Archive for the 'Real Estate News' Category
Infectious Hyperbole in The Mortgage Industry
June 17th, 2008 Categories: Mortgage News, Real Estate News
Market bubbles and depressions tend to be more social phenomenon than rooted in fact.
Credit Crunch, Mortgage Meltdown, Sub-Prime Crisis, Alt-A Debacle, Housing Doom, Bursting Bubbles…the cliches are as creative as the financing options that used to permeate the marketplace. But what are the real numbers behind such doomsday hyperbole?
They’re not quite as sexy nor remarkable:
National Foreclosure Rates…
The Spin: National Foreclosure Rate Almost Doubles in 2008! | Foreclosures Hit Historic Highs | Homes in Foreclosure Top 1 Million
Reality: National Foreclosure Rate = 0.7%…up from 0.4% around this time last year. Roughly 7 out of 1000 homes are in foreclosure.
National REO Rates...REO or Real Estate Owned property is the ‘inventory’ banks hold, homes they likely foreclosed on and have yet to resell back into the marketplace.
The Spin: Bank REO’s up 100% From 2007
Reality: National REO Rate = 1.0%…up from 0.5% last year.
With all of the suspect to downright criminal practices that have been unveiled in the mortgage industry over the past year and a half, coupled with mainstream media spin, one would think that the housing and mortgage markets are in a state of pending armageddon, as in the end of days are upon us. It’s simply not true. Yes foreclosures are up and will likely continue to rise but they are the result of unprecedented, unsustainable expansion and growth…what goes up must come down at some point.
During times of lower trending mortgage rates, property generally appreciates as consumers can afford ‘more house’, sales flourish. Consumer defaults and subsequent incidences of foreclosure remain low because money is cheap. When rates rise the same consumer cannot afford the higher costs, appreciation levels or dips (depreciation), defaults and foreclosures increase. -Masters in Rocket Science not required to understand these fundamental market corollaries.-
Much of the skewed perception results from looking at the state of the union through the wrong set of glasses. Map mash-ups like this one:
…do well to point out which States have:
A. The highest degree of mortgage fraud/predatory lending.
B. Fundamentally impractical (stupid) appreciation.
C. Deteriorating local economic conditions.
D. All of the above.
A more useful set of information would compare common interest rates (and their indices) against home sales, values and the relative number of delinquencies/foreclosures across recent history.
Since I can’t find this chart, nor have the time to create one, I’ll use a few others’ ‘chart porn’.
According to this Calculated Risk chart, between 2002 and 2007 there were ~37,950,000 home sales.
What caused this historically explosive growth? Historically cheap and easy money.
The indices in the chart above represent those that are tied to popular mortgage programs. The COFI, MTA, and CMT directly effect (the terribly abused) Option ARM programs while the LIBOR is the index for many conforming ARM mortgages. It’s easy to see that home sales and prices blew up as rates bottomed out in late 2003, early 2004. Lower rates = lower payments. Lower payments = lower income needed to qualify for a mortgage. Lower qualification requirements = more qualified applicants…you get the point.
Consumer demographics that historically would have never qualified for a mortgage suddenly and briefly did qualify. Lenders threw gasoline on this spark and continued pouring it on by further dropping long standing underwriting qualification criteria. Wall Street greatly subsidized the raw fuel to further this incendiary trend: money, gobs of it. The Dream of Homeownership was sold like hard candy. For those consumers that f into the brief
The indices above reached their peak around July 2006, not coincidentally the wheels began to loosen on the market shortly after this and the sky began to fall shortly thereafter…
Advancing to February 2008, median home values and sales are actually increasing. What, Why, How? Rates have recently trended downward again, relieving some of the downward pressure in the housing market.
