When a Sale isn't a Sale

I love wine. For my birthday this year my wife took me to a really nice wine tasting where I got to sample wines from around the world and learn some simple wine-tasting techniques (in addition to trying absinthe, I love living in Europe). Despite all of that, I'm also a cheapskate and hate to pay too much for wine. So when I go to the supermarket and I see a wine advertised "HALF-PRICE" at 4 GBP (about $8), I'm obviously interested.

This, of course, raises the question of why the supermarket would be selling the wine for "half-price". In a strictly economic sense there are only 3 reasons why you could ever buy something at a discount.

  1. The product was over-priced to begin with
  2. The product was over-stocked and inventory needs to be reduced
  3. The losses I take on this sale will statistically be offset by greater economic gains from getting you in the store
Realistically any of the above three are possible. However #2 is a result of an error on the part of the company and should only happen every once in a long while. Since I see wine for half-price every single day at every single supermarket, I have to assume that they aren't over-stocked.

That leaves two possibilities, first that the supermarket is willing to take a loss to generate business, either by hoping that you'll do all your other shopping there (very possible) or by taking losses to drive other wine sellers out of business (also possible, but illegal). Or second that the supermarket is deliberately over-pricing the wine so that it can make glitzy sales that attract your attention.

As it so happens, the reason (at least according to one british financial website) is the second:
The practice of 'marking up, only to mark down' has been rife for years, according to industry experts. The supermarket pretends to be offering a 'great discount' on a £7.99 bottle of wine, but the real price of the wine is £3.99.
This strategy works only in fields where things are remarkably unique, such as wine or clothes. In those fields, value is very fuzzy to begin with, so it's hard to understand when something is very over-priced. If you tried that strategy with cars, people would think you were awfully weird for first listing your Honda Civic at $30,000. And then offering it at $15,000 and claiming it was "half-off". That's because consumers have a fairly good idea of what a Honda Civic should cost.

Is real estate one of those fields in which a "sale" works, or isn't it?

I ask that because one of the first things I see in real estate advertisements in the US these days is "REDUCED!!!!!!!". Is that a good indicator or a bad one? Looking above to our earlier list it's obvious that the seller isn't overstocked on house and needs to make room, that argument doesn't hold in real estate (unless you are talking about builders, which is a very different story).

It's also obvious that the seller has no way to make back a loss from you if they sell under-market. In other words a person who is selling a house is probably looking at it as a one-time transaction. So there is no economic reason for them to purposely take a loss just to get your business.

So the last point remains. The reason 99% of REDUCED!!!!!! homes had their prices dropped, is almost certainly because they were over-priced to begin with. To me this is a negative indicator, because the seller and the agents seem to be fishing out-of-their-league for a greatest fool, not looking to sell at a honest value.

But still, the word "sale" brings on positive reactions even when we cognitively know better. Even knowing that the wine really isn't on sale, I still find myself more likely to buy the wine that's "half-off" than wine that isn't (but has the exact same price). and my very intelligent wife, even knowing that those boots aren't really worth $400, still sees the "$250 off" sign and thinks "bargain". Maybe we are just wired that way.

So maybe you should consider using the word "reduced" in your home sale advertisement. It won't impress buyers who are using their heads, but it will call out to all buyers that maybe, just maybe, there's a bargain to be found here.

Spiders and flies

There are two things I hate in this world.

  1. Stupid people
  2. Those who prey on Stupid people
You'd be surprised about the conflict this creates for me. Take student loans, for example. I Will Teach You To Be Rich recently asked for people to share their debt stories. Each was a horrible sob story, like this poor grad:
I'm 26 with ~40k in student loans and CC debt, just starting to manage to chip away it. It's awful, having that weight. I feel like i have no freedom; with that $500 due every month, I can't afford to be without income for a second. I live alone, but have no independence; I'd like to have the freedom to move to another town, or another state; to switch careers if I get bored.
Oh the dilemma. Part of me just wants to give that person a hug and shake my finger at those naughty companies for offering you money so freely. A small part of me doesn't think you should be allowed to get more than $10k in student loans unless you are studying engineering, medicine, law or software development. Recent history proves that many people have a poor understanding of time and money, and need to be protected from those who would lend to them.

The other half of me fumes at this fool. You borrowed a lot of money from other people, and now you are sad that you have to pay it back? Seriously? You wish you could just move where ever you like? That's for hobos, not intelligent people. You chose to borrow money to aim for a better quality of life, and that money is already spent. Sometimes I wish I didn't have to pay the mortgage on my investment property (usually during the gap between tenants), but I accept that I do because it's called responsibility.

