Are Short Sales Shorting the Real Estate Market?

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 (FNM)/Freddie Mac (FRE) 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!

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"? 

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 lowball 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.

Another factor that 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, "Just Say No" to overly hyped, "short" on substance short sales.

Comments

[westwest888]

Short sales are just a carrot the banks use to get homeowners to keep making payments. If they were astute, they'd know it's never happening and the bank is conning them out of a dozen PMTs they could have walked away from. I don't think short sales are fake inventory, rather future inventory. Clearly these homes will be foreclosed on. Get used to the banking system being the biggest landlord in the country, with more inventory than new homebuilders combined.

8 or 9% interest would be great for young buyers (anyone under 30). You can refinance away interest; you can't refinance away $500,000 of principal on a 3br 1ba house. Let prices fall.

[stopforeclosure]

Bad advice telling people to stay away from short sales.
So basically you're telling any investors and/or realtors that if a homeowner is behind on payments, and needs to sell, they should ignore them or walk away?

The only people screwing up short sales are agents/investors who don't know what the heck they are doing, and greedy lenders who think that if they take back the property they'll make out better selling it as an REO, rather than taking a discount and not going through the foreclosure process.

If you learn how to do short sales the RIGHT way, or better yet, have a professional company to outsource them to, you'll be just fine.

Telling people to stay away from short sales is only compounding the foreclosure problem.

The investors/agents getting short sales approved and sold are the only ones today helping the bottom of the real estate market stabilize.

[mlimberg]

I agree with westwest888, much higher interest is the best solution to get out of this mess. Waiting for the non-fixed loans to reset will drag this issue out for the next 6 years... or the max length of the non-fixed loans. 8 or 9% will bring the price of a home to reasonable levels.

It's like buying a car, they want to sell you the car based on the payment... The only figure I want to know is the cost of the home... Any mention of payment is based on this cost first and the interest can be changed as time goes on and according to market conditions.

[LiquidSoapDispenser]

Okay, I guess I'm dense. How would high interest rates help our situation?

With 8% interest rates, there would be less people out there buying homes, because now they would cost more (including the interest). So, unlike now, where there are too many homes and not enough buyers, there would be too many home and even less buyers. This would cause more homes to foreclose, worsening the housing market, and worsening the credit crisis that has brought down a few major companies already. Plus, someone who simply wants to sell their house and buy one in another area would be discouraged, because they would be able to afford less house due to higher interest payment.

I may not know as much as you guys do, but the very basic stuff I do know tells me that higher interest rates would do more damage than good.

[SusieQRealtor]

Just about every bank will NOT accept a Short Sale Package until THERE IS AN OFFER ON THE PROPERTY. All I can do as the listing agent is request their instructions (there are a few variations from bank to bank re: requirements) and begin to get the package ready, just in case someone makes an offer on one of my Short Sale listings. I can't put the whole thing together since banks want RECENT bank statements and paystubs and it could take a couple of months (or more) before we get an offer. All I can do is let the homeowner know what will be required and help them with their hardship letter. This is NOT incompetance, this is the reality in today's market. The banks are the one who are messing up the system. No answers for months, then even AFTER you have a bottom line approval, they come back and want MORE, and take even longer before a final approval. Then once you get an approval, they want the sale closed just about immediately. It is a lot of work for the listing agent, and very frustrating process for the buyer and the buyer's agent. All we can do as Realtors (R) is work the market as it is and do everything we can to bring buyers and sellers together... irrespective of how difficult the banks are making it.

[carey_jim]

Depositors entrust their money to banks because they think it is safe in banks and also because they are paid to do it (interest.)

But in the real world of inflation, depositors PAY banks for the privilege of safe guarding their money because banking interest rates are below the inflation rate (both the official rate and the "real" rate.)

You might call this "over confidence" in banks or just stupidity.

But in this real world, housing prices continually rise (rose) faster than inflation and so people are persuaded that they MUST buy property to stay ahead of inflation.

The smartest people realize that low down payments and quick turnover of property provide a leveraged means of making a lot of money.

This produces a Ponzi scheme where banks lend money to people who buy property which appreciates, they quickly sell the property and deposit their profits in banks which loan the money to people who buy property which appreciates ....

The system heats up. The laws of physics, not to mention economics and common sense, take over and what goes way, way up eventually falls way, way back down to earth.

We have a banking crisis.

I can't see how Big Brother is responsible for this.

Can someone enlighten me?

[Tom Lindmark]

Could you please tell me where I can go to find the "standard commission rate that is typical for Phoenix". I naively assumed that this was a negotiated rate and that it was illegal to set "standard commission rates".

On the subject of short sales, a lot of them are just homeowners who are under water and want out. They can afford to make the payments but would prefer to have the bank eat the loss.

[thecondoguy1]

Everybody is getting what they deserve when it comes to short sales, GRIEF, it was a matter of if you lie, I will swear to it, it was all a scam and there is plenty of guilt to go around. Yes SusieQ, that means you and your fellow Realtors (R), as well............

