Jun 21, 2008
Finding the upside in “upside down”
21 Jun 2008
Posted by VAR
The Short Sale has become so commonplace in some Virginia markets that we’re already able to draw on
substantial experience with these critters. Not all of what follows will apply in all markets, or in all sales within a market, or even in all sales with the same lender in a given market. As the Romans used to say,
though, “Experiencia docet” — and experience really can be the best teacher in short sales, perhaps the most taxing transaction a residential REALTOR® will have to deal with.
REALTOR®, know thy lender
Lenders today, especially those holding a snootfull of bad loans, are facing unique pressures. A 2002 Tower Group study found that the average cost to a lender of foreclosing, holding, and disposing of
a property was almost $60,000, and that number is likely a good bit higher today.
Adding to lender woes is the simple reality that the market still has a way to go before we see home prices back into historical balance with household incomes. (See The subprime meltdown) A lender might not be anxious to take a property and try to sell it 12-18 months from now, when prices might well be lower.
Lenders are no fans of foreclosures. Taking ownership of a home means it has to add to its reserves, which reduces money available for lending and other income-producing investments. That damages its balance sheet even before considering the cost of maintenance, repairs, and real estate taxes.
Trying to offload REO into a saturated market can further depress values, starting a vicious cycle of
decreased worth and further defaults by borrowers.
So if we do our homework and give the lender a deal it can’t refuse, it will have every incentive to take it.
(There is one thing to be prepared for: Short sales take a long time — anywhere from 30 to 90 days more than a typical resale. With lenders and loan servicers already overworked, it might even be longer. With short sales, patience is not just a virtue, it’s a necessity.)
REALTOR®, know thy seller
Your first task is to get all the information you can about your seller and the property, and determine whether you’re likely to be dealing with a short sale.
That might mean making some probing questions during your initial interview with the seller. You will have done a CMA, of course, but now you’ll need to know how much it will take to clear existing liens and deliver good title.
Often your seller will know, and be willing to speak candidly with you about the facts. Sometimes, however, the seller won’t know all the facts (whether there’s a judgment lien, the amount of late fees, penalties and accrued interest, the amounts owing on credit lines, etc.). Sometimes the seller will know these things, but will not want to give you a candid response to your questions, either because of embarrassment or out of concern that if you know the facts you’ll urge a strategy that leaves the seller well short of the net needed to clear the title.
You’ll also want to know whether he’s current in his payments, and if not, how far behind is he? Has he
received default notice? Has foreclosure begun? If you are not 100 percent satisfied with the answers, consider doing your own lien search, or at least asking the seller to dig out his payment records.
You’ll want to know the seller’s motives for selling, and as much as possible about the seller’s financial condition. Is he unable to make his payments because his ARM has reset? Is he able to make his payments, but just doesn’t want to continue to throw good money after bad?
And don’t forget to ask your seller for a copy of his loan application and any other financial information he gave the lender when applying for the loan. (You’ll see why in a moment.)
You should also get as complete a picture of the condition of the property as possible. You’ll likely have
to structure the purchase agreement differently from the more common resale, and surprises about property condition will not be helpful.
It will also be helpful to know the area. Has it been classified “declining”? Are there nearby short sales? How many foreclosures have occurred in the last six months? With most or all of this information in hand, you can begin to prepare a marketing strategy.
REALTOR®, know thy marketing strategy
Your first decision is pricing, where you’ll run into the first counter-intuitive reality: Your pricing needs to meet your client’s urgencies, but you must be relatively aggressive, at least if you have any time at all to do so.
Why? Consider the lender’s reaction if you present a low offer shortly after putting the house on the market. If the lender is not confident that the offer is reasonable, your change of approval is slim. And most lenders will want to see that you’re making a reasonable marketing effort, especially if there are few other distressed sales in the area.
In fact, you might want to approach the lender as soon as you know you’re facing a possible short sale. Some lenders won’t talk to you if your seller isn’t well behind in his payments, and it’s important to know that up front. And lenders are increasingly willing to discuss strategy and, in some cases, even pricing, early on.
There are other benefits to early contact with the lender. You can find out who your point of contact is, what the lender’s list of requirements for approval are, and, possibly, how long the lender anticipates it will take to approve a request once submitted. (Knowing how long a wait to expect can smooth things over with buyers, too. They’re more likely to show patience if they know how long they will have to wait.) Some lenders will want to deal with the seller directly as well; they may have specific forms and requirements only he can provide.
