A client recently contacted me about a short sale in the Cleveland market that seemed to be priced way below market value. After digging into the listing info, I found a fairly typical approach to marketing these properties, which rarely benefits a buyer.

As you know, short sales occur when more is owed on the mortgage than the property is worth. The owner cannot make the payments, or from an economic perspective, sees that it makes no sense to continue making the payments. I won't discuss the ethical aspects of that particular decision, but it happens.

The concise version of a short sale is: The owner stops paying the mortgage; the property is listed for sale in the MLS; offers are solicited, and one is submitted to the lender; the lender requests info on the owner's financial situation to determine if the ability to pay exists; the bank obtains an appraisal of the property to see if the market value is in line with the offer; The bank loses the paperwork at least once, causing the process to restart; the bank may counter the offer, but at some point, a deal is reached, and the sale proceeds; the owner cannot receive cash at closing in any way, for any reason. Title transfers, and the deal is done.

So, where does a short sale go off the rails?

The property is listed far below market value to drive offers, hoping that the potential buyer will meet the bank's counter-offer. It also acts as a lead generator to bring in potential buyers.
A variation on the lowball listing price is the "auction" process. A property is supposedly put up for "auction" to the highest bidder; since it's a short sale, it's simply a way to solicit more offers and find new customers. It used to be that banks would set their bottom-line pricing (essentially pre-approving a short sale), but that practice rarely happens.
The short sale takes forever to complete. I have managed short sales that took more than a year to get to closing, and I have managed short sales that were all done in 3-4 months. The process depends on a myriad of factors coming together in a strict timeline. The year-long sales usually occurred because the bank lost the paperwork or the buyer was borrowing to buy, and the property didn't appraise, requiring it to be re-listed.
Obscene fees are charged by the listing agent or the short sale negotiator. When short sales were in high volume, it was typical for a title company to have a negotiating person who handled the bank's communication for a small additional fee. Sometimes attorneys got involved for a somewhat higher fee, but overall, I think the general cost of short sales was $500-$1,200 depending on the length of time they ran. Unfortunately, various players realized that there was money being left on the table, and the fees started going up - way up. I recently saw a short sale that required the buyer to pay a non-refundable deposit when the seller accepted the offer, plus a $3,000 "short sale fee" at closing. Since most short sale negotiations happen online through various portals and require very little in the way of time, there is no basis for the excessive fees I see being charged to buyers.
Even my complex short sales (when I was actively doing them) took maybe a max of 8-10 extra hours over the normal listing agent business, so I was fine just providing the service. Since title insurance is so profitable for the title companies, it made sense to offer the service with a modest fee structure to get the business in the door.

For any buyer, one of the risks of a short sale is the lack of incentive for the owner to maintain the property beyond subsistence levels. If a tenant is in the property, that can be a problem because the owner will still collect rent without providing any but basic services. The result is the investor inherits a hostile tenant or a property that needs excessive repairs. Since the short sale property is probably occupied, it's difficult to deep-dive into potential repair and maintenance issues.

The optimal way for a realtor to handle a short sale is to list it at a price that's in the ballpark of where the property will appraise so that it's more likely the bank will accept the offer. For the investor, doing as thorough inspections as possible to document costly repair issues afford the chance to negotiate a reduction with the bank because of those problems. If the property starts below market, forcing the bank to expend resources to negotiate the price up, they will be less likely to turn around and let the price fall. As with any investment purchase, understanding all the underlying risks is key to becoming a viable property.

Last word: We use the term "bank" as the target of the short sale negotiation, but in reality, there is rarely a "bank" on the other end. The initial contact for short sale negotiations is either a third party hired to handle the interaction or the entity that is servicing the loan. In fact, the original loan was sold off the day after the purchase closed and was probably sold multiple times thereafter, so the entity that actually owns the note is a construct - a trust or a fund or Santa Clause with no human face. I have conducted negotiations with third-party companies acting on behalf of the servicer, operating based on the noteholder's redemption parameters. It would take weeks for answers to questions to come back because the communication process was so convoluted, plus it was common to have the person who initially engaged in the negotiations on behalf of the lender leave the company or transfer out, so you'd end up with a new person, new approach, new hostility, etc. Frustrating.

Bottom line: Don't dismiss short sales as a way to acquire income property, but don't make them your primary focus. They should be an ancillary part of your strategy, not the main focus.

Cleveland, Ohio

1 Vote