Often investors will be enticed by the idea of a short sale as a cheap fix & flip. But before you reach out to the real estate agent with your offer, let’s discuss what a short sale is and how you do a short sale as efficiently as possible!
To do a short sale, you’ll need to have your offer accepted by the buyer and approved by the bank, as they’re agreeing to take less money on the property than they originally forecasted. While that might seem like an automatic “no” from the bank, they’ve got a good reason behind accepting a lower offer. The trade-off for them is that they get this property off of their hands without the hassle of a drawn-out foreclosure. Sometimes, the opportunity cost is just too great for the bank to walk away when they’ve got a ready buyer waiting.
But let’s get into the nuance behind short sales and offer you some tips for turning them into a sound investment!
What is a Short Sale?
Let’s first define what a “short sale” is so that you’re not confusing it with a foreclosure.
A short sale is a term used when a seller owes more on the property than what the property is actually worth. When a homeowner gets behind on their payments, they’ll draft what’s known as a “hardship letter.” This is a statement delivered to the bank that says the homeowner is having difficulty keeping up on their financial obligations. Their real estate agent then goes to a bank with this notice and asks the bank to take less than what’s owed from a willing buyer.
Why Would a Bank Do a Short Sale Instead of a Foreclosure?
The idea of a bank accepting less than what’s owed sounds counterintuitive, right? Why would a bank willingly agree to accept less money than what the property owner actually owes? Can’t they just say “no” and force the homeowner to keep paying?
Essentially it boils down to the bank understanding the underlying costs associated with saying “no.” If they don’t accept a short sale offer, they’ll most likely have to go through a foreclosure process, as a short sale isn’t something a homeowner does on a whim. In most cases, telling the bank you’re unable to keep your financial obligations is an acceptance that one way or another, you’re losing your home.
For banks, the foreclosure process is as much of a headache as it is for the homeowner. In addition to the legal costs, there’s also eviction costs, costs to maintain the property until it’s sold (lawn care, taxes, snow removal, utilities, etc.), and the hassle of finding a buyer.
In addition, the property could actually be worth less than what’s owed thanks to market conditions, inflation, and other economic factors. In the end, it might actually make more financial sense for the bank to accept a ready offer now than drag it out and wait for a better offer later.
How Do You Do a Short Sale
So let’s say that you’ve put in an offer for a property that’s being listed as a short sale. What happens next?
First, understand that putting an offer in doesn’t mean you’re in the clear or that this will be a quick process. Your offer must first be accepted by the homeowner, which the homeowner then takes to the bank. The bank then decides whether or not to accept the offer, so even if your seller says your offer is good, the bank may reject it. Since they have the final say, this could mean your investment is stopped in its tracks.
But for the sake of this article, I’m going to pretend that your amazing offer was so enticing that both the seller and the bank were intrigued. They haven’t yet said “yes” but they also haven’t said “nope” yet either.
Once the bank receives the offer, they’ll then send someone out to the property. This person appraises the home and starts crunching numbers to determine whether or not your offer is a good deal for them. Factors like how hot the market is, what the potential ongoing maintenance costs will be, if the property will need to be fixed up to be sold later on, and any other mitigating factors are all considered.
So prepare yourself for a long process, as it will usually take a few weeks at the very least for the bank to make a decision. Once the cost-benefit analysis is done, the bank then returns to the homeowner to let them know of their decision. The bank rarely deals directly with you in a short sale, so expect the homeowner to be your newest best friend (at least throughout the short sale process).
A Few Tips You Need to Know About Short Sales
One stipulation for short sales is that the property is required to be listed on the MLS so that, ideally, the bank can entertain multiple offers. So if you’ve got a buddy who might be falling behind on their mortgage, you can’t just swoop in and save the day through a quiet short sale offer. It needs to be publicly announced and go through the proper process.
Also, if you’re looking to invest in a hot market, you won’t see a lot of short sales happening. Short sales only happen when banks think it’s worth taking the loss to get the property out of their inventory. If it’s a seller’s market out there, the bank knows they can make a profit if they can sit on the property even with foreclosure costs, so they’ll rarely accept a lower offer.
Another thing for you to consider is that banks aren’t dummies when it comes to short sales; they know that a lot of real estate investors like to jump on these deals. Consequently, there are some stipulations that will prevent you from doing a quick fix & flip on the property.
Banks will make sure you as a buyer are not wholesaling the property with what’s known as a 90-day deed restriction. A 90-day deed restriction is a stipulation that says the new buyer cannot sell the property within 90 days of closing.
Don’t let that stipulation scare you, though. While they don’t want you flipping the house right away, they also want the property off their hands so they won’t have a problem with what’s known as “value-add property sales.”
Value-add property sales are simply you fixing up the property after purchasing it and then selling the house immediately. So as long as you make improvements before selling it, you’re in the clear. Also, considering how long it will take you to fix it up, get it on the market, find a buyer, and then close, you’ll most likely be past that 90-day window anyhow.
In the end, patience is key when it comes to short sales. They rarely happen quickly, but if you play your cards right, a short sale can be an incredible opportunity for a profitable investment in your portfolio.
Any tips you’ve found to be helpful when it comes to short sales? Leave a comment and let us know!