II. STATE LAWS OFFER VERY LITTLE PROTECTION TO HOMEOWNERS
III. BECOME AN EXPERT SHOPPER BEFORE
IV. WORKING WITH A REAL ESTATE AGENT
V. BUYING THE HOUSE
VI. THE CLOSING
VII. TAKING POSSESSION
As you know, buying a home, whether it’s your first or your tenth, can be a very stressful experience. The buying process will arouse emotions that you didn’t even know you had.
- Are you looking for a new home because you are relocating to a new city, or are you moving to get into a new neighborhood?
- Do you view a home purchase as a form of investment, or just a home?
- Do you think bigger homes are better investments?
In 2006, the National Association of Home Builders reported that its June index of future construction activity had dropped four points to 42, the lowest level since April 1995. The Wall Street Journal reports sharp drops in housing activity, and increased inventory of homes in previously “hot” markets. What does this mean for you as a potential buyer? Should you wait for prices to drop? If you do wait, does that mean you will sell your current home for less? What’s better? Should you enter the market now, hope to sell your house at the current high prices, knowing you will probably pay more for a new house than if you wait for prices to drop?
- In July 2006, a leading investment manager, Ken Heebner, reported to MarketWatch.com that he expected overheated markets to fall 25%. Are you in one of those markets? If so, should you try to sell now to get the most for your current home, then hang on to make a purchase later, after prices have fallen?
Whatever the reason you are buying, and regardless of the timing, buying a home will almost certainly stretch your financial resources to the limit. Although you may convince yourself that you can afford the slightly more expensive home, or that you will certainly get the raise or promotion that will offset the increased mortgage payments, the fact is that, except for a few downsizers who truly want to lower their monthly expenses, most buyers will increase their debt, their monthly expenses, and their nervousness.
Our guide to buying a home, whether a new home or an existing one, will help you avoid some of the common problems we see, and give you the confidence to negotiate the best deal possible. With the housing market turning a little softer in 2006, buyers should be in a better position to bargain with builders and sellers.
We examine the steps most buyers take when deciding to look for a new home. We assume most buyers will hire a realtor and finance the purchase with a loan. If you won’t be doing that, or are past that point, you can skip ahead to the part of the process you are at. In any event, use this information as a guide, talk to trusted friends and financial advisors, including lawyers and accountants.
You will note that we address both single family homes and condos. If you are interested in condos, you should read everything here. If you are only looking at single family homes, you can skip the materials pertaining to condos and town homes.
Market Observation: On June 12, 2006, Global Insight and National City Corporation released a major study called House Prices In America. It found that “71 metro areas, accounting for 39% of all single family housing value, were deemed to be extremely over-valued at that time ( March 31, 2006) This represents an increase from 64 markets, and 36 % of all single family market value, during the fourth quarter (of 2005).” “The coastal states of California and Florida continue to show the highest concentration of overvalued markets, accounting for 17 of the top 20.” Housing prices climbed 7.3% annually, the slowest rate since the third quarter of 2003. Among Washington markets, Seattle’s average selling price of $344,700 was considered to be 34.1% overvalued, where 34% overvalued is considered to be “extremely overvalued” by the report’s authors. Other overvalued Washington metro areas include Bellingham at 51%, Mt. Vernon at 45%, Olympia at 39%, and Longview at 36%. To put these numbers in perspective, the top 10 overvalued markets ranged from 72 – 102% overvalued.
In another article on June 13, 2006, MarketWatch.com reported on a Harvard study:
Climbing interest rates and cooling speculative demand is putting pressure on the housing boom, but as long as jobs continue to be created and builders curb production, the sector will experience a soft landing, according to Harvard’s Joint Center for Housing Studies.
On June 13, 2006, the Seattle Times reported that for the fifth consecutive month this year, new job creation slowed from the prior month. While the local economy is still creating jobs, the pace has slowed to its slowest pace in the past couple of years. This suggests that home price appreciation may begin to moderate, if not decline, as it has in other parts of the country. All of this should make for a more balanced market between buyers and sellers.
LEVY WARNING #1: No one involved in the process of selling you a home is your friend. Sellers, realtors, and lenders are in business to make money, some of which will come out of your pocket. Most realtors and lenders are dedicated and committed professionals, and will work endlessly to help you find the right home at the right price. But, finding them and using them appropriately is the key to a successful home search. If you and they make a mistake, you pay too much for the house, or finance more than you can afford, you and your family will be stuck with the problem. The realtors and lenders won’t offer to share the financial loss with you. If you keep this in mind, and that you cannot predict markets, you’ll be much better prepared for the process.
II. STATE LAWS OFFER VERY LITTLE PROTECTION TO HOMEOWNERS
LEVY WARNING #2: The law is not your friend. The law presumes if you can afford to buy a house, you can take care of yourself.
We start our analysis with a discussion of state laws because we think buyers have to understand the legal foundations of home buying. You may have heard the old adage, “Buyer beware”. That rule applies here and in all states to a great extent. What does it mean? The seller is not your friend or your protector.
- Sellers must disclose honestly only what the law requires them to disclose. In Washington, home sellers do not have to disclose anything.
- If buyers ask specific questions about a house, the sellers must avoid misleading answers.
To put this in context, if a seller knows his house was one of 50 built by the same builder and most of the others, but not his, suffered from roof failures and leaks, he has no duty to disclose this to a buyer. Similarly, if he knows that underground water floods the basement of his house once or twice a year, the law does not require him to disclose this.
In Washington, a separate realtor-provided form, known as Form 17, asks the seller a series of questions, including one about floods or leaks in the basement. The seller has to answer honestly or not at all. How does that work in the real world? Here are some examples:
- If the seller suspects his waterfront home flooded several years before he bought the house, but not since then, does he have to disclose that? Probably not, but he should.
- If the builder/seller knowingly left out a layer of building paper on the house, does he have to disclose that? It depends on the definition of defect. If it hasn’t shown up as a problem, he might say it’s not a defect. Besides, a builder doesn’t complete a seller disclosure statement, and has no duty to tell you how he built the house.
- If the approved plans called for ¾” plywood, but the builder or existing homeowner installed 5/8″ plywood, does he have to disclose that? Is it a defect, a code violation, or breach of contract? It may be a defect, if it violates a code, and it may be a breach of contract if the code is incorporated into the contract.
You would think that you could rely on the existence of building codes and building inspectors to protect you. All states have building codes, and building inspectors to enforce them. So why doesn’t this prevent sloppy construction practices? We think there are three primary reasons. First, municipal inspectors are simply overwhelmed by the volume of new homes built. They cannot keep up with the demand for inspections. Second, cities can’t find and train qualified inspectors to stay current with new building practices.
Third, building inspectors are responsible only for health and safety issues. Typically these include structural, electrical, mechanical, and sanitary systems. Once those systems are in place, the inspectors have no duty to check for proper waterproofing, or quality construction work. They do not inspect for proper installation of siding, roofing or windows. We have seen dozens of homes approved by inspectors despite clear evidence that the wood siding leaked so badly carpets and wood floors were soaked after every rain fall. Their response: these aren’t life and safety issues.
- According to a Consumer Reports article dated January 2004, “Housewrecked” 15% of all new homes are built with major defects.
Here are a few of the problems we have seen:
- 33 homes near Olympia, Washington were built with no foundation drainage, even though the plans required the builder to install pipes around the foundation to carry away sub surface moisture. Somehow, the city inspector missed this problem. Repairs cost $3000+ for each house.
- Another home was built in Bellevue, Washington without any form of building paper over the exterior plywood, no flashing around windows or doors, no caulk, no waterproofing, a roof with bare spots, roof drains that poured water directly into walls.
- One of my favorites was a high end custom home in an exclusive neighborhood in Seattle. When it was time to fill in the excavation hole at the front of the house, the builder ordered his foreman to gather all the plastic erosion control material and other construction debris, and dump it into the hole, then cover it with dirt and concrete, which he did. Every year thereafter the driveway cracked and pulled away from the house.
Even custom, high end remodeling projects suffer from builder and inspector incompetence. Here are a few such examples:
- Approved remodel plans required a builder to extend a foundation wall about 8 feet and to connect it with a new 32 foot long foundation wall. The builder built the short extension wall, but ran out of cement during the pour, so he added more water to extend the mix until it became so watery it ran out the bottom of the form. The builder omitted the 32 foot wall altogether. The inspector signed off on the work, apparently from the comfort of his car. The new owner discovered the problem and had to pay for the repairs himself.
- In a luxury remodel of a $1.5 million home, the builder took the downspouts from the roof and sunk them directly into the ground next to the house, a clear code violation. The house flooded every year. The builder also failed to bolt the wood framing to the foundation, another code violation. Fortunately, the house didn’t blow away. The inspector approved all the work. When the owner sued the contractor, the contractor argued that his contract with the buyer did not require him to comply with the building codes, so failing to do so was not a breach of contract.
First Buyers who buy homes from builders have only the rights provided in their contracts and very limited state law. We’ll start with basic terms of a new home purchase. Even when you are buying a home before it is finished, what you are contracting for is the purchase of real estate. The contract requires the builder to sell you the completed home. It is not a custom construction contract in which the builder agrees to build the house in accordance with the plans and specifications provided by your architect. In a contract for the sale of a new home, the builder agrees to sell you the property with the finished home, matching either the model home or simply as built.
