you satisfaction with a newly discovered issue, maybe you should want to. There's nothing wrong with exercising the inspection and appraisal contingencies, assuming you have them in the contract, or forcing the buyer to consummate the transaction or get out of the way of someone who will, or getting the lender to deliver the loan they said they would.

Greed envy is one of the banes of a successful transaction, and if you don't have a successful transaction, you don't have anything positive, and you quite likely have significant extra expenses. To go back to the dog and the bone, a failed real estate transaction is worse, because not only have you lost your bone, you've lost everything you spent in obtaining it, and you still don't have what you wanted, whether it is your new property or cash for your property or new financing. If you make your initial choices based upon the benefits to you, the fact that someone else is getting a benefit as well is not something to cause you heartburn and make you want to take it away from them. That way lies disaster. Instead, think of it as insurance that you're going to be getting that benefit that you wanted enough to sign the contract or loan application in the first place. And if you're not going to be getting the benefit you thought you were, maybe you're the one who's going to want out.

Caveat Emptor

I got a search for how one spouse could sign while the other was out of town, and act on their behalf. Since both spouses usually need to sign real estate papers, this is a real concern.

Actually, almost anybody you designate can sign for your real estate transaction, whether or you're available. The usual thing is you're out of town for some reason when closing happens, and so your spouse signs for both of you, themselves in their own right, and you by Power of Attorney, but it covers all kinds of situations, and not just real estate.

The document required for this is called a Power of Attorney. You must sign it and have it notarized that it was really you that did so. In it, you designate one particular person who has the right to undertake an action or group of actions, and they then act on your behalf, as your "attorney" for this matter.

Powers of Attorney can be made for all sorts of things, not just real estate transactions. For instance, pretty much everyone should have a Durable Power of Attorney for Health Care. Powers of Attorney can be very broad and ongoing or limited to one specific action in a limited range of time. You set this up at the point in time when you execute it. Whatever terms you set up when you signed it are binding, both upon you and the person you designate. Most stationery and office supply stores have ready made ones where you just fill in a few blanks and you're ready to have it notarized. I've seen ones with boxes for check marks, but those are dangerous in my opinion, as when a particular check mark was placed on there is a matter for considerable legal dispute.

It is a misconception to believe that this person must always be an actual licensed attorney. In general, they need not be an actual attorney, only a competent adult. I'm sure there are circumstances when being an attorney is necessary, but it is not necessary most of the time. There may be circumstances where you may want a licensed attorney even where it is not legally necessary, but there's a major difference between being legal and being smart.

I've seen not only spouses used, but other relatives, close friends, and professionals such as accountants and attorneys. Note that the person you designate does not have to accept, and does not have to act even if they accept. The idea is to get their consent first, and make certain they know your mind in the matters you designate them for.

Extremely important: You really need to trust the person you designate to act in your best interest. If they sign something that you would not have, you are still stuck, as long as it is within the mandate of that power of attorney. Whatever contract they signed on your behalf, you have to live up to the terms. Your designate doing something you would not have is a side issue between you and the person you designated. That person with your power of attorney designate's signature on a contract can force you to live up to that contract, which is how it should be. Otherwise, nobody would accept powers of attorney, and they would be regarded as one more way to run a scam. They're not supposed to be a scam at all, it's intended to be a way for one person to do another person's business legitimately.

Caveat Emptor

One topic I haven't covered yet here is homesteading. This has nothing to do with the Homestead Act of 1862 that encouraged settling the western United States.

A declaration of Homestead basically protects your equity. In many cases, you may not even have to file a declaration to receive the benefits, but whether this is so is complex. If you file, you remove the ambiguity.

A homestead declaration may only be filed upon a primary residence, and only if you own it. Rental property, second homes, and property held for business purposes is not eligible. Law between the states varies, as does the exemption amount

How it works is pretty consistent. First off, it protects no equity arising from dates prior to declaration. If you are in one of those situations where you have to explicitly declare homestead instead of it happening de facto, you have to actually declare it before the incident happens. You get in a traffic accident that's your fault, and go out and declare homestead the next day, it won't help you protect your equity against that particular lawsuit.

