Be careful how you hold your investment properties; New IRS "high wealth unit"

It was announced last week that the IRS has established a new unit for the purpose of discovering hidden assets and income of wealthy individuals:

The high-wealth unit is focusing on trusts, real estate investments, privately held companies and other business entities controlled by rich individuals.

H/T Reuters

While the announced intention is to focus on international investments and activities, those investors who employ layers of trusts, LLC's and related entities to hold real estate should view the above references ominously.

While use of sophisticated legal structures can be legal, in other instances they "mask aggressive tax strategies," [IRS Commissioner] Shulman said.

And don't waste time wondering if your activities qualify as "high wealth." If you catch the IRS' attention, you will be considered "high wealth" regardless of what you man own or earn.

Read the Reuters article for more information.

Avoiding minefields in the purchase of investment real estate.

I previously wrote about hidden landmines in the purchase of investment properties. Unwary buyers often walk into the middle of legal disputes with existing tenants. These landmines can be avoided by obtaining a few simple representations when closing on an investment property.

Many buyers obtain a copy of the leases at settlement, at which time the seller writes the word "assigned" on a corner of the leases. This practice is insufficient.

A buyer must obtain a complete Assignment of Leases at settlement. This assignment must specify the following:

• The identity and unit number of each tenant.


• The monthly rent for each tenant.


• The expiration date for each lease, including a statement as to whether each lease is month-to-month.


• A representation that there are no disputes between the seller and any of the tenants.


• The amount of each tenant's security deposit (which amount should be specifically credited to the buyer).

The parties should include language that the document "survives closing," so the buyer can enforce it later against the seller. This document will be a starting point to discover and avoid future legal disputes with the tenants. If any of this information is inconsistent with the written leases, the buyer can ask questions before settlement is complete.

• If the seller is crediting the buyer a smaller security deposit than is specified in the lease, the buyer might learn at that time that the seller has already used some of the deposit to repair damage caused by the tenant or offset unpaid rent, none of which the seller has previously reported to the buyer.


• If the name of the tenant on the Assignment is different from the name on the lease, the buyer might discover that the original tenant has moved out, leaving a new tenant with only an oral lease.


• If the rental amount listed on the Assignment is different from the amount specified on the lease, the buyer might discover unwritten oral arrangements between the seller and tenants (or at least that the seller has raised the rent since the lease was signed).


• Before signing the Assignment, the seller often "remembers" that one of the tenants hasn't yet paid this month's rent (yet he will expect to be reimbursed for a pro-rated portion of this month's rent since the buyer will undoubtedly collect it soon).

As I wrote, this document is only a starting point. It helps identify issues that the parties can then resolve prior to completion of settlement. There are additional documents for the tenants to sign, particularly in the case of commercial real estate purchases and particularly in cases where the Assignment of Leases has raised red flags.

Investment properties come with ticking time bombs.

Given the state of the economy, it is more likely than ever before that you will be stuck with bad tenants and pre-existing disputes when you buy an investment property.

• Sellers will fill their properties with bad tenants just to show occupancy in anticipation of a sale.
• Sellers are less likely to evict delinquent tenants when they expect to complete an imminent sale.
• Financially distressed sellers are more likely to commingle and make use of tenant security deposits that should otherwise be segregated and turned over to the buyers and/or returned to the tenants.
• Financially distressed sellers are likely to ignore maintenance issues, thus causing disputes with tenants and local governments.
• Financially distressed sellers are more likely to make oral agreements with tenants for reduced rent in exchange for labor.
• Sellers often have made promises to tenants (especially commercial tenants) regarding lease extensions (or options to purchase) at rates that are well below what the market will bear.

Sellers rarely disclose these issues to buyers unless the buyers exercise due diligence and force the issue. Each of the above issues can create litigation and/or eviction issues for the buyer after settlement. Disgruntled or delinquent tenants are likely to force the new owner to bear the cost of these problems with no consequence to the former owner. (These disputes would be, of course, in addition to problems related to undisclosed defects in the physical condition of the property.) But there are ways to discover and avoid each of these problems by taking action before settlement.

Check back for further updates.

update - 12-11-09 - Click here for solutions to these problems.

The rise of the suburban high rise.

In July, USA Today published an article chronicling the increase in high rise residential complexes in suburban areas throughout the United States. The paper attributed this trend to energy savings, traffic congestion, land prices and the prevalance of Asian investors in the real estate market.

While this trend has not affected the Harrisburg area in recent years, Harrisburg may be ripe for suburban high rise development soon. There are numerous residential high rise developments in the city of Harrisburg, all or most of which have or will face the prospect of increased costs resulting from Harrisburg's ongoing fiscal crisis. City residents and developers already face higher taxes and municipal utility charges than their suburban counterparts. But soon they may face the possibility of even higher city taxes or other fees designed to offset the debt created by the Harrisburg incinerator.

