Understanding the Short and the Long of it: Short Sale 101

“Short Sale” doesn’t have to be a set of dirty words.

Sure, the process has gained a sour reputation since the housing recession, but there isn’t anything wrong with doing it if you do it well.

To simplify it, a short sale is, “a sale of real estate in which the net proceeds from selling the property will fall short of the debts secured by liens against the property… If all lien holders agree to accept less than the amount owed on the debt, a sale of the property can be accomplished [netting you a profit].”*

This is not a new strategy. It’s been a buzzword since the recession of 2008, but many investors are beginning to shy away it thinking that it’s an outdated strategy. They’re wrong.

If you’ve ever wondered about short sales–what they are and how you can benefit from them–consider this a lesson in Short Sale 101. A short sale is nothing more than a specified bid at a foreclosure auction done months in advance. Let me explain…

There are two types of bids; full debt bids and specified bids:

1- FULL DEBT BID. The opening bid is everything the homeowner owes the bank. It is the total debt bid you pursue in the strategy of an equity deal.

and

2- SPECIFIED BID. The opening bid is lower than what is owed, and though the bank is not guaranteed to get what is owed on the house. They know this but also do not want the house back.

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Let’s say $220,000 is owed on a property that went into foreclosure. It’s worth $180,000 in its current condition, but the opening bid is $60,000. There’s a big difference between $60,000 and $220,000, and a where the bank loses, the bidder could win. Now, the bank is legitimately willing to let the property go for $60,001 because there’s no guarantee that the bid will go any higher than the opening bid. Unfortunately, the problem with the specified bid is your abundance of competition.

Years ago, I saw the opportunity in this bidding structure but wanted the ability to buy at $60,000 without other bidders driving the price up so much that I made less and less profit. That’s where the short sale came in.

In most markets, a foreclosure process typically takes anywhere from 90 days to 180 days. And in judicial markets, like Florida and Georgia, the process can take 12 to 18 months before the property ever arrives at auction.

If you know a house is going through this process, you can wait until the process matures and jump in at auction time, or you can be proactive and pursue the property before anyone else.

Foreclosures typically begin 90 days before the sale and from the beginning, they have to post some type of notice. “Lis Pendens” or “Lean Pending Filing” (this is the bank suing the homeowner to regain possession of the property) or in a non-judicial market where they begin with a notice of default filing.

Whether it’s a lis pendens filing or a notice of default, this is a notification to you as an investor that this property is in trouble, and unless something changes over the next few months, the homeowner is going to lose the farm. A lot of homeowners going through this process have no idea what the process is or how it affects them. This is where you swoop in as the alley to the homeowner and create a win-win situation where you can help the homeowner lose the house to foreclosure, but you can buy that property at the specified price.

Pros:

– You can help a homeowner stay in the home longer than if the home went into foreclosure.
– Often, you can help the homeowner lower their payments through modification and increase their equity in the house.
– You can inspect the interior where at auction you can’t do that.
– It requires no rehab in the homeowner stays in the property
– You don’t need all cash.
– You don’t have the competition of other bidders.
– We can charge higher than market rent by renting back to the homeowners (not legal in all markets, so check before pursuing this strategy).
– The tenant pays all of your mortgage which = positive monthly cash flow.
– Best of all, you’ll have instant equity in the property and plenty of options if any of the cons below happened…

Cons:


(You’ll see these are similar to any property you would buy and rent out)
– There is a possibility that the tenant doesn’t pay you.
– The tenants could trash the place.
– Or the tenants could abandon the property, leaving you without a renter (until you got another one).

Now, as you’ll see, this is a pretty short list compared to the list of pros. And there are other cons that you would need to consider if you pursued a bank loan or conventional financing to purchase a short sale; such as the bank requiring a BPO, or Broker price opinion, or having to wait several months while the banks call the shots on your financing, which can be frustrating! But, you can often get private money for these short sales, seeking out competitive terms and interest.

So what are the advantages of short sales?

There has been a lot of negative press about short sales because yes, they have changed their guidelines and short sales have become a lot more cumbersome from the standpoint of buying and investing in them. But you can still benefit from this opportunities and do it well.

 

Here are a few of my rules for short sales.


