X-Pert Knowledge: February 2007 Archives

Dear Mr. Melson,
I was wondering if you could offer some insight re: the other side of the equation: what to do *after* you've bought a vampire property.

We bought one, quite by accident, despite a house inspection by a certified inspector and an additional mechanical inspection. Turns out we had a huge lemon. It was a combination of inexperience and bad luck. Some things were hidden really well. The owners were drug addicts, and their agent spent $6000 making the place look nice (we learned this upon closing, when we saw that $6000 of the profit was
being paid to the agent on top of her fee). For the things that were more obvious, we thought the costs of fixing them wouldn't be as bad as they were, and our inspector didn't do a very good job of explaining his findings and their implications. The mechanical inspection was a joke. Our agent didn't represent our interests very well. And we were stupid, too caught up in the process to understand the red flags. Despite some poor representation, we blame ourselves.

We're not going to pursue a lawsuit with deadbeats since collection notices for their accounts continue to come to our house. So I guess I'd like to hear a professional perspective on how to handle a house like ours. Yes, we're looking into more work and income, but we have some limitations in that arena. We can't be the only idiots! If you have any suggestions, I'm sure there are a lot of us who'd appreciate it.

This is why I emphasize the importance of education and prevention. I am once again embarrassed on behalf of my profession, and offer you loads of sympathy, but there is no way to make it not happen. Unfortunately, this kind of scenario is all too common. People get caught up in the emotion of the fact that they're Buying a House! That We Will Own! It will Be Our Very Own! and then, because they were so caught up in the emotions of the moment to really examine the situation, they ended up buying a Vampire Property.

Indeed, a very large proportion of my profession makes a habit of building those emotions specifically so that you won't examine the situation. Not so much that they're intentionally trying to mess with folks, just that they don't care. They want a fast, easy transaction that results in a commission check, and they just don't care very much what happens after that.

I encourage everyone who reads this site to test their Buyer's Agent for attitude. Anybody can point out nice things in a property. But the true test of the attitude you want your Buyer's Agent to have is "Are they willing to say bad things about a property?"

Properties that are real bargains are never perfect. Actually, if it is perfect, odds are overwhelming that it will be overpriced. That's why the current owners put all that work into it: They want some innocent suckers to come along and plonk down way too much money because the property is "Just soooo beautiful!"

Now, as to your situation. You're right not to sue the broke deadbeats - sue those alleged professionals who did not represent your interests despite being paid to do so. To wit, the inspector and your buyer's agent brokerage. Depending upon your state, it may be that you even have a good shot at the listing agent and that brokerage. It's one thing if they honestly didn't know about the property's faults, but it's quite a different thing to spend $6000 hiding problems. That evidence puts a good strong bit of presumption on your side. Talk to a lawyer.

Not an optimal solution, but the reason I'm so big on education before hand and preventative measures is that once it's done, there is no going back to the way things were before. A lawsuit takes a long time, and doesn't make it all better, but it may give you some of the wherewithal so that you can make it better yourselves. In the meantime, of course, you're miserable.

Now the neighborhood must have been attractive to you, and odds are that you can improve the situation with some work. It might not be wonderful, but you probably have a property you can live in while dealing with the problems as you get the time and money to do so. "Make the best of the situation" is a rotten thing to be telling someone who thought they were getting their dream home, but we're all adults in the real world here. It's going to take time and money and a lot of work and it isn't going to be pleasant, but you can almost certainly improve your situation if you make the effort.

For Buyer's agents, it really is all about attitude. I can teach newer agents everything I know about construction and negotiations and all that agent stuff a million times easier than I can teach attitude. It's about being willing to walk in and tell people "Don't buy this POS, let me find you something better," instead of trying to sell every property. That's the listing agents job. The Buyer's Agent's job is to debunk the Male Bovine Fecal Matter. It's about honest evaluation and compare and contrast the benefits and drawbacks of each property with those of similar properties, and working within your budget, instead of grabbing commission checks as fast as possible. Sure, I do it because I want to get paid, but when the transaction closes I want to be proud of myself, not want to take a long hot shower to get the slime off.