Note that it protects your equity, not your asset value. If the home is worth $500,000 (as is often the case in San Diego) but you owe $400,000, you have $100,000 of equity. How much it protects is dependent upon your state law and exact situation. Default protection in California is $50,000, but it can be up to $150,000 if you or your spouse are 55 or older, disabled, or have income less than $15,000 per year.

It can also prevent sale of the property in some, although not all situations. In California, the judgment creditor usually has to get a court order, after they have won the judgment, in order to sell the property. I'm not a lawyer, so I'm not going to presume to advise anyone on what those circumstances are.

Now, there is some question in some minds as to whether a homestead declaration inhibits enforcements of Deed of Trust, so many lenders will require an abandonment of homestead prior to funding their loan. You can always re-declare as soon as the loan funds, anyway. I know that some folks have fought this issue in court, costing the lenders money to pay their lawyers, so it's hard to blame the lenders for requiring it. You can refuse to do this, but they can also refuse to give you the loan. It's their money, and they are the arbiters of how they lend it out.

Caveat Emptor

Having done both, there's no question in my mind. For the average person and the average transaction, the buyer's agent makes a lot more difference. In the aggregate, a good buyer's agent has the opportunity to make a lot more difference to the situation than a listing agent.

There are exceptions. I don't know any rule of thumb that don't. But the leverage is all on the side of the buyer's agent. There is nothing about the situation that the listing agent deals with that does not have its roots in the purchase of that property.

That listing agent does a lot of work, and provides a lot of value. They have absolutely no input, however, on the identity of the property being sold. You can clean it, paint it, put additions in, landscape it. It's still the same property the people originally bought, however long ago. Nothing that listing agent can do is going to change the location or basic construction. If those are a problem, it's because of the buyer's agent, who could have directed the owners to a different property. Without a bulldozer, nobody is changing the basic construction, and nobody is changing the location of the property, period.

Maybe there was no buyer's agent. The observation stands. Whether the people acted as their own agent or went along with Dual Agency, somebody did it. If a better buyer's agent, or one actually working for the buyers, could or would have brought something to the owner's attention that led to them not making an offer on that property, they wouldn't own it now. Therefore, it lies squarely in the purview of the buyer's agent.

From the first moment prospective owners consider visiting a property, the buyer's agent is involved. Even before. The buyer's agent should be working with the prospective owners on what they can afford, what they must have, and what they can live without. Everything in real estate is a tradeoff. Price versus number of bedrooms versus location versus time to buy versus literally hundreds of other characteristics. Amenities that will make a positive difference later, whether in price or in ease of sale, are a buyer's agent's responsibility, as is keeping people from paying extra for things that don't make a difference.

Your ability to enjoy a property for the period of time you live in it traces directly to how well the buyer's agent did their job. All of that time you lived in the property, whether you realize it or not, you were either praising or cursing that buyer's agent. Maybe you could have done better with a bigger budget - but the buyer's agent can always make a difference. Maybe you could have done better with more patience -it's up to the buyer's agent to make that clear. Whether you're able to rent it afterwards, how easily and for how much, the marketability of the property when it comes time to sell, the repairs you have to make, and the differential between that property and the rest of the neighborhood as far as desirability and sale price, all trace back to how well the buyer's agent did their job.

Owners can modify property. The buyer's agent should have made clear what's likely to make a difference in the sale price, and what's more likely to end up being simply for your own enjoyment. Most major work typically does not return anything like 100% of the cost in terms of sale price, meaning the remainder of that cost had better be indicative of how much enjoyment you personally got out of it in the interim. A good agent will go over likely remodels that will do you some good, whether they're helping you buy or sell, but truthfully, in which case is it more likely you'll do some significant work?