[Sippn]

Short sales are pseudo inventory - future REO inventory, as such a very small % of short sales actually result in closes. In the mean time, Joe homeowner who paid $1.2 mil for his big tract home, watches his neighbors blow out of there with $600K priced short sales - the question is... why be left behind while the lender that financed your home and apparently made a mistake appraising it, gets your monthly ransom. To make matters worst, word on the street is FNMAE, etc are working on products and ways to "forgive" those short sellers and foreclosees sooner so that they can be new customers/borrowers sooner..... lenders digging their own graves.

[Did U ThinkThe PonziSchemeWould Last?]

Short sales are shorting the market??? Ummmm, NO. They are not "shorting" anything.

They are simply unwinding margin positions of unholy leverage. Amazes me that some people like you have it backwards like that.

[bearfund]

"If those two entities were to stop funding mortgages, interest rates on loans would spike up considerably..."

Yep. Exactly what the market needs to correct itself. You've just admitted, perhaps without intending to, that mortgage rates have been capped artificially low for decades. You then, correctly, argue that higher rates would mean lower prices. But you fail to acknowledge the corollary: that prices in the past - and still today - are therefore kept artificially high by the existence of Fannie and Freddie. By extension, because mortgages pay artificially little, those who hold them are incentivised to use greater leverage than they otherwise would in order to maintain profits. This combination of artificially high asset prices and artificially low yields coupled with excessive leverage is EXACTLY what caused the current financial meltdown - and arguably what has caused EVERY financial meltdown in the fiat money era.

The lesson to learn here is that you cannot fool all of the people all of the time. Some people will always be fooled into believing that the market price represents fair value. And perhaps at some times substantially all of the people can be fooled into believing that house prices only go up. But at some point a critical mass of people will start looking at modest houses priced at 16x the income one can obtain in a good job and say definitively that, 4.5% option ARM with no down payment or not, it's just not worth that much. Then, well, you've seen what happens after that.

The flood of cheap money has to be shut off at its sources. Home ownership is not for everyone. It is not in the national interest to pretend that it is, nor is it in the national interest to encourage it by supplying ever-cheaper money to would-be buyers who cannot realistically afford to own. And this strategy does not even work - all it does is drive up prices so that ordinary working folk are once again unable to afford to own, but are trapped in the belief that prices are rising so fast that they cannot afford *not* to own and that any buying opportunity, however overpriced the property and however absurdly implausible the financing, must be taken for fear that there will never be a better one.

Much better to unwind the whole madness. Let the market set interest rates. Let those own who wish to own save their money for a down payment and pay a fair rate of interest on the fair value of a property, and those who do not wish to own not be pushed - with tax incentives and a flood of cheap money - into making a purchase they may be ill-equipped to sustain. Congress should revoke Fannie's and Freddie's charters. As private companies, they are clearly insolvent; a bankruptcy court will need a few years to figure out how best to break up the companies, sell off their assets, and allocate them among the various claimants. In the meantime interest rates need to rise and prices need to fall much further. And as a side benefit, higher interest rates across the board will help rein in inflation. The tax deduction for mortgage interest should be phased out over the next 10 years. Not only would it increase revenues and shrink the deficit, it would further push house prices back into balance.

Who wins in that scenario? Arguably, the right people will win: people who have lived within their means. Those who have saved money. Those who bought property years ago and have increased their equity in it rather than withdrawing it through HELOCs. Those who treat their homes as mere objects of utility rather than life-altering investment assets. Those who chose not to buy property that was patently overpriced. The losers would be those who overreached, spent too much money, used too much leverage, and chased yields. From a basic risk management standpoint, this outcome would reward the wise and punish the foolish: an ideal solution. But it will never happen because too many Americans are foolish and too few are wise. A tipping point was crossed some years ago, beyond which the majority became too invested in all the wrong things and all the wrong ideas. Everyone wanted something for nothing and too many became too accustomed for too long to getting it. A pliant government will have neither the desire nor the ability to crush the foolish majority for the sake of good government, economic stability, or even the long-term security of the nation if those who would reap their hard-earned gains are too few to sustain it in power. There is no turning back now. America is done. There will be reversals, there will be rallies, there will be optimism. But there will be no salvation.

[jigs]

The author has not mentioned the most important distinction between a short sale and a fore-closure. Either he is as ignorant about it like the rest of realtor's I come across or too afraid to speak it out...

Here:

Short sales result in a big Tax-bill for the seller as the difference between amount owed and sale amount is considered as an income to the seller by IRS. I believe there is a bill in the work to forgive the same but am not sure if that has been passed.

www.thinkglink.com/Sho...

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So in short, short sale is nothing but a gimmick employed by Sellers to price the property so low that the Lender rejects it. And it can then go into foreclosure. That way, the seller avoids the tax bill. Credit score is impacted the same in Foreclosure and Short sales...

homebuying.about.com/o...

so why incur the big Tax bill...

One could argue that why would the seller take all the trouble to try and short-sale and not just walk away if his intentions are to fore-close..., this is something I am still looking an answer for...

BTW, what I am saying about is from an article on about.com but cannot find the link to it...

