BEWARE OF PHANTOM EQUITY!

BEWARE OF PHANTOM EQUITY!

Tips to Prevent Your Clients' Financial Future Become a Real Estate Horror Story!

For years, the equity in the marital home has been used as a bank when negotiating divorce settlements. It's understandable. Divorcing couples are counting on that equity to build their nest eggs, purchase their next homes, support their children, and sometimes even pay their attorney's fees. What if there is not enough equity to pay these obligations? Now that's a scary thought!

Here's the problem: If the home hasn't sold when the divorce is negotiated, we don't know what it's actually worth. We can estimate its value, but we can't know what a buyer will ultimately pay. And without knowing the sales price, how can we know how much equity will be available?

In my 15 years in the real estate trenches, working with divorcing clients, I've seen just how frightening the consequences can be.

I've lived this nightmare myself! During my own divorce, my home represented a comfortable nest egg. Then came the real estate crash. By the time I sold (post-decree), my home was worth roughly 30 cents on the dollar. Seventy percent of what I thought I had was gone!

I hope we never experience that kind of market crash again. But real estate is cyclical. Markets rise, markets fall, and the value of a home when a decree is signed may be very different from its value when the home finally sells.

And that's how Phantom Equity comes back to haunt us!

A Real-Life Horror Story

Home Valuation (pre-decree): $500,000

Home Sold (1-year post-decree): $365,000 – due to the poor condition and market shifts

Loan Payoff: $315,000

Expected Equity: $185,000

Realized Equity: $50,000

Phantom Equity: $135,000

The Scary Truths: What's Haunting Your Equity?

Banking on an Unknown Future: Homeowners and attorneys may rely on anticipated equity to fund a financial settlement. But until the home sells, that equity is only an estimate. What happens when the money simply isn't there?
Skeletons in the Closet: Divorce homes often fall into disrepair, especially when months or years pass between separation and sale. Deferred maintenance, outdated interiors, and unfinished projects can substantially affect value. And there are rarely perfect apples-to-apples comparables. You need to know how the home's actual condition compares with recently sold homes and those currently competing for buyers.
An Unpredictable Market: Real estate is cyclical. A home purchased at the height of the COVID-era market may not command the same price today. Buyers' expectations, inventory, interest rates, and market conditions can change dramatically before the property sells.
Those Scary Investor Offers: Sellers often call them "lowball" offers, but investors aren't necessarily the villains! They can be the solution for homes needing substantial repairs. Investors must account for renovation expenses, carrying costs, risk, and profit. They don't work for free! Meanwhile, many traditional buyers prefer to pay more for a beautifully remodeled, turnkey home rather than take on a project. And homes in poor condition may not qualify for certain financed purchases, making cash investors an important part of the buyer pool.
Appraisals: A Snapshot, Not a Crystal Ball! Appraisals have their place in divorce, but after six months, their valuations may be dead and buried! Appraisers rely on statistics and adjustments, while experienced Realtors understand buyer behavior. An appraiser might deduct $20,000 for a home's condition, but buyers may see $50,000 in repairs—or simply walk away!
Frightening Online Valuations: Zillow and other automated estimates can't reliably account for deferred maintenance, the home's actual condition, or the circumstances surrounding a divorce sale. Don't let an online estimate become the ghost of equity that never existed!
The Wrong Realtor Can Be a Nightmare: Some Realtors recommend inflated listing prices simply to win the listing. An experienced, divorce-savvy Realtor understands how disagreements, court orders, property condition, and market realities affect the sale. An unrealistic listing price can lead to months of delays, reductions, and disappointing results.
When the Equity Can't Cover the Decree: Here's a frightening scenario I'm seeing more often. The decree provides for reimbursements, offsets, or other payments from the sale proceeds—but the home sells for less than anticipated. What happens when there isn't enough equity to cover those obligations? Who gets paid? Who doesn't? And where does the money come from? Those questions should be considered before the decree is finalized, not when the title company is trying to close!

Tips to Keep Phantom Equity from Haunting Your Clients!

Attorneys will continue using anticipated home equity when negotiating divorce settlements. That's not going to change. But there are ways to help protect clients from the unknown.

1. Hire a Realtor Twice!

First, when negotiating or mediating the divorce, obtain a realistic Broker Price Opinion (BPO) from an experienced Realtor or consider an appraisal. Understand the current market, the property's actual condition, and a reasonable range of potential sales prices. Ask for both best-case and worst-case scenarios.

Then, when it's time to sell, hire a Realtor who understands divorce real estate. These are two different jobs, and both are important!

2. Don't Let the Wrong Realtor Haunt the Transaction!

A divorce real estate transaction isn't an ordinary sale. Court orders, disagreements, timelines, reimbursements, and offsets can all affect closing.

While Realtors aren't responsible for providing legal interpretations of decrees, they should understand the real estate provisions, recognize issues requiring clarification, and know when to involve the attorneys.

I've developed the Real Estate Divorce Specialist AZ (RDS-AZ) designation to train Realtors on these very issues. You can read more about that in my article on RDS-AZ.

3. Have a Plan When the Equity Disappears!

What happens when the net proceeds aren't sufficient to pay the reimbursements and offsets ordered in the decree?

Consider addressing that possibility in the decree itself. Who is responsible for any shortfall? How will disputed funds be handled? What happens if the home sells for less than anticipated?

I'll address possible decree language in another blog. But the important point is to plan for the nightmare before it happens!

4. Consider Bringing in a Real Estate Special Commissioner.

When the parties can't agree on pricing, repairs, offers, or other matters affecting the sale, a court-appointed Real Estate Special Commissioner may help move the transaction forward.

Depending on the circumstances and authority granted, a Family Law Master or an agreed-upon arbitrator may also help resolve disputes before they derail the sale.

5. Beware of the Title Company Nightmare!

Here's another story from the trenches: I've actually had a title company tell me they weren't bound by court orders!

Title companies are becoming increasingly cautious about interpreting decrees, following disbursement instructions, and holding disputed proceeds. Some may decline to hold funds even when a court order contemplates a holdback.

That can create a frightening surprise just days before closing!

Attorneys should consider discussing anticipated disbursements and any holdback requirements with the selected title company early in the process. Don't assume the title company will interpret the decree or handle disputed proceeds without additional instructions or agreement.

6. Give Your Clients a Roadmap Out of the Haunted House!

Once the decree is final, consider providing your clients with a summary of the real estate provisions, especially if you're withdrawing from the case.

You might highlight the relevant paragraphs in the decree or Rule 69 Agreement, or prepare a short letter identifying the listing requirements, deadlines, mortgage and repair obligations, equity division, reimbursements, and offsets.

I've found that many clients simply don't understand what their decrees require. And occasionally, a party may prefer to overlook an obligation they'd rather not fulfill!

A simple roadmap can help the Realtor, the clients, and ultimately the title company understand what needs to happen to get the home sold and the proceeds distributed.