Is Another Housing Bubble Looming?

April 2013, the more things change, the more they stay the same. It seems like Deja Vu all over again.

There are very few listed houses, multiple offers, bidding wars, double digit price inflation, and listed houses are on the market for a very short time. Seems like all of the ingredients for yet another housing bubble that is about to burst, even when considering most owner-occupant buyers are putting down 20% or more of the purchase price and surviving very onerous bank qualification criteria.

Appraisers are still getting their fair share of criticism. Instead of appraising high (like just before the 2008 housing crash), appraisers are now under very strict guidelines imposed by new federal and state regulations that are forcing appraisers to estimate low comparable sales values. This disconnect between appraised value and what highly motivated buyers are offering is causing contracts to fall out of escrow or causing the buyers to come up with more down payment.

There is a more detailed article at Inman News by clicking here.

By the way, in my humble opinion, lenders would be better served by lending a percentage of what the property can afford to pay for debt service according to market rents, rather than comparable sales. Comparable sales are greatly influenced by buyer financial capacity, which has little correlation to what market rents can afford in the event that the borrower must move out of the property and get a tenant to service the debt. Also removing the “due on sale” clause to allow someone else to take over the debt would greatly reduce the risk of foreclosure. Trying to negotiate with a lender over the “due on sale” clause causes significant delays in curing debt defaults and resuming the debt service. Some may argue that the lender has a duty to qualify the new debtor, but they ignore the fact that if the new debtor also defaults then the lender can still foreclose. At least with a new debtor, there is a better chance to rehabilitate the loan, and to avoid the cost and delays of a foreclosure. (I’ll get off my soapbox now.)

Can an investor make money in a market about to crash? Yes. Just think of how a stock market investor makes money when the stock price crashes. When the market signals an imminent crash, he buys a Put Option. A Put Option is the legally recognized right and option for the Optionee (seller) to force the Optionor (buyer) to buy the asset at the contracted price for a specific time frame. The Optionee buys the Put Option and then decides (before the option expires) whether to exercise the option to force the Optionor to buy the asset. Most option contracts also include a “cash settlement” clause that allows the Optionor to avoid buying the asset and just pay a settlement amount that is the difference between the Option price and the lower market price. If the market price remains above the Option price, then Optionor continues waiting without exercising the option.

In real estate terms, this is the same as a property seller (Optionee) entering into a purchase & sale agreement with a buyer (Optionor). The seller provides an earnest money deposit that is forfeit to the buyer in the event that the contract expires. The Optionee does not sign the contract, only the Optionor (buyer) signs and notarizes the contract and agrees to Specific Performance. The Optionor may also post collateral with the escrow agent as security to the seller in the event that the Optionor is unable or unwilling to perform at exercise.

By the way, most folks don’t understand that an Earnest Money Deposit (EMD) is not legal consideration for a valid binding contract.  EMD is not required unless the contract specifically states that it is required. Either party can provide the EMD according to the terms of the contract. A valid binding contract requires the equitable exchange of consideration or the promise of an equitable exchange of consideration. For example, the buyer promises to deliver $200,000 in good funds to escrow and the seller promises to deliver clear marketable title. The consideration is equitable (viewed as having equal value in an arm’s length transaction according to the informed perspective of the parties).

The Specific Performance clause legally requires the buyer to purchase the property at the agreed price in the event that the seller signs (exercises) the “Put Option”. A “cash settlement” clause can be included to allow the buyer to simply pay the difference between the contract price and a lower impartial appraised value. The earnest money deposit (paid by the seller) is held in escrow until the contract is exercised or expires. If the contract expires, then the escrow agent releases the EMD to the buyer as compensation for surviving the risk. If the contract is exercised, then the EMD is used as part of the “cash settlement” clause paid to the seller.

The “Put Option” is rare in real estate. It is a risk management tool that provides benefits to both seller and buyer. The seller is essentially buying an insurance policy to guard against a price decline and the buyer is getting paid to take the risk of a price decline. The buyer negotiates a contract price that represents a good discounted price on a quality asset in the event that the contract is exercised.

In a free market society, both buyer and seller must be thrilled to complete the transaction according to each party’s informed decision.

You can learn more about sophisticated real estate strategies for “Call Options”, “Put Options”, “Cash Flow Notes”, “Wholesaling” and “Rehabbing”, and many other topics in my special report “How to Pyramid Your Equity to Create Wealth and Financial Freedom” at http://bit.ly/pyecw-1.

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