Realtor MLS statistics indicate that on average short sales sell for 50% less than a non-short sale transaction. So how can you share in the profit?
How to Make money buying short sales
The nationwide mortgage meltdown and housing price bust just maybe a once-in-a-lifetime opportunity to accumulate wealth for many of us. Banks were foreclosing on properties with reckless abandonment until Obama was elected. The new administration put in all kinds of constraints to slow down the foreclosure process. One of those constraints included allowing a homeowner to short sell the property before the mortgage lien holder can complete the foreclosure process.
Historically, it was nearly impossible for a homeowner to get a lender to approve a short sale, they just were not willing to take a loss on the property, plus it could take 3-6 months to get approved to short sell. Lenders would rather foreclose than work with a homeowner to short sell.
With many mortgage lenders being insolvent and requiring federal bailout money, short selling suddenly became a faster way to liquidate loans in default to improve the lender’s balance sheet. The result is the concept of a lender “pre-approved short sale”. Some lenders offer HAFA short sale programs (sponsored by the US Treasury Department). Others are offering traditional pre-approved short sales—there are restrictions with a HAFA short sale.
What does short selling include, how does it operate, and how can it be profitable?
- Short selling occurs when a homeowner sells their house for less than the mortgage lender is due.
- Pre-approved short sales are where the lender and borrower have already processed all the required paperwork and wiped out or negotiated with any junior lien holders to allow a deal to close in 45 – 60 days, just like any average transaction would.
- The lender has already approved property values, and list prices, all you need to do is get your contract accepted and the new loan approved.
- HAFA Short Sale is a Government-sponsored short sale as part of the US treasury department HAMP program.
- A traditional sale would be a non-HAFA short sale.
Suddenly, all of the short-selling barriers have been removed, with the mortgage lenders leading the charge.
So how do I profit? Many homeowners are being denied loan modifications and forced into short selling, so there is currently a virtually unlimited supply of short sales. Many of these homeowners could afford their homes at the quick sale price, but the lender denied them a loan modification for whatever reason. Profiting from a short sale may be accomplished in two ways.
- Buy the home and flip at a higher price at a later date. HAFA short sales require a 90 hold period.
- Buy the home and do a sale-leaseback to the existing homeowner with equity participation, giving both seller and buyer an opportunity. HAFA short sales do not allow sale-leasebacks.
The sale/leaseback or rent to own program is a great way to stabilize the market, allow someone to re-establish their credit, let them keep their home while providing rental income, tax deductions and capital gains to you as the investor.
However, before you jump into buying short sales as an investment under a sale-leaseback arrangement, You must ensure that you have all of your ducks in a row. For example:
- Make sure you are pre-approved with a reputable mortgage lender for an investment loan; underwriting guidelines are more stringent for this type of loan.
- Ensure you have adequate reserves to make the mortgage payment if the tenant is late paying rent.
- Consider having the utilities put in your name, so they don’t get shut off if the tenant does not pay them. The rent should be adjusted to reflect this.
- Meet with the owner and interview them. How did they end up in foreclosure? Predatory lending, loss of job, illness, death of a family member, overextension of credit. Don’t be judgmental and be empathetic; they may be your new business partner.
- Is the current owner employed? Remember, you are now a landlord, and you need to understand how your tenant will pay your rent.
- Ask for documentation proving the lender has pre-approved the short sale.
- Use an experienced realtor that knows how to write a short sale contract and use all the applicable disclosures and contingency clauses to protect you.
- Use an experienced real estate attorney that is familiar with closing short sales.
- Be prepared to visit the property regularly and realize you may need to repair it to maintain its value.
- Make sure you understand the local real estate market for this property. Is it located in a desirable neighbourhood, good schools, close to employment centres, low crime rate?
- Ascertain that you are familiar with municipal property upkeep rules, resale code compliance, and rentals. Some cities have ordinances you need to comply with.
- Have the sale-leaseback agreement in writing along with any equity participation for when the market recovers or how capital improvements made to the property are recaptured.
- Have a defined end date and goals the tenant can work towards; remember you eventually want out and profit, not be a perpetual landlord.
- Avoid properties with undesirable issues: wrong locations near train tracks, commercial, industrial, busy road, floor plan issues, etc…
- Initiate the process by obtaining a home inspection from a qualified inspector; if problems are found, get contractor estimates and send all the documentation to support your offer. Even on a pre-approved short sale, the lender still needs to approve the proposal.
- Get a title report to make sure the title is clear.
- Don’t get emotional; it’s a business decision, the numbers work, or they don’t work. It would be advantageous if you had at least a 30% gain when the market rebounds to offset your holding expenses.
The due diligence required for short sale investing is just as necessary as it would apply to any other sort of real estate investment.
The significant advantage to short sale investing is that you already have a committed tenant lined up and provides you with a pre-determined exit strategy. Do not violate HAFA rules; it would be a federal violation and subject to Federal Penalties and could be considered fraud.