Very seldom in these contracts will a builder represent to the buyer that it is complying with state or local building codes, industry standards, or other minimum levels of construction quality. In fact, builders have learned that is better to make no representations about the quality of the home. Basically, you take the home “as is” on the date of sale, with whatever limited repair promise the builder offers.
Do state laws provide any protection? Yes, but not much. When you buy a new home from a builder, you get what is called an implied warranty of habitability from the builder. This means the house is supposed to serve its purpose as a house, providing reasonable shelter for the occupants. Courts have interpreted this to require that homes should not collapse, that the occupants should be able to live safely in the house. But some courts have limited the warranty to catastrophic failure only. They have ruled that leaks, cracks, peeling paint, mold, dry rot, and collapsing decks do not violate the implied warranty of habitability as long as the occupants have been able to stay somewhere in the house. Taken to its extreme, as long as you have one safe room in the house, it may be habitable.
Where does the implied warranty come from? Not from your legislature. Courts have created this warranty to provide the least level of quality necessary to assure you the house will function as safe shelter. The reason the courts have had to create this implied warranty is that most states have done nothing to protect homebuyers. As discussed above, there are building codes, but buyers and homeowners cannot enforce them. Beyond the codes, most states offer no protection in their laws.
The implied warranty of habitability is all the protection you get in Washington. Aside from that, you have to look to your purchase contract with the builder, which we discuss below.
Second buyers have no rights at all. Consider the buyer who buys a one year old home from the first buyer, who left the state to take a new job. A year after that, the new owner discovers mold growing on his walls and ceiling. When he investigates the problem he finds that water has been leaking through gaps in the roof membrane. To fix the problem he has to take off the existing roof, remove the ceiling and walls, and possibly the floors as well. Is the builder liable? Not at all. Because he didn’t contract with the builder, the second owner has no rights.
What if you find that the roof and walls are starting to sag? You investigate and discover the architect undersized all the structural framing. You contact the city and the city orders you out of the house due to the risk of collapse. Clearly, the builder and architect violated the building codes. Can you force the builder and architect to comply with the building codes and repair the damage? Do you have any recourse against the builder or architect? No. Unless the house collapses and hurts you, you have no rights against them. You also have no right to enforce the building codes.
Can you hold the city inspector liable? We uncovered a case in which a city inspector had to perform 15-20 inspections a day, covering over 200 miles of driving. During a deposition, he admitted that when pressed for time he didn’t bother to get out of the car to do his inspections. Can he or the city be held liable? The short answer is “No.” Cities and their inspectors are immune from claims for negligent inspection.
Are there any laws protecting homeowners against shoddy construction? The only law in Washington is one that requires builders to provide a $12,000 bond for the benefit of laborers, subcontractors, and homeowners damaged by the builder’s failures. That may seem like a lot of money, but with the average Puget Sound area home costing $450,000, $12,000 isn’t much to spread around when a builder goes broke.
Perhaps you have heard that contractors have to be licensed? Well, that’s almost true. Washington builders are registered, not licensed. Washington law is very generous with builders. It only requires that they put up a bond, and buy an accident insurance policy, then register as a contractor. In other words, unlike hair stylists and manicurists, builders do not have to pass a test, or provide evidence of experience or expertise. ANYONE can be a registered contractor in Washington. It is easier to register as a contractor and qualify to build a new hospital in Washington than it is to get a barber’s license.
Surely there must be a remedy if you discover, as I did with my house, that the builder dropped a rusty old metal bed frame into newly poured cement to serve as my foundation. Surely Washington law will protect you in the event you find, as I did, that the builder built the new master bedroom over the existing deck, but didn’t bother to level the floors. Surely there must be a remedy if the same city that missed the original inspection now says the new owner must fix the problem. Sorry, but the answer is no. Apparently, during the course of our great state’s history, homeowners and buyers didn’t get much attention from their legislators.
The situation is actually worse than I describe it. For example, Washington law allows parties up to six years to sue to enforce a written contract. But, Washington law also allows parties to contract as they wish and to ignore the statute. Thus, builders today often require homeowners to limit their potential claims against builders to a maximum of one year. And nothing in Washington law prevents this.
Some builders go even further and force buyers to waive all rights directly against them. In hot markets such as in 2005-06, buyers have accepted these unconscionable terms. Even supposedly reputable organizations such as the Master Builders Association offer no standards for either home construction, or minimum warranties. In fact, the Masters Builders Association, which is truly comprised of some of the state’s best builders, lobby against any regulation of their industry, even if as a result they would force the bad builders out of business. Ladies and gentlemen, the State of Washington is not the homebuyer’s friend. It is truly a disgrace. For years many concerned legislators have tried to create protections for homebuyers, but every time they try, they get blasted by the construction industry, including builders, lenders, title companies, and realtors. As in Washington D.C., money talks. The building industry spends so much money lobbying state legislators, they refuse to do anything for the consumer.
So, in case you missed the gist of this discussion, and you need a synopsis of Washington law, let me reiterate that the law in the state of Washington treats homebuyers with the contempt apparently due to those without high paying lobbyists. Knowing this should help prepare you for the rest of our guide to home buying. Protect yourself with information and a healthy dose of skepticism, because no one else you are about to meet will protect you.
FIGURE OUT YOUR MAXIMUM PURCHASE PRICE (BEFORE YOU GO SHOPPING)
It seems almost too obvious that you should figure out how much you can afford before you begin the house-hunting process, but too many people look first, fall in love with a house or condo, then try to find the money to pay for it. Even before considering neighborhoods, bedrooms, schools, buildings or the hundreds of other factors that go into deciding which home to buy, first you have to look at the economics of purchasing the home. Here are just a few of the issues you need to consider:
- Cash available for downpayment. Remember, the more cash you put into the purchase, the less you have to finance. Here are a couple of simple examples assuming a conventional 30 year mortgage at 8%:
There are a couple of other financial issues to consider. If you leave an extra $40,000 in savings, at today’s money market rates of about 4.75%, you could earn $158 a month, or slightly more than half of the extra monthly payment. Even this math is deceiving. The interest you earn of $158 a month is taxable, which means you could be required to pay up to one-third of those earnings in tax. Alternatively, the extra interest you pay on the larger mortgage, approximately $300 a month, or $3600 a year, could save you as much as $1200 in taxes. So, assuming you can afford the extra monthly payment, and you have earned income, you may be better off with the higher loan.
Each buyer has to decide how much cash to use. If you are just starting out in your career, you may not have much cash available and you will have to finance 80-90% of the purchase price. But, if you are approaching retirement age, and you won’t have much earned income in the coming years, you may want to put more cash down and finance less. As long as the IRS lets us deduct interest payments, you may as well take advantage of the benefit while you can. In the 35% tax bracket, every one hundred dollars you pay in interest results in a reduction of thirty-five hundred dollars off your tax liability.
LEVY WARNING #3: No matter what, don’t plan on using all available cash for downpayments just to lower your payments. You’ll need cash to cover the costs of buying boxes, paying movers, painting the new house, and then treating yourself to the inevitable urge to buy new furniture after you conclude that your existing furniture just doesn’t work well with the new house. Here are a few estimates of various expenses you should anticipate:
- Cost of moving (local): $1000 per 1000 square feet of existing house
- Cost of painting: All walls and trim: $1000 – 1500 per 1000 sq. ft.
- New Carpeting: $10-15 per square yard, or $2000 – 3000 for 1800 sq. feet of carpet, a rough estimate for a $3000 sq. ft house.
- New furniture: the sky is the limit here, but figure you will spend at least $1000 per 1000 square feet of new space. If you are replacing all your furniture, you should figure at least $4000 per 1000 square feet of home. If the new house is larger than the existing house, you can count on spending $2000 per 1000 square feet of excess house size.
- Exterior maintenance and repairs: Even if the house is new, you will spend some money on landscaping, potted plants, new hoses, gardening tools, fresh paint, and a few other must haves. These will run from a few hundred to a few thousand dollars.
- Earnings available for monthly finance payments. Banks and other lenders used to say that your monthly home mortgage payment should not exceed 25% of your net monthly income. When interest rates went up and put many potential buyers out of the market, lenders relaxed their standards and raised the maximum percentage to as much as 40%. With rates near historical lows, but rising, lenders may again relax their standards and allow borrowers to raise their payments as a percentage of their income.
LEVY WARNING #4: Lenders are not your friends. They are in business to make the most money they can and one way to do so is to make the largest loan they can justify. Therefore, even if you have enough money to put down 40% cash, a lender may suggest a conventional 80% loan to value. Why? Because loan originators are typically paid a commission based on the size of the loans they write.
For example, if you are buying a $350,000 house and you borrow $300,000, you might pay a lender two points for the loan. If, however, you put 50% down, and borrowed only $175,000, the difference in fees to the lender would drop from $6000 to $3500. Just beware a mortgage broker’s suggestion that you borrow the most possible. He may be lining his own pocket rather than looking out for your interests.
- If you will need all of your monthly income to cover your mortgage and other recurring expenses, make sure you leave enough cash or other liquid assets to cover several months of routine expenses. Otherwise, you may get into the new house and find out your washer and dryer don’t fit, or you can’t get your grandma’s old sofa into the living room, and you are forced to buy new furniture you didn’t plan on buying.
- Don’t count on a possible year end bonus to cover all your possible expenses. The bonus may never materialize or may end up being less than you expected.
