DISTRESSED PROPERTIES are a big part of the modern real estate market. They can be confusing, frustrating and time consuming if you don’t have the education and guidance you need to understand how they work.
1) SHORT SALES
If a homeowner is unable to make their mortgage payments (in “default”), they will be facing foreclosure (where the bank re-possesses the property as per the agreement when the loan was made). One option to a homeowner facing foreclosure is to sell the property before it is foreclosed upon. Because of market conditions over the last few years that have caused a decline in value since many people bought their homes, in many cases, the market value of the property facing foreclosure may not be sufficient to pay off the entire debt the property secures. In such a situation, the homeowner must either bring sufficient money of their own to closing or convince one or more creditors (lenders) to accept less than the full amount that is owed. A sale contingent on the agreement of creditors to accept less than what they are owed in order to sell the property is called a “Short Sale.” An offer made on a short sale will typically be accepted by the seller, and then submitted to the lender for approval.
The notorious uncertainty that comes with Short Sales stems from 3 main things:
- The lender may never respond or may take an unacceptable amount of time to do so.
- The lender has no obligation to agree to the terms that have been offered. They may eventually respond, only to demand a higher purchase price, or debt forgiveness terms that the seller cannot agree to.
- The lender will rarely agree to any repairs, so even if the transaction moves forward, you may hit a wall if you find something wrong with the property that is beyond your scope to handle.
It is also sometimes possible that a homeowner is not in “default” on their mortgage, but is still in a situation where they MUST sell the property, and its decline in value puts them in a short sale position. These situations can make the process even more difficult, as it is nearly impossible to convince the lender that a short sale is in their best interest when foreclosure is not imminent (more information on this in the next section). When a buyer makes an offer on a Short Sale property, it is contingent on the lenders’ approval, and the buyer faces no risk if the lender does not respond or rejects/counters the offer made. Short Sale offers are structured so that no earnest money is due, no inspections are completed, and all normal contingencies of the sale agreement do not begin until approval from the lender(s) has been received in writing. We advise our clients to pursue Short Sale properties if they are able to remain objective about the process, and strongly encourage continuing to look, as a Short Sale offer may be withdrawn at any time if another desirable property is found.
2) FORECLOSURES/BANK OWNED/REO
Once the foreclosure process is complete, the bank now has ownership of the home. There are many terms that refer to property in this category – Foreclosures, Bank Owned Homes, and REO’s (Real Estate Owned).The most accurate/useful term, and the one that we will use, is Bank Owned. Once a home is Bank Owned, it is the lenders’ primary goal to sell the property as quickly as possible. It is important to note that the reason that a lender may agree to a Short Sale is because of the costs that they will incur during foreclosure. There are legal fees, holding costs, and often, some money that must go into preparing the property for sale. In many cases, the lender will agree to the Short Sale because they consider the loss that is on the table to be less than what they may face down the road in and after foreclosure.
There are two basic ways that a lender will usually sell a bank owned property :
3) AT AUCTION
When a property is first re-possessed by a lender, they often conduct an “auction” sale at the County Courthouse, where qualified bidders may purchase the property on the spot. Due to the nature of this process, excellent deals can be obtained, but you must bring cash, and be willing to purchase property without having inspected it in any way (lists of properties to be auctioned can be obtained from public records, so you can usually at least do a drive by).
4) ON THE MARKET
When the property does not go to auction or does not successfully sell at auction, the lender will put the home on the market through typical means. They usually have relationships with pre-selected real estate brokers who handle a large volume of Bank Owned properties. The home is usually “fixed up” as little as possible to make it presentable (new paint, etc.). Unlike a short sale, when a Bank Owned property goes on the market, the list price HAS already been approved by the lender. With the exception of a few extra hoops to jump through, and more extensive paperwork, if you make an offer on a Bank Owned home, the process is similar to dealing with a regular, non-distressed seller.
The biggest downside of buying a Bank Owned home is that the lender usually will not complete any repairs, just like a short sale. Occasionally, if there are defects with the property found that prevent financing from moving forward, certain items may be negotiated, but even that is not a guarantee.