Tonight is the night. We are scheduled to have an IHB Block Party on Monday, March 9,
2009, at J.T. Schmids at the District.

This is a special invitation to lurkers. I always enjoy meeting the silent majority who read the site but otherwise stay in the shadows. Please come out tonight.

In California, we are concerned about picking the bottom because prices are so volatile. In normal real estate markets, the bottom is not a price point; it is a condition of price stability.

Formerly million-dollar properties offered at a 35% discount are pretty rare in Woodbury. It is a sign of things to come.

Asking Price: $650,000

Address: 94 Rinaldi, Irvine, CA 92620

{book2}

Rock Bottom — Eminem

A-yo!
This song is dedicated to all the happy people
All the happy people who have real nice lives
And who have no idea whats it like to be broke as f@#$

I have written about the conditions and circumstances at the market bottom on other occasions including: The Market Bottom and Fundamentals at a Market Bottom. The obsession we have in California with picking market bottoms is an unusual but necessary function of the extreme volatility in our real estate market. Not long ago I wrote Timing Does Matter.
When prices are extremely volatile, as they are here in California,
proper timing of a real estate purchase is very important. However, if markets were to stabilize and remain stable, picking a bottom would be unimportant. Stable markets are always at the bottom.

A stable market, a market that is at the bottom, is a combination of psychological and technical factors. Psychologically, in a stable market, there is an absence of belief in appreciation. When people believe prices are going to rise significantly (faster than wages or other investments), markets become unstable because people buy to speculate on appreciation rather than to provide shelter for their families. This buying constitutes the self-fulfilling prophecy of irrational exuberance and kool aid intoxication. Technically, in a stable market, loan terms limit price increases to the level of wage growth. Affordability products destabilize markets by allowing prices to rise faster than wage growth.

Cause we see them dollar signs and let the cash blind us
Money will brainwash you and leave your ass mindless

Stable markets are always at the bottom. Nominal prices are going up, so it isn’t a bottom from a pure price-point perspective; however, real prices–prices adjusted for wage inflation–are not going up. When real prices do not go up, you are at the bottom, irrespective of the increase in nominal prices. In terms of the percentage of income people have to put toward housing to obtain the same quality of life, nothing changes.

For example, if you make $100,000 a year, with low interest rates and a sizable downpayment, you may be able to afford a $400,000 property (most stable markets actually trade at less than three-times income). Next year if you get a 3% cost-of-living adjustment raise, you would be making $103,000, and you would be able to afford a property that is 3% more expensive. You could finance a $412,000 property instead of a $400,000 one putting the same percentage of your income toward housing. This effect of increasing bids with increasing wages is why house prices rise with wage inflation in a stable bottoming market.

In California, our real estate markets are not stable. Prices often rise here in excess of wage inflation. This occurs because irrational exuberance takes over and people become convinced prices will rise forever. When this cultural pathology is enabled by lenders through affordability products, lowered lending standards, higher allowable DTIs, and other methods, our prices take flight.

As I mentioned in another post Affordability Mortgage Products Make Prices Unaffordable, Lenders enable people to bid up pricing. Increasing prices engage the cultural pathology of kool aid intoxication, and an unsustainable rally begins. Since affordability products result in high default rates and foreclosures, these products are withdrawn from the market, prices crash, and psychology turns bearish.

I feel like I’m walking a tight rope, without a circus net
I’m popping percocets, I’m a nervous wreck
I deserve respect; but I work a sweat for this worthless check
Bout to burst this tech, at somebody to reverse this debt

If we eliminate affordability products–something the financial markets are doing anyway–our real estate market will be stable. Of course, we still have to endure the price crash down to stable bottoming price levels; although, once we are there, if affordability products are not brought back again, houses will be affordable, and the market will always be at the bottom.

The real estate cycle is an interrelated series of changes in credit availability and market psychology. Affordability products are the root of the problem because they are inherently unstable. When financing is unstable, market pricing is unstable. Our recent experiment with affordability products was a failure. This isn’t our first attempt; we tried in the late 80s and, and we failed. I hope this most recent failure seals the fate of these loan programs. When you consider how painful the second strike against these products has been, if we take a third swing, there will be no joy in California–the mighty Homedebtor will strike out.

