Fiscal Cliff Approval and Real Estate

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Real Estate Tax Provisos for 2013

 

Finally, “fiscal cliff” debate is over! For months now, it’s been impossible to turn on the TV or radio without getting an earful of breathless and mostly unwanted information.  Even though most of us now regard Congress as on a par with cockroaches, what happens there does have an impact on our lives. All the more reason for members of Congress to act like grownups, but that’s another topic…

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Real Estate Tax Deductions

Rushed through at the last minute, the “fiscal cliff” legislation contains a number of important provisions and none more important than those that relate to real estate.  Here are a few of the most salient.

  • Short sale taxation relief extended for another year until January 1, 2014
  • Deduction of mortgage insurance premium is retroactive to 2012 and extended to 2013 for incomes under $110,000
  • 10% tax credit [up to $500] for energy-saving home improvements retroactive to 2012 and through 2013.
  • Capital gains tax stays at 15% except for those earning over $400,000 [single filer] or $450,000 [joint] and then it’s 20%.
  • $250,000/$500,000 [single/married] exclusion on capital gain from sale of principal residence remains unchanged.
  • Estate taxes on first $5 million for individual and $10 million for family estates are ZERO.  Above those amounts, the rates are 35% and 40% respectively.

Effect of Real Estate Provisos of 2013

Given these provisos, it’s clear that real estate remains in a privileged position as far as federal taxes go. Not only do homeowners get a tax deduction  for the interest in their mortgage payments, which is unheard of in other developed countries, such as Australia and Canada, but we can deduct mortgage insurance premiums which are only applied if the equity in the home is less than 20%. By extending this tax deduction, Congress is implicitly encouraging home ownership among those who do not have the traditional 20% down payment. Is this a good thing? Considering the recent mortgage meltdown, maybe not.  It does help lenders and real estate professionals, though.

Homeowners also get to purchase equipment for their homes and then deduct some of the cost–just so long as it saves energy and fits the criteria.  Naturally, no one can argue that energy-saving is bad, but here the government supports homeowners and no one else.

Additionally, estate taxes on the first $5 or $10 million, depending, amount to nothing. This also supports homeowners since a large proportion of most estates of this size is made up of real estate holdings, both principal residence and investment properties. Again, the tax code is supporting home ownership and investment in property.

Last, but not least, the tax code encourages home ownership by not taxing any capital gain up to $250,000 or $500,000 respectively. This means that home owners can sell their homes frequently, pocket the gain or purchase a more expensive home, without worrying at all about taxes. This has been part of the tax code several decades, though the amounts have increased, and does encourage home ownership. In fact, it encourages or at least does not discourage serial home ownership.  Of course, this benefits those who change jobs and must change jobs, but it also benefits lenders and real estate professionals.

Extending the tax relief to those who short sale their homes is in a different category. So long as underwater homeowners face no tax penalties for short selling their homes,  they will usually prefer it to the foreclosure alternative. At the same time, short sales are a much faster way of  dealing with an inability or unwillingness to pay the mortgage in underwater homes.  Short sales help to clear the vast inventory of underwater property which has been clogging the system for the past few years making it difficult for the real estate industry to recover.

 

Is The Housing Crisis Over and Out?

Housing Is On The Upswing

The Good News

The worst of housing times may be slowly working its way into a dim memory as home buyers are returning to the marketplace. The national housing stats are suggesting that the terrible pain of the last six years may, at last, be coming to an end.  According to the National Association of Realtors [NAR], national home sales rose 3.4% in April for a total of 4.6 million homes sold  and the median home price for the nation rose to $177,400, a full 10% over last year. Of course, the  NAR has a vested interest in the health of the housing sector and its stats may be on the rosy side, as many commentators have pointed out. Still, 10% increase in value, even 5%, is terrific news.

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For more good news,  purchases of new homes rose almost 10% over last year. At the same time the purchase price of these new homes rose almost 5% to a national median of $235,700. Housing starts are up over 50% from their 2009 low.  So, it does seem as if there is some ground for optimism. Finally, the combination of  incredibly low mortgage rates and low home prices has begun to attract the public, still stunned from the worst economic downturn in decades.

Why Is This Happening?

For the millions still underwater and behind in outrageous payments, even thinking that the housing crisis may be on its way out is a cruel joke. Nevertheless, there are some solid reasons for an eventual and actual end to the housing crisis of the last few years.  Our U.S, labor market has been improving over the last two years ever so gradually, diminishing the ranks of the unemployed slightly month by month. Add to that enticing mortgage rates which remain at historic lows and it makes sense that home buyers with the wherewithal would begin to have enough confidence in their future prospects to make that big home purchase.

