Are Short Sales Shorting The Real Estate Market?
Friday, July 18, 2008 | Ethan RobertsRating:
A few weeks ago, I wrote an article about my 300 mile trip to buy an investment property because I felt that, in the particular area where the property was located, the prices have declined to the point where it was reasonable for an investor to become active again.But we still have lots of difficulties in the Real Estate market on a national level. Today I would like to talk about the myth of "Short Sales" as a way to help homeowners save their homes from foreclosure, and as a means for buyers to make a lot of money. In fact, short sales are actually hurting the Real Estate market by artificially increasing the inventory numbers with excess homes that aren't selling. But before I address all that, I want to briefly touch on the Fannie Mae/Freddie Mac problem.
Last Friday, Wall Street was buzzing with concerns that both Fannie Mae and Freddie Mac might run out of funds. President Bush called a news conference to say nothing, and basically left it all on Treasury Secretary Henry Paulson's shoulders. Said Paulson, "Our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission."
The New York Times said the government was considering a plan to put both companies into a conservatorship (i.e. Big Brother will take over and protect the interests of those who can not do the job) if their financial problems worsen.
Fannie Mae (FNM) dropped 40% on the story, later recovering to finish ONLY 24% down. Small consolation to those who are long that stock. Freddie Mac (FRE) was down 46% at the open, then came roaring back to finish about 9% down after the FED said they would step in and help if necessary.
Realize that Fannie Mae and Freddie Mac either own or guarantee $5 trillion in mortgage debt -- about 50% of all the mortgages in America. If those two entities were to stop funding mortgages, interest rates on loans would spike up considerably, as it would become much more difficult for banks and mortgage companies to find funding for their loans. With all the current woes of the Real Estate market, can you imagine what would happen if interest rates shot up to 8 or 9 percent, or higher?
To add insult to injury, Fannie Mae announced the day before that they are again capping the maximum number of loans any one person can have through them at four. That means an investor can only have their own primary residence mortgage, plus three other home loans, whether they are rentals or a second home. Although it is easy to understand their caution, given Fannie Mae's current financial difficulties, in essence they are doing to the legitimate long term Real Estate investor what Jesse Jackson was recently caught off air saying he would like to do to Mr. Obama!
The new Edward Scissorhands?
Talk about bad timing when you are trying to clear the Real Estate markets of excess inventory!
Fortunately, by Monday, order was restored in the financial markets when it was announced over the weekend that the U.S. Treasury and Federal Reserve will be lending money to and buying equity from Fannie and Freddie if necessary. Initially on Monday morning, the stocks of both Fannie Mae and Freddie Mac came roaring back, only to see their rally fizzle later that morning.
Then there was the strange story of Charles Schumer (D-NY), the affable senator who was accused of triggering a $1.3 billion dollar run on IndyMac Bank by publicly releasing a letter of concern he wrote to the Office of Thrift Supervision and the FDIC about IndyMac's viability. Nice going, Chuckie. Ever heard of "loose lips sink ships"?
Smiling Chuckie, an unlikely invitee to the IndyMac Christmas party
By the way, Schumer defended himself over the weekend by saying about IndyMac,
"The regulator here was asleep at the switch. The administration is doing what they always do, blaming the fire on the person who called 9-1-1"
Maybe so, Chuck, but even the arsonist sometimes pulls the fire alarm box...
But I digress. As bad as the Fannie/Freddie mess is, there is yet another problem that is adding to the woes of the Real Estate market. It's the abundant number of Short Sales in large states like California, Nevada, Ohio, and Florida. These were the states where the largest number of sub prime mortgages were produced, and are now awash with borrowers who can no longer pay their mortgages.
By definition, a "Short Sale" is a home sale in which the lender agrees to accept less than what the borrower owes on the mortgage when that property is sold. The reason that a lender is willing to do this is to prevent the home from going into foreclosure, which ultimately may cost the bank even more money in time and lost equity.
A short sale also "helps" the homeowner, because even though their credit score will suffer from having delinquent mortgage payments, that is not as damaging to one's FICO score as having a foreclosure. A foreclosure will absolutely ruin one's credit score for several years. And let's face it, a foreclosure also wreaks havoc upon one's personal life and their family's emotional well being.