My life is full of empty promises
And broken dreams
I’m hoping things will look up
But there ain’t no job openings

Today’s featured property is a hugely discounted and relatively new home in Woodbury.

Asking Price: $650,000

Income Requirement: $162,500

Downpayment Needed: $130,000

Monthly Equity Burn: $5,416

Purchase Price: $1,010,000

Purchase Date: 8/27/2006

Address: 94 Rinaldi, Irvine, CA 92620

Never lived in? Unfortunately, I cannot locate the property records on this property. Is this the builder dumping it? It this a flipper bailing after two years of bleeding cash? I don’t know.

According to Redfin, the owner paid $1,010,000 on 8/27/2006–right at the peak. I do not know who owns it or what financing they have in place. Given the $360,000 discount of its purchase price, if there is financing, it is likely a short sale. If this sells for its asking price, and if a 6% commission is paid, the total loss will be $399,000; let’s call it $400,000. Ouch!

For as painful as this loss is going to be, the people who must really be freaking out are the comparable properties. If you look at the list at the bottom of the sales page on Redfin, you see all the similar properties in the neighborhood that are for sale. The asking prices range from $775,000 to $888,000 with an average cost per square foot of $396. Today’s featured property is undercutting them by over 15%, and the asking price is $309/SF. Those other sellers just witnessed their own doom. Any potential buyer is going to have great difficulty obtaining financing with this new low comparable in the area.

The crash of the high end is gaining momentum.

{book3}

A-yo!
This song is dedicated to all the happy people
All the happy people who have real nice lives
And who have no idea whats it like to be broke as f@#$

I feel like I’m walking a tight rope, without a circus net
I’m popping percocets, I’m a nervous wreck
I deserve respect; but I work a sweat for this worthless check
Bout to burst this tech, at somebody to reverse this debt
…
Cause we see them dollar signs and let the cash blind us
Money will brainwash you and leave your ass mindless
Snakes slither in the grass spineless

My life is full of empty promises
And broken dreams
I’m hoping things will look up
But there ain’t no job openings

Rock Bottom — Eminem

If people took responsibility for themselves, we would not need paternalistic rules and regulations. Unfortunately, they do not. Now that we are all paying for the foolish risk taking of the past decade, it is time to access what risks people should be allowed to take.

Our property today is an REO rolled back to 2002 pricing.

Asking Price: $299,900

Address: 7 Goldenbush #28, Irvine, CA 92604

{book1}

Rules and Regulations — Rufus Wainwright

I will never be as cute as you, according to the board of human relations
I will never fly as high as you, according to the board of public citations

Flying high is dangerous; just ask Icarus. Everybody was flying high on free money but they got too close to the sun and got burnt. When they fell back to earth, their impact created a debt crater that the rest of us are being asked to fill in.

Borrowers took on enormous risks during The Great Housing Bubble. If this were not the case, we would not now be facing a foreclosure crisis that eclipses the magnitude of the Great Depression. As a society we need to accurately identify the risks assumed by borrowers that caused them to lose their homes. We must enact legislation that limits or reduces these risks in the future. We need to do this for one simple reason: those of us who did not take on these risks are being asked to pay the price. The benefits of these risks are privatized while the losses incurred from these risks are being socialized. This is not just.

I first wrote about this issue in the post Bring Back Paternalism in The Mortgage Market. In that post I suggested limitations to mortgage equity withdrawal through home equity lines of credit. This post I’m going to go even farther and suggest that mortgage options should be limited to fixed-rate financing with reasonable debt to income ratios and high down payment requirements. In my book, The Great Housing Bubble, I provide detail and nuance to these legislative mandates, but I will discuss the basics here.

{book2}

The foreclosure crisis of the Great Depression was caused by a number of related factors. First, there was systemic mortgage related risk. At the time almost all mortgages were interest-only loans with very high equity requirements (50% down was the norm). Loans were interest-only because banks wanted to pass interest rate risk on to the borrower, and equity requirements were very high to insulate the banks from risk of loss if people defaulted. Despite the lenders low risk tolerance, many banks failed during the Great Depression.

