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The Multiple Personality Market

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With the unemployment rate in California still in double digit territory, there are still 5 auctioneers at the LA County courthouse steps trying to handle thousands of foreclosures per day. Most of the sales are postponed as lenders try to accommodate modification applications only to resurface a month later along with a fresh batch of inventory.

As a result, appraisers have an unusual challenge. They have to determine the value of a house in a neighborhood where half the properties were sold by investors for $400,000 to first-time homeowners and the other half of the properties with the same square footage and bedroom/bathroom count were purchased by investors at the trustee sale or from banks as REO’s for $300,000. The difference is attributable to the following dynamic.

1. High demand due to high affordability and cheap money: the real estate market has experienced a dramatic drop in home prices exceeding 50% in many areas; interests rates are at historic lows further increasing affordability (homebuyers who have been priced out of the market for many years are clamoring to finally get a home)

2. Lack of liquidity blocking access to foreclosures: conventional homebuyers who require financing to purchase a home are unable to buy the foreclosures either at the trustee sale or as an REO from the bank after the bank has repossessed the property (acquiring property from either source requires an all-cash offer)

3. Lack of appeal of foreclosures: inexperience in renovating properties makes it undesirable for conventional homebuyers to buy foreclosures either at the trustee sale or as an REO (most foreclosures are not market-ready); in addition, many financing sources such as FHA lenders will not lend on a property in need of certain repairs

The result is a bifurcated market with two significantly different price points: one for investors with cash, one for homeowners with financing.

In the standard appraisal report there is a space for the appraiser to indicate whether the market is declining, stable or increasing. The problem is which market is the appraiser describing. There are certain areas with the homeowner prices increasing at the same time the investor prices are decreasing and other areas where the opposite is true.

In order to determine value in this market you really have to identify who is selling and who is buying.

Finally…Real Strides Towards Solving the Housing Crisis

Attempt after attempt to resolve the housing crisis has failed to stem the wave of foreclosures. In part the problem is exotic loans, in part the problem is job losses, but another contributing factor is good old-fashioned rational economic decision making. Here is what I mean. John Smith bought a house on 123 Main Street in 2006 for $350,000. He obtained a loan at 90% loan-to-value equaling to $315,000. John acquired the property with a negatively amortizing option arm and his balance has climbed to $340,000. Concerned about the negative amortization, John applied for a loan modification and was successful in securing a 30-year fixed mortgage at 5% with a payment of $945. John is extremely pleased with his new loan and can definitely afford the payment. He is pleased until his wife comes home one day and tells him that the bigger homes down the street with the island in the kitchen are now selling for $160,000 and the mortgage payment at that price would be $444.

John begins to ask himself some tough questions: (1) is it worth it to keep paying on a $340,000 mortgage when bigger homes in the same neighborhood are selling for $160,000? (2) how long will it take for my property to get back to $340,000, 3, 5, 10 years? (3) how much is my 750 FICO really worth or is it better to just walk from this house? One can easily see that many people have decided that it makes sense to walk and take the credit hit. Is that the right decision? There are arguments on both sides but the point is that to the extent people continue to conclude that it does make sense, the housing crisis will persist.

The solution of course is for banks to modify the principal balance when they adjust the terms of the loan. But, up to this point that solution was simply off the table. That all changed this past week when the White House announced that it was going to make two additional attacks on the housing crisis in the coming months:

Restructure the Housing Affordable Modification Program (HAMP) to give greater relief to borrowers who are unemployed by lowering their payments to affordable levels while they seek out new employment.
Require lenders to consider reducing the principal balance of the loan in the following circumstances:

• Super Underwater Borrowers: All servicers will be required to consider a principal write-down for HAMP eligible borrowers who owe more than 115% of the current appraised home value

• Pay for Success Structure: Some underwater homeowners will be eligible for a principal balance reduction in steps over three years, if they remain current on payments

• Forbearance Approach: Servicers will initially treat the write-down amount as forbearance and will forgive 1/3 of the forborne amount each year for three years, as long as the homeowner remains current on payments

• Retroactive Application: For borrowers who have already received a permanent modification, or who are in a trial modification, and are still current on payments at the time this new program takes effect, servicers will actually be required to retroactively consider extinguishing an amount of principal balance in the same amount that would have been forgiven under the new alternative approach. This is a pretty aggressive move.

In addition to the reduction of loan balances, this program will encourage lenders to expedite the processing of short sales, approve more short sales and pursue other alternatives to foreclosure.

About Living Trusts

There is no doubt that a living trust helps you get your affairs in order, but what is a trust really? The history of this unusual legal creature is very interesting and important to understand for our purposes.

Trust law developed in England around the time of the Crusades (12th and 13th centuries around the same time as the Knights of the Round Table; this no coincidence). The Crusades was a war of Christian nations including England against Muslim nations with modern day Istanbul, Turkey being ground zero. As required by the feudal system, an English knight had to go to war so he would often entrusted his land to a friend to run the estate in his absence.

