HUD HOMES - YOU'VE BEEN WARNED

HUD Homes are the root canals of real estate.

Thank goodness they are on the decline.  I have probably sold 20 HUDs during the downturn, and I have one under contract now that is reminding me why I need to quickly make a U-turn and head the other way anytime I see a HUD sign planted in front of a vacant property.

A HUD home is a property owned by the Department of Housing and Urban Development.  This is the government agency that insures FHA loans, meaning that if banks will underwrite loans to guidelines established by FHA, the government will step in and make the lender “whole” if the buyer goes into foreclosure.

This means minimal risk to the banks, which meant that a whole bunch of FHA loans were done during the downturn that never would have been approved if there wasn’t the government’s “guarantee” of buyer performance.

So when a bank forecloses on an FHA buyer and submits and insurance claim to HUD, the government pays off the bank and takes the house in trade. 

This is where the fun begins.

I know my candor in this post will be upsetting to some people, but the first thing you need to know is that HUD does not hire based on merit. 

So when HUD sends in an “Asset Preservation Company” to drain the plumbing lines and secure the property, there’s no guarantee that this is being done correctly.  (And yes, just yesterday, I did an inspection on a HUD home where the contractor brought in to winterize the property failed to do so properly, resulting in a series of frozen pipes that caused a series of mini-floods throughout the house when the water was turned on… ah, but that’s a story for another day).

Once the property is “winterized”, HUD then puts it on the market. 

Here’s an overview of the rules:

- Home is placed on the market for 10 days;

- “Bids” are submitted online on behalf of owner-occupant buyers, but they must be working with a “HUD-certified” broker (which, fortunately or unfortunately, I am);

- Investors are not allowed to bid during this initial first-look period;

- Homes are sold strictly “AS IS”, with no repairs made by HUD, ever.

- High bidder wins, regardless of qualifications

If you’re lucky enough to win a HUD bid, now things get really exciting.

If you’re the broker, you have 48 hours to get a fully-executed contract package to HUD’s field office in Texas.  If the package doesn’t show up in 48 hours, delivered by overnight mail, your bid is tossed aside and they go to the next highest bidder.

What’s in that contract package?  Page after page of eight-point font legalese, which must be filled out in BLUE ink (no exceptions), with each and every signature and initial space fully executed (or see paragraph above).

HUD also views its transactions as so important that they require the signature of the owner of the real estate broker’s company.  So yes, the owner of my company is expected to sign a document (in BLUE ink) verifying that he knows this transaction is happening and that he personally vouches for the fact my client is an owner-occupant (although of course he has no idea who my owner-occupant buyer is).

It’s up to me to track down the owner of my company and get his signature (no matter where on the planet he may be), after I have presented the 49 pages of contract paperwork and addenda (signed in BLUE ink) to my buyer and picked up his cashier’s check for $1,000 (HUD’s standard earnest money deposit).

I then need to rush this package overnight (at my expense) to Texas, where it generally sits on someone’s desk for two or three days until it is opened and reviewed.  Eventually I get an email including a copy package of the contract, signed by an authorized desk jockey at HUD.

At this point, you have 15 days to get an inspection done.  If flaws are discovered with the home that were not disclosed by HUD (which is a pretty sure bet), you can cancel.  But your 15 day time limit is fixed and there are no extensions granted for any reason.

So the first thing you’ll want to do for your inspections is to get the water and utilities turned on. 

But… not so fast.  HUD wants a $150 cashiers’ check before they will fill out and sign a “Utility Activation Form”, which most water districts and utility companies require before temporarily restoring service to the house.

Once you have purchased this form (by sending another overnight package at the broker’s expense), you can call the water company and the gas/electric company.

Most water companies will not leave the water on for more than 72 hours, and they require that someone be at the property when the water is turned on at the street (to ensure the house doesn’t flood when the water is turned on).  Of course, they give you a nice four hour window with no advance notice, so plan on spending half a day at the house waiting for the water guy.

Working with the utility company can be even more fun.  Xcel will give you a day’s notice when they are coming to turn the gas on, but that’s it.  If you’re not there, no heat for you. 

So plan on spending up to a full day waiting for the gas service to be restored.

Once you’ve got water and power turned on, now you have a small window of time to get your inspection done.  This will be another $350 to $400, and as much as $500 if your client wants to test for radon. 

If your buyer is financing the property, chances are the appraiser will need to be squeezed in during this tight little window as well so he or she can verify that you have hot and cold running water.  Plan on writing another check for $400 for the appraisal. 

Let’s say, however, that the appraiser doesn’t show up during your 72 hour window of time with the utilities on. 

No problem, we just get another cashier’s check for $150 to HUD, get another Utility Activation Form, and we start the process over.  

Spend a half day waiting on the water.  Spend a full day waiting for the utilities.  And then hope that the appraiser shows up during your window of water/power time.

Let’s backtrack to yesterday for a moment.  Say, hypothetically, the Asset Preservation Company (Lowest Bidder Asset Preservation Company, LLC) botched the winterization and your plumbing is damaged. 

Let’s say your buyer spends $400 on inspections to learn that the plumbing is broken. 