The most salient part of a buyer's agent's job is to keep you from wasting money - paying more for the property than you can get an equally valuable property for nearby. By the time the listing agent comes on the scene, that's a moot point. The property is what it is and is worth what it's worth. If it's good, the listing agent has a much better success story. If it's not, all the listing agent can do amounts to rearranging the deck chairs on the Titanic. On listings, it's really rare that I have have more than two weeks to work with a property before it hits the market. I can help the owners make what's there more visually attractive, but I can't really change it much in most cases. When I'm helping buyers, the vast majority of the time I can keep them from dealing with a problem property at all.

When I'm listing, my clients own a property, and they would like to exchange it for cash. I can get more people interested enough to view it, I can stage it so it's more attractive to them, and I can definitely concentrate my efforts on people fitting the property in terms of lifestyle and requirements. But the property itself pretty much already has to fit their requirements, at a price they can afford. If it doesn't do the former, they won't make an offer, and if it doesn't do the latter, the escrow will fail, as the era of make-believe loans is over. I can't really make a two bedroom structure into a three, no matter how many agents try by entering the larger number. I can't magically add another tub, or an entire bathroom, either. If the lot is 5000 square feet, steeply sloped, and planted in water efficient desert plants, that property is not likely to be attractive to the family who wants a place for their young children to play outside. Potential buyers are going to figure the basic elements of this out, and they'll do it before they make an offer. It's not like it requires any intellectual feats more impressive than Og the Australopithecus was capable of. Or even George of the Jungle. I can market the property ahead of this curve, or behind it. The former leads to fewer showings, but better, more qualified prospects. The latter leads to frustrated clients who have opened their house to dozens of prospects, but no offers. That's one of many real differences the listing agent makes.

But when I'm helping some people buy, the only limits upon the process are the number of properties that match my client requirements. My buyer has either cash, or the ability to get it, and that's what every seller wants. Consider groceries: With two or three dollars you can always walk into the store and buy a loaf of bread of your choice. But if you choose the wrong loaf, changing that loaf of bread back into dollars is a lot more problematical. The same thing applies, greatly magnified, to real estate.

Good agents can spot most of the signs of destructive settling, of likely non-permitted additions, leaky roofs, bad plumbing, ancient wiring, and the vast majority of the time, good agents will talk clients out of a problem property before it gets to the point of an offer, and steer them to a property that they're going to be much happier with (and usually for about the same price, if not less). This translates to a property that's much easier to sell, and for a higher price, than the one I talked them out of. Not to mention fewer, less costly repairs, and increased general enjoyment for the time they live there. Not to mention administrative details such as if the sellers of the Nightmare (house) on Elm Street never have my client's deposit money, we definitely don't have to go hand to hand combat in the courts to get it back, and if they don't get into a bad situation in the first place, my clients don't have to pay attorneys to get them out of it - Maybe.

If our clients want to know what my company's stake in them buying one property versus another, I think we should tell them (once we look it up). It shouldn't be relevant to the thought process of either client or agent. Either this property is the one with the better trade-offs for the buyers, or it isn't. If it's not, I shouldn't be trying to sell it to them. If it is the best possible purchase, the fact that the seller wants to pay my company eight percent of the sales price to get it sold versus two and a half or three doesn't make it not so (and no, I've never seen anything higher than five, although the ones offering more than customary are as likely to be overpriced as the ones offering too little, and more likely to have problems that will be revealed at some point in the escrow process). If my client wants to weigh my motivation, they're entitled to do so. If I need to do some introspection on my own motivations, pretending I don't isn't going to help me. But the vast majority of the time, it means I need to explain myself better, and show the client so they can see what I'm talking about with their own eyes.