While certain of these fees will have questionable validity, the larger question is whether these fees will be enough to push the investors and developers into moving their high rise operations into the suburbs. A national trend already exists and conditions in Harrisburg already tend to push investors into the suburbs. How much more in taxation and municipal costs will it take for the Harrisburg area to go the way of the communities referenced in July's USA Today article?

Quote of the day - Thomas Sowell - mortgage debt forgiveness

Government pressures on mortgage lenders to accept less than the full amount they are owed may win votes for politicians, since there are far more borrowers than lenders. But how much future lending can be expected when the lenders know that politicians are ready to intervene at any time to prevent them from getting their money back?

Thomas Sowell - 12-1-09

Suburban development trends

The USA Today published an item this month regarding suburgan development trends throughout the United States. The paper noted the end of four decades of suburban growth throughout the nation:

"Places that have done the worst are places where basically real estate was the economic engine," says Ed McMahon, senior research fellow at the Urban Land Institute, a non-profit group that promotes sustainable development.

emphasis added

What does this mean for Central Pennsylvania? We have not suffered the same consequences as the Sun Belt cities during the recent economic downturn, thus indicating that real estate is not the real "economic engine" for Central Pennsylvania. Instead, government employment has been the main economic engine in the Harrisburg area and continues to prop up the real estate business locally (with help from stimulus money and homebuyers credits).

Does this mean that the real estate bubble is safe in Central Pennsylvania forever? Will real estate prices forever rise? Don't count on it.

Natural Gas prices linked to real estate litigation; Marcellus Shale

The consequences of the ongoing devaluation of the dollar are far reaching and hard to predict. One such consequence has been felt by Realtors attempting to sell raw land in rural areas of Pennsylvania (and other states).

As the government printing press weakens the dollar, prices of commodities, such as fuel, increase. We saw just such a skyrocketing price effect in 2008 with the price of gasoline (and other fuels). When fuel prices shot up, there were many casualties, such as the contracts between real estate sellers and their listing agents. Sellers that had previously signed listing contracts with Realtors to sell their raw land now found themselves with an opportunity. Natural gas prices had risen along with other fuel prices. These rising natural gas prices had made raw land more valuable in many parts of rural Pennsylvania. While this may have seemed to be a welcome surprise to many landowners, many of their properties had been previously listed for sale at pre-inflation prices.

The only way for some land owners to take advantage of the rising natural gas prices was to break their contracts with listing agents (or even sales contracts with buyers). Litigation between Realtors, owners and buyers often resulted.

Keep in mind that fuel prices rose, creating this situation, despite the discovery of 500 trillion cubic feet of natural gas in Pennsylvania and neighboring states (otherwise known as the Marcellus Shale) during roughly the same period as the general commodity price inflation.

Only when the dollar is being devalued at an alarming pace can commodity prices rise despite discovery of tremendous new supplies of said commodity. That same dollar devaluation that caused (1) natural gas prices to react unpredictably and (2) unforeseen litigation will continue to create unpredictable consequences for the economy as a whole, especially the real estate market.

Marcellus Shale - H/T Lycolibrary.org

Buyers tax credit less important than home prices

I have previously written here on Congress' extension of the home buyers' tax credit.

A recent survey suggests that the homebuyers credit was not as big a factor in home buying decisions as previously believed:

But in a recent NAR survey, only 6 percent of first-time home buyers—who made their purchase during the 12 months ending last June—cited the tax credit as the primary reason behind their decision. The results suggest that other factors, such as attractive interest rates and falling home prices, deserve more of the credit for the market's recent uptick, says Keith Gumbinger of HSH.com. "The most powerful force at work is the desirability of buying a home and the market conditions—that's your mortgage rates and your prices," Gumbinger says.

H/T U.S. News and World Report

The tax credit (and the recent extension) will actually prop up prices. The credit thus appears to be hindering the volume of sales.

Mortgage applications reduced to 2000 levels.

Bloomberg reports that home mortgage applications for purchases are down to their lowest level since 2000:

The drop in buying plans points to the risk that the recent stabilization in housing will unravel without government help. In a bid to sustain the recovery, Congress passed and the administration signed a bill last week to extend jobless benefits and incentives for first-time homebuyers, adding a provision that also made funds available to current owners.

This article and this trend indicate that the government considers it to be a problem when buying returns to levels from the year 2000. I remember 2000, and the economy, including the real estate market, did not seem to be in desparate shape at that time. Yet sales at only the year-2000 level seem to be insufficient to avoid dire economic consequences.

This is one of the characteristics of an inflationary era. Economic activity that is sufficient to maintain prosperity for a short time will not be sufficient without substantial increases. In this case, continued government stimulus is necessary to push real estate sales to higher and higher volumes just for the purpose of avoiding the return of 2000 levels. The stimulus acts like a narcotic, and previous levels are never enough.