Once you know what the lender needs, start putting it together. At a minimum that will mean a seller’s W-2 or proof of unemployment, the last two tax returns, financial statements, the last couple of years of bank statements, and a hardship letter. You will almost certainly have to give the lender your CMA or obtain an appraisal of the property as well.
Needless to say, be careful. If the seller obtained a stated-income or no-documentation loan, compare the information on the loan application with the what you are preparing to submit with the request for the short sale. Be especially alert to evidence that the seller falsified or overestimated income and/or assets, or lowballed or underestimated debt. Serving up to the lender evidence of seller’s loan fraud is probably outside the scope of your authority.
Along the same lines, be alert for evidence that the seller has frittered away his earnings or assets on a lavish lifestyle. Lenders respond favorably to legitimate hardship, but frown upon profligacy when they are being asked to take a haircut and forgive debt.
REALTOR®, know thy ethical obligations
Whether you are certain you are dealing with a short sale or just suspect it will take a stroke of good fortune to avoid one, you might be tempted to note in the MLS that this is a short sale. In fact, some MLSs have a field for this information.
You can’t make this decision by yourself, regardless of what you hear from other REALTORS®. The Virginia Code requires you to “maintain the confidentiality of all personal and financial information received from the client during the brokerage relationship … unless otherwise provided by law or the seller consents in writing to the release of such information.” This certainly includes the fact that the seller cannot pay off his mortgage(s) from the anticipated proceeds of the sale.
Your seller will need your professional guidance here. There might be an imperative that he get the best offer he can quickly (if he is already under the gun of foreclosure, or behind in his payments) even if it is well below what he owes. In such a situation, it might make sense to let participants in the MLS know how things stand.
On the other hand, he might insist on trying the market without letting prospective buyers know of his distress. This might be the case if he has hopes of avoiding a short sale, or is hopeful of securing a workout with his lender — if he is moving to take a better job, for instance, and offering the lender an unsecured note for the deficiency.
If you do agree to notify the world of a possible short sale, be sure to get the seller’s consent in writing.
REALTOR®, know thy buyer
When you get an offer on the property, you’ll have to approach things somewhat differently
from how you would with a more routine resale.
In the first place, the lender is not going to waste time on a deal that can’t close. This means
that your buyer will have to qualify to not one but two lenders — his own and the seller’s.
The seller’s lender is unlikely to be satisfied with just approval from the buyer’s lender, let alone a “prequalification” letter. Many payoff lenders will actually require the buyer to make a full-fledge loan application with it — not to borrow money, but to prove he’s actually able to get the loan he’s seeking.
Obviously, the better your buyer’s loan profile, the better the chance of approval. Whomever your buyer is, he must be able to close and convince the payoff lender of that fact. You might as well make that clear from the start of your dealings.
On the other side, if you’re a buyer agent, you’ll want to know your client’s tolerance for a short sale. And, of course, you’ll want to know when you’re about to enter one. If the listing agent has not made that clear in the MLS or otherwise, ask. If you don’t get a satisfactory answer, at least conduct a down-and-dirty lien search to find out if a short sale is in the cards. But don’t blame the listing agent for not telling you up front: he might not be able to.
REALTOR®, know thy contracts
A well-drafted is always central to a successful transaction, but this truth is magnified in a short sale. A contract with contingencies and full of seller concessions and credits will probably grate on the payoff lender’s last nerve.
Do as much up front as you can: get approved, get inspected, and put all necessary credits and seller concessions in the price. A contract that comes to the payoff lender clean stands a much better chance of success. A leaky roof should be your seller’s problem, not the lender’s.
A short-sale contract is going to have a contingency for third-party approval. But how should it read? Most contain a provision along the lines of, “This contract is contingent on approval by seller’s lender.”
What does such language mean? It could mean that there is a ratified contract but that seller’s obligations are contingent on lender approval. In this case, the earnest money deposit must be placed in escrow (with all that means), and the buyer will find it difficult to back out of the deal while approval is awaited.
Or it could mean that there is no contract until the lender approves. In this case, either buyer or seller can back out before approval arrives. It also means that the earnest money should not be deposited until approval is received.
So which is it?
It’s worth considering whether to be crystal clear on this point. The contract might say: “Seller’s obligations under this contract are contingent on approval of seller’s lender” or words to that effect. Or “Acceptance of this offer and creation of a binding agreement is subject to written approval of seller’s lender.”