The foreclosure crisis of the Great Depression was triggered by mass unemployment causing borrowers to default. As these defaults caused banks to lose money, it imperiled our entire financial system. It caused a contraction in lending and created an economic contraction that resulted in even more unemployment; a downward spiral ensued. It is the same phenomena that we are witnessing today.

The Great Depression exposed the risks of the debt-service mentality. Since the primary loan program of the Great Depression was the interest only loan, most people did nothing to retire their debt. If people are not retiring their debt, lenders have an ongoing problem with risk. This lending risk is so great that even the high equity requirements of the pre-depression era were not sufficient to save the banking industry. Everyone who analyzed this problem realized that a new loan program that retired debt was needed.

After World War II lenders embraced a new loan program, the fixed-rate conventionally-amortized 30-year mortgage. This loan program had a mechanism to pay back the principal and retire the debt. This retirement of debt compensated the banks for the interest rate risk they were taking on. Also this allowed banks to lower their loan-to-value ratios because over time their risk was being reduced. The lower loan-to-value ratios opened the housing market to many new people and contributed to the housing boom immediately following World War II.

Our foreclosure crisis, the one resulting from The Great Housing Bubble, is caused by a failure of finance. Numerous unstable loan programs were introduced that inflated house prices to unprecedented levels. These loan programs encouraged people to take on numerous risks that most people were either ignorant of or did not believe would become a problem. Of course they were wrong. Removing these loan programs is what is causing the house price collapse. Part of these unstable loan programs is the mindset that debt can be endlessly serviced. It is the same problem that plagued the Great Depression. The unstable loan programs and the debt-service mindset prompted copious borrowing. People were allowed to take on risks that cost them their homes.

The risks borrowers took on are easily identified. These risks include:

1. interest-rate risk,
2. mortgage-availability risk, and
3. increasing-payment risk.

Interest-rate risk is caused by the use of adjustable-rate mortgages. I have written many times about the ARM Problem. The Federal Reserve is working hard to artificially manipulate mortgage interest rates to deal with this problem. Lowering interest rates may help if the payment is simply resetting but it does nothing for those facing a recast of their loan from an interest-only to a fully-amortized payment. This loan recast is the root of the problem.

It is amazing to me that former Fed Chairman Alan Greenspan actually suggested people take on interest rate risk and use adjustable-rate mortgages. It is debatable whether or not he was a great central banker, but it is clear that he was a very poor financial advisor. People are not capable of managing their own interest rate risks as Mr. Greenspan had suggested. In reality everyone is merely betting on lower interest rates. If this bet moves against them, the government or the Federal Reserve is asked to step in and bail everyone out. Again, the rewards are privatized and the risks are socialized.

{book3}

Mortgage-availability risk is the problem being faced by those who assume they can serial refinance from one teaser-rate mortgage to another. Everyone who has a mortgage that is going to require refinancing before it is paid-in-full has assumed mortgage-availability risk. Of course most people simply presuppose that favorable loan terms will be available forever and they will always have access to capital. Our recent credit crunch has shown how serious this risk really is.

Increasing-payment risk is caused by loan terms where the borrowers payment may go up over time. Loan terms that have increasing payments have high default rates; people cannot afford the increased debt-service burden. This commonsense fact seems to have eluded lenders as they developed these unstable loan programs. This increasing payment forces people to refinance which in turn exacerbates the mortgage availability risk when people find their ability to refinance curtailed.

Borrowers should simply not be allowed to take on these risks. Once the downside of these risks comes to be, it leads to a foreclosure crisis. This leads to government bailouts which in turn leads to the prudent paying for the sins of the irresponsible. The borrower risks described above can be eliminated.

We can require high down payments. Initial equity in the form of a down payment provides a buffer in case house prices fall so homeowners do not go underwater. We can limit the debt-to-income ratios of borrowers. If people are not over extended under mortgage debt they are far less likely to default. Statistics bear this out. And we can limit lending options to the fixed-rate conventionally-amortized mortgage. It is the only product that pays down debt and does not face an escalating payment.