Rent vs. Buy

Rental rates have been rising throughout the country and renting has many advantages over owning a home. Nevertheless, rental rates are still much higher than the cost of owning a home in great swaths of the country. This is based on purchasing a home with 20% down and owning the same home for at least 5 years  Additionally,these stats take into consideration only the purchase price of the home,  not the ongoing costs of maintaining it.

Though for the most part  in Southern California rental rates are still cheaper than owning a home, the allure of home ownership is still a strong pull both for the younger, first-time buyers as well as older, more experienced ones. The many young people who have returned to live with Mom and Dad or those who have rented with roommates for several years are now yearning to live free–in their own homes.

Is The Crisis Finally Over?

Millions of homes are still underwater. Millions of homeowners are still faced with foreclosure or the prospect of short sale. With that in mind,  the housing crisis is certainly not over.  Despite the modest recovery in the U.S., now our global trading partners are starting to slow down or even crash themselves, especially the EU and the BRIC countries [Brazil, Russia, India, China], which had been keeping the economic engine stoked.  This country is recovering and we may manage to keep up the trend going mainly by satisfying pent-up internal demand, especially in housing.

 

Should I Buy Or Sell Now?

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It seems clear that now and for the rest of this year, it’s a good time to buy a home. Prices are still very low and mortgage rates are very low. Both of these factors are likely to extend through the end of the year and into 2013.

For those thinking of selling, it’s a more mixed picture. For those deeply underwater, home prices are unlikely to spike in the next few years, so better to bite the bullet and sell now.  For those who want to move up, this  seems to be the ideal time to make the move. And, of course, many have little choice in the matter: whether it’s through marriage, divorce, new babies or new jobs, selling is really the only option.

 

 

Financing Investor Real Estate: Two Evergreen Methods

The Horse Is Already Out Of  The Barn

These days mortgage lenders have tightened the screws, battened down the hatches or however you might want to put it. The fact is that getting a mortgage for any property, including and especially investment property, is more difficult than it has been in a long time.  Back in the Bubble years, 2003-2007, lenders crowded the market with “product.”  This so-called product included many versions of no-money down loans, interest-only loans or adjustable loans, all with varying schemes for interest rates. Qualifying was a breeze. Even the self-employed, who typically inflate their expenses to moderate their taxable income, got mortgages based almost solely on credit reports with income self-reported, the  famous “liar” loans.  Of course, creative lenders figured out how to get loans to borrowers with no credit or poor credit or even terrible credit. Those were the days.

We are now reaping the whirlwind in the form of foreclosures, toxic debt, short sales, and home values spiraling ever downward. Nevertheless, the new guidelines, instigated in the aftermath of the Bubble, do strike me as shutting the barn door after the horse has fled. Today, many excellent buyers are not able to get financing or not able to get their desired financing for a variety of weird reasons. Some underwriters appear, to me at least, to have lost their minds. For instance, I had one short sale where the underwriter of the loan for the buyer wanted financial information from the seller. What?  Others have told me equally harrowing stories. So, what to do?

We’re back to 1950s type of financing, 20% [or more] down with excellent credit.  So, let’s go back to the 1950s for some other tried and true financing methods. One of the very best is seller financing.

Seller Financing

More than half the homes in America are owned outright with no mortgage. Surprised? Sometimes these owners have to sell for any of a myriad of personal reasons-retirement, sickness, divorce, death of a spouse, job loss, job change.  Some of these owners will sell and have a pile of cash they don’t really know what to do with since, as mentioned in previous posts, traditional CDs are close to zero and the stock market has lost its luster for many. Sellers in this position can and should offer seller-financing to help sell their homes quickly and for top dollar. Seller-financing is a terrific buyer incentive.

Seller-financing is not complicated.  The seller qualifies the buyer by checking his credit and income just like any lender. Escrows and agents can help draw up the actual contract and the buyer and seller can agree on terms. The seller can charge more than normal market rates because the buyer is saving all the normal closing costs associated with a mortgage, usually running to 2% or more of the mortgage.  The escrow will set up a service to check the taxes and insurance are paid every year. The seller will have the same protection as any mortgagor, the right to foreclosure should the borrower fail to make payments.