Studying the data above, it’s relatively surprising that the ‘housing epidemic’ hasn’t actually become one on par with how big the ‘housing bubble’ actually got. The mortgage and housing markets may be suffering from a bad cold, but it’s far from terminal. Much of the same infectious exuberance that permeated the housing market from 2002-2006 has today mutated into a plague of doomsday hyperbole. Market bubbles and depressions tend to be more social phenomenon than rooted in fact. A disjunctive phenomenon can drive an otherwise practical market into uncharted, volatile territory…alas hindsight is 20/20.
So, knowing what we now do, how can the highly contagious, overly optimistic peaks and financially draining valleys be mitigated in the housing and mortgage markets?
A logical first step is transparent access to better mortgage data, I know someone who has a line on this ;) Next would be understanding how to best disseminate through and correlate it against housing market data using meaningful, effective strategies.
The relatively new real estate futures market could serve as an effective tool to hedge against impractical social phenomenon like bubbles. Futures markets are speculated by highly informed and educated people who have access to quality data that can spot potential bubbles well before they get too big. If they begin selling short, its a good idea to curb the enthusiasm. In the alternative, if they’re bullish or going long, lower interest rates, property appreciation, new housing starts and higher sales are likely.
It’s about time these Industrial Age marketplaces started using Information Age practices to stem future ‘epidemics’ and other like hyperbole from unnecessarily spreading…
Sphere: Related ContentHow Real Estate Professionals Can Properly Finance Their Business
March 5th, 2008 Categories: Business Models, Incorporation Advice, Real Estate News, The XBanker
My last two posts have focused on the importance of incorporating and the resulting tax savings. I continue here with potential financing options for your corporation.
The goal is to create separation between your business and personal activities. This separation provides for asset protection and the ability to obtain capital for your business.
The scoring of personal credit is inherently biased against business owners and investors, because they don’t fit the typical consumer norms. What most entrepreneurs discover, usually when it is too late, is that their business activities drag down their personal credit - making everything else they do more expensive. In order to preserve your personal credit, you need to have access to non-reporting business financing.
Business financing comes in many forms, such as retail or trade credit, credit cards, vehicle and equipment leases, business loans and lines of credit. The key attribute is that they don’t report on your personal credit report. Some will require no personal guarantee at all! Most bank lines and credit cards will have what I call a “ghost guarantee” - which means that you are approved based on your personal credit, with you personally on the hook, but as long as the account is in good standing nothing will be reported. This helps preserve your personal credit by reducing your revolving debt ratios and personal debt-to-income.
Most business owners get the most excited about business lines of credit. The appeal of $50,000 to $250,000 of available cash credit is a no-brainer. The flexibility to use that credit for investments, payroll, or even a latte, makes it the most sought after lending product. I like to see breadth to a business’s financial and credit resources, so I prefer to compliment the lines with credit cards, trade credit and vehicle and equipment leases (and yes, you can get just about any car on a business only lease).
I know investors that will leverage lines of credit to secure a property and use trade credit with Home Depot for materials - enabling them to flip properties without ever walking into a bank. I’ve also seen the other side of this. I spent time trying to help a successful agent get financing so they could take on a huge opportunity with a builder. Unfortunately, I was too late to the scene. By the time I arrived, years of running their business and investments on their personal credit had taken its toll. Despite $800,000/yr in commissions they couldn’t get $10,000 in credit. Don’t postpone taking action, because when it is too late - it’s too late!
In my next post, I’ll focus on the actions you ned to take to best position your business for obtaining financing.
Sphere: Related ContentReal Estate Professionals Need a Better Compensation Model, One as Local as They Are
March 4th, 2008 Categories: Business Models, Real Estate News, alternative real estate commission models
I’ve been an advocate of trashing ‘The Traditional 6% Real Estate Commission Model’ for almost 10 years. When I owned a brokerage I offered alternative commission models to clients and was nearly hung, tarred and feathered (definitely blackballed) at the bequest of numerous other Realtors and NAR’s local chapter.
In spirit of my experiences, any time a chance arises to take a swipe at NAR’s antiquated ways and membership, I’ll oblige.