When you really think about who makes the most difference to the future of the prospective client, basically all of the factors line up on the side of the buyer's agent. There is usually nothing about any situation any listing agent ever deals with that does not have its roots in an issue a buyer's agent did or did not deal with. Talk with successful, experienced, long term, multiple property investors. They'll tell you the same thing - they made most of what they made because of what they bought or didn't buy. The money was really made on the purchase; the sale only formalized the exact dollar amount. This also illustrates why you need to be able to get rid of ineffective buyer's agents, hence my recommendation of non-exclusive buyer's agency agreements. It's easy for agents to talk a good game in the office, and it's easy to burn a few listings they don't really want you to buy. You want someone who will continue to be a good buyer's agent, because they haven't got you trapped by their agreement for months. The vast majority of the people I work with never go see another agent, but that's always their choice, because they know from having seen me in action that they're not likely to find anyone as good, not because I have them stuck in an exclusive agreement for six months. Show me someone who requires an exclusive agreement, and I'll show you someone who isn't secure in their own ability.

Caveat Emptor

Real Estate Boycotts

I simply love: "Fear and Greed, or How Did the Housing Bubble Get so big?

I'm not sure if you are aware that there is a grass-roots group that is starting a "boycott on housing." They feel that the prices in the San Francisco Bay Area are unreasonable.

It's kind of interesting.

The website is at:

What do you think about websites like this? Do you think that something like this is "catch on?" I submitted my vote (I'm currently boycotting myself until my six figure downpayments actually matters in this wacky market). But I was just wondering what your thoughts would be on this issue.

Can boycotters make a difference in the "real estate" game?

I'm outraged at the high cost of food. Do you think me boycotting buying food will have an effect?

Well, if enough of us did, it would have a marginal effect for a while. But people have to have food to live, and creating all of your own food yourself is just not an option for most folks. This leaves your choices as supermarket or starve. Given those choices, I'll take the supermarket (much as a couple weeks without food might benefit my waistline)

The same goes with housing. I went and poked around that site, and just couldn't find any evidence of knowledge of the laws of economics. The only effect that boycotters will have is to marginally reduce demand, thereby slightly reducing prices for those who are buying, for which my clients surely thank you. If you couldn't afford to buy anyway, it makes zero difference. If it makes sense for you to buy but you choose not to, then you are hurting no one except yourself. If you want to do something real about the high cost of housing, you'd do better to read my article on The Economics of Housing Development and act accordingly.

There are circumstances where I straightforwardly recommend against buying. Right now, given the state of the market, those are a lot of circumstances. I could have made a lot more money than I have these last eighteen months had I been a shark. But the recommendation to buy or not to buy is always based upon individual circumstances balanced against the state of the market.

The clients I'm pursuing right now are those who are looking for a place they can be happy in for the next ten years. Speculators, Flippers, and other players of real estate roulette have mostly gotten the message and dropped out of the market anyway. Given past performance and the approximate size of the bubble (roughly 30 percent at peak in San Diego, in my estimation, which has since deflated by about 20 percent), the speculators who are left are like participants in a game of musical chairs who don't yet realize that the music has stopped. On the other hand, those who need a place to live and can afford it will do very well once prices recover in a few years. I know this from personal experience; I was one of those folks who bought near the peak of the last cycle. Furthermore, with the desperation of many sellers, the bargaining is highly favorable to my buyer clients right now.

There are also significant and increasing opportunities in distressed properties, providing you've got some cash and are willing to buy and hold for a while, or do some significant work. Distressed properties are not a game for the weak of wallet, because you've got to have a certain amount of cash to play the game decently. Given the state of the market, it's very possible to lose significant money even there, mostly if you're a do-nothing flipper. If you're a buy-and-holder or a fixer upper, there are still places for you to do very well in this market segment.

