Luxury homes at auction

Homes that were valued in the multi-million dollar range just a few years ago being auctioned off for an order of magnitude less in some cases. Bankruptcy is sometimes the culprit behind the auction.

Mr. Warner, 61, bought his house and an adjacent property that once had a trailer park on Little Torch Key, north of Key West, in 1993. It was appraised at nearly $14 million just two years ago. But after losing a large amount of money, he liquidated his construction business in Elkhart, Ind. Last year, another company he owned, Lucky’s Landing, which essentially owned his Florida real estate, filed for bankruptcy protection and its assets came under court oversight.

When no buyer emerged at the listing price of $5.9 million, Mr. Warner asked the United States Bankruptcy Court in Miami to approve the property’s sale at auction. He had a lot riding on the request. To avoid personal bankruptcy, he said, the sale had to generate more than $3 million, roughly the remaining amount of the mortgages.

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Stacy Kirk, who together with her mother co-founded Grand Estates Auction Company in 1999 to handle multimillion-dollar homes exclusively, said her business had grown to 30 homes last year, from 20 homes sold in 2005. “We have been receiving more inquiries from homeowners in the $1.5 million and up price range,” she said. “And we are talking to banks for the first time about whether we can help sell similarly priced homes that are headed for foreclosure.”

FHA loan limits have increased

Good news for any of the mass affluent in the market for a new home. The FHA has increased the loan limits of its loan guarantee program. Insured mortgages equals lower rates. (To see what I mean, compare the differences in rates between jumbo mortgages and insured mortgages.)

The stimulus bill allows FHA, Fannie Mae and Freddie Mac to guarantee loans of up to 125 percent of the median home price in high-cost markets, up to a maximum of $729,750 for one-unit properties. The cap for two-unit properties is $934,200; three-unit properties is $1,129,250; and four-unit properties is $1,403,400.

The floor limit for FHA loans in "normal markets" remains $271,050 for one-unit properties, $347,000 for two-unit properties, $419,400 for three-unit properties, and $521,250 for four-unit properties.

What are the high-cost markets? You can find the list on the FHA Web site (it's an Excel spreadsheet). Basically, the markets center around the major U.S. cities; New York, D.C., Los Angeles, Denver. etc.

Real estate driven tax changes

I wasn't really paying attention to this before, but I've seen quite a few stories on the Housing Assistance Tax Act of 2008 over the last week. (The about.com story gives better examples.)

A few things the new law encompasses

• First-time homebuyer credit of up to $7,500
• Property tax deduction even if you don't itemize
• Better tax credits for low-income housing and renovating old buildings
• More relief for 2005 hurricane victims
• Changes in capital gains exclusion for real estate
• Reporting of credit and debit card payments

Being a law written by our Congress, there are of course other provisions in it (why can't our laws ever be simple changes?). I'm interested in the first-time homebuyer credit and the changes in the capital gains exclusion for real estate.

First-time homebuyer credit

The first-time homebuyer credit is a credit up to $7,500. The 'credit' has to be repaid though over 15 years. And there is an income limit of $95,000 for individuals and $170,000 for married couples filing jointly, so those in the mass affluent segment may not qualify due to income.

Changes in capital gain exclusion for real estate

Previously, the tax laws allowed a homeowner to exclude up to $250,000 in gains (or $500,000 for joint filers) as long as the homeowner owned and lived in the house for at least two years out of the five years ending on the date of sale. Now, any gains will need to be allocated based on usage. Only gains allocated to time spent living in the property as a primary residence will qualify for the tax exclusion

OK, an example really helps to understand this.

Here's an example: Suppose a married couple buys a home on Jan. 1 next year for $600,000, says Mr. Olivieri of White & Case. They plan to hold it as an investment. On Jan. 1, 2012 -- three years later -- they begin using it as their principal residence. They live there two years and sell it on Jan. 1, 2014 for $1.1 million, for a profit of $500,000.