Number 1: It cannot be listed.

Do not come to me with a listed short sale expecting for help. Here’s why. If you are a homeowner who’s losing your house and you owe $250,000 on it, and the fair market value on it is $200,000, clearly you are $50,000 under on the deal. An unknowing, uneducated, unskilled, and untrained agent is going to do what they learned to do in real estate school, which is list it for the fair market value. So they’re going to price it at $199,900. This won’t benefit you.

As you know, the foreclosure timeline is 90 days. If you list a property at the full market value in a market that has a 120 day marketing time, it’s going to take you four months to find somebody willing to pay $199,900. When you are dealing with a listed property where the agent has listed it at fair market value, you have killed any chance of negotiating with the homeowner for a lower price. It has been anchored too high.

When you now submit an offer on this deal for $100,000 and the bank receives your offer, they go, “Okay, you listed it for $199,000, and you’re offering us $100,000? That’s fifty cents on the dollar. No way.” Banks don’t understand or appreciate real estate investors, and the last thing they want you doing as an investor is making any money off of them.

You need to control the listing, and you need to find an agent willing to work with a real estate investor creatively.

 

Number 2: Always list low.

 

There is a theory in business, as well as in negotiation, called “anchoring.” This is where your anchored price dictates the mental state of the person receiving the offer. In other words, wherever you “anchor” the price subconsciously locks in the expectation of the seller via the corresponding offer.

Let me tell you what I mean by this.

If we take the same house that has a fair market value of $200,000, list it for $99,900 and attach a corresponding offer for $99,900 cash to close three days.

Now the bank is looking at:
1. The amount that’s owed, which is $250,000;
2. The fair market value of $200,000;
3. The list price of $99,900, and;
4. A full price cash offer also for $99,900.

In this scenario, we have offered the bank 100% of asking price. If you’re a bank, what sounds better to you? Do you want 50% of your asking price, like in the first scenario, or do you want 100% of your asking price like in the second scenario?

“Well, Lee, all you did was reduce the list price, so the full price offer looked like the 100% financing.”

I know. Brilliant, right?

But if it’s already listed, you can’t do that. If you come to an agent who listed this property for $199,900, you can’t ask them to come down on the listing to $99,900, because there’s a thing in the MLS called “listing history.” Any agent, any appraiser, any investor who knows what they’re doing, is always going to go in and check the listing history of the property. If I see that yesterday there was a $100,000 price reduction in the listing, it looks fraudulent, and it’s going to flag the deal every time.

If you have ever wondered, “Why won’t they fund a listed property?” It’s for this very reason. When an agent lists a property, they anchor the price too high so we can’t get the bank to accept less. Also, if you buy a listing that was listed high and you get it for $140,000, that listing still exists. However, if you do it my way, they are going to see that it was listed for $99,900 and you bought it for $99,900. Now, when you go to turn it around and sell it for more, it shows that you paid full retail value, you’ve now fixed and cleaned it up, and now you’re selling it for close to that $200,000 price point.

It simplifies the process.

If you went to the seminar that said, “Go find yourself a good agent and write offers on a bunch of REO’s, listed short sale and bank owned property,” you went to the wrong seminar. If you are looking for leveraged financing, where you have a partner or a company like ours, come in and fund the deal for you, you can’t be going after already listed properties. You must be pursuing properties that we call “off-line.”

So in light of all this, why consider doing deals on short sales? The pros for a short sale is that you can inspect the interior. Frequently, they need no rehab because people already live there. You can get bank financing. In an auction play, if you’re going to go down to the courthouse and buy it, you have to have cash. You can’t get financing for that.

You can charge higher than market rent if people want to stay in the property. The tenant pays all the mortgage so you can acquire wealth without money out of pocket to service the debt.

The bottom line is there are multiple ways to find a good deal. If you think finding a short sale property is right for you, do your research and go for it. We’ll be here to offer a financing option for you when you do.

To Your Success;

Lee A. Arnold

CEO

The Lee Arnold System of Real Estate Investing

Follow me on Twitter: @CogoCapital  and @LeeArnoldSystem 

*https://en.wikipedia.org/wiki/Short_sale_(real_estate)

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