There was a 30-year era were borrowers were not permitted to take on these risks. From 1948 to 1978, we experienced price stability (after the brief price recovery following the Great Depression and WWII). House prices were relatively stable even when the economy was not. The era ended with the hyperinflation of the late 70s and the first California housing bubble which coincided. This ushered in an era of price instability and experimentation with affordability products (See Robert Shiller’s chart above).

Our modern era of experimenting with affordability products has been a dismal failure. The Great Housing Bubble is a direct result of this failure. We must return to the lending practices of the 1948 to 1978 era. Many will view this as a big step backward. However, when lending steps off a cliff, perhaps a step backward is a good thing.

Maybe that cartoon should read, “What Lender’s Believe?”

Today’s featured property is one of those undesirable condos that is likely to crash in price down to cashflow investor levels. It is probably already at rental parity, but would you want to live there for the next 10 years?

Asking Price: $299,900

Income Requirement: $75,000

Downpayment Needed: $60,000

Monthly Equity Burn: $2,500

Purchase Price: $280,000

Purchase Date: 7/3/2002

Address: 7 Goldenbush #28, Irvine, CA 92604

Light and bright with nice wood laminate floors throughout first level.
Beautiful slate and cherry-wood fireplace in living room. Needs carpet
and paint. Great potential!

As you can see, this is quickly approaching its 2002 purchase price.

Listing and Sales History

So what would this place be worth with 4% appreciation since 1998?

Somewhere around $232,000 is a reasonable bottoming figure, perhaps a bit higher if interest rates remain artificially low. Just think, the peak appraised value for this property was around $450,000…

• This property was purchased on 7/3/2002 for $280,000. The owner used a $280,000 first mortgage, and a $42,000 second… Wait a minute. How is that possible? I suspect the purchase price as reported is incorrect. This most likely sold for $322,000. If so, then this asking price is a 2002 rollback.
• On 10/13/2005 they refinanced with a $330,000 Option ARM.
• On 5/31/2006 they opened a HELOC for $100,000. It does not look as if this money was taken out.
• On 4/28/2008 they took out a stand-alone second for $28,579.
• Total property debt is $358,579 plus negative amortization.
• Total mortgage equity withdrawal is approximately $50,000. It is impossible to be accurate with the data I have.

These were actually somewhat conservative borrowers. They were not going back to the housing ATM every year, and when they refinanced in 2005, they did not take out all their equity. The bank foreclosed and bought the property for $379,000 which was probably the balance of the first mortgage (with negative amortization) and the small second they took out. It looks as if these are people who were simply in over their heads. They tried to be responsible, but they could not afford their home.

Perhaps they should not have been loaned more money than they could pay back…

{book4}

I will never be as cute as you, according to the board of human relations
I will never fly as high as you, according to the board of public citations

These are just the rules and regulations
Of the birds, and the bees
The earth, and the trees,
Not to mention the gods, not to mention the gods

These are just the rules and regulations
Yeah, these are just the rules and regulations
And I like every one, yes I like every one
Must follow them

Rules and Regulations — Rufus Wainwright

A look at the various paths the market may take as it wends its way back to fundamental valuations. Will it fall quickly in a ball of fire? or will it hold steady, frozen in time?

The featured property is a tiny 1/1 condo in The Lakes selling for 35% off the peak. This may be the least desirable property in Irvine, and its least expensive.

Asking Price: $197,900

Address: 144 Streamwood, Irvine, CA 92620

{book2}

As you may have noticed, we are experimenting with a new way of organizing posts. When we first converted to the split post format, I struggled for a
place to divide the posts. After about a month of experimenting, it
seemed logical to divide them at the property information breakpoint.
At first, when people would come to the IHB, they would see a few
pictures and the data on each property. We looked like a real estate
blog.

Over time, I started writing more and more in front of the property
description. This made the opening summary much longer, and it began
shifiting the emphasis away from the properties toward my writing about
the market or whatever. Then I added the youtube videos and other
stuff until finally we had 70% of the post above the dividing line. The
dividing line no longer makes sense, and it no longer functions as a
summary. Hence the new format.

