A Distress Property Primer

Many buyers ask me about buying foreclosures or short sales thinking they are the “best” deals.     I have helped buyers, particularly investors, make great below market acquisitions but just because a home is a foreclosure or short sale does not mean it is a great value.  And, more importantly, depending on your situation and goals, distress property may not be the right type of property to consider.

Below is a brief review of the pros and cons of foreclosures and short sales.  I also have some comments on court ordered sales, another type of distress sale but one that is not as prevalent as the other two.

Foreclosures.

For most buyers foreclosures are a valid avenue to pursue.   The process of buying a foreclosure is the same as a regular sale.  There is an easily identifiable owner (the bank), negotiations often are wrapped up in a few days (with the exception being that the banks typically are not available holidays and weekends) and settlement can occur within the normal 30 to 60 day time frame.

The downside is that the homes convey strictly as is and the banks will make no repairs.   Home inspections, radon tests, mold inspections, termite inspections are all encouraged by the banks but they are strictly to allow the buyer to understand the condition of the property.  If the condition is not to the buyer’s liking, they can back out and get the earnest money returned.  There are no credits or repairs that will be executed by the bank.  And they do not care about whether appliances are there or not.  (I once had a buyer contract for a foreclosure and when we did the home inspection there was a washer and dryer in the house.  When we did the pre- settlement walk thru they were gone.  The bank said sorry, buy the property as is or back out and we will keep the earnest  money.  Appliances are personal property, not real estate.)

Are the prices better than the market?   In my opinion, slightly but most of the price differential is  sweat equity.  The banks have the local listing agent (and sometimes more than 1) do a market analysis.  The cost of any repairs are built into the price and there may or may not be some additional allowance for unknowns.  But if you can do the repairs yourself, you  come out ahead as you get tremendous savings on the labor.

Another reason to buy a foreclosure is that it may get a buyer into a neighborhood they could not otherwise afford.  Say a home is in a $500,000 neighborhood but because of the work  needed, it is priced at $450,000 and $450,000 is the top range the buyer can afford.  Well, that home could be a very wise purchase.

One mistake buyers make is to think the banks will come way down off the asking price to get rid of inventory.  That may be the case in cities around the country that are rather depressed but not in Northern Virginia.  Between October 1, 2011 and today, there were just 345 settled foreclosures in Fairfax, Arlington and Alexandria.  They ranged from a low of $72,100 to a high of $900,000.  The average list price was $316,745 and the average sale price was $313,974 – not much of  a difference.  In fact, 108 of the homes sold ABOVE list price while only 18 sold for more than 10% less than list.  The scarcity of inventory has  buyers fighting over what is out there

(FYI, I do not list foreclosures but have helped buyers on dozens of foreclosures over the last few years.)

Court Ordered Sales

The most common type is a bankruptcy sale ordered by the court.   There is a local bankruptcy attorney that has referred several of these to me so I am quite familiar with the process.  These cases only get referred to a Realtor when there is equity in the property and that equity can be used by the court to pay off the other debts of the homeowner.  In this case, the buyer negotiates directly with the homeowner and once an agreement is reached, the contract is forwarded to the court for review.   Settlement can not take place until about two weeks after the court approves the sale.  So, one has to plan for at least a 45 to 60 day time frame between contract and settlement.   There is nothing that can be done to speed this up.  The bankruptcy attorney for the homeowner will get it on the docket as quickly as possible.  Now, I have never seen one of these sales denied by court.  If the the Realtor, homeowner and bankruptcy attorney work together, it is just a rubber stamp by the court.  The bankruptcy attorney knows what numbers will or will not work so the homeowner is well advised to speak with their attorney before officially signing the contract.

Now in a bankruptcy sale, of course, the homeowner is struggling financially so the possibility of the homeowner executing any repairs is probably pretty slim.  However, after a home inspection if there are issues that surface, there can be a 2nd negotiation conducted to either reduce the price and/or have the seller pay closing costs.  All of this needs to be done before the contract is presented to the court.

