The Milestones of Science Series
Mr. Science gives us practical advice on real estate.
We're computer scientists, not sales people...and we want to provide practical answers to practical questions.
Redfin's "The Real Estate Scientist"
When pigs fly.
John Fyten, one of those sales people
Let's say you've got a practical computer question. You want a practical computer answer. Do you go to a computer scientist? Heck no. You go to a computer sales person. Makes sense, doesn't it?
It does. Because the key word here is "practical". Mr. Science has a rep for having his head in the clouds, a rep that, based on his analysis of real estate, is well-deserved. The experienced sales person, on the other hand, or the tech your help desk sends when all you see is a blue screen, deals with users like you on a daily basis, has heard it all and seen it all, and has answers to same.
It's a good match. The knowledge of the experienced sales person or technician is practical, not theoretical. Your needs are practical, not theoretical.
Hold that thought.
If Redfin knows anything, it's how to get free publicity, and The Real Estate Scientist is part of that savvy marketing scheme. "Marketing": not something you'd think would come from the laboratory of Mr. Science. It's no coincidence that I learned about Mr. Science's latest milestone, "Seven Tactics for Real Estate Bargaining", from real estate reporter Broderick Perkins' September 4, 2008 article, "Finding Discounted Homes for Sale". I also ran across it in the San Jose Mercury News at about the same time.
Reporters love stuff like "Seven Tactics" because it's an easy article, virtually pre-written and delivered free to their in-box. And I'll bet Redfin knows that its target audience instinctively genuflects to Mr. Science, or to his stand-in in the social sciences, Mr. Softscience, or to the guy in baggy pants and big red rubber nose who often shows up when the pseudo-science of real estate is the topic. (In a future article I'll explore the idea that Redfin's real, as opposed to target, audience isn't homebuyers at all but rather virtual thrill-seekers who follow real estate like others follow fantasy-league football, a not inconsiderable drawback if your business plan says you sell real estate.)
The title Mr. Science chooses, "Seven Tactics for Real Estate Bargaining", is rather misleading. As Perkins points out, "the recommendations aren't negotiating tips but 'where-to-look-for-bargains' tips".
Let's see where Mr. Science sends us to find those red-hot bargains.
1. "Focus on listings unsold after 90+ days." Yes, it's true, homes that have been on the market longest often make the best deals. I've said this a few times myself, even though the credibility of my opinions is seriously hampered by the fact that I don't wear a white lab coat. Stale listings can indeed be good deals, assuming the seller is truly motivated and not just fishing for the "perfect buyer". The more over-priced a home, the more stale it gets, the less it sells for if it sells. That's why it's so important for sellers to get the list price right.
But then Mr. Science blows it by using a bogus yardstick for determining the "best deals". Mr. Science assures us that the bigger the discount from list price you getthe "heavily discounted homes" he encourages you to focus onthe better the deal. That's a very common attitude"I paid way less than they were asking, so I got a great deal"with a very slight grip on reality. Why? Because it measures the goodness of that "good deal" by the size of the difference between the list price, real estate's "asking price", and the sales price. And like any asking price, list price happens to be a very poor indicator of market value.
Asking or list price is nothing more than a seller exercising his or her first amendment right to free speech: "I think my house is worth X". Seller (or seller's agent) may have simply pulled the list price out of the air. The list price may be based largely on wishful thinking, my-house-is-better-than-anyone-else's ego tripping and market conditions that haven't existed in years. No one can prevent Seller or agent from setting a list price this way. But no one can force buyers to pretend that setting a list price this way leads to a list price that makes sense. So it follows that any discount off a number that can easily be artificial and irrelevant can, itself, easily be artificial and irrelevant. The discount is no longer a discount but simply a market-driven correction from an arbitrary value to true market value.
Now I'd like to draw your attention to the implicit relationship Mr. Science makes between "heavily discounted homes" and "screaming deals". These days I see condos, single-family homes and small apartment buildings in areas hard hit by the subprime crisis selling for half what they sold for a year or two ago. These properties make remarkable opportunities for first-time buyers priced out during the boom, and for investors looking for that rarity in Bay Area real estate, the "income property" that actually produces income.
And often these properties can be purchased at a substantial discount from list price, which makes them Mr. Science's touted "heavily discounted homes". But are they screaming deals? No. They offer good value to the buy-and-hold homeowner or investor, but then, so does every property in this area that sells at market value, which is to say, every property. The heavily discounted prices found in the low-end market today simply reflect the tremendous uncertainty in that market. Buyers who operate in an uncertain market take a sizeable risk and so demand a commensurate reward. With low-end real estate, that reward is a sales price, yes, "heavily-discounted", but discounted only from the boom pricing of a few years ago, not from its true value today in a depressed market.