Now the summary be a true summary by moving 98%
of the post below the break. This has several advantages: 1. It makes
it easier to scroll down and see several post headlines and brief
descriptions. 2. It gives me something to copy and paste to produce a
newsletter (more on that later). 3. The page should load faster because
there will be no graphics above the line. The big disadvantage is that
it may start to look like a news aggregator site. I would like to try
this for a while and see how it looks and feels. If you don’t like it, let me know, we may try something else.

Fire and Ice — Pat Benatar

Fire and Ice

Some say the world will end in fire,
Some say in ice.
From what I’ve tasted of desire
I hold with those who favor fire.
But if it had to perish twice,
I think I know enough of hate
To say that for destruction ice
Is also great
And would suffice.

Robert Frost

Desire, greed, avarice: house prices rose at unprecedented rates
because people motivated by greed were enabled by lenders (who were
also motivated by greed) to bid prices higher and higher. There is a
certain Karmic justice to the idea of the market perishing in fire.
Those who were motivated from desire should suffer in direct proportion
to the greed to which they succumbed. In fact, all moral hazard
problems emanate from this relationship. If people are not punished by
this behavior, it is magnified in the next generation as more and more
people choose to behave unwisely. In short, each bubble grows bigger
than the last because the survivors tell their tales. If you don’t
believe this is true, take a look at the series of bubbles in
California since the 1970s, and you will see a series of higher peaks
and deeper corrections. It is Karma in action.

Some say our market will crash and burn in a dramatic firestorm;
some say prices will experience a long deep freeze at current levels.
Today we will look at these two possibilities and try to determine
which outcome we will see.

So you think you got it all figured out
You’re an expert in the field, without a doubt
But I know your methods inside and out
And I won’t be takin’ in by Fire and Ice

First, let’s take off the table any ideas of a return of sustained
or rapid appreciation before prices return to fundamental valuations.
The only people who suggest such ideas are self-serving liars and those who chose to believe them. Anything is possible, but this outcome
is so unlikely that I will not waste any print discussing it.

Above is a look at the Fire and Ice scenarios for Irvine median home
prices. There is a tendency when looking at charts like this one to
assume that one scenario is aggressive and the other conservative, so
the truth must be in the middle. Don’t make that assumption. Prices
could easily crash below fundamental valuations as I described in How Bad Could Bad Get. If you think this is not possible, I suggest you check out Christopher Thornberg’s predictions (PDF) he just delivered to the BIA of Orange County. He is predicting a 32+% decline from today’s prices, that is over 50% off the peak. He is more bearish than I am; he may be right.

Take a look at the grey line in the graph above. That is the fundamental value. It is calculated based on income growth (which has now stopped), 6% interest rates, and a 30-year conventionally-amortized, fixed-rate mortgage with a 20% downpayment and a 28% DTI. That is where house prices would be if we would not have had a real estate bubble. The Federal Reserve is working to raise this line by lowering interest rates, but even a drop to 4.5% will not raise it enough to intersect those falling lines at a significantly higher price point. Prices will fall to this line before they find support.

There are several reasons I believe the fire scenario is far more likely:

1. Price momentum
2. Return to stable financing terms
3. Increase foreclosure due to ARM resets

Look at the time it takes fundamental valuations to catch up. Does it seem likely to you that prices would hover in a tight range for 12-15 years? Would it be better to drop quickly then resume its ascent? or it is better to have a slow deflation as Japan did?

The year-over-year price declines have been breathtaking in most markets, although Irvine has held up better than others. The momentum of prices is downward. This will not change until buying makes sense again, and that does not occur until prices are aligned with rents.

The credit crunch has seen the purging of the worst of the “financial innovations” of the housing bubble. We are on our way back to conservative financing terms. Since people will not be able to borrow more, prices will fall to levels consistent with the new loan terms. That is lower than today’s pricing.

I have flogged the deceased equine over ARM resets, but I still see astute observers who believe that low interest rates will stop this bomb from going off. Until that craziness is gone, I will keep mentioning the ARM reset problem. It will create massive numbers of foreclosures. In fact, last Wednesday, I went to a BIA function and I was talking with a representative of Wells Fargo. He told me the foreclosure problem is far worse than most people realize. As he started telling me about the growing problems with Alt-A and Option ARMs, I felt like he was reading from the IHB. He did not know I am Irvine Renter.