- Be careful borrowing money for your downpayment. For one thing, lenders want to see where all of your downpayment money came from, and they will not consider money borrowed for your downpayment as your money. If you do borrow from friends or family, be sure to put it in writing unless you are sure your private lender won’t ask for the money sooner than you plan on repaying it. If you borrow money from your in-laws, be especially careful. If either that relationship or your marriage turns sour, your in-laws could demand immediate repayment you can’t afford.
- Loan Types: There are now as many types of loan as there are types of houses. Lenders will get ever more creative to help buyers, especially during periods of rising home prices. The rising prices give lenders the same confidence buyers rely on to justify ever more expensive homes and mortgages. During declining prices, lenders will find more ways to limit loans or make them more costly. Here, we will discuss briefly several of the more typical loans available:
Conventional Loans: The most common is the thirty year loan, where monthly payments are comprised of principal and interest, amortized over the thirty years of the loan. Assuming the buyer stays in the house for thirty years, the loan would be fully paid off at the end of the loan period. In this type of loan, most lenders will require at least 10% down with a mortgage of 90%. Some veterans and low income families may qualify for 95% loans. Generally, the longer the loan period, the lower the monthly payments. As of June 11, 2006 30 year fixed rate loans are averaging about 6.25%, with a 1-2% loan fee.
15 Year Fixed Rate Loans. A 15 year loan works the same way as the 30 year loan, but the payments to retire the debt are amortized over 15 years rather than 30. This of course will increase the amount of monthly payments, however, typically 15 year loans have a lower interest rate. For example, the average 15 year rate is 6% with fees of 1-2%. Let’s see how a 15 year loan compares to a 30 year loan. We assume a purchase price of $200,000, with a 20% downpayment, and $160,000 mortgage:
|30 year loan||15 year loan|
Over the life of the loan, you will save $111,600 with the 15 year loan, before taking into account the benefits of deducting interest payments. Once you factor in the benefit of deducting the additional interest payments, the net difference could be as low as $72,500 (assuming a 35% income tax rate).
Adjustable Rate Loans, also known as ARMs. These loans are usually fixed for a period of one to five years, then adjust either up or down for the balance of the 30 year loan, depending on where rates are at the end of the fixed rate period. From that point until the end of the 30 years, the loans readjust every year.
One of the features of these loans is that the starting interest rates are usually lower than for 30 or even 15 year loans. For example as of June 11, 2006, lenders are offering 5 year ARMs ranging from 5.25 – 6%, depending on the points you pay. If the spread is great enough, and you are confident you will move before the end of the fixed rate period, you would save a significant amount of money over that period of time.
If, however, you have no plans to sell the house, ARMS involve a huge risk. For example, the typical ARM can adjust upward as much as 6% from the initial rate. So, let’s see what that would do to your monthly payments.
|Interest Rate||Monthly payment|
Obviously, the risk to the borrower is that your income won’t rise enough to cover the additional monthly payment. If you cannot afford the monthly payment, you may be forced into foreclosure. According to a story in the Seattle Times by Chicago Tribune writer, Becky Yerak, dated June 11, 2006, about one percent of loans typically go into foreclosure. Yerak points out that over the next 18 months $2.7 trillion in adjustable rate mortgages will adjust, and most likely to much higher interest rates. A 1 percent increase from 6 – 7% will raise the monthly payment $66.
Mortgage brokers are like middlemen everywhere. Their job is to find a loan they can sell to a lender. They will get as creative as they need to because they make money on packaging and selling loans to their favorite lenders. They may be very helpful in getting you into a house, but if the deal is risky, they may also be nudging you into the ranks of those whose homes have been foreclosed. REMEMBER: Mortgage brokers make money only when they make a new deal, whether it’s good for you or not.
- Interest only or Payment-Optional Loans. As property values rise, and fewer buyers qualify for conventional loans, loan brokers and lenders will propose interest only or payment optional loans. As to the first, interest only loans, these loans require fixed monthly payments of interest only on the principal amount of your loan. If it’s a ten year loan, you will pay interest for ten years and earn no equity on the house.
Lenders love to offer their Payment Optional loans. These deals permit borrowers to decide how much they want to pay, if at all, for some pre-determined period. Thus, for the first five years of the loan, you may have the option of paying nothing, paying some interest, or both interest and principal. The lenders will tell you that as your income rises, you can begin to increase your payments, including both principal and interest. What they don’t tell you is that if you don’t pay at least the interest on the principal each month, your outstanding principal balance will actually increase. This is called a negatively amortized loan. The amount of unpaid interest each month adds to the principal balance, thereby increasing the amount of your loan. You could easily end up owing far more at the end of the loan period than when you started.
Many borrowers chose these loans in 2004-2005 when home prices were rising quickly. The borrowers figured they would sell the homes within a short time and take the profit on the investment. In fact, many buyers were really quick flipping investors who planned to hold the homes for as little as three months, then sell them. But, some of last year’s hottest markets, including Miami, Southern California and Nevada, are this year’s losers., according to Bloomberg News writer John Wasik. In Washington, he identifies Bellingham and the Tri-Cities as having excessively high risk factors. At the very least, if you are looking at buying a home there as an investment, you better be sure you can afford the risk of holding the home, rather than flipping it.
LEVY WARNING #5: House flipping only works until the bubble bursts. Consider the costs of flipping a home at your original purchase price. Let’s say you buy a home for $500,000 and plan to flip it one year later. You put down 20%, and finance $400,000 at 6% on an interest only loan. In addition to your purchase price, you pay a 1% loan fee, or $4000, plus other closing costs, including insurance, recording fees, and insurance of $1500, for a total of $5500. Monthly mortgage payments run another $2000.
At the end of one year you will have spent not only the $5500 in closing costs, but another $24,000 in interest, for a total of $29,500. If you were lucky enough to rent it out for $1500 a month, your net out of pocket cost for the year has been $11,500. Now what happens if you put the house on the market and it doesn’t sell for another 6 months, and your ARM payment adjusts by 2% to an 8% annual rate. Your new monthly payments will be $2667. If you hold the house for another 6 months, then sell it for exactly $500,000, here’s what it really cost you:
|Initial purchase costs:||$5500|
|Costs of Ownership for 18 months:|
|Insurance for the last 6 months||$750|
|Landscaping and maintenance||$200 a month x 18 = $3600|
|Less income of||$18,000|
Selling costs: approximately 8%, including commissions and excise tax = $40,000.
Total Expenses and Net loss (excluding interest deduction) for 18 months: $66,350. (Excluding the value of the interest lost on the downpayment)
Now, let’s look at what happens if you take a 5% loss on the house, as is happening now in many U.S. markets.
Sales Price: $475,000
Selling Costs of 8% $38,000
Net Loss for the year: $93,350. (Excluding the value of the interest lost on the downpayment)
This analysis isn’t meant to discourage people from buying houses, but only to show that buying houses for investments is no guaranty of making a profit. If, as has been reported, between 25-40% of all home purchases in 2005 were for investment, rather than as primary residence for the buyers, then if and when those investor buyers decide to sell, some markets could be in for major declines in value.
III. BECOME AN EXPERT SHOPPER BEFORE
YOU HIRE A REAL ESTATE AGENT
Shopping for a home may be a little like shopping for a spouse. Everyone’s got an opinion of where you should look, what the best qualities are, looking carefully at the neighbors, and possibly, hiring a matchmaker. In the case of house hunting the matchmaker is the real estate agent. So, if you have decided to look for a house or a condo, you know the right neighborhoods and buildings, and you have figured out your maximum purchase price, what’s next?
Before you hire a real estate agent, do a little homework. Drive the neighborhoods, check pricing online through websites such as Zillow.com or HouseValues.com. The more information you gather ahead of time, the better off you’ll be. At a minimum, here are a few things you should know before you meet with a realtor:
- What’s the average price of a home in your target neighborhood?
- How many bedrooms does the typical house have?
- How many bathrooms does it have?
- What’s the average age of the home?
- What’s the typical style, i.e, craftsman, colonial, traditional, or modern/
- What’s the typical material used on houses in the neighborhood? stucco, brick or wood siding?
- What’s the reputation of the neighborhood?
- What schools would your kids go to?
If you are considering a condo, in 2006 and 2007 you will have an enormous and growing inventory to look at. All around the country we are seeing unprecedented condo development. What special factors go into selecting a condo?
- First and foremost, find out everything you can about the reputation of the developer. How many buildings has it built?
- How have the buildings held up over time?
- Have the buildings been in litigation because of construction defects
- Do they have views, and are the views likely to remain, or will future construction block your Million Dollar views?
- Are you buying in a joint condo/hotel project? If so, do you know which hotel operator will be there? What amenities will the hotel provide? Has the hotel operator signed an agreement yet, and is it contingent on a minimum number of sales of condo units?
- Can you see a comparable building by the same developer? If so, is it dark and tunnel-like, or does it receive adequate light?
- Who are the typical buyers? Are they your age group? Will you fit in or be isolated?
Why do we suggest getting all this information before meeting with a realtor? Because, unless you have great confidence that you can trust your chosen realtor, you should do most of your own homework rather than relying primarily on a realtor for advice. Go online to your realtor’s website and look at all the available houses and condos in your price range and neighborhood. The listings will tell you how long the houses or condos have been on the market and whether the home you want is still offered at its original listing price. Depending on the agent, and the extent of your homework, you may find yourself more knowledgeable about neighborhood values than your agent.
