We Don't Know What We Don't Know -- Buying, Selling & Financing Real Estate

We'll segue into real estate in a moment. First, a few words about how we overestimate our own competency.

A sizable body of research suggests that:

• the less we know about a subject the more we tend to overestimate how much we know.
• a solid four out of five of us are less competent than we believe ourselves to be.
• many of us lack the expertise necessary to assess our own competency. 

To put it plainly, a great many of us aren't nearly as "expert" as we believe ourselves to be, and simply don't know what we don't know. This is especially true in subjects, tasks and skills outside our own core competencies.

The illustration below is a recreation and interpretation of results published by researchers Dunning and Kruger among others -- for more information refer to the Dunning-Kruger Effect and illusory superiority.

Figure: Illustration of the Dunning-Kruger Effect 

What does this have to do with real estate? Well...

Buying, selling and financing real estate easily tops the list of the most complex, expensive and invasive processes most of us will encounter in our lifetimes. Whether a $250k condominium or a $2.5 million dollar estate, the stakes are high for buyer and seller alike, there's zero tolerance for dupery and repercussions can last years into the future.

Every day around the country thousands upon thousands of home buyers and homeowners fail to approach real estate transactions and financing with due care and caution. We tend to overestimate our real estate knowledge and expertise and underestimate the value of experienced professional help. Worse, too often we are convinced that we know better. As a result, we suffer the consequences of our own ignorance in a variety of ways:

• netting less from a sale
• paying more for a purchase
• incurring higher initial expenses than we anticipated
• incurring short and long term expenses and penalties that could have been prevented
• agreeing to terms that only complicate the transaction
• experiencing greater stress, frustration and anxiety throughout the process
• embroiled in conflict with neighbors and local government
• loss of property or our interest in it
• loss of our rights to specific legal and financial remedies
• broken plans and promises
• and the list goes on...

Fortunately, most of these consequences can be prevented or minimized by following three simple rules.

Rule #1: Never rely primarily on the Internet, friends and family for advice

Pick a topic, any topic. We have a seemingly endless variety of resources at our fingertips both online (i.e., from blogs, forums, chat rooms, review sites, news sites, etc.) and offline (i.e., in conversations with friends, relatives, neighbors, colleagues, etc). As we sift through this information to find "answers" to our home buying, selling and financing questions we must keep a few things in mind:

• Real estate rules and regulations -- and especially mortgage lending rules -- change on a regular basis. From flood zone boundaries and local bylaws to documentation requirements and mortgage insurance formulas, what was applicable yesterday may not be today. 

• Our individual circumstances are more unique than our own fingerprints, and change day-to-day. One person's solution may be inappropriate for another. Similarly, the strategy that worked for us last time may not be the best course of action this time around.

• A few months of "research" on the Internet or the purchase and sale of a dozen properties does not make us experts. However, it does help us understand some of the basics as well as the legal and financial gobbledygook that inevitably comes up during conversations with professionals.

• Advice from friends, family members or peers who happen to be experienced, practicing industry professionals must be considered in the context of their areas of expertise as well as their degree of familiarity with the intimate details of our personal and financial circumstances. Bear in mind that a personal injury attorney friend is no more qualified to advise us about real estate, and a real estate agent uncle is no more qualified to advise about financing, than a neuroscientist is qualified to advise about cardiothoracic surgery. Intelligent and qualified are not synonymous.

• Until qualified professionals review and assess our circumstances we're working with assumptions based on our lack of expertise rather than factual guidance from those who possess the experience necessary to prescribe a course of action.

Suffice it to say that we do ourselves a great disservice if we rely primarily on the Internet and those around us (who are not industry professionals with a proven track record) for opinions, advice and planning. The old adage "you get what you pay for" applies here and free can prove to be very expensive.

Rule #2: Seek qualified, experienced professional assistance early in the process

Too many of us are misguided in our approach to real estate transactions and financing. Sure we do our research, create spreadsheets, run calculations based on hypothetical scenarios, generate break-even analyses, scour forums and blogs for the opinions of others, talk about our plans with friends and family, etc. That is, we do everything except discuss our circumstances and goals with experienced professionals early in the process.

While this may not apply to everyone -- some of us are more prepared and proactive than others -- it does apply to a large majority of consumers. Ample evidence is on display every day in lender, attorney, tax, finance, insurance and real estate offices across the country where new clients begin their conversations with phrases such as "If only we had...", "I thought...", "We never thought...", and "My <enter relationship here> told me...".

Here are a few examples...

Attorneys: There was a time when attorneys were at the core of every real estate transaction -- an invaluable member of the team hired to protect our best interests and watch our backs from start to finish. These days attorneys find themselves in the role of a firefighter who receives a call from us only after we've set our transactions ablaze. On one hand, we aren't likely to hear them complain about the additional revenue that comes from their effort to clean up after our messes. On the other, when out of sight they shake their heads knowing we could have avoided the significant additional expense and stress had we got them involved from the start. 

Loan Officers: Another example is the uncountable number of times we approach loan officers for pre-approval just days or weeks before we begin house hunting, or worse, after we've already made an offer or signed a Purchase & Sale Agreement. Typically we've made assumptions about our ability to qualify for financing. Irrespective of our level of income and assets, a number of other factors may prevent or delay us from obtaining financing. Whether we are planning to buy a first home, or an investment property, or to sell one home and purchase another, our eligibility for financing should always be assessed well in advance (i.e., months ahead) of a planned purchase -- and again just prior to the purchase -- to avoid issues that could easily undermine our plans. 