The third group of clients I'm seeking out is those who were taken advantage of by their agents and/or loan officers, to see if I can fix the situation with a new loan. These are folks who were sold on unstable or unsustainable loans in order to get into the property. I'm not an altruist by any means, I'm getting paid for my work, but that doesn't alter the fact that the client wins also, by being put into a better situation if it can be done. If it can't, I am set up to handle a distress sale to get them out of the situation before it gets worse. I'm not a magician who can make it never happen (and nobody else is, either!), but I can stop the green bleeding. Once the bleeding is stopped, then you can talk about getting some money back for having been the target of a Dastardly Deed™, but those sorts of solutions take years. If you try to get your pound of flesh first, you'll bleed to death long before you might possibly get it, with all kinds of unpleasant consequences.

To summarize, housing is a necessary good, one third of the basic "food, clothing, shelter" that everyone is familiar with. This creates a "need" as opposed to a "want". Mind you, many folks have wants bigger than their needs (and eyes bigger than their pocketbooks), but some market segment boycotting housing will hurt only themselves as rents get higher so that the landlords can feed the loan alligator. High demand is not going away. If you really want to make housing more affordable, start doing something about the low supply of new housing. Artificial scarcity benefits only those who are already owners, and that includes the flippers and speculators who are probably the largest part of the reason for the current bubble.

Caveat Emptor

Appraisal Fraud

| | Comments (1)

I enjoyed finding your blog today. It was enlightening, particularly in the area of real estate appraisals.

Mortgage fraud is something I've been reading about lately. Since the FBI says 80% of it involves collusion and usually with the appraiser, it made me wonder why underwriters don't just ask for second appraisals when a loan looks like it could be part of a flipping scheme (e.g., the owner hasn't had it for long and the new appraisal has it coming in much higher than the last one).

Have you looked at this area at all? I'd be interested in your point of view.

Appraisal Fraud is more of a problem than it was. A couple of years ago, the appraisal was treated and regarded differently than it is now. On the one hand, appraisers were regarded as gods sitting in judgment of a property, which never was true. They're human, subject to human foibles and tendencies. On the other hand, it has perhaps swung a too far in the opposite direction, with many appraisers doing whatever the loan provider wants in order to continue to attract business.

A good balance is somewhere in between. Appraisers don't want to work any harder than necessary, of course, but they've got to remember that they are, first and foremost, business folk selling a service. I agree with the law that says minimum appraisals are prohibited, as it protects everyone. On the other hand, when I ask an appraiser to reconfirm if comparables don't support a value of $X, what I'm trying to do is protect my client. This gives me a chance to re-work the loan, or re-open negotiations with the seller, before my client has wasted hundreds of dollars for an appraisal that doesn't help. Eighty to ninety percent of the time, the appraiser who tells me the value isn't there gets paid anyway, because I can re-work the loan or renegotiate the deal to the point where everybody's happy and the transaction proceeds. If the appraiser just goes out, takes the check, and drops an appraisal that's $20,000 low on my client, I have a screaming mad client on my hands who is poison to my business because in their eyes I was the one who "tricked" this money out of them, and perhaps a seller and seller's agent who are angry as well because I hired an "incompetent" appraiser, with repercussions next time I write an offer for one of my clients, and nobody is happy, least of all me.

On the other hand, an appraiser who is willing to manipulate the data to come up with value no matter what is one I want to stay away from, and it's because of fraud. If there's no default and the loan gets paid back in full, appraiser fraud doesn't matter. But that's not the usual thing that happens with appraiser fraud.

I keep writing that a certain percentage of all attempted real estate transactions are fraudulent, and a good agent and especially a good loan officer keeps their eyes peeled for evidence. Real Estate transactions are very large dollar amounts. A one bedroom condo around here goes for over $200,000. This is more than most families make in a couple of years. An average single family residence might be $500,000 or more. This makes the temptation level considerable, and there are always folks around who have an eye for the quick easy dollar and never mind the effects on others or the prospects of prison if caught. Sometimes the lender is the intended mark, sometimes the other party to the transaction. I could tell you about all varieties of scams, but appraisal fraud is one of the most common.

