Real Estate

April 9, 2009

Hatteras Island Real Estate: Buying foreclosures and short sales

BY TOM HRANICKA

While the number of foreclosed properties and short sales is relatively small on Hatteras Island, this market segment is growing rapidly. During 2008, bank-owned cottages and condominiums represented about 15.7 percent of all residential sales on the island. During the first quarter of this year, foreclosed properties accounted for 43.5 percent of residential sales. Since distressed properties are clearly of interest to prospective buyers, I thought that it might be beneficial to take a look at some of the unique characteristics of this emerging market segment and how it differs from the traditional sales environment with which we are all familiar.

Background

Before we begin our discussion, let’s be sure we have a common understanding of some of the terms that we will be using. A foreclosed property is one that has gone completely through the foreclosure process and is now owned by the lender. We sometimes refer to these properties as “bank-owned.” Negotiations for the sale of the foreclosed property take place directly between the buyer and the lender. The former homeowner is completely out of the picture.

A short sale, at the risk of oversimplification, is a property that is still owned by the borrower, but the homeowner owes more on their mortgage than the current fair market value of their property. Therefore, the property is being sold “short.” While the homeowner may negotiate a short sale offer to purchase with the buyer, the contract must be contingent on final approval by the lender, since the lender is agreeing to take a loss and to let the homeowner sell the property for less than the amount of the mortgage balance plus closing costs. Short sale situations are also known as being “under water” or “upside down.” Foreclosures and short sales can be either residential properties or unimproved lots.

For additional perspective, there are currently far more foreclosures nationwide than there are short sales. According to a recent report by the Office of the Comptroller of the Currency and the Office of Thrift Supervision, during the fourth quarter of 2008, there were about six foreclosures for every short sale. However, as the housing downturn lingers, lenders are approving more short sales. This makes sense since it has been estimated that the foreclosure process from start to finish can cost a lender between $30,000 and $50,000. In a short sale, the lender suffers a loss on the difference between the outstanding mortgage balance and the selling price, but never has to take actual possession of the property.

Buying A Foreclosed Property

Whether someone is purchasing a foreclosed property or a short sale, it is important to enter the market with realistic expectations. These are not the typical real estate transactions which most of us have experienced. Every lender and every situation is somewhat different.

The most basic difference when considering a foreclosed property is to realize that you are not dealing with a conventional seller. You are interacting with a completely emotionless corporate entity that has virtually thousands of properties that it is trying to sell. The lender usually has no first hand knowledge about the property and relies on third parties, such as real estate brokers and appraisers, to tell them such things as the condition and the approximate value of the property being offered for sale.

Lenders in many cases are using computerized algorithms as well as pre-established corporate guidelines and parameters in their decision-making. There is a belief by some that your initial offer may be evaluated by a computer applying predetermined standards rather than being reviewed or considered by an employee on the lender’s staff. If your offer meets the established criteria, it will probably be accepted. If not, it will be rejected. Lender response times to offers on foreclosed properties vary from 30 minutes to several days. This is far more timely than short sale responses as we shall see.

Knowing that lenders are working according to structured guidelines can potentially be beneficial for buyers who can identify the lender’s pattern with regard to pricing. As a hypothetical example, a lender may establish the initial asking price based on one or more appraisals and broker price opinions. Their practice may be to leave the initial list price unchanged for 30 days and then start reducing the price by $10,000 every two to three weeks. The buyer can ask the real estate broker who is representing them in the transaction to research the pricing history of a property. By noting whether a price reduction has just occurred or whether another reduction is about to be made, the buyer can get a feel for what a successful offer price might be.

Having said this, do not expect that you will be able to purchase a foreclosed property for 50 percent of its list price. Looking at all of the foreclosed properties that were sold on Hatteras Island during 2008, the ratios of the selling prices to the list prices ranged from 78 percent to 102 percent with more than half of the sales falling between 95 percent and 100 percent .

There is no doubt that foreclosed properties can represent very attractive values under certain circumstances. However, buyers need to be prepared for what they will find when they look at foreclosed homes. In most instances, the property will not be furnished, and it may not have any appliances. There may be wires sticking out of the walls where televisions and speakers were once connected, and the property may be in worse physical condition than most non-foreclosed properties. A comprehensive inspection by a licensed home inspector is recommended, but you should be aware that it is common for lenders to state that they will not make any repairs. The inspection may sometimes have to be made without any water or electrical service to the property.