So I think we can all agree that at least on paper, the short sale seems like a terrific quid pro quo for all parties involved. The bank gets the property sold and nets more than they would on a foreclosure. The owner gets to save a little face and keep their credit score from falling into the 400's. And the new buyer gets a bargain price on the home they are purchasing.
But not so fast! In this case, all that glitters is NOT gold.
I have previously written about the many seminars that were advertised to Realtors on how to work short sales. The entrepreneurs giving these talks made a lot of money selling their "secrets", but the Realtors who paid good money to learn these secrets were the ones who came up "short". Ditto for investors, who were promised they could get rich buying these pigs in a poke.
The facts are, lenders are in no way obligated to approve a short sale. Also, the short sale process is extremely cumbersome and slow. Before they will approve a short sale, the lenders require a tremendous amount of information and documentation from the home owner. The Real Estate agent working with the owner needs to submit a "short sale package" to the bank, detailing the borrower's financial hardship and reasons for needing the short sale. The agent will also complete a Comparative Market Analysis of home values in the same area, or an appraiser may even be called in to assess the current worth of the home.
However, there are some Real estate agents who set up the so called "short sale", without even submitting the proper paperwork to the lender in advance. This is more often incompetence than shady practice. Yet some agents may dangle a low ball price on the home that has not yet been approved by the lender, just to lure in reluctant buyers. Then once an offer is submitted, they send it to the lender, hoping that they will miraculously agree to the price.
But the lenders are backed up with a tremendous number of short sales, and in some cases a depleted staff to weed through them all. Lender approval, if it comes at all, can take up to 60 days. Buyers will often decide they can't or won't wait that long, and walk away from the deal. It's also possible that while the bank is considering the first offer, other offers may be submitted for the same property. The Listing agent is required to send them to the bank for consideration as well.
With all of this, it is no wonder that agents who work with buyers are beginning to shun the whole short sale fiasco. Most agents don't mind doing extra work to make a sale, but when so many of the short sale offers are rejected or lost to other buyers, the agents become discouraged. Word gets around among agents and pretty soon the short sale listings are not even shown anymore. On my recent trip to the Gulf Coast, agents were writing "THIS IS NOT A SHORT SALE" on their listing sheets to make sure that their listings would be shown. Obviously, when it comes to short sales, the bloom is now very much off the rose.
How Realtors are now perceiving Short Sales
Another factor which discourages short sales is when banks try to minimize their expenses by reducing the agent's commission, depending on the final price that is negotiated. This is the final straw that kills the desire for agents to show these properties.
Compounding these problems, lenders are sometimes reluctant to approve offers because their payout from private mortgage insurance (PMI) can cover whatever they will lose from a foreclosure. Sometimes there is a second mortgage on the home as well, and the second mortgage lender can nix the deal. There may also be other liens on the home (IRS, contractors, code violations, etc) that would need to be paid off as well.
So what should you as a home purchaser or investor do about short sales?
The answer is STAY AWAY! Unless you have an unlimited amount of time to wait, do not waste your time trying to buy a short sale, no matter what the listing price may be. If you are looking for a bargain, there are a ton of foreclosures on the market. Foreclosures are less expensive to purchase, easier to close, and you won't have to wait more than a few days to learn whether or not your offer has been accepted. Most often if your initial offer is not accepted, the bank will give you a counter offer, and the whole process can be wrapped up over the telephone or by e-mail in a few hours.
If you can't find a foreclosure that you like, or if the typically necessary repairs and improvements are not for you, look for an owner who is motivated, but where the home is not under short sale. Many people need to sell their home and have had it on the market for a long time. Those who are truly motivated will be willing to reduce their price and/or consider paying closing costs for the buyer.
Many people ask me when do I think the Real Estate market will recover. My answer is that in some parts of the country it is already happening, but in many areas where inventory is still high and the foreclosures and short sales are plentiful, it will take many more months, or perhaps even a few years. In my own area, only about 5% of the short sales are actually making it to closing. The rest continue to languish on the market, keeping inventory artificially high and the market soft.
