When is a 2 unit a 2 unit? A 2 unit home, sometimes referred to as a duplex, is a home where there is a rental unit, usually in the basement. Over the years I have seen much confusion surrounding what officially defines a home as a 2 unit. I can tell you that an appraiser, banks and Fannie Mae (all the people that count when you need mortgage financing) will be looking for the following:

-Is there a Certificate of Occupancy (C of O) for the rental unit?

-Is there separate metering for the utilities for both units?

-Are there separate exterior entrances for each unit, in the front and rear of the home?

-Is there interior access to the lower unit from the upper unit?

-Is there a tenant currently occupying the lower rental unit?

If you have a C of O, with no interior access, with separate meters, separate entrances and a tenant, then you have a 2 unit.

If you have no C of O, with interior access, with common metering, with separate entrances, and a tenant, you have a single family home with an “in-law suite”.

There are numerous other variations I won’t bore you with. You may have some of the traits of a 2 unit and some of a single family with an in-law suite. It will ultimately be up to an appraiser to make the final decision, and the underwriter will interpret based on the appraisal.

It is important to know what your home may be called by a lender for several reasons:

-A 2 unit appraisal is more expensive than a single family with an in-law suite (by $150-$250).

-A 2 unit home can borrow up to $533,850 and still be called a Conforming loan, while a single family with an in-law suite can only go to $417,000 as a Conforming loan.

-A 2 unit home will be charged a higher rate, usually .25% in rate or 1% discount point higher.

-Some loan programs state that only single family homes (even with an in-law suite) are eligible, so a formal 2 unit may not qualify at all.

Obviously how your home is defined, if you have a rental unit, is very important. Make sure to ask your lender a lot of questions as to how your property may be defined, how it impacts your eligibility for whatever loan you are applying for, and if it changes the terms.

If someone told you that the first level of your home was a basement, and did not count towards the livable square footage of your home, would you be upset? It would be as if someone arbitrarily erased part of your home, and made it smaller than it really was! This is a really important story for more people than you might first think.

Many traditional homes sit on flat lots and are uniformly situated. They may have a basement, then a 1st level with kitchen, living room and dining room, and then a 2nd level with bedrooms. But what about the surprisingly large number of homes that sit on odd lots and don’t have a basement. These homes may find that part or all of the first level is below grade. Fannie Mae, banks and underwriters will tell you that if a home’s first level is below grade at all, that level cannot count towards the “gross living area”, and as a result greatly reduces the value of the home since it will be counted as a basement instead of living space. Here is what one bank representative had to say about this:

“With regards to areas below grade, it is common for the appraiser to not include areas in Gross Living Area (GLA) as per Fannie Mae Guidelines XI 405.05 and ANSI Standards Z765. Which are consistent in definition by stating: The above grade finished square footage of a house is the sum of finished areas on levels that are entirely above grade. The below-grade finished square footage of a house is the sum of finished areas on levels that are wholly or partly below grade. Any level that is partially below grade makes the entire area ineligible for being determined in GLA.”

I had a client who had a three level contemporary home in a neighborhood with rolling hills and a lake. As a result, the first floor of the home, which contained one bedroom, one bathroom, and a recreation room, sits partially below grade at the back of the house. Her home is almost 3,000 square feet of total living space in the real world. But in the banking world, based on the Fannie Mae definition of what creates GLA, the appraiser counted my client’s house as closer to 2,000 square feet with a basement! Hence, instead of the $900,000 appraisal we were confident in getting in order to refinance the home, we got an appraisal of $780,000 and the refinance had to be canceled.

Imagine telling someone who raises a child in that 1st floor bedroom, and entertains and lives in the recreation room, that the square footage has now been erased from the ability to be counted as Gross Living Area! It seems absurd. If the market will bear a price of $900,000, why wouldn’t it be able to be appraised that way.

And the more frustrating part of this story is that when my client bought the home in the real estate boom of the early 2000′s, Fannie Mae and the banking industry interpreted their own rules much more loosely, so this issue did not come up when my client bought the home. So now the client may have trouble selling the home, because potential buyers will have trouble getting the proper appraisal to support the contract price.

