Short Sales: Hurting Values Overall?

Yesterday I featured homes that are currently on the market as short sales in my House Hunt column.

Short sales are becoming a bigger part of our market with each passing day. I follow the foreclosure auction and it’s striking how often foreclosures are postponed, particularly if there is a chance the home will sell as a short sale. This is a big difference from a year or two ago when foreclosure auctions were much more common.

Let me back up, just to make sure I’m not leaving anyone wondering: What is a short sale? It’s such an everyday part of my vocabulary I assume that’s true for everyone else. But I took a test, and asked my mother-in-law, “what is a short sale?” She said, “I’ve heard of those. Do you know?” Well, yes, I do. First of all, it’s misnamed: a short sale is not a quick sale; that’s a common misconception. Quite the opposite: the short sale is a long process.  

When a property is listed as a short sale, it means that the owner owes more to the bank than the house is worth -- and that the owner doesn’t have the money to make up the difference after the sale. The owner is asking the bank to “forgive” part of the loan.

Banks don’t want to own real estate, so the bank may agree to this in order to avoid the expensive foreclosure process.  

The short sale process is lengthy because once a bank (or banks because there is often more than one loan involved) is approached with an offer, it needs to research the value of the home, and the assets and hardship situation for the seller. Typically, this will take about three months, occasionally less time and quite often much longer. One agent in my office just had two short sales close that took more than a year. 

The short sale is intended to help out the homeowner who bought at the wrong time and has since lost a job or suffered a similar hardship. While I'm glad there is an avenue that is helpful for underwater homeowners, I worry that short sales are hurting our home values overall. These sales are distressed, and as such, they are not selling for the highest possible prices.

In general (there are many wonderful exceptions), short sales are not aggressively marketed, are often hard to show, are almost never staged -- in short, no one is bending over backward to achieve top dollar. Which is understandable -- the homeowner is already losing money, I don’t fault them.

Put yourself in their shoes. They may not want to sell their home, but it's the alternative to losing it to the bank. By definition, they've endured a hardship of some kind that put them in this position. And of course it's hard for them to get excited about showings. My heart goes out to them.

But when I show a short sale and I’m stepping over dirty underwear and socks in the teenager’s bedroom; well ... the house may not be staged, but this is quite the opposite.

What happens when a buyer steps over dirty teenage underwear to view a home? It’s really hard for most buyers to see the house and its potential with distractions like that. If there is interest, they are going to expect a large discount for the perceived condition of the home (the underwear does not come with the house, so in theory should not adversely affect the value), and for the hassle of the short sale process.

“Fifty percent of homeowners in America may go through a short sale before this is over.” That statement caught my attention. The speaker was a lender who was pointing out that the short sale creates a domino effect, lowering home values so that the next house is underwater.

In other words, if your neighbor has to market their home as a short sale, chances are they will sell for less than market value. But that sale will be the new definition of market value -- once it becomes a sale, it’s a comp.

There is something new in the lending world that may help some of these underwater homeowners. Imagine that your house is worth $500,000 but you bought it for $700,000, and your loan is $540,000. Maybe your interest rate is 6%, and if only you could refinance at today's wonderful low rates, that would be enough to save the day. But, ironically, even the same bank that holds your loan has not been able to refinance since the house would not appraise for the loan amount plus 20%.

The good news is (and check with your favorite lender, there is a lot of fine print), now that refinance can happen with no regard to the appraisal.

I was delighted to hear this new change, and I'll have more information on it in this column soon. I will illuminate the fine print.

Short sales so far this year compared to last year:

• In San Ramon, pretty steady (about 25% of the total sales both years)
• In Danville, up a few points this year (16% from 13.5%)
• In Alamo, the biggest change: up from 10% last year to nearly 15% this year.

Sellers opt to do a short sale to avoid the more detrimental credit hits associated with a foreclosure. However, sellers should be very cautious in taking this step, and consult with an attorney and/or a CPA about the tax ramifications and potential for a deficiency judgment as every case is different.

For buyers, the short sale pricing is very attractive, but keep in mind that the price is not necessarily a reflection of what the bank will accept. It isn’t until there is an offer on the table that the bank will evaluate, examine the hardship letter and evidence, inspect the seller’s financial situation and then make a decision.  

For an investor hoping to get a good deal, this process may be worthwhile. For a buyer looking for a home to live in, this process is often unbearable.   It’s not just waiting with anticipation, it’s often waiting for something that won’t happen. If the banks can’t come to an agreement, the process could end with a foreclosure and the home may become bank-owned.

All short sales are not created equal. An “approved” short sale usually refers to a sale that had an offer, but by the time the bank returned with an agreement, the buyer was no longer in the picture. This is fairly common with the long process. In this situation, the process will be swift (swifter anyway) with the next offer: the bank has already done the time-consuming work.

If you decide to go after a short sale, find out how many banks are involved and how short the sale will actually take. The fewer banks and the smaller the loss, the more likely it will be to happen. Then, have patience -- the quickest short sale is still a long process!