A PERMANENT LOW INVENTORY MARKET?

Much is being made of our current inventory drought here in Denver.  A severe shortage of homes for sale is inspiring multiple offers, bidding wars and near double-digit price appreciation (especially at the lower price brackets) once again in 2014.

So what's up?  Is this the new reality for home shoppers in Denver?

I believe it is.

And here's why.  As I have chronicled extensively on this blog, low inventory is the result of no more foreclosures, virtually no new construction under $350k, huge population growth, an improving economy and the "turnstile effect" of having more than 100,000 first generation foreclosure owners cycling back into the market.

Couple that with low rates, and you have a tsunami of demand sweeping over a tiny island of supply.  But here's the new twist...

When the Fed began systematically undercutting the mortgage market through Quantitative Easing (QE)  in 2009, ushering in an era of record low interest rates which extended into the second half of 2013, the goal was to breathe life into a lifeless housing market and put more disposable income into the pockets of refinancing homeowners.

All well and good, but now here comes the boomerang.  Fast forward a few years, and those homeowners who refi'd into rates in the 3's are suddenly pretty addicted to those low payments. 

When you pair that with the steep price increases across the board we have seen over the past two years, the cost of picking up an extra bedroom or a larger yard is inducing pretty severe sticker shock.

Follow this scenario:

- Homeowners Bob and Jane have two kids and own a three bedroom home at the start of 2012 that is worth $250,000.  Refinancing their loan at 3.25% at an 80% LTV gives them a monthly principal and interest payment of $870, an almost ridiculously low amount, which is fixed for the next 30 years.

- Two years later, Bob and Jane learn they are expecting child number three.  Thinking that a fourth bedroom would serve them well, they start exploring their options.

- Immediately, there are two problems.  While their existing home has increased in value and is now worth $300,000 (giving them more equity), the home they are hoping to buy has also gone up in value.  Available for $300,000 just two years ago, today those sellers are looking for something upwards of $350,000.

- The second shock is with interest rates.  That 3.25% mortgage of two years ago is gone.  The new number is 4.50%.  So even with a 20% down payment on their $350,000 replacement home, the new loan is $280,000.  And with rates at 4.50% instead of 3.25%, the reality is that their new payment will increase from $870 to $1,419, a 61% increase in housing payment.  

All for one extra bedroom.

And that's not the end of it.  Say what you will about "subprime financing", but ten years ago, if a homeowner wanted to move from their exiting home to a new home in one shot, they could do it by taking out a "bridge loan" that would allow them to purchase home number two before home number one even went on the market.

Buy home number two, move, and then go back and sell home number one.  That was easier, less disruptive to the kids and it allowed them to both buy from a position of strength (non-contingent) and sell from a position of strength (with a vacant or properly staged, turnkey ready home).

Those days are over.  Now, if a homeowner wants to sell and can't carry two mortgages, they must either sell home number one and attempt to purchase home number two "contingent" upon the successful sale of home number one (a heavy layer of risk in a hot market that greatly reduces the likelihood of any sane upleg seller agreeing to it)... or sell their home and ask the buyer for a rentback period (generally limited to 45 days in financed transactions) during which they hope to secure and close on a replacement home (again, darn near impossible in a zero-inventory market).

Neither of these options has a high probability for success. 

The third option is to sell home number one, sign a lease and move into an apartment for six months while your belongings sit in storage.  This is actually the preferred option, in my mind, because it provides the time and flexibility to be selective with your new home, and when the time comes to write an offer, you are non-contingent and ready to go. 

But who actually wants to do all that for one extra bedroom?

People are addicted to their low payments, and that's not a bad thing.  But it has the effect of freezing people in place, which means the upward mobility that was a hallmark of previous hot markets isn't showing up the same way here.

That means slim pickings, bidding wars and ongoing price aggression as a huge and growing pool of buyers compete in a continuing zero inventory environment.

For many sellers, the pain and discomfort of moving, both financially and emotionally, is greater that the pain of simply staying put.

THE BANK OF MOM AND DAD

In the past two weeks, I have written financed offers on properties that were $9k, $10k and $14k over list price.  Three incredible offers submitted, all rejected outright.

Why?  In each of these cases, it’s because the Bank of Mom and Dad beat us to the punch.

What is the Bank of Mom and Dad?  In a market where sellers love cash offers (as I documented here earlier in the week), the Bank of Mom and Dad comes into play when a buyer’s parents step up and purchase a home outright for their son or daughter, who then doubles back and refinances it after closing in order to put the cash (less their down payment) back into the pockets of Mom and Dad. 

