Market's Down—Short Sales Are Up (Part 1 of 2)

by Bernice Ross, Ph.D. MCC
Owner, Teleclass4U.com, LLC and RealEstateCoach.com

Copyright © 2006
RealEstateCoach.com and Teleclass4U.com
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Have you ever closed a short sale? If you've been in the business for less than ten years, this may be an entirely new term for you. It's also one of your worst nightmares as both a listing and selling agent.

A "short sale" refers to a situation where the seller lacks sufficient equity to close their sale. When this occurs, the seller must contribute additional funds or ask the lender to reduce their loan amount in order to close the sale. As you might imagine, earning a full commission under these circumstances can be extraordinarily difficult.

Short sales normally occur in flat or declining markets. It's also common when large numbers of buyers have purchased with no money down. In 2005, approximately 40 percent of all sales closed with nothing down. Virtually all of these loans are adjustable rate mortgages. If the loan readjusts and the sellers cannot afford the increase in payments, the loan will become delinquent. Most sellers in this situation will attempt to sell their property. Assuming a six percent commission and two percent in additional costs, the sellers of a $200,000 property would have to come up with $16,000 in closing costs. If these people were unable to come up with a down payment, the odds are extremely high that they will be unable to come up with enough money to close the sale.

Typically, when a seller is upside down (i.e. they owe more than the property is worth), one of the following scenarios results. First, the owner may try to sell the property without representation. In a depressed market where there is a large amount of inventory, chances are slight that the seller will be successful. The second approach is to allow the property to go into foreclosure. Depending on the state, the seller may pick up six to nine months of "free rent" by not paying their existing mortgage. Once the lender completes the foreclosure proceedings, they still may have to evict the delinquent seller from the property. This may take an additional 30 to 60 days. The third scenario involves going to the lender and asking the lender to lower the amount that they would have normally required to close the sale.

It's extremely difficult to persuade lenders that they should reduce their loan balance to close the transaction or that they should be responsible for paying the closing costs. Their typical reaction is, "We'll just foreclose on the property." I had a blatant example of this when I had a short sale escrow with a property in Malibu. The day after the Malibu fire, the lender turned down our request for a short sale. Their reasoning was that their comparable sales showed that the property was worth more. I persuaded them to take the short sale by sending them the pictures of the comparable sales. They had all burned down. Furthermore, the tenant, who moved out the day of the fire, took all the fixtures including the toilets. Clearly, the property was no longer worth what it was before the tenant trashed it and 80 percent of the neighborhood burned to the ground.

Persuading the lender to pay the commission is also a challenge. The best approach is to make the following argument:

If you foreclose on the property, you will achieve the highest possible price in the shortest period of time by listing with a top agent. This means that you will pay the commission anyway. Given that sales are declining and that inventory is increasing, it may take a number of months to sell the property. This means that you will have the commission costs, several months of holding costs, and a possible loss in value because of the substantial amount of competing inventory. Selling now may actually net you more money than waiting. Would you prefer to lock in a sale today or would you prefer to wait and perhaps take even less for the property?

Any time you speak with a lender, it's critical that you have hard statistical data to show them. Your data should include how much inventory is on the market, how much the inventory has increased or decreased in the last six months, as well as whether prices are increasing, decreasing, or staying flat.

With almost 9,000,000 loans readjusting to a higher rate in 2007, there will be an increasing number of people who cannot afford to make higher loan payments. Foreclosure rates are continuing to climb. If you want a steady stream of business during a market downturn, learning how to negotiate short sales can be a lucrative source of business. Representing sellers who have little or no equity is not for the faint of heart, however. If you're ready to tap into a difficult but lucrative market, see next week's article, "When Markets Go Down, Short Sales Go Up", to learn how.