When you ask friends for a referral to an agent, make sure you talk to people who used an agent to buy a house, not just sell their existing homes. If you want a condo, ask for referrals to those agents who helped others buy their condos. Selling homes requires different skills and motivations than assisting buyers in buying a home. I remember when I bought my first house 26 years ago in the rainy northwest, my agent told me there was nothing wrong with a house that didn’t have a garage or a carport. Intuitively, that seemed like bad advice, but she assured me it would have no impact on resale value. About seven years later when I tried to sell it, every potential buyer walked away because it had no garage. Some people refused to walk in the door. 18 months later, I sold the house for a loss.
IV. WORKING WITH A REAL ESTATE AGENT
Some homebuyers will shop alone, while others will depend on a real estate agent. Some buyers meet their agents at open houses, others by asking friends for referrals. A good agent can be a huge help to you, while either an ignorant or self-serving agent can cost you tens of thousands, even hundreds of thousand of dollars with bad advice. What should you look for when working with an agent?
- Who is the agent working for? In Washington, an agent is presumed to work for the seller. When you go to an open house and you meet the agent, it will be obvious the agent is working for the seller. What if you go to a subdivision sales office or condo office and meet an agent? If that agent then goes with you to visit houses or other condos, is that agent working for you or the seller? The Seller.
- Seller’s Agent. A seller’s agent works solely for the benefit of the seller. And, unless the agent agrees to work solely as your agent, or as a dual agent, you should understand the agent is working strictly for the Seller. Thus, if you go to an open house and want to make an offer through the agent onsite, be aware that if you tell the agent you are willing to pay more than your offer price, the agent may tell the seller and destroy any chance of negotiating for your target price.
- Selling Agent’s Duty of Disclosure. A seller’s agent owes no loyalty to a buyer. An agent owes no duty of fairness to a buyer. For example, if a buyer tells an agent he wants to buy the house to remodel, and the agent knows that there are restrictions on the right of remodeling, the agent probably has no duty to tell the buyer. Further, if a buyer says the home looks like a bargain compared to other homes in the neighborhood, the agent has no duty to tell him the house is overvalued because of its proximity to a noisy neighbor.
- What if an agent suspects there is a boundary problem with the house, that the beautiful hedge and trees are really a neighbor’s? In Washington, unless the agent has actual knowledge, and unless the buyer asks specifically about the trees and hedge, the agent will not be liable for failing to disclose these facts to a buyer.
- What if the agent knows that kids use the backyard to go to and from school? Again, if the agent is working for the seller, and no one asks about this issue, the agent has no duty to disclose it. In fact, if the seller found out his or her agent disclosed something to the buyer that discouraged the buyer from buying or paying full price, the seller might have a claim against the agent for making an unauthorized disclosure.
- Dual Agents. A dual agent is one who works for both seller and buyer in the same transaction. Ask yourself whether an agent working for a seller, who wants the highest price possible for his or her house, can serve your interests in negotiating the purchase price for your new home. It would be similar to a husband asking his current spouse for an opinion about taking his secretary on an overnight business trip.If an agent offers to act as a dual agent, the agent must disclose this to both buyer and seller and both must sign an acknowledgement in writing. That form has been written not only to provide such notice to the parties, but also to absolve the agent of all responsibility should anything go wrong with the transaction. (Insert Form Language)
LEVY WARNING #6: Unless you have 100% confidence in using a seller’s agent as your own, just don’t do it. Get another agent to act as your agent, a true Buyer’s Agent, described below.
- Buyer’s Agent. A true buyer’s agent is one that represents only the buyer. Remember unless the agent agrees in writing to act as a buyer’s agent, the agent is a seller’s agent in the eyes of the law. So, if you really want the confidence that an agent is working just for you, ask him or her to serve in that capacity. If the agent doesn’t agree to do so, run, don’t walk, to another agent. (Insert Buyer Agent Language)
General Disclosure Requirement: Even buyers’ agents have no duty to disclose important facts unless they have actual knowledge of them. Thus, an agent’s concern about a boundary line or construction problem could remain her little secret if she doesn’t have actual knowledge of the problem. For example, if she suspected the house, or others in the neighborhood by the same builder, have had leaks, but she doesn’t confirm that, she would have no obligation to tell the buyer. If after the purchase, the buyer finds prior problems with moisture intrusion, the buyer could not pursue a claim against the agent for non disclosure. Of course, a good agent would share her concerns, suggest an expert to investigate, and steer you away from troubled properties.
Agent/Builder Relationships: If an agent is working with a homebuilder, you can take it to the bank that she will preserve her relationship with the builder, and all the future business she can do for him, rather than jeopardize that relationship for a one time deal with a buyer. There is nothing wrong with an agent working for a builder, but you should know that the agent’s loyalty will strongly favor the seller.
LEVY WARNING #7: Don’t jump to make a quick offer because your agent tells you it’s a hot market, and you’ll lose the house. I have never known a time, despite several recessions, and several building booms, that agents have described every moment in time as the right time to buy. Even in the worst seller’s market, pushy agents will tell you time is working against you, that you have to make your move quickly before someone else snatches the house out of your hands. In a very hot market, that may be true. But, even today in Washington’s red – hot housing market, in certain price ranges there is no extreme urgency.
Other warnings about Agent Advice:
- There is no room to negotiate: We often hear that sellers just won’t negotiate, that they won’t discount the asking price. Some agents tell their customers not to “insult” the sellers with anything other than full price offers. Only in the hottest markets do buyers have to make full price offers. Even there, most sellers expect some discount. You should know before you look at the first house what kind of market you’re in. Otherwise, you may be a sucker for an agent’s dire warning.
- Waive the Inspection Contingency. This is like asking the buyer to step barefoot on broken glass. You know it’s going to hurt. Unless you plan to bulldoze the house and rebuild, you can’t afford to waive the inspection. If an agent tells you to waive this contingency, you should consider finding a new agent. Believe it or not, throughout most of 2005 and so far this year, many agents recommended to buyers that they waive the contingency if they wanted any chance of buying hotly contested homes. As you will learn below, that is a risk very few buyers can afford to take. If your agent insists, ask the agent to indemnify you against any losses. You can be sure no agent will accept this demand.
- We are not your Lawyer, but you don’t need a lawyer: When it comes time to write up an offer, be aware that real estate agents are not and cannot act as your lawyer. If the deal is complicated you should not rely on your real estate agent to advise you. A good agent will tell you he can’t act as your lawyer, and will recommend you hire a lawyer to review the deal, before you submit it to the seller. If you don’t understand the terms of the offer, you probably need help.
Attributes of a GREAT Agent. Having had several agents of my own, and worked with dozens more for clients over 25 years, I will share my thoughts on what makes a great agent:
- Discretion. Before I hire an agent I ask whether the agent can be totally discrete. I insist on 100% confidence, integrity and discretion. I insist the agent promise not to discuss any aspect of my house search with anyone else. I demand that they promise not to share a single thought about her role in representing me with anyone else.
- Why is this important? Because too often I have learned that well intended, but loose lipped agents sometimes share my goals with sellers’ agents, who then use that information to inform the sellers. Once they have that information, I may lose important bargaining power I thought I had.
- Intelligence. I want the smartest agent I can find, someone who understands the intricacies of the business, someone who studies the market, studies the law, and understands her colleagues. I want her to teach me something about the process I don’t understand.
- Knowledge of the market. This is so crucial I can’t stress it enough. I have met agents who have told me that a house was undervalued and a great buy, when even a newcomer to the area could figure out that a house was way overpriced. You have to have an agent who knows the local market. If there are no condos in your area, you can’t choose a local agent to shop for a condo. Conversely, if your agent knows only the downtown condo market, don’t ask her to show you suburban houses. I want an agent who knows everything about my market goals.
- Respect of her Colleagues. It is important to have an agent who is respected. Usually, if your agent has the other attributes listed above, she will also have earned the respect of her colleagues. This will minimize the temptation of one agent to take advantage of your agent.
- A long term view of the relationship. A great agent thinks about every aspect of the house you are considering buying. She will ask how long you expect to be there, what your financial situation is likely to be in 5, 10, 20 years. A great agent wants to be sure you can afford the house. Even if you say you want to be there for 20 years, she will think about whether the house will have good resale qualities in 7-10 years. She knows how important it is that you not lose money by overpaying for the house to satisfy your impatience.
- An ability to confront her buyer and say “NO.” A great agent stands between her buyer and the house the buyer cannot afford, and says “NO.” If your agent doesn’t do that, she isn’t worth having.
- Integrity. I want an agent who would rather sell me a less expensive house that is right for me, and make less money, but earn my gratitude and loyalty.
V. BUYING THE HOUSE
We break this discussion into two parts: (1) buying a new house from a commercial builder, and (2) buying an existing house from a private seller.
Buying from a commercial builder: When you buy from a builder, you will not write up an offer. The builder will present you with a purchase contract, using the builder’s form. In a seller’s market, you will have very little, if any, bargaining power. The builder will present the form on a take it or leave basis. The contract will be very one sided, as discussed in more detail below. Before you proceed with this builder, you should gather as much information as you can about it. Start with a review of the builder’s website, go to Google and Yahoo and search other public records to find out what you can. Ask the builder for references. If you get them, call them. The most important thing is to find out how the builder has handled problems. Does he truly stand behind his product, your home, or does he ignore you once he has sold the house?