The fire and ice scenarios are also playing themselves out in different neighborhoods and different market strata. I lifted the chart above from Piggington.com. As you can see, all market segments are dropping, so the aggregate is dropping steeply. However, different market strata are dropping at different rates. The high end is not dropping as fast as the low end. This doesn’t mean the high end is not going to catch up. In all likelihood, the low end will bottom before the high end, and the lines will all intersect just after the market bottoms.

You can see this same phenomenon if you look at cities or neighborhoods. Santa Ana has experienced Armageddon, and its resale value chart looks like the orange line above. Tustin would be the blue line, and Irvine would be the green one. If you wanted to break down Irvine’s neighborhoods, you would see the same pattern going from the least desirable (like El Camino Real) to the most desirable (like Turtle Rock).

It is important to note that this does not mean that premium neighborhoods will retain a premium on their premium. This is another common misperception. For instance, Turtle Ridge commands an approximate 10% premium over Quail Hill on rentals for identical floorplans. Since the rents are 10% higher, the resale prices will be 10% higher as well. The GRMs in both neighborhoods would be the same. It is not that Quail Hill will bottom with a GRM of 160 while Turtle Ridge bottoms with a GRM of 200. The premium is already factored into rents. There will be no premium on premiums at the bottom. GRMs will be very similar across the entire market (although individual properties will see variations as some drop to investor cashflow levels).

Today’s featured property is a tiny 1/1 condo in The Lakes selling for 35% off
the peak. This may be the least desirable property in Irvine, and one of its
least expensive.

Asking Price: $197,900

Income Requirement: $49,475

Downpayment Needed: $39,580

Monthly Equity Burn: $1,649

Purchase Price: $300,000

Purchase Date: 9/22/2006

Address: 144 Streamwood, Irvine, CA 92620

That entry photo has a wonderful artsy quality to it. You can really feel the depression growing with each step into the black hole. The bleak, featureless walls, the interesting composition, and the unique play on perspective are all great — if you were trying to convey the emotions of despair. I question whether or not this technique will help them sell real estate though.

Perfect starter home! LOL! If you are a family of hobbits.

This property was purchased at the peak for $300,000. The borrower used a $239,900 first mortgage, a $60,000 second mortgage, and a $100 downpayment. She must be really upset over losing that much money.

The lender bought this at auction for $263,418 on 12/8/2008. If this sells for its asking price, the lender stands to lose $113,974 after a 6% commission. Not a big loss by Irvine standards, but considering the entire loan was only $300,000, it is pretty substantial.

{book}

Ooo, you’re givin’ me the fever tonight
I don’t wanna give in
I’d be playin’ with fire
You forget, I’ve seen you work before
Take `em straight to the top
Leave `em cryin’ for more
I’ve seen you burn `em before
Chorus:

You come on like a flame
Then you turn a cold shoulder
Fire and Ice

Fire and Ice — Pat Benatar

The current business model for selling real estate needs to change. The collapse of the housing bubble may be what causes a major shift in the way real estate is sold in the United States.

Today’s featured property was purchased by us at auction. IndyMac,
which is now owned by the US taxpayer, bought this property, and now
they are trying to get some of their money back.

Asking Price: $631,900

Address: 4 Rockrose Way, Irvine, CA 92612

{book}

The End — The Doors

Of our elaborate plans, the end
Of everything that stands, the end

I got out my crystal ball this weekend and gazed into the future of
the residential real estate sales business. I foresee the end of the 6%
sales commission model.

The 6% Business Model

When a seller signs a listing agreement with a realtor, the
commission is typically 6%. This commission is split between the
buyer’s broker and the listing broker. Each one gets 3%. This
commission is often further split between the broker and the
salesperson. Each one gets 1.5%. Each real estate commission could
potentially get split into 4 pieces each representing 1.5% of the sales
price. This structure supports a great many people — too many.

The 6% sales commission business model only survives for two
reasons: 1. The National Association of Realtors (NAR) lobbies every
level of government to maintain their advantage, and 2. The NAR
controls market data through the Multiple Listing Service (MLS).

