[Written from an Investor's standpoint]
When was the last time a Realtor, that you know, has performed a short sale where they have requested a discount in excess of their commissions and covering closing costs?
Why is it that most Realtors don't know or attempt to negotiate a bigger discount in a short sale on behalf of their client?
You wouldn't think that the banks would give these foreclosure properties away now would you... but understanding just how a non-performing asset affects the bank's ability to borrow money helps us to see why they would want to...
Understand that if the bank (or mortgage company) has a $100,000 mortgage that is in default, this affects their ability to borrow by a factor of 9. This means that they lose the ability to borrow up to $900,000 from the FED.
This works with credit cards too - say that you apply to get a card with a line of credit of $5,000 - the bank who just issued you the card with a line of $5,000 uses your credit to borrow 9 times that amount - so they leverage your credit worthiness to borrow $45,000 from the FED.
So it stands to reason that the bank (Mortgage Company) will be willing to discount the payoff of the underlying mortgage when it is in default. The amount that they are willing to accept is dependant on several things - actually it's a very simple calculation and if you understand this, it will be easy for you to calculate what you might pay for any property in Foreclosure...
So how can you know what to offer the bank? How will you know what they are willing to accept? Well, it's a simple calculation and basically it's 80% of ‘As-is' value of the property. Pretty simple calculation wouldn't you say? And they may go to 75% if there is a Realtor involved assuming a 6% commission structure.
Ha - there is a catch...
The bank has a certain way that they calculate that As-is value... each bank is different, and in some cases their calculations are cast in stone - there is a reason for this too, which we will cover later - let's just say that it has to do with a thing called mortgage insurance - and this isn't PMI either.
Ok - so some banks rely on an Appraisal and others will accept a Broker's Price Opinion (BPO). In either case the local market, property condition, and several other points will affect the actual value that the bank puts on a property. Contrary to popular belief, you can only influence this process so much - you can't get the bank to believe that the property is worth less than it really is.
Banks do exactly what we should be doing... they evaluate their risk associated with a given property without even looking at the borrower. If the subject property is in the inner-city then the bank knows that the borrower will most likely be a high-risk borrower (because of income or other social economic concerns). They will also know that the property is old and will not appreciate much over the term of the mortgage. There are also several depreciating issues that the bank will look at, and the most important one is crime... yes crime does depreciate the value of a property.
So now since the banks will offer discounts on most all properties with defaulting mortgages, what should we look at as an investor? First - you've heard this so many times before -location, location, location!
The banks do not want to hold on to Real Estate! The banks want to liquidate anything and everything that they can and they will mitigate their loss as best they can. This means that while we can get them to discount just about any mortgage payoff, there will be some that they will be more willing to discount than others. We just need to figure out where we can make the most profit at the end of a transaction.
I guess that maybe this isn't obvious - the whole point of doing a Short Sale is to get the bank to accept less than what is owed to pay off the existing mortgage.
If you have purchased or sold Real Estate before you know that at closing the existing mortgage - the one held by the seller, needs to be paid off before the bank releases it's interest in that property. A Short Sale allows the buyer to negotiate a much lower payoff of the existing mortgage. In many cases today it may be 50-60 percent of what is actually owed. Don't quote me on this discount as it truly depends on the current value of the property in today's market.