Can everyone go the Bank of Mom and Dad?  Of course not.  In fact, only a small minority of buyers overall have the ability to play this card, because only a small number of parents are willing (or able) to serve up $200k, $300k or more on demand. 

But guess who probably just bought the home you had so fallen in love with?  Yep, BOMAD.

Is the Bank of Mom and Dad unfair?  Sure.  So is life. 

But the fact is in a market where multiple offers on everything is now pretty much the norm, those powered by the finances of Mom and Dad are winning.  And having the ability to buy a home in 15 days (or less), as is, with no appraisal and no underwriting, is going to win out every single time.

If you've been out writing offers and have found yourself inexplicably losing time after time, you might want to set aside a few minutes this weekend to call dear old Mom and Dad, wherever they may be, and reconnect.  Because cash is king right now in Denver real estate, and for many buyers, the Bank of Mom and Dad is the competitive advantage that is setting them apart from everyone else.

WHY DO SELLERS PREFER CASH OFFERS?

Sellers prefer cash offers for several reasons.  When you contrast how “easy” a cash purchase is compared to a financed offer, especially in a hot market, the bias towards cash is obvious.

CLOSING TIME FRAME – A cash buyer can, theoretically, close the next day.  Usually, the cash buyer will want 10 to 15 days to get the home inspected, review the title commitment and (if applicable) HOA docs, but after that… it’s straight to closing.

INSPECTIONS – Not all cash buyers will take a home “as is”, but many will.  Inspections are usually just to verify there are no major deficiencies, with no “nickel and diming” arguments over minor repairs.

APPRAISAL – Many cash buyers are confident and know what they are doing.  Therefore, they will often skip right over an appraisal, which is a huge issue in today’s rising-prices environment.  Because appraisals look backwards, at closed sales, and many homes are now going to the highest bidder, eliminating the risk of a low appraisal is another major incentive to take a cash offer.

What’s missing from this list of key components of a cash offer?  Uh huh, financing. 

When a seller chooses to work with a financed buyer, there’s a whole new set of risks that enter into the transaction.

First, the appraisal.  Any financed deal is going to require an appraisal, and the lender will only finance on the LOWER of the contract price or appraised value.  Let’s say you off $300,000 for a house with a 10% down payment.  That would be a $30,000 down payment

But in today’s super-heated, emotional world of bidding wars, the appraisal comes back at $285,000.  Now you have a problem, because instead of loaning 90% of $300,000 ($270,000), the lender is only going to lend 90% of $285,000 ($256,500).  That means if the seller won’t lower his price (he won’t), the buyer’s only recourse is to find another $13,500 to add to his down payment. 

Does the buyer have it?  Maybe, maybe not.  But if not, the deal is dead.

Now we have the biggest challenge of all, and that is getting a loan through underwriting.  Unlike 10 years ago, when lenders willingly gave money to anyone who could blink their eyes or touch their nose, it takes a real job (with a two-year employment history), real credit, and a real down payment to buy a house in 2014. 

Not everyone fits neatly into that box. 

With rates having gone up and buyers desperately trying to get into the market before rates rise further, some buyers are borderline in terms of qualifying.  (That’s why, as an agent, you absolutely MUST make sure your buyer is in competent hands with financing and that nothing is being left to chance here)

Let’s say a buyer with a 42% DTI ratio goes under contract today, but tomorrow, rates go up .25% and they haven’t yet locked in their loan.  Now their DTI is 46%, and suddenly their financing is dead. 

If you’re a seller, you would rather not deal with this.

But let’s go all the way now and talk about FHA and VA, because in addition to being the lowest possible down payment products on the market, FHA and VA have condition requirements for properties.  Fifteen of them, in fact. 

Things like cracked or broken panes of glass, missing handrails, exit doors that don’t open and close cleanly, trip hazards (think heaving sidewalks), roof issues, peeling paint… all of these are subject to review in an FHA or VA appraisal, and if issues exist, the deal dies unless the seller will fix them.

While most homes don’t have these types of issues, many do.  And especially in a hot market, sellers simply have no interest in creating transactional risk by opening the door to these kinds of reviews, many of which are subjective. 

This is not an all-inclusive list of why sellers prefer cash to financing, but it illustrates the point. 

Now I know what you're probably saying.  "Who's got $300,000 in cash sitting around to buy a house?"  Ready for a shocker?  Right now, nationally, 35% of all buyers are showing up to closing with cash.  

All things being equal, a cash buyer beats a financed buyer every time.  And if no solid cash buyer exists, a more qualified financed buyer beats an FHA or a VA buyer. 

