The Basics of Short Sales for Beginner Real Estate Investors

A short sale is not named as such based on the amount of time it takes to complete the transaction, as the average short sale can take between 3 and 9 months. Rather, it is named based on “shortening” a bank on the amount owed on a given mortgage.

Short sales are generally used when the seller is behind on payments and owes more than the property is worth.

Your goal as an investor is to gain control of the property, negotiate a discount on behalf of the seller, and purchase the property for cash. Banks will want an immediate cash transaction in exchange for discounting the mortgage. Therefore, prospective investors in short sales will need to have access to considerable amounts of cash.

Remember, the cash does not have to be yours. You may have access to good hard money lenders, private lenders, or other people’s retirement accounts. Usually it won’t be a conventional loan as banks don’t want to wait 90 days for their money when they offer a discount. But if you don’t have money or access to other people’s money, then this is not the strategy for you.

Short selling is also not the most pleasant of tasks. Talking to distressed homeowners can be emotionally draining for some people. Dealing with the sheer inefficiency of banks can be frustrating. Organizing all the necessary paperwork can also be a complicated task.

But if you have great organizational skills, patience, and empathy, then you can be a great fit for short sales.

Why would homeowners be willing to let someone else do a short sale? Well, filing for bankruptcy or allowing a home to go into foreclosure can be devastating to a person’s credit for 7-10 years.

However, having a short sale done on your home can only hurt the homeowners credit score for 2 years.

So if the homeowner is in danger of losing their home anyway, they will save themselves a great deal of money by letting an investor try to negotiate with the bank on their behalf.

It is important to note that the homeowner cannot short sale their own home, nor is they permitted to benefit financially in any way from a short sale. From the banks’ perspective, they are willing to take a loss and dispose of a non-performing asset as long as the owner does not benefit from the transaction. In this case, the bank requires a ‘lose-lose’ transaction, where both parties must make sacrifices.

This means that an investor cannot offer to split the sale price with the owner. Once the owner agrees to a short sale, they are selling the house, they are not allowed to make a profit or live in the house after the transaction.

There are other potential dangers that an ethical investor should disclose to the Seller. Except for certain conditions under the Mortgage Forgiveness Debt Relief Act of 2007, keep in mind that the IRS may treat debt forgiveness as income. There is also no guarantee that a lender who accepts a short sale will not legally pursue a borrower for the difference between the amount owed and the amount paid. In some states, this amount is known as a deficiency. An attorney can determine if her loan qualifies for a judgment or deficiency claim. Finally, the bank may decide to claim the entire promissory note by invoking the maturity at sale clause. Although these consequences are rare, it is always a good idea to inform the Seller of the possibilities.

As stated above, a large amount of paperwork is needed for a short sale. The best advice is to meet with your team, specifically your attorney and the title company, to put together the necessary forms. Also, when you first talk to the bank, find out if they have a short sale requirements packet for you to fill out. I learned the hard way that some banks have different requirements than others. Going back to a landlord and asking them to fill out paperwork multiple times is unprofessional and unnecessarily painful for the landlord. Do your homework and ask them to go through this process just once.

The following are some of the forms generally required to conduct a short sale:

o Authorization to Release Information. Form required by the bank. Seller authorizes my staff, associates, the Title Company and myself to speak with the bank, creditors and/or lien holders on Seller’s behalf. Banks usually won’t even talk to you unless they’ve received a copy of this form. Attny’s limited power. A limited or specialized power of attorney may be used in place of the authorization form. This form is ideal if the Seller is unable to attend the signing for any reason. It must be signed by both parties and notarized.

o Contract for the Sale of Real Estate. Form required by the bank. Describes the sale of the house between the buyer and the seller. Generally, it is best to use the state approved form most often.

o General Warranty Deed. A general warranty deed is a type of deed in which the grantor (seller) guarantees that he or she has clear title to real estate and has the right to sell it to you. This form is given to the title company showing that the Seller is serious about selling the property. It is in custody pending approval. His title company and his attorney can advise you when to apply.

