Short Sale – Say What?

My visit to the USA has been very educational.  I’m learning new terms; new concepts.  Especially when it comes to real estate.  One especially common term these days is “short sale.”

So, what is a short sale?  What’s it all about?  Well, let’s listen in on a compilation of conversations I’ve had over the past week about this real estate ritual; a ritual that has become standard practice since the Global Financial Crisis (GFC) hit back in 2008 or so.  I’ll just pass on to you what I’ve been told and what I’ve heard.

The Short Sale Conversation:

Me:  So, educate me about short sales.  How does it work?

Agent:  A short sale is when the bank agrees to sell a property for less than what’s owed.

Me:  Why on earth would the bank do that?

Agent:  Because the bank in not in the real estate business; they’re in the money business.  They want the house off their books.

Me:  Ok, but why would the owner agree to a short sale?

Agent:  Most of these owners are in way over their heads.  They just want to get out from underneath the debt.

Me:  Can you give me an example of what you mean?  I still can’t understand why an owner would go for a short sale.

Agent:  Well, let’s look at this house you want to buy.  The owner owes about $150,000 on the home and you’re putting in an offer of $77,000.  So, the owner has a property worth about $77,000 in this market but owes $150,000 on it.  A short sale gets him out from under this negative equity situation.

Me:  I can see the cashflow would be terrible on a debt of $150,000 because the place would only rent for about $800 a month.  So, the owner is out of pocket every month by probably $800 bucks.  Not exciting.  But, what about the loss from the deal; doesn’t the owner have to absorb that?

Agent:  Well, this is part of the good deal for the seller.  If it’s an owner occupier, I believe there’s no debt to repay.  The bank let’s the owner off the hook.  But, if it’s an investment property, then the owner has to pay taxes on the loss.  In other words the loss is reported as income and taxes are owed.  Still a pretty good deal.   Some of these investors have multiple properties so the tax could be substantial.  But, it’s still better than paying off the debt.

Me:  Why would the bank agree to let the debt slide?  It doesn’t make sense to me?

Agent: Well, this is where the bailout must come in, because you’re right.  I’ve never heard of the bank taking such losses.  And, the banks are reporting huge profits.  Maybe the government is working a deal where the banks get a payout from the government.  I’m not sure how that works or why the banks are so agreeable to taking these losses.  The banks are accepting fifty cents on the dollar these days.  You can get the house for about half what’s owed.  Crazy.

Me:  Another thing I can’t work out is how did people get into such a financial mess?  What was the driver?  Why would someone pay so much for a house and the rental is so low?

Agent:  When the market was hot we had a lot of speculators.  Folks coming out from California and just buying up everything – at high prices.  The blocks over in Citrus Springs were selling for maybe $4,000, then the boom hit and we were getting over $30,000.  This was way too high.  I even tried to talk some people out of paying that much but they wouldn’t hear of it.  Everyone wanted in, money was cheap and the banks were lending to anyone.  If you could breathe and put a little fog on a mirror, the bank would lend you money.

Short Sale Expert?   I Don’t Think So!

There you have it.  A brief discussion on the ubiquitous “short sale.”   Does this make me an expert?   No way.  But, we’re looking a buying one.  I’m sure the process will allow me to learn much more about short sales than I ever wanted to know.

It appears the short sale is good for all involved.

First, it allows the owner to gracefully get out from under a bad investment debt/deal.  The owner avoids the foreclosure process and preserves a good credit rating (I understand).

Next, somehow it’s good for the bank.  The bank get the property off the books and clears the debt.  Does the bank have some sweet deal with the government to recoup this loss?  Not sure.  But, it does seem fishy that the bank is willing to take fifty cents on the dollar to get out of the deal.  Have you ever heard of a bank taking that kind of loss?

Finally, the short sale is good for the buyer.  I’ve never seen such attractive buying conditions in all my years of investing.  You can buy a two or three year old home and the rent will cover all your holding costs (e.g. interest, management, taxes, insurance).  And probably leave you some cash left over at the end of the month!

What are your thoughts about short sales?  What insights do you have?  Please share them so we can all learn.