It is hard to say what the future is for the NAR lobbying efforts.
I, for one, have been suggesting that the NAR be regulated by the
Securities and Exchange Commission (SEC) due to their propensity to
routinely make false statements regarding the financial performance of
housing as an investment class. When people stop to examine the role of
the NAR in the inflation of the housing bubble, the power of their
lobby may be pushed back by public opinion. Of course, they were just
as responsible for helping inflate the coastal bubble of the late 80s,
and they managed to convince people the deflation of the bubble was due
to the economy. The realtors were blameless, of course. Perhaps they
will get lucky and avoid responsibility again in the eyes of the public.

The big problem for the NAR and their business model is the
free-flow of information on the internet. The internet is taking away
the exclusivity of their information. Eventually, this factor alone
would lead to the death of this sales model. Competition for
commissions among all those with data access who are not subject to the
cartel arrangement of the NAR would cause commissions to fall.

We already see this among the buyer’s brokerages like Redfin who are
offering 1% buy-side sales commissions instead of the usual 3%. Redfin
and other discount, buy-side brokerages like them have already chipped
away at half the commission structure. The only thing missing is a new
business model to chip away at the sell-side of the equation. That is
where today’s post comes in.

Problems with the Current Model

In the 6% business model, the realtor is totally responsible for the
sales and marketing effort. Any staging, photography, advertising or
other resources devoted to the marketing effort comes out of the
realtor’s pocket. If there is no transaction, the realtor does not get
paid, and any sums spent in marketing efforts is gone. There is no risk
to the seller in this business model as the risk of a sale resulting in
a commission is entirely on the realtor.

This creates a number of incentives that do not work very well.

Since all the financial risk is on the realtor, their incentive is
to do as little as possible. Even though there is a fiduciary
responsibility to market the property, realtors often do nothing that
requires an outlay of money. They will take their own poorly-staged
photographs and write the awful descriptions I lampoon on a daily
basis. They will sign up for whatever free marketing is available, and
do little else that costs them money.

Realtors are not entirely to blame for this behavior. Since owners
have no risk, and since they are not personally invested in the
process, they often behave in ways that inhibit a transaction from
taking place.

Owners will list their homes for sale purely for vanity. They put a
WTF asking price on the property so they can brag about how much it is
worth.

Owners are sometimes very greedy. They put a WTF asking price on the
property to make sure they extract every last penny from the sale.
Prices outside the realm of possibility simply waste everyone’s time —
and the realtor’s marketing dollars.

Owners do not always stage the property well or keep it clean for
showings. If a realtor has to show a pigsty, it does not help
facilitate a sale.

Owners are not always emotionally ready to sell their property. This
often causes them to behave in ways that prevent a sale without their
even realizing it. Owners may know they need to sell, so they list a
property, but unless they want to sell, it will not happen.

The Pay for Marketing Model

The business model I propose changes these incentives. It would have the following characteristics:

• Sellers contract with realtors for marketing services.
• A 1% commission is paid to the listing agent if there is a sale.
• The buy-side commission is set by the seller ranging from 1% on up.

Contracting between the potential seller and the listing agent takes
the risk away from realtors and compensates them for their marketing
efforts, whether or not a sale occurs. It changes the mindset
of sellers. Once a seller starts spending money to sell their house,
they are far more motivated and committed to completing the transaction.

There is a 1% sell-side commission to provide additional incentive
for the realtor to perform their marketing and sales duties well. It is
nice to know they are making enough to cover their expenses and make a
few bucks through the marketing program, but the commission structure
is still necessary to motivate them properly.

The seller also gets to determine the buy-side commission. A typical
commission would be 1% similar to what Redfin makes on its buy-side
activities. However, if the seller is particularly motivated, they can
increase the buy-side commission to attract more attention to their
listing.

How It Works

Can you picture what will be
So limitless and free

The business model of a consultant is fairly simple: you write a
scope of work detailing what will be done, and you list the deliverable
products you will produce. The purchaser of these services agrees to
pay for these services as work proceeds and deliverables are produced.

