If you haven’t already encountered these terms in casual conversation – don’t worry – there’s still plenty of time to catch up. After the following introduction, you’ll possess just the right amount of knowledge to be able to discuss these most important matters over a cup of tea, a pint of brew, or a tall glass of heavily chlorinated new world water.
A short sale occurs when a property is sold at a purchase price that is insufficient to cover the amount necessary to pay off any liens and/or encumbrances secured to the property (first/second mortgage, prepayment penalty, etc.) and the expenses (real estate commission, documentary stamps, attorney/title fees, etc.) associated with the sale.
For a short sale to take place, the lender must agree to accept a discounted payoff. In other words, the lender must be willing to receive less money (from the sale of the property) than is actually owed in exchange for releasing the “short seller” from the lien(s).
The term “pre-foreclosure” is commonly used to describe a short sale situation.
The following is a fictional scenario that should help you better understand the concept of a short sale:
Jose Sabelotodo, better known to his personal and “business” associates as Cheito, purchased a bad a*s penthouse in an 8-story luxury boutique building with only 3 units per floor in the Patta Alla section of town. He paid $500,000 at the height of the condo boom in the summer of 2005. In need of keeping his payments as low as possible in order to maintain his enviable lifestyle – Benzino, Rolex, pinky ring with a 2-carat diamond, Armani suits, dinner at Azul, a nose candy habit, and a revolving door of the finest escorts north of Cali, Colombia, Cheito leveraged as much of his money as he could and opted to finance 100% of the purchase price with a 2-year interest-only adjustable rate mortgage (ARM).
At the time, he figured, “in two years when the interest rate on my ARM adjusts from a 6.25% to a 9.25%, I’ll be able to refinance into a 30-year fixed mortgage. By then, after I marble out the living room, remodel the kitchen and all 3 baths, this baby’s gonna be worth about $675,000. With my clinics and the Assisted Living Facility (ALF) doing this well…oh and that condo conversion my buddies and I are doing in East Hialeah….quien sabe? I’ll sell this y me mudo pa’ Cocoplum.”
Fast forward two years (Cheito’s ARM is set to adjust).
Cheito’s bachelor pad (he’s now twice-divorced with two child support payments – one to each baby momma) depreciated a whopping 20% (he took a bad hit – he failed to factor in the importance of being in an established or emerging neighborhood when he decided to purchase in Patta Alla).
In addition, he had to let his clinics go pennies to the dollar cause the Feds were hot on his trail.
The ALF? That got shut down – it wasn’t licensed and the daughter of one of the elderly under its care blew Cheito’s cover when she complained to the Agency for Health Care Administration (AHCA) about her mother’s soiled sheets not being changed, as well as the weeks-old bedsores that were left untreated.
You’re probably wondering, “Cheito still had that condo conversion thing going though right?”. Not quite. After choosing not to renew any of the leases and “decking out” the 10-unit all studio building, the on-site sales team from Yo Lo Vendo Realty was unable to close one sale. The keys to the locks of all 10 doors were recently handed over to the lender who financed the project, El Diez de Oro.
Cheito’s income stream is now down to a small percentage of what it was just two years ago. In fact, the only thing keeping him from going hungry these days is the graveyard shift one of his few remaining “socios” was able to hook him up with en un “huerhow” (that’s warehouse) west of Miami International Airport.
Cheito cannot refinance his property – it has no equity and besides, lender underwriting guidelines have become much, much stricter these past two years. Furthermore, his bank account is in the red and he cannot afford to make these exorbitant payments anymore.
What is Cheito to do?
Cheito, ladies and gentleman, is a prime candidate for a short sale. He has no problem proving a hardship (although you have to wonder how Cheito was able to qualify for that loan in the first place), he has no assets, and he can prove that his bank account hasn’t seen a deposit in over 6 months.
“How about if the lender doesn’t accept a short sale”?
Well, that leads us to our second term for 2008.
If the lender doesn’t accept the short sale and Cheito hasn’t made a payment in about 90 days (this varies), chances are that the lender will begin a legal proceeding known as a foreclosure.
A foreclosure is a legal proceeding in which the lien holder (usually a bank or other financial institution) sells or repossesses a property due to the borrower’s (Cheito’s) failure to meet his or her contractual obligations – a default in payment of a promissory note, secured by a lien on the property.
In other words, the borrower is delinquent on payments and the lien holder either sells the property at a foreclosure auction after going through the legal process of “foreclosing the mortgage or the lien”or receives title to the property if no buyer steps forward at the auction.
If misery truly enjoys company, boy is Cheito enjoying himself these days. As of October 2007, 20,457 mortgage foreclosure filings had been filed with the Miami-Dade County Clerk of Courts. Compare that to all of 2006‘s filings of 9,814 and that gives you an astounding 108% increase from 2006 to 2007 (November 2007 and December 2007 figures are pending).
In a case such as Cheito’s where the remaining mortgage balance is higher than the actual value of the property (negative equity), the lien holder is unlikely to attract any bids and, as a result, becomes the owner of the property.
At this point the property becomes…
Real Estate Owned (REO)
Real Estate Owned, more commonly known as an REO, is a class of property owned by a lender after an unsuccessful attempt to sell the property at a foreclosure auction.
REO’s are becoming more and more common these days in South Florida due to the fact that a very large percentage of the properties going up for sale at the auction have negative equity and therefore, are not sold.
The lender now attempts to sell the property (at a loss) through more traditional channels (i.e. the use of a realtor). The lender may remove some of the other liens or encumbrances attached to the property and/or repair some of the damages in order to make the property more marketable.
In general, REO properties are known to suffer from deferred maintenance and/or are in need of extensive repair. However, in some cases obtaining a property at a low enough purchase price may be enough to compensate for the condition of the property.
2008 promises to be a year filled with opportunity for savvy real estate investors looking to benefit from current local real estate market conditions.
Will you be a spectator, a participant, an innocent victim or any combination of the three?
You don’t have to answer that.
Disclosures: Any similarities to persons and/or corporations living or dead is purely coincidental. Adrian Salgado is a Realtor Associate with RED I Realty in Miami, FL. He is not licensed as a lawyer nor a CPA and cannot advise on those consequences. However, he can be reached at 305-491-7179 or at SalgadoA@gmail.com if you have any real estate-related questions or just need someone to talk to about society’s ills.