In a buyer’s market, or at least a balanced market, such as we had a few years ago, you may be able to bargain. For one thing, you may be able to ask for certain upgrades at the seller’s expense, depending on the stage of construction at the time you approach the seller. Perhaps he can add landscaping or upgrade appliances. If he has been sitting on the house for several months, you may be able to extract a compromise on the price, and possibly on some of the limitations in the contract.
To start with, the builder’s standard contract will provide you with virtually no protection or benefits. It is so one-sided that no one should ever sign one. Here are some sample contract terms from builders:
- If any defective materials and workmanship appear within a period of one year from the date of final completion of the residence, at Contractor’s option, Contractor shall either repair or replace such defects or pay the owner the cost of repair or replacement of such defects.
- This term is intended to limit the builder’s obligation to repair problems for a total of one year. If you discover a problem, even if it was hidden and undiscoverable, on the 366 th day after you purchased the home, the builders will tell you they have no obligation to fix it.
- CONTRACTOR WARRANTS WORKMANSHIP AND MATERIALS TO BE FREE FROM DEFECTS FOR A PERIOD OF ONE YEAR FROM COMPLETION OF THE RESIDENCE. THE FOREGOING WARRANTY IS IN LIEU OF ALL OTHER WARRANTIES, EXPRESSED OR IMPLIED. CONTRACTOR SHALL NOT BE LIABLE UNDER ANY CIRCUMSTANCES FOR ANY CONSEQUENTIAL OROTHER DAMAGES ARISING ON ACCOUNT OF SUCH DEFECTS OR CONTRACTOR’S WORK AND THE REMEDIES HEREIN ARE EXPRESSLY AGREED TO BE EXCLUSIVE.
- This waiver is intended to eliminate your only protection, the implied warranty of habitability. But it’s worse than that. It is intended also to eliminate any claim you might have for damages caused by the defects. For example, if the builder used defective lumber to support the roof, and the roof collapses and damages other parts of the house and its furnishings, you would have no right to make a claim against the builder.
- BUYER HEREBY AGREES THAT ANY AND ALL CLAIMS AGAINST THE CONTRACTOR MUST ARISE DURING AND BE BROUGHT WITHIN ONE YEAR OF COMPLETION OF THE HOME. THIS PERIOD OF LIMITATIONS IS INTENDED TO REPLACE ANY AND ALL STATE LAW LIMITATIONS PERIOD. BUYER ACCEPTS THIS PERIOD OF LIMITATION AND AGREES THAT SELLER WOULD NOT PROCEED WITH THIS SALE ABSENT BUYER’S AGREEMENT.
According to Washington law, you have six years from the completion of work to sue your contractor for a breach of contract. In the example above, the seller is clearly trying to limit the buyer to both discover defects and to bring a claim within one year, or he loses all his rights. Nothing in Washington law prohibits the builders from limiting your rights.
Home Warranty Policies. Many builders now require, that is, they force buyers to accept what they politely call warranty programs provided by third parties. These programs are a toxic cocktail of deception. Even realtors want you to acknowledge on their forms that such warranties are available, as though they offer meaningful protection to buyers. In some cases, the builders charge the buyers for this third party warranty, and refuse to sell to any buyer who won’t accept it. In fact, it is a giant fraud on the buyers.
When some of our clients bought their first homes from a developer, they were informed that as an added benefit, the developer was giving them a ten year warranty provided by a major warranty company. Let’s call it Big Fat Warranty Company, or BFWC. In fact, the very limited warranty was a boilerplate form presented to the buyer on a take it or leave basis. Our clients could not buy the houses without signing the warranty. So what’s the big deal? By signing the warranty, the buyers accepted the BFWC definition of construction standards, agreed to look only to BFWC to solve all complaints about the houses, and gave up all rights to sue the builder for breach of contract or construction defects. To notify BFWC of any claim or defect, our clients had to send a non refundable check for $250. These warranty programs are a giant money making machine masquerading as a warranty. For example:
- The first thing it does is establish what a defect is. For example, it says that cracks in sheetrock and stucco are normal, that only larger cracks are considered defective. Water leaks through the exterior siding that don’t cause any obvious damage are not considered defects. Ask yourself whether those are reasonable standards when you are buying a new house for an average price in Washington of $450,000.
- Although the warranty is packaged as a ten year protection warranty, the only thing covered in any way for ten years is a complete structural failure. To qualify, the house has to collapse. If the house is standing, no matter how weakly, the warranty doesn’t apply.
- If the buyer wants to lodge a defect claim against the builder, he has to submit a payment of $250 per claim to BFWC. The only effect of doing so is to notify BFWC of the claim. After that, when the builder ignores or disputes the claim, the buyer has to put up another $250 per claim to submit an “unresolved warranty claim” to arbitration.
- When the builder and BFWC still refuse to process the claim, you have to send additional funds to pay for an BFWC arbitrator. Even if you win the arbitration, which is highly unlikely, you still aren’t entitled to payment. BFWC processes the arbitrator’s award by seeking to obtain the builder’s compliance with the award. Meanwhile, the defect continues, and you keep pouring money down the sewer.
There is another problem that builders won’t mention when they force you to take these third party warranties. What happens to your warranty if the company who writes it goes out of business? The warranty providers are not true insurers who have to register with the state and qualify to do business as insurers. That ought to tell you something about the sincerity of the program. Instead, if the warranty company goes out of business, you lose completely. The warranty you sign says you waive all rights to bring a direct claim against the builder. Now, you are truly alone with the problem.
Finally, I would ask any builder to prove to you that he has given up all rights against his own builder and substituted the useless “limited warranty”. I doubt you’ll find any.
Buying from a private seller: When you buy from a private seller, you can, to some extent, control the process. You will write up an offer and present it to the seller. By the time you are ready to write up an offer, you should be excited and nervous, but also reasonably confident. Now, what are the usual terms? In Western Washington, you will almost certainly use the Puget Sound Multiple Listing Association Purchase and Sale Agreement. What you must understand as soon as you sign your name to the agreement is that you are making a legally binding offer to buy the house. Depending on the terms of the deal, if the seller accepts your offer, you have a completed contract. So, be sure you have all the terms in the agreement you want, and none that you don’t want. The typical Agreement will contain these basic terms:
- The purchase price
- Earnest Money, the good faith payment to show your interest in the property
- Offer Expiration Date
- A closing date
- Legal description of the property
- Inspection contingency and time to complete the inspection
- Neighborhood review and time to waive or approve the review
- Title inspection contingency and time to inspect title and waive contingency
- Contingency for sale of the buyer’s existing home
- Financing Contingency with deadline for applying and waiving contingency
- Forefeiture clause if the buyer fails to complete the agreed transaction. Typically, this will be the earnest money.
- Identification of appliances and other items included in the sale
Of course, there are many other possible terms you might add to the agreement. Remember, if you want the custom chandelier marked “not included” during your walk through of the house, you have to include it in your offer agreement.
You should determine what your non-negotiable terms are, before you walk into the agent’s office to write the offer. For example, if you have to sell your home before you can close on the new one, then your purchase offer must clearly be contingent on selling your existing home. To make this a meaningful term, you have to put an outside date into the agreement for the closing of the first sale. In a strong market, maybe it should be 2-3 months. In a weak market, give yourself enough time to sell the house. If it doesn’t sell by the agreed date, the purchase and sale agreement will terminate. Again, in a weak market, the seller may actually want to give you more time if there is no other buyer on the horizon.
Default and Forfeiture of the Earnest Money:
This is an important term, and one that buyers often misunderstand. The common Washington form says the buyer’s money will be deposited in an interest bearing account for the buyer’s benefit. The Default term requires the buyer to check one of two boxes indicating the remedy upon the buyer’s default:
Foreiture of earnest money, or Seller’s election of Remedies
If the buyer checks Forfeiture of earnest money, the agreement says:
if the buyer fails without legal excuse to complete the purchase of the Property, buyer forfeits to the seller that portion of the earnest money that does not exceed 5% of the Purchase Price, and this forefeiture will be the seller’s sole remedy
If the buyer checks Seller’s Election of Remedies, the agreement provides that
Seller may, at Seller’s option, (a)keep the Earnest Money as liquidated damages as the sole and exclusive remedy available to Seller for such failure, (b)bring suit against Buyer for Seller’s actual damages, (c) bring suit to specifically enforce this Agreement and recover any incidental damages, or (d) pursue any other rights or remedies available at law or equity.
The importance of the distinction in the two remedies cannot be overstated. If the buyer checks the forfeiture box, and the buyer defaults without legal justification, he will lose the earnest money. In a typical $450,000 purchase, the average for Bellevue, Washington today, the earnest money is likely to be at least $20,000. If the buyer checks the other box, the seller will have the right to choose his remedy. He could keep the earnest money, then put the house back on the market. He could sue for actual damages. In a declining market, those damages could be enormous.
For example, if the original agreement is for $450,000, and the buyer defaults, the seller could recover the difference between $450,000 and the actual and eventual sales price, regardless of how low it goes.
Buying Condos and Townhomes
In addition to everything else you should do as part of your investigation into buying a single family home, with condos and townhouses you have more homework to do before making an offer on a unit. I’ll start by telling you how developers build condos.