Before we go any further, let's examine what an appraisal is. Accountants value goods using a method called "Lesser of Cost or Market," or LCM for short. This means a given property is valued for accounting purposes at either the purchase price (cost) or appraised value (market), whichever is lower. But this has been modified from its original form for real estate lending purposes, because in the real world real estate appreciates in value. At purchase, the cost or value argument still applies. No matter what, the lender will not lend based upon a value greater than the purchase price. Later on, however, they will, because land does not depreciate, it does not in general vanish or get used up, and it does increase in value (Pretty much universally over time frames of a decade or more).

This gives scam artists all the leeway they need. Some of them are relatively harmless, in that all they're looking for is a better rate on a loan that they do intend to repay. This doesn't mean it's smart to cooperate with them, as many agents and loan officers who did are likely to discover quite soon, as the loans default and the lender investigates why. The balance sheet reads a little differently when you discover that cooperating with the guy who just wanted to cut a few corners is going to cost you your license.

Appraisal fraud, however, is usually aimed at a large quick score. I'm going to keep my examples basic, lest I inadvertently release a couple more ideas into the wild. Let's say you own a property that's worth (pinky finger extended) one million dollars. You owe $900,000. If you sell, you're going to net about $30,000. But if you can persuade a buyer that property values are increasing much faster than they are, many will bite off on an increased sales price. You tell the appraiser "Appraise it for $1,250,000 and it's worth $25,000 to you!" He does so. You pay him his $25,000 and your net is still around $235,000 to $240,000. It's fraud, but fraud that many folks have gotten away with because the buyer doesn't realize he's been had and keeps paying the bank. Or you can't keep up the payments but want to walk away with as much cash as possible. Instead of a distress sale, where you'd be very lucky to break even with a sharp buyer's agent, you pay the appraiser $25,000 to appraise it at $1.25 million, refinance for cash out to maybe 90 percent of that value, pay the appraiser and walk away with a cool $200k, never making a single payment on the new loan.

Appraisal fraud can also be intentionally low. A buyer wants to buy the property, pays the appraiser to appraise it low, and renegotiates the price. I had this tried on me about two years ago. It didn't work.

Now once upon a time, there were real constraints to keep an appraiser from pulling this, on residential properties at least. To a certain extent, there still are but those guidelines have been relaxed due to the hypercompetitive market we've had the last few years. For instance, it used to be that the lenders would accept a value for a property on a refinance no higher than an annualized increase of 10 percent for the first couple years. That's gone by the wayside, as lenders get used to the fact that values are increasing faster than that. With many lenders, it's whatever the appraiser says the day after the sale. This is an invitation to fraud. Invitations to fraud do not excuse fraud, but they certainly make it easier. It used to be that no matter what, you couldn't pull cash for six months after a sale. That's now changed.

Underwriting in many lenders no longer has to pass a "smell test," where the lender pulls up the local market and sees what similar properties have really sold for recently. They're competing for loans! First time they tell the folks "no" that loan officer may not give them any more chances to do loans, choosing instead other lenders with more accommodating employees and policies. They have to do loans to stay in business, and avoid layoffs, but those lenders with more accommodating employees and policies are going to be in a world of hurt if the local market cools much further.

Now appraisers that do this are subject to discipline and legal penalties, starting with the fact that the lender has the option of never accepting one of their appraisals again and going up through loss of license and jail time. I'm not up on the penalty structure, but fraud that costs in excess of $100,000 is a serious felony. They've got the appraiser's name, license number, and other identifying information. In my opinion, aiding and abetting fraud is stupid and if you can't get them to fly straight, walking away as quickly as possible is your best option, but real estate compensations (and the amounts at stake) are large enough that many will do it. If you're not a pro yourself, your best protection is a good agent that's working for you, not splitting loyalty between both sides of the transaction, and making sure somebody working for you is there at the property to meet the appraiser.