Part 1 Freakonomics
A New York Times best seller (and blog) written by Steven Levitt and Stephen Dunbar pointed out that a real estate professionals traditional compensation methodology is (way) out of sync with buyers and sellers economic interests and incentives.
Levitt writes that incentives are tricky when it comes to real estate commissions. The traditional 6% is typically split between sellers and buyers agents and split again between the agent and their agency, so the agent may only end up with 1.5% of the sales price, not 6%. At a $300,000 sales price, this would yield $4500 to the (buyers and/or sellers) agent. Drilling down quickly here, the basis of the argument is:
What is the agents incentive to sell the house for more than $300,000? What if they were a little more patient, put in a little more effort and could have secured a $310,000 sales price?
That would put $9400 net more in the sellers pocket, a good chunk of change. How much more would the agent receive?
$150.00
The same happens in reverse. You list the home at $300,000 but a buyers agent brings an offer of $290,000. You stand to eat ~$10,000 while the agent only stands to lose $150.00, but puts money in their pocket much quicker.
Long and short of it: The home seller and listing agents incentives are no where close to aligned.
*Pow* A black eye to the real estate commission model from a highly respected economist.
Part 2 Mark Nadel
Mark penned the following blistering expose for the FTC:
A Critical Assessment of the Traditional Residential Real Estate Broker Commission Rate Structure
To which I compartmentalized a bit here:
The Traditional Real Estate Commission Model. A Critical Assessment
Critical Assessment of The Traditional Real Estate Commission Model II
*Ugh* Gut punch from the Ivory Tower
Part 3
B. Douglas Bernheim and Jonathan Meer from the Department of Economics at Stanford University released the following case study last month:
HOW MUCH VALUE DO REAL ESTATE BROKERS ADD? A CASE STUDY
From the Introduction section of their study:
Historically, sales commissions for residential real estate brokers have averaged between five and six percent of sales prices. In 2004, commissions paid to brokers in the U.S. totaled roughly $61 billion (Hagerty, 2005). Do brokers provide commensurate value?
Sellers potentially benefit from brokers’ services in a variety of ways:
First, brokers provide promotional services. They help prepare a house for sales, circulate flyer’s, place advertisements, hold open houses, and recommend the house to individual buyers.
Second, they often assist with negotiations.1
Third, they screen prospective buyers, facilitating and potentially accelerating the process of matching buyers and sellers (Salant, 1991).
Fourth, they provide access to the Multiple Listing Service (MLS), which lists all homes available for sale.
Fifth, they provide market information and recommendations pertaining to the appropriate asking price.2
Sixth, they of-ten assist with paperwork and legal documentation.
How much is this bundle of services worth? Because the component services are some-times unbundled, we can judge their value by examining market prices.
Discount brokers provide access to the MLS for as little as $300 (Darlin, 2003).
Market information and forecasts of selling prices are available through professional appraisals, which cost a few hundred dollars. 3
In Illinois, where sellers are required to retain real estate attorneys to prepare and review sales contracts, legal fees average roughly $700.4
Thus, the total market value of the fourth, fifth, and sixth benefits listed in the previous paragraph is roughly $1400 – enough to justify a 6% commission on only the first $23,000 of proceeds from the sale of a home.
To justify brokers’ commissions, the value of the first three benefits must be substantial.
Berheim and Meer test pool consists of homes sold on Stanford Universities campus over a 26 year period. It’s an interesting microcosm to study since it allows the authors to hone in the first three perceived benefits of a real estate agent:
Several features of this data make it particularly useful for our purposes. First, since the eligible buyer population is limited, the MLS plays no role in the campus housing market. Instead, the Faculty Staff Housing (FSH) Office maintains a free listing service for eligible buyers and sellers. Consequently, there is no risk of confounding the value of broker services with the value of access to multiple listing services. In addition, access to free listings has historically enhanced the willingness of homeowners to sell their homes without brokers. Indeed, during the 1980s, brokered transactions were rare. Second, our data sample spans a major regime shift. Brokered transactions became increasingly common during the 1990s, and have accounted for roughly half of all sales in recent years.