Another aspect of a foreclosure transaction is that once an agreement has been reached on the selling price, the lender will generally require the buyer to sign an addendum to the contract, which is written almost exclusively to benefit the lender. Typical provisions of the addendum might include items that make contract dates non-negotiable, monetary penalties for failing to close on the specified date, and statements absolving the lender from responsibility for any property defects that might be discovered. Changes to the addendum usually cannot be made by the buyer.

A few other things to know about the process of purchasing a foreclosed property include a requirement for the buyer to submit a loan pre-qualification or pre-approval letter with the initial offer. Surveys, rental histories, and other property specific documents may not be available, and customary contingencies other than financing are unlikely to be accepted.

Buying A Short Sale Property

In contrast to a foreclosed property, the purchase of a short sale generally involves much more uncertainty. Obtaining agreement between the buyer and the seller is just the first step in what can be a lengthy and sometimes challenging negotiation. One of the reasons is that there are potentially so many cooks in the kitchen. Depending on the circumstances, there could be a mortgage servicer, a first lien holder, a second lien holder, and a private mortgage insurance company, all of whom may have to approve the transaction or waive all or a portion of their financial interest. It is important to recognize that the lender is under no obligation to accept a short sale.

While an offer to purchase a foreclosed property may be negotiated in a matter of days and closing will usually occur within 30 days of contract acceptance, buyers should expect to wait a month or more for the lender’s initial review, approval, or disapproval of their offer. Some transactions move more rapidly, but 30 days or more is a common norm. The presence of more than one lien holder can complicate the short sale process and may diminish the probability of a successful conclusion to the negotiations.

Short sales can also have more loose ends than foreclosures. For example, when a buyer makes an offer on a bank-owned property, they can be fairly certain that the title is clear, i.e., all liens have been satisfied. A short sale is in many ways a pre-foreclosure transaction. During the course of the sale, the owner may declare bankruptcy as a way to delay or avoid foreclosure, or the property may actually enter the foreclosure process -- possible situations which should be monitored by the real estate brokers in the transaction. If the closing of the short sale does not take place before the completion of the foreclosure proceeding, the seller will lose all rights and interest in the property, and the contract will become void.

A short sale can also be complicated by the requirement that in order for a short sale to be approved by the lender, the seller must have a valid financial hardship that is responsible for their inability to pay their mortgage, and the borrower must either be in or headed for foreclosure. The fact that the homeowner owes more on the property than the home or lot is currently worth may not in and of itself qualify the transaction as a short sale in the absence of a financial hardship. It may just have been an investment that did not work out as planned for the seller. The tricky part is that the “rules” that lenders follow when considering short sales are not as clear cut as those associated with foreclosures, and the rules change frequently. The good news is that the trend is toward lenders approving more short sales, and organizations like Fannie Mae that back a significant number of mortgages across the country are encouraging their mortgage servicers to be more receptive to short sales.

Some of the positive aspects of a short sale include the observation that these properties are typically in better condition than foreclosures. These homes are furnished, and they are often in an active rental program.

While many lenders want to see a short sale property listed at fair market value for up to three months before a price reduction is made, the seller controls the price reduction process. The lender, however, controls the ultimate approval. During 2008, the selling prices for short sales ranged from 73.7 percent to 97.4 percent of the list prices of the properties with the majority exceeding 94 percent - not too different from the selling prices of foreclosed homes.

Because of the uncertainties associated with the approval of short sale offers, buyers should not order home inspections or authorize appraisals to be completed until lender agreement on the price and the terms of sale has been obtained.

To foster a better understanding of the short sale process together with the rights and obligations of the various parties, the North Carolina Association of Realtors has recently developed a Short Sale Addendum to accompany all offers on short sale properties.

Wow! We have really covered some territory in this article haven’t we? I think that when all is said and done, an objective observer would conclude that there are certainly good opportunities for buyers in both foreclosures and short sales. However, they are not plain vanilla transactions. Buyers and their agents need to enter the buying process with realistic expectations, and they should apply an extra measure of due diligence at each step from initial exploration of the market through closing. They should also be clear about the true cost of the property if furniture and appliances have to be purchased, and repairs have to be made.

When you combine the values to be found in bank-owned and short sale properties with today’s historically low interest rates, it may be just the right combination that will pave the way to turning your dream of owning a place at the beach into reality.

(Tom Hranicka is an associate broker with Outer Beaches Realty. Questions, comments, or suggestions for future articles may be sent to Tom Hranicka at P.O. Box 237, Avon, NC 27915, or e-mail to hranicka@hatterasisland.com )

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