Tom just inherited his great Aunt Berta’s house in a small town in Virginia. Tom didn’t know her all that well, save for the few stories his mother told him. He knows even less about the area where she lived. Tom doesn’t have a clue about the condition of the property, the character of the neighborhood, or the state of the local market. All Tom does know is that the house is his responsibility now and that he’d like to sell the place reasonably soon with the least amount of headache.
The house is a 1,600-square-foot, 1960s brick ranch on three acres along the main road into town. Tom notices a Wal-Mart down the street when he pulls up the house on Google Maps. He calls up a local broker whose name is on just about everything around there. The broker gives his condolences and offers to help out any way he can. He didn’t know Aunt Berta, but he is familiar with the house. “It’s not much of a house,” says the broker. “I’m not sure that we could even get what’s owed on it.” Tom is a little deflated by this as he hoped that the house might fetch enough to help put a dent in his own bills. “What kind of buyers do you think would be interested in it?” asks Tom. “Well,” says the broker, “it’s hard to say. I do know of a group of investors that buy old houses and turn them into rental properties. I could take it to them directly and see if they’re interested. I’d only charge half my normal commission if they went for it.” Tom’s ears perked up at the mention of half commission. Maybe he could pay off the Visa after all. “Give them a call,” says Tom.
In the meantime, Tom calls an appraiser to see about getting another opinion on value. The man is nice enough and seems to know the local market well, but Tom balks at the appraisal fee and decides against the man’s services. In that appraisal, he would have read that the house three doors down sold for nearly twice what Tom will soon be offered by the group of investors.
What neither Tom, the broker, nor the investors know is that the well runs dry after one long shower. Only the previous tenants know about that, but they moved out a while back. To top it off, the furnace is on its last leg and won’t make it through the next winter while that funny smell in the basement will turn out to be mold. Those three surprises will wipe out any and all profit the investors hoped to make by buying the property cheap.
The appraisal, or a quick call to the zoning office, would have also informed Tom that the property is zoned commercial. A developer aware of its commercial potential will soon call Tom out of the blue with an offer to purchase and the promise of a quick, hassle-free sale at a slightly higher price than the investors. The developer believes this spot should be perfect for the retail strip center he’s got in the works.
Members of town council know that a new landfill has been proposed for the 50 acres right behind the house and should receive final approval before the end of the year. This will certainly put a damper on the rural charm of the neighborhood, but the developer could probably survive that headwind if that was all.
Above all their heads, the out-of-state ownership group for the local factory, the major employer for the town, knows that bankruptcy and mass layoffs are imminent, which will knock the knees out from under the local economy and sink the developer’s strip center in its wake. The bank will then foreclose on the vacant property and list it with the local broker.
In the fictional scenario above and in any real estate deal, Discoverable Information represents those things you don’t know upfront that could be found out through research, relationships or experts. Tools of discovery include inspections, which are intended to answer questions about the property itself and the current condition, and appraisals, which help increase your understanding of the market and the property’s place in it. Throughout the transaction process, agents act as a wise guide for their clients. You don’t want to leave Discoverable Information on the table.
Asymmetric Information is when some people involved in a real estate transaction know more than others, typically as a result of experience or expertise. The tenant who has lived in and taken care of a house for the last few years will know more about its current condition than the out-of-town landlord. The broker who has worked in this market for 30 years will most likely know more than the first-time homebuyer. Brainstorm all the things you’d like to know and who might know them. Go talk with those people.
While some things can be found out and some people know more than others, Imperfect Information is an inescapable reality for all parties involved in a real estate transaction. Certain things are just unknowable. Unforeseeable micro and macro events can and do happen. Even for the savviest participant with unlimited resources, obtaining the perfect knowledge necessary to make the best decision every time is impossible.
There are four ways to deal with the information gap:
#1 – Do your due diligence. Hire experts to help you.
#2 – Build relationships with people who know things.
#3 – Recognize and acknowledge the unknowns that can’t be discovered or predicted. Every deal has them. Decide if you can live with them.
#4 – Do the best you can with the information you have. The ability to make good decisions amidst uncertainty will serve you well in real estate and in life.