So the idea that a sales price heavily discounted from list price is a sure-fire sign of value is both bogus and amateurish. Buyers know this. Apparently Mr. Science doesn't, which may tell us something about his bona fides as a real estate expert. In fact, Mr. Science has just demonstrated a) how little he adds to the discussion, and b) a positive correlation between the average number of days it takes to sell a house and the likelihood that prices in that market are steeply declining. Mr. Science advances the cause by proving the obvious: it takes longer to sell a house in a market where home prices are plummeting like a piano dropped off a twelve-story building.
Why? Because in a neighborhood with a steeply declining real estate market, even a list price that was market-correct when selected weeks before a house came on the market, a list price scientifically calculated using only comparable homes that closed in the preceding month or two, may well be, despite this scrupulous care, too high when the house hits the market. And as prices continue their rapid slide, a house over-priced on day one will be even more over-priced on day one hundred. An over-priced home hangs around, unloved and unwanted and, when and if it does sell, sells for considerably less than the original list price which, as you'll recall, was higher than its market value to begin with. This yawning chasm between original list price and sales price so characteristic of a hard-hit neighborhood is enough to qualify a house as one of Mr. Science's "heavily discounted" screaming deals, even though it merely sold at the new (and rapidly declining) market value, which is, yes, "heavily discounted", but only from a price that was meaningless. Which makes the heavy discount just as meaningless.
So let me rephrase Mr. Science: "Focus on neighborhoods where homes sell very slowly." Which is another way of saying, "Buy where very few people are buying". But now the perspicacious buyer will ask, Why do people not buy in this neighborhood when they buy in others? Is it because they perceive it to be less desirable? I can't speak for every part of the country, but here that's certainly the case.
Se let me rephrase Mr. Science: "Buy in neighborhoods relatively few people want. And don't be rude enough to ask why."
2. "Focus on fixer-uppers". On close examination, suggestion 2 proves to be just a variant of suggestion 1. Because perhaps one buyer in a hundred is willing to buy a fixer. Put another way, virtually every buyer wants a great home in the well-known "move-in condition". In a boom real estate market, the only people who buy fixers are those who can't afford the great home they really want, which is another way of saying that in a boom market, fixer buyers are usually buyers who can't or won't compete with more aggressive and more affluent buyers for the limited supply of great homes.
But in a declining market, two things happen. First, of course, prices go down, even prices of great homes. And second, of course, buyers are fewer in number, so there's less competition for great homes (although often there's competition). So let's summarize a declining market: lower prices for great homes and less competition for them. In a market like this, who wants a fixer? In a market like this, demand for fixers plunges and fixer prices plunge with it, even faster than demand and prices for non-fixers. And because the discount from list price to sales price is greater for fixers than for non-fixers in a declining market, fixers meet Mr. Science's definition of "best deals": those "heavily discounted homes". But is a fixer really a good deal, even with that whopping declining-market discount? That's between you and your contractor, but the vast majority of buyers vote "no" with their checkbooks. In a declining market they'd rather hold out for a great house, a house that someone else has gone to considerable trouble to improve. Wouldn't you?
So let me rephrase Mr. Science: "Focus on homes no one wants, perhaps with good reason."
3. "Back off on remodels." This is just another way of saying "focus on fixer-uppers". Remarkably, even Mr. Science sees the connection, although "it nonetheless surprised us. We had expected sellers who invested in a remodel to have unrealistic expectations". What Mr. Science doesn't know, because Mr. Science has never worked with buyers and sellers (and sounds like he may never have been a buyer or seller himself) is that buyers willingly pay a premium for a remodeled, "move-in condition" home. In fact, remodeled homes are about the only homes that don't have to be "heavily discounted" to sell in a slow-selling market, because virtually every buyer still active wants a home in move-in condition. And speaking of "unrealistic expectations", note that Mr. Science unrealistically expected unrealistic seller expectations to influence price in a market where no buyer cares about seller expectations, unrealistic or otherwise.
So let me rephrase Mr. Science: "Don't focus on the homes you really want."
4. "Assume you can negotiate an already discounted price." Mr. Science first explains this nugget by suggesting that "once a seller lowers his asking price, he sends a signal to buyers that he (is) willing to accept further discounts in negotiations". Then he rejects this explanation in favor of the idea that both reductions in list price, and further reductions during negotiations, are driven by the same thing: days on market. Which makes sense (see suggestion 1) because, again, homes in markets where prices are plummeting shed value so quickly that one, two or even three reductions in list price may not be enough to catch up to market value, even though enough reductions may finally attract a buyer's interest and get the home in escrow, where the grinding on price continues in private.
So let me rephrase Mr. Science: "Buy in neighborhoods relatively few people want."