If sell-side realtors embrace a marketing consultant business model,
with a 1% sales commission incentive bonus, they would have limited
risk of spending money without getting paid (every consultant has this
risk), they would not be starving to death in the lean times, and they
have some upside potential if they do the marketing job well enough to
make a sale happen. The advantage to sellers is obvious: a 1%
commission plus direct marketing expenses is much less expensive than
paying a full 3% on the listing side of the commission structure. It is
truly a win-win.

A good realtor or property marketing company can devise a number of
marketing plans to suit any budget. The minimum plan would contain
whatever services the realtor felt was essential to facilitate a home
sale. It is a waste of time to do less than this. Each realtor or
marketing company can devise their own plans and cost structure. They
could even keep track on statistics on each plan’s success (did it
sell, and how fast). Since the focus is on tasks and deliverables, the
seller of the property who is contracting for these services can easily
verify if the services are actually being performed. As stated
previously, the seller pays for these services whether or not a sale
occurs.

For instance, a realtor may have a minimum package that is one step
above a for-sale-by-owner effort. The property can be photographed by
the realtor who also writes the description and loads it into the MLS.
For an extra $1,000 the property can be professionally staged and
photographed, and a professional copywriter can write a description.
For more money, the property can be included in various real estate
advertising publications. I think you get the idea. A full menu of
possible marketing possibilities can be put together into packages or
sold to the property seller a-la-carte.

The savings for the seller would be enormous. For example, the
typical 6% commission on a $500,000 property is $30,000. This comes
right out of the seller’s pocket at the closing table. If the seller
were to contract with a realtor for $2,500 in direct marketing (which
would buy a lot of marketing), a 1% sell-side commission, and a 1%
buy-side commission, the seller would be spending $2,500 trying to
facilitate the sale (a motivating risk to the seller) and $10,000 in
commissions ($5,000 to the listing, sell-side broker, and $5,000 to the
buy-side broker). Instead of costing $30,000, the sale costs the seller
$12,500. That is a 59% reduction in cost to the seller.

{book}

There will be resistance to this plan on the part of some realtors
who would prefer to continue to get 3%-6% for doing little or nothing.
Those that have been enjoying the free ride will have the most to lose.
However, this has not stopped Redfin from taking 2/3 of the commission
out of the buy-side of the transaction. If a person or organization
with vision, good marketing skills, and a basic understanding of the
consulting business model were to go after the sell-side, I don’t think
there is much that would stop them.

I am not a marketing expert, so I am not the one to do it, but
perhaps one of the readers of this blog is. I hope someone does this —
at least by the time I am a seller again…

This is the end
Beautiful friend
This is the end

Today’s featured property was purchased by us at auction. IndyMac,
which is now owned by the US taxpayer, bought this property, and now
they are trying to get some of their money back.

Asking Price: $631,900

Income Requirement: $157,975

Downpayment Needed: $126,380

Monthly Equity Burn: $5,265

Purchase Price: $870,000

Purchase Date: 12/20/2006

Address: 4 Rockrose Way, Irvine, CA 92612

Beds:	4
Baths:	3
Sq. Ft.:	2,500
$/Sq. Ft.:	$253
Lot Size:	3,328 Sq. Ft.
Property Type:	Single Family Residence
Style:	Traditional
Year Built:	1966
Stories:	2
Area:	University Park
County:	Orange
MLS#:	P672478
Source:	SoCalMLS
Status:	Active
On Redfin:	3 days
Fixer-upper

Lately, I have been trying to look at properties as if their prices were approaching reality. Even with the big discount, this property is still grossly overpriced. I might become interested at $420,000, but at $631,000… not.

This property was purchased on 12/20/2006 for $870,000. The owner used a $696,000 first mortgage, a $130,500 second mortgage, and a $43,500 downpayment. The owner went into default, and the property was purchased by INDYMAC FEDERAL BANK FSB on 12/10/2008 for $552,758. That sale represents a 37% drop from the peak.

If this property sells for its asking price, and if a 6% commission is paid, the total loss on the property will be $276,014. I, you and every US taxpayer will lose $232,514. The original owner lost $43,500.

{book}

This is the end
Beautiful friend
This is the end
My only friend, the end

Theres danger on the edge of town
Ride the kings highway, baby
Weird scenes inside the gold mine
Ride the highway west, baby

The End — The Doors