Under the old law, they would have been able to exclude the entire $500,000 gain from their taxable income, Mr. Olivieri says. But under the new law, they could exclude only two-fifths of the gain, or $200,000, since the other three-fifths would be considered attributable to the three years the home wasn't their principal residence, he says.

Cheap custom homes! Fire sale prices! Won't last!

Consumers can get better prices on a custom or semi-custom home these days from a mass market homebuilder (free Yahoo link) (I found the Yahoo link since I had to search Google for the story after I couldn't find it directly on the WSJ site). The housing slump is pushing the builders to find more profitable niches.

A number of big home builders are now getting into the custom-home game -- an area that was once almost entirely the province of boutique builders. Companies such as John Laing Homes, Toll Brothers Inc. and K. Hovnanian Homes are all venturing into a field that takes more time, patience and hand-holding than production building.

The reason is simple: Custom-home building is more profitable for builders. And -- in this tough market -- it also carries less risk: Builders avoid the carrying costs of land, taxes and other monthly expenses that can come with speculative building. Because custom building caters to the upper end of the market, it's doing better than production building right now, says Steve Melman, an economist with the National Association of Home Builders. Although home building of all types is stagnating, he says that the custom share of the market tends to go up during down times, while production building peaks during boom times. In 2007, the custom share of the market was 24%. In 2005, during the peak of the boom, the custom share was 19%.

To see the difference in prices, look at one couple building a house in the Lowcountry of South Carolina. The per square foot cost from Toll Brothers was $137, while custom builders quoted between $170 and $200. The couple had to tweak an existing Toll Brothers design as opposed to a fully custom house, but the price break they got seems worth it. If you're in the market for a custom house, the big builders are worth checking out.

Keep non-mortgage costs for homes in mind

A Connecticut couple is putting up their (amazing) home for sale through a sealed-bid auction. Their reason is that it is too much house for just the two of them (it's a 26,000 square foot house).

The thing in the story that stuck out at me was this:

The upkeep, more than $200,000 a year, was part of what soured the dream.

“It needs a staff — a chef and groundskeepers and gardeners,” Mrs. Cheslock said. “Trees, lawn, gardens, pool, deer-repelling. We have three different kinds of grounds teams.

Keep non-mortgage costs in mind when purchasing a house. There's also time that has to be invested in a house, whether homeowners perform maintenance themselves, or spend the time hiring someone to do it.

(Hat tip to FreeMoneyFinance for this story.)

Buy vs. rent calculator

Here's a link to a cool buy vs. rent calculator on the New York Times site.

Tax advantages of being a landlord

Did you know there are benefits to being a landlord beyond having to fix a tenant's plumbing at 3A.M.? There sure are. Landlords can receive numerous tax benefits including:

• Deducting the mortgage and real estate taxes on a rental property
• Deducting all operating expenses on a rental property
• Depreciating a rental property over 27.5 years

There is a nice gotcha in the tax laws for landlords too. Something called passive activity loss rules.

If your property throws off a tax loss — and most do at least during the early years — things get complicated. The so-called passive activity loss, or PAL, rules will probably apply. The fundamental PAL concept is this: You can deduct passive losses only to the extent that you have passive income from other sources — like positive operating income from other rental properties or gains from selling them.

There are exceptions to the rules, but one of them is that adjusted gross income must be less than $100,000 (or under $150,000 to get a portion of the exception). Chances are that if you're mass affluent you won't pass this exception rule. The IRS has several articles and publications on passive activity losses.

Manipulation of LIBOR

BusinessWeek is running a story on possible manipulation of LIBOR (the story was originally broken by the Wall Street Journal). Now, the upshot is:

Because Libor may be lower than it should be, consumers are actually spending less on interest payments than they should be. "It's one of those rare instances where financial institutions might not be quite on the up and up, but it's worked out to the consumer's benefit," says Keith Gumbinger of mortgage researcher HSH Associates. If the BBA discovers that rates were manipulated, loan rates could bounce up the next time they are reset.

A cheat that actually benefits consumers, nice. How widely is LIBOR used? Glad you asked.

