Builder Incentives Distort Home Prices

The Wall Street Journal recently reported that some well-known home builders and lenders have offered home buyers incentives that make it difficult for consumers, Realtors, appraisers and lenders to know how much some home buyers actually paid for their houses.

If home builders are selling houses for less than they used to, it's not in their best interests to make this public knowledge. Public disclosure of reduced sale prices could anger buyers who recently paid higher prices, and it could also make it more difficult for the builder to unload his housing inventory. So while the recorded sale price may be the same as it would have been six months earlier, some builders may have offered incentives like cars, free upgrades and cash back to the buyer. These incentives conceal the fact that the cost to the buyer and the net to the seller were actually less than the sale price.

The article said giving cash back to buyers isn't illegal as long as it's disclosed to the lenders and any investors who may buy the mortgage. This was news to me, as I had always thought that cash rebates were just not allowed by lenders. It's obvious why the lender wouldn't approve a cash rebate or other kick backs to the buyer. If the lender loans $200,000 for a house, but the buyer wouldn't have bought the house without the free Mustang convertible or $30,000 cash rebate from the builder, the house is worth less than $200,000, and the lender is going to have trouble selling it if the buyer defaults.

This article also described a ruse that wasn't on my radar screen. A home builder may hire a company to find a buyer for its house. In the example given, KB Homes in Parker, Colorado sold a house for $196,000. That was the sale price recorded with the county clerk. However, KB paid a third party $27,600 for locating the buyer. Some of that payment to the third party may have been passed on the buyer. At any rate, the net to KB was $168,400. This is the actual value of the house, without the rebates. The buyer obtained two loans totaling $176,400, which is 5% more than the net to KB. So the buyer was already "upside down", owing more than the house was worth.

I don't know whether this sort of hocus pocus occurred in Tucson, and I don't know whether it's still going on anywhere. The sales described in the article occurred before the mortgage industry melt down in August 2007. Many of the lenders who made these Wild West maneuvers have gone out of business. But the damage is done. Buyers need to look very carefully at comparable sales when deciding how much to offer for a house, because the recorded sale price may not show all the terms of the sale. If there were hidden rebates and incentives, the actual value of the comparable sales is lower.

Occasionally, appraisers will call me to ask about the terms and conditions on a house I sold. Perhaps they are trying to find out whether there were any hidden rebates or incentives that aren't recorded in the public record. This Journal article stated that Realtors and builders are not required to disclose the terms of past sales to appraisers, so appraisers may not be able to determine the actual value of the houses they use as comparable sales.