How Hidden Incentives Distort Home Prices

How Hidden Incentives Distort Home Prices
Wall Street Journal - December 19, 2007

PARKER, Colo. – As the housing market slump deepens, disguised discounts are making it harder to tell exactly how much people are paying for homes.

Buyers, sellers and other market participants typically monitor fluctuating home values through sale records that legally have to be listed with county clerks. But incentives offered to buyers – ranging from free cars or furniture to cash rebates – are making those prices less reliable as a sign of what buyers actually paid, netting out the giveaways. And that may be misleading lenders and people shopping for homes, some real-estate lawyers and appraisers warn.

KB Home in January sold a new townhome with green siding in the Denver suburb of Parker for $196,000, according to the deed recorded with the Douglas County clerk. But a disclosure form provided to the buyer and seller of a particular property, which isn’t part of the public record, shows that home builder KB paid $27,600 to another company, which made a cash payment to the buyer. Netting out that effective discount, the price was $168,400.

Incentives of all kinds have mushroomed in recent years as sellers found it harder to unload homes, says Jonathan A. Goodman, a lawyer in Boulder, Colo., who gives seminars to real-estate professionals on how to avoid fraudulent transactions. Fannie Mae, the nation’s largest investor in home loans, sent a memo to lenders this month warning them to watch out for “practices that may distort or artificially inflate” house prices, such as payments from sellers or builders that effectively rebate part of the recorded price.

Incentives to buyers are becoming more common in a glutted market. For builders, an incentive can mask a discount that might lower the value of nearby homes the company is still trying to sell – or avoid angering previous buyers who paid more. For buyers, cash from the seller can finance a down payment.

One risk of these transactions is that they can mislead other buyers into overpaying for similar houses nearby, or give owners of nearby properties an exaggerated notion of their home equity. Lenders can make loans on the basis of an artificially high value, increasing the danger of losses from any default.

The national builder Lennar Corp., for instance, last year offered buyers in certain Florida communities vouchers to purchase Mustangs from a local dealership. Lennar said the voucher was deducted from the recorded sales price of the homes. A few months ago, a small builder in Tacoma, Wash., offered a $20,000 Harley-Davidson to buyers of a $479,000 home. One buyer skipped the Harley and instead took a $20,000 incentive from the builder, which reduced the sales price of the home. But in other cases, " the incentive is not always public knowledge," said an agent involved in the sale, Jeff Jensen of Windermere Professional Partners, Tacoma.

It’s impossible to determine how frequently such deals distort recorded prices because public records don’t usually contain information about incentives. But the practice appears widespread. Mr. Goodman examined all metropolitan Denver home sales in a real-estate agents’ database for the 15 months ended March 31, 2006, and found that 1.5% of the homes sold for at least 10% above the listing price. Sometimes, there are legitimate reasons for paying more than the asking price, such as when sellers agree to make major home improvements. But Mr. Goodman figures that at least two-thirds of those sales involved manipulations that disguised the true value.

Giving cash back to the buyer isn’t fraudulent if the payments are clearly disclosed to lenders and to investors who buy loans from lenders. But mortgage-fraud experts say the rebates often are designed to fool lenders into making bigger loans than they otherwise would.

In estimating the value of a home, appraisers rely on prices recorded at county courthouses for similar, nearby houses sold recently. Before using the price from a recent transaction as an indicator of another home’s value, appraisers or buyers should check with real-estate agents or others involved in that transaction to find out whether incentives skewed the price, says Jeffrey Otteau, president of Otteau Valuation Group, an East Brunswick, N.J., appraisal firm. But that information can be hard to obtain, he and other appraisers say, and agents and builders aren’t required to divulge information about past sales to appraisers.

Distorted prices also can fool computer programs – known as automated valuation models, or AVMs – that estimate home values based on sales of nearby properties and other factors. Lenders often use AVMs to check appraisers’ work or in some cases as a cheaper substitute for a human appraisal. and other Web sites consulted by people shopping for homes also rely on AVMs. estimates the value of the townhome in Parker at about $191,274, or about 14% above the net price paid by the buyer. A spokeswoman for Zillow said the company “looks at many homes in order to extract patterns used for valuing homes” and that the estimate doesn’t hinge on one, possibly distorted past sales price.

In the townhome sale in Parker, public records show that KB sold it to Ruby Gomez on Jan. 5. The HUD-1 settlement statement provided to buyers and sellers shows that KB paid $27,600 as part of the transaction to a firm identified as Falcon. Mr. Goodman said he was told that the payment was made to Falcon Marketing Group. A representative of Falcon couldn’t be reached to comment.

Falcon’s Web site, no longer operating, this year promoted a program that it said could help people “purchase a property in the next 30-60 days with little or no money out-of-pocket.”

A spokeswoman for Los Angeles-based KB confirmed that the company provided an “incentive” to the buyer of the home but added that this was “certainly not standard procedure.”

When a reporter visited the home in late July, the occupants turned out to be the family of Jesús Acosta, who identified himself as a construction-site safety inspector. Mr. Acosta said his sister, Ms. Gomez, obtained the mortgage loans and bought the house because she had a better credit record. But Mr. Acosta said he was making the loan payments. Mr. Acosta said that the original asking price of the home was increased and that in return his sister was given cash, but he said he didn’t know the details of that arrangement. Ms. Gomez couldn’t be located for a comment.

Silver State Mortgage, Henderson, Nev., provided two mortgage loans totaling $176,400 to Ms. Gomez, according to the HUD-1 form. Based on the recorded price, those loans totaled 90% of the home’s value. Taking into account the true price of $168,400, the loans totaled about 105% of the value of the home at the time of the purchase, suggesting that the buyer started out owing more than the home was worth.

Silver State Mortgage, a closely held company, went out of business early this year. R. Glen Woods, a lawyer representing Silver State, says it relied on independent brokers to originate loans in Colorado. “If the loans failed to conform to underwriting guidelines, those facts were unknown to Silver State Mortgage. Silver State Mortgage and the investor who eventually purchased the loans in question have suffered losses from situations such as this, in which independent mortgage brokers failed to follow established criteria for the origination of mortgage loans.”

Another transaction that shows signs of price distortion is the sale of a home on Olen Mattingly Road in Avenue, Md. The two-story, 2,158-square-foot home, built within the past two years, was originally listed for sale in February 2005 for $635,000 but languished on the market for more than a year, according to local real-estate agents. The owner, builder Bennett Homes LLC, gradually reduced the price to $469,000 by March 2007. In May, however, the home sold for $600,000, far above the recent asking price. Vangie Williams, a real-estate agent who represented the buyers, says the sale involved a payment by the builder to an organization that collected fees for finding buyers. Officials of Bennett didn’t respond to requests to comment.

A unit of Wells Fargo & Co. provided two loans to finance the purchase, the first for $479,800 and the second for up to $120,000, for a total of just under $600,000. That is about 28% more than the asking price for the home two months before the sale. A spokesman for Wells says the property was appraised at $615,000. He adds that Wells relies on “objective third-party appraisals in making all lending decisions. While we expect that appraised value [will] be close to market value, that may not always be the case.”

The house recently was back on the market. The latest asking price: $499,000.

Write to James R. Hagerty at bob.hagerty@wsj.com1 and Michael Corkery at michael.corkery@wsj.com2