Preventative measures: If you know about an issue, don't take an agent's word, or an inspector's word, about what it's going to cost to fix. Get a contractor out there who's willing to give you a repair estimate during your contingency period at the latest. If someone who can fix it tells you how much they'll charge, that's better information than anything anyone else can give.

A good Buyer's Agent is not afraid to give you their best honest evaluation of the good and bad points of a property - not just for living in, but for resale when you eventually do. When I take prospects out hunting, most of them drop their jaws the first time I say something uncomplimentary about a property. How can you honestly represent someone's best interest if you won't tell them about the flaws you see? Nonetheless, many members of my profession won't.

You can sell properties by being honest. It just takes a little more effort. And everyone except the owners of Vampire Properties are a hundred times better covered against "unhappily ever after" I'm making two offers right now with prospects who know all the warts that I do. What happens if they find something else after it closes? They are going to know that it was something I had no clue about. They'll call and tell me, I'm certain, and I'll go look so as to increase my knowledge. But that will be the end of it as far as I'm concerned - they're not going to sue me. Even if they try, a good lawyer is going to tell them they're wasting their money. But they are going to know that I did my best to protect them, no matter what happens.

There is a move afoot to make being a real estate agent into being a transaction facilitator. Many agents, particularly at the big chains, are trained to make it clear that that's their job function. They are not inspectors, market evaluators, or anything else. But they simultaneously want to be paid an expert's commission. Not going to happen. If that's all you've got, disintermediation is going to eat your business for lunch. There's no reason why the same person who processes the loan can't do that for an extra $500 - as opposed to regular real estate commissions. The first question I ask discounters is why they should get paid as much as they do, because I can point to flat fee open listing services that work just as well for far less. But the average home buyer is not an expert, and is not financially equipped to undertake, or even to understand, the risk that the person at the beginning of this article was on the losing end of. The reason that I'm worth every penny of what I get paid is because I've taken the time to learn what is necessary to act as their expert, as well as coordinating the real specialists, and prevent this sort of problem before it happens.

After the above was written, I got a follow-up email:

Thanks so much for your response. I usually reply a little faster to emails, but I have a sick toddler and was in crisis mode for a couple of days. I do really appreciate your taking the time to write.

I'll talk to my husband about approaching a lawyer. I think he feels it's probably not worth the effort and money, and that given our situation, we should save what we have to fix the house. He might be correct, but we should talk to an attorney anyway.

I agree with you that it's about attitude. We asked our inspector and agent for their opinions on the house, and they both hedged. We asked because we didn't understand everything, and when we didn't get a real opinion from those folks, we tried to educate ourselves and get estimates. We didn't see the red flags, both with the house and with that type of situation.

It's a learning experience, albeit one that keeps us up at night. I'm looking for some resources/books on what to do when you're in a vampire — where to skimp or delay, where to put more effort and energy. Some of these decisions will be made for us, since things break pretty regularly. I'm also thinking of bringing in a realtor in a year or two to make suggestions (we might have to sell in 5 years) on what would make the place more appealing. If you think that's a terrible idea, I'd appreciate your thoughts.

I hope your article prevents others from making the mistakes we made. I tell everyone about what we've gone through. I know that people don't like to hear about negative things, but we want people to know that this can happen even when you think you've educated yourself & chosen good representation. In the days leading up to our closing, I had a really bad gut feeling, and I was talked out of it. People need to know that they should listen to their guts!

Not certain that it's always a good idea to listen to your gut. Allowing gut level, irrational fear to overcome reason is a recipe for disaster - or at least huddling in caves in the shadows of modern skyscrapers. But there's usually an unexamined aspect to the whole situation, that as soon as you do investigate, it becomes obvious that you were heading for the abyss, awaiting only that quintessential moment when Wile E. Coyote (Super Genius!) looks down. Since real estate transactions are so large, there are a lot of people out there hoping you don't notice the ACME logo, so that they can go their merry way with your money. Kind of like those old Medeival period maps that say, "Here be Dragons." You need a guide who, if they haven't been precisely there before, is at least a trained explorer. That's why you need someone who's determined to be the best advocate they can for you. I'll take a first time agent with the right attitude over a commission grabber with forty years of experience, every time. That newbie agent can get the guidance they need from veterans in the office. The commission grabber won't even try to spot the issues. In fact, many of them do their best to collude in covering them up, as you have unfortunately discovered.

