View the original article here written by my business partner Johnny Schiro
So you want to invest in real estate, and like any smart investor, you want to buy low (and later, sell high). Logical thought process leads you to distressed property: foreclosures, pre-foreclosures, estate sales, and so on.
Getting Started
A quick google search for distressed real estate statistics reveals the following: bank foreclosures (REO) and short sales account for at least 15%-and up to 30%-of the homes sold in August of 2008. Why such a broad range? Well, foreclosure stats are inherently difficult to track - homes fluctuate in and out of foreclosure status as banks and homeowners negotiate last-minute repayment terms. By the time property becomes bank-owned (referred to as REO), it may have been reported as a foreclosure two, three, or more times. Short sales are even more difficult to track: county tax records do not recognize short sales, and most Realtor Multiple Listing Services do not yet include a short sale designation.
So back to the point: distressed properties account for a huge percentage of today's home sales. Unfortunately for us investors, it's still not so easy to tie up a great deal on a short sale or foreclosure. Why? Because despite the relentless news about our terrible economy, there is still a surplus of cash floating around among the investment community. And since most investors think alike, everyone is in on the hunt.
Ok then, so everyone knows about short sales and foreclosures. Is there anything you can learn from this article to get ahead? Yes, actually, there is.
Recognizing Short Sales
So what exactly is a short sale? Just as the name indicates, in a short sale transaction the seller's net from sale is short of what is needed to pay off existing mortgage obligations. Instead of asking the seller to write a check at closing to cover the deficiency, the mortgage holder accepts a lower, or 'short' payoff; the seller's resulting net-from-sale is $0. By definition, a short sale takes place anytime the mortgage holder releases the mortgage lien for less than the full payoff.
Exploit the Semi-Interested Third Party
Short sale transactions are tagged in some MLS systems as "Third Party Approval Required". The so-called Third Party is the seller's mortgage company-the current lien holder. Yes, this third party must approve the sales contract, but no, they do not have the same motives or requirements as a typical home seller. This is where we as investors can take advantage of a distressed property. The bank (surprisingly) doesn't care about what is currently owed on the property like a typical home seller might. They don't care much about time on the market, and they don't care about the property's last sale price. All the bank cares about is the ratio between the new offer price and their determination of today's market value. If you're really reading carefully, that last sentence should have highlighted two key questions:
- How does the bank determine today's value?
- What price-to-value ratio is acceptable to the bank?
The above questions, together, help to determine a realistic short sale purchase price.
Predicting the Bank's Determination of Value
The method by which the bank determines today's value varies. Some banks use a real appraisal (the same type you'd pay for as a financing requirement), where other banks use the Broker Price Opinion (BPO) method. A BPO is essentially a real estate agent or broker's opinion of market value...which, as you may expect, can have a wide range of accuracy. Especially when a property is not in perfect condition, most agents price opinions may vary up to +/- 10% , which makes it difficult to forecast the bank's determined value. Key point: the bank's assessed value is not necessarily the real market value.
Realistic Short Sale Prices
So how can you-the investor-predict the bank's value? You probably can't with any real accuracy....but your Realtor can. Competent Realtors not only know their local market, but they also know the attitude and perspective of their local peers. And that means they should be able to predict, with some accuracy, how a BPO might value a specific property. You are working with an experienced distressed property Realtor, right? If you're not, you should probably stop reading now and move on to an article about how a local, specialized Realtor can help you multiply your dollars in real estate investment.
So on to the paramount question: what is a realistic purchase price? The benchmark from most banks is 90% of their determined value. Simple and easy. Just figure out what the bank thinks the home is worth, take a 10% reduction, and you have an acceptable price. Now that doesn't mean any short sale purchase will come with 10% equity, and it doesn't mean you can't do better. If you want a bigger discount, however, you'd better be prepared to wait.The short sale negotiation process includes several stages: offer, counter offer, preliminary acceptance, another counter offer, and so on as the transaction moves from the bank's front-line negotiator up through managers and ultimately the top-level investor.
As is the case in most real estate transactions: make sure you have the assistance of a legitimate short sale expert Realtor.
To take full advantage of a short sale or a foreclosed property, you'll need to be knowledgeable about your target market. Sorry folks, but just a short sale doesn't mean you'll be getting a great deal. It just means you'll be able to tell your friends you scored a short sale. So that said, please make sure you do one thing before you attempt a short sale: learn your market. And if you're not an expert on the target market, make sure that your agent is.
Coming in my next post on this subject: Pros and Cons of the Short Sale.
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