Getting Real About Real Estate

Last year the question was whether the housing boom would slow down. Now it’s how bad it will get. Navigating the market is more challenging than ever.

By Ellen Florian Kratz

January 30, 2007

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Take, for example, Larry and Wanda Grover, 66 and 60, respectively, who bought a 1,700-square-foot house last August in Culpeper, Va. Ryan Homes, the developer, knocked $10,000 off the $319,000 starting price, kicked in $9,000 for closing costs, and agreed to an upgrade in the master bathroom. “Maybe if I’d held out, I could have gotten more,” says Wanda. North of Sacramento, Pulte Homes recently agreed to part with a 2,700-square-foot four-bedroom home for almost 18% off the $497,000 list price, plus an additional $8,500 in credits. “I’ve never seen anything like it,” says Lance Pagel, the realtor on the deal. “I recently point-blank asked one developer’s agent what incentives she was offering, and she point-blank answered $80,000.”

To compete with the big boys, sellers of existing homes are also sweetening the pot. Feel free to ask sellers to cover closing costs or several months of mortgage payments. In order for David Reznikow, 34, to get a buyer to sign on the dotted line for his one-bedroom Boston condo, he agreed to incur moving costs that the buyer would have to pay to get the current tenant out. Retired insurance executive, Ed Thompson, 72, hasn’t had much luck selling his Estero, Fla. home. He’s asking $799,000 but if prospective buyers don’t start showing serious interest by spring, he may tempt them with a $45,000 golf membership and a new golf cart. Why not just cut the price? He explains that he’s already come down $80,000, and going much lower would impact his friends’ houses in the gated community. “It would be too damaging to take the money and run,” he says.

As for the Patels, they’ll be moving into a new home next spring that comes with a bunch of extras. Among them: three more sets of French doors, an extra dishwasher, a warming tray, built-in bookshelves, and other upgrades they have yet to choose. Total value: $55,000. “We’re happy,” says Shim. “It’s a scary market, but I think we got a good deal.”

Consider Renting

Stephen Levy knows how lucky he was to sell when he did. He put his San Diego penthouse on the market in August 2005 for $2.65 million, more than double what he had paid for it in 1998. That October he got an offer for $2.25 million but turned it down. It would be months before he got his next offer. Luckily for him, he was finally able to sell, closing for $2.1 million. "It was a gift,” he says. “Is the property still worth $2.1 million? I’m not so sure about that.” Like any precious gift, Levy, who is 58, is holding it dear. So dear that he decided not to roll it into another house right now. He deposited the proceeds into accounts that earn about 4% after taxes. The interest just about covers the $3,700-a-month oceanview home he is currently inhabiting. “I’ve never been a renter in my life,” he says. “It’s not bad.”

Economist John Talbott, author of Sell Now!, applauds the notion of renting in a market like this—even if it isn’t part of the classic American dream of owning your own home. “Maybe you don’t live to the same standards, but don’t worry about it,” he says. "If we’re talking about the chance to bank $1 million, that’s real money.”

The economics of renting make sense to Spencer and Jacey Davis, 31 and 29, who are moving to the Boston area—probably for no longer than 18 months—with their three children for Spencer’s next assignment with medical technology company Medtronic. They took their sweet time weighing one rental in Concord that they’d been able to talk down to $1,800 a month against another in Andover that was asking $2,000. Why no rush? “There is no competition,” says Jacey. “We were hoping to get a bigger bargain.” They did. The Davises are moving to the Andover rental. Monthly payment: $1,850.

Step Away from the Exotic Mortgage

Of all the nonsense that the boom has wrought, little has been crazier than the proliferation of adjustable-rate mortgages, or ARMs, often called exotic mortgages because so few people understand them. A refresher: ARMs offer a low interest rate—a.k.a. teaser—for a certain period of time, after which it varies according to prevailing rates. To complicate matters further, banks also offer interest-only ARMs that allow borrowers to pay just the interest in the beginning and save the principal for later. The most dangerous type is the “option ARM,” which causes a home to amortize negatively. That means the borrower pays just a portion of the interest due; the rest is added to the principal. As long as the home keeps appreciating, the borrower keeps his head above water. If the market stalls, an unprepared homeowner can drown.

ARMs have traditionally been the province of wealthy and sophisticated homebuyers. During the boom, however, banks went after anyone with a wallet. As a result, a lot of homeowners out there are living under a roof they soon won’t be able to afford. Worse than that, these poor saps may have no idea what they’re in for: According to a study earlier this year by Fed economists, 41% of ARM holders do not know the maximum interest rate they might have to pay. They’ll find out soon enough, though, because next year an estimated $1.5 trillion worth of these mortgages are scheduled to reset. (By the way, ARMs make even less sense right now given that introductory rates aren’t much lower than fixed rates.) “There’s all kinds of language in these ARMs that allow the rate to rise much faster than interest rates are rising,” says financial guru and actor Ben Stein. “They can be treacherous. I had one, and it screwed me over.”

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