That’s okay, you still might have 24 hours to get a plumber out (hypothetically), fix the plumbing (at the buyer’s expense) and get the home inspector back out to finish the inspection (with an additional trip charge). 

Even if that happens, though, we’ve run out of time for the appraiser before the utilities are turned off again.

Ok, freeze.  Go get another cashier’s check.  Send it to HUD.  Wait four days.  Get another Utility Activation Form.  Call for water and power.  Sit in the house for a day.  Get the appraiser out.  Hopefully no one has broken in and stolen the appliances or the copper pipes during this time.  Finally the appraiser signs off.

Now the lender can underwrite the file and (hopefully) approve the loan. 

If all of that happens, you’re almost there. 

Except now HUD requires that all closing figures and documents be sent to the title company eight full business days before closing.  No, I am not making that up. 

So your lender busts his or her tail, gets everything to the title company, and you wait.  And wait.  And wait. 

Finally, HUD looks at the paperwork and signs off.  You’re set to close!

You bring your funds to closing.  You sign you paperwork.  You finally own a HUD house!

You ask for the keys.  Um, you ask for the keys.  Keys? 

Oh yeah, HUD doesn’t allow me to give you the keys.  Per HUD’s policies and procedures, since the same key opens all 4,000 HUD homes in Colorado (that is some brilliance, right there), I am not allowed to give it to you. 

Instead, I am supposed to drive you to the house, open the front door, and wish you the best.  Then I am supposed to mail the key back to the listing agent.  Again, I am not making this up.

By this point, I think you can see the thread of insanity that runs through this process. 

It is my belief that at least half of the brokers in Colorado won’t even mess with HUD homes because of the absurdity of the process.  But, because HUD generally gives homes away for cheap (after all, the taxpayer foots the bill for losses), buyers go after them. 

The thing I want to do with this post is to use this as an educational tool for future buyers.  You need to know what this looks like up front, because by the time you figure out you’re in the middle of a three ring bureaucratic circus, you’ve already invested significant time, money and emotional energy.

I’m fine with HUD homes.  They are what they are.  They are often sold well below market value.  But if you find the process stressful, confusing and fraught with upfront costs and mind-numbing sideshows, don’t blame me.  You’ve been warned.

FULL SPEED AHEAD

Two months into 2014, and it's starting to feel a lot like 2013 all over again.

Record low inventory, multiple offer shootouts, an overall market absorption rate of 1.45 months.. yeah, this is the same song that just led to 10% appreciation in 2013.

The inventory of homes for sale in the metro area fell to 6,026 homes at the end of January, a new all-time low that was nearly 10% under last March's previous bottom.  From December 31 to January 31, a time when you might think more listings would come on the market, the active inventory actually plunged by 800 homes. 

Why did this happen?  In short, the number of buyers in January (about 4,200 homes went under contract) swamped the number of new sellers (about 3,400), which led to a net loss of 800 listings. 

If you're a buyer looking to "steal one", this is a little bit demoralizing. 

We've talked repeatedly here about why the inventory is low - no more foreclosures, large numbers of "boomerang buyers", no new construction under $325k, record in-state migration, an improving Denver economy, low rates, high rents.  Add it all up and the market remains just smoking hot.

We actually had an increase of more than 8% in the number of homes that went under contract in January of 2014 versus January of 2013, despite the fact that prices are up to 10% higher and rates are up a full percent over the past 12 months.

In Denver, higher prices and higher rates are not deterring anyone from buying a house.

With the Fed now backing off of Quantitative Easing (which has artificially held rates down since 2009), the near certainty of higher rates a year from today seems to be driving buyers to act while affordability is still reasonable. 

A year ago, however, affordability was unbelievable. 

I do believe that this year's market is going to be even more "tiered" than in past years, meaning that demand for homes under $300k is going to continue to sizzle while higher end homes are more vulnerable to value stagnation, especially as rates rise later in the year.

For 2014, the psychology on the street is that owning is better than renting, rates in the 4's today are better than rates in the 5's tomorrow, and migration and a dramatically improved economy have essentially driven all fear out of the market. 

If you aren't ready to get in, don't bother showing up.  The market in Denver below $300k remains swamped with buyers, and the only way to create balance between supply and demand is for prices to continue going up until buyers back off, which hasn't happened yet.

THE $73.97 PER DAY QUESTION

"Are you in, or are you out?"

That's the real question for buyers in the Denver real estate market right now.  

I'm sorry to have to go into "tough love" mode, but as a broker, figuring out whether your buyers are contenders or pretenders is one of your primary responsibilities these days.  

This past weekend, I wrote an above list price offer on a south Denver home for well-qualified buyers one day before the property hit the open market (yes, I got us in early) and we didn't even draw a counter offer.

The seller chose to sit on our offer until the crowd came storming through the next day.  At the end of that first day, the scorecard read multiple offers, cash buyer, game over.  

Back to the drawing board.

But at least these buyers are contenders.  They wrote an extremely solid offer that would have been a slam dunk three years ago.  And even in this hot market, I thought we had at least a 50/50 shot.