On any given Sunday, if you open the local newspaper in a major city, you will find full page ads for condos and townhomes for sale. In many cases, the developers will promote themselves and their experiences. But, look carefully at the end and you will rarely find the true owner of the property. This is because most developers set up individual limited liability companies, LLCs, to own and develop each condo project. Sometimes, a big developer will have several projects going on at once, but each project has its own name and is usually owned by a different LLC. Sometimes they are as simple as BIG DEVELOPMENT PROJECT I, II, or III. If the first one fails, it will have no impact on the others. Similarly, if the first one is a huge success, but the second and third are busts, the assets of the first project will not be available to creditors of the second and third projects.
There are other unique problems with condos and townhomes. Unlike apartments or hotels, when developers build condos they don’t plan to keep them. Rather, developers build them solely for sale at the highest price they can obtain. Any problems with construction will fall to the condo association the developer sets up at the beginning of the project. As the developer sells the units, he applies a certain amount of each sale to satisfy the lender, then keeps the other as profit. But, by the end of the last sale, he will have emptied the LLC bank account and distributed the profits to the shareholders asap. Why? In case of claims or lawsuits the association or individual buyers may file later, the developer and his LLC will have no assets with which to satisfy the claims. In effect, the developer wants to make his business as risk free of lawsuits as possible, but not by building better buildings, but rather, by constantly draining the business of assets to remove them as a source of recovery for an unhappy customer.
Recently, we found a builder who had developed 5 individual condo projects, and at the time of looking at the fifth project, we discovered the prior four had suffered from water damage that lead to lawsuits. We also found an interesting disclosure statement he provided every prospective buyer. It read something like this:
During construction we employed an engineer to observe the work. The engineer documented many leaks from the roof, windows and siding materials. We attempted to find and correct the causes of those leaks, but we have no confidence that we succeeded.
Following construction, we observed evidence of continuing water infiltration. Again, we tried to find and stop the water from getting in, but until the next rainy season we won’t know for sure. In the interest of full disclosure, we want you to know that 28 out of 40 units were affected by water intrusion. Floors got wet, ceilings and walls dripped, and sheetrock was damaged. We are offering these units for sale now, but make no representations that we have corrected the problems or removed all the damage. In fact, you should presume that you will find more damage later.
Finally, while we have insurance, we want you to know that from past experience with our projects, our insurer will probably reject any claims we make due to defective construction. You should assume that if any problems occur requiring repairs, you and your association will have to make the repairs on your own, both because we probably won’t have insurance, and because we do not keep any cash or assets in this business. Upon the last sale of these units, it is our intention to terminate this LLC and distribute all assets to investors. We will then legally dissolve the LLC, which will further reduce your chances of recovering from us. Basically, if you proceed with purchasing one of our leaky but expensive units, you should expect to suffer from ongoing water damage and the costs of repairing it along with your fellow suckers who bought this leaky pile of sticks and stones.
Finally, with respect to condos, you have to distinguish between buying an existing unit or one in a new building. We’ll start with a new building.
If the building is new, and the unit you are interested in has been completed, you will be given a disclosure statement and public offering statement, probably totaling 75-100 pages of legal confusion. Basically, these are statutory documents required to inform you about the development of the building, its bylaws, management and probable cost structure. As we discussed above, you should have already
Typically, the seller pays for a standard title insurance policy. This policy provides minimal protection to the buyer that the seller was in fact the owner, that the seller can convey legal title to the buyer, and that at the time of closing the buyer will own the property free and clear of title problems. Of course, if he borrows money from a lender the lender will have a mortgage interest in the property.
There are times we recommend that buyers obtain a broader form of title insurance called extended coverage. This policy costs more money, and the buyer will have to pick up the additional cost. When should you buy extended coverage? We recommend it whenever there are questions about the boundaries of the property, possible encroachments or claims by neighbors to portions of the property, or when you may be considering expansion of the house and you have to have a professional survey. The extended coverage will protect you against unrecorded claims against the property, whether by the neighbors who built a wall years ago on your property, or by the seller’s contractor who may file a lien against the property after your sale closes.
We also recommend that all waterfront buyers obtain extended coverage. In Puget Sound we have seen cases where dozens of homes were staked out years ago from an incorrect starting point. Each of the homes was placed several feet to the north of the true boundary line. Well, you may ask, if they are all off, what difference does it make? If a new buyer moves in, obtains a new survey, and sees that his neighbor’s patio extends three feet onto his property, it may make a great deal of difference to his remodeling plans. In fact, we know of a case where a buyer begin installing a retaining wall along what he assumed was his northern property line, when the neighbor came out and showed him that the actual line was three feet to the south. This had the effect of reducing the buyer’s property from 60 to 57 feet. At a current value of $50,000 a lineal foot for Mercer Island waterfront property, that became a significant issue.
Title Insurance for Condos: For a change, title insurance for condos is a little simpler. You aren’t so much concerned about boundary lines than you are about home owner association dues and other expenses of common ownership.
Probably the most crucial term is the inspection contingency. Here’s how it works. The buyer makes an offer to purchase the home contingent on his satisfaction with the inspection. The standard form agreement says that the inspection contingency is automatically deemed “Satisfied” unless the buyer disapproves of the house within 10 days of mutual acceptance of the offer. Within that 10 day period the buyer has to find an inspector, get the house inspected, and obtain a written report from the inspector.
The inspector should look at all operating systems of the house, including plumbing electrical, heating, air conditioning, windows, floors, appliances, roof, siding and foundation. A good inspector should spend at least 3 hours for a typical home and charge approximately $300. For a more expensive home, we would expect the inspection could take between 4-8 hours. What should he look for?
Evidence of Good Construction:
- Where visible, signs of good framing practices, the use of positive connections between studs and joists (alternatively, be suspicious of framing that is only nailed together without use of brackets)
- Level floors that don’t creak
- Ceilings and walls without cracks (here, a good inspector will look for evidence the seller has painted over cracks in an effort to hide them)
- Concrete foundation walls that show no signs of distress, cracking, tilting or excessive air pockets
- There should be threaded steel rods coming up through foundation walls, and bolted through wood plates on top of the concrete
- Walls should be plumb and square, meaning they are vertical, without slope
- The roof should be in shape to last another 10 years, should show that it was installed properly and has no signs of deterioration or leaks.
- A good inspector can see whether the roof has been patched before.
- Look for penetrations through the walls of the house, also called parapet walls. Often there are scuppers, drain collection boxes, that are cut through the parapet walls to allow for roof drainage. These are often a source of leaks.
- If the roof is made of concrete or clay tiles, look for evidence of breaks or missing tiles.
- Check the conditions of the siding, whether vertical or horizontal wood, brick, stucco or EIFS (synthetic stucco applied over foam panels)
- Look for evidence of water intrusion, bowed or swollen wood panels, staining, cracks in stucco.
- In wood siding, check for evidence of soft or decayed wood.
- In stucco, look for horizontal and vertical lines, called control and expansion joints. These help prevent undue cracking.
- In brick siding, check for look bricks. If tapping on them produces a dull or hollow sound, they may be loose, meaning the grout joints and cement has separated
Windows and Doors:
- These are areas of possible leaks. Where you have wood window frames, check for soft or decayed wood, especially at the window sills and the vertical pieces that adjoin the sills. If they have absorbed water from the bottom, often there will be decay that will worsen over time.
- Door thresholds often show evidence of water infiltration. If you step on a wood threshold and it feels soft, it has probably begun to decay.
- Both windows and doors should reveal a piece of metal flashing above them, at the heads. These run under the siding and over the window head to shed water that might have found its way behind the siding.
- Check that the windows and doors open easily.
- Check that they are all operating properly, that there are no gas leaks, loose or missing parts, bare wires, or obvious faults. You don’t want to find out a month after you buy that you have to replace a stove or refrigerator.
- This is so important that we recommend bringing in a heating specialist. If you are buying during the summer and the heating system is off, it will be very difficult to check it adequately. Only a heating contractor can tell you what to look for.
Review the Seller’s Disclosure Statement:
To protect themselves, the real estate industry requires sellers of existing homes to fill out a form called a Seller Disclosure Statement. This form is intended to force sellers to disclose all pertinent information that a prospective buyer would want to know before buying. The key points in a disclosure statement include:
A preamble that says:
- The seller makes disclosures of existing material facts or material defects to buyer based on seller’s actual knowledge of the property at the time seller completes this disclosure statement.
- The Buyer has 3 days from receipt of the disclosure to rescind the purchase agreement.
- The disclosures are made by seller, not the real estate agent.
- The information is for disclosure only and is not intended to be part of any written agreement between buyer and seller.
- Whether seller has the right and legal authority to sell the property.
- Source of water for the house.
- Whether the house is on a sewer or septic system.
- Information about belonging to a homeowner’s association.
- Covenants, conditions and restrictions that may affect the buyer’s right to remodel, height limitations, view easements, road maintenance agreements, architectural review boards, even whether you can park your boat on the street.
- Homeowner’s dues.
- Leased equipment (such as water heaters owned by the gas company).
- Challenges to the boundary lines, such as a neighbor’s continual use of a portion of the seller’s property, an encroaching patio or driveway, a misplaced fence
- Defects affecting major components of the house.
- Drainage problems, fire, wind, flood earthquake or other property damage.
- Contamination by toxic or dangerous substances.