Caveat Emptor

I had the idea for this article some time ago. It took me a long time to decide to share it publicly, because quite frankly, knowing what I know now, I was an idiot. I was still young enough to think I knew more than I did. Now that I've learned a lot more, I still don't know what I thought I knew then, but I'm getting closer. When I repeat transactions of this nature now, I don't repeat these completely boneheaded mistakes.

The year was 1990, and I was still working for the federal government in my first career, air traffic control. Controllers are not your most humble of people, and for better reasons than most. Most days, I could go home secure in the knowledge that without me there, a couple of airplanes would have crashed together, and even if everyone walked away from it, however unlikely that was, there would have been anywhere from a couple hundred thousand dollars in damage to millions. But, as you're about to see, this has nothing to do with competence in real estate.

Before I go any further, let me tell you that things could have been much worse than they ended up being. I understood a lot of things about real estate and finance, even then. Even then, I knew enough to know how simply full of excrement most of the people claiming do it yourself real estate was the way to go were. Ignorant. Guilty of wishful thinking. Neglecting terms in mathematical equations. Just plain wrong.

I simply thought I was better than that. At the time, I thought I did pretty well. But in retrospect, boy did I get taught a lesson by a pro.

Let me tell you what the problems weren't. It wasn't that I didn't understand how to check out a property. I grew up a contractor's son. From the time I was old enough to wield a paintbrush with a modicum of control, I was helping my dad on his projects. Some of my earliest memories are of helping my dad mix and pour concrete. You name the project, I've pretty much done it. I learned how to spot construction defects, problems, and things that needed to be fixed before I figured out that girls didn't have cooties. I have an excellent idea of what's involved in fixing most of them, much better than you get by watching any of those home repair or decorating programs. Furthermore, I had my dad with me to help me spot potential problems.

I did pretty darned good on the loan. Through both intentional and accidental learning (i.e. formal classes and having friends and co-workers older than I was, and listening to the problems they had had), I had a pretty good understanding of the pitfalls there. I knew what the options to compare were, and I knew why a 5/1 ARM is better than even a 7 year balloon, and how both compare to 30 and 15 year fixed rate loans. Through the financial markets, I understood that there was a tradeoff between rate and cost. I could have maybe shopped it a bit more, and probably should have taken a less expensive loan, but the higher cost for the lower rate worked out in my case.

(Amazing that for all the "do it yourself without an agent" advocates out there, I've never encountered a single person encouraging you to be your own loan broker, despite the fact that I can get a newly licensed person up to speed on common loans a lot more quickly and easily than I can teach them the rest of what they need to know to act as an agent)

My problems wasn't location, or lack of knowledge of the area. I bought less than three miles from my mom's house, about four from my dad's. I had been on that street at least dozens of times prior to buying that property. I knew the area cold, and I love the area even today.

It wasn't a failure to shop, or not knowing what would do well upon resale. I did my homework, and looked at a dozen properties before I made my offer. It certainly wasn't failing to do research, on the internet or elsewhere. I read several books that are still well-regarded today. Yes, this was before the World Wide Web, but newsgroups and forums existed back then, and were easy to access, and I always had a good internet connection. It's become easier to use the internet since then, but the signal to noise ratio has gotten considerably worse. Not that it was stellar in the first place, but I find more spectacularly wrong "information" out there now with an agenda of selling some thing or idea in particular, than I did then. At least in the newsgroups, you could always count upon having opposing points of view. Just surfing the world wide web, you're at the mercy of the publisher of that particular website if you don't know any better.

Now here's what the problem was: My ignorance. Ignorance of the market, ignorance of procedures, ignorance of what everything meant and the implications thereof.

Let's be honest. It could have been much worse than it was, even with everything else covered.