The inventory of homes for sale in Denver now sits below 7,000.  In 2007, there were 31,000 homes for sale.  In 2010, there were 23,000 homes for sale.  In 2013, we peaked at 10,000 homes for sale.  As of February 10, the number of homes for sale in the Denver MLS was 6,026.  

Why the plunge?  As I've discussed repeatedly on this site, it's a combination of no more foreclosures plus limited new construction (especially at the lower price points) plus a large number of "boomerang buyers" (Foreclosure 1.0 people) looping back into the market, coupled with low rates, a rapidly improving economy and massive Colorado population growth over the past five years.

Whereas the market was full of headwinds from 2006 - 2010, today's buyers are walking into a market with gale-force tailwinds.  

Buying a home in 2014 bears absolutely no resemblance to the process of buying a home in 2007 or 2010.  Sellers (especially at the lower price points) clearly have the upper hand today and buyers who don't realize this aren't really buyers at all, at least as I see it.  They are pretenders.

With the median home price in Denver now right around $270,000 and 2013 appreciation of 10%, the median equity gain for homeowners in the metro area last year was $73.97 per day.  That's every day.  For the past 365 days.

Truth is, for most people at the median price, equity gains more than offset mortgage payments in 2013.  Think about that for a moment.  Free mortgage payments for a year.  That is simply remarkable.

If you are looking to get into the market as a buyer during 2014, you had better have some conviction.  Because those who truly want in are running right over the timid when it come to taking advantage of this bright season for housing.  

Nothing lasts forever.  In reality, those who bought a year ago will do better than those who buy today.  Rates are higher.  Prices are higher.  But the tailwinds are still firmly blowing, and the benefits remaining are reserved for those who get in while time and demographics remain on your side.

POCKET LISTINGS

Here comes the nonsense, again. 

With the Denver housing market on fire during the first six weeks of the year (again) and listing inventory now officially at a 39-year low (unbelievable), some practices many professionals consider “questionable” are creeping back into the market.

One of these practices is the “pocket listing”.  A pocket listing is a property that a broker lists for sale but never enters into the MLS.  The agent, in effect, keeps the listing in his or her pocket and does not broadly market it through the MLS.

Why would an agent do this? 

Most times, unfortunately, the answer is outright greed.  If an agent can get his seller to sign a disclosure authorizing the agent to withhold the property from the MLS, that agent effectively becomes the only one who can represent the buyer.  It means the agent is one or two opens houses from a double-ended deal, and a fat payday.

And many sellers, unfortunately, are so poorly educated by the agent they don’t even know what they are signing, or why it might be desirable to have 14,000 dues-paying MLS members with buyers having access to their property instead of just one.

If you are selling a home, and you were interested in the highest and best possible price, why would you willingly give up access to 13,999 other brokers being able to show and sell your property?

You can see why there is controversy around pocket listings.  Agents freezing other agents out of transactions is never looked upon favorably, and from an ethical standpoint, you have to wonder how many sellers (who are often older, or living out of state, or may simply be clueless about this) really understand what is happening. 

I saw a similar practice during the final days of the housing boom in California back in 2005.  Several agents began listing homes in the MLS so that they were fully marketed to all brokers… but with a buyer’s agent commission of $1.  Yes, one dollar.

Agents have long memories.  If, as an agent, you decide to go down this road, you need to realize that other agents are going to remember how you chose to do business when times were good.  Because when the market changes, and it will change one day, your reputation is all you have.

While our market continues to sizzle and significantly lift Denver’s overall economy, the smash and grab mentality of agents pursuing pocket listings is one trend I could live without. 

THE "AS IS" SALE

Part of being an effective negotiator is realizing who has the leverage in a negotiation.  Conditions can change – and they do – which means the side that may have the advantage in one market may be at a total disadvantage in another market.

That’s pretty obvious, but it’s amazing how slow people are to adapt.

Right now, due to record low inventory, surging prices and extremely strong buyer demand (especially below $300,000), sellers have the upper hand.  Homes at the lower price ranges are getting a ridiculous number of showings, and properties that are priced with some modicum of common sense and which aren’t completely falling down are regularly going under contract in a day or two.

That’s a far cry from 2007-2010, when buyers wouldn’t even imagine the thought of writing a full price offer and homes languished on the market for months at a time.  (Distressed inventory also made up nearly 50% of the active market during this time, too, as opposed to 5% today)

So realizing that times have changed, you have to change.

If you’re a buyer, that means recognizing you are likely to be in competition for any good property, which means you need to tone it down with your list of demands and realize that there will be no future equity gains for you if you don’t find a way to own a piece of something.

With sellers, that means you might be able to sell your home on an “As Is” basis, meaning you are telling buyers that “what you see is what you get”.  No repairs.

Now every situation is different, and so this isn’t a universally applied principle.  It’s a tool – one of many in the negotiation toolbox. 

If I have a buyer and we’re looking at a clean property that’s sure to attract intense interest… I am now talking to my buyers about the “As Is” purchase.  We still get to do inspections, and we still have the right to cancel if something unforeseen turns up in inspections.  But if the house is what we think it is, we’re telling the seller in the contract that we are prepared to go forward “As Is”, subject to an inspection for buyer’s knowledge only (but retaining our right to cancel).