Note: This is a real estate blog and I very easily could have gone the route of yelling at people buying too much house with nothing down who are in danger of losing it. It would have been easy because it's hard to have sympathy for a person making $30,000 a year trying to own a $500,000 home. But I ranted against foolish student loans, a more controversial subject. I really have no patience for people who cry to society because they got what they wanted but "didn't know it'd be so hard to pay it back".

Still, even though many of these stories pull me all over, I still hate real estate gurus with an unbridled passion. While surfing the web today I came across some photos from a "real estate education seminar", courtesy of Casey Serin, that kid who failed in real estate investing to the tune of $2.2 million. Let's look at the wonderful education you would receive if you had paid $15,000 to attend one of these workshops (this one I believe was The Learning Annex):

This is a "sample script" that you should use as a template when discussing a property with the seller's Realtor. Since it can be hard to read, here's the transcript:

(Listing agent on phone now) Hi, my name is Larry Goins and I'm an investor and I saw your listing at _____ address. Could you tell me a little about it? (Ask the following questions in a conversational manner) #br, #ba, Sq. Ft, age, vacant? Bank owned? How much work does it need? $amount of work? How much would it rent for? How's the market there? Would this be a good rental or a better retail house? What would it appraise for after repairs? Could you sell it for that once I fix it up? How long would it be on the market? Have you had any offers on this house? How long has it been on the market? I know you work for the seller, but I also know you want to get this house sold. What do you think it would take to buy this house

I'll let you read through that and draw your own conclusions. Aside from the fact that asking an agent questions like "How's the market there?" is patently ridiculous (do you think you're going to hear "not so good right now"), and that you should have a much better idea of rent tenancies in any areas you intend to invest than a selling agent would, I wanted to bring up the last question which trailed off at the end.

The realtor's job is to represent the seller's best interests. that means that if they place it at an asking price of $300,000, that's because the Realtor and the owners decided that was the best possible price to attract offers. If an agent tells you over the phone "oh, they want $300,000 but I could probably talk them into accepting an offer of $270,000", that agent has just broken every code of ethics even remotely involving real estate. I try to get the best offers I can when buying, but I won't stoop to encouraging the corruption of others.

Look at the by-line of this one. The entire focus is on the $249,000 net profit! But this raises a ton of questions.

-First of all the slide says that the house was worth $1,200,000 but it was sold for only $850,000 in auction? So your "investor" knowingly took a $350,000 loss? Basically this slide shows that selling at a public auction is a great way to lose money.

-Of course, I'm not sure where that $1.2 million number comes from, because if you look closely at the photo you can see that the flyer advertised the house as being appraised at $973,000.

-Assuming the house is really worth $850,000, what idiot in their right mind would sell their equity of $230,000 for a mere $24,000? The worst possible idea that I can think of would be the owner no longer being able to afford payments and afraid of losing the house. If that's the case, get a HEL to cover payments and put the house on the market immediately!

Take special note of the $100 deposit. It'll come back in just a second.

Note that this guru is talking about buying foreclosures with "Only $100 at Risk"! What a deal, right? As I wrote earlier, just because you only put $100 down doesn't mean that you are only on the hook for $100. It's called leverage for a reason. The only possible way to sell a house while only risking $100 is to use that $100 to purchase an option to sell.

Maybe that takes a little explaining. Let's pretend that I have $100 to invest and I think that Microsoft is going to explode in the next 12 months. I can use my $100 to buy 3 shares of MSFT ($28.91) right now and wait, but with only 3 shares I might not get a lot of return.

Alternatively I can purchase an "option". That's when I say to my broker "I'll give you $100 right now, and in return you'll promise that 12 months from now you will sell me 8 shares of Microsoft for $28.91 if I want to buy them". 12 months later, if the stock has climbed to $35 I can exercise my option and net a $6.09 profit on each share (you don't have to have enough money to actually buy the stock at that time, you can just collect the money). But if the stock falls to $20 a share, you can just chose to let the option expire and you won't lose any more money.

So why is this guy's idea to get foreclosures for $100 ridiculous? Because no one will ever sell you a sell-option on a home for that little money. the strategy he is probably pimping requires a $100 down payment and a hell of a lot more money borrowed (which will have to be paid back).

So far do you think the advice might be worth $15,000?

If not, then you should spend even more money on worthless products! And guess what? Not only does this fantastic package come with a 3 Ring Binder! but it also even installs bookmarks on your computer for you! You won't find a deal like that except in spy-ware!