Financial/Tax Advisors: Yet another example is the financial advisor or tax advisor whose experience is instrumental in determining tax implications, risk exposure and returns on investment. According to RealtyTrac some 50% of the residential real estate transactions completed during September 2013 were cash transactions and only 14% of those transactions involved institutional investors (those who acquire 10 or more properties in a 12 month period). That equates to millions of individual cash home buyers. Sellers love, love, love cash buyers. Why? Because cash buyers aren't exactly well known for being as thorough and careful as lenders when it comes to vetting a deal. The likelihood that cash buyers will consult with a tax or financial advisor ahead of the purchase -- to make sure that is it financially sound in the context of their current positions -- is low. It is equally unlikely that cash buyers will pay for a title review, title insurance, an appraisal or home inspection in advance. No seller would ever refuse such a sweet deal virtually devoid of due diligence. 

Real Estate Agents: One final example is our generally poor attitude toward the value of real estate agents based on past experience or second hand opinion. As with any of the occupations mentioned above, real estate agents vary tremendously in their professionalism, experience and track records. More often than not, highly experienced, full-time, reputable agents will run circles around less experienced agents and "go-it-alone" consumers. They typically sell many more homes more quickly, generate higher sale prices, and net more profit for their clients -- even after deducting their commission-- than their clients could have accomplished on their own in the same market. And in the role of a buyer's agent they can provide early guidance about the local market, properties, pricing and realistic negotiations that Zillow, Trulia and other resources cannot easily provide. Their past performance is what fuels significant repeat and referral business.  

Yes, even the best trained, most experienced professionals are not infallible. Still, we should leverage their experience to identify and proactively address issues that we are simply too inexperienced to recognize and properly react to on our own. And we should never be afraid to ask questions and learn from their experience along the way.

Rule #3: Place more emphasis on proven track records and outcomes, and less on upfront costs

Everyone loves a bargain, but at what cost?

Here's a fact: a relatively small number of real estate transactions and loan applications are genuinely "vanilla" meaning they are without complications. Vanilla transactions are the unicorns of real estate, law and mortgage lending. Anyone with enough experience in the industry knows the likelihood that a real estate transaction will be completely free of complications is about the same as the likelihood of seeing an actual unicorn. It's never a question of whether complications will arise, but what it will take to successfully resolve the issues when they do.

How much are we prepared to risk based solely on the chance that our real estate transaction will be vanilla and not end up costing us far more than we expected to save? Here is a simple and all too common scenario:

A couple selects a lender because its interest rate on a 10 year fixed loan is 0.125% lower (1/8th, or about ~$42.00/month) on a $400k loan amount than its competitor. And its closing costs are attractively $1000 lower as well. A bargain, no? Let's find out. 

The buyers were unaware that the lender's close-on-time ratio was less than 50% meaning 1 out of 2 of its loan applications miss contractual closing dates. Should the seller not agree to extend a closing date the buyers would be out of luck and potentially lose their earnest money deposit as well. The buyers were also unaware that this lender's typical turnaround time is greater than 45 days on a purchase and that the loan officer with whom they've been speaking has less than a couple years of experience under his belt. Their loan officer encounters a previously undisclosed issue that he's too inexperienced to address in a timely manner on his own. He's wasting precious time "researching" a solution rather than approaching his manager. Days pass and his manager finally gets involved, reviews the documentation and cites a lender "overlay". Try as she might his manager cannot find a way to satisfy or waive the overlay. The loan falls apart after seven weeks of effort - one week after the original closing date. 

The seller is irate. The buyers' deposit is in jeopardy. Their belongings (and possibly the seller's) are sitting in boxes or worse, in storage while they're living out of a hotel because they had to vacate their apartment at the end of the month. And if that's not enough, interest rates have risen since the first application was submitted. They return to the other lender praying something can be done to save their purchase. 

This lender has a 98% satisfaction rating that the buyers chose to ignore to pursue a lower interest rate. On average its loans close in less than 35 days. Its loan officers each have 10-15 years experience and thousands of loans under their belts, and the overlays are minimum. It'll get the job done. The buyers will pay for another credit report to be pulled, and it's very likely they'll have to pay for a new appraisal (not all appraisals are transferable). The previous interest rate is long gone. The new rate is 0.25% higher -- a full 1/8th more than this lender was previously able to offer. Time is not on the buyers' side and they move forward.

Three weeks later their loan closes and they're finally able to move in and move on with their lives. Thanks to the more experienced loan officer and operations team the buyers secured financing, and thanks to their real estate agent's finesse the seller, while upset, didn't kill the deal and choose another buyer. The buyers did pay for a second credit report and a second appraisal in addition to hotel and storage costs for the past 4 weeks. And they'll now pay $42 per month more than they would have had they chosen this lender from the start. 

An expensive lesson learned.

Experienced professionals can offer countless examples of the many ways by which real estate transactions fail or end up more costly than necessary in the hands of those with less than adequate experience and expertise.

Getting It Right

If you don't have time to do it right, when will you have time to do it over? - Hall of Fame basketball player and coach, John Wooden

A proven track record is the gold standard of performance in any area of expertise. As consumers we must first admit that we aren't experts -- not even close. There's no shame in retaining the help of professionals with solid experience and track records as a means to achieve our objectives and save overall.

If we choose to skimp on professional services by hiring the cheapest rather than the most qualified, or opt for the "do-it-ourselves" approach to real estate then we should be prepared to absorb the potentially costly and otherwise avoidable mistakes.

I'll close with a spin on Clint Eastwood's famous line as Inspector Harry Callahan in the 1971 movie Dirty Harry:

I know what you're thinking. "Are there six unresolved issues to address or only five?" Well, to tell you the truth in all this excitement I've kinda lost track myself. But this being a real estate transaction, one of the most expensive and complicated you'll encounter in your lifetime, you've got to ask yourself one question: "Do I feel lucky?" Well, do ya, punk?

As always, I wish you all the very best.