For many sellers, who dread the inspection process (we’ve all heard horror stories, right?), it’s much easier to say yes to the “As Is” buyer than someone who might carve you up and cause you heartache by nitpicking, or worse yet, tearing you apart on inspections.

If you can reasonably expect 5% appreciation in the coming year (which is a strong probability at the lower price points), a $250,000 purchase will net $12,500 in equity gains in the coming year.  If you forego $2,000 of possible repairs to secure a $12,500 gain in 12 months, that still makes plenty of sense. 

This past week, I closed on my first “As Is” listing in many years.  I sold a ranch home built in 1971 that had a fair amount of deferred maintenance – nothing fatal, but a lot of little things.  Old paint, old carpet, old wood trim, aluminum wiring, an older roof, old appliances, an older furnace. 

Because of the price point and the location, I knew we would get a lot of showings. 

If my sellers started to address these issues, my fear was that it would only make the other deficiencies more glaring.  If he painted, the carpet would look bad.  If he updated the appliances, the dark wood would be out of place.  If he replaced the furnace, why not the roof? 

In this case, we decided that whoever would buy the house would probably want to do a total remodel, so why gum up the works by starting a handful of projects?

So did we discount the price?  Not really.  We just braced for the fact that this house would not be for everyone. 

What’s different today is that when you have a dozen motivated buyers coming through in the first two days, you don’t need all 12 of them to love your house or love your price.  You just need one. 

And so that “As Is” strategy, which would have been unthinkable 24 months ago, is now a viable option for many sellers. 

Again, I must emphasize that every situation is unique and these strategies are not universally applicable.  But in some situations, they make all the sense in the world, whether it’s writing an “As Is” offer for a buyer or offering a property strictly “As Is” for the seller. 

The “As Is” sale is merely another tool in the negotiation toolbox, albeit one that hasn’t been broken out on a widespread basis in many, many years.  But then, we haven’t had a market like this in many, many years.

Change is a fact of life.  The market has changed.  You must be willing to change your thinking as well. 

RETHINKING 2014

In the end, markets boil down to two things:  supply and demand.

Now supply can be affected by many things, including the economy, tax laws, materials shortages, labor shortages (or surpluses), weather patterns, government mandates... lots of things can affect supply.

Demand can also be affected by many factors, including demographics, the economy, interest rates, and psychology.  

The point is that supply and demand are living, breathing concepts and their intensity varies with time.  You could almost say that supply and demand is like a weather pattern, in that it will always be changing to some extent.

Through the first five weeks of this year, the temperature in the market has definitely gone up, again.

As of mid-January, our inventory of homes for sale in Denver has fallen to fewer than 7,000 and it's getting dangerously close to the all-time low (dating to 1985!) of 6,682, which was the inventory count on March 31, 2013.  

Meantime, buyers have come charging out of the gates again in 2014, fearing that rates are bound to go up and that prices will continue to rise.  

Marketwide, there is just 2.52 months of inventory today.  Two years ago, at the start of 2012, we had 5.88 months of inventory on the market in Denver.

The chart accompanying this post is quite telling. The blue line shows the number of homes for sale (supply) at any point in time going back to 2004.  The red line (demand) shows the number of homes under contract at any point in time.  

I tell my clients that the white space in between the two lines reflects your ability to negotiate.  Notice anything?

Of course, it's plainly obvious that the market today looks absolutely nothing like the market of 2007, or 2009, or 2011... in fact, in two decades as a broker (including 11 years in a red hot California market), I have never seen the velocity that we have seen in this market over the past 18 months.

I listed a home last week that had 12 showings and multiple offers within 48 hours.  I put a home under contract for a buyer on Friday that had three offers within 24 hours.  

When you consider that a good number of the homes on the market are either conspicuously overpriced or suffering from piles of deferred maintenance (or both), the universe of homes that are actually salable is even thinner than these numbers suggest.  

In a normal market (which we haven't had in over two years), you will normally see a ratio of about 2 homes on the market to each one under contract.  Today, we have 6,800 homes on the market and 5,700 under contract.  That's an overall ratio of 1.19.  

Below $250,000, however, that ratio falls to 0.64.  From $250,000 to $400,000, it's 1.23.  

What that means is that below $400,000 there literally is nothing for sale and yet buyers are seemingly everywhere.  

And what does that mean?  

For 2014, it means prices are going higher.  Again.  

We truly are living through a golden age for real estate in Colorado.  And depending on whether you own or rent, you are either loving it or hating it.

HGTV EQUALS “NOT REAL”

It’s amazing to me how many people I come across who derive their perceptions of real estate from HGTV.

Including my daughters.

Yes, it’s true, my 13 and 14 year old daughters are HGTV junkies.  “Love It or List It”, “House Hunters”, “Property Virgins”… my DVR is like a never-ending loop of nightmarish real estate programming.

Here’s the problem – it’s all bogus.

