Investment Comparison: How Does Real Estate Stack Up?

There’s no question that we are in funny economic times.  The stability of the housing market is potentially uncertain.  With the downgrade, the stock market is extremely volatile.  Even “safe” investments (like commodities and bonds) bring their own risks.  Here’s why to invest in real estate versus other places:

  1. Leveraging: the idea of leveraging is very important within real estate.  Let’s say you’ve got $100,000 to invest.  You can take that money into the stock market and invest in companies.  Today, the United Parcel Service (UPS) is trading at $66.26 per share.  You can take your $100,000 and buy about 1,500 share of UPS stock.  If UPS increases by 10% in one year you’ve made yourself $10,000.  Congratulations.  Within real estate, however, you can leverage that same money and increase your return on investment.  With a mortgage, $100,000 can be a 20% down payment on a $500,000 house.  If one year later the real estate market appreciates by 10% your $500,000 is now worth $550,000.  Same time period.  Same percentage increase.  Different result: congratulations times 5.
  2. Tangibility: similar case as the one above, only flipped.  Instead of a 10% increase, both the stock market and real estate markets take a hit of 50%.  Everything is worth half of yesterday.  Your $100,000 investment in UPS is worth $50,000 (on paper) and your $500,000 house is worth $250,000 (on paper).  The difference is that your house is something tangible you use everyday.  If UPS goes out of business and their stock goes to $0.00 you just had a really bad day and nothing to show for it.  If your house became “worthless” in the same time period, you would still be living there, still raising your family there, still able to rent it out or run a business out of it.  Neither is a great day and paying a mortgage on a house less than is owed is a crappy place to be, but nevertheless you’ve got a roof over your head and something physical to hold on to.
  3. Tax Shelter: I’ve talked about it much within many other blogs.  In the stock market (like other places) you can write off your loss.  Only in real estate is there the potential for tax write-offs when the property is going up in value. Property taxes and interest are just two of many places to save money within your taxes by owning.  Consult your CPA for additional information.

Are There Any Penalties for Backing Out of Escrow As a Buyer?

I was asked this today by a first time buyer and thought it would be a good question to blog about.  In California real estate, the buyer is protected by the contract.  First off, with most transactions the buyer will write what’s called an Earnest Money Deposit (also called an Initial Deposit or EMD).  This is generally 1-3% of the sales price and is put into escrow.  The money is taken out of the account and held.  Think of it like a security deposit when you rent a place.  The buyer puts some skin in the game and then has the option of getting it back.  How you ask?  Everything is negotiable but in a standard contract the buyer has 17 days after acceptance to get all inspections done, review disclosures from the seller, get the loan in order, and order and approval an appraisal.

Side notes (it’s easy to go off on many tangents but I will try and keep it simple):

1.   Notice that I say “the buyer has 17 days after acceptance…”.  Let’s say the buyer writes an offer on Monday and the seller counters the offer (Counter Offer #1) on Tuesday.  Then, after thinking about it for a day the buyer accepts the sellers Counter Offer #1 on Thursday.  All the time periods for the transaction will be based off the buyer’s acceptance date of Counter Offer #1 (Thursday).

2.  The seller can never cancel the deal… unless the buyer says they’re going to do something and then doesn’t do it.  For example, a standard contract says that the buyer has 17 days after acceptance to remove contingencies (meaning, the buyer has done all inspections, read all the disclosures from the seller, had the property appraised by the lender, etc and is willing to move forward and make their Earnest Money Deposit non-refundable).  If day 18 after acceptance comes around and the buyer hasn’t removed contingencies (as they said that they would do in the original contract), then the seller has the opportunity to take action.  The seller can give the buyer a “Notice to Perform” which gives the buyer 48-72 hours (depending on the contract and what’s been agreed to) to “perform” (in this case, remove contingencies).  If the buyer doesn’t perform in the time specified by the seller, then the seller has the ability to cancel the agreement.  Under section 14C of the Residential Purchase Agreement discussing the Seller’s Right to Cancel it states:

“If, within the time specified in this Agreement, Buyer does not, in writing, deliver to Seller a removal applicable contingency or cancellation of this agreement (in other words, if after the 17 day period or whatever was agreed upon in the original contract, the buyer hasn’t given the seller a removal of contingencies or a cancellation) then Seller, after first delivering to Buyer a Notice to Perform, may cancel this agreement.  In such an event, Seller shall authorize the return of Buyer’s deposit.”

3.  Long story, short: if the buyer backs out of the transaction within 17 days (or whatever is agreed upon) and never removes contingencies, in writing, then the contract says that the buyer is entitled to their full deposit.  In California you don’t a reason to back out of a transaction as a buyer.  Cold feet, changed your mind, spite, etc.  These are all acceptable answers.  (Not so in the famous Seinfeld episode of the “spite” coat.  Take a study break and watch the 1 minute video by clicking the link below)

\”You Said Spite\”

As is traditional with my blog posts, I’m getting long-winded.  The answer to the question, “Are there any penalties for backing out escrow as a buyer?” is that it depends on when you back out.  The only money you don’t get back is the money you pay for the physical inspection (since it’s a third party company coming to do it) and the appraisal.  Both are about $400-$500 each.  If you back out within the contingency time period (usually 17 days, as discussed) then you are entitled to your full EMD back.  If you remove contingencies in writing, you are making that money non-refundable and it goes to the seller for costs they’ve already incurred (moving vans, repairs, etc) as well as their time off the market.

Buyer’s Closing Costs: What Are They and How Much?

Any time you buy or sell a house there are fees.  As a buyer,  a general rule-of-thumb is that closing costs are about 3% of the purchase price.  In other words, if you buy a $400,000 house the closing costs will be about $12,000 for the buyer.  This number is separate from your down payment and is an estimate.  There is no way to know exactly as to how much a buyer’s closing costs will be because everything is negotiable (i.e. what’s your lender’s fee? are you buying down your rate at an additional cost? when are you closing escrow within the month since all property taxes, HOA dues, etc are prorated? etc etc).  In California, the seller pays the buyer’s agent’s commissions so none of these closing costs are going to the agent.  An important thing to note, however, is that many agents use a Transaction Coordinator (a person within the agent’s office who keeps the file in order and makes sure all disclosures, reports, etc are signed correctly).  Many buyer’s agents will charge their client for this service.  I personally don’t feel it’s justified (since it’s not the buyer’s problem that the file needs to be in order) and I recommend that every buyer ask their agent to waive this fee.  I’ve seen them go for anywhere from $500 -$2,000.  It’s an important thing for the file to be in order, but it’s a business expense your agent should pick up.  Look for it hidden in an “Additional Fee Disclosure” or “Transaction Coordinator Fee Disclosure”.  Ask your agent, lender, and escrow for an estimate of costs and push hard for your agent to remove that fee.  If you have questions about closing costs or want a estimated breakdown, please contact me.