-j

[johnnnyb]

First this article needs to be read in the light it is intended. And I am not sure what the authors motivation for this article is - but it reads like a text book summary that is being taught by a professor in Eco-101. The title of the article catches your attention because he uses a term most often found in stock market legal ease. The author proceeds to state "In fact, short sales are actually hurting the Real Estate market by artificially increasing the inventory numbers with excess homes that aren't selling." Then he spends most of the article lecturing us about other non-pertinent issues off the mark of his original allegation as if he needed to prove his expertise in this particular arena of economics. But ole Tycoon is probably looking to impress all of us so we click on his sight and get more free advice - forget it.

Now let's talk about short sales of housing shorting the housing market. In the first place short selling executed in the stock market bets that a certain stock will decrease in value over the next - lets say - two or three months. So they sell it - Freddie Mac and Fannie Mae come to mind. Investor sold at say $ 35.00 betting they could buy the stock back at $10.00 and so they did. That is not what a short sale in the housing market accomplishes. Far from it.

Is a short sale good for the Buyer, the Seller, the Realtor or the lender?

For the lenders part sub-prime loans are being marked down as much as 80% because the banks have no way of easily reviewing millions of loans in a systematic way to determine the value of any house loan in their portfolio. So the bank may be better off taking a lose of 20% in a short sale. The hard part for the lender is it is a case by case basis and the author is right these lenders have to few employees (oh yea experienced in this area are required I should add) that they can allocate to this particular type of work so it is slooooow!

How about the Seller. It would appear that the Seller may be better off accepting a short sale on their property subject to their lenders approval. This gives the Seller a better chance of restoring their FICO or other credit scores more quickly to acceptable levels again. But remember the Seller also has a liability at the end of the year in a short sale and that's a little item called forgiveness of debt. If the bank forgave the Seller $20,000.00 when the sale was closed the Seller must report the additional $20,000 on their salary for 2008 and pay regular income taxes on it - oooops!

The Buyer could be at risk here. O yea he got a great deal on that house purchase, but the author is correct in itemizing several issues the Buyer must know for certain, including second liens, construction liens, IRS liens that may have to be paid in addition to the great price obtained on the property. What happens gentle reader if the market declines another 20% as most in-the-know folks are saying. Now how good a deal did the Buyer get and how does it affect his bank loan - ooops they are underwater just like the former owner.

The Realtor who is doing their job correctly is aware of all of the issues discussed here on this blog and assist the Seller in making good decisions about accepting a short sale. Most Realtors know about forgiveness of debt - most homeowners do not. So counseling the homeowner at least helps them decide how much short sale debt forgiveness they can afford to pay taxes on at year end as an example of some of the Realtors duties. By the way the author believes that the listing agent must present all offers made on a short sale property sale. That depends on the Real Estate laws in each state. In many states if the if Seller says do not accept any more offers then the agent is obliged to decline any further offers on the property reducing the potential for confusion always present with multiple offers.

I find the discussion on interest rates very sobering. Ben Bernanke has a job I would never ever want. Most astute investors are aware that the real inflation rate is closer to 7% than it is to 3%. For those of you who are on social security you know this fact. How? Because you got roughly a 3% increase this year in monthly SS payments. But the proof of the pudding is that your medicare cost rose by about 7% - the real cost of inflation. Even the IRS is recognizing this higher inflation number by allowing a deduction of $0.58/mile when driving your personal car for work related purposes about a 12% increase over the published rate just six months ago. That means the man is under incredible pressure to raise the rates to fight inflation which would as some observed raise interest rates on home loans and I believe throw us into a depression. So instead they continue to print money and since this is not just the Federal Reserve of the United States anymore but the Federal Reserve of the world (I am being facetious but it's true!) so as we print more money we pass this inflation along to the world. The short of it is that oil in part is reflecting the price of a dollar being printed and printed and printed and none of it backed by anything except faith. We are in a world of trouble and most folks can not get a grip around this concept.

Mr. Lindmark I love your sarcasm about fixed commissions. All real estate commissions are negotiable all the time in all of the western states at least and most elsewhere as well.

Carey_jim the banks are in trouble by their own doing. They lied to all of us about the quality of the loans they were selling to investors. These banks got the rating agencies to play along with their game until they were recently unmasked. It's a shame the IRS is so understaffed, otherwise most of those folks would be going to jail a lot quicker then not! What rankles me is that Bernanke isn't asking for legislation stop this deceit in the big banks and mortgage companies. In most areas, unlike licensed Realtors, the mortgage brokers usually have no fiduciary, ethical or moral obligation to anyone (borrower, real estate agent, seller) except themselves. Get these guys licensed state by state as Realtors are and these less than interest only loans will disappear forever.

Que Sera sera!

[wghog]

Your article has some points of interest and equally some points of mis-information. First, lenders don't require all offers to be submitted. The opposite is true. They only want one at a time and it's the inexperianced Realtors submitting multiple offers. Pricing a short sale is not difficult if you understand the process, and knowing which offers are worth sending to the lender for approval is also something that is easily done if you understand the process as well. We conduct short sales for Realtors all over the country and have a very high success rate for closing the transaction.

Short sales are not something one can take a class on and be competent with overnight. It takes years of practice and constant education to be proficient.

please be careful giving advice that is not accurate.

Wayne