Overview

There is certainly substantial confusion in the market about the differences between foreclosures and short sales. In the case of home sales a buyer is typically required to borrow a portion of the funds from a third party in order to purchase the house. That amount is paid at the closing in order to convey the property from one owner to the next. The lender (usually a mortgage company) provides the money and the closing agent settles the amounts owed by each party and collects and distributes funds.

Typically the seller then makes regular payments to the lender while they live in the house. When that seller decides to sell the property the money collected on the sale is divided up and the lender is paid from the proceeds. In addition to that cost, several other expenses are covered including title insurance, any unpaid taxes, home owners or condo association fees, etc. In addition, outstanding liens and the professional fees are deducted. The remaining amount is provided to the seller.

In a typical real estate market property values rise at a normal level over a long period of time. However, when we’ve had real estate market changes like we’ve seen recently the property may not have increased in value sufficiently to cover all outstanding debts and closing costs.

If the market value of the property is insufficient to cover the mortgage and closing costs there are a few options:

1. The Seller can bring the additional funds required to close.
2. The Seller and the lender or lenders can negotiate to determine a fair solution that will sell the property for a reduced amount and that both the Seller and the Lender can agree upon. (Short Sale)
3. The Lender may be forced to take the property back from the Seller and sell it on the open market through a foreclosure action.

Comparing the processes from the Buyer’s Perspective

Buying Short Sales

Short sales have become far more common over the last several years. Not long ago Realtors, lenders, title companies, buyers, and sellers were all relatively unversed in the use of short sales. They simply hadn’t been necessary do to as prices enjoyed many, many years of consistent growth. More recently all parties have been trained and departments have been created to address the specifics. However, from a buyer’s perspective the important thing to understand is the difference in timing. A short sale requires the seller and the lender to come to terms that are agreeable to both parties.

When looking at a short sale it is not uncommon for no conversation between the seller and the lender to have taken place. In fact, many lenders will not discuss a short sale with a seller until an offer has been procured. Once you write that formal offer, the seller and his representatives will approach the bank and propose a reduced payoff of the outstanding balance.

For example, as the buyer you may have offered $150,000 for a property. That may be fair market value but the seller may owe substantially more. If the seller owes the lender $200,000 they will have to ask the lender to accept the $150,000 that is offered minus common expenses outlined above. In this example, the bank will have to determine to its own satisfaction that the following conditions apply:

• The offer of $150,000 is the fair market value of the property.
• The seller is unlikely to continue existing payments.
• The buyer and seller are not related in any way and have no other agreements that would defraud the lender.

That process involves a series of steps and negotiations that the lender will work through along with an appraisal or opinion of value for the property. In addition, the lender will want a thorough review of the seller’s financial position. Once all of that is completed the lender and seller will strike an agreement and the buyer can proceed to closing.

The most important impact on a buyer in short sales is the time associated in bringing the deal together. Buyers should be prepared to be very patient. It is not uncommon for a short sale to take six months and it has taken over a year in some extreme cases. The process continues to get better but these transactions are not for buyers who need to be in a house by a particular date.

Buying Foreclosures

In a foreclosure situation the lender typically holds title to the property. The lender has already completed the steps to remove the seller from the situation. These properties are also called REO (short for Real Estate Owned) properties and are being maintained by the lender. Most lenders are not in the business of holding property and would prefer not to be holding these types of assets. In addition, while they own the property they are paying the taxes, insurance, and other expenses associated with ownership. To that end, lenders tend to be very motivated sellers.

The condition of foreclosed property varies from one to the next. One challenge associated with lender owned properties is that the sellers are typically not aware of the current condition or any history of maintenance. The seller will also generally require a very lengthy addendum to the traditional contract for sale and purchase disclosing that they have no knowledge of the property. As is always the case when purchasing property it is very important to have a professional inspection completed.

Lenders will typically price the property more aggressively because they are motivated. It is not at all uncommon to have several offers on a single property. It is also not uncommon for these properties to sell above the asking price. Be prepared to act quickly when you find the right property.

Statistics

Price

One of the most frequent questions asked is with regards to price. The following statistics were derived from the Daytona Beach Area Multiple Listing Service and only include cities that are directly in that system. Out of area properties have been excluded. The information looks at the full year of 2010.

Traditional sales of non-distressed properties sold at an average of approximately $97 per square foot. By comparison, Short Sales averaged only $82 per square foot in the same time period. Lender owned properties sold for an astonishing $61 per square foot on average. To translate that into a typical 1,500 square foot home, the average prices would have been $146,000 for a traditional sale, $123,000 for a short sale, or only $92,000 for the lender owned.

These sales prices do not take into consideration the condition of the respective houses. In addition, they are hard to compare as the lender owned homes were substantially smaller in comparison to the other two categories.

Transactions

All three categories are important to the overall market. In this subset of the market as a whole, there were just under 3,000 transactions last year. During that time: 1,645 (55%) were traditional sales; 953 (32%) homes were sold by lenders; and 391 (13%) were sold as short sales. Each category is important with distressed sales making up a significant portion of but less than half of the market today.

Summary

Both short sales and foreclosures are distressed sales. However, they are very different from a buyer’s prospective. When purchasing a short sale, the buyer should be prepared to wait. The buyer may not feel like progress is being made but they should understand that negotiations are taking place between the seller and the lender. For lender owned properties the process is typically much faster but the buyer should be prepared to make an aggressive offer and be ready to move quickly. Buyers who have cash and can close in a timely manner are the best options for foreclosures.

There are deals to be had in each category and a buyer should determine how one of these solutions fits their particular needs.