The issue is these cases is that the timing between contract to settlement is based on the timing of the court so buyers on a tight timetable should not pursue these homes.  Additionally, the homeowner is often living in the property and needs to find a new place to live.  This is extremely hard while in the middle of a bankruptcy so a buyer should be prepared for potential delays involving occupancy.

Short Sales

Well now we come to thorn in the side of every Realtor.  I strongly urge all buyers to pursue every other angle before pursing a short sale.  They are a vast wilderness full of pits, traps and winding paths that lead to nowhere.

First, by definition, a short sale means that the homeowner owes more on the property than it is worth and is behind on their payments.  Instead of having a  foreclosure or bankruptcy on their credit record, they decide to pursue the short sale route.  Sometimes there is one bank involved and sometimes the seller has a 2nd trust as well.

Prices on short sales are set by the seller and listing agent and often look extremely attractive.  Furthermore, you can make just about any offer you want on a short sale and it is likely  the seller will sign it.  Really what do they care?  They are not making any money at full price so 10% or 20% off full price is the same to them.  And for reasons too complicated to go into here,  it may be in their best interests to sign any contract presented to get the process started.

So once, the contract is signed and ratified, it is sent to the bank or banks for review.  The bank needs to approve both the seller and the contract.  The seller needs to submit all of their financial data to the bank so the bank can be assured that they are really in distress, unable to make the payments and not just taking advantage of the system.  Often this first part is done (or partially done) before the home goes on the market but some sellers, listing agents or banks start this once the contract is ratified.

Then once the seller is approved, the bank needs to understand the value of the home.  The bank will hire local Realtors to give them a BPO  (broker price opinion).  They may even hire an appraiser.  This is where that supposedly good deal starts to look less attractive.   It is not uncommon for a bank to counter the contract price and force a number that is closer to market.  This can happen weeks or months after the contract was ratified. Of course the buyer does not need to accept and can walk.  If  a home is valued at $500,000 and the contract states the sale price is $400,000, the banks will not work with that as they feel they would be better off letting it go to foreclosure where they can get a better net – even after all of the carrying costs.

Then after that is resolved, there is continuing negotiation between the 1st and 2nd trust holder as to how much of a loss each will take.  There may be negotiations between the bank and the mortgage insurers or negotiations between the bank and other investors.  And, maybe  somewhere along the way perhaps the bank negotiator is reassigned, a new person looks at the file, orders another BPO, wants updated financials from the sellers  and the whole process starts all over again.

Bottom line, when you contract for a short sale you

a) do not know when you will settle( definitely will not be 30 days but will probably be 2 to 4 months or more from the contract date)

b) can not lock in an interest rate since rates are only good for 60 days and you need to wait for bank approval to be within that window (it’s possible that rates will go up while you are waiting making the purchase less attractive) and

c)  have no idea of the final price until the banks have fully reviewed the file and even then they reserve the right to change their mind until they issue the approval letter.

Bottom line,  folks on a strict timeline or a strict budget should stay away from short sales.  Investors or those with open ended timelines can pursue these.  For me, it is always frustrating working short sales as there is nothing I can do to speed up the process.  Everything goes through the listing agent.  As a buyer’s agent, the seller’s bank is not authorized to speak to me so I can not get any progress reports directly from them.  Everything depends on the professionalism and experience of the listing agent.  Some are fantastic while others have done very few of these and don’t know how to guide the deal through the system.  Personally, while I have helped many buyers purchase short sales, I have never listed one nor do I plan to. (If you need to sell via the short sale process, still give me a call.  I will refer you to agents I know who are experts in working these deals from the listing side.)

By the way, in the end, after waiting for months, you may not settle. The bank may not  approve the sale.  The homeowner may suddenly decide bankruptcy is the better option or some homeowner judgment or lien surfaces to stop the whole process and force a foreclosure.

Check out this recent post on real short sale situations I have encountered: Tales From the Front Lines:  Short Sale Shorts

There is so much more I could get into on distress sales.  If you would like to learn more, please give me a call or write a comment or question below.