Inflation may not always be reflected in prices, but it is reflected in trends found at the crossroads of economic output and government stimulus.

Gold prices and the economy

Gold prices have set record highs recently, as the dollar continues to weaken.

gold















Why should this matter to those who are concerned about real estate in Central Pennsylvania? Because gold is an indicator of weakness or strength in the dollar. As the dollar weakens, prices of commodities in general will tend to rise. These price increases will include oil, building materials and other commodities whose prices directly impact the real estate market.

The price of gold does not cause the other prices to rise. The price of gold merely helps indicate the direction of other prices. As we await the disaster that must surely follow the government's trillion dollar "stimulus" bill, gold prices will help provide an early warning of the deluge that is to come.
-------------
update

Philadelphia, 19104, 19148, 19145; CNBC's hottest zip code list

CNBC recently posted the "Hottest Zip Codes for Home Prices" and Philadelphia has three zip codes in the top 15. Zip Codes 19104, 19148, and 19145 ranked 14th, 3rd and 2nd based on year-over-year price increases ranging from 13.5% to 19.1% for the third quarter.

MSN's top 13 tenant excuses.

MSN posts what it calls "13 outrageous tenant excuses" for tenants' failure to pay rent and other lease violations.

The stories are interesting, but successful landlords try not to focus on excuses. If they get stuck on each excuse offered by the tenants, they will go broke.

Renting/Leasing as a solution to mortgage foreclosure?

According to CNN, Fannie Mae announced last week that it would allow distressed borrowers the opportunity to remain in their home by deeding the property back to the lender and renting the property as tenants:

The effort is aimed at borrowers with mortgages owned or guaranteed by Fannie Mae who do not qualify for or cannot sustain a loan modification. Borrowers must live in the home as their primary residence and must be released from any subordinate liens.

Private lenders have tried similar methods in recent months and years. The idea bears many risks for all parties, as owners may be tempted to rent the property to new tenants or otherwuse violate the residency requirement.

Not all lenders who offer this program to distressed owners are doing so under the supervision of Fannie Mae's program. Many private investors will purchase the home from the distressed owner as a way for the owner to avoid foreclosure or bankruptcy, only to evict the former owner (now tenant) under some pretext shortly afterward.

If you are an owner facing foreclosure, be sure to explore all of your options before entering into this type of arrangement, including bankruptcy. Be aware of how much equity you have in your real estate. Most importantly, be aware that your home is not worth trying to save if you cannot make the payments. If you cannot make the monthly mortgage payment, chances are that you cannot afford the new rental payment either.

Pennsylvania school tax increase set for 2012-2013.

School taxes are set to increase in less than three years throughout Pennsylvania due to a pension increase lawmakers voted for themselves in 2001:

Think your school taxes were high this year? Start saving for 2012-13.

That's when Pennsylvania property owners will pay a lot more money to cover the generous pension bump state lawmakers awarded themselves, school employees and state workers in 2001.

H/T Pittsburgh Tribune-Review

The tax hikes will cost the average property owner $558.00.

Jay Himes of the Pennsylvania Association of School Business Officials has tried to estimate the effect on particular school districts:

"I was in the Erie area the other day, and one school district there calculated they would have to raise taxes 14 mills on top of their 48-mill taxes to cover it. That's a 25 percent property tax hike just to cover retirement costs. I don't think the property owners will stand for it. Something absolutely has to happen," Himes said.

Read the Tribune-Review article for the history of the pension increase.

Needless to say, as these tax hikes approach, property prices in Pennsylvania will face downward pressure.

Congress ready to extend the real estate bubble; Homebuyers' tax credit

Congress apparently intends to extend the tax credit now in place for first time home buyers:

Senate leaders have reached a tentative deal to extend the first-time homebuyers' tax credit that was originally passed earlier this year as part of the stimulus bill, Republican and Democratic sources told CNN on Wednesday.

The credit would be extended through April and a new credit of $6,500.00 would be added for existing homeowners to buy new homes.

[The following analysis was written mainly with the Central Pennsylvania real estate market in mind.]

While this news may be welcomed by the real estate industry, it contains hidden consequences. The real estate bubble burst for a reason. Houses were overpriced, lenders were overextended and the economy could not sustain the false prosperity. We cannot get rich as a nation by trading the same real estate with each other at constantly increasing prices. The government can reinflate the bubble only for so long.



The only real cure is to allow prices to fall so that the real estate inventory can clear. There are deals to be made and there is money to be invested, but that will not happen if the government keeps propping up prices and turning what should be a buyers' market into a sellers' market. I have personally witnessed sellers that stuck to their unrealistic bubble inspired asking prices because the tax credit program was feeding new buyers to them. I have seen first time buyers feel pressured into paying too much for a home (or into buying a home with defects) because of the approaching expiration of the tax credit program.

