The Next Great Real Estate Reset Will Be Squarely the Responsibility of Real Estate Brokers

Those real estate agents that were around in 2006 and 2007 during the height of the worldwide economic depression probably tread lightly now a days because of what they learned back then.  It likely has not accurately been communicated to today’s agents.

Let’s walk down memory lane.   Prior to the real estate market correction of 2006–2007 and the resulting worldwide economic depression, the unprecedented increase in house prices starting in 1997 produced numerous wide-ranging effects in the economy of the United States.  In September of 1997, Bill Clinton, then president of the United States signed a bill that allowed ARM’s to be allowed as an interest option for home purchases.   For those who don’t know, an ARM is an adjustable-rate mortgage, and it also on the rear end had a balloon payment.  Most of the issues arose as it also terminated the last parts of Glass-Stegal, the law that was put into place to separate banks from mortgage companies from Wall Street.

It was put into place after the 1929 economic disaster when the same named banks in 2007 crash did the same thing in 1929.  History repeated itself, the lesson was forgotten.

The US housing bubble affected half of the states because of subprime lending, spiking in land prices, cutting mortgages in which people applying could not afford them, and a few other issues.   What we mean by that is that for sub-prime mortgages, many of the mortgage lenders were cutting checks back to people to put them in homes.  At that time, it was a buyer’s market, and it was led by Democrat Senator from North Carolina John Edwards.   Several market reporters at the time would say “If you are breathing, you could get a mortgage.”

“That can’t happen,” said a MSN Business anchor.  But… It did.  Real Estate brokers at the time put people they knew or should have known were working at McDonalds, and showing them $450k homes, or part of the top end of the “Jumbo” loan packages.   Lucky for the Real Estate Agents, they were not part of the lawsuits against Countrywide and other companies that were pressuring brokers to find buyers to cut mortgages.

From Wikipedia, we find the following “The chief economist of Freddie Mac and the director of Joint Center for Housing Studies (JCHS) denied the existence of a national housing bubble and expressed doubt that any significant decline in home prices was possible, citing consistently rising prices since the Great Depression, an anticipated increased demand from the Baby Boom generation, and healthy levels of employment. However, some have suggested that the funding received by JCHS from the real estate industry may have affected their judgment. David Lereah, former chief economist of the National Association of Realtors (NAR), distributed “Anti-Bubble Reports” in August 2005 to “respond to the irresponsible bubble accusations made by your local media and local academics”.

While the beginning of the crash was evident, the NAR was still pushing Anti-Bubble Reports until the actual crashes.  The NAR and many Real Estate Websites such as Realtor.com (where most people believe the NAR owns Realtor.com) continue to promote the overpayment of homes and housing either through news articles or via an online appraisal that is higher than most sensible brokers would apply. If it is applied properly, the disclosure for the reports should say that it is based on data 18-35 days old, and in some cases, it might be quarter to quarter.

During the initial crash, other statements, the reports stated that people “should [not] be concerned that home prices are rising faster than family income”, that “there is virtually no risk of a national housing price bubble based on the fundamental demand for housing and predictable economic factors”, and that “a general slowing in the rate of price growth can be expected, but in many areas inventory shortages will persist and home prices are likely to continue to rise above historic norms”.  Following reports of rapid sales declines and price depreciation in August 2006, the NAR’s chief economist admitted that he expected “home prices to come down 5% nationally, more in some markets, less in others. And a few cities in Florida and California, where home prices soared to nose-bleed heights, could have ‘hard landings’.

In October 2005, David Lereah, the NAR Chief Economist was busy calling the bubble believers ‘chicken littles.’ Many of the predictions espoused by the ‘chicken littles’ are fast becoming closer to reality. Inversely, David Lereah has lost credibility because of his irresponsible cheerleading.  However, by that time Realtors across the nation were in full swing selling homes for more than what could be afforded, Wall Street was pushing for more and more mortgages to be cut in an attempt to make quarterly numbers.  Afterall, they had nothing to lose as they were dumping those mortgages on to Freddie and Fannie as fast as they could, as they knew it was a hot potato.

Fast forward to today.  We have seen the housing markets do pretty much the same thing, they have gone about it a different way, but in essence, it has done the same.  “ I have sold homes $40k over the comparable, and had buyers submit offers for way more than reasonable for places that needed foundation work,” said Matt Price, Auctioneer & Realtor.   The supply never caught up with the demand, due to the rash of builders in 2007-2009 that were going bankrupt.   Because of that, many of the builders who weathered the storm of the 2000’s was skittish in over building.   Then in 2019, at the end of September and early October, the word of a new threat came on the landscape.  The Covid pandemic.