I have actually tried to wade through a few of these programs with them, and I always end up in the same place… embarrassed, demeaned, and feeling like I just wasted another valuable hour of my life.

While there might occasionally be some miniscule thread of reality actually running through these “reality” shows, you have to search hard to find it.

Egotistical, golf-loving real estate agents.  Overly-zealous property stagers salivating over the prospect of a five-figure design budget.  Clueless buyers with no regard for value, negotiation or exit strategy.  It looks absolutely nothing like reality, or at least reality for someone actually selling homes to clients who actually matter.

There is a firm 80/20 rule in real estate, as there is in life.  Twenty percent of the agents do 80% of the business, and everyone else is fighting for table scraps.  Or trying to launch their acting career on HGTV.

HGTV is not for the doers.  It is for the posers.  Most of the agents on these shows are not serious professionals.  In fact, I would love it if HGTV would actually post sales production history next to each character’s name.

“Bob Smith, Real Estate Agent.  Sales in Past 12 Months – 3.  Income - $17,213.  Lives with his mom.”

“Randy Raccoon, Real Estate Agent.  Sales in Past 12 Months – 5.  Trust Fund Baby.  Scratch Golfer.”

The people who are actually selling homes, the top 20%, are far too busy closing deals and helping people to participate in this nonsense.  So you end up in a parodied world of clichés and cluelessness, scripted by screenwriters and directors who know nothing about the real world of real estate.

It doesn’t bother me.  It humors me.  But it also concerns me when people poised to make decisions involving real money with real consequences show up utterly clueless when it comes to their understanding of what a real estate transaction should look like. 

Most people will only buy a few homes in their lifetime.  Therefore, these outcomes are important.  You don’t buy a home for its cabinets or its carpet.  You buy a home based on value, based on its location, based on its resale potential, based on the improvement in your quality of life that comes from signing that purchase offer and negotiating that deal. 

If you’re smart, you buy guided by logic, not emotion.  You assemble a team of competent, ethical professionals and approach it seriously.  You shun the spotlight because there’s serious work to be done and important decisions require your full attention.    

Look, if you want to watch HGTV, have at it.  There’s far worse stuff on television.  Just realize that what you’re seeing is about as real as Marge Simpson’s blue hair.  

CONSPIRACY OF THE COMPETENT

This post is probably going to ruffle some feathers, but I think it’s worth putting out there.  I showed some restraint in posting it, however, because I actually wrote this in the fall of 2013 but held on to it for a few months so as to protect the identities of those (most recently) involved.

There’s a conspiracy going on in real estate right now.  It’s the “Conspiracy of the Competent”.

What does that mean?

It means that, all things being equal, agents who do deals prefer to do deals with agents who do deals. 

In a hot market, sellers have far more leverage than they have had in many years.  In a cold market, buyers get to set the rules of engagement.  In any market environment, the leverage shifts from one side to the other based on whose side the numbers are favoring.

Right now, if you’re selling a home, the name of the game isn’t simply “getting an offer”.  It’s getting the RIGHT offer, from the RIGHT buyer, with the RIGHT agent, with the RIGHT terms. 

Sound farfetched?

If you understand what this market is, it’s not farfetched at all.

One of the classic mistakes lower-producing agents make is that they fall in love with any deal, because they think that being under contract is all that matters.

Well, that’s like saying it doesn’t matter who you get engaged to, as long as you are engaged.

As the father of two daughters, I can tell you that kind of thinking is preposterous!

It completely matters who you contract with, because for the next 45 days, you’re going to be in an intense relationship that is almost certain to have dips, turns and drama at some point.  If both sides are committed to the interests of their clients, it’s almost inevitable.

So why would you knowingly contract with an agent who sells five homes a year when you could find someone successfully selling 20 or 30? 

Now it’s true, there are a handful of really good agents out there (perhaps semi-retired) who only sell a few homes a year by choice.  And there are some "high producing" agents who you would be well-advised to stay away from.  That’s why I get on the phone and ask questions.

I also do my diligence to figure out who the buyers are.  How did the agent meet them?  Past client?  Referral?  Blind call from a bus bench ad?  It matters.

Then we talk about the lender.  If it’s Quicken Loans or the Bank of Zimbabwe, you might want to pass.  I strongly prefer lenders who are locally-based and who have established relationships with their real estate agents, because again, teamwork and solving problems is at the core of making it to closing in one piece.

Three years ago, I didn’t vet things so invasively.  That’s because three years ago, you weren’t going to get multiple offers.  Buyers were scarce and sellers were plentiful.  That meant buyers got to call the shots, and sellers who wanted to sell had to deal with a very thin buyer pool.  And that meant sometimes you simply needed to contract with people who might cause more problems than they solve. 

Of course, every situation is unique and sometimes I do choose to work with agents who don’t sell a lot of homes.   Maybe they have an incredibly well-qualified buyer, with bank statements submitted to back up a large down payment.  Maybe they are new to the business but are working under an accomplished and well-respected agent.  Or maybe, on occasion, every now and then you simply have no choice but to contract with someone who doesn’t sell a lot of homes.  Those are often the deals that hasten ongoing hair loss and these stupid crows’ feet next to my eyes.

