foreclosure forecast February 2007

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Marketing Mania
Author: Alexis McGee



Short Sales: Don't Waste Your Time

by Alexis McGee


Does this sound familiar?

"With the latest in discounting techniques, you will learn how to steal
properties from the banks and create giant profits for yourself"
Welcome to the newest twist in Guru Marketing: "Short Sales, The Hottest Topic in Real Estate Investing Today." (Hot topic for WHOM, I wonder?)

Not a day goes by that I don't get an email asking me about short sales...

"Alexis, how do they work? Do you do them? Are they the "best way" to find a deal?" and so on. Before I answer those questions, let me give you a bit of background on banks and foreclosures.

So what are Short Sales?

A short sale occurs when a lender agrees to write off the portion of a mortgage balance that's higher than the value of a home. A buyer must be on hand and ready, willing and able to purchase the property.

Why would a lender do that?

It would seem simple. Banks are in the business of loaning money, not managing and selling real estate. Although they may seem quick to pull the foreclosure trigger, they also want to minimize their holding expenses and any losses.

One way to accomplish this is to sell the property through the Short Sale process, to keep from owning the property (aka: REO property) through foreclosure. If they do nothing, and let the property go through foreclosure, they will end up owning a property they didn't want in the first place, along with the costs of the foreclosure process, and holding expense as long as it's on their books.

But there is more to it than meets the eye.

When I first started in the foreclosure business in the late 1980's, most banks didn't have a REO (real estate owned) department. Forget about a Short Sales department, they just didn't exist either. Any bad loan simply went back to the loan officer, as a form of punishment. Great idea huh?

That poor loan officer (aka: REO asset manager) had to do it all. They had to foreclose on the property, hire the team to fix it up, manage it, and then sell it. As an REO property they had more time and costs invested, and often times sold their properties for a bigger loss than if they had "cut their losses" by doing a Short Sale in the first place.

At the same time, during the late 1980's, our real estate markets were in a mess, with a banking crisis, rising interest rates, falling property values, and a new tax reform act to swallow.

But back then; lenders just weren't as organized as they are today. They did the best that they could. I was thankful for that. I bought a ton of property at very deep discounts. Banks wanted cash and "as is" quick sales. And for that, I got tremendous deals. Those were the days....

Fast forward to 2007.

Banks now have full Short Sale and REO departments and are ready and able to facilitate deals in the best interest of their bank. They have agents doing BPO's (brokers' price opinion) for them, as well as doing all their legwork. They work their agents to death, get their houses on the market quicker and sell their houses for close to full market value.

Yes, Banks are our competition now! (Read more about this here.)

What does the current surge of foreclosures mean?

Foreclosures are up pretty much everywhere in US. On average we have 51% more foreclosures now than we did a year ago. More foreclosures mean more investment opportunities for investors. It also means in some of our over priced and over supplied markets have seen price corrections and an erosion of equity.

And with less equity, fewer owners in default are able to borrow their way out of trouble. These owners will be faced with doing a Short Sale or letting the property go back to the bank as a REO foreclosure.

BUT.... Short Sales Are Not Worth Investors Time.

Yes, the Short Sale can offer a softer financial landing than bankruptcies or foreclosures, provided you survive the turbulence on the way down.

But, what no "Guru" will tell you is the truth about the tasks required to get a short sale approved, or the likelihood that your wholesale price will not be accepted.

Short Sales involve much, if not more paperwork than the original mortgage application itself. Plus, it is an extremely difficult real estate transaction for a consumer to get approved. What really surprises me is how many agents have listed homes as "Short Sales" on the MLS. But when you ask these agents if they’ve received the banks approval for the Short Sale, their answer will be NO! Now look at what has to be done, and why would any buyer want to go through this?

1. Tons of Paperwork:

Instead of the owners proving their credit worthiness and financial stability, as they must to get a loan, they now must document that they are broke. They must be without cash flow, and have no other assets, including savings, investments, trusts, liquid retirement funds or other finances to tap. Wait until you see the list of papers the homeowners will need to accumulate to prove they are worthy of doing a short sale. It will boggle your mind.

2. Fraud from the Past:

Ironically, while they are proving their insolvency they may also reveal the dark under side of their original loan application. Their insolvency today could be rooted in financial trouble that began before they purchased their home. That spells trouble if they didn't reveal things to their lender in the beginning, and who could now consider their tight lips at the time of application to be fraud from the past.