Buyers who see the immediate cash benefit of the tax credit often fail to realize that this tax credit is reflected in the price of the house.

With foreclosures at an all time high, this is supposed to be a buyers' market. We are bombarded with advertisements explaining how we can obtain good deals now at rock bottom prices. But it appears, instead, that we are seeing the worst of both worlds. Foreclosures continue at a record pace while prices remain high and unrealistic.

The real effect of the home buyer tax credit program will be to bail out sellers that paid too much for their homes during the bubble, while creating a whole new group of victims (the buyers) that will need to be rescued when the new bubble collapses.

Seller's Property Disclosure Statement; Pennsylvania's real estate disclosure requirements; seller's refusal to provide disclosure; 68 Pa.C.S.A. 7303;

From April 2005 comes this blogpost about an attorney-seller that refused to provide the required disclosure form until after a buyer presented a written offer:

The following caveat appears in a listing for an Easton (PA) property: "Sellers Disclosure will be disclosed when offers are presented. None online. Investor has not lived in property."

The language quoted above conflicts with 68 Pa.C.S.A. 7303, which requires delivery of the disclosure form to the buyer "prior to the signing of an agreement." The Realtor in that case "had an appointment to show this property on Saturday and requested the disclosure. I was told that the seller would not release the disclosure until he had an offer in hand: "'He is an attorney and he knows the law.'"

The blog post concludes as follows - "We passed on that showing."

While the statute does not say "prior to presentation of an offer," any offer would become a binding agreement upon acceptance by the seller. Following the seller's instructions in the above case could very well create a binding agreement before the buyer ever saw the disclosure form.

The point I am trying to make by quoting this blog post is not merely to point out the disclosure law requiring provision of the disclosure form prior to execution of an agreement, but to point out the proper response by a buyer to a situation like the one presented above. The Realtor's response was correct. She passed on the showing.

Don't bother with sellers that appear to be cutting corners in the disclosure process. Sellers that act secretive are acting that way for a reason. Rather than confront the seller with the statute and try to force a disclosure out of him prior to making an offer, move on to another property.

In many of the cases that come to me regarding real estate fraud and nondisclosure of defects, the sellers had acted suspicously like the seller above. But in the cases that have ended up in court, the buyers had forced the issue rather than walk away prior to making an offer. Don't chase sellers whose behavior indicates that they have something to hide.

Strategic defaults, deficiency judgments and bankruptcy

I have written earlier about "strategic defaults," by which homeowners intentionally stop paying their mortgage company even though they can afford the monthly payments. The owners intend to abandon the home to the bank because the home has declined so far in value that the mortgage debt far exceeds the value.

While this may seem like a viable option and a way to get rid of debt, homeowners in Pennsylvania must remember that the banks have the option of pursuing a "deficiency judgment" against the owner. Even if the bank forecloses on the home, the former owner remains indebted for the full amount of the loan less whatever the bank recovered by selling the home. The bank can pursue the former homeowner for the difference (or "deficiency"). Laws vary from state to state - and differences in state laws partially account for differences between states in the rate of "strategic defaults."

A former homeowner that is determined to avoid paying the deficiency can discharge any such claim by declaring bankruptcy, but there are pitfalls in this approach also. Both the foreclosure and the bankruptcy will create serious black marks against the former owner's credit (especially the foreclosure). A bankruptcy might result in the forced liquidation of some or all of the debtor's assets.

The bottom line is that you must be careful of financial advisors that present risky strategies that might not be tailored to Pennsylvania law.

Strategic Defaults

One of the newest trends in mortgage foreclosures is the "strategic default," where an owner abandons the home and simply stops paying the mortgage company, even though the owner can afford the monthly payments. Owners do this because the home has declined so much in value it becomes pointless to pay off a 30 year mortgage on a home where the owner will never recover his investment.

McClatchy posts details about this trend.

We are less directly affected by these strategic defaults here in Central PA, as market prices are somewhat more stable than in other areas of the country.

More casualties of the real estate bubble?; Stuyvesant Town and Peter Cooper Village; Manhattan disaster to cost Florida and California pensioners?

From New York City (via AP) comes the story of the largest ever U.S. real estate deal heading toward bankruptcy, foreclosure or both:

It was the most expensive real estate deal in U.S. history. Now it's poised to become one of the biggest flops.

At the height of the real estate bubble in 2006, an investment group led by New York City real estate firm Tishman Speyer Properties and BlackRock Realty Advisors paid $5.4 billion for a pair of gigantic Manhattan apartment complexes known as Stuyvesant Town and Peter Cooper Village.

Click here for more background on the original purchase. In addition to the bubble collapse that has devastated so much of the real estate market, this particular deal has been hampered by lawsuits from tenants resisting the new owners' conversion to higher priced units:

Tenants fought back, conversions happened much slower than expected and a state court ruled Thursday that about $200 million in the company's new rent increases were improper.