It’s not fair, but it’s a fact.  Even if a lender says you’re qualified to buy a home, in 2014, the market may not agree.  

THE PERILS OF GOING OFF-MLS

Coming Soon.  For Sale by Owner.  Make Me Move. 

These are all potential “off-MLS” sales, meaning these are properties that never hit the Multiple Listing Service and, thus, are never seen by thousands of real estate brokers with active buyers looking to purchase a home.

When a market heats up, like this one has, you always see a rise in this type of activity.  But because of technology, we have never had the quantity of offline sales, nor the quantity of buyers looking to go offline to purchase a home.

Frankly, I don’t care if you go offline, online, or over the line.  I just want you to know what you’re getting into. 

The MLS has been around for decades, first in printed form, then in online form, and now fully digitized, with updates pounding our phones with emails, texts and instant alerts in real time.  It’s been the primary way homes have been sold for 60 years. 

As a real estate professional with 20 years of experience, I can summarize what the MLS stands for in two words:  fair trade.

It’s fair trade because it sets ground rules.  It provides full exposure and equal access.  And the agents who belong to the MLS agree to certain rules and regulations that promote ethics and integrity.

When you go “off-MLS”, these ground rules quickly disappear.

For example, agents who submit properties to the MLS agree to abide by mediation or arbitration (as opposed to a formal court proceeding) in case of a dispute.  No MLS, no mediation or arbitration, which means if there is a problem there is no set protocol short of going to court (which is the most expensive option) when it comes to seeking resolution.

For the majority of licensed agents who are also Realtors, there is an enforceable code of ethics that requires full disclosure of material facts about the property, no undisclosed or “secret” compensation, and disclosure of any potential conflicts of interest.  Go “off-MLS” and this code of ethics disappears.  It suddenly becomes a "one and done" world, with significantly higher potential for fraud or non-disclosure of pertinent information.

And for agents, going “off-MLS” is huge because when you leave the MLS system, there is no guarantee of compensation.  What is the commission if you bring a buyer to a Make Me Move seller?  Zero, unless you can get the seller to toss something in (but the vast majority of Make Me Move sellers are going this route because they have no intention of paying a commission in the first place).  

This means many agents flat out won’t engage with these types of sellers, because there is no guarantee of compensation.  That means not only is the seller unrepresented by a licensed agent, the buyer often ends up without representation, either.  That greatly increases the chances of a dispute, which greatly increases the chances of litigation.  So much for saving money.

Finally, no issue in Denver real estate has become a bigger flashpoint during 2014 than the “Coming Soon” sign.  You see these signs all over town, with agents or individual sellers marketing properties via a “Coming Soon” sign instead of through the MLS.

Why is this an issue? 

Sometimes, the “Coming Soon” sign is a legitimate marketing tool.  But in this market, it has become the epicenter of “off-MLS” sales.

How does it work?  An agent will list a home for a 6% commission.  However, as part of the listing agreement, the agent tells the seller that if he is allowed to “pre-market” the home for two weeks, and he is able to find a buyer, he will lower the total commission to 5% (representing both sides as a transaction broker, which means limited representation for both buyer and seller, which the buyer and seller may or may not even understand). 

The agent posts the “Coming Soon” sign, buyers line up to see the property, and the agent collects a commission on both sides of the deal.

Is this illegal?  No, if it is expressly agreed to by the seller in the listing agreement.

But is it best for all parties?  We know it’s best for the agent, because he just increased his commission by 60% or more. 

But for the seller, is it better to have one agent bringing buyers, or is it better to allow true market exposure by promoting the property to more than 14,000 dues-paying members of the Denver MLS?  What gives you the better chance for a highest and best final offer?

For the buyer, is it better to be represented by someone whose interests are aligned with the seller (or by collecting an oversized commission), or by having your own competent and experienced representation?  Again, I would argue that good representation is worth its weight in gold (see my Zillow Reviews), but because our industry has failed so badly in articulating its value proposition to consumers, buyers are often inclined to go it alone and hope that things work out. 

When a market is overheated and full of emotion, as this one is, decision making skills often break down.  There is an emotionalism to this market that is causing buyers to lunge at properties, and there is a profit opportunity for some listing agents that is too enticing to pass up, ethics be damned.

As someone who has always taken a big picture approach to this business, as someone who takes a real and vested interest in what's best for my clients, and as someone who focuses on long-term relationships instead of quick-buck transactions, this market sucks. 

It’s gone Wild West out there, and professional ethics are dying a slow and bloody death.