John M. Lee: Profiting from Short Sales

As the unemployment rate continues to increase in California and more homeowners are strategically walking away from their properties, I am getting many questions on how to purchase these properties. The thought is that distressed properties will sell at a discount, and thus buyers think they can profit more from such a transaction. In some cases, that is true, but in others disaster awaits on the other side of the door. You must be careful when contemplating such a purchase.

Foreclosure is a process that allows a lender to recover the amount owed on a property in the event that the borrower defaults on the loan. Typically, the lender will try to work with the owner to come up with a repayment plan if at all possible because the banks do not want the properties back.

However, if a borrower is 90-days late, the lender will start the foreclosure process by recording a Notice of Default on the property. This gives public notice that the borrower is delinquent and that unless they make good on the loan payments, the lender will do what it can legally to recover what is owed, including principal, back interest, late charges and legal fees.

Once the foreclosure process is initialized, it can end in one of four ways:

1) The borrower can reinstate the loan by paying off the default amount during the grace period;

2) The borrower can sell the property to someone else and pay off the loan and other charges;

3) The bank files for a Trustee Sale and, at an auction, sells the property;

4) The bank completes the foreclosure and takes ownership of the property.

During each of these stages, there are opportunities to create a win-win situation for both buyers and sellers.

Initially, during the foreclosure period the buyer and seller can come to an agreement whereby the buyer will pay the seller a certain amount of money and assume the balance of the loan. The buyer can then apply to the bank and get approved. Both parties can benefit because the buyer gets the house, and the seller avoids foreclosure.

In the event that the seller owes the lender(s) more money than the home is worth, they can apply with the lender(s) for a short sale, meaning the banks will accept a lesser amount than the mortgage owed on the property. Please keep in mind that this is a long drawn-out process and sometimes the transaction never closes.

If a trustee sale occurs, a buyer may purchase the home at an auction sale, which is usually held in a public place, such as the front steps at City Hall. The bidding process occurs quickly, and buyers must purchase the property on the spot for all cash. The disadvantage of this type of transaction is that most of the properties are bought "site unseen," which often comes with its own problems, such as massive deferred maintenance, tenant issues and/or owners refusing to vacate. Because of these potential headaches, the number of buyers is limited, presenting an opportunity for those willing to take a risk.

Once the foreclosure occurs, the bank becomes the owner of the property. Normally, the tenants will be evicted so the title will be clear and cosmetic touch-up work can be completed before putting the property on the market through a local agent and the Multiple Listing Service (MLS).

There are different opportunities for buyers of foreclosure properties along each step of the way. The most difficult parts are identifying and contacting the parties involved and negotiating the transaction because there are strong emotions involved when a homeowner is losing his or her home. There are also pitfalls and unforeseen problems along the way. But, with persistence and some experience, foreclosures can be, and have been, a way to riches for some investors.

John M. Lee is a top broker with Pacific Union specializing in the Richmond and Sunset districts. If you have any questions about real estate, call him at (415) 447-6231 or send an e-mail to johnlee@isellsf.com.