The AP article speculates on foreclosure possibilities. The bottom line is that a court's proclivity to limit rent may partially contribute to history's most costly foreclosure. If you are thinking "so what?" consider the following:

Some of the biggest equity investors in the deal are public pension funds that manage retirement system benefits for millions of government employees.

Florida's State Board of Administration had put $250 million into the project. It has already written off the entire investment as a loss.

California's two largest government pension funds, the California Public Employees' Retirement System and the California State Teachers Retirement System, invested a combined $600 million. CalSTRS has also already written off its $100 million stake.

The real estate bubble will affect everyone, even those who did not know that they were participating. The consequences in this case are being aggravated by rent limits being imposed by the courts.

Stuyvesant Town and Peter Cooper Village (New York Times photo)

Seller's Property Disclosure Statement; Repairs and past conditions

If you are selling real estate, you should be certain to be thorough in completing the Seller's Property Disclosure Statement.

Many sellers believe that if they have fixed a problem, they are safe in answering "no" to certain questions. An example occurs in question 6 (a), where the seller is asked whether he is "aware of any past or present water leakage. . . ." Many sellers answer "no" because they replaced the roof in response to prior leaks and the problem no longer exists. It is a mistake to answer the question this way. This question (as well as others) asks about "past" conditions as well as "present" conditions. Just because you have fixed the problem does not mean you need not disclose the conditions about which the question is asked.

The buyer will eventually find out about past conditions and problems (usually after he moves in to the house and talks with the neighbors). If those problems reappear (or if new problems arise) the buyer will use any inaccuracy in the seller's completion of the form to justify a lawsuit against the seller. Any inaccuracy in the form will play very badly against the seller in court.

Seller's Property Disclosure Statement

A real estate seller is required under Pennsylvania law to disclose to any potential buyer known material defects in the property.

most real estate defects will not be this obvious












The Pennsylvania Association of Realtors (PAR) provides a disclosure form that goes beyond the requirements of Pennsylvania law for disclosure of defects. The basic disclosure requirements are found in the Real Estate Commission's form here at the Pennsylvania Department of State website.

If you are a buyer, you are better off using the PAR form, especially in light of the increased risk of fraud in today's real estate environment.

Seller's home inspections; seller-Realtor disputes.

I have written previously about the use of home inspections in real estate transactions, including the potential for sellers to hire their own inspectors prior to entering into a sale.

One advantage for the seller of hiring his own inspector is the ability to avoid conflicts with his own Realtors. Often when a buyer sues a seller (and the Realtors) over a defect discovered after the transaction is complete, the seller and the Realtors dispute among themselves whether such a defect was disclosed. The seller often claims to have reported the defect to the Realtor, thus blaming the Realtor for failing to disclose the defect to the buyer. The seller will also downplay the Seller's Property Disclosure Statement, claiming to have written only what the Realtor instructed him to write.

Sellers and Realtors fighting between themselves often make it easier for a buyer to prove fraud









A written inspection report can limit many of these seller/Realtor disputes. When a seller hires his own inspector and provides the written report to the listing agent, both the seller and the Realtors will be limited in what they can claim the other told them. It will be clear that the seller disclosed everything that is on his own inspection report (and probably nothing more).

There are always areas where problems slip through the cracks. The Realtors and the sellers must make sure that the Seller's Property Disclosure Statement is consistent with the inspection report and that the report is given to the buyers, no matter how negative. All parties must make sure that any inspection activities are not interfered with or influenced. If the seller takes steps to influence his own inspector or prevent the inspector from finding or reporting problems, the resulting disputes will be worse than if no inspection was arranged in the first place.

More foreclosure bad news; CNN

CNN reports more foreclosure bad news today:

Despite concerted government-led and lender-supported efforts to prevent foreclosures, the number of filings hit a record high in the third quarter, according to a report issued Thursday.

"They were the worst three months of all time," said Rick Sharga, spokesman for RealtyTrac, an online marketer of foreclosed homes.

CNN cites nationwide data and specific data for Nevada and Vermont. My own observations (and those of associated professionals) is that central Pennsylvania foreclosures appear to have been generally steady during 2009.

The bad news relates to foreclosures that are still to come. Banks have been slower to initiate foreclosures (both nationally and locally) than in prior years:

[T]he RealtyTrac statistics may understate the depth of the foreclosure mess because lender and government actions have delayed many filings. As a result, some delinquencies have not been counted on the foreclosure tallies. That means the crisis may not end quickly.

Lenders are also slow to dump delinquent properties back on the market for fear of causing a free fall in real estate prices. Foreclosures tend to depress real estate prices in general, not merely the prices of foreclosed properties. If real estate prices spiral downward, existing homeowners will not be able to sell or refinance their homes due to lack of equity. This problem will result in more foreclosures and a worsening real estate downward spiral.

