Loss-on Sale: Factors to Consider

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1 Loss-on Sale: Factors to Consider With home prices dropping and real estate markets nationwide negatively impacted by record foreclosures, it s increasingly likely that your relocating employees will find their homes selling for prices below their original purchase price. To overcome this issue, accelerate transferee mobility and boost satisfaction and productivity, a growing number of companies are revisiting loss-on-sale programs. D eclining home prices, shrinking demand and the subprime market crunch have increased the likelihood of sellers taking a loss on the sale of their homes. But where typical sellers can wait out slow markets, relocating employees must deal with whatever market conditions prevail when their companies ask them to move, making them especially vulnerable to potential losses. Offering loss-on-sale protection can be a critical factor in getting key talent to accept moves, especially in an anemic housing market, which is the root of most employee reluctance. As part of our commitment to knowledge sharing and thoughtleadership, WRRI has created this informational white paper to help companies better understand losson-sale policies, and the factors to be considered in developing and implementing them. Reasons for Employee Reluctance to Relocate (percent of organizations) Based on 95 companies that are experiencing problems with employee reluctance to relocate. Slowed real estate appreciation/depressed housing market at old location Old location home is in a negative equity situation 88% 93% High housing cost areas 39% Employee/family resistance to move 32% High cost-of-living areas 30% Spouse reluctance to leave his/her job 25% Undesirable areas 11% Less than adequate relocation policy 6% Employee satisfaction with current position 2% * Percentages do not total 100% due to multiple responses. 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

2 Technically, most companies define a loss-on-sale as the difference between the highest sales price today and the original purchase price, assuming no major improvements and/or incentives were built into the original purchase price. Who currently provides loss-on-sale assistance? In conducting our 2010 benchmark survey, Mobility and the Current Real Estate Market, WRRI found that 48% of companies currently provide loss-on-sale assistance. But 26% of companies provide it on a case-by-case basis, which can cause policy exceptions, a program that s difficult to administer in a volatile market, and inequities among transferees. What is considered a loss-on-sale: decreased appreciation, inability to recover the original purchase price, or negative equity? Anyone selling a home today may not recover what they hoped or expected to receive several years ago, before prices really tumbled. Although decreased appreciation or paper losses may increase reluctance to relocation, they are rarely factored into a loss-on-sale policy. Technically, most companies define a loss-on-sale as the difference between the highest sales price today and the original purchase price, assuming no major improvements and/or incentives were built into the original purchase price. (The original purchase price would be determined by reviewing the HUD statement and any original independent or lender pre-purchase appraisals that may have been conducted.) In the wake of creative mortgages and unrestrained home equity offers, negative equities are occurring more frequently. Negative equity occurs when an employee owes more on his or her home than the current market value, yet the market value may be higher than the original purchase price. To avoid subsidizing the employee for a new car or their children s college education, most companies consider just the first mortgage (not seconds, thirds, home equity loans or wraps) as documented by the original HUD and/or original lender appraisals, which clearly demonstrate the loan-to-property value. Do you have a loss-on-sale program? Case by Case 26% Yes 48% No 26% Source: WRRI s Mobility and the Current Real Estate Market survey, 2010 Although policies vary considerably, results of WRRI s 2010 Mobility and the Current Real Estate Market survey indicate that only 3% of companies will make up the difference in a negative equity situation. The largest percentage (65%) indicate that it s the employee s responsibility to absorb the loss or otherwise pay off the mortgage before the home can be accepted into a home sale relocation program. Another 27% handle these situations on a case-by-case basis by: offering company loans (exclusive of Officers who may not be eligible due to Sarbanes Oxley); paying off the difference for the employee but deducting payments via payroll withholdings; extending home marketing time in the hopes that the employee will generate a home sale bonus, or that lump sum allowances will cover the costs. (Just be sure to watch for mounting exception costs, and note that typically, the longer a home stays on the market, the greater the loss.) 2