Could this situation be fixed? Of course! But here is what it would take:
1) Owners or their agents would have to submit all the proper documentation to the lenders BEFORE listing the property for sale. Once a listing price is approved by the lender, then the public can be assured that the price is valid.
2) Lenders need to reduce the time of consideration for all offers to a maximum of 14 days.
3) When an offer to purchase the home is submitted to the lender, all other offers should have to be held as backup offers until and unless the first offer is rejected or is rescinded. All offers should be considered one at a time, in the order that they were received by the listing office.
4) A standard commission rate, which is typical for that city, should be paid to all agents involved in the short sale. There should be no reductions of commission applied, no matter what the final negotiated price may be. If lenders want agents to show their short sales, they are going to have to compete with the local markets.
Without these changes being instituted, the vast number of short sales will eventually become foreclosures. So if you are interested in a home that is currently being marketed as a short sale, keep your eye on it. Most likely it will not sell, and in a few more months you may see it re-listed as a foreclosure for thousands of dollars less!
In the meantime,
To overly hyped, "short" on substance Short Sales!
Have a great weekend. See you soon.
Fortunately, by Monday, order was restored in the financial markets when it was announced over the weekend that the U.S. Treasury and Federal Reserve will be lending money to and buying equity from Fannie and Freddie if necessary. Initially on Monday morning, the stocks of both Fannie Mae and Freddie Mac came roaring back, only to see their rally fizzle later that morning.
Then there was the strange story of Charles Schumer (D-NY), the affable senator who was accused of triggering a $1.3 billion dollar run on IndyMac Bank by publicly releasing a letter of concern he wrote to the Office of Thrift Supervision and the FDIC about IndyMac's viability. Nice going, Chuckie. Ever heard of "loose lips sink ships"?
Smiling Chuckie, an unlikely invitee to the IndyMac Christmas party
By the way, Schumer defended himself over the weekend by saying about IndyMac,
"The regulator here was asleep at the switch. The administration is doing what they always do, blaming the fire on the person who called 9-1-1"
Maybe so, Chuck, but even the arsonist sometimes pulls the fire alarm box...
But I digress. As bad as the Fannie/Freddie mess is, there is yet another problem that is adding to the woes of the Real Estate market. It's the abundant number of Short Sales in large states like California, Nevada, Ohio, and Florida. These were the states where the largest number of sub prime mortgages were produced, and are now awash with borrowers who can no longer pay their mortgages.
By definition, a "Short Sale" is a home sale in which the lender agrees to accept less than what the borrower owes on the mortgage when that property is sold. The reason that a lender is willing to do this is to prevent the home from going into foreclosure, which ultimately may cost the bank even more money in time and lost equity.
A short sale also "helps" the homeowner, because even though their credit score will suffer from having delinquent mortgage payments, that is not as damaging to one's FICO score as having a foreclosure. A foreclosure will absolutely ruin one's credit score for several years. And let's face it, a foreclosure also wreaks havoc upon one's personal life and their family's emotional well being.
So I think we can all agree that at least on paper, the short sale seems like a terrific quid pro quo for all parties involved. The bank gets the property sold and nets more than they would on a foreclosure. The owner gets to save a little face and keep their credit score from falling into the 400's. And the new buyer gets a bargain price on the home they are purchasing.
But not so fast! In this case, all that glitters is NOT gold.
I have previously written about the many seminars that were advertised to Realtors on how to work short sales. The entrepreneurs giving these talks made a lot of money selling their "secrets", but the Realtors who paid good money to learn these secrets were the ones who came up "short". Ditto for investors, who were promised they could get rich buying these pigs in a poke.
The facts are, lenders are in no way obligated to approve a short sale. Also, the short sale process is extremely cumbersome and slow. Before they will approve a short sale, the lenders require a tremendous amount of information and documentation from the home owner. The Real Estate agent working with the owner needs to submit a "short sale package" to the bank, detailing the borrower's financial hardship and reasons for needing the short sale. The agent will also complete a Comparative Market Analysis of home values in the same area, or an appraiser may even be called in to assess the current worth of the home.