We are witnessing the bursting of a very deep bubble.

US flag banned at Oaks Apartment apartment complex in Albany, Oregon

From KATU in Albany, Oregon comes the story this week of an apartment complext that has ordered residents to remove all flags, including the U.S. flag, from windows and other visible areas.


KATU photo - flag banned from motorcycle at Oaks Apartment complex in Albany, Oregon












According to KATU:

Resident[s] we talked to who had been approached to take down their flags all told us the same thing: that management told them the flags could be offensive because they live in a diverse community.

Would such a ban be upheld in court in Pennsylvania? It depends. If the landlord refuses to renew a tenant's lease at the expiration of the term, the landlord generally does not have to provide a reason. The landlord can refuse to renew a tenant's lease even if the reason is the tenant's display of an American flag. [This analysis would be different if the real reason involves discrimination against minorities or other protected classes.]

If the landlord seeks to terminate a lease during the lease period solely on the basis of the American flag display, the landlord would probably lose in court, as long as the American flag was the only violation. But that is only speculation, as the real answer would depend on the judge and whether the judge believes that an American flag display constitutes a material violation and whether a ban on such displays can be lawful or enforceable.

Seller's home inspections.

Click here for a previous article on the use of home inspections.

I have written on the advantage to home buyers in using home inspections prior to closing on their house, but there is an advantage for sellers also. A seller can arrange and pay for his own inspection prior to listing the home for sale. The inspector will prepare a report that the seller can give to his realtor and to any potential buyer.

Many sellers resist having their own inspections done because they prefer not to know the defects in their house. They believe that if they are not told about a defect, they will not be responsible for it. But whether they know of any defects or not, they can still be sued over said defects later on. And they might lose any such lawsuit, depending on who the jury believes. It is easy for someone to say they are unaware of something. The jury is able to reach its own conclusion. If the seller provides a written inspection report at the start of the process, it is much more clear exactly what the seller knew.

There are pros and cons to this approach, which pros and cons I will address in a future post.

Home Inspections and pitfalls

I have written about the use of home inspectors to prevent yourself from becoming the victim of real estate fraud. I stressed that hiring a home inspector is only the beginning of the process. The buyer must follow through to determine what areas the inspector's report may have missed. Inspectors will not move items in the house and will not speak with the seller. Piles of boxes or furniture can easily conceal a defect.

Inspectors have missed roof leaks and other areas of water seepage. Inspectors have missed floor damage as well as mechanical failures. That the inspector missed these items does not relieve the seller of responsibility for fraud, but the buyer should not wait for the outcome of a lawsuit to protect himself.



The same policy that causes inspectors to miss concealed items often causes them to report items as faulty that have nothing wrong with them. Inspectors confronted with unplugged items have reported those items as faulty rather than plug them in before completing the report. The inspectors' refusal to alter the status quo may be quite sound from the perspective of protecting the inspector and the buyer from claims for damaged items in the home, but that policy places limits on what the inspection might accomplish.

As I wrote before, use home inspectors when you purchase your home. But know the limitations of the inspection process and work to overcome those limitations.

Home equity, savings and the current economic crisis.

A recent quote from David Goldman ("Spengler") helps put the role of home equity in context in today's economic crisis:

Americans have saved almost nothing during the past 10 years, relying instead on home equity that now has vaporized. The proportion of Americans over 60 will jump to 25% from 19% during the next 10 years, an unprecedented shift. Americans must save to compensate for past profligacy, from a lower starting point after the destruction of so much wealth, and with lower prospective returns.

Remember, equity in an inflated asset does not take the place of actual savings.

Home Inspectors - the beginning of the story; hidden home defects;

I have written previously about the use of home inspectors for buyers seeking to avoid being defrauded on the purchase of real estate.

If you are a buyer, do not simply send a home inspector to the home you wish to purchase and expect that any issues will be discovered with no further effort on your part. Sellers have become good at hiding defects from inspectors. Sellers will frequently leave debris piled up against walls that otherwise would bear obvious signs of water leakage or other defects. Inspectors will not move any item in the house. If a defect is somehow concealed, chances are that the inspector will not find it. The inspector will identify all obstructed areas on his report. It is up to the buyer to demand that all obstructions be removed and arrange for followup inspections.

Talk to the inspector, ask him how difficult it would be to expose common areas. Ask him how common it is for defects to exist in the particular type of obstructed area in the home you are buying.

The inspector's report is only the beginning. A buyer must follow through and make sure that the report is as complete as it can be before the buyer closes on the deal.

previous - Mortgage foreclosures - a catalyst for real estate fraud?