3 Shared Responsibilities Should the employee absorb some of the loss? Advantages Decreases/controls cost to the company. Recognizes the impact of personal preferences and decisions made by the employee. Recognizes that market volatility and home values are beyond the company s control. Easier to administer in the future when prices may normalize. Disadvantages Creates dissatisfaction. May not be competitive enough. May be inadequate to overcome reluctance to relocation. May not cover the loss, resulting in rejection of the move. Won t this add to our overall program costs? Yes, adding loss-on-sale to your policy will represent a hit to your bottom line. But not providing this benefit could prove infinitely more costly, increasing reluctance to relocation, prohibiting growth in new markets, and thwarting recruitment and mobility objectives. To accurately assess the net cost impact, companies should establish a proposed loss-on-sale formula and make educated assumptions about the frequency and severity of the payments based on their unique departure locations. These costs should be compared to the amount your company is spending on cancelled moves, exceptions for extended temporary living, duplicate housing costs, household goods storage, return visits, and inventory costs. In addition, if your company has tracked reluctance to relocation, you can make some assumptions about the level of turnover or recruiting expenses your company has incurred because you don t have a loss protection policy. Should we establish a threshold or share the responsibility for the loss? Results of WRRI s 2010 survey indicates that few companies have minimum loss requirements (6%) or geographic requirements (3%) for loss-on-sale assistance. However, cognizant of the ill-advised home purchase decisions, poor financing choices, and over improvements that employees can make, many companies will not cover 100% of the amount of a loss; instead, they look for simple ways to share responsibility. One technique is to establish a threshold or minimum amount of loss that must be incurred before the company bail-out applies. This shared responsibility concept, similar to an HMO s co-pay or deductible, holds the transferee accountable for a portion of the costs associated with the loss. For example, the transferee might be responsible for the first $5,000 of the loss; after that, the transferee and the company would share equally in the remaining amount. Companies might also consider tying the amount to the final disposition of the home; 80% of the loss if the home comes into inventory or 100% if it s sold during the self-marketing period. Another alternative is a graduated level of assistance. For example: The first $15,000 is 50% reimbursed The second $15,000 is 75% reimbursed The third $15,000 is 100% reimbursed This results in a maximum benefit received of $33,750, while recognizing up to a $45,000 loss with the most significant company assistance helping to offset the costs at the deepest level of loss. Should we establish an overall ceiling or cap? WRRI s 2010 survey indicates that almost 85% of companies that provide loss-on-sale assistance establish a maximum cap. Policies vary considerably, but range from $10,000 to $200,000, with maximums at the higher end of the range attributed to companies with very high average home values (typically in excess of $1M+). These caps help to establish budget parameters and ensure consistency. The cap your company establishes should be based on your average home value and evaluated against the overall business case and justification for typical moves (not the exception to the rule). If warranted, approval for amounts that are above what is documented in policy should be approved by senior management. This allows you to minimize exceptions and implement a more equitable policy. Do you cap loss-on-sale? No 15% Yes 85% The cap your company establishes should be based on your average home value and evaluated against the overall business case and justification for typical moves (not the exception to the rule). 3

4 Should we include capital improvements in the calculation? Among the companies we surveyed, 75% do not include capital improvements in the calculation. Often, it is difficult to document the cost for capital improvements, making it more difficult to establish a total cost basis for the home (purchase price + capital improvements). In addition, if the capital improvement added living space or useful life to the property, ideally the value associated with improvements will be reflected in the appraisals, appreciated in the marketplace, and reflected in offer prices. Do you include capital improvements? No 75% Yes 25% If we do provide a loss-on-sale payment, should we tax protect the payment? The majority of companies (72%) that provide loss-on-sale DO tax protect or gross-up the payment, following their established gross-up methodology (i.e., if they gross-up for federal only, that is the level of tax assistance they would provide on this payment; if they typically gross-up for federal and state, they would apply that same calculation to this payment.) What eligibility guidelines should we implement to limit the total cost of a loss-on-sale program? When an employee is facing a loss-on-sale, they have a greater tendency to test the market and list high to minimize their loss. Yet, research shows that when a home is overpriced by 15%, it is five times less likely to sell than if it were properly priced. Therefore, the most important component to minimize the loss and total overall costs is to make sure the home is priced right initially. To avoid over-pricing and compounding costs, it is essential to establish eligibility guidelines and implement mandatory policy provisions, as follows: Use only company-approved real estate brokers. Make necessary repairs and improvements prior to listing. Require an appraisal and home inspection up front. Provide a collaborative marketing allowance aimed at buyers. Implement mandatory list price guidelines. Require list price adjustments every 30 days (as stipulated by the relocation counselor). Require a minimum marketing period (no less than 120 days) prior to accepting the guaranteed offer. Require the employee to present all offers (to the counselor). The most important component to minimize the loss and total overall costs is to make sure the home is priced right initially. Do you provide tax protection? No 28% Yes 72% What are short sales? Should we provide loss-on-sale for Short Sales? According to the California Association of REALTORS, a short sale is a sales transaction in which the seller s mortgage lender agrees to accept a payoff of less than the balance due on the loan. This may sound ideal; but, typically, the employee must demonstrate to the lender that he or she has no other assets to settle the debt, including eligibility for a company reimbursed loss-on-sale or home purchase. As a result, short sales are typically excluded from home sale programs and therefore do not qualify for loss-on-sale. 4 Some companies also link eligibility for a home sale bonus and/or loss-on-sale protection to these provisions (again, similar to using a preferred network in an HMO). When combined with an aggressive marketing plan, such Next Practice strategies will increase the likelihood of an offer and minimize the gap the company has to pay as loss-on-sale. To avoid future loss-on-sale situations, companies should also require employees to use home purchasing counseling and avoid buying new construction, which tends to be more susceptible to loss. You might require the employee to provide a copy of the lender s appraisal for future reference in a loss-on-sale situation and/or reimburse for a pre-purchase inspection and independent appraisal that can help ensure the employee is buying right in the destination and that the home isn t overpriced/overvalued.