There are more homes than you may think that fit this scenario. I have seen homes in urban settings where the 1st level is entirely below grade to some degree, and I have seen many homes in areas that are not flat where part of the 1st floor is below grade. Take a look around you the next time you are driving around a neighborhood, and see how many homes have a 1st floor that is not a basement, that are partially or completely below grade.

As an aside, below is the oddball potential solution my client andI considered at the time:

“I just had an odd idea pop into my head on the issue of the first level being partially below grade, which Fannie Mae uses as an excuse to dismiss all of the first level and not use it as Gross Living Area. I am getting ready to go through a similar scenario on another appraisal right now, and was trying to come up with something for what I know will be a problem for those clients. And it just hit me, and it may sound crazy to you but I wanted to run it by you nonetheless, how about digging out around the first level, re-landscaping, and magically make the whole first level above grade!?

I ran it by my other clients who will have this issue, and they are considering this and are going to get estimates to dig it out, make it pretty with new landscaping, and then we can use the whole first level as Gross Living Area, and get the appraisal that we deserve. Obviously we do not want to do something that would ruin the way the house sits and looks against the landscape and the yard, and we also would not want to do something that would be expensive, but just a thought I wanted to run by you.”

Imagine having to dig out part of your first level, rip up shrubs, plant new landscaping, painting, and paying for all of it, just to be able to sell or refinance!

I think there should be a variance on this rule, with some logic introduced into each situation. Obviously if a house has “some” of the yard pushed up against it on 1/3rd of the house on the backside, and the 1st level has plenty of light, windows and gets used a living area, an exception should be made!

Does anyone know how Realtors really get paid? I know people love to complain about Realtors and how they “get 6%” of the sales price, but that is not the whole story. It’s barely any of the story. I love to beat up on any industry with grossly overpaid and inefficient workers as much as the next person, but only if it is merited.

First, each Realtor will only get their share of the total commission. If the total commission is 6%, then each Realtor gets 3%. But they really don’t get 3% each. Each Realtor’s employing broker will take their share first. Let’s assume that our imaginary Realtors in this story are on an 80% split, that means they each get 2.4% after their employing brokers take 20%. We are already a long way from 6%…

And as for the listing agent we’d have to deduct expenses to further show an accurate picture of their earnings on each deal. Since it is part of a listing Realtor’s job to advertise the home for sale, and those costs come out of the Realtor’s pocket BEFORE ANY EARNED COMMISSION, we have to net those costs out as well.

Let’s assume, and this varies, that the average Realtor spends about .5% to 1% of the sales price to advertise (this percentage may go way up on a smaller sales price, and it may go down on a larger sales price) the home for sale. So now the listing agent’s net commission is down to:

3% gross
x 80% split
=2.4%
-.5% to 1% ad costs
=1.4% to 1.9%

On the sale of a $600,000 home, for example, $8,400 to $11,400 is a final net commission.

There are lots of variables to this story, so we could debate it endlessly. I know a seller paying a 6% commission for a house that sells in a week with multiple bids sounds wrong, and some think the seller should pay less in this situation. But would a homeowner pay 9% for the house that sits on the market for 6-9 months and take an enormous amount of marketing costs that comes out of the Realtor’s pocket? Likely not.

So some Realtors get sales that are quick and easy, some get sales that take a long time and involve a lot of hours and cost, and some work with clients for numerous hours only to never get paid because the house never sells or the buyer buys through someone else! So when you average it all in, I don’t know that Realtors are as overpaid as everyone thinks they are. As a matter of fact, the average Realtor makes a very modest living.

When I choose a Realtor I want to work with someone who makes a LOT of money, and I hope they profit greatly from their exchange with me. When you work with successful Realtors you get successful results. When you beat up on a Realtor for making too much money, or if you ask them to cut their commission, I am not sure you are doing yourself a favor. Buyer’s agents are less likely to show a house that offers a reduced commission, and selling agents won’t have as much inducement to spend as much money on marketing when they are getting paid much less.