Caution: As indicated above, the disclosure statement requires the seller to disclose information as of the date of completing the form. If prior to putting the house on the market, a seller discovered a roof leak, but hired a contractor to repair it, would the seller have to disclose the prior leak? If the sellers have repaired it to the best of their knowledge, there would no longer be a defect to report. The seller will have no liability even if shortly after the sale closes the buyer finds the roof repair was done with tissue paper. Assuming the seller had no knowledge of the improper repair, he is not liable for misrepresenting the condition.
If the seller is a hands-on home repairman, and he undertook certain repairs himself, then any inadequacies in the repairs could create some liability. Again, if he performed the repairs in good faith, thinking he had corrected the defect, he will have no liability. The difficulty comes in proving that he or his contractor truly corrected the defect, or just covered it up.
LEVY WARNING #8: We litigated a case where the seller hired a contractor to repair a number of leaks at the roof, decks, and around windows.Either the repairman was incompetent, or the seller told him to the work as cheaply as possible to get it ready for resale. Rotten wood was left in the walls to continue decaying; decks were left with decayed support beams; leaks in roofs were covered over with globs of tar, while the water was trapped underneath. We sued the seller for falsely representing the condition of the house, but to prove the case we had to show that he knew the repairs were inadequate and that the conditions were still defective at the time of sale. This is very expensive litigation to pursue and is only rarely successful.
You might think that the Seller Disclosure Statement would be part of the purchase and sale agreement, but no. The realtors and their attorneys who drafted the forms specifically exclude the statement from the official purchase and sale agreement. Why? We think it is to protect the realtors from liability, not to help the buyers. By excluding it from the sales agreement, the realtors never acknowledge its existence or significance. They don’t sign or initial the Disclosure Statement and it isn’t even included in the package of escrow papers or lender’s documents. In fact, once the deal closes, the law presumes the disclosure statement becomes a non entity, moot. We think this is intended to prevent lawsuits based on buyer claims of seller and realtor misrepresentation.
What can you do about it? You could insist on adding the Disclosure Statement as one of the documents included in the purchase and sale agreement. That way, if you ever discover a material non disclosure or misrepresentation, you could claim the seller breached the agreement. If you prove that, you would be entitled to recover contract damages, plus attorney’s fees and costs. If the disclosure statement is not considered part of the contract documents, you would have to sue for fraud, and you would not be entitled to attorney’s fees even if you win.
Hiring an Inspector:
The typical homebuyer probably doesn’t know of a good inspector, so usually his agent will suggest one. While this may work out just fine, we urge you to look for an inspector with no ties to realtors, one who can be brutally honest about a home’s condition. If he isn’t dependent on realtors for his inspection work, he won’t worry about the effects of his report on future business. We have encountered some realtors who have discouraged use of specialty inspectors who, they feared, would find problems that would discourage the buyers from proceeding. The best realtors will insist on special inspections to give their clients the best information possible, both to use in negotiations and to prepare them for unforeseen costs. Less knowledgeable realtors anxious to do the deal may ignore the best interests of their clients by wanting to hire “yes men” inspectors.
The Inspection Agreement:
The typical agreement that inspectors want you to sign will say the following:
Our inspectors are not engineers or architects, but are experienced in conducting home inspections. You may want to hire engineers or other professionals to make more thorough and technical evaluations.
Our building inspection is limited in time and scope (2-3 hours) and is essentially visual. The inspector and our report cover only what was observed visually at the time of the inspection. We can’t see everything, and we accept no responsibility for things we can’t see.
NO WARRANTIES OR GUARANTEES ARE EXPRESSED OR IMPLIED. WE DO NOT CLAIM, WARRANT, REPRESENT OR INSURE THAT ALL DEFECTS IN THE BUILDING WILL BE OBSERVED OR COMMENTED UPON, AND IN ANY CASE YOUR SOLE REMEDY AGAINST US IS LIMITED TO THE AMOUNT OF OUR FEE
Here are a few of the problems that were easily visible that inspectors missed:
- Bare wires hanging throughout crawl spaces and attics that should have been run in conduit piping
- Framing visible in crawl spaces showing undersized framing, such as 2×2 instead of 2×4 studs
- Mold covering the bottom of a floor
- Roof vents intended to allow air flow through the roof but blocked by plywood
- Window frames so badly decayed (but freshly painted over) that the windows had to be replaced
- A torch down roof with hundreds of gallons pooled under the membrane
- A roof that funneled most of the rain runoff behind the stucco siding instead of into the downspout
- Toilet waste lines so badly clogged with tree roots that within 2 weeks of the sale the buyers had to pay thousands to tear up floors and patios to install new pipes
These are just a few of the problems we have seen from clients. Surprisingly, many of the problems involve new construction, not older homes. It seems that every time we have a strong housing market, the quality of work declines, possibly because builders cannot find quality experienced tradesmen. Whatever the true reason, it is clear that buyers take big risks when they skip the inspection process, or hire realtor-recommended “yes men” to inspect the homes.
What should you do if your inspector presents you with a form that absolves him of all liability for damages? We suggest you look for another inspector that will stand behind his work.
Buying a condo or townhouse is similar, yet different from buying a home. We’ll start with a new building.
Inspecting Condos and Townhouses | Here are a few of the issues to consider:
- Is the building under construction, or has it been completed? If under construction, what part of it will the developer let you inspect?
- If the building has been completed, will your inspector see only your individual unit? What can you see inside that unit? What should you want to see?
- Because as a condo owner you will be buying not only your unit but also a proportional share of all the common areas of the building, including entry way, hallways, recreational or meeting rooms, room, garage, and parking areas, you should be interested in the entire building.
- What are the acoustics of the building? We represented a buyer/owner of a penthouse unit. For three years she suffered with horrible noise and vibration problems caused by the rooftop air conditioning and mechanical equipment immediately above her bedroom. All night the equipment came on and off, and each time the fan motors started, the entire unit shook. The condo association refused to spend any money to fix it, and eventually the owner sold it to get away from the problems.
- What is the quality of noise separation between side to side units? In one case, a client complained that she could hear every amorous sound as well as argument coming from her next door neighbor. As it happened, the master bedrooms backed up to each other, with only a cheap sheetrock wall separating them.
- Is there a model unit to look at? Will your unit be finished the same way or will you get a chance to make your own modifications? Do you finish it yourself, or does the developer do that? Seattle developers of condo/hotels build the shell, then sell you the empty shell for as much as $2000 per square foot, and you still have to pay to finish it.
If the building isn’t new, you will want your inspector to research the history of the building for prior problems and leaks. Not only will you want the seller’s disclosure statement, but copies of meeting minutes of the condo association to determine whether they have had to deal with leaks or other defects. If one of your motives for buying a condo is to reduce the headaches of home ownership, you may be sadly mistaken. Ask the thousands of Seattle, Portland, and Vancouver, B.C., condo owners whose buildings have been wrapped in plastic while the owners pay to repair the damaged buildings.
- At a minimum, you will want to investigate the developer’s history, whether he or one of his companies has been sued before, whether he settled the lawsuit, and what, if anything, he has done to change his construction methods.
Even if you aren’t looking for a condo, it would be impossible to miss all the condo development in nearly every metropolitan area. The newspapers are full of color ads proclaiming the qualities of maintenance-free condo life. When asked about prior construction problems with condos, the sales reps will tell you that they have learned their lessons and have incorporated all the latest building technology into their condos. Here is an example of a building in Bellevue, Washington that is undergoing its second exterior repair due to poor quality workmanship.
Presenting the Inspection Report to Sellers:
Let’s assume you have found a good inspector and you now have an inspection report that reveals several possibly expensive problems, such as a short term roof, water leaks in the basement, and windows that won’t open? Your choice is to ignore the problems in the report and proceed with the purchase, or to disapprove the inspection, and see what the seller will do to correct the defects.
The seller can either agree to make or pay for all of the repairs, some of the repairs, or none of them. If the seller refuses to make all of the repairs, the next move is up to the buyer, who can terminate the deal or waive the inspection at that point. He can also negotiate with the seller to correct some of the problems and to seek monetary compensation for others. The important point is that the buyer must ackt quickly to preserve his rights both to terminate and to proceed with the deal.
What should you do? Before proceeding, you should have a contractor or qualified repair person estimate the various costs involved in correcting the problems. Ask for firm bids so if you decide to proceed with the purchase you will know what it is likely to cost you to make the repairs.
If your report reveals a major defect, one that the seller will have to resolve whether he sells to you or to the next buyer, you should have some bargaining power. If the defects are relatively small, and the seller refuses to repair them or compensate you, you will have to decide whether to take the house and those costs at your expense.
One advantage of providing the seller with a copy of the report, with its evidence of defects, is that the report gives him actual knowledge of the defects, which he must disclose to all potential buyers. Thus, once you’ve pushed that button, the seller has to deal with it, either by fixing it or disclosing it to all buyers. Once the seller has actual knowledge of a defect, he has a legal duty to disclose it. That may be all the incentive he needs to take on the expense of fixing it himself. The buyer could also ask for a discount equal to the probable cost of repairs.
LEVY WARNING #9: In one case, a buyer presented evidence of a missing foundation wall. The buyer asked the seller to pay for the cost of installing the wall, as well as several other deficiencies. The seller refused to fix the wall, but agreed to make other minor repairs. He also insisted the seller agree to destroy the inspector’s report, retrieve all copies from the inspector and treat it as though it had never been written. He asked the buyer to hold the seller harmless from any and all claims that might arise as a result of the inspection report.