People were driven out of the cities and into the smaller towns, many of which did not have the infrastructure or capacity to handle the large influx of people moving to those areas.  While the towns and smaller cities weather the influx, not enough money is being put into the improvement of the roads, upgrading them from one level of traffic pattern to the almost interstate like requirements.   Then just recently, a local TV station reported that Realtors are fielding offers as high as $1 Million above asking prices on homes in the Capital area of the state.   This kind of over bidding, or over offer, is aligning with the past.

Land prices skyrocketed, and home process have soared to values that have never been seen.  In one area alone, prices are up well over 18%, and in another 22%.   Additionally, the sold prices on the homes, the main indicator that is used in reassessment, has driven tax values equally through the roof.   In one instance, a home that sold in 2019 for $179,000 was put up on the market for $280,000 and with three showings there was a full price offer no less than 36 hours on the market.

That is an increase of $101,000 in less than 21 months.

Most of the sales come with hefty Due Diligence payments, and in other cases, high Earnest Money Deposits.  If the home does not appraise for what the buyer puts the offer in, there are two things the buyer can do.  First, come up with the difference in the appraisal and the offer price of the home.  Second, back out of the deal and leave the Due Diligence on the table.  Some say there is a third option of asking the seller to navigate down from the price, however, in a sellers’ market, that is not common.

To equate it to car sales, if you have a Maserati and a seller price the million-dollar car for $950,000 and you offer $750,000 – what do you think the seller will do?  Especially when the value of the car, because of the lack of inventory is going to do?

So here is why the practice absurd over listing prices and even worse due diligence fees will cause collateral damage down the road.  

First, when buyers come to real estate agents, the agents ask a few questions.  Some ask what they are looking for, and other ask if they have a prequalification letter.  More often than not, the number one thing is “Are you qualified?”  As we seen in 2005-2006 sending them to a mortgage company if the buyers did come up with the delta difference in the sale of the property, it creates a situation where all of the properties come up in value.   Not a bad idea, the seller builds equity. 

But there is a snakebite that comes with that.  

A home that was valued at $550,000 now gets looked at as possibly being worth double that price, which if the mortgage company that is paying the taxes on that level will find that the home owners will have to come to the table more money, potentially putting the home in default and into a tax sale.   In some metros, the tax rate is $1.73 per thousand.   So rather than paying $951.50 in taxes, the owners of that property would be on the hook for $2,681.50.    If the wages do not keep up with that level of inflation, then we are looking at tax foreclosure sales in bulk.  And with everything else inflating, we are looking at the possibility of bankruptcies, and another crash that is larger than 2007.   Mortgage companies will have a hard pill to swallow in that if the crash in 2006 didn’t get them, this one will – they still have not recovered from the last.

Second, Real Estate Brokers who are advising their clients that in order to get the home they have to put large Due Diligence down, and the property not appraise – and they wind up backing out will learn a large and expensive lesson in that they will not get that money back.  Some brokers ask for the Due Diligence back.  But here is the warning.

Due Diligence is where you are paying for the right to have the marketing for the property temporarily halted while you get your inspections, appraisals, and surveys done.   And it goes directly to the seller – and they don’t have to return it – even if the buyer can’t complete the transaction.  If the right was purchased – don’t expect it back, as the check gets written directly to the seller. That Due Diligence check is written to the seller to take the house of the market as a convenience fee – and nothing more. 

Millennial’s coached by agents to throw 20% due diligence at a property – only for them to lose it because of the current environment where the house does not appraise, and they have no option to pay the difference between the sale price and the appraisal has been the defacto practice of late.  When they lose several thousand dollars in Due Diligence, or tens of thousands, they are less likely to search for another home and do the same thing over again.  As has been seen in several markets.

In fact, we have seen buyers who have lost out on properties because of that practice take a break until they can rebuild their savings accounts.   “We put offers with due diligence money in on four properties and lost all of them because they came in with more money,” said an IRS agent. “We were not willing to do any more than what we knew was reasonable.

The rebuilding of their accounts may take anywhere from 3 to 5 years.   If on the advice of their broker it was because of putting forward due diligence and not Earnest Money, looking into a crystal ball, there will be a lawsuit against those brokers to recoup that money, or their firm.  All it takes is one to set a precedent.

One Brokerage in North Carolina states: “Due diligence money is at risk immediately, so the more you put down, the more you might lose if something goes awry.”  Then they go on to say that the more you put into the Due Diligencce Pot, the more likely you are to win the property in a multiple offer situation.  But, for certain types of loans, it has to appraise for the offer price or you have to make up the difference.  If you cannot – then you lose the due diligence money.  Some say you can ask the seller to come down, however in a sellers’ market, it is highly unlikely, and to the seller – unreasonable.

In the houses that are bid $1 Million over asking, the question remains how much is the broker going to advise in Due Diligence?  How is your client, for which you are a fiduciary going to respond when they lose the house over appraisal and can not close?   What are you going to be on the hook for legally?  And how is your client going to get that 20% due diligence back.

Here is a hint, they are not.

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