Short Sales - What is it, and what does it mean for real estate investors?

Short Sales - What is it, and what does it mean for real estate investors

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Most short sale transactions involve the investor finding a motivated seller, engaging the seller, negotiating an offer with the lien holder(s), and hopefully selling the property to an end-buyer for a nice profit. The steps can look something like:

1. Find prospects, through marketing, networking, etc

2. Talk to a homeowner-via phone

3. Analyze the deal (pull comps, etc) and guess if "big" enough to not lose money

4. Drive to the property

5. Inspect the property

6. Expend time to "sign them up" and maybe "get the deed" and maybe "record the deed"

7. Gather bank required short sale documents-via email or snail mail

8. Negotiate short sale debt with bank-via phone, fax, email, etc.

9. Stage the property (if vacant) and sweat until offer is presented

10. Attend closing

Recently I was working with a client who was facing foreclosure. They had been working with their lender on performing a loan modification. According to the bank representative, their income ratios were not sufficient to do the modification.

Therefore, our focus was to stop the pending foreclosure by conducting a short sale. I asked the homeowner how many loans she had on the property and she responded, one. Next I asked if this was basically a 100% first-only loan, and she replied yes.

The next question was critical--Do you have PMI (Private Mortgage Insurance) on this loan?

This homeowner, like most I work with, did not readily know the answer to my question. I told her to call her lender and ask. Sure enough, their single loan had PMI. I responded: Unfortunately, I think a short sale on this property is unlikely (keep in mind, I have closed over 100 deals).

And here's why...

This property was purchased at the peak of our real estate market in 2006, for about $300,000. Also, remember there is one loan of about $300,000. PMI normally insures for up to 80 percent of the loan amount. (It is the 80/20 financing that was brought about to eliminate the need for the PMI.)

This means that the lender can collect about $240,000 (300,000 * 0.80) if the property is foreclosed. In our short sale scenario, I was guessing a "retail" offer would come in at around $200,000-$220,000, given our buyers' market in Denver. Plus, the lender normally has to cover all of the short sale closing costs, say another 8 percent. So with our theoretical short sale, the lender would be looking to net about $202,000 ($220,000 * 0.92). Our offer could quite easily be lower, since the property's area is flooded with foreclosures.

Obviously the lender will be inclined to take the PMI offer of $240,000, versus our theoretical offer of $202,000. Unless you want to spring for the additional $38,000!

I have been down this dusty old road a few times (all the way to the non-deal), and I make sure to ask before I choose to work them.

The problem:

I used to run my short sale business in a manner similar to the steps outlined above. However, as my volume began to grow, I fell into a time trap: I could no longer work new deals because I was too busy working the deals that I already had.

Then I would make a very bad business decision and slow down the marketing process to limit new deals. I would then work all of the current deals and find out that my incoming pipeline was empty. At that point, I was the "proud owner" of a feast or famine short sale business.

The Tip:

The key point is to understand that we have to be ever more diligent on calculating the offer. Note, formulas used to calculate offers on long-term hold real estate are not at all related to fix and flip formulas, and these deals are normally disastrous for the unsuspecting investor.

We talk much more about this in the What2offer mentoring program. After years of doing these calculations by hand, my partner and I have developed an online real estate software to make our lives much easier. We can now crank out offers and determine the exit strategy in seconds.

To Your Success,

Tom & Svein

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