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Wednesday, July 12, 2006

Housing Appreciation: the dirty little secret

First, I'd like to thank Tim Ellis for inviting me to discuss housing and escrow topics on this blog as a guest. Being that many readers of this blog want to demystify home ownership and aspire to become homeowners in a meaningful way, my hope is that our collective experience (wife and I) will be a resource of good, relevant and neutral information regarding buying, selling, fixing up property and escrow issues, our profession. We do not sell property or earn commissions, not that there's anything wrong with that. The bulk of work sent our way is from Realtors and FSBO transactions.

About us: We have purchased three homes together since we were married, all fixers of various degrees. (ok, our first in Ballard was a tear down the size of a garage, but we had to start somewhere) We also have had the perspective of selling homes both as licensed Realtors a long long time ago and currently own Legacy Escrow Service, Inc. located in south Everett. My wife Lynlee and I met just after college where we attended at Seattle Pacific University. We have three kids and live way out in the sticks at a place the locals call Snohomish. There are a lot of trucks around here and cows and horses. My wife is much smarter than I am, but at least I don't do silly things like pick Cherries on the 2nd- to- top rung of a ladder and break ribs because the ladder kicks out and she falls down on the ladder, like she did this past Friday evening. She reminds me that she's really not talking in a sultry manner, it's just that she's having a tough time breathing.

Moving along, we were discussing today's work this evening at dinner and my wife reminded me of this oft forgotton but important topic. So, if you don't like it then throw tomatoes at her. On a serious note, this is a very interesting topic and does have serious implications. So let's get to it and debate it.

Housing Appreciation: the dirty little secret

We'll it's not really a dirty little secret, but like my mother-in-law says about certain things taboo, "we just don't talk about that." One of the least talked about facets of home price appreciation and what we see on the majority of the purchase transactions we close that were 100% financed, is this little secret: It's simply sellers jacking up the sales price to cover the buyers request for paying closing costs. The cause and effect: artificial appreciation and compounding that spirals house prices upward absent of fundamental economic drivers.

Ok, fine you say. What's the big deal. What's the big deal??? Let's discuss the ramifications of this because it is quite remarkable. In a recent transaction at our office a home (numbers are for example only) was listed for $450,000. It was sold for $458,000. The seller was quite happy with just accepting a full price offer, but here comes a very enthusiastic buyer that is qualified to purchase the home, but like many buyers, is cash poor. So the buyer and seller agree to artificially increase the appreciation of the home via a sales price increase that covers the closing costs for the buyer. While this appears to be somewhat routine, the inertia from compounding price appreciation from this sale and others identical to it, creates a domino affect that is hard to stop. Think about this. If our firm has closed 75 of these transactions (and we have) in 2006 alone, imagine what the title companies who dominate the market must be closing, in each county (King, Pierce, Snohomish etc...). Now think all across the state. Now think all across the country. The numbers could be staggering.

Was the true market price of the home really nearly $460,000? The seller boasts that he got over the asking price and the neighbor down the street named Ted, says, "boy, since Roy got $460,000, I'm going to ask $465,000. The appraiser and/or comparative market analysis (CMA) from the local Realtor shows only the sold prices, not how they achieved the price. And, there we have it. All those homes that sold for over asking or were they? Not exactly.

When Ted the excited neighbor lists his house with Mary, the local Realtor, for $465,000, they expect a quick sale. Just as they thought, here comes Joe & Jill Buyer, and they do the same thing and ask for the seller to pay closing costs and they increase the sales price to $475,000. Tongue-in- cheek, VoilĂ ! the appraisal comes in at exactly $475,000. And this cycle goes on and on.

A recent comment I placed on a post at the Seattle P-I Real Estate professionals blog discussed this very scenario and the reasoning why my wife and I pulled out of a multiple bid situation in the late Summer/early Fall of 2004.


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biliruben said...

Nice post, S Crow.

Do you have any figures on how many home buyers roll the closing costs into the home price?

This may exascerbate housing appreciation, but I don't think it accounts for more than a small percentage median increases. I would love to see data that prove me wrong, however.

Anonymous said...

This happened with me when I sold my Crown Hill home in 2004. The buyer wanted money back so he could cover the moving expenses into the house, I got an additional 15 grand or so. He also was doing 80/20 loans, one loan for the 80%, another short-term one for the 20% to avoid PMI...

richard said...

It's ironic that the buyers lack of money is driving appreciation.

S Crow said...


No hard numbers, but let's put this into perspective. It's very large.

If 71 out of every 100 purchase deals our office closed in 2005 were 100% financed (true), the borrowers rolled the closing costs into the home price/loan amount and most of these people jacked up the sales price to offset the seller paying closing costs.

A ton of people refinancing also roll the closing costs into the loan amount.

And I do think this scenario impacts housing prices more than one would think. We all use sold data to justify our own selling prices as do appraisers. Unfortunately, it is impossible to track unless you have someone such as myself really in the trenches, or have people come out of the woodwork like Anonymous from Crown Hill who confirms this.

I really would like an appraisers perspective on this.

Anonymous said...

My gut says that the appraisers are under too much timing pressure to sniff out the details and, even if they do, at best they are going to get the confirmation of the sale from a Realtor that may or may not be motivated to disclose what the "real" transaction price was. They might call the buyers and sellers to find out, but again, the timing pressures are too much to warrant a detailed confirmation effort. A residential appraiser that wants to make good money has got to be turning out at least one, closer to two or three, appraisals a day. That is a helluva lot of calling.