The result, though, is a win-win for both buyer and seller. Seller gets a nice return every month, secured by the property itself. That’s better than the stock market and more secure. The buyer gets a no-red-tape loan and an actual person to whom he sends payments. For those buyers and sellers able to take advantage of this type of financing, it’s a godsend.

Assumable Loans

Another traditional way to purchase property is by assuming a loan from the seller.  For instance, if  the purchase price is $300,000, the seller may already have a $200,000 loan on the property. If it’s assumable, the buyer can take over payments and give the seller the rest in cash, $100,000, saving himself closing costs and more red tape.  Many times investment property is sold this way, including large apartment complexes.

The down side to this method comes from the original lenders. Today, many loans are not assumable. Those that are assumable often require both an assumption fee and qualification process with the lender.  Despite these drawbacks, the process is still far easier and cheaper than acquiring another loan.  Plus, the qualification process is not as stringent.  The buyer with cash may well be able to strike a great deal, saving himself thousands of dollars in closing costs and lender’s fees while simultaneously avoiding most of the complications engendered by the new guidelines.

Home Values & The Demographic Time Bomb

The bomb has already exploded and suburbia has been left childless. Suddenly, it’s not just rural areas and the Rust Belt that’s losing population.  Even, Beaver Cleaver’s neighborhood has no kids.  That’s what’s contained in the 2010 Census. Very few of the 3143  American counties report any growth in population and many [58.6%]  report steep declines. Children used to make up 25.7% of the population, even a scant 10 years ago. Now, children are 24% and still declining. In only 49 counties did the kid population increase, most in suburbs around mid-sized cities like Charlotte, NC.

Los Angeles  County, as reported in the L.A. Times, is losing children at a rapid rate due to the high cost of housing and the high unemployment rate. Too, hard times have led many new immigrants, many illegal, to return to their home countries, rather than tough it out here. That group had among the highest birthrates.

Time was when new schools were popping up all the time to accommodate the burgeoning baby boom. Now, even the youngest boomers are into advanced middle age.  And, they have not produced children like their parents. As a result, the archetypal American neighborhood, Suburbia, USA, is increasingly childless.  This  fact is having   massive impact in those communities.  As in L.A. Unified, schools are closing, pools and recreation areas are shutting down. All the activities we associate with child-rearing are diminishing or eliminated altogether–youth sports, music and dance classes, martial arts, swimming, skiing, birthday parties.

With the vanishing children goes the need for the 3-bedroom, 2-bath home with yard. Perhaps, too, the whole concept of suburbia is fading as newer communities insist on walkability, proximity to shops and public transportation.

Who Will Be Future Home Buyers?

During the real estate boom, as home values moved inexorably upward,  buyers spread out to purchase a second or even third home. Will this trend accelerate? It’s possible, yet, given the moribund state of housing right now, it doesn’t seem too likely. What does seem likely is that the buyers will increasingly be singles, childless couples, older singles and couples.

Where will they want to live? That, too, is not really known as yet.  Many young singles spend their twenties in urban areas like San Francisco and Manhattan or Brooklyn, Boston or Miami. They are marrying later and putting off child-rearing to their thirties.  Many of these want to stay in the urban core. With only one or, possibly, two children, that’s what they are doing.  The childless couples are doing the same thing. They like the amenities so close by–public transportation, great shopping, wonderful restaurants. Why move?

The Baby Boomers, many of whom were themselves raised in Suburbia, also raised their own children there. But, the kids are long gone for the oldest boomers and going for the younger ones as now even they are in advanced middle age.  No longer tied to school districts or commutes, many of the still-huge boomer generation are likely to  leave the suburbs where they brought up their children in search of new horizons.

Effect On Today’s Housing Market

None of this is terrifically good news for today’s market of foreclosures, short sales and underwater property. If the  kids are grown, why would a couple  hang on to the four bedroom home on which  they owe twice as much as it’s worth? They would be better off short selling the house and finding something smaller. On the other hand, if they were counting on sellling the home to move to a cheaper, slower-paced area, that option is closing fast as well.  Not only has their equity dropped like a stone, but who is going to buy that big house? Who’s going to be rushing to the suburbs to buy anything?

 

After December, The Avalanche?

Louis XIV of France, styled the Sun King, famously opined, “Apres moi, le deluge.”  After me, the flood. He was right, of course, for his excesses so infuriated the people that his successor was guillotined and his monarchy overthrown in the French Revolution.