3. Those who will Stand in Your Way:

Property encumbered by a junior mortgage will likely kill a short sale deal, because the second lender often won't remove its lien and risk losing its investment. A private mortgage insurance holder will also want to protect its interests.

4. No Wholesale Deals:

Before the owner can even approach the lender they must have a firm "market value" (you read correctly here that no "wholesale" deals will be accepted) offer from a qualified buyer (that means you must be rock solid financially) and a broker who can negotiate the deal (like there's room to pay a commission).

5. Deficiency Judgments:

Whether a deficiency judgment is available depends upon a number of complex criteria. A "deficiency judgment", generally speaking, is the amount of money owed by the borrower after the mortgage holder forecloses on the property.

In non-purchase money loan situations, the borrower must carefully analyze the risks faced, including the possibility of a deficiency judgment, when negotiating with the lender. Borrowers, incorrectly, often believe that a lender must allow a short sale and/or short refinance if the property has negative equity. Of course, the lender has no obligation to agree to a short sale or short refinance.

6. Adverse Impact on Credit Rating and Short Sale Service Companies:

One of the more serious concerns many borrowers have is that their credit will be ruined by whatever action they take. In recent years, many borrowers with "negative equity" are persons with previously good credit. For them, defaulting on their loan and giving a deed in lieu of foreclosure or allowing a foreclosure may be unacceptable. Unfortunately, many lenders are not responsive to a request for a short sale from such borrowers, insisting that they will only discuss a short sale if and when the loan is in default. For borrowers with good credit, a short sale may be the best way to proceed particularly if there is little or no tax consequence. Many of the companies providing services via acquiring property with negative equity provide mechanisms that are designed to mitigate credit problems.

The most typical technique is to transfer the property to an entity created for the purpose and allow the property to be foreclosed or deed the property in lieu of foreclosure in the name of that entity. The transfer, of course, often creates a default under the due-on-sale clause in most lender's mortgages unless consent to transfer is obtained, an unlikely event. Most companies which provide short sale services to homeowners arrange for or provide a letter to credit reporting agencies or future lenders stating that the homeowner was not the owner of the property at the time of default, foreclosure and/or deed-in-lieu.

Similarly, as debtors are permitted by law to put explanations into their credit report regarding derogatory entries, many short sale companies and attorneys take advantage of this by explaining the borrower was not the vested owner when the foreclosure etc. occurred. In many instances, such letters of explanation are legitimate and have been accepted as a valid explanation by the lending and credit community. However, as these explanations become prevalent through companies providing short sales or negative equity property disposal services, the acceptability of such explanations may diminish or evaporate.


7. Tax Bill Nightmare:

One of the major concerns which exist with respect to short sales is the issue of income tax consequences. Many real estate investors over the last two recessions have been shocked to learn that, when they sell or convey real property where the mortgage exceeds their tax basis, the sale or transfer of that property results in taxable gain to the extent there is mortgage debt in excess of basis. This is true even though the owner receives no cash from the sale and even though the property is lost through foreclosure proceedings or a deed in lieu of foreclosure.

Thus, when there is a deed in lieu of foreclosure or foreclosure sale of a property with a mortgage in excess of basis, the now-former owner still owes taxes on the capital gain just as if a third-party sale had occurred.

8. The Rational is Simple:

A borrower cannot be allowed to pull his equity out (i.e., capital gain) through a loan and then dispose of the property by deed in lieu foreclosure or foreclosure without paying taxes on the capital gain already realized from the property. Thus, rather than taxing the borrower when equity is cashed out through a loan, the IRS defers the taxable event until the property is sold or conveyed. Similarly, in short sales, the homeowner will often have tax liability to the extent there exists mortgage debt in excess of basis.

In addition, lenders will write off the difference between their loan balance and the amount they actually received in the short sale. As such, the lender will issue the homeowner an IRS form 1099 for the difference. Potential income consequences may create a greater economic burden to the borrower than continuing to make the monthly payments on the property, even though there is negative equity.

Wow! Where's the good in that? If you believe in the Golden Rule as I do ("doing unto others as you would have them do unto you"), then Short Sales are NOT for you. After 20 years in the foreclosure investing business, I know there is a better way.

Get yourself up to speed, and find out how here.

Until next month, happy investing!
Alexis :)









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