5 Additional Resources: Please refer to these resources for additional information: National Association of Realtors Worldwide ERC at IRS Publications Publication 523, Selling Your Home Publication 544, Sales and Other Dispositions of Assets Publication 908, Bankruptcy Tax Guide Form 1040, U.S. Individual Income Tax Return Form 1040, Schedule D, Capital Gains and Losses Form 1099-C, Cancellation of Debt Research Highlights Companies that offer Loss-on-Sale 74% Cap No Capital Improvements 75% Gross Up Payment 72% Link to Marketing Guidelines Negative Equity Short Sales Conclusion There is no one-size-fits-all approach to loss-onsale programs. What works for one company will not necessarily work for another due to variances in market conditions, budgets, and needs among different employee tiers. But the evidence suggests that companies that manage loss-on-sale on a case-by-case basis tend to spend more than those companies that maintain a consistently implemented policy reflecting the Next Practice guidelines and mandatory program eligibility. A case-by-case policy can quickly translate into an expensive game of let s make a deal or name your price, with exorbitant costs mounting up for extended temporary living, duplicate housing, return visits and lost productivity for everyone involved. Regardless of the formula or maximums that are put in place, it s important to re-evaluate your loss-on-sale program regularly to ensure it meets the needs of key employees and the company s mobility goals. Finally, minimize future losses by providing comprehensive home finding assistance, mortgage counseling, pre-purchase appraisals and inspections, and discourage new home construction typically the properties that take the hardest hit in declining markets. 85% (varies widely) 80% (estimated) Case-by-case Case-by-case Loss-on-Sale Policy Recommendations Eligibility restricted to current and new hire senior/ critical level employees who have purchased in the last three years (or as a result of a company sponsored move effectively making new hires ineligible for loss protection). Defined as the difference between the sales price and original purchase price for the primary residence only, based on preliminary equity calculation. Home must meet other home sale program eligibility (i.e., must have marketable title and meet the definition of a qualified home). Loss will not include any capital improvements. Employee will share in the loss as follows: - $0-$5,000* 100% employee responsibility. - $5,001-$25, % covered by the company if home sold during self marketing period. - $5,001-$25,000 80% covered by the company if it comes into inventory. Loss payment will be treated as income and tax protected according to company tax gross-up policy. Employee must adhere to the following home sale program guidelines: - Use only company-approved real estate brokers. - Make necessary repairs and improvements prior to listing. - At least one appraisal and a home inspection will be ordered up front. - A collaborative marketing allowance will be provided (at the company s discretion), aimed at buyers. - Implement company-approved list price strategy. - Implement company-approved list price adjustments every 30 days. - Implement a minimum marketing period (no less than 120 days) before accepting guaranteed buyout (if appropriate). - Present all offers (to the counselor). * Caps and thresholds should be established based on the company s unique average appraised value and move corridors. About WRRI Weichert Relocation Resources Inc. (WRRI) provides global relocation and assignment management solutions to some of the world s most respected corporations. As the architects of Next Practices, the next generation of relocation best practices, we maintain an extensive collection of research, surveys, and trend information, which is used to help clients benchmark current programs, evaluate alternatives, and make well-informed decisions about their mobility programs. For more information, visit our Resource Library online at wrri.com Note Weichert Relocation Resources Inc. has made every attempt to ensure the accuracy of this information, and any errors or omissions are unintentional. When making any policy or program changes, we recommend you consult your corporate legal department with regard to any interpretation of applicable laws, regulations, or internal practices. 5