When we bought a house last year, we wanted a $1,500 rebate for a couple of minor fixes. We paid list price and got the rebate back against closing costs. The relocation company that was handling the transaction did not reimburse the sellers for this rebate--therefore, when the double escrow closed, two different sales prices came up, $1500 apart.

A workaround for this, were it to become a problem (which it might be) would be to publish the closing statements in the same way that excise tax affidavits are a part of public record.

jcricket said...

A ton of people refinancing also roll the closing costs into the loan amount.

This isn't necessarily a bad strategy and you don't have to be a 100% financer/sub-prime borrower to have it make sense. For example, if you originally had a $400,000 loan at 7%, and then rates drop to 6% in a year. You have only paid down (say) $5k in principal, so you can refinance for $397k or $395k and put out $2k in cash. Seems reasonable enough (since it's only been a year from your last set of closing costs) to make the decision that while refinancing is smart, you don't need to further deplete your cash position right now.

While the $395k has a slightly lower monthly payment, it will take something like 10 years before paying the closing costs up-front is equal in cash outlay. That's a long time. Preserving a little extra cash is often worth it to cover any emergency situations that come up (to avoid going into any other kind of debt - further exacerbating the cost of paying the closing costs in cash).

To me this is the same with the issue of whether to pay points or not. Unless you can assure you'll be in the house almost 10 years it's definitely not worth it. It usually takes 5 years before the cash outlay is the same and another 5 years before you've really started "earning money" for your decision.

Personally, I don't think this contributes that much to ongoing price appreciation. I don't buy the argument that a price that goes from $350k to $355k ($350k price + $5k closing costs) leads the next person to market their house at $365k, then $375k and so on. That market's not that simple, unless you're a bull who believes the market will only go up :-)

At any rate, is there any inherent problem with ths practice? Sellers get a little more cash? Is that bad? If housing prices depreciate, people might still roll in closing costs.

There is, I agree, a larger problem with most people doing 80/20 loans, or paying 50% of their gross to PITI, etc. - closing costs are but a teensy tinsy part of that overall problem. Which could perhaps be made smaller if we eliminated all this BS paperwork the escrow and title companies force us to pay for and instead had a standard Internet-based way of closing :-)

S-crow said...


good points regarding the efficacy to refinance when considering all costs and length of stay in the home.

To clarify, the transactions we are closing where the property sale price was jacked up solely for the purpose of the seller to pay the buyers closing costs, clearly influences future sales prices.

For example, if my neighbors rambler sold for $390K, that's THE sold price and THE new benchmark for others to justify their list prices with similar homes. It was listed for $380K. The buyer/seller agree to sell the house for $390K to pay for the buyers closing costs. My home is essentially the same and we used the comp of our neighbors to justify a $390K list price. And, so do the Realtors and appraisers.

This is classic appreciation with an asterisk ("*"). And there is no way most consumers would learn of this practice without S-Crow or others disclosing it.

There is nothing wrong, illegal or unethical about this practice. But it does influence market prices, upward.

blueskitten said...

That explains a lot... my neighbor just sold his condo for 220K and the asking price was 209K. I think it's a single mom who bought it, so I can see how she'd have a lack of disposable cash.

Deflation Guy said...

To me, the fact that buyers do no not have any skin in the game is upsetting. If you can't even pony up a 5% down and pay the closing cost then why in the heck would the creditor accept so much risk? Why would a bank not charge PMI if the 20% came from debt? Is not the debt backed by the RE as well? When prices do decline and these people are underwater on their loans there is no incentive for them to stick around. It bothers me as a tax payer because many of these creditors are backed by government guarantees.

When I bought the house I'm in right now back in '96 the standards were much tighter. There were no loans for down payments or zero down loans. You had to pay PMI if you could not come up with the 20% down. All lendors verified income.

Doesn't the current environment cause concern to others?

The end of the credit bubble can not be that far away. I mean, how much looser can the lending get?

Van Housing Blogger said...

"I mean, how much looser can the lending get?"

Please don't ask - I'd be scared to see the answer . . .

SeattleMoose said...

S Crow....thank you.

Your insights from an "insider" position are always very interesting and much appreciated.

SeattleMoose said...

DeflationGuy said..."The end of the credit bubble can not be that far away. I mean, how much looser can the lending get?"

Well it could be worse. Imagine being scared to walk by a bank for the fear that you will be mugged, taken into the vault, and forced to sign up for a toxic loan on some POS at gunpoint.

Capitalistchristian said...

Deflation guy

In response to your questions about buyers...

If someone is doing an 80/20 loan, then the interest rate on the 20% loan is significantly higher than the 80% which is why they don't pay any PMI. For instance if you got a loan with your 80% loan at 7% rate, then your 20% loan would most likely be between 9.5 - 10.5%. This higher return is essentially similar to paying PMI, because the second loan knows that they are in second position and the first to be wiped away in a foreclosure. So basically instead of having to pay PMI like you had to back in 1996, they just have to pay a higher note rate on their second.

In regards to govt backed loans. Any FHA and VA type loans have to pay an up front Mortgage Insurance Premium (between 1.5 - 2% of the loan value) and this is their PMI. So they have "insurance" backing their zero down loans. Hope this helps.

Easy Street said...

Yeah, artificially appreciating the price to kick back the money at closing is done all of the time. Wonder how many know that they are actually breaking the law by doing so, federal tax law at that. Because it some cases it may slightly alter the capital gains consequence and what is actually declared as closing costs, you are commiting an act of fraud!

Anonymous said...

Whoah- If it's illegal, it should be reported, no?