Now, "Vampire Properties" is just a label I invented because it seemed particularly appropriate. I've never seen it used elsewhere, although it's likely that I have "independently re-invented the wheel", because it seems like such a logical, appropriate, memorable phrase in retrospect. And it's not for nothing that they say, "Experience is what you get when you didn't get what you wanted."

Caveat Emptor

When I'm driving, and get to busy main streets, I hate turning left unless there's a light there. Traffic is coming hard both ways, usually at high speeds, and with only intermittent breaks in each direction. If you're turning left, you've got to wait for those intermittent breaks to happen from both directions simultaneously. So for at least the past twenty years, I've employed an alternate tactic. Instead of sitting there waiting to turn left, hoping the deities of traffic are kind or risking an accident by pulling into traffic and stopping, I'll turn right instead, go down a block, and shoot a U turn. At least nine times out of ten, the person who was there ahead of me waiting to turn left will still be sitting there when I go by, already on my way despite having gotten there later than him.



Real estate can be a lot like that. Sometimes the best way to get what you really want isn't the direct and obvious one. Sometimes, taking what looks like a detour can help you.



This can take various forms. Every once in a while, a question hits my site like "Lenders who do 100% financing with a 520 credit score." Three words: Not. Gonna. Happen. But there are alternatives. Seller carry-back or raise your credit score are the first two that come to mind. Given the market right now, a seller carry-back can be the little detour that gets both of you to where you want to be, if the seller has the option of doing it, which a good agent can find out. You'll pay a more than you might have with a good credit score and 100% lender financing, but it can be done. Raising your credit score is also surprisingly easy in many cases. I've gotten people's credit score up to 660 or even 680 in a couple of months. Pay your bills on time, know how to get rid of old derogatory items, a few other tricks. It takes some time and a surprisingly small amount of cash.



Those are comparatively easy. There's a much harder hurdle: "I can't afford anything I want!" The obvious - and deadly wrong - solution is an unsustainable loan like a Negative Amortization Loan or another unsustainable loan. What those have in common is that they are short term patches to a longer term problem. There are several better alternatives.



You can make your stuff last longer. No $600 car payments or $400 per month credit card obligations means that you can afford more for a house. Pay them off and keep the cars running and don't charge up any more. Assuming a 45% debt to income ratio, I've just added back as much into your housing budget as getting a $2250 per month raise - $27,000 per year. People who keep buying SUVs as opposed to compacts must want them more than they do a better dwelling place - and if they do want to drive an new SUV instead of an older compact more than they want to own a house, they are making the correct choice.



First time buyer programs such as the Mortgage Credit Certificate and Locally based loan assistance can help you stretch what you can afford. Between the two, it can make a difference of as much as twenty or possibly even twenty-five percent of your budget. They cost a little money and you have to jump through their hoops, which can include where and when you buy, but they make about the same real difference as choosing some of the more dangerous loans - and instead of a risky gamble, they turn it into something sustainable.



You can find a partner. Sure, you can only afford $275,000 by yourself - which might be enough for a two bedroom condominium. Put two people who can afford $275,000 together, though, and that's a $550,000 house. That's an above average 4 bedroom house with money to spare in a lot of areas. Put three of you together, and you've got an $825,000 mini mansion big enough for the three of you to rattle around in. It takes some legal preparation to protect the partnership from a bad partner, but it's not that difficult or that expensive. And it needn't be permanent. Let's say two of you buy that $550,000 house with zero down payment, instead of saving for a down payment at $500 per month each. If you were to save that money, earning 10% tax free for five years, you'd each have just over $40,000 each, or about $81,000 grand total. If the house appreciates at 5% per year (low for this area by historical computations) and you make regular amortized payments, the home is worth $702,000, you owe $515,000 if you never paid an extra cent, and net of the cost of selling, you're splitting $137,000 two ways, or not quite $69,000 each. That $425,000 3 bedroom house you really wanted to yourself has appreciated to about $542,500, but now you have a $70,000 down payment. Assuming you got annual salary increases of 3%, it's 7% more affordable now, instead of only 1% - equivalent to boosting your monthly savings to $850 - and it's unlikely you'll make 10% tax free, which that assumes. If you last ten years in the partnership, you come away with $183,000 each instead of $112,000 by investing your $500 per month tax free at 10% and the house you really want is seventeen percent more affordable instead of only five.