SoCal Plunge In Foreclosure Filings

Something similar seems to be brewing in Southern California and maybe even nationwide as lenders ratchet up their foreclosure filings after the “robo-signing” lull. Though foreclosures dropped dramatically in SoCal this fall, so, too, did all home sales. The reasons seem to be many: the end of the home buyer tax credit, stubbornly high unemployment and the generally still-moribund economy. In fact, sales are down a full 16% from November of 2009. This at the same time foreclosure filings fell 14% from the previous November after a 22% decline in October for a two-month total 36% decline. Nationwide, the filings fell 21%.

December is traditionally a slow month in real estate as consumers focus on retail buying, parties and holiday travel plans. Typically, though, also in December  smart investors are out there snapping up last-minute bargains of the now-extremely motivated sellers still on the market. Competition is almost always much less, to put it mildly, and sellers are determined to close out their books for year’s end.  This year seems to be different as even investors are holding back.

That may be because the huge drop in  foreclosure filings this fall has ominous repercussions for home prices in the new year. With the foreclosure freeze over, informed observers now expect to see the banks ratchet up their foreclosures with a vengeance, restarting filings begun in October and November and barreling ahead with new ones in January. Executives from RealtyTrac, a real estate data collection firm, speculate that the housing recovery could be set back three months, if not more, as the foreclosures pile up. In fact, we can expect ” an avalanche” of foreclosures shortly.

SoCal Home Prices

The most immediate effect of an avalanche of foreclosed properties on the market will be to further depress prices in Southern California which had started a slight upward movement. Los Angeles County home prices had dropped 1.2% over November 2009 to a median of $325,000. Riverside and San Bernardino Counties, the hardest hit by the bursting of the real estate bubble, lost 2.5% and 5.0% respectively to medians of $195,000 and $152,000. But, that is a huge improvement over the 30% and 40% drops of previous years. Other SoCal counties actually gained in value. Orange County eked out a .6% improvement for a $435,000 median home price. San Diego topped the charts with a 3.1% improvement over last year to a median of  $335,000 with Ventura County just behind at 2.7% uptick to a median of $375,000.

Future: More Underwater Homes

These hard-earned gains will soon be lost as the promised avalanche of foreclosures hits the market. Perhaps sales will pick up as buyers and investors are lured back into the game. But, bargain-hunting fun aside,  another price drop for already distressed homeowners will plunge yet more homeowners underwater.  That, in turn, spirals down into more foreclosures and more equity loss in future.

Like Louis XIV, banks see this as well as anyone, yet still refuse to modify loans in any serious way. Like Louis, they see, but, obviously, don’t give a damn as long as they get their bonuses. Short-term is the only term.

Seller Financing: The Upside

One of the least understood means of purchasing property has to be seller financing. Even though many sellers don’t understand it, if it is done correctly, it is a win-win for both buyer and seller.

Communication: Key To Successful Negotiation

Just like any financing, seller financing is a negotiation. When the buyer and seller are close to making a deal,  that’s when the fine points of the financing come into play.  In order to do this correctly, buyer and seller need one vital key ingredient: communication. What are  the seller’s motivation and expectations in offering financing and what are the buyer’s? Once that has been determined, the rest of the negotiation should fall into place.

Let’s take an example. An 80-year-old man who has owned his multi-family property for 25 years is selling. He has other properties and makes a habit of selling them as they reach the end of their depreciable years which is 27. Like anyone else, he wants top dollar for his property, but he has plenty of equity and has no plans to purchase anything else.

Is he a prime candidate for seller financing? You betcha’. First, he doesn’t seem to need a big chunk of cash to buy something else. He already has other rentals, so he’s not in any rush to buy more. And, since he will get a big chunk of cash if the buyer of his property gets a loan, he will have to pay capital gains tax on that money. Currently, the tax would be 15% of the proceeds. But, if he takes a down payment from the buyer, he can get the rest of his money in smaller increments and, although the rate will be the same, because it’s a smaller amount of money, he will have a steady stream of income for many years.

Here’s another example. A good buyer is between jobs, though he has advanced degrees in accounting and every expectation of getting a good job as soon as he completes the requirements for his CPA. To get along during this period of low income, he sells a rental property for a good price and then looks to purchase another closer to where he lives. Although as a professional, he is a good risk and he has good credit, he may have trouble getting a loan from a conventional bank. So, what does he do? He looks for a property offering seller financing.

This buyer and this seller may be able to make a deal which is congenial to both of them.

This would be a win-win for both buyer and seller and represents the most common scenario for seller financing. Not every seller is interested in financing the sale, but you never know until you ask…