But all things being equal, I’m drawn to competence and proven results.

If you’re working with your hairdresser or your cousin who just got his real estate license, you might not want to hear this.  But good agents prefer to work with good agents.  

HOW MUCH HIGHER WOULD YOU LIKE YOUR PAYMENT TO BE - 12%, 18% or 24%?

I am convinced that 2013 will go down on record as the best year in our lifetime to buy a new home.  It’s pretty simple – prices were near the bottom and interest rates were ridiculously and artificially lower than at any time in history, thanks to the Federal Reserve’s efforts to jack up the economy with “free” money (okay, nearly free).

Last February, I had one client close on a 30 year loan with a rate of 2.875%.  That is a fixed rate.  Yes, it really happened.

Many others closed at 3.25%, 3.50% or 3.75%.  Again, all utterly ridiculous in the context of historical norms (see chart to right).

The fact is, that with just over 10% appreciation (last year’s average in Denver) and a 1% increase in rates (which happened over the course of the year), the monthly payment on a new purchase December 31 was 26% higher than it was on January 1. 

That’s why last year was the best time ever to purchase a home.

So what does that mean today?  Have you missed the market? 

Of course, everyone must make their own decisions, but for reasons I have outlined extensively on this blog, I think there’s plenty of gas left in the tank – but with a strong bias toward better performance at the lower price points.

As I discussed in my 2014 Client Letter, the Federal Reserve has announced it will discontinue its policy of “Quantitative Easing” (printing money for banks to use on mortgage loans, then buying back the notes at below market rates) by the end of this year. 

That’s $1 trillion in mortgage capital annually that the Fed has said will go away. 

Does that mean higher rates?  Assuming the economy continues to make strides and there are no unforeseen global disruptions (terrorism, war, chemical attacks on US soil, etc), I would place the odds of higher rates by year end in the 90^th percentile.

So have you missed the market if you didn’t buy last year?

Well, let’s consider a couple of scenarios.

Let’s say real estate matches its performance of 2013 (optimistic, but possible).  If values go up 10% and rates go up 1%, your payment one year from today will be 24% higher than it is today.

A $250,000 purchase with a 10% down payment would have a $225,000 loan.  At 4.5% over 30 years, your monthly principal and interest payment is $1,010. 

A $275,000 purchase with a 10% down payment would have a $247,500 loan.  At 5.5% over 30 years, your monthly principal and interest payment is $1,254.

That’s a 24% increase.

You can easily run scenarios on other projections as well.

A one percent increase in rates coupled with 5% appreciation leads at an 18% increase in payment.

And for the naysayers… let’s say housing is flat in 2014, with no appreciation at all.  A one percent increase in rates will drive your payment 12% higher.

That means the likelihood of higher payments at year end is a virtual certainty.  That means your dollar goes further now. 

And remember that mortgage payments, unlike rent, do not adjust for inflation or future market conditions.  A $1,200 P&I payment today will be the same payment in 2019, 2024, 2029 or however far out you wish to project. 

It’s mid-January and the market is already teeming with buyers.  Inventory remains near all-time lows.  Distressed sales are history. 

With each passing day, housing will become more expensive, meaning that when it comes to making a move, sooner truly is much better than later.

2014 CLIENT LETTER (LONG FORM)

Here is the long form version of my 2014 client letter, which goes out in the mail next week.  (Only the true housing junkies will make it through all six pages!)

Enjoy - DB

******

Dear Friends,

Greetings, and Happy New Year!

On New Year’s Eve, the Denver Business Journal released its list of top news stories for 2013.  Ranked #1?  Denver’s remarkable housing recovery, which featured record-low inventory, an increase in sales of nearly 20% and a top-five ranking in several national surveys. 

It also featured appreciation.  Lots of it.  Here are the most recent 12-month appreciation projections from various reporting sources:

Core Logic: 10.2%
Trulia:  9.6%
Zillow:  9.3%
Case-Shiller:  9.5%
Metro Denver Economic Development Corporation:  9.2%

The growth in values triggered 2013 equity gains of over $21 billion in the Denver metro area alone.

And that growth in equity resulted in increased consumer spending, which resulted in increased hiring, which resulted in increased new construction of homes and apartments, which resulted in the best year for overall economic growth since the recession began in 2007.

But what does it mean going forward?

While 2013 was a record-breaking year for housing, I believe there’s more fuel in the tank for 2014.  However, it’s going to look different.  Appreciation rates are going to drop back to more traditional levels, as higher rates and higher prices cause buyers to think longer and harder before pulling the trigger.

The fact of the matter is that when you combine interest rate increases with price appreciation, homes are significantly more expensive today than they were 12 months ago.  One recent report shows that with 10% appreciation and 30-year mortgage rates going from 3.25% at the start of the year to 4.50% today, purchasing a home on the last day of 2013 would be roughly 26% more expensive than purchasing it on the first day of 2013.

That’s going to slow some people down.

Which is a perfect lead in to the concept of “market velocity”.  I believe the low prices and low rates we saw during the first half of 2013 created a near-perfect storm for buyers and sellers alike, which resulted in unprecedented market velocity. 