It has the biggest reach in the mortgage arena, where, for example, it was used in 2005 and 2006 to set rates on approximately 75% of subprime, adjustable-rate mortgages (ARMs)—about $700 billion worth of the loans, according to Guy Cecala, publisher of Inside Mortgage Finance.

I had no idea how often LIBOR is used in setting variable rates in the U.S. I'd always thought that the prime rate was king. Personally, I wouldn't be comfortable getting a loan based on LIBOR. It would be my luck that prime would take a dive right when LIBOR took off. (Note: This analysis shows the move roughly together, so I realize my fears of this happening are irrational. However, since I live and work in the U.S., I want loans that track U.S. set interest rates, which in theory track the health of the U.S. economy.)

Update: LIBOR didn't drop as quickly as the prime rate did in the latter half of 2007.

Price chopping hits the high end real estate market

This week's Barron's has the goods on the real estate slowdown finally hitting the high end market.

A SLICE OF THE GOOD LIFE -- THE REALLY GOOD LIFE -- HAS GOTTEN a lot more affordable lately. From Miami to Beverly Hills, homes with bowling alleys, theaters, steam rooms, heated decks, six-bay garages and other luxury must-haves are sitting on the market for at least twice as long as they did a year ago, and many sellers are doing what was, until recently, unthinkable: slashing prices. "Sellers are listening to offers they wouldn't have considered before," says Anita Bigelman, a broker/owner at Harding Realty in Miami. "We just sold a house for $10.5 million that was listed for $12 million. Before, that would have never happened."

After seeming impervious to the main market's woes of the past two years, homes in the $5 million-plus market have come down an estimated 10% to 15% in the past two quarters, and they are likely to shed another 10% or more over the next 12 months, according to Housing Predictor, a Destin, Fla., company that crunches data on 250 U.S. regions. "The high-end market is the fortress of the real-estate asset class, and the inner sanctum has been breached," says David Darst, chief investment strategist at Morgan Stanley.

Renovating your home? Don't expect to recoup the costs

You probably won't recoup the costs of doing a home improvement project when you sell your home, despite what you see on the home improvement shows on TV. (I admit I love watching those shows.) This should be common knowledge. You'll get even less of a return on the project now, compared to the housing boom days (free WSJ Digg link).

During the housing boom, such ambitious projects would recoup as much as 90 cents on the dollar. Not today. The resale value of improvements in general is sliding, according to experts. In a departure from recent trends, homeowners are getting the best payback from relatively mundane improvements, such as sprucing up the exterior of their house or putting in new windows.

After spending $400,000 remodeling the suburban East Greenwich, R.I., home he bought for $820,000 in 2002, Jonathan Salinger learned he probably couldn't sell it for more than $1.1 million in today's market. That's after posh additions that included landscaping, a pool, an outdoor kitchen, first-floor laundry and mud rooms, and custom cabinetry. As a result, the 45-year-old district manager for a mortgage lender recently decided not to list his house for sale and scratched plans to move the family closer to his children's private school in Providence.

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Nationally, returns for all major home-improvement projects are fetching 70 cents on the dollar, according to a Remodeling magazine survey of real-estate professionals conducted late last year. That's down from 80 cents in 2004. Back then, a minor kitchen remodel cost an average $15,300 and recovered an estimated 93% if the home was resold within a year. Today, a similar remodel costs $21,100 and would recoup only about 83%.

The story also points out some improvements, such as backup power generators, that have a regional appeal (the generators being more popular in the West and Southwest. The story says the generators are popular because the extreme weather in those regions can cause blackouts, but I'm thinking blackouts of the more man made variety.)

What kind of home $400,000 will get you

The Journal has a story on how much house $400,000 will buy you throughout the country (free WSJ Digg link). Your dollar goes farthest in Detroit. Too bad there are no jobs there because the American automakers are tanking.

Hard money lending

I dug around for this story on hard money lending after hearing about it on a Wall Street Journal podcast.

Some mortgage seekers spurned by banks and other traditional lenders are turning to high-cost loans known as "hard-money mortgages."