Now, different models of selling and buying real estate (online Realtors, fee for service Realtors, For Sale By Owner, etc.), and different models of compensation for those different ways of buying and selling real estate, is a whole different discussion, and one I will blog about in the near future.

But for now, it seems 97% of all real estate is sold in the traditional way, with traditional Realtors, being paid traditional commissions, and trying to deviate from that may cause you to end up shooting yourself in the foot.

Alexandria Virginia was hoping that Verizon would bring its high speed internet and video service called “Fios” to the area, and Verizon chose not to. Now Alexandria Virginia is hoping to be a test site for a new high-speed internet service being developed by Google. And anyone that owns real estate in Alexandria should hope this happens!

Having high speed internet access, while one factor of numerous factors that affect real estate values, would be good news for real estate in Alexandria. The speeds for data are supposed to be 100 times faster than most sources. I, for one, might lean towards buying a home in Alexandria for this reason alone! And if having this type of high speed advantage were to win over more people, that creates demand, which pushes up real estate prices.

Alexandria Virginia hopes to be selected as a test city. Google calls this nationwide project the “Fiber for Communities Project”. I’d call it the “Fiber For Real Estate Benefit Project’, that is how much I believe in these types of technology infrastructure improvements, and there power to create population movement and real estate demand.

You can find an FAQ on Google’s site about this, click here. The deadline for responses from interested communities was March 26. I hope everyone that wanted to get in, got in! I hear that Montgomery and Prince George’s counties in Maryland were also interested in the Google project. I hear that Google will decide by the end of 2010 who is in, stay tuned.

What affects real estate prices? Perception. The macro-economy. The city. The neighborhood. The street. The curb appeal. The house. The square footage. The bedroom count. The view. The neighbors. The local economy. The condition of the house. Local zoning issues, if any. Access to transportation. Marketing. Government. Tax breaks. Interest rates. Rents. The weather. The landscaping. The Realtors involved. The sellers. The buyers. Emotion. Local income patterns. Local employment. Competition. Supply. Demand. Chocolate chip cookies…and more?

I cringe when I hear someone try and find a small handful of factors as being responsible for the value and direction of real estate. There are so many factors I don’t even think that most people could discuss them all in one conversation. It would take a book, let alone one blog post. It would take a series of books!

So instead of trying to discuss each factor that influences real estate prices, I’d just like to say that we all need to keep in mind that real estate is multifaceted, as is the value of anything. It is local, and its national. It can be higher in Summer and lower in Winter. It can be higher in Winter and lower in Summer. It can be perception. It can be supply versus demand. It can be smelling freshly baked chocolate chip cookies when walking into an open house, that triggers a childhood memory, that makes you want to bid a bit more than you may have under non chocolate chip cookie circumstances. It is everything. It is nothing. It is a business. It is emotion. It is a science. And it is random.

This is the whole point of the “free market”, it usually cannot be explained and pinpointed, it just “is”. When some other economic system tries to make a science of something, that is when the problems begin. The “market” is simply too big to understand and break down into small bits and sound bites.

The bottom line is that sellers try and sell for as much as they can, and buyers try and buy for as little as they can, and things usually work out from there and the final selling price is accurate most of the time. If sellers did not get the price they wanted, then that price was never realistic. If buyers feel they overpaid, they likely paid a market price. There was no specific reason, like “my Realtor was not effective”, or, “we did not have enough open houses”, or, “it rained the whole month we tried to sell”, or, “I should have painted the bedrooms a neutral color.” Things sell for what they are worth, most of the time, period. The marketplace is very effective, most of the time.

There are usually hundreds of forces at work, many unseen, culminating in a selling price for a house. Embrace the chaos, as a buyer or seller, and you will sleep better at night.

Does traffic affect real estate in Washington DC, of course it does! We plan our lives around traffic, we look for the best routes to get where we are going, we think about the best times to come and go, we telecommute to beat traffic, we move into the city to beat traffic, and we work late to avoid rush hour. We do anything we can to avoid traffic!