Market velocity is simply a fancy term for how quickly things sell.  During June of 2013, half of the homes that went under contract were on the market less than six days.  That is simply astounding, and in 19 years as a broker, I’ve never seen anything like it.

I listed one home in February that had 29 showings and 4 offers in 48 hours – and we were not giving it away!  To the contrary, this sale established a new high for the neighborhood, but with rates being so low and payments being so much cheaper than rent, buyers were climbing over one another to take advantage of these conditions.  (We also did an amazing job of staging it, but that’s a separate conversation)

So while the conditions were great for buyers, they were just as good for sellers.  Multiple offers, over-list price offers and “escalator clauses” became very common through the middle months of the year.  Sellers made excellent profits while buyers still felt they were getting great value.  It truly was the best of times.

As I referenced above, it’s going to change some in 2014, but I believe we’re still in a good place.  Zillow recently ranked Denver as the fifth strongest housing market in the country, and the highest ranked market in the country not located in California (which saw value losses of up to 50% during the downturn, compared to losses of 10 to 15% in Denver). 

Zillow’s “Market Health Index” gave Denver an overall score of 8.1, meaning that the fundamentals of the Denver market are stronger than 81% of the metro areas in the United States.  Over 86% of all homes sold in the Denver metro area during 2013 were sold at a gain, and only 11% of mortgages remain in a negative equity position.  Prices today are higher now than they were at the peak of the market in 2006.

So clearly there’s plenty that’s going well, but there are also some things to keep an eye on in 2014. No market cycle lasts forever, and the truth is that part of our upward trajectory has been caused by unprecedented government involvement in housing. 

Let me share with you some reasons the housing recovery still has legs, as well as things to watch for that could signal a change in the future direction of the market. 

POPULATION GROWTH

If you have spent any time on I-25 in the past three years, this isn’t news to you:  the population in the Denver metro area is exploding. 

The US Census Bureau recently reported that Colorado has picked up over 839,000 new residents in the past three years, a stunning annualized growth rate of 4.76%, fourth highest of the 50 states.  A growth rate between 2 and 2.5% is considered average.

So where are these 839,000 new residents going to live?  In the past three years, there have been fewer than 100,000 permits pulled for new homes and multi-family units.  That’s a dramatic shortage which is keeping rents at all-time highs and vacancy rates at all-time lows, while also ensuring a continuing demand for housing.    

ECONOMIC GROWTH

Denver’s unemployment rate fell from 7.0% at the start of 2013 to 5.9% at the end of 2013.  The national unemployment rate began the year at 7.9% and was 7.3% as of the end of October, according to the Bureau of Labor Statistics, so Denver continues to significantly outperform the rest of the country.

Consumer confidence for the Mountain Region (which includes Colorado) hit a six-year high of 80.7, more than 10 points above the national level of 70.4.  Significantly, while consumer confidence nationally has fallen by 1.7 points since the beginning of the year, the Mountain Region reading is 18.5 points higher than it was at the start of the year. 

The NASDAQ was up 38%, the S&P 500 increased 29% and Bloomberg’s Colorado Index improved by over 28% during 2013.  Coupled with housing’s huge comeback in 2013, people are feeling the “wealth effect” of newfound equity for the first time in at least seven years.

Let me make one important disclaimer, however, about the economy.  If you have a job, own a house, and have a significant portfolio of stocks, these are good times.  Unfortunately, 35% of the population rents and an even larger percentage has no stake in the stock market.  For these people, the economy remains extremely challenging, and I don’t see it getting better. 

Right or wrong, the divide between the rich and poor is growing wider, and you need to be aware of this when you make housing decisions. 

FORECLOSURES, SHORT SALES NO LONGER RELEVANT

At the start of 2011, 45% of the homes for sale in the Denver MLS were short sales or foreclosures.  Today, that number is 5%.  From a housing standpoint, foreclosures and short sales are statistically irrelevant. 

The disappearance of foreclosure inventory is one the big factors in our overall lack of inventory.  As of today, there are just over 8,000 homes for sale in the Denver metro area, down from a high-water mark of nearly 31,000 (most of them foreclosures) during the summer of 2007. 

When you consider that over 83,000 homes were lost to foreclosure in the seven-county Denver metro area during the peak of the recession, and many of these “boomerang buyers” are now re-entering the market, you see how lopsided the supply-demand imbalance has become.

And because builders cannot build anything with a profit below about $325,000, and most of these first-generation foreclosure folks are looking for homes well below that price point, it’s not hard to envision continued upside at the lower price points.

REPLACEMENT COST

As I just referenced, while builders are most definitely cranking out the homes again, it’s virtually impossible to find a new single family home below $325k (unless you are willing to move to Fort Lupton, Firestone or Lochbuie, where the land value is essentially zero). 

Replacement cost is a very important number in the context of understanding real estate values. 