Another way of putting leverage to work for you is to buy what you can afford, now. If you can only afford a two bedroom condominium, better you should buy that and the kids have to share a bedroom in a property you can afford, than that you buy something you cannot afford. My uncle raised a family of four in an 762 square foot two bedroom place - and he had my grandmother living there also when his daughters were teenagers. Most two bedroom condos are bigger than that now. If he could do it for twenty years, you can do it for five. This is why, for example, certain Asian and African immigrants are doing very well despite being only a few years from having nothing and living in an apartment. It certainly beats the alternative. $69,000 and change net proceeds from the sale in five years, and once again you've got that 7% affordability increase after five years, and seventeen after ten - without saving one extra penny.



When you buy with a sustainable loan, you place your cost of housing forever under your own control. You step off the escalator of rising rents, and rising housing costs. The math in my examples assumes marriage, but it's more strongly in favor of ownership if you are single because the standard federal tax deduction is lower.



You can rent a storage closet for the stuff you don't use every day.



You can drive a couple miles further.



You can rent out a room.



You can take a second job, and use the difference to save money. It'll also leave you less likely to buy stuff you don't need.



You can invest some time and money and effort in improving your value to prospective employers.



I am well aware that "settling" is not attractive to most folks. I'm also aware that some neighborhoods are less desirable, and others are considerably more so, some living conditions less desirable and others more. We live in a culture accustomed to instant total gratification. Nonetheless, if by accepting some delays and some costs you get what you want and end up in a better situation, isn't that something to consider, as opposed to crying that you can't have what you want right now and so you're not going to do anything?



Doing nothing means that you miss out completely because the situation isn't perfect. How does that help the situation improve? Do you just wait and hope that housing values crash? What is likely to cause such an event? Interest rates rising drastically is the only thing I can think of, but then the loans and their payments get commensurately more expensive. Instead of being unable to afford it when it costs $425,000, now you can't afford it even though it only costs $225,000. It also leaves your future subject to factors beyond your control. Suppose housing prices don't crash? We're twenty percent plus down, locally. Suppose that's all the further down prices go? We've got an ongoing and increasing scarcity problem - not building enough new housing to cover the population increase. Even if rational growth policies took over all the planning commissions and departments tomorrow, do you think the environmentalists and NIMBYs are just going to roll over and play dead in court? I can hope, but that's not the way to bet.



I hope this gives all of you some you some useful alternatives to consider. There is usually more than one way to get something that you want. Sometimes it means that you have to go a bit out of your way, or do something that isn't quite as satisfying for a while. And if you're not willing to do a little bit extra, but expect it handed to you, then either you don't want it very badly, or you are extremely likely to get burned by people who put you into a situation that you were trying to avoid.



You can usually get what you want. Sometimes it just takes intelligent planning, and a step or two in between.



Caveat Emptor

A while ago a reader gave me a heads up that Illinois HB 4050 was hurting residents of certain poverty stricken Illinois Zip Codes. Now I have to pick on our own state:

California law generally requires special handling of sales transactions to protect homeowners in foreclosure. This law, called the Home Equity Sales Contract Act, generally applies to transactions that meet all of the following four conditions: the property is one-to-four family dwelling units; the owner occupies one of the units as his or her principal place of residence; there is an outstanding notice of default recorded; and the buyer will not use the property as a personal residence. The Home Equity Sales Contract Act does not apply if one of these four conditions is unmet. If, for example, a seller occupies a property in foreclosure, but the buyer will be occupying the property as his or her personal residence, the home equity sales law does not apply.