With an influx of people into Washington DC in 2009, traffic is getting worse, and that translates into more people bidding on real estate (to be fair it also means more people seeking rentals since not all people moving to DC are home buyers).

A recent Washington Post article says:

-”There are million and a half regional residents who commute to work every day, each spending an estimated 62 hours a year battling heavy traffic.”

-”Among those employed outside the home, 28 percent have decided to bypass the gridlock by working remotely, and the same amount report that they have moved closer to work to ease their commutes. About four in 10 people who telecommute say they do so at least once a week.”

-One person polled by the Washington Post said, “I was out at Tysons Corner the other day, and it was so bad that I just went to Starbucks and worked on my laptop.”

There also seems to be a lot of confusion as to how to relieve the traffic. More taxes? More roads? More something! In the meantime, until the geniuses that brought us the federal deficit figure out the problem with roads and the traffic, people are desirous to move closer into the city to be closer to work, so close-in Washington DC area real estate seems to have some built-in price supports, thanks to traffic, and thanks to the area’s largest employer, the Federal Government. And as just abut everyone knows, traffic does not seem to have the ability to get better, and the Federal Government never seems to shrink, so it appears close-in Washington DC real estate will have built-in price supports for the foreseeable future.

I could tell you how Washington DC had an influx of population in 2009. I could tell you how strong the job market is in Washington DC. Or I could even tell you how real estate prices were up 2.9% in Washington DC last year. Instead I am going to regale you with some anecdotal stories to illustrate what is going on here in the real estate market.

There are certainly some pockets in the Washington DC area that suffer soft to weak prices. And it seems the further you push out into the suburbs, the weaker the prices. And I am sure that is due to the seeming trend of people flocking to urban centers, and wanting to be as close in as possible. But the really interesting stories are the anecdotes that you won’t see in the statistics.

1. In a town north of Rockville, MD there was a house with an asking price of $695,000. It has been on the market for 3 days. There were 3 offers, and my clients got the house, and bid $20,000 over the asking price and paid $715,000! And this was a house that all parties knew was only worth $635,000 because the exact same house just sold 3 months ago for that very price. But all the buyers overbid, and were comfortable paying well over appraised value, even over the asking price. That is on how in demand this house was.

2. A house on Capitol Hill that was put on the market late last year was intentionally priced low by the listing agent. The Realtor thought the house was worth $600,000-$610,000, they priced the asking price at $539,000 to try and stand out. It drew so much attention that there were 9 bids, and the final selling price was $639,000! It ended up selling over what even the Realtor thought it was worth!

3. There was a renovated home in Northwest Washington DC that sold in a matter of days, for full asking price, no appraisal contingency, no financing contingency, and a 21 day settlement.

4. And if I have heard the below once, I have heard it dozens of times, this year alone: “Hi Brian. Unfortunately, we didn’t win the contract.  We put in what we thought was an aggressive offer, but there was a better one.  We’re going to continue looking and will keep you updated on when we plan to put in our next offer.”

I could write pages of these examples. And I don’t mean to mislead, since I can tell just as many stories of properties that sit and sit on the market for months, quarters, even over a year. I can site examples of weakness from Falls Church, Alexandria, P.G. County, Anne Arundel County, Loudon County, Calvert County and more. And there are even some examples of properties sitting on the market in Washington DC, but those are usually homes where the seller has grandiose ideas, has over priced the home, and simply won’t budge.

I could also site examples in those weaker markets in the suburbs of some homes selling quickly, and for strong prices, but those seem to be the exception to the rule, and seem to be very nice properties.

The moral of the story is that the inner city is very strong in all the good neighborhoods, and the suburbs seem to be weaker in general.

But, a fairly priced home, no matter where it is located, will sell, and will sell quickly. But the tricky part is getting a seller to price fairly. It is human nature for all of us to think that our home, our renovations, our neighborhood, and our general area are special, and deserve a price premium. The marketplace ultimately decides what the fair price is, and its an interesting experiment to witness!