5. "Look for homes owned a long time." Mr. Science opines that "the longer the seller has owned a property, the more equity he has likely accumulated, and the more likely he is to make the kind of significant price concessions seen in The Discount Group [the "good deals"]". Certainly sounds plausible, doesn't it, which should be a red flag, because Mr. Science should be challenging the plausiblethe mis-information that's widely accepted because it makes sense to the non-expertrather than giving it science's seal of approval. So let's take Mr. Science's claim and rephrase it slightly: buy from long-time owners, because sellers with little or no equity have to sell their homes at higher prices. Now here's the world according to Mr. Science: Don't have any equity, Mr. Seller? No worries. Mr. Buyer will help you out by paying you more for your house than he would for the identical home down the street being sold by an owner with twenty years of equity.
No, no, no Mr. Science. It doesn't matter how much or how little equity a seller has. You think it matters to the only person who matters in a buyer's market, the buyer? Then here's something that'll rock your world: all buyers care about is the home's current market value. Buyer couldn't care less whether Seller has $200k or $20k in equity or, for that matter, negative equity. That's Seller's problem, not Buyer's.
Look at it this way. To sell in a declining market, Seller has to get from here, where he is, to over there, where Buyer is waving at him. That move is going to cost Seller X dollars; X is the cost of Seller's ticket to sell. If Seller can cover the cost of X with his equity, that's fine with Buyer. If Seller can't cover the difference with his equity, then Seller either has to bring additional funds to the closing table or talk his lender into accepting less than the loan balance. Either way is still fine with Buyer, just as long as Seller somehow comes up with X. But if Seller can't, either because he has no reserves or because his lender won't cooperate, Buyer moves on to the next house and Seller doesn't sell. Ever. Because Buyer won't ever accept less than that discount of X, and Seller can't fork up X. Buyer won't give Seller a break just because Seller needs it.
All Mr. Science has done here is unknowingly reveal the positive correlation between "homes owned a long time" and "fixers" and, as we already know, fixers sell at an increased discount in a declining market. Why the correlation? Because I can just about guarantee you that the home Ma and Pa owned for forty years ain't got no granite. In fact, Ma and Pa have probably let even the routine maintenance slide during the last ten years or so, as their income stayed fixed, maintenance costs skyrocketed and their house aged gracefully, at least in their eyes, and imperceptibly, at least in their eyes.
So let me rephrase Mr. Science: "Focus on homes no one wants."
6. "Look for builders, flippers, troubled sellers." Here Mr. Science admits he's flummoxed by the data. In suggestion 5 he has buyers out scouring the countryside for homes owned a long time, and now he has them zeroing in on homes owned by speculators who've owned them a short time, less than five years. Let me suggest that the data isn't the problem here, it's Mr. Science. But to be Mr. Science is to be adept at wriggling Houdini-like out of logical quandaries. So Mr. Science merely acknowledges this harrumph "remarkable...exception", then says, "Do both".
So let me rephrase Mr. Science: "Sometimes even the data stand up on their little hind legs and scream that I don't know what I'm talking about. But I always find a way to ignore them."
7. "Don't expect banks to negotiate much." "The data suggest that the selling bank had already accounted for much of the distress in the asking price. Buyers may be in for a rude surprise if they think that they can win further savings in negotiations with a bank that is hardly prepared to negotiate." I can tell Mr. Science from experience that banks are no different from other sellers in one important respect: it's hard to generalize about them. Like non-institutional sellers, some banks over-price their houses, others under-price them. A bank may be willing to negotiate price on one home, even after it's in contract, yet stand firm on another. It just depends. On the bank, and on how long the bank's had the home.
I'll close by noting that Mr. Scientist isn't content just to fold, spindle and mutilate perfectly good data. In suggestion 7 he casually lets slip something that invalidates his data: it's taken from three different geographic markets with markedly different characteristics. "Roughly one in three houses for sale fell into one of these categories [short sale, foreclosure or bank-owned] in Los Angeles County, and one in five in Fairfax County. By contrast, King County hardly saw any sales involving a bank." In other words, Mr. Science draws his data from 1) a catastrophically distressed market in which one-third the homes for sale are bank-owned or almost certain to be, and 2) another market, severely but not catastrophically distressed, and 3) a market showing little distress. It's no accident that these markets are performing differently in a declining market. They do so because their demographics differ substantially, which means that their market drivers differ substantially. Which means that what's true of one market may well not be true of another. A hot house-hunting tip for one market may be anything but in another.
In other words, Mr. Science threw apples and oranges into his blender along with a few brussel sprouts and came up with a theoretical mish-mosh that's no market at all (which seems to be Mr. Science's signature market). Then Mr. Science uses the imaginary lessons gained from analyzing an imaginary market to instruct flesh-and-blood buyers operating in a variety of real-life markets. Hilarity ensues.
So let me sum up Mr. Science's hot tips: "Focus on homes and neighborhoods no one wants."
And let me sum up Mr. Science's "practical answers to practical questions": "Anyone know where I left my big red rubber nose?"