The value of real estate brokers for Stanford campus transactions is likely confined to promotional services, negotiations (the first and second roles listed above), and the interpretation of market data (an aspect of the fifth role). Given the small numbers of available houses and active eligible buyers as well as the physical proximity of all the homes, the costs of comprehensive search, and hence the value of pre-screening by brokers (the third role) is small for both buyers and sellers.
As we have mentioned, the value of MLS listings (the fourth role) is zero. The FSH Office also makes comprehensive market information (home characteristics, listing prices, listing dates, selling prices, and closing dates) for all transactions available to all buyers and sellers. Because market participants are generally familiar with the campus neighborhoods, and because the number of comparable transactions is limited, sellers can acquire and review virtually all pertinent market information at low cost. Thus, the value of brokers as providers (rather than interpreters) of market information (another aspect of the fifth role) is likely negligible. Finally, the FSH Office assists with paperwork, largely eliminating the value of the sixth role. Therefore, an analysis of the Stanford campus housing transactions permits us to hone in on the value of brokers as promoters, negotiators, and interpreters of market data.
Berheim and Meer use a series of coefficients and variables to create complex but proven statistical models, as well as reference Levitts (and others) data to substantiate their work. It’s not an easy read but the results are predictable, even though they don’t come right out and say it. The 6% Realtor commission model is economically and practically retarded.
The study draws two primary conclusions:
First, using a real estate broker does not significantly affect either the average initial asking price or the average selling price of a home. This dispels the theory that brokers have negotiation power, thus diminishing their second perceived value above.
Second, using a broker does lead to a quicker sale. An added value, unless you consider Levitt’s work stating that agents are incentiveized to move a home quicker simply to turn inventory over. Holding out for a higher price, even $10,000 higher, is economically insignificant for an agent. We’re all driven by motive, ‘altruistic business practice’ is an oxymoron.
Even more interesting, an agents ability to sell a home quicker apparently is only prevalent during the first 60 days on market, after which homes represented by agents sell slower in months three and four, slightly higher in month 5, with no difference in month six. It would seem to make sense to fire your Realtor if they haven’t sold your home in 60 days…or at least not sign an agency agreement that binds you for longer than that.
Dialing back to a paragraph from the study’s Introduction:
Thus, the total market value of the fourth, fifth, and sixth benefits listed in the previous paragraph is roughly $1400 – enough to justify a 6% commission on only the first $23,000 of proceeds from the sale of a home.
To justify brokers’ commissions, the value of the first three benefits must be substantial.
Refresher:
First, brokers provide promotional services. They help prepare a house for sales, circulate flyer’s, place advertisements, hold open houses, and recommend the house to individual buyers.
Second, they often assist with negotiations.1
Third, they screen prospective buyers, facilitating and potentially accelerating the process of matching buyers and sellers (Salant, 1991).
The second benefit appears to be negligible according to this case study. The third is effectively the job of a mortgage professional or disintermediated by the advent of better information online which allows prospective buyers and sellers to quickly disseminate through and find each other, sans agent.
All of ‘this’ would lead someone like me (and many many more people) to summarize that a Realtor will sell your home fast and cheap for 6% of the sales price.
Granted, Berheim and Meer ’s case study isn’t the final word and may be off on more than one account, there are many debatable points and the same holds for Levitt and Nadel’s work. But when you start to add up the cumulative work from hundreds of hours of comprehensive study and research by highly intelligent people and institutions, you don’t have to posses a masters degree in Business Economics from an Ivy League school to understand that the traditional real estate commission model is (has been) broken.
Maybe one day the NAR will use it’s collective wisdom (and money from it’s million person army) to offer their membership some worthy advice and strategy instead of trying to protect some antiquated legacy.
Disclaimer: I believe real estate professionals provide a valuable service and aren’t the scourge of the earth. I also happen to like attorneys and claim members of both groups as friends.