I saw a house recently that was priced at $659,000. This house had been on the market for 60 days, with no offers, at $659,000. I noticed that they did a price reduction of $10,000 to $649,000 after they were on the market for 60 days. And this begs the question, “is a ’1.5% OFF SALE’ going to draw buyers into the store?”

I believe a $10,000 price reduction is a slap in the face to the marketplace, to potential buyers, and to logic. If the house was not worth $659,000, guess what, it ain’t worth $649,000!

Now, if you got some offers at $659,000 that you were not happy with, but they were around the $620′s or $630′s, then a $10,000 reduction from $659k to $649k may be a good strategic move to signal to the potential buyers that you were willing to come down some, if they are willing to come up some. But if you have not even had offers after 60 days, clearly the market is signaling to you that the house is more vastly over priced than 1.5%.

I think if people thought more in terms of percentages, and less in terms of dollars, real estate would sell more quickly. I know $10,000 sounds like a lot of money, but relative to a $659,000 asset, a $10,000 price move is insignificant. I know dollars are hard to come by, but a $30,000 price drop that is advertised as “significant” on a $1,800,000 house, is not as significant as it sounds. I know $30,000 is a lot of money, and can buy lots of things, but its not a significant price drop. We all need to take a harder look at percentages. A $30,000 price drop on a $420,000 home, to a new price of $390,000, now that is getting more significant.

If you were selling $2 lemonade on the corner in a tough economy, and people were passing you by to instead go home and drink tap water, would you think a price drop to $1.97 will suddenly make people want to open their wallets for your lemonade?

If you were selling $5,000 wedding dresses in a down economy, would you really expect a new price of $4,925 to make people buy?

These are 1.5% price drops, and I hope it makes the point of how silly it is to drop a price of something you are selling by 1.5%, when there was no interest at the original price.

And this theory also works the other way too, where buyers have to realize making slightly higher offers to outbid someone else, if there is competition for a home they are interested in, is not the end of the world. To bid 1% to 3% more for a property than you had originally planned to, if you are in a competitive situation, is not as huge a financial pain as you think, when measured properly in percentage terms.

Buying distressed properties, whether they are in foreclosure or are a short sale, can be difficult. I am going to cut and paste an email from a prior client in relation to this topic, and my reply, as an example of how difficult it can be to buy distressed properties:

“Hi Brian,
I found myself doing initial legwork for a home purchase and found myself posting the following to a forum. I’d like to hear your recommendations, as someone who is in the business. Thanks
________
In this day of browsing for your home, I do not see why Redfin cannot represent buyers for homes below their target price, or foreclosed homes for that matter. If there is an expense issue, buyers like myself may be willing to pay the regular commission just to facilitate property purchase.  There is much opportunity there. I find a property that is outside Redfin’s purview and search for the listing agent and/or actually visit the property and write down a posted number. Somehow, I cannot get anyone to either call me back, or follow up with initial contact. I can’t believe this. I saw one house in foreclosure that I was willing to pay cash for due to location, land etc. and willing to accept other conditions. I call the agent, leave a message, and nobody returns my call. House sits on the market for a few more weeks. Then its price drops! WTF?

Second case, I find another property that a local says is on the market. The empty looking house has no signs on the lawn, no listing in Redfin.com, Homesdatabase.com, or Google Real Estate. A few weeks pass. The other day I drive by and BINGO – brand new sign with agent contact info. I call the number and get my call returned promptly (unusual) only to tell me that the property is under contract. That property was so ideal, I would have been willing to engage in competitive bidding to acquire it. Now I can only hope that their financing falls flat. 

I don’t understand what I am doing wrong, other than the fact that I should probably not represent myself without a broker, which I want to avoid!. Now that my time has been wasted finding out about this chaotic process, I am forced to find broker representation elsewhere unless Redfin can fill the niche presented by loan free buyers.

Any advice?”