Because England was a long way from Istanbul, the Crusader, as they were dubbed, would actually convey ownership of his lands to the friend, on the understanding that the ownership would be conveyed back to him if he made it back alive. What do friends do when you give them your house and no return date? They party. By the time the Crusader returned, the friend had gotten so used to being the head honcho with all of the attendant perks, he would refuse to transfer title back to the rightful owner. You gotta love friends like that.

Unfortunately for the Crusader, English law at the time did not recognize his claim so the courts offered no remedy. The pissed off Crusader would then petition the King, who would refer the matter to his Lord Chancellor. The Lord Chancellor had the power to offer any remedy to someone that was wronged that he deemed “just” and “equitable”. Time and again the Lord Chancellor would consider it unjust that the legal owner, so called “friend”, could deny the claims of the Crusader (the “true” owner) and would find in favor of the returning Crusader. Over time, the idea evolved that the legal owner (“trustee”) was only holding title for the benefit of the Crusader (“beneficiary”) and the trust was born.

Kwame J Granderson, J.D.

Buying and Selling Distressed Property

Obviously, the ability to buy and sell a house is only as viable as the prospects for resale. For this reason, the due diligence and research process often works backwards. Namely, that you start by trying to identify where buyers are buying before you start looking for the property to sell them. In addition, you also want to know how long, on average, it takes to put a buyer in escrow because this will dictate the timeline for the flip and how many flips you can do in a year with a particular pot of money.

As a result of the instability in the market over the last couple of years, I started researching market trends pretty intensely to get a better sense for how to identify a safer, more reliable investment climate. As part of this Flip Series, I will share some of the results of that research and go into greater detail in the webinars. One measure of sales activity is the average time on market. For over 20 years the average time on market for home sales in California is approximately 53 days or about two months. This is to say if you put a home on the market and it takes about two months to get a buyer you are in a relatively healthy market.

The first step, then, in considering an area is to examine how it compares to the statewide days-on-market average with respect to the price range that fits within your investment budget. Keep in mind, however, that if you renovate to a higher standard than is typical in the area you are considering, you will decrease the resale time. For example, in the Faulkner property featured in the previous issue, I installed an entire kitchen with granite countertops and stainless steel appliances for $12,000 because of a great cabinet supplier that I work with for remodels. Granite sells. Stainless steel and granite sell even faster. I will do a separate article on important things to consider when renovating a property for resale and how they differ from renovating a property for rent.

In addition to the statistical data on the sales activity of an area, it is also important to gather anecdotal support. In other words, talk to the local realtors about the activity in area. In this conversation, you are looking both for information on buying activity as well as information on the caliber of the buyers. What you want to hear is that appropriately priced properties consistently have multiple offers, which is happening regularly in this market because of increased affordability.

In the next installment of this series, I will discuss how buyers are qualifying for properties in this market.

Kwame J Granderson, J.D.

WHO DOES THE APPRAISER WORK FOR?

Appraisers work for the person or entity that engaged them. The client of the appraiser, in other words, is related to the purpose of the appraisal. In the case of a home purchase the purpose of the appraisal is to establish the value against which the lender will set its loan amount. The client, then, is the lender (or the mortgage broker who will be brokering the loan to a lender). A common misunderstanding of homebuyers is that they are the client because they pay for the appraisal. This makes sense but the appraiser has to make very specific representations concerning how they conducted the appraisal, so the purpose of the appraisal is more important. The responsibility to the client, however, absolutely does not mean that the appraiser is a hired gun whose directive is to “justify” a predetermined value. The appraiser’s job is to arrive at an unbiased opinion of value based on acceptable appraisal practices and standards.

HOW DO YOU INTERACT WITH THE APPRAISER?

The appraiser should be courteous and professional to the seller of the house (or the homeowner who is refinancing). The homeowner should be accommodating but not annoying. Make sure that every room in the home is available at the time scheduled. But, do not follow the appraiser from room to room pointing out all of the wonderful little treasures. Nobody likes to be told how to do their job; appraisers are no exception. It is important and relevant, though, to notify the appraiser of major upgrades (especially, electrical and plumbing upgrades that are not readily observable during a walk-through).

WHO OWNS THE APPRAISAL REPORT AND WHO GETS A COPY?

The client owns the appraisal and the appraiser is required to protect the confidential nature of the appraiser-client relationship. This confidentiality requirement prohibits the appraiser from providing a copy, or even disclosing the contents of the appraisal to anyone other than the client. Nasty things can be done to the appraiser by the Office of Real Estate Appraisers if this prohibition is violated, so do not even bother asking the appraiser for a copy of the appraisal. To the extent the appraisal was used in connection with a decision to grant credit, the homeowner/borrower is entitled to a copy of the appraisal from the lender (or broker). This copy can be obtained from the lender by written request, provided the homeowner/borrower has paid for the appraisal and the loan involves 1-4 unit residential property. Homeowner/borrower has up to 90 days after the lender has provided notice of their lending decision to submit a written request for a copy of the appraisal.

APPRAISER’S CERTIFICATION

The certification is the appraiser’s way of telling the client “I really did what I was supposed to do. I promise. I really went out to the subject property and actually went inside. I did an exterior inspection of all the comps I used. I stayed up late and researched the market. And I arrived at my conclusions independently.”

Kwame J Granderson, J.D.