Why Buying Short Sales is Better than Buying Foreclosures

There may never be a better opportunity to buy a home or an investment property in San Jose. Prices have dropped by 25% from their peaks in some market areas and there may still be another 15% of negotiating room left on the table for buyers who are willing to tolerate the vagaries of buying a short sale listing. What many buyers don't realize is that short sales can be a better bargain than buying a bank owned home (REO). That is because with the Tax Relief Act of 2007 passed in December the owners in a short sale have no concern as to the actual price they accept for their home. They aren't getting any proceeds from the sale and the debt forgiveness is generally non-taxable from a federal standpoint. California hasn't yet followed suit but it seems likely that they will. This means that the bank is the only party with an interest in the sales price and they're going to be weighing their options on the basis of which outcome will net them more a short sale or a foreclosure. Since a short sale has several advantages for the bank over the foreclosure then the price they are willing to accept on a short sale is lower. Those advantages are 1) Time; the short sale will get the cash back in the bank's hands anywhere from 90 days to 6 months sooner than going through the foreclosure process. 2) Time again; the short sale will get the non-performing loan off the bank's books that much sooner as well. This will relieve them of having to keep reserves for that loan thus shoring up their balance sheet. 3) Certainty; a bank will be willing to take a little less for a certain payoff today rather than an uncertain payoff in the future. This is especially true in areas that they have determined to be a declining market. That includes much of California right now. By definition, in a declining market you'll get less for an asset tomorrow than you will today. Of course, nobody knows when a declining market will bottom out and become an appreciating market. More on that in future blogs regarding negotiations on a purchase. Suffice it to say that a lender would rather have a controlled loss today than an uncertain loss in maybe six months. 4) Condition; in the same vein lenders would rather sell a home that they know the condition of than a home that may be in very poor condition. In the 1970s there was an extreme down market in Texas (nationwide actually, but Texas particularly). Banks learned then that foreclosed upon homeowner can do quite a bit of damage to a house on their way out. Owners were know to put a running garden hose into the window, flush concrete down the toilets, take entire kitchens, cabinets and all and then some rather rude items were also left behind. Even though this is considered a criminal act if the home has already been foreclosed, it seems unlikely to be prosecuted. Also in terms of the condition of a home when the bank gets it back goes to deferred maintenance such as water damage, landscaping becoming ruined or roofs left to leak. In addition is the possibility of vandalism or squatters. Many insurance companies won't insure a property if it is vacant for extended periods of time since they know that risks of loss increase dramatically in an unguarded property. 5) Perhaps most important to the bank is the cost associated with a foreclosed home. There are costs associated with every step along the way. They need to serve papers record notices of default and notices of sale. They need to pay the trustee to offer the property for sale at the courthouse steps. They need to pay an eviction company to get the property vacant including the likelihood of giving "cash for keys" to the foreclosed upon occupant. They need to pay an asset manager to prepare the home for sale which generally will include changing locks, repainting the interior, putting in new carpets, and generally preparing a home for sale. On top of that they will need to pay a Realtor a full commission in order to get the home listed and marketed. Often in a short sale the bank can negotiate a lower than market rate commission.

Given all of these costs associated with disposing of a foreclosed upon property, it is clear why many lenders would prefer to accept a preforeclosure short sale. There are some factors which make it difficult for a lender to do this process mostly having to do with the contract that they have with the ultimate investor who holds that mortgage backed security, but that is something that is becoming more and more negotiable since even these investors understand that they are better off following the bank's lead and accepting a short pay-off. So, how much will a bank accept on their preforeclosure homes. Of course that varies. The conventional wisdom is that they will accept 90% of market value for the home. Market value is always nebulous since there are many homes for sale and not too many closing in the affected areas. This is where a trained agent can work in your favor since a large part of getting a bank to accept a short pay-off is preparing a proper package to demonstrate to the loss mitigator at the bank that this offer is closer to the actual market value than the other resources that they are relying on will tell them. There are several tools that a bank will use to determine the value of the house in question. Each of these has their own motivations, not the least of which is to list the property for sale as an REO. Everyone wants to paint a rosy picture for the bank even if the number of sales in the field indicate that the sooner they liquidate the asset the better. So if you can convince the bank that your offer is their best option you can get a pretty nice home for as much as 15% below the current market value. When you're dealing with ballpark $500,000 homes this is like a savings of $75,000. In addition I am offering a buyer rebate of half of my commission so add perhaps another 1.5% rebate onto that $75,000. You may also get closing costs paid by the lender built into the deal. Not bad for a house that 8 months ago would have sold for $650,000 and in another 24 months might appreciate by 10-20% over its current market value. Almost certainly within 5 years this market will be on fire again since Silicon Valley is the export engine of the nation and has products that the world needs in order to develop their infrastructure and quality of life. California's population is expected to increase by 20 million people in the next 20 to 30 years and there really isn't much space in the Silicon Valley to build more single family homes. The 6000 square foot lot is becoming a thing of the past and there are only about 106,000 in all of San Jose, a city of over 900,000 population. Given the law of supply and demand there isn't any question that over the long run Silicon Valley real estate will be an excellent appreciating asset. Given that rents are increasing in Silicon Valley at a rapid rate, the ability to buy a positive cash flow house is finally within the investor's grasp. This is the most tangible investment that you can make, especially given the tax advantages to owning both you own primary residence and investing in homes for rent.