Sphere: Related ContentHow To Maximize Your Income and Minimize Your Liability as a Real Estate Professional
February 26th, 2008 Categories: Business Models, Incorporation Advice, Real Estate News, The XBanker
Allow me to introduce myself; I’m the XBanker – a business-financing insider, shedding some light on the murky world of small business lending and business credit. This is the first post in a 4 part series focusing on business strategies for Real Estate Professionals.
Tom Peters’ article in Fast Company several years ago: The Brand Called You, had a drastic impact on
my life and career. I quit looking at myself as an employee and instead as an independent business and brand. I highly recommend this article to everyone, regardless of career. Since branding isn’t my bag – I’m not going to pretend that it is by discussing it here.
If you invoice for your services or receive a 1099 from an “employer” – chances are that you pay too much in taxes, unduly burden your personal credit and are missing out on a huge opportunity to access cash and credit for growing your business.
Last year I invited a handful of listing agents into my home to win my business. Each conversation turned to the very topics that I’m going to address in this series. One of the agents in particular was walking the razor’s edge. His family-run real estate team was making close to $1m/year in commissions. This was on top of a number of income-generating investment properties. After 15 years in business, this professional was still operating as a Sole Proprietor. Not only was he paying way too much of his income in taxes, he was literally a car accident away from losing everything. If that wasn’t enough, he needed float to cover his team in a slowdown and reserves to jump on investment opportunities – without drawing upon the equity in his home. My advice for him is the same that I extend to you.
The first thing that you need to do is to incorporate. I’ll keep this really simple: form an S Corporation. My simple rule is: corporations for business activities, LLCs for holding assets (such as real estate); if you have a business partners that you aren’t married or related to, form an LLC for your business (but still form an S Corporation for your interest and income). Your tax advisor should be able to adequately address the advantages of these structures. I’ll address tax benefits in my next post, but please keep in mind that tax savings is just one component of what I’m addressing; obtaining capital is my primary focus.
Forming a corporation is the first step of separating you from your business activities. Once the separation is complete, you can build a credit profile for the business and begin to obtain business loans and lines of credit. I’ll provide some tactical strategies for optimal positioning for your corporation to obtain financing. In my next post, I’ll focus on the tax benefits of creating this separation.
Sphere: Related ContentLack of ‘Make Sense’ Business Models In Real Estate and Mortgage Still a Cause for Concern
February 15th, 2008 Categories: Mortgage News, Real Estate News, Real Estate Technology, XBanker, alternative real estate commission models
When the real estate and mortgage industries realize their traditional business models are now broken, the world will be a better place for all.
Words of advice: Pay more attention to the Loss side of a P&L and the right side of the balance sheet. Too much attention toward generating more revenue and not enough consideration to stopping the internal bleeding is the core of the overall problem…akin to emptying the water from a boat with a hole in the bottom using a (small) bucket.
This problem’s solution is routed in the fact that most professionals within these communities are not astute at running a business. A testament to this statement lies in that many RE and MoPro’s operate as ’sole proprietors’ (or submit as W-2 employee’s) when they should choose a corporate structure more in tune to maximizing income via benefits afforded other corporate structures. Just because one can sell doesn’t mean one can run a business.
The 6% real estate commission model is a horrid example of sound business practice. Economists routinely wonder aloud how this model has stood the test of time (answer: The omnipotent NAR ether/kool-aid). The commission ’split’ model commonly found in the mortgage broker industry (coupled with serious lack of disclosure issues), is far less discussed in open forums, yet just as fundamentally challenged.
It’s evidently apparent what happens in the down part of what are cyclical marketplaces…a mass exodus from the small business world, and thats not good.
I’d like to explore alternative business models that could work for both real estate and mortgage professionals by laying out some succinct recommendations and strategies for 2008, going forward…
I’ll be recruiting some seasoned experience from the world of business to opine via future posts regarding this topic. One of them is an XBanker 
