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Cash and non-cash incentives prop up sliding home prices

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NEW YORK -- Buyers latched onto mortgages with all kinds of exotic teaser rates to be able to afford the soaring home prices that sellers were demanding during the boom years.

Now that the situation is reversed, buyers are demanding cash payments and other incentives that may be artificially propping up sales prices -- suggesting the market downturn could be even more pronounced than has been reported.

Gonzalo Sotelo, a licensed real estate agent in Salinas, Calif., said that three times in the last few months, buyers' agents approached him about securing cash back at closing without informing the lender. In the most expensive proposition, an agent from the nearby San Francisco Bay Area proposed having a home with a $539,000 asking price reappraised and sold at $600,000, with Sotelo's client paying back $60,000 in cash to the buyer. Sotelo, of Prudential California Realty, said he turned down the deal and hasn't heard from the agent since.

The type of offer Sotelo received prompted his boss, Jose Palma, to devote a recent staff meeting to a discussion of how to avoid potentially fraudulent deals, since giving cash back without telling the lender creates legal liabilities for the broker and seller.

"Because the market is changing right now, I think people are trying to be a little bit more creative," Palma said. "We tell our agents: 'There's a black area and a gray area.' I tell them to stay away from the gray area."

Offers abound from sellers willing to pay closing costs, several months of mortgage payments and, in some cases, cash. Giving cash back allows a seller to sweeten the offer without having to lower the actual stated value of the home.

Buyers are taking the incentives, and economists say the practice could be inflating reported prices and distorting our view of a market already suffering from higher mortgage rates and a sense that the market is enduring a significant correction.

Fears that overextended homeowners would default on mortgages led banking regulators last month to direct banks to explain the risks to borrowers from interest-only and other nontraditional mortgages, which had helped many homebuyers buy expensive homes during the boom. The Government Accountability Office told Congress last month that from 2003 to 2005, nontraditional mortgages rose from less than 10 percent of all mortgages to about 30 percent.

Inflated prices potentially cause harm to banks, which could take a hit if the mortgage holder defaults and the home turns out to be worth less. It also could affect buyers of neighboring homes, who may be making decisions based on faulty data.

When sellers use incentives to reduce the actual price without cutting the reported price, "then the reported prices are an overstatement of the true net selling price," said Lawrence White, Deputy Chairman of the economics department at the Stern School of Business at New York University. "So that very likely means that the real drop in home prices is greater than what the standard sources, like the National Association of Realtors (NAR), have been reporting."

The NAR reported that prices of existing homes fell in August for the first time in a decade. The median price of a home sold in August fell to $225,000. That was down 2.2 percent from July and down 1.7 percent from August 2005. That marked the first year-over-year drop in home prices since April 1995.

In calculating the much-watched home price statistics, cash and non-cash perks are left out, implying that true prices are even lower than the statistics indicate.

Non-cash incentives, such as improvements paid by the seller, also have an effect since any add-ons change the quality of the houses but aren't reflected in the prices -- or for that matter, the statistics.

"It's simply not reflecting the pace of change in them," Mortgage Bankers Association Chief Economist Doug Duncan said.

"If you look at the federal statistics on price, it's not adjusted for the quality change," he said. "So if you take the house and list it for $250,000 and you add a finished basement and granite countertops, is it still the same house? Not really."

In the current slowdown, sellers and builders are moving beyond kitchen remodels to offering just plain cash. "An economist would call that a price cut," Duncan said. "That's not captured in the data."

Home shoppers seeking price cuts have an abundance of options.

Pulte Homes Inc. (NYSE: PHM) has recruited recent buyers to offer $500 referral discounts to prospective buyers near Austin, Texas. A Web site, iNest, offered $1,540 off on homes in another Pulte development in the area.

D.R. Horton (NYSE: DHI) offered buyers $120,000 in savings last month at the Tuscan Estates in the Elk Grove area near Sacramento. A Pulte development near there advertises homes valued between $456,000 and $654,000. And Beazer Homes USA Inc. offered no monthly payments for six months at Fieldstone Meadows in Folsom, Calif.

Citigroup (NYSE: C) economist Steven Wieting said, "It's possible the price statistics are not reflecting the incentives." In a recent report, Wieting wrote, "In August, the median new home sales price fell 1.3 percent. Building 'incentives' are probably much larger."

In some cases, owners of existing homes are offering their own inducements. A homeowner in Tampa, Fla., recently posted a sign in the front yard, with an offer to subsidize closing costs and pay the first few months of mortgage payments. Larry Lietzman, research and marketing coordinator for a Grubb & Ellis affiliate in Tampa, said he sees individual sellers frequently using such techniques. "The incentives are just extra to get the home to sell at the asking price," he said.

Cash incentives also help the market resist the slowdown by attracting buyers who might otherwise still be renters.

The inventory of unsold homes rose to a record 3.92 million units at the end of August, the NAR reported. The incentives bring buyers into the market who might not normally enter, and without them, the backlog of homes on the market would be even bigger.

"For the buyer, it might be the difference between renting and owning," NAR spokesman Walter Molony said. But he added that the incentives themselves have little financial impact for the seller and are part of a normal market.

"It does impact the net for the seller, but you also have to put into perspective that the median time a seller is in a home is six years, so if you're looking at a seller today who purchased six years ago, the gain in home value over the last six years is 60 percent. So if they're getting a few thousand (cut), it's not really hurting them."

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