Finally some real information! Marketing can be a valuable part of real estate information, and while I find direct mail to be a bit crass it obviously works for everyone from political candidates to credit card companies. Of course the information on this slide is relatively worthless. Knowing that the color of the envelope makes a difference is relatively worthless unless you know which colors lead to higher success rates.

For a good example, check out this graphic from Google illustrating effective adsense placements.

This not only shows you that the placement of ads makes a huge difference in how many users actually click them, but it also shows you the relative click rates, which areas generate the most traffic.

To be fair, the picture of the slide from above is just a single slide, and maybe there's a chance that the speakers then went on to explain color theory and how various colors affect the people you try to reach through your advertising. But I doubt it.

So here's my conundrum. Who am I to be mad at? The blood-sucking self-proclaimed "gurus", or the puppets that are too foolish to stay away from them? Both drive me nuts, both are a burden on society. It's tough to be me sometimes...

A moment for Virginia Tech

Jst wanted to take some time to remember the fallen Hokies. As I've mentioned before, both Biff and I are alums of that great institution, and this event has cut us both deeply.

Hokie, Hokie, Hokie, Hi
Tech, Tech, V-P-I
Sol-A-Rex, Sol-A-Rah
Poly-tech Virgin-i-a

How a liar gets caught

A while ago I wrote an article about what happens to a mortgage after you sign the papers. Read the article if you really want to know, but the cliffnotes version is that your mortgage gets bundled up with hundreds or thousands like it, and then sold to an investor (like a pension fund, or an asset management company). My new job in London actually involves helping banks make financial packages like this.

The sale of your mortgage not only gives the bank more money with which make another loan, but it also moves the risk of default and foreclosure to the investors. In other words, when people fail to make their payments, it's the investors, not the banks, who lose money (this isn't entirely true, but it's close enough and the truth would be a whole different article on the structure of mortgage-backed securities).

So investors know that when they buy a mortgage investment, there is a chance that they could lose money. They (and the banks) then hire PhD's in the fields of statistics to figure out how many people in each investment will foreclose. It's kinda like the national elections when we know who won the state of California, and by what percentage, even though only 5% of the votes have been counted.

These calculations are based on very specific things, ranging from income levels to credit scores to occupation (uh-huh... remember when that mortgage application asked if it was going to be your primary residence?). When the facts are right these investors are spot-on and they end up getting the return they were looking for and everyone goes home happy. But what happens when you lie on your loan application?

If the loan was fraudulent (using fake income numbers, etc.) then the investors (remember that the money being invested is usually someone's pension, or someone else's college fund) get screwed. There's a great article on CNN.com about a new industry being founded, which exists to analyze bad loans and discover if they were fraudulent.

The result is that banks are going to soon be under attack for the thousands of "liar loans" that they issued. Liar loans are already discounted at sale due to a statisically higher risk of default, but if an investigator can determine that fraud was involved (such as people falsely claiming that the house was "owner occupied", or grossly inflating income) they can push the loss back on the bank. And the bank, with the new evidence of fraud, has the ability to then pursue the borrower.

Casey Serin (someone you are probably sick of hearing about if you read any blogs about housing) is a prime example of someone who fit all of the "fraud" requirements. He lied about occupation, he lied about income and he bought multiple houses at the same time so that
the lenders wouldn't be aware of each other.

By law, if they had evidence, the banks could foreclose on Casey properties, and then sue him for any losses they took, since those losses were the result of fraudulent behaviour. The good news for Casey is that they are unlikely to pursue him. He's so deep in debt that there's nothing for the banks to go after.

But liar loans are everywhere. A wide spectrum of the population, ranging from the investor who wanted just a little bit more than he could chew, to the couple who wanted a house just a little bit bigger for their family. What do you do if you wake up one morning with the guilt (and fear) of being in a fraudulent loan? The market was going crazy and you just had to get in, and you just fudged the data a bit to make it possible.

The official advice is to gather up all of your paperwork and turn yourself in to the attorney general in your state. But no one is going to do that.

The next best thing is to re-finance or sell. Doing either will pay off your fradulent loan in full and give you a fresh start with an honest loan. Your new loan probably will have a higher rate than your old one, and your monthly payment will likely go up. But that's only fair since you payments were illegally low to begin with. Does that make everything better and your fraud go away? Of course not, it's like stealing something, but feeling guilty and returning it before anyone notices. Just like the theft, your odds of discovery will probably drop significantly by doing this, but you are still liable for your past actions.

Oh, and from now on, fill out your mortgage application honestly. The peace of mind you will get will greatly outweigh the slight loss in cashflow.