Many of you have heard a story I told repeatedly this year of a client who sold a home here in Denver in order to move to Las Vegas.  He made an offer on a 3,000 square foot ranch home on a golf course that was built in 2007 and originally sold for $525,000.  The Las Vegas property was bank-owned and he ended up in a bidding war.  The bank listed it for $255,000 and he ended up going all the way to $280,000 (and outbidding several other buyers) to get the home under contract.

When he asked me what I thought of his deal, I suggested that he take a hard look at replacement cost.  And sure enough, when the insurance company went to the house to prepare an insurance quote, Allstate estimated the replacement cost at $440,000. 

If you can buy something for $280,000 that costs $440,000 to rebuild, you are not overpaying.  And that’s why you’ve heard stories of 25% to 30% price appreciation in places like Phoenix, Las Vegas and the hardest-hit foreclosure markets during 2013.    

Because of the absolute stupidity and mismanagement of the financial crisis by the banks and the government, homes have been selling at absurd discounts, with the losses offset by the Federal Reserve and banking regulators (or, if you want to be painfully precise, current and future taxpayers).

Lower-priced homes are going to continue to be the safest bet in housing because the supply is limited, the demand for them is extreme and builders can’t build them for a profit.  Even with prices coming off the bottom, entry-level housing is still the most secure place to invest in real estate.

NEW CONSTRUCTION

Now playing in a city near you.  There’s plenty of new construction once again, although as I referenced, very little of it is what we would call “affordable”. 

New construction is booming because money is cheap, homeowners in the mid-price ranges now have equity and builders can’t help themselves. 

Are we overbuilding again at the higher price points?  I believe we are.  And when interest rates go up, eventually, new construction will be the first sector of the market to feel it.

New construction is most often an emotional purchase based on wants and desires, not need.  When economic conditions change, luxuries go out the window and people focus on what they need, not what they want.  As always, be careful with new construction in 2014.

CONDOS

Conversely, I think there is evidence to support the theory that the condo market is about to get healthy. 

Truthfully, condos are very rarely a “first choice” when it comes to housing, but I believe we are living in an economy where second choices are going to become a primary alternative (out of necessity) to more and more people, especially at the lower price points. 

And that’s what condos generally are – more affordable entry-level properties that give people a foot in the door when it comes to housing.

In the boom market of 2000 – 2006, condo buyers could get in with little or no money down.  And that’s pretty much how it went.  For five or six years, most condo buyers put no money down and had zero equity.  When the market turned, they had the least incentive to stick around, and so condo foreclosure rates soared and property values crashed. 

During the recession, conventional lenders took an exceptionally hard line on condos, with many refusing to do any loans for buyers who didn’t have 20% down.  That further thinned the buyer pool, which caused more value losses and even more foreclosures.  Then FHA essentially abandoned the condo market in 2009, and it just got awful.  This regrettable cycle finally bottomed in 2011, but now it’s starting to turn. 

I just sold a condo in November to a buyer who purchased with a 5% down payment.  Now that we’re done with foreclosures and the market is improving, more lenders are getting back into the game. 

When that happens, and you let more 5% and 10% down payment buyers into the arena, the buyer pool expands.  And since we don’t have any more foreclosures and inventory is so low, condo prices figure to continue trending upward.

Condos are not for everybody, but after avoiding them at any price for five years, I expect to sell more of them in 2014.

QUANTITATIVE EASING

Finally, we can’t discuss housing without some mention of Quantitative Easing (known as “QE”).  If you don’t know what this terms means, you should get educated quickly.  (I wrote about it extensively on my blog September 20, 2013 – go to www.DaleBecker.com for the five-minute crash course)

In short, Quantitative Easing is a policy the Federal Reserve began implementing during the darkest days of our financial crisis back in 2009.  To keep the mortgage market from completely collapsing, the Fed began printing money to fund mortgages and purchasing the notes at below market rates.  The overreach is that, five years later, they’re still doing it.

That’s how buyers have been able to get rates in the 3’s and 4’s over the past two years, when market conditions would warrant a higher rate of return for investors (and higher interest rates for buyers). 

The Fed has been pumping $1 trillion a year into the economy via the QE program, and it has done its job.  It has stabilized the market and now it has fueled significant price and equity gains, which is what the government has wanted all along. 

It’s time to stop printing money, but I fear the government lacks the courage to do it. 

QE purchases are supposed to slow by $10 billion per month starting in January, and the Fed has said it plans to be out of the market entirely by December.  I personally don’t see it happening because the benefits of low rates and soaring home prices are just too tantalizing for the government to back away from (especially in an election year), but for the future sustainability of the market, I hope it happens. 

If you have made it this far, I commend you for you diligence and desire to understand the housing market.  I have always said that I want my clients to be best-educated buyers and sellers in the marketplace, and that is why I write this annual overview at the beginning of each year.

This will be my 20^th year as a real estate broker.  In those years, I have seen all types of markets.  The one constant is that I have always worked to protect my clients and help them create opportunities for success. 

I am deeply humbled by your continued support, your ongoing friendship and the amazing quantity (and quality) of referrals you send my way. 

I wish you and your loved ones all the best for a happy, healthy and prosperous 2014!

Dale Becker, CRS

RE/MAX Masters

(303) 416-0087