o Authorization of payment of security deposit. If there is money left in the escrow account, this would be applied to the loan. The signed copy goes to the bank.

o Letter of Difficulties. This letter should be handwritten by the seller detailing the situation they are in and why this short sale would be beneficial to them. To validate this information, the bank will require basic financial information from the seller.

o Basic financial information. Banks will generally want to see back taxes, pay stubs, bank statements, and other financial information to determine the Seller’s financial standing. Having a template for a profit and loss sheet or balance sheet will help you to complete the collection of this information in a timely manner.

I recommend creating these forms with your attorney and having the Seller sign these forms and keep a notarized copy in your own file:

o Short Sale Acknowledgment and Disclosure Form. This form lists some of the things that could go wrong, such as the events listed above. This signed document can help you if a nuisance seller ends up paying taxes a year later and claims you defrauded them.

o Form of acknowledgment of receipt of expiration of the sale. This form states that banks, during the short sale process, may decide to declare the loan past due. Since the Seller is agreeing to sell his house and has defaulted, this bank tactic doesn’t make much sense. But it can happen. It is always a good idea to prepare the seller for the worst case scenario.

Once the bank has all the documents in hand, it will authorize a Broker Price Opinion (BPO). The BPO will determine the value of the home based on its condition and based on the market value of comparable homes in the neighborhood. YOU WILL ALWAYS WANT TO BE PRESENT DURING THE BPO INSPECTION. Why? To help influence the BPO! Point out everything that is wrong in the house. Indicate what you think is the low value. The lower the BPO, the lower the house will collect!

Once the bank receives the BPO, they will either accept your offer or make a counter offer. This part can be really frustrating for many investors! I spent 4 months in short sales only to have the bank counter my offer with a price higher than any of the comparables on the block! Banks are not always reasonable with what they ask for a house. Going back to the salesperson and telling them that the deal is not accepted, as well as the fact that you just worked 4 months for free, can be discouraging.

Now, there are ways to counter a bank. First, please provide photographs of the property showing all defects. Second, provide estimates on how much it will cost to reach market value. Third, provide any other statistics that might influence the bank, such as crime rate, foreclosure rates, average days on market for the area. Fourth, review in detail how much time and money it will cost the bank to go to the auction, and how your offer will greatly benefit them. Remember; Make it about the bank, not about you and your effort! You want the bank to give you that property for fear that they will have to repair it and keep it for a long time. Since this is not what the bank does in business, the more you focus on that aspect, the more successful you will be with your counteroffer being accepted.

Once you finally agree on a price, you can start marketing the property. During this time, you will need to arrange for the seller to vacate the property if they have not already done so. You must then acquire the cash necessary to close the deal and schedule the closing. Finally, find a buyer for the property and reap the rewards of your efforts!

The following would be an example of a successful short sale.

o Market value of the property: $200,000
o Seller owes: $210,000
o After sending all the documents to the bank and influencing the BPO, it returns with the following value: $180,000
o Bank discounts 80% – $144,000
o Investor resells within 30 days – $185,000
o Investor Gain: $41,000 less fees

Imagine doing 1 short sale a year. Would that improve your finances? How about 2 a year, or 1 a quarter? But how about one short sale a month? The potential to make money on short sales is great.

After all, regardless of the market or the economy, if you can buy a house cheap enough and market it far enough below market value, you will sell the house and make a profit! Short sales allow you to create capital where it would not otherwise exist. It is a ‘win’ for all parties. The seller is happy because he did not go through the foreclosure process and can repair his credit in 2 years instead of 10. The bank is happy because despite the discharge, he removed a non-earning asset from his account and can start lending plus. And you are happy because you successfully made a profitable transaction!

So if you have an empathetic personality and great patience and organizational skills, this may be the perfect strategy for you!