Once thought of as a last resort for strapped borrowers, these products -- also called "private-money mortgages" -- have different lending standards than traditional mortgages and carry substantially higher interest rates and fees. These days, however, they are attracting a larger, more-affluent group of consumers.

These loans were often used by real estate investors to get quick financing for an investment property, which was later refinanced with a traditional mortgage. The Real Estate section of the Blogs I Read section has links to a couple of blogs that give real world examples of both getting and making hard money loans. Hard money loans are being used for more purposes than these bridge loans in the face of the subprime collapse.

Commercial real estate basics

Recently, I read an article on the basics of commercial real estate, and am passing it along.

Mortgage refinancing tax trap

Business Week ran a column on a mortgage interest deduction rule that piqued my interest. The interesting parts:

In general, the IRS lets you deduct 100% of the interest you pay on one or more home mortgages, up to a total loan value of $1 million. But when you refinance and withdraw cash, the rules change: Only the interest on your original mortgage balance, plus an additional $100,000, qualifies for a deduction. (If you want to take out more cash, use a home-equity loan or line of credit. The law allows a separate deduction for interest on borrowings of up to $100,000.)

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Here's how the refi tax trap works. Let's say you borrowed $500,000 at 8% in 1998 to buy your house. By 2003, the house had appreciated substantially and the mortgage balance had been whittled down to $450,000. Then you refinanced, taking a new loan of $650,000 at 6%. At tax time, Form 1098 would show that you forked over about $39,000 in interest on the $650,000 mortgage in 2003.

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If you use that $39,000 figure to calculate your annual mortgage interest deduction and you're in the 33% marginal tax bracket, you would wind up taking $1,980 more in deductions than you're entitled to, according to William Lazor, a CPA at Kronick Kalada Berdy in Kingston, Pa. That's because you may take a deduction on a mortgage of only $550,000—the $450,000 left on the original loan plus $100,000. On $550,000, the interest paid would be $33,000, says Lazor.

I did some further looking into this by reading IRS Publication 936. It says that any secured debt that's used to refinance home acquisition debt is treated as home acquisition debt. However, the new debt will qualify as home acquisition debt only up to the amount of the balance of the old mortgage principal just before the refinancing. Any additional debt is not home acquisition debt, but may qualify as home equity debt.

My reading of this publication is that in the example from the article, the $450,000 is the home acquisition debt, and the $100,000 is the home equity debt ($100,000 is the maximum home equity debt you can deduct interest on). I'm a little confused on the first paragraph I quoted, where it implies that the $100,000 in the refinance PLUS a separate $100,000 in another home equity loan can both have their interest expenses deducted. I'll try to contact the author for clarification.

Update:
I was able to get in touch with the article author, and she graciously replied to me. She says that the explanation given in the article was confirmed with several tax experts. I'll continue to research this to prove it to myself.

Real estate commissions

OK, so it's a two-year old article in the Times. But I didn't want to lose track of this. See how one couple lowered their real eastate commissions:

Stan and Gloria Wakefield are no fools. They built their three-bedroom house 12 years ago in Ponte Vedra Beach, Fla., an oceanside resort community dotted with golf courses and picturesque inland waterways. The real estate market in the area, near Jacksonville, took off and the house, overlooking lagoons, rose in value to nearly $1 million. "This house has appreciated almost obscenely, " said Mr. Wakefield, a retired naval intelligence officer.

What the Wakefields did next should scare real estate agents everywhere.

They decided to put their house on the market this year, and concluded that the house would sell itself. So why pay a real estate agent a 6 percent commission? They tried negotiating a lower commission with prospective agents, who stood to make about $60,000, but the best they could get was 4.5 percent - and 5.5 percent if the agent had to share the commission with a buyer's agent.

They chose instead to list their property with one of the many real estate services that are challenging conventional brokerage firms, in this case, Assist2sell.com, an agency that charges a flat fee instead of a commission. The Wakefields had an offer within six days and sold their home for $985,000, paying a $10,000 fee to Assist2sell and $14,775 to the agent who brought in the buyer, for a savings of about
$30,000 over a conventional broker.

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