Dr. Seuss, inflation and the reinflation of the real estate bubble

It has been eight months since Congress passed the nearly 800 billion dollar "stimulus" bill. We continue to await its effects on the economy in general and on inflation in particular. Most of the stimulus money has yet to be spent by the federal government. There are those who hope that the stimulus money and the $8,000 new home buyers credit will spur real estate sales and, in effect, reinflate the bubble. For those of this mindset, nothing could be better than another round of inflation to restore real estate values and start the good times rolling again. If you are one of those people, remember the old phrase, "Be careful what you wish for."

Most people do not know that Dr. Seuss used to write political cartoons before he produced books for children. I found this cartoon from April 19, 1942 on the University of California at San Diego website.

Dr. Seuss on inflation





Do not be in such a hurry to see the government spend the "stimulus" money. Once Washington begins forcing the money through the economy, you won't like the consequences.

Inflation adjustment clauses in leases.

Ever since the "stimulus" bill was passed in February by Congress, we have been waiting for the inevitable inflationary results. We do not know how bad the inflation will be. We do not know how fast the government will force the new money into the economy.

In any case, real estate investors should prepare for the worst. If you own property and lease it to tenants, it would be wise to include a clause in your lease that allows the rent to be adjusted to keep pace with inflation. Otherwise, you will see your expenses skyrocket while your rents will be locked in by the term of your lease. This is especially true in commercial leases that last longer than one year. Over the course of a year or more, inflation could skyrocket more than we have seen in our lifetimes, depending on how fast the government lets the new "stimulus" money percolate through the system.

Real Estate Prices, Diana Olick, inflation, Richard Daughty, stimulus money

Earlier this week, I summarized the conflicting forces that may affect housing prices:

Long term price trends will depend on whether the FED's next rate hike and the next wave of foreclosures will take effect before the "stimulus" money has a chance to generate inflation.

If the foreclosures and higher interest rates win the race, long term trends will favor lower prices. But if the stimulus money percolates through the economy first, then nothing will stop the price of housing (and everything else) from skyrocketing.

Diana Olick of CNBC believes that the foreclosures and general economic bad news will win the race over the inflationary stimulus money:

There is now an estimate out there that rising foreclosures will add 7 million homes to the for-sale inventory over the next two years. Inventories of new and existing construction have been falling, but that could U-turn this fall, as foreclosures rise, banks let go of the homes that didn't qualify for modifications, and job losses push good quality borrowers into default. Pile that on top of seasonality, and I'd watch for home prices to dip again as we get readings on the fall months

.
Diana Olick - [CNBC photo]













On the other hand, the federal government and the Federal Reserve are trying to reflate the bubble so as to avoid this outcome. Richard Daughty of the Daily Reckoning has tried to place the stimulus package and related efforts in context:

. . . the Federal Reserve (as expressed in their secret motto "We Are Evil") created, out of thin air, a new US$29 billion in bank credit! Wow!

The interesting part is that the Federal Reserve used that new money - and a lot more - to buy $62 billion of US government debt last week! . . . . . And now here - here! - is Greenspan successor Ben Bernanke’s monetary insanity to create, in One Freaking Week (OFW), $62 billion whereas it took old Greenspan an entire month to come up with $10 billion!

This type of currency expansion cannot exist without disastrous consequences for prices in general. [Daughty's column appeared in April, but it reflects the worst trends in monetary policy for the past year.]

If the stimulus package has its predicted effect and results in disastrous inflation, all prices, including those of housing, will rise. But the price of housing in real terms relative to other products may still fall due to the inventory and foreclosure concerns voiced by Olick. If you rely on real estate values to keep up with inflation, you may find yourself falling behind quickly.

Home Inspector organizations; NACHI, ASHI, NAHI

I have written previously about the use of home inspectors to assist buyers in avoiding real estate fraud. Using an inspector does not guarantee that a buyer will discover every defect in the home, but using an inspector is a good start. Make sure that your inspector belongs to one of the three main home inspector organizations - ASHI, NACHI or NAHI. A qualified inspector can show you his credentials and his proof of affiliation. Do not use an inspector with no affiliation.

There are additional steps you must take to make sure that you will get the most out of your inspection process, as I will discuss in future posts.

Inflationary pressure on housing prices; Lawrence Yun

An article at CNNMoney today claims that the leading home price index rose in July. But this trend may be only temporary according to the chief economist for the National Association of Realtors:

Yun points out that there will be another foreclosure spike over the next six to 12 months as the terms of option ARMs and interest-only mortgages reset, raising monthly payments for many borrowers and pushing some into delinquency. Foreclosed homes will continue to come back onto the market, padding supplies and dampening prices.

Lawrence Yun - National Association of Realtors
















The downward tendency caused by foreclosure activity is being countered by the economic stimulus package passed in Washington in February. With hundreds of billions of new dollars being injected into the economy, the prices of all products will increase. The $8,000.00 first time homebuyers' credit adds to upward pressure on real estate prices:

The other major uncertainty is over the first time homebuyers' tax credit that currently gives back up to $8,000 to taxpayers who buy before Dec. 1 and who have not owned a home within the past three years.