It’s especially important to consider the language if more than one contract/offer is being presented to the lender. I have heard of several instances recently where seller has received multiple offers, signed all of them, provided that “This contract is contingent on lender approval” and sent them to the lender for consideration.
This can create a great deal of ambiguity as to where the parties stand. In the first place, are all the contracts “ratified” or not? Does each escrow agent have to keep the deposit and await the lender decision and approval of the seller to release the deposit if the contract is not approved? Does the listing agent have to note in the MLS that a contract is pending with contingency?
If you don’t know the answers, you should.
REALTOR®, protect thy commissions
Now we come to perhaps the most contentious issue of all: commissions. Some lenders will require, as a condition of approval, that the listing agent reduce his commission.
Let’s say the seller has agreed to pay the listing firm 600 chickens and that the listing firm has made an offer in the MLS of 300 chickens to the firm that procures the buyer. What happens if the lender requires the listing firm to accept only 400 chickens?
First, let’s dispose of the ethical issue here. Is the listing agent ethically obligated to accept the reduced fee to make his client’s deal happen? After all, the lender is offering to accept a deal that allows the seller to avoid foreclosure and possible bankruptcy, and to salvage something of his credit, if the listing agent will only concur.
The answer here is simple: A REALTOR® is never obligated to reduce the fee he has been promised to make his client’s deal work. You might find it in your interest — compelled by your conscience or your moral compass — but you have no legal or ethical duty, under the Code of Virginia or the Code of Ethics, to do so.
And if you agree to a reduction? Most of the time you’ll want to approach the buyer’s agent and request that she reduce her co-broke fee to 200 chickens from the 300 that were offered in the MLS. Is she ethically obligated to do so? May you even ask her, within the strictures of the Code of Ethics, to accept less than was promised in the MLS?
It comes as a surprise to most REALTORS®, but the Code of Ethics does not prohibit a listing agent from using a purchase offer to renegotiate the terms of what’s in the MLS.
Standard of Practice 16-16 prohibits the buyer agent from using the terms of an offer to renegotiate the listing company’s offer in the MLS, but it does not work the other way around.
But does the buyer agent have a duty to her client to accept the reduction to make the deal happen? Again, the answer is no. No REALTOR® ever has to accept a reduction in the promised fee to achieve a client’s objectives. It’s entirely your decision as to whether to do so.
So if the buyer agent rejects the offer and even refuses to ask his buyer to pay the difference — or if the buyer refuses to pay the difference when asked — what happens to the listing agent? With the lender requiring the reduction, and the buyer and buyer agent refusing to cooperate, can the listing agent count on the seller to support her? Remember that at this point, the listing agent has agreed to accept 400 chickens but finds herself having to pay out 300 to the recalcitrant selling agent, leaving only enough to make a couple of omelets.
Who do you think the seller, seeing only 100 stinkin’ chickens standing between him and foreclosure, is going to support? No, I’m afraid the listing agent is at the mercy of the buyer agent here, and that’s a shame for both.
The problem has not gone unnoticed. Some listing agents have taken to putting conditional offers of compensation in the MLS. They will offer something along the lines of, “300 chickens or one-half of the fee approved by the third-party lender.”
Let me be clear: Such offers do not belong in the MLS and probably violate NAR multiple listing policy,
which has long required that a selling agent be able to calculate, from the offer, the amount of compensation she will receive upon procuring a buyer. When the offer of compensation is essentially “one-half of what I agree to accept” the selling agent has no idea what the compensation, if any, will be.
What principle dictates and what reality dictates can be two different things. The NAR legal staff agrees that NAR policy does not permit this kind of offer. But the market is roiled and many agents are framing offers this way because they’ve been burned by uncooperative buyer agents. Virtually all MLSs are accepting them, so — are you ready for this? —we’ll just have to rely on the arbitration panels to sort it out.
There’s much more to say about short sales — how you deal with second mortgages or other junior lien holders, for example — but then there’d be nothing for you discover on your own. So lets just say that the short sale requires us to know a lot — about lenders, the economic environment, the clients, the property, the neighborhood, the other party, the contract, the Code of Ethics, Virginia law, and ultimately, ourselves. Do we have the stomach for this unique opportunity to show expertise our clients desperately need? The answer is “Yes.” But they won’t last forever, so if you don’t want to miss the fun, you’d better get hopping.