If all four conditions are met, however, the buyer must use a home equity sales contract, such as the C.A.R. standard form "Notice of Default Purchase Agreement" and attachments. This agreement gives the seller, among other things, a five-day right to rescind the contract. Furthermore, the home equity purchaser cannot be represented by an agent. More accurately stated, the law requires a buyer's agent to be bonded by an admitted surety insurer, but C.A.R. is unaware of any insurer currently offering the bond.

Actual Code Here



This is so brain damaged it has to be the idea of some clueless person out to save the world without first stopping to consider the Hippocratic Injunction to "First, do no harm."



Now, in the business, the term "equity sale" or "equity purchase" is most commonly used in conjunction with a sale subject to existing trust deeds. So this is a significantly different meaning to a similar phrase. Keep in mind that there are four conditions that need to be met:



1. Residential property (1-4 units)

2. Owner occupies one unit

3. Notice of default recorded

4. Buyer does not intend to occupy.



But what happens with such properties? Who buys them? Investors, that's who. Guess what? The owners want them sold! What happens if they don't sell? They go to auction, and the owner basically gets nothing, whether the property sells at auction or it doesn't, in which case the lender now owns it.



Furthermore, they're requiring that the buyer's agent have a bond that is not available, and has not been for ten years. So if whether they're working with a shark or with an investor who is actually going to give the people a decent price, the buyer's agent cannot be compensated. So what are most buyer's agents going to do? Answer: Wait until after the trustee's sale! As the buyer's agent, they have no fiduciary responsibility to that seller, and no ability to get paid. But the owner wants to sell before the trustee's sale. The chances of them getting anything from a trustee's sale or afterwards are about equal to one my grandfathers giving birth to triplets.



Now, this does theoretically create an opportunity for certain people who might be willing to live in the property to buy for lower prices, since investors are (mostly) out of the picture. So we are robbing Peter (the current owners) to pay Paul (in search of new housing). There are also some truly outstanding issues. What happens if my buyer client is lying to me about whether they intend to live there? The contract is already written, the terms of the transaction set, and the buyer's agent can't back out at the last minute when they change their mind about whether they're going to live there. Also, what happens if everything is fine when the contract is written, but the lender drops a Notice of Default on the sellers they day we're set to close?



In the current market, most of the folks in default do not have large amounts of equity. Matter of fact, the typical seller who is delinquent is really hoping that the lender will sign off on a Short Payoff. This is not shark investors swooping in and buying granny's $500,000 property for $80,000. With the number of people there are pushing Reverse Annuity Mortgages, that's not going to be the case any time in the foreseeable future. Granny can get a RAM, after which she can last long enough to sell for a good price. Instead, what's going on is that the properties are going to foreclosure, costing the lenders more money, adding to the fees the owners pay, and lengthening the odds against the current owners coming out of the situation with anything. They want buyer's agents on the job, finding these bargains for their clients so that the sale gets made before the trustee's sale. Keep in mind that the seller is always allowed an agent, and the seller can always say "no," to the offer. Which is preferable: Not getting as much as you might have gotten for a sale under ideal conditions, or getting nothing?



Henry David Thoreau had some words on this situation:

If I knew for a certainty that a man was coming to my house with the conscious design of doing me good, I should run for my life, as from that dry and parching wind of the African deserts called the simoom, which fills the mouth and nose and ears and eyes with dust till you are suffocated, for fear that I should get some of his good done to me -- some of its virus mingled with my blood. No -- in this case I would rather suffer evil the natural way.

Caveat Emptor

This is something that often happens with highly appreciated properties where the owner can no longer keep up the payments, they get hit with a notice of default, and along comes Joe or Jane seemingly riding to the rescue on a noble white steed, offering to buy the owner out of the property "subject to" existing deeds of trust.



This is a terrific position for the buyer to be in, and a rotten position for the seller. Nor are the prices usually very good for the seller - that white knight usually ends up looking a lot more like a thief. So why does it happen? Why does the seller agree to it?