And my reply:

“Interesting post. I have heard similar stories. In fact, I have seen some Realtors say they flat out will not work with anyone interested in foreclosures and short sales, because the banks and listing Realtors are so difficult to work with. Most people feel buying these properties is difficult to impossible. Many Realtors feel it takes too many hours and their time will be more rewarded in regular resale’s.

I don’t know if its due to them being inundated with interest that they are unable to handle? Think about it, if you are a bank and just want inventory off your books, and you are a large out of control organization, not unlike government, do you care about getting top dollar or being efficient? So if a foreclosed property gets 34 calls, and half go unreturned, and the 17 parties that got called back bid the property up to the right number the bank was looking for, do you think the bank and the Realtor care about the other 17 people who did not get calls back who all insist they would have bid “a little bit more.” My guess is it just a sloppy inefficient process, the banks are probably leaving some money on the table and are too inefficient to know it, and I think buying these properties is like finding a needle in a haystack.

I am not sure getting a Realtor to help you will improve your odds, but I’d be interested to hear how that goes if you go that route. In other words, I am not sure a Realtor is going to return another Realtor’s call and faster than they would return your own call. I just think the process is a mess. I have done financing for a few foreclosures, and can see why people don’t want to work with them. It takes weeks or months to get a reply from a bank on a simple question pertaining to the loan of the buyer, or the settlement date, or a change to the sales contract. Good luck”

To finish the discussion, I just had a Realtor friend of mine finish my sentence. I said, “I am blogging about how hard it seems to be to buy foreclosed/distressed real estate for the…” and he stopped me and said “for the average consumer.” And I said yes, how did you know!? And he responded that regular consumers are getting beaten out by investors who are paying cash. He said, “its a waste of time for someone who wants to buy a foreclosed home and live in it, because they usually have financing contingencies, take too long to settle, and want home inspections!” Further, “investors come in and offer above asking, with no contingencies, pay cash, and settle fast, then they fix them up and flip them.” So it seems the bottom line is that if you want to buy a distressed/foreclosed home, you need to have all cash, settle fast, and maybe even say you are an investor!

Has anyone else noticed that buying new investment real estate does not cash flow? At today’s prices, which are likely lower than in the last several years, you still seem unable to find real estate that can turn a profit as a rental property. I wonder why that is?

A January 3rd 2010 article in the “Washington Post” titled “Cash-rich real estate investors trigger bidding wars, frustrate other buyers” discussed how investors are beating out homeowners in making offers on homes, but these investors are solely the type to buy a property, fix it up, and sell it for a profit to a homeowner. That seems to be the only real estate “investment” going on these days, by real estate investors. These “investors” were not of the “buy and hold” sort.

So my question revolves around the “why” of the story, not how. Why can you not turn a profit renting real estate if you buy real estate at today’s prices? Is real estate still vastly over priced? Are there simply far too few renters in the Washington DC Metro area, too few to push up rents to the point of positive cash flow? My guess is that this is the case in most areas of the country, certainly most urban areas. What is the answer to my question?

I took a call from a client recently, who was excited to buy a piece of investment real estate, and hold it for the long haul. But my first question without even knowing the numbers was “why?”. I had a feeling it would not cash flow, and wondered if the investor had even gone through the numbers. He had not.

The investor told me the price of the townhouse was $410,000. He saw this as a bargain since it was a bank sale/foreclosure, and he thought the value was more realistically $440,000. I told him the total mortgage payment, after putting down 20% (20% is the current minimum down payment for buying investment real estate) would be $2518 when including taxes, insurance and a small HOA fee. I then asked him how much it would rent for, the answer was $2100/month! Clearly this is a home that is suitable only to a homeowner, or if the numbers support it, an investor purchase, renovation, and quick resale for a profit. No investor would want to buy a long term rental property at a $418/month loss, and I did not even include expenses for maintenance, repairs and property management expense.

And the above story is not unique. I have been in the mortgage business for over 24 years, and I have not seen a property show a positive cash flow since the late 1990′s. So it all makes me wonder “why?”. Why is it that real estate in the Washington DC Metro area, and most other areas, does not seem to ever show a positive cash flow? Anyone else have any theories?