An AP report today confirmed the potential inflationary pressures on the economy as a whole:

To prevent inflation from taking off, the Federal Reserve will need to start boosting interest rates quickly and aggressively once the economy is back on firmer footing, Fed officials warned Tuesday.

Any such action by the Federal Reserve may curb inflation, but will curtail loan activity as interest rates rise.

Long term price trends will depend on whether the FED's next rate hike and the next wave of foreclosures will take effect before the "stimulus" money has a chance to generate inflation.

See Bubble Meter for more information.

previous - Mortgage foreclosures - a catalyst for real estate fraud?

Home inspections as a remedy for real estate fraud.

I have written about the increased risk of misrepresentation by sellers of real estate in the current economic climate. As housing prices stagnate, sellers will resort increasingly to fraud in order to rescue their expected gains from the sale of their properties.

In order to protect themselves, buyers must increasingly use home inspectors in order to discover hidden defects in the houses they would purchase. A home inspection can reveal structural or other defects that might cost the buyer dearly once the transaction is complete.

But home inspections come with limitations. The home inspector will not look in obstructed areas of the house during his inspection. Sellers know this limitation and will find ways to obscure the various defects. Inspectors are not aggressive about seeking out defects or questioning sellers. Home inspections must be performed and presented to the seller within a certain time period. Sellers may dispute the results of a home inspection and attempt to retain the buyer's deposit if the buyer backs out of a deal because of a negative inspection report.

There are ways for a buyer to deal with all of these issues - ways that I will discuss in later posts.
-----------
update - home inspector organizations.

Mortgage foreclosures - a catalyst for real estate fraud?

There are indications that a new wave of mortgage foreclosures may soon hit the already weak economy. The impact of those (and previous) foreclosures reaches far beyond the houses that are actually being foreclosed upon. As we have all learned, foreclosures tend to depress the price of all real estate, as lenders end up dumping large amounts of foreclosed real estate on the market in an attempt to cut their losses. The price effect of a few foreclosures spreads throughout the entire real estate market.

But prices fall slowly. Sellers are reluctant to lower the price of their house, as they harbor long held expectations of what their house is worth. Rather than lower the price of their house, many sellers will resort to misrepresentation and fraud in order to unload their property. There is hardly a characteristic of a house that a seller will not misrepresent. Fraud comes before price concessions.

We are told that the current real estate market is a “buyer’s market.” We are led to believe that buyers can obtain good deals by taking advantage of depressed prices. That theory is true only for those buyers who can withstand the gauntlet of misrepresentation that awaits anyone who attempts to obtain a bargain.

While specific cases of misrepresentation will have to await future posts, suffice it to say that buyers should assume that the road to a good bargain is paved with hidden costs. There are many ways for buyers to protect themselves, but they won't get this protection unless they assume the worst in each case. Stay tuned for details . . .

---------
update -
Home inspections as a possible solution.

Adjustable rate mortgage defaults and lending industry consolidation.

Reuters warned last week of the next round in the ongoing financial crisis:

The federal government and states are girding themselves for the next foreclosure crisis in the country's housing downturn: payment option adjustable rate mortgages that are beginning to reset.

"Payment option ARMs are about to explode," Iowa Attorney General Tom Miller said after a Thursday meeting with members of President Barack Obama's administration to discuss ways to combat mortgage scams.

The impact of this round of foreclosures could be severe:

The mortgages tend to be "jumbo," or for significantly large amounts, Goddard said, making it even harder for borrowers to sidestep foreclosure. He said he expected to see an increase in scams as distressed homeowners become more desperate to refinance big debts.

The loss for lenders on each "jumbo" mortgage foreclosure would be greater than the losses on smaller loans.

All of this bad news makes the following item even more interesting:

Peter Eavis, writing in the Wall Street Journal on Friday [September 18, 2009], noted: "More than half of US residential mortgages are being made by just three large banks. It is a stunning change, but is it good for the housing market, and to what extent will it boost profits over the long term for this elite trio: Wells Fargo, Bank of America, and JP Morgan Chase? Right now, housing remains on government life support. Treasury-backed entities are guaranteeing about 85% of new mortgages, while the Fed buys 80% of the securities into which these taxpayer-backed mortgages are packaged."

While this second item refers to new mortgages instead of the existing ARM mortgages of the first article, it should cause great concern that lenders are about to take another round of bad hits just as the mortgage industry seems to be consolidating into only three major institutions.

The articles cited above were speaking of national trends. But someday, this crisis has to reach the point where even the supposedly stable Central Pennsylvania market will feel the effects of the credit crunch more sharply than it has thus far.