Here they are sitting on this highly appreciated asset, with loads of theoretical equity, and they cannot make the payments. If they go through the foreclosure process, chances are better of flying to the moon by flapping your arms than of getting any of the equity back out. Yes, in California it's got to sell for at least 90% of appraised value or it doesn't sell at auction, in which case the lender owns it. But those appraisals are intentionally low, because the lenders don't want to own them. Furthermore, all of the payments that weren't made, and the interest on them, all gets piled into the loan, as do fees for the default process and the trustees sale. If you have a mortgage loan, read your contract. Sight unseen, I'll bet you a penny there's a clause in there saying they can sock you for "reasonable" fees in the event of default or foreclosure.



So you have a $450,000 property which you paid $120,000 for and owe $320,000 on, but something has happened and now you can't make the payments. You put it on the market for $450,000 and don't get any takers. Then along comes someone and says, "I'll take over your payments and pay you $20,000 if you sign the property over to me."



This is certainly a gray area, legally. The loans have "due on sale" clauses, and the lender can call the notes as due in full in such situations. The buyer basically tells them, "tough", knowing that if they foreclose, the lender ends up in the situation they didn't want to be in in the first place, of owing the property, not to mention that the person who bought "subject to" can cost them a lot more money by delaying it in court, and there's a good chance they can win the case. Meanwhile, if they don't act quite so hard-nosed, this new owner is making the payments. They have the option of refusing the payments, but then we're dealing with the foreclosure process, and in the meantime, the checks for payment are there every month. What do you think most lenders will do? They will accept the payments!



Notice, however, that I didn't say the payments get there on time. This is the second raw deal that the seller has to swallow. The buyer's cash flow is a little tight, and the payment gets there 40 days late on a consistent basis. Who gets marked late? Whose credit gets dinged every time this happens? Not the buyer's. That buyer never applied for a loan with that lender on that property, the lender doesn't have their signature on a contract that says, "I agree to pay..." It's the seller's credit that gets hit. Kind of a nice situation to be in, no? Make a late payment any time you feel like it and your credit doesn't suffer! Not only that, but since the loan is still in the seller's name, the payments don't hit the buyer's debt to income ratio, allowing them to qualify for more loans, with larger payments, than they really should. Trying to leverage their investments like that is one reason why the folks who make a habit of "subject to" deals usually have tight cash flow. They don't want to let the property go into default, but as long as they don't get to the stage of being 120 days late (90 in some places), they have the best of all possible worlds!



Suppose, for whatever reason, it becomes a short sale? Well, since the seller is the one that violated the loan contract, there will be recourse on them, not the buyer. Many times the buyer makes side deals for "pay me" type stuff and manages to make money, or at least get their money back, even though the property doesn't sell for enough to pay off the existing liens.



If you are getting the idea that agreeing to a "subject to" deal isn't the smartest thing in the world, why do buyers agree to them?



Desperation and Panic. They listened to the agent that told them that they could get more money than was likely by market conditions, or they listed with the cheap bump on a log agency that really doesn't do anything to market the property, or they just sat in denial until far too late. Nothing happens instantly in real estate; it always takes several weeks at a minimum to get a property sold, even if you get a fantastic offer on the very first day. In some cases, I can get a loan done in one or two days, but that's not a situation you want to be in, because I don't know anyone who won't charge more in such a situation, and all of the usual loan caveats apply. But for whatever reason, the owners let the situation go too long, let themselves get behind the power curve, and suddenly realize that they are not going to catch up. They are looking at losing the property and getting nothing, so they panic. This is only one of the many reasons why staying ahead of the situation in real estate is so important. At the point where you're looking foreclosure square in the face ten days from now, there's not much else that can be done. I can offer you entire supertankers full of sympathy, and it won't make any difference. So if you're in this kind of situation, get the property on the market quick, price it attractively, and find an agent who will market it effectively, so that you avoid getting into the situation where the shark's offer is the best one you're going to get.



Caveat Emptor