Smart mortgage consultants

Brokerage Commissions, a direct cost: In the United States, if a house is sold, the seller’s broker typically receives six percent of the value of the house as commission (and splits this commission with the buyer’s agent). Thus, if a real estate agent manages to sell a house for $300,000, the commission is $18,000. Put di?erently, without an agent, the buyer and seller could have split the $18,000 between them. (Of course, brokers do many useful things, such as matching buyers and sellers, shepherding the selling process, etc., so the $18,000 may just be the intrinsic transaction cost to selling a house. However, inconsistent with this view, real estate commissions are much lower in other countries, and it is di?cult to see why the cost of selling houses would be exactly 6% in practically all markets in the United States.)
Although only the seller pays the broker’s cost, it makes sense to think of transaction costs in terms of round-trip costs—how much worse you are o? if you buy and then immediately sell an asset. You would mislead yourself if you thought that when you buy a house, you have not incurred any transaction costs because the seller had to pay them—you have incurred an implicit transaction cost in the future when you need to resell your investment. Of course, you usually do not immediately sell assets, so you should not forget about the timing of your future selling transaction costs in your NPV calculations.
Housing transaction costs are so high and so important that they are worth a digression. If you borrow to ?nance the investment, transaction may be higher than you think. The real estate agent earns 6% of the value of the house, not of the amount of money you put into the house. On a house purchase of $500,000, the typical loan is 80% of the purchase price, or $400,000, leaving you to put in $100,000 in equity. Selling the house the day after the purchase reduces the owner’s wealth of $100,000 by the commission of $30,000—for an investment rate of return of –30%. This is not a risk component; it is a pure and certain transaction cost.
Let us brie?y consider what happens if the house price decreases or increases by 10%. If house prices decline by 10%, or the buyer overpays by 10%, the house can only be resold for $450,000, which leaves $423,000 after agent commissions. The house owner is left with $23,000 on a $100,000 investment. A 10% decline in real estate values has reduced the home owner’s net worth by 77%! In comparison, a 10% increase in real estate values increases the value of the house to $550,000, which means that $517,000 is left after real estate commissions. The house owner’s rate of return for the same up movement is thus only 17%.
With the tools you already know, you can even estimate how the value of a typical house might change if the Internet could instantly and perfectly replace real estate agents. You cannot be too accurate—you can only obtain a back-of-the-envelope estimate. A typical house in the United States sells every seven years or so. Work with a $1,000,000 house, and assume that the expected house capital-gain appreciation is 0%—you consume all gains as rental enjoyment. In this case, the house will stay at $1,000,000 in value, the commission will stay constant at$60,000 and will be paid every 7 years. If the appropriate 7-year interest rate were 40% (around 5% per annum), then the value of the brokerage fees would be a perpetuity of $60, 000/40% = $150, 000. The capitalized transaction cost would therefore have lowered the value of the $1,000,000 house by $150,000. If you could eliminate all commissions, e.g., by selling equally e?ciently over the Internet, such a house would increase in value by about 15%. However, if you believed that the brokerage commission were to go up by the in?ation rate (2% per annum, or 15% per 7-years), the friction would not be $150,000 but $240,000—more like 25% of the value of the house, not just 15%.
Other direct costs: In addition to direct agent commissions, there are also many other direct transaction costs. These can range from advertising, to insurance company payments, to house inspectors, to the local land registry, to postage—all of which cost the parties money.
Indirect and opportunity costs: Then there is the seller’s own time required to learn as much . about the value of the house as possible, and the e?ort involved to help the agent sell the house. These may be signi?cant costs, even if they involve no cash outlay. After all, the seller could spend this time working or playing instead. Furthermore, not every house is suitable for every house buyer, and the seller has to ?nd the right buyer. If the house cannot be sold immediately but stays empty for a while, the foregone rent is part of the transaction cost. The implicit cost of not having the house be put to its best alternative use is called an opportunity cost. Opportunity costs are just as real as direct cash costs.

Death is a certainty for all of us. Failure to carefully plan for this eventuality may result in inability to achieve your desired objectives. Consideration must be given, not only to the way property will be distributed at your death, but also to ensuring lifetime income for yourself and possibly a surviving spouse. Certain characteristics of agricultural estates pose additional problems. Lack of liquidity may require the sale of business assets in order to pay estate taxes and debts. Indivisibility makes periodic gifts more difficult. In addition, many farm operations are very capital-intensive with low cash returns relative to the amount of investment. These problems are not unique to agriculture. Many estates involving other closely-held businesses encounter similar problems.
Faced with these problems, and not knowing what to do, many families do nothing, or delay planning until it is too late. A few of the typical problems which may result from lack of planning include:
• The division of a farm under state inheritance laws results in small, uneconomical units.2 The combined value of the small units when sold separately may notequal the value of the farm when sold as a total unit; nor could the smaller units be separately operated as efficiently as the whole farm.
• The farm-operating heir may not be adequately compensated for contributions to capital improvements, labor and management, and the care of the parents. Understate inheritance laws, the heir will share equally with other broth- ers and sisters who have not made similar contributions.
• Guardianship of minor children may require close court supervision with numerous costs and restrictions where one or both parents die without a will.
• A will may be challenged for incompetency of the parent or parents who waited too long to make a will or the potential of undue influence being placed upon the parent from other sources or family members.
• Land may be divided and subdivided to the extent that it becomes difficult to obtain a mineral lease covering an entire tract inherited by widely scattered co-owners.
• It may be necessary to sell much of the estate if no provisions are made for payment of taxes and other costs.
• Estate taxes may be greater than they would have been if some other method of distributing the estate had been chosen.
• The farm-operating heir may be saddled with an impossible debt-load. This sometimes results from attempting to buy out the other heirs at an unreasonable price and on inadequate terms.
• Ill-feelings and bitterness may arise among heirs, resulting from lack of knowledge and understanding of the law.
• Parents may suffer from economic hardships due to unexpected illness or disability if insufficient property is re- tained to care for them adequately during their remaining years.
• Unnecessary problems may be created by not understanding implications of a joint tenancy or life estate.
• Problems may also arise from failure to consider desired qualifications of an executor.
Many of these problems could be eliminated by proper planning. Determining the facts in the particular transfer problem and understanding the alternative ways of handling the problem, are the first steps that must be taken.

In broad terms “estate planning” involves the acquisition, investment, protection and disposition of assets. Oklahoma families are faced with many problems in transferring property to the next generation. Increasing numbers of farm families are becoming aware of these problems, and are searching for satisfactory methods of transferring property within their families.
This publication is intended to furnish basic information about the problems existing, to point out the many alternatives that are available, and to encourage more families to make adequate plans. Major emphasis in this publication will be placed on minimization of disposition costs. Careful estate planning under legal advice can reduce probate expenses and tax losses.
This circular is not designed as a substitute for legal advice. Rather, it is designed to acquaint families with the various alternative methods of land transfer and thereby enable them to consult legal counsel more intelligently. An informed client makes better use of the lawyer’s time. Farm families are encouraged to use this publication as a means of becoming informed and then to consult an attorney to develop a plan best suited to their own situation.