What was the seller’s motive? He was afraid the buyer would sue him for various non-disclosures. He hoped to kill the deal by discouraging the buyer from proceeding, but was reluctant to do so as long as the inspection report was alive. He thought he could relieve himself of any duty to report defects if the report creating the duty were to be destroyed. Such an attempt wouldn’t work, but shows the extent to which a devious seller would go to deceive an innocent buyer.
What if the seller offers to repair the decayed windows, or to fix the cracks in the concrete? Should you accept the offer? One problem with this approach is that by accepting this offer you lose any ability to control the means and methods of doing the repair. The seller will want to do it as cheaply as possible. It may be only a temporary solution. A buyer will want the problems fixed properly. One way to handle it is to agree to hire a neutral repair contractor who works off an agreed repair plan. You would want your inspector, assuming he is knowledgeable about the specific repair, to inspect the work. You would have to retain the right to object to substandard workmanship.
Alternatively, you might ask the seller for a credit based on a couple of credible repair estimates. That way you could control the repair, do it the way you think it should be done, and pay for any upgrades you desire.
If you should elect to have the seller do the work, ask the seller to assign his rights against the repair contractor. Such an assignment would look like this:
Seller, for valuable consideration, hereby assigns to Buyer all of his right, title and interest in and to that contract between Seller and XYZ Contractor for work performed by Contractor to repair the (i.e. roof). This assignment shall include, but not be limited to, rights to enforce the contract, the warranty, and all other obligations of the Contractor. Seller warrants that he knows of nothing that would prevent the enforcement of this Assignment or the validity of the underlying contract with Contractor
The benefit of obtaining the assignment is that it entitles the buyer to call the repair contractor back to perform any required warranty work. If the repair fails altogether, the buyer could sue the contractor directly to obtain the benefits of the work originally performed for the seller. Most sellers will agree to this because it doesn’t cost them anything and doesn’t expose them to any risk.
Major Construction Defects and What to Do with them Before You Buy
A couple of years ago, a client of ours put his recently remodeled home on the market and reached an agreement with a buyer for $1.6 million. The deal was subject to a typical buyer’s inspection. The inspector immediately identified the exterior siding as EIFS, a synthetic stucco system. This system has been the subject of many news reports and articles in the northwest, and elsewhere. When water gets behind the siding, it destroys the plywood and wood framing.
Here are some pictures of the house before repairs:
The inspector took some moisture readings with a moisture probe in 8-10 locations. This revealed evidence of water damage on the south side of the house which received most of the heavy winter weather. The buyer asked for a $200,000 reduction in the purchase price to cover the estimated costs of repairs. The seller asked his remodeling contractor to estimate the repairs, and the contractor said it would be a maximum of $50,000. The seller then offered a $50,000 reduction, but the buyer refused and walked away from the deal.
It turns out that was a great move on his part. When the seller realized he couldn’t sell the house without making the repairs first, he decided to proceed with the repairs. What we show you below are just some of the pictures revealing the level of damage at the house. By the time he was done repairing the house, he had spent $350,000 to strip all of the siding, all of the parapet wall metal caps, all the deck railings, the front stairs, and half of the roof. He also discovered extensive areas of dry rot which did not show up during the inspector’s exam because dry rot conditions, by definition, do not reveal active moisture. Here is one picture of a short wall destroyed by water damage:
So, what should you do if you discover the house you love and want to buy is covered with one of the products you see in the pictures above, known as EIFS, Dryvit, Senergy, Parex, or Pleko? Of course, you shouldn’t do anything until you get a qualified waterproofing inspector to take moisture readings around the house. If the seller refuses to allow that, either walk away from the house, or offer to buy it after discounting the purchase price by at least $100,000 per side covered with the material for a 4000 square foot home. If the house is larger, increase the discount proportionately. If the seller refuses, consider it a blessing and move on.
Here are some revealing facts about EIFS-covered homes, the estimates of repair costs, and the actual repair costs after all of the siding was removed and inspectors could see all the damage:
The point of this is to show how far off the original damage estimates prove to be once the siding is removed, and inspectors and contractors can see how much framing damage has occurred. In one case, the owners had to move out to permit repair crews to remove all the kitchen counters, the countertops, and appliances. In that case, water had damaged the floor and framing under the kitchen. In the Laurelhurst home, water had damaged the floor joists extending from outside to about 4 feet inside the living room, none of which could have been anticipated from an external, moisture testing inspection.
Remember what we said earlier that no one involved in the process will be your true friend. In these situations, with many homes in upper end neighborhoods exceeding $1 million, realtors will not want to see $60,000 – 70,000 commissions disappear because of the possibility of water damage. We have found that the seller’s agents will criticize the inspectors, tell the buyer’s agent that the buyer is missing out on a great deal, and that the buyer’s concerns are unfounded. Don’t believe it. We have seen dozens of homes that looked perfect from the outside, but which hid hundreds of thousands of dollars of damage beneath the surface. Water damage is an equal opportunity agent of destruction. It affects the largest houses as well as smallest, the modern house as well as traditional.
Waiving the Contingencies: Assuming you followed the usual course, your purchase of the house is contingent on selling your home, approval of financing, appraisal equal to the selling price, neighborhood review, title review and physical inspection. Most, if not all of these contingencies will be waived automatically if you don’t reject them. For example, if you do not object to the title review within 5-10 days of mutual execution of the agreement, you are deemed to have approved the title, and lost any right to object to. The same is true of the other contingencies, unless you have written the proposal differently.
The one that you want to be sure doesn’t expire with time is the contingency on selling your existing home. If you cannot finance the new purchase without selling your existing home, make sure the contract provides that the deal terminates unless you have sold your home by a certain date. You could also attempt to negotiate for a thirty day extension. But, the important point is that you should not be found to be in default and lose your downpayment if you don’t close.
Here are some of the key contingencies to track, approximately in the order they will occur:
AFTER ALL CONTINGENCIES REMOVED BUT BEFORE CLOSING
What do you do, if anything, after you have removed all contingencies and you are waiting for the sale to close? One thing that may cause serious problems is the seller’s obligation to make repairs to the house as agreed in the purchase and sale agreement. Here’s an example: Let’s say you negotiated for the seller to fix a portion of the roof, and paint an exterior wall. You should reserve a date for re-inspection of that work. What happens and what are your rights if the seller fails to make the repairs or doesn’t perform the work adequately? Assume the seller was supposed to re-roof a portion of the roof, but instead, he only replaces a few broken tiles instead of the entire area? Depending on the specific language in your agreement, you will have to analyze whether his failure is so clear and objective that you could terminate the deal and recover your downpayment.
What if it’s a grey area, the repair work is done but not quite to your expectations? If the seller repainted as required, but the quality of the work is noticeably poor, what can you do? If you inform the seller that you reject the work, the seller may either re-do it, or could argue he doesn’t have to. Then you and the seller will each risk being the party that breaches the agreement.
One way to avoid this is to require a neutral party to evaluate and judge the quality and adequacy of the seller’s repair work. You could agree together that a respected contractor who is not involved in doing the repairs would inspect the work and have the right to accept or reject it.
Okay, what happens if your neutral inspector rejects the work? Consider this possibility: the seller gets cold feet and decides he really doesn’t want to sell. So, to antagonize the buyer, he either refuses to do the repairs, or does them so poorly he knows the buyer will reject them. That will force the buyer to make a decision about proceeding or terminating. In a rising market, where the seller may think he could sell the home for more money, he may intentionally try to sabotage the deal. In that situation, the buyer may be forced to accept the improper repairs if he wants the house.
VI. THE CLOSING
The closing should be a nonevent, just the formality of signing all the sale and loan documents. But, there are several things to do before the closing that will help you avoid problems.
First, look at the “good faith” closing estimate you should have received from your lender. This document, required by Federal law, is supposed to provide you with an estimate of all the closing costs that will be imposed upon the closing of the transaction. It is based on the terms of the loan you chose with the lender. For example, if you committed to a 30 year fixed rate loan, where you locked in the loan rate, the good faith estimate would provide you with a calculation of your monthly mortgage payment, the amount of downpayment required, and all the closing costs, including the loan fees (“points”), escrow fees, title insurance, and other typical expenses.
Several times in my own home buying or refinancing experience, I have gone to the closings and found that the escrow company had made mistakes. For example, I once refinanced a loan to take advantage of declining interest rates, but the escrow company had used a higher loan rate than my lender had committed to, as well as the wrong loan amount. You should know in advance the following:
- The amount of the loan
- The loan rate
- The term of the loan
- The approximate monthly payment
- The downpayment
- The fee in percentage terms you will pay to the lender
You should take all of this information with you into the closing. In fact, before I go to a closing now, I ask the escrow company to fax me a draft statement with all the loan information and closing costs. That way if there are any mistakes, I can deal with them before going into the escrow company offices.
VII. TAKING POSSESSION
Congratulations! You own a new home.
Before you start moving in, survey the house and make sure everything you expected to be there really is there. Are all the appliances there? Are the fixtures there? Is the house in the same condition it was last in when you inspected it? If not, take pictures of the conditions immediately so you can send those pictures to the realtors and escrow agent involved in your transaction.
Even if the house appears to be in perfect shape, take pictures of everything, inside and out. Then file the pictures away with your closing papers, as a photographic record of the home’s condition on the date you took possession. That may come back to help you with an insurance claim years later.
Finally, go enjoy your new home.