What I was paying attention to was asking price, not comparable sales. Furthermore, since I hadn't been in any of those comparable sales, I didn't have the basis for a valid comparison and pricing. That listing agent did. Furthermore, the local real estate market at that time was getting ready to fall, much like things were in much of 2006. Sellers were just starting to realize things were not likely to fall their way in the future. A good first offer would have been $10,000 less than I offered, then negotiate hard, and settle on maybe $8000 less than I actually paid. Considering prices were much lower then (still under $100,000!), I overpaid by about 10%, and there were enough properties on the market, and few enough buyers, that if they hadn't been willing to negotiate, I could have walked away and found something just as good for about that price in the exact same area.

It gets worse. Because I didn't know what local procedures were, I ended up paying just under $3000, more than a buyer's agent would have made, in various fees that were really the seller's responsibility. Not to mention using the wrong escrow and title company.

All told, my ignorance cost me somewhere between ten and fourteen thousand dollars, out of a purchase price significantly under $100,000, and it could have been much worse. There were no issues with title of construction defects or anything else. This meant ten to fourteen thousand dollars more to pay interest on. Rates then were higher than most people have since become accustomed to (The seller was proud of the fact they had an assumable loan at 10%). I can do a better loan cheaper today on a thirty year fixed rate basis than was available on a 5/1 ARM back then. On top of that, it made the difference between not needing PMI on my loan and PMI being required, at about $80 per month in addition to the extra interest. PMI used to be much more expensive than it is now, also, and the whole piggyback loan thing was not yet a real option.

Lest you not understand, the listing agent was doing nothing other than her job with all of this. She was responsible for getting the best possible deal for her seller. If a sucker swam into the net, so much the better. I understand this now. I didn't then.

One more thing that may not be clear to the average reader: Most real estate transactions doesn't get dissected like this, in retrospect by someone who is now a trained professional with lessons to learn from it. Most people never realize how much they've been taken for, and I did a lot of things right that most people working on their own behalf don't.

Why did I make this mistake? I was in, "I don't want to deal with sales people!" mode, even though that's precisely what I was doing, and even if it had been "For Sale By Owner," that doesn't magically change the fact that the person who wants to sell it has become a sales person by that act. I was so focused on "not wasting money with a commission," that I rationalized doing one of the biggest transactions of my life without expert help. Even if I had ended up paying the buyer's agent commission out of my own pocket (I wouldn't have) that would have been at most a quarter of what not having one cost me, and it could have been much worse. Even so, I rationalized my way into completely wasting four to five times the amount I would have spent. The difference between 99 percent of the "do it yourself" crowd out there and me, is that I have subsequently looked at what happened with more experienced and educated eyes, even though what I have now learned makes me want to hide my face in embarrassment.

I could pretend it came out better than it did. This was before I was married, and the only person who was hurt by this was me, and my wife wasn't there, so she doesn't know enough to keep reminding me about what a loser I was (not that she would). But that wouldn't help me not to make the same mistake again. I can have my ego and false illusion of invincibility, of thinking "I'm da MAN!", or I can face my mistakes, learn from what I did wrong, and not make those same mistakes again. I know which bodes better for my financial future, and that of my family. I've decided I can take the ego hit more easily than I can take repeating the same mistakes next time, let alone for one of my clients. I've since acquired one of the most valuable skills anyone can have: The ability to assess when you're beyond your level of competence. I've done a lot of loans since then, and a not insignificant number of real estate transactions, and I keep learning new things with most of them. The largest difference between me, now, and me, then, is that I've learned a lot more about the problems with believing you know something that is not, in fact, true, and how to investigate and research and just plain ask other professionals who have previously dealt with a given issue. This knowledge and experience and skill doesn't come at a price most people consider "cheap". But it will save most likely save you several times what it costs. Offer most people the choice between spending a flat $1000 or a ninety percent probability of being forced to spend between $4000 to $5000, and the rational, logical choice is obvious. It's the cheapest insurance you will ever buy, in terms of real cost to expected benefit - you're getting several times the expected value in return. Now consider that with property values several times higher than that now, the amounts at stake locally are ten times that or more.

Caveat Emptor


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