However, there are some Real estate agents who set up the so called "short sale", without even submitting the proper paperwork to the lender in advance. This is more often incompetence than shady practice. Yet some agents may dangle a low ball price on the home that has not yet been approved by the lender, just to lure in reluctant buyers. Then once an offer is submitted, they send it to the lender, hoping that they will miraculously agree to the price.
But the lenders are backed up with a tremendous number of short sales, and in some cases a depleted staff to weed through them all. Lender approval, if it comes at all, can take up to 60 days. Buyers will often decide they can't or won't wait that long, and walk away from the deal. It's also possible that while the bank is considering the first offer, other offers may be submitted for the same property. The Listing agent is required to send them to the bank for consideration as well.
With all of this, it is no wonder that agents who work with buyers are beginning to shun the whole short sale fiasco. Most agents don't mind doing extra work to make a sale, but when so many of the short sale offers are rejected or lost to other buyers, the agents become discouraged. Word gets around among agents and pretty soon the short sale listings are not even shown anymore. On my recent trip to the Gulf Coast, agents were writing "THIS IS NOT A SHORT SALE" on their listing sheets to make sure that their listings would be shown. Obviously, when it comes to short sales, the bloom is now very much off the rose.
How Realtors are now perceiving Short Sales
Another factor which discourages short sales is when banks try to minimize their expenses by reducing the agent's commission, depending on the final price that is negotiated. This is the final straw that kills the desire for agents to show these properties.
Compounding these problems, lenders are sometimes reluctant to approve offers because their payout from private mortgage insurance (PMI) can cover whatever they will lose from a foreclosure. Sometimes there is a second mortgage on the home as well, and the second mortgage lender can nix the deal. There may also be other liens on the home (IRS, contractors, code violations, etc) that would need to be paid off as well.
So what should you as a home purchaser or investor do about short sales?
The answer is STAY AWAY! Unless you have an unlimited amount of time to wait, do not waste your time trying to buy a short sale, no matter what the listing price may be. If you are looking for a bargain, there are a ton of foreclosures on the market. Foreclosures are less expensive to purchase, easier to close, and you won't have to wait more than a few days to learn whether or not your offer has been accepted. Most often if your initial offer is not accepted, the bank will give you a counter offer, and the whole process can be wrapped up over the telephone or by e-mail in a few hours.
If you can't find a foreclosure that you like, or if the typically necessary repairs and improvements are not for you, look for an owner who is motivated, but where the home is not under short sale. Many people need to sell their home and have had it on the market for a long time. Those who are truly motivated will be willing to reduce their price and/or consider paying closing costs for the buyer.
Many people ask me when do I think the Real Estate market will recover. My answer is that in some parts of the country it is already happening, but in many areas where inventory is still high and the foreclosures and short sales are plentiful, it will take many more months, or perhaps even a few years. In my own area, only about 5% of the short sales are actually making it to closing. The rest continue to languish on the market, keeping inventory artificially high and the market soft.
Could this situation be fixed? Of course! But here is what it would take:
1) Owners or their agents would have to submit all the proper documentation to the lenders BEFORE listing the property for sale. Once a listing price is approved by the lender, then the public can be assured that the price is valid.
2) Lenders need to reduce the time of consideration for all offers to a maximum of 14 days.
3) When an offer to purchase the home is submitted to the lender, all other offers should have to be held as backup offers until and unless the first offer is rejected or is rescinded. All offers should be considered one at a time, in the order that they were received by the listing office.
4) A standard commission rate, which is typical for that city, should be paid to all agents involved in the short sale. There should be no reductions of commission applied, no matter what the final negotiated price may be. If lenders want agents to show their short sales, they are going to have to compete with the local markets.
Without these changes being instituted, the vast number of short sales will eventually become foreclosures. So if you are interested in a home that is currently being marketed as a short sale, keep your eye on it. Most likely it will not sell, and in a few more months you may see it re-listed as a foreclosure for thousands of dollars less!
In the meantime,
To overly hyped, "short" on substance Short Sales!
Have a great weekend. See you soon.
(Please let us know what you think about Ethan Roberts's article.)
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Ethan Roberts
Contributing Editor
The Tycoon Report
